Barriers to Entry and Regional Economic Growth in China

China’s economic growth has been the subject of much study. In 1978, China began its remarkable economic transformation and fully realized this boom with its incredible growth rates in the late 1990s. But what drove this growth post-1995, and why is it slowing down today?

Loren Brandt, Professor of Economics and Noranda Chair in Economics and International Trade at the University of Toronto and Research Fellow at the Institute for the Study of Labor in Bonn, Germany finds that productivity is directly linked to entrepreneurship and the growth of new firms in China. In China, many industries are controlled through state-owned enterprises (SOEs), but since China’s opening up a healthy private sector has developed. Brandt finds that from 1995 to 2004, new firms accounted for 60 to 65 percent of China’s booming productivity rates, leading to increased wages and value added per worker.

Brandt and his co-authors developed an analytic model of firm entry, hoping to understand “firm wedges”: the probability that a new firm is allowedentry into the market through licensing from the sub-provincial, or prefectural, authorities. Entrepreneurs thus need to find it profitable to enter the market, and they must receive explicit permission. This wedge, Brandt contends, is more prominent in areas in with SOE presence is large; it is harder for new firms to enter the market when the state controls much of the business in a given prefecture.

The entry of new firms into the market allowed for a wonderful boon and created a convergence of prefectural allocations: in 1995, prefectures had staggeringly different levels of productivity, but by 2004 they had converged to fairly equal levels due to new firms. However, after 2007, new firms added almost no productivity to the Chinese economy. Brandt hopes to extend his work to understand these effects, especially in the context of the Great Recession. Has the firm entry process changed?

Brandt’s talk today was a presentation coming from research for a forthcoming paper with Gueorgui Kamborouv and Kjetil Storesletten. If you’re interested in looking at more of his research, you can find some of his projects here.

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