Chinese Economy

Members of the NBER's Chinese Economy Working Group met March 21-22 in China. Research Associates Hanming Fang of University of Pennsylvania, Shang-Jin Wei of Columbia University, and Wei Xiong of Princeton University organized the meeting joint with Fanhai International School of Finance, Fudan University and School of Entrepreneurship and Management, ShanghaiTech University. These researchers' papers were presented and discussed:

Ziying Fan and Hang Zhang, Shanghai University of Finance and Economics, and Xiaxin Wang, Fudan FISF & University of Michigan

Understanding Misreporting: Responses to a Housing Transaction Tax Notch in China

In China, for second-hand housing transactions, a business tax is levied on reported housing transaction prices once prices are above a certain threshold. Under an environment with weak enforcement, reported prices could deviate from true prices in response to the tax notch, creating an incentive for misreporting. Fan, Wang, and Zhang obtain from a large real estate broker company a unique dataset that includes both true and reported prices of second-hand housing transactions in Shanghai, which allows us to directly study the misreporting behavior. A simple tax evasion model predicts a novel three-segment misreporting pattern against true prices: no misreporting for houses with true prices below the notch; reported prices equal the notch value for true prices in a certain range above the notch; underreporting is largely constant for true prices well above the notch. The empirical misreporting pattern is remarkably consistent with theoretical predictions. In addition, the researchers explore how various factors affect the misreporting pattern both theoretically and empirically. These factors include tax rate, housing loans, and a policy that imperfectly curbs evasion by setting a lower bound for misreporting. Potential alternative forms of the misreporting cost function are explicitly discussed and tested using data.

J. Vernon Henderson, London School of Economics; Dongling Su, Boston University; Qinghua Zhang, Peking University; and Siqi Zheng, MIT

Local Factor Market Distortions in China

Tao Chen, Nanyang Technological University; Yi Huang, The Graduate Institute, Geneva; and Chen Lin, The University of Hong Kong

Finance and Volatility

Shang-Jin Wei, and Chunliu Yang, Fudan University

Do Internet Finance Platforms Mitigate Conflicts of Interest? The Case of Mutual Fund Investment

Kaiji Chen and Tong Xu, Emory University; Qing Wang, Southwest University of Finance and Economics; and Tao Zha, Emory University and NBER

Aggregate and Distributional Impacts of Housing Policy: China's Experiment

What's the role of credit conditions in housing booms and busts and what are the distributional consequences of housing booms and busts across households of different characteristics? Chen, Wang, Xu, and Zha take China's recent changes in housing policy as an experiment to address these two key issue. During 2014Q4-2016Q3, China relaxed its housing policies by reducing the minimum down payment ratio of non-primary houses from 60-70 percent to 30 percent. By exploiting two unique micro-level data sets, the researchers find that that this policy change induced a significant increase in mortgage credit demand among high-educated middle-aged households, while crowding out mortgage credit to young households. Moreover, consumption growth by middle-aged high-educated households slowed down following this policy change. To quantify the aggregate and distributional impacts of housing policies, the researchers construct an overlapping-generations economy with household heterogeneity and calibrate it to match various aggregate and cross-sectional moments of China. The policy experiment suggests that a cut in the minimum down payment ratio for non-primary houses involves a self-enforcing effect on housing demand via equilibrium housing price: a reduction in the down payment ratio for non-primary housing triggers an initial housing price increase. This, in turn, generates capital gains for homeowners before the policy change and allows them to switch to a larger house by overcoming the credit constraint for housing investment. Such a process is self-enforcing via the equilibrium housing prices due to the interaction between stronger housing demand and higher housing price.

Ran Duchin, University of Washington; Zhenyu Gao, Chinese University of Hong Kong; and Haibing Shu, Shanghai Jiaotong University

Involuntary Political Connections and Firm Outcomes

Using a unique setting in China, where the geographic distance between firms and local governments is set exogenously, Duchin, Gao, and Shu investigate the role of government involvement in small firms that lack the resources to cultivate political connections. Distant firms, with weaker government involvement, have better operating performance and higher growth and entry rates. The researchers find similar effects around exogenous government relocations, and weaker effects when the legal system is more developed, when road infrastructure is better, and following adverse economic shocks. Furthermore, distance from government increases firm autonomy, and reduces taxes, protectionism, and anti-competitive behavior.

Yan Bai, University of Rochester and NBER; Keyu Jin, London School of Economics; and Dan Lu, University of Rochester

Misallocation under Trade Liberalization

What is the impact of trade liberalization on economies with sizeable distortions? A Melitz model incorporating firm-level wedges shows that trade liberalization can exacerbate rather than improve resource allocation, causing a decline rather than a rise in TFP. Bai, Jin, and Lu show a theoretical decomposition of the various channels through which trade can engender welfare losses in the presence of policy distortions. A quantitative assessment using Chinese manufacturing data shows that trade integration has led to a TFP loss and a significantly smaller welfare gains compared to the standard numbers implied by the ACR formula (12.7%). The researchers demonstrate that micro-features of the data are still crucial for welfare analysis.

Guangwei Li, ShanghaiTech University

The Role of R&D Offshoring in Knowledge Diffusion: New Evidence from China

Li uses analysis of patent citations and field interviews to examine the impact of multinational R&D offshoring to China on knowledge diffusion from the multinationals to Chinese organizations. First, following the literature, Li uses a matching procedure to construct a sample consisting of focal and control patents, and a t-test to compare citation rates received by focal and control patents from Chinese organizations. Next, Li adopts a Difference-in-Differences (DD) approach to address the endogeneity problems of the t-test. Both the t-test and DD estimation suggest patents created outside of China by MNCs that have offshored R&D to China receive, on average, significantly fewer citations from Chinese organizations during the post-offshoring period. Insights from field interviews suggest that multinationals offshoring R&D to China enhances their ability or potential to monitor the learning and invention of their indigenous competitors. Being aware that MNCs could combine the monitor ability or potential with other strategic tools to retaliate, indigenous Chinese organizations may choose not to build on MNC R&D at first place. The finding suggests an unusual possible benefit for MNCs to move R&D operations to emerging markets that has not caught the attention of scholars. This paper calls for a reconsideration of the implications, both for corporate strategy and public policy, of the current trend of multinational R&D offshoring in emerging markets.

Sumit Agarwal, Georgetown University; Yongheng Deng, University of Wisconsin-Madison; Quanlin Gu, Peking University; Jia He, Nankai University; and Wenlan Qian and Yuan Ren, National University of Singapore

Mortgage Debt, Hand-to-Mouth Households, and Monetary Policy Transmission

Using a representative sample of credit card holders from a Chinese commercial bank with a 10% credit card market share, Agarwal, Deng, Gu, He, Qian, and Ren investigate how consumers respond to an unexpected interest rate decrease, which automatically reduces interest expenses for almost all mortgagors in the country and thereby generates significant positive disposable income shocks. The difference-indifferences analysis shows that compared with homeowners without mortgage obligations, mortgagors increased their monthly credit card spending by 7.2% after the policy announcement of a 2.3% reduction in September 2008. The researchers find a significant consumption response both immediately after announcement and during the post-reset period. Consumers with cash-on-hand constraint experienced an equally strong consumption increase, even among those with a high credit limit, and their response is concentrated in the post-reset period. The researchers also observe a decrease in the credit card delinquency rate after the mortgage rate reset. Subsequent to an interest rate increase episode, the researchers find a symmetric decrease of credit card spending. The debt service channel plays an important role in transmitting monetary policy -- the estimate implies an MPC of 0.400.51 through credit card spending.

Zheng Michael Song, Chinese University of Hong Kong; Duncan Thomas and Daniel Xu, Duke University and NBER; and Miaojun Wang, Zhejiang University

The Rise of Modern Retail in China: An Anatomy of the Footwear Industry

Song, Thomas, Wang, and Xu analyze the transformation of retail and production activities within a set of Chinese footwear manufacturing firms. They combine administrative and survey data to document the substantial increase in the number of brand-name chain stores, often called "modern" retail, from 2006 to 2013 in this industry. The growth is accompanied by rising market share of high quality firms and more prevalent domestic outsourcing activities. The researchers then illustrate empirically that the entrepreneur's comparative advantage determines these observed specialization patterns in manufacturing, "traditional", and "modern" retail, both in the cross-section and overtime. The researchers construct and quantify a model of non-homothetic demand, retail segment choice, and industry dynamics that account for the salient features of this transition process. They find that the changing relative factor prices can account for about half of the expansion of the modern retail in the data. The income effect is quantitatively small.

Kevin Lim, University of Toronto; Daniel Trefler, University of Toronto and NBER; and Miaojie Yu, Peking University

Trade and Innovation: The Role of Scale and Competition Effects

Lim, Trefler, and Yu study the effects of scale and competition on firm-level innovation in China. Using both econometrics and a calibrated structural model, they disentangle the mechanisms via which trade affects innovation, focusing on scale effects (impact on market size) and competition effects (impact on markups). The structural model also examines heterogeneity of these affects across firms, which leads to a new mechanism for competition effects: firms can escape the competition by innovating into a market segment where competition is less intense. The econometric estimates and simulations of the calibrated structural model indicate that both scale and competition effects are important for understanding how trade affects innovation in China. In particular, scale effects of trade on innovation are positive in the aggregate, whereas competition effects are negative. However, when firms can innovate to escape the competition, greater competition induced by lower trade barriers can lead firms to increase innovation rather than reduce it. Finally, the calibrated model allows for the examination of the impact of reductions in trade costs between China and the OECD on quality, productivity, markups and innovation around the world.

Bo Li, Tsinghua University, and Jacopo Ponticelli, Northwestern University

Going Bankrupt in China

Li and Ponticelli investigates how legal reforms affect judicial outcomes and credit markets by studying the introduction of courts specialized in bankruptcy in China. They construct a new case-level dataset on corporate bankruptcy filings and exploit the staggered introduction of specialized courts across Chinese cities. Specialized courts are run by bankruptcy professionals that are less likely to be under the influence of local governments. The researchers find that cases filed in cities that introduced specialized courts are assigned to more experienced, better trained judges, and reach resolution faster. Specialization increases the number of bankruptcy filings and the share of state-owned firms filing for bankruptcy. Cities that introduced specialized courts experienced a decrease in the share of "zombie" firms and an increase in average product of capital of local firms. State-owned firms operating under specialized courts experienced a decrease in the size of new bank loans, lower access to new loans, and lower investment in physical capital. These results have important policy implications in light of the recent increase in insolvency that followed China's debt boom.

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