Highway infrastructure policy, financial frictions and capital misallocation: Evidence from China

This paper investigates the causal impact of government policy interventions on capital allocation using a geo-coded firm-level panel dataset of Chinese manufacturing firms and geo-referenced highway routes spanning 1998–2007. To address the endogeneity arising from the non-random distribution of highways, three sets of time-varying instrumental variables are employed. The results indicate that improved highway proximity enhances the allocative efficiency of capital and reduces the dispersion of the marginal revenue product of capital (MRPK). Specifically, highway infrastructure mitigates MRPK dispersion through four primary channels: (i) lowering productivity volatility, (ii) reducing markup dispersion, (iii) exerting heterogeneous effects via financial constraints, and (iv) policy distortions. These findings highlight that investments in transportation infrastructure can serve as an effective policy instrument for improving capital allocation efficiency, thereby fostering productivity growth and broader economic development.