Do Larger Cities Eliminate More Low-Productivity Firms? Evidence from Infrastructure Construction in China

Abstract

This paper re-investigates whether larger cities eliminate more low-productivity firms, the so-called firm selection hypothesis. We exploit a huge boom in infrastructure construction in China during 1998- 2007. We find that firm selection is quite apparent when we compare large cities to small cities which are not connected by controlled-access highways; however, firm selection disappears once we compare large cities to small ones which are connected by highways. This result suggests that market size is dictated less by geography (city boundaries), but rather by transportation costs. The estimated effects of firm selection are robust to the potential endogeneity of highway construction. Moreover, evidence for firm selection is generally absent in inland provinces, perhaps because the market economy was relatively poorly developed in those areas during our study period.