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Productivity As If Space Mattered: An Application to Factor Markets Across China

  • Wenya Cheng
  • John Morrow
  • Kitjawat Tacharoen

Optimal production decisions depend on local market characteristics. This paper develops a model to explain firm labor demand and firm density across regions. Firms vary in their technology to combine imperfectly substitutable worker types, and locate across regions with distinct distributions of workers and wages. Firm technologies which best match regional labor markets explain both productivity differences and firm density. Estimating structural model parameters is simple and relies on a two stage OLS procedure. The first stage estimates local market conditions using firm employment and regional data, while the second incorporates regional costs into production function estimation. The method is applied to Chinese manufacturing, population census and geographic data to estimate local market costs and production technologies. In line with the model, we find that labor markets which provide cost advantages explain substantial differences in firm productivity. Furthermore, regions which have lower optimal hiring costs attract more firms per capita.

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Paper provided by Centre for Economic Performance, LSE in its series CEP Discussion Papers with number dp1181.

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Date of creation: Dec 2012
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Handle: RePEc:cep:cepdps:dp1181
Contact details of provider: Web page: http://cep.lse.ac.uk/_new/publications/series.asp?prog=CEP

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