Chinese Economy

November 18-19, 2016
Hanming Fang of the University of Pennsylvania and Shang-Jin Wei of Columbia University, Organizers

Yongheng Deng, National University of Singapore; Shang-Jin Wei; and Jing Wu, Tsinghua University

Estimating the Unofficial Income of Officials: The Case of China

While government officials in many countries take bribes and corruption hurts economic growth, estimating the size and prevalence of the unofficial income are difficult since bribes are largely unobserved. Deng, Wei, and Wu propose a way to systematically estimate the unofficial income based on observed purchases of large-ticket items under the assumption of a stable relationship between large ticket purchases and total wealth. The researchers apply this idea to China by using a detailed data set on house purchases in a city and the characteristics of the purchasers including legal income recorded in the social security fund. In their baseline specification, the amount of unofficial income for an average government official is estimated to be 67 percent of his or her official permanent income, and the unofficial income (as a percent of government salary) tends to increase steeply with the rank of the officials and the relative importance of government agencies. The researchers also estimate that 23 percent of officials may acquire unofficial income.

Yu-Hsiang Lei, Yale-NUS College

Can Governments Harvest Connections with Firms? Evidence from China

It is well-known that governments sometimes favor connected firms. This paper provides evidence on the reverse — firms providing favors to governments in a reciprocal relationship — exploiting a natural experiment from China. In October 2001, the tax revenue sharing rule between central and local governments was unexpectedly reformed: the higher the local tax revenue in 2001, the higher the share that local governments would get post-2001. From a newly collected dataset, Lei finds that before the reform the governments that granted more favors to firms — access to credit and tax deductions — were able to mobilize more assistance from firms in order to raise the tax revenue in 2001. Furthermore, this reciprocation is not an institutional relationship, but hinges on a repeated interaction between firms and local leaders. Exploring the variation in leadership turnover, Lei finds that firms who had previously received government favors provided no assistance to leaders who would soon leave office. These results are consistent with a theory of reciprocal relationships between governments and firms. Lei's findings not only suggest that governments and firms can form dynamic relationships to exchange favors intertemporally, but also shed light on the government-business relationship in China.

Ruixue Jia, the University of California at San Diego, and Hongbin Li, Tsinghua University

Access to Elite Education, Wage Premium and Social Mobility: The Truth and Illusion of China's College Entrance Exam

This paper studies the returns to elite education and their implications on elite formation and social mobility, exploiting an open elite education recruitment system – China's College Entrance Exam. Jia and Li conduct annual national surveys of around 40,000 college graduates during 2010-2015 to collect their performance at the entrance exam, job outcomes, and other individual characteristics. Exploiting a discontinuity in the probability of attending elite universities around the cutoff scores, the researchers find a sizable wage premium of elite education that stems from variation within occupation-industry. As a result, access to elite education does not promise one's entry into the elite class (measured by occupation, industry and other non-wage benefits). While access to elite education does improve one's income rank, it does not alter the intergenerational link between parents’ status and children’s status. The wage premium appears more consistent with the signaling mechanism of elite education than the role of human capital or social networks.

Innovation (Two Papers)

Lily Fang, INSEAD; Josh Lerner, Harvard University and NBER; and Chaopeng Wu, Xia Men University

Intellectual Property Rights Protection, Ownership, and Innovation: Evidence from China

Using a difference-in-difference approach, Fang, Lerner, and Wu study how intellectual property right (IPR) protection affects innovation in China in the years around the privatizations of state-owned enterprises (SOEs). Innovation increases after SOE privatizations, and this increase is larger in cities with strong IPR protection. These results support theoretical arguments that IPR protection strengthens firms' incentives to innovate and that private sector firms are more sensitive to IPR protection than SOEs.

Jing Fang, Huazhong University of Science and Technology, and Hui He and Nan Li, International Monetary Fund

The Rise of China's IQ (Innovation Quotient): Firm-Level Evidence

This paper examines whether the rapid growing firm patenting activity in China is associated with real economic outcome by building a unique dataset uniting detailed firm balance sheet information with firm patent data for the period of 1998-2007. Fang, He, and Li find strong evidence that within-firm increases in patent stock are associated with increases in firm size, exports, and more interestingly, total factor productivity and new product revenue share. Event studies based on first-time patentees also demonstrate similar effects following initial patent application. Contrary to conventional perception, the researchers find that although state-owned enterprises (SOEs) on average have lower level of productivity, increases in patent stock are associated with significantly higher productivity growth among SOEs compared to their non-state-owned peers, especially after the SOE reform in late 1990s. The study also investigates the role of firm dynamics and ownership changes in shaping this strong association, and possible channels that help to understand this observation.

Panle Jia Barwick, Cornell University and NBER; and Shengmao Cao and Shanjun Li, Cornell University

Local Protectionism, Market Structure, and Social Welfare: China's Automobile Market

While China has made great strides in transforming its centrally-planned economy to a market-oriented economy, there still exists widespread interregional trade barriers, such as policies and practices that protect local firms against competition from non-local firms. This study documents the presence of local protectionism and quantifies its impacts on market competition and social welfare in the context of China's automobile market, the largest automobile market in the world. Using a census of vehicle registration records, Barwick, Cao, and Li show that joint ventures (JVs), and especially state-owned enterprises (SOEs), command much higher market shares in their headquarter province than at the national level. Results from a spatial regression discontinuity analysis at provincial borders and falsification tests suggest that this pattern is not driven by differences in consumer preference or dealer network, and point to local protectionism such as subsidies of local brands as the primary contributing factor. The researchers then set up and estimate a market equilibrium model to quantify the impact of local protectionism, controlling for other demand and supply factors. Their counterfactual simulations show that local protectionism leads to significant choice distortions and consumer welfare loss. It also benefits JVs and SOEs at the expense of more efficient private firms. In the long run, local protectionism could have important impacts on market structure such as firm entry and exit as well as resource allocation across regions.

Sebastian Heise, Yale University; Justin Pierce, Federal Reserve Board; Georg Schaur, University of Tennessee; and Peter Schott, Yale University and NBER

Trade Policy and the Structure of Supply Chains Trade Policy and the Structure of Supply Chains

Heise, Pierce, Schaur, and Schott model the impact of changes in trade policy on supply chains and show that a reduction in the probability of a trade war can foster the adoption of "Japanese"-style procurement practices, in which domestic buyers ensure the provision of high-quality inputs from foreign suppliers via long-term, just-in-time relationships. Empirically, the researchers first show that the model provides a useful framework for analyzing shipments between U.S. importers and foreign exporters, and then demonstrate that a change in U.S. trade policy that eliminated the possibility of substantial increases in U.S. tariffs on Chinese goods coincides with a shift towards "Japanese" procurement.

Russell Cooper, Pennsylvania State University and NBER, and Guozhong Zhu, the University of Alberta

Household Finance in China

Cooper and Zhu study household financial choices in China, focusing on the high savings rate, low equity share in portfolio composition and low participation rate in asset markets. These decisions by education group are studied in a lifecycle model. Preference parameters, the cost of stock market participation and portfolio adjustment costs are estimated to match the financial decisions of different education groups. These estimates are compared to those obtained from a parallel study using U.S. data. Key differences between China and the U.S. portfolio decisions emerge from: (i) differences in income profiles and risk, (ii) differences in out-of pocket medical expenses, (iii) higher entry and adjustment costs in China, (iv) a lower consumption floor in China exposing households to more risk and (v) differences in the estimated discount factors. Overall, households in China face more risks and larger costs of entering into asset markets. Low educated households are less patient and high education household more patient than their U.S. counterparts.

Markus Brunnermeier and Wei Xiong, Princeton University and NBER, and Michael Sockin, the University of Texas at Austin

China's Model of Managing the Financial System

China's economic model involves active government intervention in financial markets. It relaxes/tightens market regulations and even directs asset trading with the objective to maintain market stability. Brunnermeier, Sockin, and Xiong develop a theoretical framework that anchors government intervention on a mission to prevent market breakdown and the explosion of volatility caused by the reluctance of short-term investors to trade against noise traders when the risk of trading against them is sufficiently large. In the presence of realistic information frictions about unobservable asset fundamentals, the researchers' framework shows that the government can alter market dynamics by making noise in its intervention program an additional factor driving asset prices, and can divert investor attention toward acquiring information about this noise rather than fundamentals. Through this latter channel, the widely-adopted objective of government intervention to reduce asset price volatility may exacerbate, rather than improve, the information efficiency of asset prices.

Shadow Banking (Two Papers)

Viral Acharya, New York University and NBER; Jun Qian, Shanghai Advanced Institute of Finance; and Zhishu Yang, Tsinghua University

In the Shadow of Banks: Wealth Management Products and Issuing Banks' Risk in China

To support China's massive stimulus plan in response to the global financial crisis in 2008, large state-owned banks pumped huge volumes of new loans into the economy and also grew more aggressive in the deposit markets. The extent of supporting the plan was different across the 'Big Four' banks, creating a plausibly exogenous shock in the local deposit market to small and medium-sized banks (SMBs) facing differential competition from the 'Big Four' banks. Acharya, Qian, and Yang find that SMBs significantly increased shadow banking activities after 2008, most notably by issuing wealth management products (WMPs). The scale of issuance is greater for banks that are more constrained by on-balance sheet lending and face greater competition in the deposit market from local branches of the most rapidly expanding big bank. The WMPs impose a substantial rollover risk for issuers when they mature, as reflected by the yields on new products, the issuers' behavior in the inter-bank market, and the adverse effect on stock prices following a credit crunch. Overall, the swift rise of shadow banking in China seems to be triggered by the stimulus plan and has contributed to the greater fragility of the banking system.

Hao Wang and Hao Zhou, Tsinghua University; Honglin Wang, Hong Kong Institute for Monetary Research; and Lisheng Wang, Chinese University of Hong Kong

Shadow Banking: China's Dual-Track Interest Rate Liberalization

Wang, Wang, Wang, and Zhou explore how shadow banking in China is mainly conducted by banks to evade the excessive credit control, which constitutes a dual-track approach to liberalize the country's rigid interest rate policy. The market track of shadow banking can lead to efficiency gain by allowing credit resale to fund the more productive yet credit-deprived private enterprises (PEs). Pareto improvement can be achieved as the banks and state owned enterprises (SOEs) participate in shadow banking and share the efficiency gain. Full interest rate liberalization may not lead to additional efficiency gain, as it magnifies the credit misallocation in favor of the less productive SOEs.

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