This paper investigates the impact of firm-level policy distortions on aggregate economic outcomes, focusing on the covariance between firm size and productivity. The authors use a harmonized firm-level database covering multiple countries to analyze the within-industry covariance between size and productivity, which varies significantly across countries and is influenced by idiosyncratic distortions. They develop a model that incorporates heterogeneous firms facing adjustment frictions and idiosyncratic distortions, calibrating it to match observed cross-country patterns. The model helps explain the observed differences in aggregate performance and highlights the role of distortions in resource allocation and firm selection. The paper also examines the impact of misallocation distortions on key economic outcomes and their potential to account for cross-country differences in productivity dispersion.This paper investigates the impact of firm-level policy distortions on aggregate economic outcomes, focusing on the covariance between firm size and productivity. The authors use a harmonized firm-level database covering multiple countries to analyze the within-industry covariance between size and productivity, which varies significantly across countries and is influenced by idiosyncratic distortions. They develop a model that incorporates heterogeneous firms facing adjustment frictions and idiosyncratic distortions, calibrating it to match observed cross-country patterns. The model helps explain the observed differences in aggregate performance and highlights the role of distortions in resource allocation and firm selection. The paper also examines the impact of misallocation distortions on key economic outcomes and their potential to account for cross-country differences in productivity dispersion.