Resource misallocation in China: Biased subsidies versus credit discrimination

This paper develops a two-sector growth model incorporating the state-owned and private-owned sectors and introduces biased subsidies and credit discrimination to explore how the effects of these two important policy distortions differ and interact. Based on the calibration of the Chinese economy, our primary findings are as follows. (1) Subsidy policies favoring state-owned enterprises improve the efficiency of resource allocation within each sector, whereas credit policies discriminating against private-owned enterprises reduce the efficiency of resource allocation within each sector. (2) Although both biased subsidies and credit discrimination lead to resource misallocation between sectors and ultimately harm total factor productivity (TFP), biased subsidies have a greater impact on intersectoral resource misallocation, limiting the TFP gains from mitigating credit discrimination. The policy implication is that mitigating distortions caused by biased subsidies should be prioritized over mitigating distortions caused by credit discrimination.