Private Debt, Public Debt, and Capital Misallocation

Abstract The aim of this article is to determine whether increases in private and public indebtedness affect capital misallocation, which is measured as the dispersion in capital returns across firms in different industries. This aim is achieved by using a dataset containing industry-level data for 18 European countries and controlling for macroeconomic indicators representing potential determinants of capital misallocation. The within-country variation across industries regarding indicators such as external finance dependence, technological intensity, credit constraints and competitive structure is used to find that private debt accumulation disproportionately increases capital misallocation in industries with higher financial dependence, higher R&D intensity, a larger share of credit-constrained firms and a lower level of competition. On the other hand, there are no significant and robust effects of public debt on capital misallocation found within the country–sector pairs in the sample.