The paradox of productivity and welfare: The role of institutional markdown

The connection between total factor productivity (TFP) growth and overall welfare has traditionally been regarded as positive. However, limited attention has been given to the fact that certain components of TFP growth may, in fact, have a detrimental impact on welfare. By incorporating markdowns into the decomposition model of revenue-based TFP growth, we identify three key components: the markdown effect, which captures the deviation of sectoral average markdown from unity; the reallocation effect, which reflects variations in markdowns across firms; and the technical effect, which represents physical TFP. Using firm-level data from China from 2000 to 2007, we derive several empirical insights. First, the markdown on labor has been decreasing, but this trend came to a halt after 2004—primarily due to a reduction in institutional power, rather than shifts in market power or the effects of the Lewis turning point. Second, markdowns contribute to approximately one-third of TFP growth, surpassing the impact of the reallocation effect in 2007. Additionally, the welfare loss due to markdowns accounted for 5.65% of total value added in 2007. Finally, using the reallocation effect as a reference, we assess the potential for a domestic Flying Geese pattern across regions. This study advances the theoretical discourse on markdowns and their implications for the productivity-welfare relationship, shedding new light on the complex interactions between distortions, firm dynamics, and economic welfare.