School of Economics and Finance

No. 584: Sources of Investment Inefficiency: The Case of Fixed-Asset Investment in China

Duo Qin , Queen Mary, University of London
Haiyan Song , Hong Kong Polytechnic University

January 1, 2007

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This study attempts to measure the inefficiency associated with aggregate investment in a transitional economy. The inefficiency is decomposed into allocative and production inefficiency based on standard production theory. Allocative inefficiency is measured by disequilibrium investment demand. Institutional factors are then taken into consideration as possible explanatory variables of the disequilibrium. The resulting model is applied to Chinese provincial panel data. The main findings are: Chinese investment demand is strongly receptive to expansionary fiscal policies and inter-provincial network effects; and although there are signs of increasing allocative efficiency, the tendency of over-investment remains, even with improvements in production efficiency.

J.E.L classification codes: E22, E62, H74, P3, C23

Keywords:Over-investment, Efficiency, Disequilibrium, Soft-budget constraint