Chinese Economy Working Group

October 1 and 2, 2010
Shang-Jin Wei of Columbia University and Hanming Fang, University of Pennsylvania, Organizers

Jun Qian, Boston College; Philip Strahan, Boston College and NBER; and Zhishu Yang, Tsinghua University
The Impact of Organizational and Incentive Structures on Soft Information: Evidence from Bank Lending

In 2002 and 2003, many Chinese banks implemented policy reforms that delegated lending decisions and increased the accountability to individual decisionmakers. These policy changes followed China's entrance into the World Trade Organization (WTO) and offer a plausibly exogenous shock to loan officer incentives to invest in soft information. Using detailed loan-level data from a large, state-owned bank, Qian, Strahan, and Yang find that internal borrowers' risk assessments ("soft" information) have a more pronounced effect than publicly available information ("hard information") on both price and non-price terms of loan contracts after the reform. When the loan approval decision is made at the branch above which the risk assessment is made, the use of soft information also declines. These results highlight how organizational structure and incentives can affect the production and quality of soft information.

Hongbin Cai, Li-An Zhou, and Yuyu Chen, Beijing University, and Hanming Fang, University of Pennsylvania and NBER
Microinsurance, Trust, and Economic Development: Evidence from a Randomized Natural Field Experiment

How does access to formal microinsurance affect economic development? Cai, Chen, Fang, and Zhou report the results of a large randomized natural field experiment conducted in southwestern China that involved insurance for sows. They find that providing access to formal insurance signicantly increases farmers' tendency to raise sows. They argue that this finding also suggests that farmers are not previously efficiently insured through informal mechanisms. They also provide several pieces of evidence suggesting that trust, or lack thereof, in government-sponsored insurance products is a signi cant barrier for farmers' willingness to participate in the formal insurance program, despite partial premium subsidies from the government.

Abhijit Banerjee, MIT and NBER; Xin Meng, ANU; and Nancy Qian, Yale University and NBER
The Life Cycle Model and Household Savings: Micro Evidence from Urban China

Banerjee, Meng, and Qian investigate the extent to which China's high household savings rates can be explained by the life-cycle theory. First, they document that Chinese parents depend on their children for support when elderly and that sons provide more support than daughters. Second, they test the two predictions of a simple life-cycle model that explain these facts: 1) parents with fewer children will increase savings; and 2) the reduction in fertility will increase savings more for parents who only have daughters. To establish causality, the researchers exploit the plausibly exogenous decline in fertility in China caused by family planning programs that began in the early 1970s and the fact that there was no sex-selection for their sample of urban Chinese households who had children during the 1960s and 1970s. Their results show that for parents whose eldest child is a daughter, having one less child increases the savings rate by over 14,000 RMB, or approximately 27 percent of average income. For those whose eldest child is a son, there is no effect on savings. Finally, the researchers apply their estimates to a simple life-cycle model of savings to predict the level and rates of savings, and thus to assess the extent to which the life-cycle model can explain the data.

Loren Brandt, Trevor V. E. Tombe, and Xiaodong Zhu, University of Toronto
Factor Market Distortion across Time, Space and Sectors in China

Brandt, Tombe, and Zhu measure the distortions in the allocation of labor and capital across provinces and sectors in China for the period 1985-2007. Most existing studies have measured factor market distortions by using some index of dispersion in individual factor returns. However, the map between these dispersion measures and the efficiency loss attributable to distortions is not clear, especially when there is more than one factor. These authors follow Hsieh and Klenow (2009)'s strategy by measuring the factor market distortions as the reduction in aggregate total factor productivity (TFP) caused by distortions. They extend their analysis by decomposing the overall distortions into between province and within-province intra-sectoral distortions. They find: 1) For the period between 1985 and 2007, the distortions in factor allocation reduced aggregate TFP by about 33 percent on average, with the between-province and within-province distortions each accounting for half of the reduction; 2) the measure of between-province distortions was relatively constant over the period; 3) the measure of within-province distortions declined between 1985 and 1997, contributing to 0.96 percent TFP growth per year, but then increased significantly in the last ten years, reducing the aggregate TFP growth rate by 1.41 percent a year; and 4) almost all of the within-province distortions can be accounted for by the misallocation of capital between the state and the non-state sectors.

Qingyuan Du and Shang-Jin Wei,Columbia University

A Sexually Unbalanced Model of Current Account Imbalances (NBER Working Paper No. 16000)

Large savings and current account surpluses by China and other countries are said to have contributed to the global current account imbalances and possibly to the recent global financial crisis. Du and Wei propose a theory of excess savings based on a major -- albeit insufficiently recognized by macroeconomists -- transformation in many of these societies, namely, a steady increase in the surplus of men relative to women. They construct an OLG model with two sexes and a desire to marry. They show conditions under which intensified competition in the marriage market can induce men to raise their savings rate, and produce a rise in the aggregate savings and current account surplus. This effect is economically significant if the biological desire to have a partner of the opposite sex is strong. A calibration of the model suggests that this factor could generate economically significant current account responses, or more than half of the actual current account imbalances observed in the data.

Ravi Jagannathan, Kellogg Graduate School of Management and NBER; Mudit Kapoor, Indian School of Business; and Ernst Schaumburg, Federal Reserve Bank of New York
Why are we in a Recession? The Financial Crisis is the Symptom not the Disease!

Globalization has made it possible for labor in developing countries to augment labor in the developed world, without having to relocate, in ways not thought possible only a few decades ago. Jagannathan, Kapoor, and Schaumburg argue that this large increase in the developed world's effective labor supply, triggered by geo-political events and technological innovations, coupled with the inability of existing institutions in the United States and developing nations themselves to cope with this shock, set the stage for the great recession. The financial crisis in the United States was but the first acute symptom that had to be treated.

Gabriella Conti, University of Chicago; James J. Heckman, University of Chicago and NBER; and Yi Jun Jian and Junsen Zhang, Chinese University of Hong Kong
Early Health Shocks, Parental Responses, and Child Outcomes

Conti, Heckman, Jian, and Zhang study how early health shocks affect a child's human capital formation. They first formulate a theoretical model to understand how early health shocks affect child outcomes through parental responses. They nest a dynamic model of human capability formation into a standard intra-household resource allocation framework. By allowing multi-dimensionality of child endowments, they allow parents to compensate and reinforce along different dimensions. They then test their main empirical predictions using a large-scale Chinese child twins survey, which contains detailed information on child- and parent-specific expenditures. They can differentiate between investment in money and investment in time. On the one hand, they find evidence of compensating investment in child health but of reinforcing investment in education. On the other, they find no change in the time spent with the child. They confirm that an early health insult negatively affects the child under several different domains, ranging from later health, to cognition, to personality. They also show that early health shocks negatively affect parental expectations, but do not change the child's perceptions of parental behavior. This suggests that the effects of early health shocks mainly operate through the budget constraint, not through preferences.

Douglas Almond, Columbia University and NBER; Yuyu Chen, Peking University; Avraham Ebenstein, Hebrew University of Jerusalem; Michael Greenstone, MIT and NBER; and Hongbin Li, Tsinghua University

The Long-Run Impact of Air Pollution on Life Expectancy: Evidence from China's Huai River Policy

Almond, Chen, Ebenstein, Greenstone and Li exploit an arbitrary Chinese law to provide the first evidence of the impact on life expectancy of sustained exposure to total suspended particulates (TSP) air pollution. During the central planning period of 1950-80, China established free winter heating of homes and offices north of the Huai River by providing as a basic right free coal for boilers in cities there, while largely denying heat to the South. The researchers find that in cities to the North of the river, ambient concentrations of TSPs are about 55 percent higher and life expectancies are about five years lower than elsewhere. Moreover, premature mortality is attributable to lung related causes of death. The authors estimate that long-term exposure to an additional 100 Mg/m of TSP is associated with a reduction in life expectancy at birth of about 2.5 years, which is roughly 5 times more than the estimated impact of TSPs on life expectancy from fitting of ordinary least squares equation.

Galina Hale, Federal Reserve Bank of San Francisco, and Cheryl Long, Colgate University
If You Try, You'll Get By

It appears to be common knowledge that external financing in China is mostly limited to state-owned firms and is hard to obtain for smaller private firms. First confirm this pattern for more recent data and then investigate ways in which private firms overcome their financing constraints. Hale and Long find that private firms reduce their need for external funds through more efficient management of inventory levels and accounts receivable. We further show that the low levels of inventories and accounts receivable in Chinese private firms are not below efficient levels and are unlikely to be a hindrance to their efficient operations. Instead, these low levels of working capital seem to be correlated with higher financial returns as well as higher productivity. We conclude that while limited access to external financing may limit the growth of private sector in the medium and long run, in the short run the lean operating budget may be contributing to Chinese private firmsa' efficiency.

Peter Zeitz, University of California, Los Angeles
Short-Run Incentives and Myopic Behavior: Evidence from State-Owned Enterprises in China

How do performance incentives affect firm productivity? In 1978, Chinese industrial planners carried out major reforms of the compensation system in state-owned enterprises (SOEs), introducing bonuses that linked pay to measures of current performance. Previous studies have argued that bonuses increased effort levels and led to large increases in productivity. However, since SOE incentives were based solely on current performance, they could have encouraged enterprises to concentrate their efforts on meeting short-run targets. Shifting effort toward short-run goals should increase productivity temporarily, but could have a negative effect in the long-run. Zeitz collects a unique panel of compensation, employment, and output statistics for the Chinese iron and steel industry and uses these data to estimate the short- and long-run effects of incentive use on labor productivity during the early period of SOE reform, 1976 to 1988. The results indicate that incentives distorted effort allocation and negatively affected overall firm performance. In the data, incentives were associated with a small increase in labor productivity in the short run, but a much larger decrease in the long run.