DP7149 Growing like China

Author(s): Zheng Michael Song , Kjetil Storesletten , Fabrizio Zilibotti

Publication Date: January 2009

Keyword(s): China , Economic Growth , Entrepreneurs , Foreign Surplus , Investment , Productivity Heterogeneity , Rate of Return on Capital , Reallocation , State-Owned Firms.

JEL(s): G18 , O11 , O16 , O47 , O53 , P31

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP7149.asp.asp

This paper constructs a growth model that is consistent with salient features of the Chinese growth experience since 1992: high output growth, sustained returns on capital investments, extensive reallocation within the manufacturing sector, falling labor share and accumulation of a large foreign surplus. The theory makes only minimal deviations from a neoclassical growth model. Its building blocks are financial imperfections and reallocation among firms with heterogeneous productivity. Some firms use more productive technologies than others, but low-productivity firms survive because of better access to credit markets. Due to the financial imperfections, high-productivity firms - which are run by entrepreneurs - must be financed out of internal savings. If these savings are sufficiently large, the high-productivity sector outgrows the low-productivity sector, and attracts an increasing employment share. During the transition, low wage growth sustains the return to capital. The downsizing of the financially integrated sector forces a growing share of domestic savings to be invested in foreign assets, generating a foreign surplus. We test some auxiliary implications of the theory and find robust empirical support.