Excess Investment and Efficiency Loss During Reforms: The Case of Provincial-level Fixed-Asset Investment in People's Republic of China

Abstract

A method is proposed to estimate efficiency of aggregate investment in a transitional economy, using provincial panel data from the People’s Republic of China (PRC) as an experimental case. Inefficiency is defined on the basis of disequilibrium investment. It is further decomposed into allocative and production inefficiency. Allocative inefficiency is related to policy/institutional factors. The main findings are: the PRC investment demand hardly responds to capital pricing signals, whereas it is strongly receptive to expansionary fiscal policies and interprovincial network effect. Once institutional factors are separated out, there are clear signs of increasing allocative efficiency and receding growth in regional investment disparity. The estimates on production efficiency are broadly in line with regional development.