Covid‐19 pandemic and its impact on capital and output distortions: Evidence from China

Based on Harrold's neutral technological progress production function, this paper studies the impact of Covid‐19 on output distortion and capital mismatch of China's A‐share listed firms in 2006–2022. It also identifies the ‘positive transmission’ and ‘backward forcing’ mechanisms of this impact effect. The empirical results suggest that there existed positive output distortion and negative capital allocation distortion and the pandemic is found to have exacerbated such distortions, especially in the manufacturing and services industries, the central and eastern regions, high‐tech industries and private firms. In the ‘positive transmission’ mechanism, reducing capital cost and improving technological progress are found to have restrained the distortions induced by the pandemic. In the ‘backward forcing’ mechanism, reducing product price is found to have reduced the distortions, but promoting market share competition is only found to have mitigated output distortion. There is heterogeneity in the efficiency of the transmission mechanisms between industries, regions, technological industry and ownership types. This study provides a solid theoretical basis and empirical evidence guiding central and regional authorities on how to alleviate resource allocation distortions and improve firm performance in response to an unexpected external shock such as the Covid‐19 pandemic.