Growing Like China

Growing Like China

Growing Like China Author: Zheng Song, Kjetil Storesletten, and Fabrizio Zilibotti Presented by Shangli Chen Instructed by Phil Dybvig Overview Introduction

Empirical Evidence Theory & Modeling

Conclusion & Discussion Introduction Background Over the last 30 years, China has undergone a spectacular economic transformation:

fast economic growth, sustained capital accumulation, major shifts in the sectoral composition of output, increased urbanization, a growing importance of markets and entrepreneurial skills. The rate of return on investment has remained well above 20 percent

foreign reserves swelled from 21 billion USD in 1992 (5% of GDP) to 2,130 billion USD in June 2009 (46% of GDP) Background Puzzle Puzzle: the consistence of high growth, high return to capital and foreign surplus

A closed-economy neoclassical growth model predicts that the high investment rate would lead to a fall in the return to capital An open-economy model predicts a large net capital inflow rather than an outflow, due to the high domestic return to capital Theory

Focal points: Financial frictions & reallocation of resources across firms Sustained return of capital and the foreign surplus arise from the reallocation of capital and labor from less productive externally financed firms to entrepreneurial firms that are more productive but have less access to external financing

Since the shrink of financially integrated firm, the increase in the investment of foreign assets lead to the foreign surplus Theory The theory yields several predictions consistent with the evidence of Chinas transition:

The theory predicts that the surplussavings minus investmentshould increase with the share of entrepreneurial firms In the benchmark model, all firms produce the same good and differ only in TFP. We extend the theory to a two-sector model in which firms can specialize in the production of more or less capital-intensive goods

Empirical Evidence Political Events and Macroeconomic Trends Political Events: First economic reforms in December 1978

New stage of the reform process was launched in 1992, after Deng Xiaopings Southern Tour Macroeconomic Trends: High investment rate, increasing return to capital in manufacturing High corporate returns have not been matched by the return on financial assets

available to individual savers Falling labor share of aggregate output Reallocation in Manufacturing The Evolution of the employment share of private enterprises

All measures suggest that the share of DPE (Domestic Private Enterprise) was low until 1997 and that most of the transition took place thereafter Reallocation in Manufacturing Productivity and Credit Frictions DPE (Domestic Private Enterprise) and SOE (State-Owned Enterprise) differ

in two important aspects: productivity and access to financial markets DPE are, on average , more productive than do SOE: DPEs ratio of total profits to fixed assets net to depreciation is about 9% higher than SOE per year since 1997

DPE are financially repressed: Discrimination in credit markets Both capital-output and capital-labor ratios are substantially lower in DPE than

in SOE Productivity and Credit Frictions Productivity and Credit Frictions Income Inequality The economic transition of China has been accompanied by increasing income inequality

the Gini coefficient of income in China grew from 0.36 in 1992 to 0.47 in 2004. Income Inequality Foreign Surplus and Productivity Growth

The timing of structural change from SOE to DPE follows quite closely that of the accumulation of foreign reserves: Both accelerate around year 2000 The breakdown of the net surplus (savings minus investment) across provinces suggests the same pattern in the cross section: the net surplus is systematically larger in provinces with a larger increase in the DPE employment share Theory & Modeling

Model & Key Assumption Financially integrated (F) firms are owned by intermediaries (to be defined below) and operate as standard neoclassical firms. Entrepreneurial (E) firms are owned by old entrepreneurs. The entrepreneurs are residual claimants on the profits and hire their own children as managers

F firms have access to the deep pockets of banks, which are perfectly integrated in international financial markets E firms are owned by agents who have superior skills and can run more productive technologies. However, they are credit constrained

Preference Preferences are parameterized by the following time-separable utility function: : discount factor Ct: consumption : intertemporal elasticity of substitution Technology

The technology of F and E firms are described, respectively, by the following production functions: Foreign Surplus, Savings, and Investments The countrys foreign surplus is given by: Financial Development

Incorporate financial development into our theory by letting the iceberg intermediation cost, , fall over time, causing a decrease in the lending rate R t l = R/ (1 t ) . Ceteris paribus, a reduction in and R t l pushes up wages and capital- labor ratios in both E and F firms. The reduction in over time can offset the tendency for the investment rate to fall (and for the average rate of return to increase). Conclusion & Discussion

Discussion of Results Despite the high investment and growth of industrial production, the rate of return of firms does not fall E firmssimilarly to DPE in Chinahave a higher TFP and less access to external financing than other firms

The rate of return to capital is higher in E firms than in F firms The transition is characterized by factor reallocation from financially integrated firms to entrepreneurial firms

The reallocation leads to an external imbalance as in the data, the economy runs a sustained foreign surplus The model predicts a growing inequality between workers wages and entrepreneurial earnings. Conclusion

In this paper, they have constructed a neoclassical model augmented with financial and contractual imperfections that affect different types of firms in the economy asymmetrically They have provided substantial empirical evidence corroborating the economic mechanism of an alternative theory that explains the build-up of a large foreign surplus in China as the outcome of structural imperfections Discussion

How is it that China grows at such a stellar rate and at the same time increases its foreign surplus? Some commentators have tried to explain this puzzle by attributing it to government manipulation of the exchange rate that holds the value of the Chinese currency artificially low

Thank you ! Presented by Shangli Chen Instructed by Phil Dybvig

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