Adjustment Costs, Financial Constraints and the Persistence of Misallocation in China

Using firm level data on all Chinese publicly traded manufacturing firms in the years 2000-2013, this paper documents the presence of misallocation in the Chinese economy. We develop a dynamic investment model with financing... [ view full abstract ]

Using firm level data on all Chinese publicly traded manufacturing firms in the years 2000-2013, this paper documents the presence of misallocation in the Chinese economy. We develop a dynamic investment model with financing decisions in the presence of financial constraints and adjustment costs, where lenders discriminate among firms according to their ownership. Using the firm level data, we estimate the structural parameters of the model which is able to generate dispersion in TFPR that closely matches the data. The framework is used to explore a counterfactual analysis comparing the levels of aggregate productivity to the efficient level when adjustment costs are removed. We find that 35% of the misallocation generated by the model in baseline economy disappears without the presence of such costs.