Urban Bias in Capital Allocation: Empirical Evidence from China

Piyusha Mutreja (James Madison University)
Abdulaziz B. Shifa (Syracuse University)
Wei Xiao (Southwestern University of Finance and Economics)

Abstract: Whether capital is efficiently allocated between urban and rural China can have a profound implication for both production efficiency and distributive equity. However, there is little empirical evidence and analysis of rural-urban capital misallocation in China. This paper attempts to fill this gap. We find that on average, marginal product of capital tends to be lower in urban areas, indicating that rural areas face a shortage of capital. Further, we find that rural-urban MPK differences are largely due to MPK differentials across state-owned enterprises in rural and urban areas. This suggests that state policies, as opposed borrowing constraint by private enterprises, are the likely factors for under-investment of capital in rural areas. We also find that development of local financial markets narrows the urban-rural gap while direct control of the local economy expands it. Moreover, the urban-rural gap is widely existed across prefectures with different status. Finally, the urban-rural gap in capital access explains a large fraction of the observed urban-rural gap in output per worker. We believe that the reported urban-rural gap in capital access provides a case evidence of various urban bias in the country.