Physical vs. institutional public goods provision: Evidence from China

This paper argues that political and market concentration levels explain why developing economies often underinvest in institutional infrastructure and legal capacity. Economic growth challenges this equilibrium, incentivizing rulers to invest in institutional infrastructure complementary to physical infrastructure. Rulers jointly invest to expand market entry and size only if they can secure higher rents and preserve institutions favoring concentration. The theoretical model predicts that physical infrastructure investment grows faster than institutional investment as market concentration rises. Using provincial coal reserve shares as an instrument for market concentration, a difference-in-differences analysis of Chinese data from 1997 to 2006 shows that the fiscal expenditure ratio of physical to institutional infrastructure increased 78% faster in provinces within the top market concentration quartile in 2000—the year before China joined the WTO.