2.1.Theoreticalmodel
ThetheoreticalframeworkofthispaperistheHsiehandKlenow(2009)modelofmonopolisticcompetitionwithheteroge-neousfirmsbasedontheMelitz(2003)closedeconomymodel.Thisframeworkallowsestimatingextenttowhichdistortionsaffectmarginalproductsofinputs(bothcapitalandlabor)acrossfirmswithinindustries,thus,loweringtheaggregatetotalfactorproductivity.Intheabsenceofdistortions,therevenueproductivityoffirmswithinindustriesshouldbeequalizedasthealloca-tiveefficiencyconceptpredicts,soitsvariationisconsideredasameasureofdistortion-drivenresourcemisallocationamongfirms.ThebasicsetupoftheHsiehandKlenow(2009)modelisthefollowing.Theeconomyconsistsofanumberofheterogeneousmanufacturingfirms,whichoperateatthemonopolisticcompetitionmarket.Allofthesefirmsdiffernotonlybyproductivity,butalsobybothoutputandthecapitaldistortionstheyface.AsinglefinalgoodisproducedbyarepresentativefirmandcombinestheoutputofSmanufacturingindustriesusingtheCobb–Douglasproductiontechnology.Eachfirmfacesaprofitmaximizationproblem,whichyieldsanoutputpriceasafixedmarkupoverthemarginalcost.IndustryoutputisaCESaggregateofMdiffer-entiatedgoodswiththecorrespondingCobb–DouglassproductionfunctionofTFP,capitalandlabor.Inputssharesdifferacrossindustries,butareequalforthefirmswithinasingleindustry.Thefirstpartofmymethodology,whichdirectlyarisesfromtheHsiehandKlenow(2009)framework,aimstoanswerthefirstsub-questionaboutthepotentialgainsofachievingallocativeefficiencyintheUkrainianeconomy.ItconsistsoftheTFPcal-culation,aggregationandpotentialgainsevaluationprocedurederivedfromtheHsieh–Klenowmodel.TheprocessofcalculatingandaggregatingTFPfollowsthreemainsteps:(i)firm-levelTFP;(ii)industry-levelTFP,and(iii)aggregatemanufacturingTFP.Thefirststepofthisframeworkisthecalculationofoutputandcapitaldistortions.Outputdistortionsaredefinedasthosewhichmovecapital-laborratiointhesamedirectionandcalculatedasaratioofactuallaborcompensationrelativetotheoptimallevel(asashareoflaborinvalueaddedpredicts):