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It is well known that south-east Europe is the least developed area in Europe. Using a methodology based on the idea of heterogeneous firms, this paper studies the degree to which firm heterogeneity and resource misallocation can explain the lower TFP in south-east Europe. The results show a significant degree of heterogeneity and resource misallocation, although the results are sensitive to the calibration used. There is evidence that firm-level productivity depends on firm size, while taxation negatively influences it. There is also some evidence that foreign-owned firms are more competitive, as are exporting firms. Results are generally robust across the various specifications used, but less so relative to the measure of productivity used. Additional evidence suggests that infrastructure-related obstacles as well as institutional instability drive the output distortion, while no factor is underlined as a significant driver of capital distortions, suggesting the need for better data sources for the latter.