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Allocative implications of government investment in private sector

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  • Lian, Lili
  • Zhang, Jingyi

Abstract

In China, state owners make minority equity investments in private firms. We study the allocative implications of such government investments using a two-sector DSGE model with financial friction and idiosyncratic productivities. In our model, private owners are more productive than state owners but face tighter financial constraints. Equity investment by a state owner alleviates the private owner’s financial constraint but dampens its own productivity, consistent with Chinese firm-level data. Under this setup, only private owners with sufficiently high productivity accept such investment, while only state owners with sufficiently low productivity make such investment. As a result, expansion of such government investment improves capital allocation within each sector and across sectors. Our analysis shows that financial liberalizations, including liberalizing interest-rate controls and reducing the loan-to-value gap between sectors, stimulate private owners’ demand for such government investment but discourage state owners from making it, thus generating an ambiguous effect on aggregate productivity.

Suggested Citation

  • Lian, Lili & Zhang, Jingyi, 2026. "Allocative implications of government investment in private sector," Journal of Development Economics, Elsevier, vol. 179(C).
    • Handle: RePEc:eee:deveco:v:179:y:2026:i:c:s0304387825001671
    DOI: 10.1016/j.jdeveco.2025.103616
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    Keywords

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    JEL classification:

    • E23 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Production
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • L32 - Industrial Organization - - Nonprofit Organizations and Public Enterprise - - - Public Enterprises; Public-Private Enterprises
    • L33 - Industrial Organization - - Nonprofit Organizations and Public Enterprise - - - Comparison of Public and Private Enterprise and Nonprofit Institutions; Privatization; Contracting Out

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