Zhuo Chen, Tsinghua University; Zhiguo He, the University of Chicago and NBER; and Chun Liu, Tsinghua University

The Financing of Local Government in China: Stimulus Loan Wanes and Shadow Banking Waxes

Chen, He, and Liu document that China's four-trillion-yuan stimulus package fueled by bank loans in 2009 (as a response to the 2007/08 global financial crisis) led to the rapid growth of shadow banking activities in China several years later. The local governments in China financed the stimulus plan mainly through bank loans in 2009, and resorted to non-bank debt financing after 2012 facing mounting rollover pressure from bank debt coming due. Cross-sectionally, the provinces with abnormally greater bank loan growth in 2009 experienced more Municipal Corporate Bonds issuance during the periods of 2012-2015, and the researchers link the stimulus loan rollovers of local governments to shadow banking activities, including entrusted loans and wealth management products. They argue that the four-trillion-yuan stimulus package has the perhaps unintended consequence of modernizing China's financial market post-2012, and highlight the market forces behind the regulation changes in China in that period.

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Davide Cantoni, Ludwig-Maximilians-Universität München; David Yufan Yang, Stanford University; Noam Yuchtman, the University of California at Berkeley and NBER; and Y. Jane Zhang, Hong Kong University of Science and Technology

Are Protests Games of Strategic Complements or Substitutes? Experimental Evidence from Hong Kong's Democracy Movement (NBER Working Paper No. 23110)

The decision to protest is strategic: an individual's participation is a function of her beliefs about others' turnout. Models of protest often assume strategic complementarity; however, the challenge of collective action suggests strategic substitutability. Cantoni, Yang, Yuchtman, and Zhang conduct the first field experiment directly manipulating individuals' beliefs about others' protest participation, in the context of Hong Kong's pro-democracy movement. The researchers elicit university students' planned participation in an upcoming protest and their prior beliefs about others' participation, in an incentivized manner. One day before the protest, they randomly provide a subset of subjects with truthful information about others' protest plans, and elicit posterior beliefs about protest turnout, again in an incentivized manner. This allows the researchers to identify the causal effects of positively and negatively updated beliefs about others' protest participation on subjects' turnout. They consistently find evidence of strategic substitutes. Analysis of control group subjects and survey evidence reinforce the experimental findings.

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Xiaoxue Zhao, Yale University, and Yu Liu, Fudan University

State Capacity and Economic Development under Capital Mobility: Evidence from China

This paper examines the effects of fiscal capacity on local states' market-supporting investment and overall economic development. Zhao and Liu build a simple model of capital competition among units with heterogeneous tax enforcement costs, and rely on the Golden Tax Project, which obviates the need for Chinese local tax agencies to deter tax evasion through onsite inspections, as a natural experiment to test the model predictions. Exploiting the heterogeneous shocks that the reform exerts on the fiscal capacity of Chinese counties with different geographic features, the researchers show that the causal effect of a county's fiscal capacity on its market-supporting investment and output respectively is, although positive for counties with the lowest capital mobility, significantly more negative in counties where firms face lower relocation costs. The researchers then provide evidence for the reason why capital mobility decreases the positive economic impact of fiscal capacity: under capital mobility, firms that seek to evade taxes have relocated out of counties that experienced a bigger fiscal capacity increase after the reform. These results imply that tax evasion was a real consideration for Chinese firms in determining where to locate. Capital mobility, which erodes the complementarity between counties' fiscal capacity and market-supporting investment, has an equalizing effect on economic outputs across counties with different fiscal capacity.

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Jie Bai, Harvard University

Melons as Lemons: Asymmetric Information, Consumer Learning and Seller Reputation

There is often a lack of reliable quality provision in many markets in developing countries. Bai designed an experiment to understand this phenomenon in a setting that features typical market conditions in developing countries: the retail watermelon markets in a major Chinese city. Bai first demonstrates empirically that there is substantial asymmetric information between sellers and buyers on sweetness, the key indicator of quality, yet sellers do not differentiate and price watermelons by quality. Bai then randomly introduces one of two branding technologies into 40 out of 60 markets — one sticker label that is widely used and counterfeited and one novel lasercut label. She tracks sellers' quality, pricing, and sales over an entire season and collects household panel purchasing data to examine the demand side's response. Bai finds that laser-branding induced sellers to provide higher quality and led to higher sales profits. However, after the intervention was withdrawn, all markets reverted back to baseline. To rationalize the experimental findings, she builds an empirical model of consumer learning and seller quality provision. The results suggest that consumers are hesitant to upgrade their perception under stickers, which makes quality provision a low-return investment. While the new technology enhances learning, the resulting increase in profits is not sufficient to cover the fixed cost of the technology for small individual sellers. Counterfactual analysis shows that information frictions and fragmented markets lead to significant under-provision of quality. Third-party interventions that subsidizing the initial demand and learning process or entry of large firms could improve welfare.

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Ernest Liu, MIT

Industrial Policies and Economic Development

Many currently and previously developing countries have adopted industrial policies that push resources towards certain "strategic" sectors, and the economic reasoning behind such polices is not well understood. In this paper, Liu constructs a model of a production network where firms purchase intermediate goods from each other in the presence of credit constraints. These credit constraints distort input choices, thereby reducing equilibrium demand for upstream goods and creating a wedge between the potential sales ("influence") and actual sales by upstream sectors. Liu analyzes policy interventions and shows that, under weak functional form restrictions, the ratio between a sector's influence and sales is a sufficient statistic that guides the choice of production and credit subsidies. Using firm-level production data from China, Liu estimates a sufficient statistic for each sector and shows that it correlates with proxy measures of government interventions into the sector. Using a panel of cross-country input-output tables and sectoral production tax rates, Liu shows that the tax rates for developing countries in Asia also correlate with the model-implied intervention measure.

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Heyu Xiong and Susan Ou, Northwestern University

Linguistic Barriers to State Capacity and Ideology: Evidence from Communist China

Xiong and Ou study the role of media in the transmission of state ideology. In particular, they explore its perverse consequences in the context of the Chinese Cultural Revolution. During the 1950s, the Chinese government developed a wired broadcasting network to disseminate state rhetoric. To combat localism, media content was largely delivered in the national standardized language: Mandarin. This allows the researchers to construct a measure of exposure based on the interaction of radio density and intelligibility of local dialects with Mandarin. They find that while the presence of radio increased revolutionary intensity locally, the effect was especially pronounced where Mandarin was more widely understood. On the individual level, they discover that native Mandarin speakers of the impressionable age group at the start of Cultural Revolution participated more in revolutionary activities, underscoring a mechanism through which propaganda operated. The results highlight linguistics as a constraint on state capacity and illustrate a persistent tension faced by the state between policy standardization and efficiency.

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Lin William Cong and Jacopo Ponticelli, the niversity of Chicago

Credit Allocation under Economic Stimulus: Evidence from China

Cong and Ponticelli study credit allocation across firms in a dynamic economy with financial frictions. In normal times, growth is driven by gradual reallocation of resources from low to high productivity firms. Recessions can slow down or even reverse this process of reallocation due to financial frictions — such as implicit government bailout — favoring low-productivity state-controlled firms. Credit expansion further amplifies this effect. The researchers investigate this mechanism in the context of China's economic stimulus plan introduced in response to the Great Recession, which triggered a large policy-driven credit expansion. Using private firm-level data they document the dynamics of credit allocation and show evidence consistent with reallocation reversal: differently from the pre-stimulus years, new credit under economic stimulus was allocated relatively more towards state-owned, low-productivity firms than to privately-owned, high-productivity firms.

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Bei Qin, the University of Hong Kong; David Stromberg, Stockholm University; and Yanhui Wu, the University of Southern California

Media Bias in China

Media in China are owned by governments with a politico-economic dual goal. Theoretically, Qin, Stromberg, and Wu argue that vertical competition between governments for economic benefits should erode their political goals. The researchers measure media bias defined as the weight placed on political goals in Chinese newspapers by analyzing the content of 117 mainstream newspapers in China from 1999 to 2010. Consistent with the theoretical predictions, they find that lower-level governments produce less-biased newspapers and launch commercial newspapers earlier than higher-level governments. Exploiting a reform that closed most county-level newspapers, the researchers show that decreased product competition increases newspaper differentiation — party papers become more biased but commercial papers become less biased.

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Zhao Chen, Fudan University; Zhikuo Liu, Shanghai University of Finance and Economics; and Juan Carlos Suárez Serrato and Daniel Xu, Duke University and NBER

Notching R&D Investment with Corporate Income Tax Cuts in China

Chen, Liu, Suárez Serrato, and Xu analyze the effects of a large fiscal incentive for R&D investment in China that awards a lower average corporate income tax rate to qualifying firms. The sharp incentives of the program generate notches, or jumps, in firm values, and vary over time and across firm characteristics. The researchers exploit a novel link between survey and administrative tax data of Chinese firms to estimate investment responses, the potential for evasion, as well as effects on productivity and tax payments. They find large responses of reported R&D using a cross-sectional "bunching" estimator that is new in the R&D literature. They also find evidence that firms relabel administrative expenses as R&D to qualify for the program. They estimate an intent-to-treat effect of the policy on R&D investment of 18.8%, and find that 45% of this response is due to evasion. These effects imply user-cost-elasticities of 2 for the reported response, and 1.14 for the real response. The researchers utilize the panel structure of the data to estimate the effect of the program on firm productivity, and find an increase of 1.6% for targeted firms. These estimates are crucial ingredients for designing policies that trade-off corporate tax revenue with future productivity growth.