Urban Agglomeration, Selection and the Impact of Policy Distortions on Firm Productivity in China

This paper estimates the impacts of China's preferential policies on the economic performance of domestic firms in urban agglomerations. First, several proxies for China's heterogenous policies (e.g. subsidies, access to loans, and tax breaks) are developed in order to examine their individual (and overall) effectiveness to mitigate the selection penalty often found in larger cities. Next, dynamic quantile regression analyses are carried out to examine the impacts of preferential policies on firm productivity, especially in larger cities. The results reveal that Chinese preferential policies create distortions in the selection mechanism by sheltering lower-performing firms from negative competition effects, thus enabling them to stay in the market. Subsequent results from the dynamic analysis reveal, however, that these lower-performing firms are unable to benefit from urbanization economies, thereby bringing into question the rationale of China's preferential policies to keep them in the market