Abstract
This paper investigates the impact of government subsidies on the firm-level markups and its mechanism of action by measuring the firm-level markups based on a micro dataset of Chinese manufacturing firms from 2000 to 2007. The findings suggest that government subsidies significantly reduce the markups of Chinese firms. Moreover, there is significant heterogeneity in the negative impact of government subsidies among different types of firms. Furthermore, analysis of the impact mechanism based on the mediation effect model shows that the increase in rent-seeking cost is an important way for government subsidies to reduce the firm-level markups. Finally, based on the dynamic decomposition of the aggregate markup of the Chinese manufacturing industry, it is found that government subsidies significantly reduce the industry-level aggregate markup through within-firm and cross-firm effects. This study enriches the literature on government subsidies and markups, and provides a new perspective for understanding the micro-performance of government subsidies.
Highlights
As a traditional and widely used industrial policy, government subsidies are an important factor in promoting economic development
Based on the dynamic decomposition of the changes in the aggregate markup of the Chinese manufacturing industry according to the decomposition method proposed by Melitz and Polanec [6], this paper examines the relationship between government subsidies and the changes in the aggregate markup at the industry level
By comparing the estimation results in columns (1) and (3), it is clear that the estimated coefficient on subsidy remains negative, but not significantly, after inclusion of the mediator, Cost. This suggests that the increase in rent-seeking cost is an important way for government subsidies to affect firm-level markups
Summary
As a traditional and widely used industrial policy, government subsidies are an important factor in promoting economic development. Many developing countries often support economic growth and industrial upgrading through interventions, such as government subsidies, at the economic take-off stage [1]. Since the fiscal decentralization reform in 1994, Chinese local governments have gained clear local benefits (i.e., local taxes). This has granted high autonomy in resource allocation to local governments. It is generally believed that government subsidies to firms have played an important role in promoting investment and economic growth, adjusting the industrial structure, guiding economic trends, maintaining social stability, and creating employment opportunities [2]. It is important to evaluate the effect of subsidies reasonably and scientifically from multiple angles
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