Decentralization and Firm Investments: Evidence from China

Taking advantage of decentralization reform that enlarges the authority of county government in China, we construct a quasi-experiment. Using a large sample of Chinese firms, we show that after the implementation of decentralization reform, firms located in decentralized counties experienced a significant increase in investment expenditure compared with other firms. We also find that after the decentralization reform, state owned enterprises (SOEs) experienced greater increase in investment expenditure on average compared with non-SOEs, and that, within non-SOEs, collective firms have an even larger increase in investments, followed by foreign firms and private firms. Further analysis shows that the influence of decentralization reform was more significant in more developed markets, and that the increased investment was associated with improved productivity, which was more pronounced in SOEs. These results are robust to an alternative sample and endogeneity issues. Overall, these findings support the view that decentralization reform improves government efficiency and creates positive externalities, thereby encouraging firms to invest.