Economic Reforms and the Evolution of China's TFP

Over the past 20 years, China has experienced one of the most remarkable growth episodes in modern economic history which has been largely fueled by growth in total factor productivity (TFP). This rise followed major economic reforms that reduced barriers to entry on private businesses. China has since transitioned from a predominantly state-run to a mixed economy of both private and state sectors. In this paper, I develop a model to investigate the extent to which economic reforms can quantitatively explain China's TFP growth. I model two sectors whose main difference is access to financial markets: the private sector faces financial frictions while the state sector does not. The model endogenously generates persistently higher TFP in the private sector than in the state sector via a selection mechanism. In the private sector, only the most productive businesses can overcome the financial frictions. In the state sector, businesses at both low and high productivity levels are able to obtain the necessary financing to operate. As a result, differences in the composition of sector-level productivities arise: the private sector has a higher fraction of productive businesses relative to the state sector. Reforms initiate aggregate TFP growth through the reallocation of factor inputs towards the productive private businesses. The quantitative analysis accounts for 25 percent of China's TFP growth since the 1992 economic reforms.