Modeling Technological Progress and Investment in China: Some Caveats

Since the early 1990s, the number of papers estimating econometric models and using other quantitative techniques to try to understand different aspects of the Chinese economy has mushroomed. A common feature of some of these studies is the use of neoclassical theory as the underpinning for the empirical implementations. It is often assumed that factor markets are competitive, that firms are profit maximizers, and that these firms respond to the same incentives that firms in market economies do. Many researchers find that the Chinese economy can be well explained using the tools of neoclassical theory. In this paper, we (1) review two examples of estimation of the rate of technical progress, and (2) discuss one attempt at modeling investment. We identify their shortcomings and the problems with the alleged policy implications derived. We show that econometric estimation of neoclassical models may result in apparently sensible results for misinformed reasons. We conclude that modeling the Chinese economy requires a deeper understanding of its inner workings as both a transitional and a developing economy.