Endowment Structure, Industry dynamics and Vertical Production Structure in China-Theory and Evidence

This paper proposes a theoretical model and shows that the comparative advantage of China’s factor endowment allows firms specializing in the midstream stage to gain at least as much as firms that specialize in the two ends of the supply chain (capital-intensive stage and labour-intensive stage) in terms of labour productivity and profitability, if and only if they have at least as much viability and use intermediate level of capital intensity. The empirical results are consistent with the theory’s predictions. Our findings on China’s industry supply chain production patterns provide a new angle on the division of gains in the vertical production network driven by the endowment structure. This could have far-reaching implications for the industrial development of other middle-income countries.