Do Government Subsidies Promote Productivity Growth in China?

Do Government Subsidies Promote Productivity Growth in China? [ 4 min read ]

Insights

  • Many indirect government subsidies (e.g., tax or in-kind subsidies) in China are hard to track. But since 2007, China has required listed firms to publicly report direct government subsidies. Between 2008 and 2018, these subsidies increased from $4 billion to $29 billion.
  • The most significant determinant of receiving direct subsidies is larger firm size, not productivity.  
  • Receipt of subsidies is linked with lower firm productivity growth and only modest growth in R&D spending in subsequent years.
  • Receipt of subsidies is associated with higher employment levels that later decline, possibly due to manipulation of employment numbers to garner subsidies. 
  • The researchers conclude that political and social considerations may outweigh efficiency considerations in the allocation of subsidies in China.   


Source Publication: Lee G. Branstetter, Guangwei Li, and Mengjia Ren (2023). Picking winners? Government subsidies and firm productivity in China. Journal of Comparative Economics.

Read this brief on SUBSTACK

Subsidies are an important source of external finance for China’s firms, like commercial loans or foreign direct investment. Many indirect subsidies to firms in China, such as tax, credit, in-kind, procurement, or regulatory subsidies are opaque and hard to track. However, since 2007, China has required listed firms to disclose direct government subsidies (for R&D and industrial upgrading, for instance). A stated goal of China’s innovation-focused industrial policies is to improve firm productivity, which experts agree is an important driver of long-term economic growth. Do China’s direct subsidies improve productivity?  

The data. Researchers gathered information on government subsidies from the financial reports of listed firms, which includes the amount of subsidies received and the reasons behind the receipt of those subsidies. Firm financial data were collected from the China Securities Market and Account Research Database and firm ownership information from the Wind financial database for a sample that includes all firms listed in the Shanghai and Shenzhen stock exchanges from 2007 to 2018, excluding financial service firms. Researchers then estimate the total factor productivity of each firm from 2006 to 2018 and examine the relationship between firm productivity, subsidy receipt, R&D expenditure, and employment. 

Subsidies distributed across industry, ownership type. Between 2007 and 2018, the total amount of direct government subsidies reported in the financial reports of firms increased by more than seven-fold, rising from 4 billion USD to 29 billion USD. According to the disclosures, subsidies were distributed for the following reasons: R&D and innovation; industrial and equipment upgrading; employment stabilization and promotion; environmental protection; general business; other; and unknown. 


 Direct government subsidy distribution by firm ownership over time

_fig_1.png


Subsidy receipt increased at similar rates for private firms, centrally state-owned firms, and locally state-owned firms. As of 2018, the largest share of subsidies went to the private sector, followed by central state-owned firms and local state-owned firms. Foreign-funded firms received the smallest share. Firms in the mining industry received the largest amount of government subsidies, followed by firms in the machinery, electronics, transportation equipment, transportation, and energy supply industries.   

Firm size, not productivity, strongest determinant of subsidy receipt. The researchers sought to determine what firm features were most highly correlated with the receipt of direct subsidies. Their analysis shows that after controlling for firm characteristics, by far the strongest predictor of subsidy receipt was firm size, as measured by a firm’s total assets. Higher profitability was weakly associated with receipt of subsidies, but the magnitude was smaller. Highly productive firms were less likely to receive subsidies than their less productive counterparts. All else equal, the number of workers at a firm was not correlated with the receipt of subsidies. Taken together, the researchers found that subsidies appear to be given to larger and slightly more profitable, but less productive, firms. 

Firms receiving subsidies see declines in productivity growth and modest gains in R&D spending. Researchers then sought to determine the effect of the subsidies on firm characteristics over time. When assessing changes at firms one and two years after the receipt of subsidies, the analysis shows subsidies were correlated with modest declines in productivity growth. Subsidies were weakly correlated with higher subsequent R&D spending, but only two years after subsidy receipt.  

Subsidies temporarily boost employment. The analysis also shows that subsidies were linked with gains in employment at the time of subsidy receipt, but that these gains reversed one year later. A possible interpretation of this finding is that firms may strategically manipulate employment numbers to get subsidies by temporarily increasing hiring during the period of receiving subsidies, and then cutting back in subsequent years.

Direct subsidies do not promote productivity, but that may not be the priority. Based on the results of this study, there is little evidence to suggest that billions of dollars of direct subsidies of the kind reported in listing disclosures have improved the productivity of China’s firms. More robust evidence suggests that subsidies support higher levels of employment, at least temporarily. This finding is consistent with the view that political and social considerations may outweigh efficiency considerations in the allocation of subsidies in China.