How do institutions a§ect resource misallocation? This paper focuses on a particular
class of institutions, namely property rights, and their relation to extortion.
Motivated by empirical evidence that there are di§erences in extortion rates across
establishments, both within and across countries, I examine whether extortion is an
important channel for understanding resource misallocation. I construct a model in
which agents choose between entrepreneurship and working, and where a criminal group
can extort entrepreneur capital. While property rights are common across agents, extortion
rates arise endogenously as an inverted ëuíshape in agentís ability. In economies
characterized by weak property rights, extortion is prevalent and resource misallocation
can generate TFP and output losses of 10 and 30 percent. TFP and output losses
arise from two channels: selection and misallocation. Extortion a§ects selection by
altering the ability threshold required for entry into entrepreneurship, while misallocation
occurs because entrepreneurs operate below the optimal scale. As property
rights decrease, extortion rates are higher and TFP and output losses from selection
and misallocation are magniÖed.