Credit Allocation under Economic Stimulus: Evidence from China

Abstract

We study credit allocation across firms in developing economies with severe financial frictions. We illustrate the effects of financial frictions on credit allocation in a dynamic setting, and find that credit expansions during recessions can slow down or even reverse the gradual reallocation of resources from low to high productivity firms. We test the model empirically using China’s economic stimulus plan introduced in 2008, which triggered an unprecedented policy-driven credit expansion. Using private firm-level data we show that new credit was allocated disproportionately more towards state-owned, low-productivity firms than to privately-owned, high-productivity firms, with significant impact on the real economy.