Barriers to Entry and Regional Economic Growth in China

Judith and Marshall Meyer Lectures on China’s Economy

Loren Brandt, Professor of Economics, University of Toronto

| Perelman Center for Political Science & Economics, Rm 100, 133 S. 36th St.

The non-state manufacturing sector has been the engine of China's economic transformation. Up through the mid-1990s, the sector exhibited large regional differences; subsequently we observe rapid convergence in terms of new firm start-up rates, productivity, and wages. To analyze the drivers of this behavior, we construct a model of new firm behavior that incorporates location-specific capital market imperfections, taxes/subsidies, and a novel entry barrier. Using Chinese Industry Census data for 1995, 2004, and 2008, we estimate these frictions and examine their role in explaining differences in performance across prefectures and over time. Entry barriers turn out to be the salient friction for explaining performance differences. We investigate the empirical covariates of these entry barriers and find that barriers are causally related to the size of the state sector. A simple theoretical model helps rationalize the links. Thus, the downsizing of the state sector after the mid-1990s appears important in explaining the rapid regional convergence and manufacturing growth between 1995 and 2008. The resurgence of the state sector and rising entry barriers after 2008 may be having the exact opposite effects, and contributing to a marked slow down in growth.