Picking Losers: How Career Incentives Undermine Industrial Policy in Chinese Cities

Rapid economic growth in China with considerable market intervention has led to renewed interest in the efficacy of industrial policy. Have industrial policies helped Chinese firms overcome market failures and boosted productivity, or have they distorted markets and undermined creative destruction? This paper explores these questions in the specific context of local implementation by studying the targeting of financial favors and the relationship of such targeting to local political incentives. Using unique and largely unexplored quasi-census firm-level data from annual tax surveys in China from 2007 to 2015, this paper demonstrates that financial favors disproportionately target loss-making, larger, older, and less productive firms. It then argues that short-term career incentives facing local officials explain this sub-optimal targeting, showing that promotion likelihood for city leaders increases with higher levels of ‘excess’ financial favors to firms, particularly when these favors are provided to loss-making firms. Finally, the paper estimates costs to the Chinese economy from misallocated financial support by showing that financial favors are associated with lower levels of firm entry and lower productivity growth. The paper contributes to the literature on industrial policy, political incentives, and misallocation, and has important implications for China’s future growth and transition.