The Cost of Poor Institutions: Estimations Based on Chinese Firm Flows

ABSTRACT

This study estimates the cost of poor institutions using cross-provincial firm investments in China based on its unique land policies. We find that provinces with better institutions attract more firm investment and that institutions are substitutive with land price distortion. Firms with high (low) labor productivity move primarily between provinces with better (inferior) institutions. This stratification effect suggests that a poor institutional environment has dynamic costs, hindering technology diffusion from provinces with good institutions to those with poor institutions. The results imply that it is difficult to achieve industrial upgrades by factor price distortion rather than institutional environment improvements.

KEYWORDS:

• Institutions
• firm flow
• subsidy
• land price

JEL:

• O10
• P16
• P51

Declaration of conflict of interest

We declare no conflicts of interest.

Notes

1. Local governments downwardly distort the price of industrial land to attract enterprise investment. At the same time, local governments rely on revenue from high-priced commercial and residential land transfers.

2. How to measure institutions is a difficult and controversial issue. We follow the existing literature and report the specific details of the institutional variables in the text.

3. Another issue is that the firm name might not be recorded in the same format in land transfer agreements and the CIED. To overcome this problem, we match firm names using keywords and manually check the matched results. Based on this procedure, we argue that there is limited nonrandom sample selection caused by different formats of firm names.

4. A good institution is a relative concept, referring to the group with the higher score of Marketization Index. For a similar approach, see Michalopoulos and Papaioannou (2014).

Additional information

Funding

This work was supported by the Fundamental Research Funds for the Central Universities, and the Research Funds of Renmin University of China [18XNI008].