A Structural Estimation on Capital Market Distortions in Chinese Manufacturing

Capital market distortions lower aggregate productive efficiency by misallocating re- sources. The existing literature infers such distortions from the dispersion of the average revenue product of capital. However, the methodology is subject to a set of identification issues: unobserved heterogeneities in production technology and market power; capital ad- justment costs with idiosyncratic shocks; and measurement errors in the data. This paper develops a structural econometric approach of estimating capital market distortions in en- vironments where all the above factors can be present. Using representative firm-level data from Chinese manufacturing from 2004 to 2007, we find that capital market distortions imply aggregate revenue losses of 40 percent. We also estimate distortions for U.S. manu- facturing firms in Compustat. Improving capital allocation e¢ ciency to the level observed among the Compustat firms would increase China's manufacturing revenue by 31 percent. Finally, we propose a simplified approach, which addresses the identification issues in a much more tractable way.