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Provincial Trade, Financial Friction and Misallocation in China

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  • Kwon, Ohyun

    (School of Economics)

  • Fleisher, Belton

    (Department of Economics)

  • McGuire, William

    (Department of Economics)

  • Zhao, Min Qiang

    (The Wang Yanan Institute for Studies in Economics)

Abstract

We study the implications of financial-market imperfections on labor and capital misallocation in China. Financial friction stems from private sectors’ credit constraints that limit the efficient use of capital relative to state firms. Our model can jointly explain labor flows out of and capital flows into Chinese provinces with high capital market distortion. To formally test our model hypotheses, we develop a measure of regional financial friction based on our model such that underlying financial friction can be inferred from differences-in-differences in the market shares of private and state sectors and their marginal rental rates of capital. Our regression results confirm that our measure of financial friction has robust power in explaining interprovincial capital and labor flows. Our structural analysis shows that improving financial frictions results in an aggregate 3.9% welfare gain in China that is rather heterogeneously distributed across provinces.

Suggested Citation

  • Kwon, Ohyun & Fleisher, Belton & McGuire, William & Zhao, Min Qiang, 2020. "Provincial Trade, Financial Friction and Misallocation in China," School of Economics Working Paper Series 2020-1, LeBow College of Business, Drexel University.
    • Handle: RePEc:ris:drxlwp:2020_001
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    More about this item

    Keywords

    financial friction; regional capital flows; Chinese economy;
    All these keywords.

    JEL classification:

    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • F22 - International Economics - - International Factor Movements and International Business - - - International Migration
    • O15 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Economic Development: Human Resources; Human Development; Income Distribution; Migration
    • P23 - Political Economy and Comparative Economic Systems - - Socialist and Transition Economies - - - Factor and Product Markets; Industry Studies; Population
    • R13 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - General Regional Economics - - - General Equilibrium and Welfare Economic Analysis of Regional Economies

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