Policy and Misallocation

Abstract

This paper investigates the effect of industrial policies on resource misallocation using a rich data-set of Chinese firms. Using a difference-in-di¤erence approach, we provide evidence that government policies favoring particular industries lead to increased resource misallocation (i.e., an increase in the dispersion of revenue productivity across firms in four-digit industries). Moreover, the differential changes between supported and not supported industries are quantitatively large and indicative of a substantial negative impact on aggregate TFP. Using a changes-in-changes model, we find evidence that the Five Year Plan had a positive and significant e¤ect for most of the TFPR distribution while the effect was negative for the lowest quintile of TFPQ and positive for the highest TFPQ quintile. Our results suggest increased misallocation is related to the way in which the Chinese government doled out support through the increase of subsidies and the improvement of credit conditions for a subset of firms.