Does industrial clustering mitigate the sensitivity of firm relocation to tax differentials? The role of financing

Abstract

This paper tests the impact of agglomeration forces on the sensitivity of firm relocation to tax differentials and examines the financing effects of clustering. Using data from the Annual Survey of Chinese Industrial Firms, we provide evidence that local tax differentials are positively associated with the probability of local firms’ migration, but this relationship is attenuated in counties with higher levels of industrial clustering. Further analysis shows that the effect of industrial clustering is stronger in regions with less efficient financial markets. These findings support the theoretical prediction that agglomeration economies can reduce the effects of tax differentials on firm relocation by providing alternative sources of financing.