Heterogeneous Firm Dynamics, Finance Constraints, and Misallocation in Nigeria’s Manufacturing Sector

Capital misallocation, whereby financial resources are not channelled to their highest-productivity uses due to market frictions and financial constraints, represents a major source of aggregate total factor productivity loss in developing economies, yet its magnitude and determinants in Nigeria's manufacturing sector remain unmeasured. This study applies the theoretical framework of heterogeneous firm dynamics and capital misallocation to estimate the productivity cost of financial constraints in Nigerian manufacturing and identify the institutional and financial system mechanisms through which misallocation operates. The theoretical contribution is an extension of the Hsieh-Klenow misallocation model that incorporates endogenous financial constraint severity as a function of firm-level governance quality, collateral availability, and relationship banking intensity. The empirical application uses the National Bureau of Statistics Manufacturing Sector Survey data and the World Bank Enterprise Survey for Nigeria from 2019 to 2023, combined with financial statement data from publicly registered manufacturers. The study employs the structural methodology of Hsieh and Klenow to decompose aggregate productivity gaps into within-sector misallocation components and tests whether financial constraint proxies predict the dispersion of revenue total factor productivity within industries. A counterfactual analysis estimates the aggregate total factor productivity gain achievable if financial constraints were reduced to comparator economy levels. The theoretical framework integrates heterogeneous firm models, misallocation theory, and the financial development-allocative efficiency literature. The PhD-level contribution lies in the theoretical extension of the Hsieh-Klenow model to incorporate endogenous financial constraints, the novel application to Nigerian manufacturing using multiple data sources, and the policy-relevant counterfactual simulations. Findings carry major implications for the Bank of Industry's lending strategy and for Nigeria's industrial policy framework. Keywords: capital misallocation, firm heterogeneity, financial constraints, Nigeria, manufacturing productivity