Government subsidies for some firms will have effects on the market entry, exit and scale of firms, result in misallocation of resource between firms, and reduce manufacturing productivity. Using data of Chinese industrial enterprises from 1998 to 2007, this paper studies the effect and micro-mechanism of misallocation caused by government subsidy on manufacturing productivity. Decomposition of manufacturing productivity indicates there is resource misallocation between firms and decreasing of manufacturing productivity. Empirical study shows
that government subsidies constitute an important factor inducing this resource misallocation. Subsidies change extensive and intensive margins of market, distort resource allocation between firms and reduce manufacturing productivity, and the resource misallocation is more serious in industries with higher proportion of state-owned assets. Specifically, subsidies hinder entry and exit of firms in extensive
margins, with subsidized firms having lower propability of market entry and exit compared with unsubsidized firms; subsidies promote scale of subsidized firms and crowds out market share of unsubsidized firms in intensive margins. The implication of this paper is that when providing subsidies government should take into consideration their effect on the firms’ dynamic and resource allocation in the frame
of general equilibrium.
Keywords: government subsidies, resource misallocation, manufacturing productivity
China Finance and Economic Review
Volume 7 Number 3 Autumn 2018.P92