Factor Market Distortions Across Time, Space and Sectors in China

Abstract

In this paper, we measure TFP losses in China's non-agricultural economy associated with labor and capital mis-allocation across provinces and sectors between 1985 and 2007. We also decompose the overall loss into factor market distortions within provinces (between state and non-state sectors) and distortions between provinces (within sectors). Over the entire period, mis-allocation lowers aggregate non-agricultural TFP by an average of twenty percent. However, after initially declining, these losses increased appreciably beginning in the mid-1990s. This reversal can be attributed almost exclusively to increasing mis-allocation of capital between state and non-state sectors within provinces, while losses from between province mis-allocation remained fairly constant. We argue that the recent increase in capital market distortions is related to government policies that encourage investments in the state sector at the expense of investments in the more productive non-state sector.