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Chapter 11. De-Monopolization toward Long-Term Prosperity in China

Author(s):
Anoop Singh, Malhar Nabar, and Papa N'Diaye
Published Date:
November 2013
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Author(s)
Ashvin Ahuja

During the past decade, the average Chinese worker earned roughly nine times less and was 10 times less productive than the average American at purchasing power parity. Current consensus attributes large differences in output per worker to differences in total factor productivity (TFP). Evidence suggests that most of the United States–China TFP differences lie in the inefficiency of China’s domestic-oriented service and agricultural sectors. This chapter focuses on (1) the evidence of monopoly rights and their influence on work practices improvement at China’s firms and plants and (2) the evidence that policy arrangements have encouraged more competition in merchandise manufacturing and heavy industries while barriers to market access remain high against new firms in the domestic market (especially in services). The empirical analysis suggests that China can enhance long-term income per capita by a factor of 10, largely through TFP gains, by implementing reforms to weaken protection of monopolies and encourage entry in all industries.

Introduction

Between 2000 and 2009, the average Chinese worker earned approximately nine times less than the average American, and the typical Chinese worker was less productive than his or her American counterpart by a factor of roughly 10 when measured at purchasing power parity (PPP).1

What accounts for such large differences in income per capita between China and the United States? Current consensus in growth and development accounting mainly attributes large differences in output per worker between rich and poor countries to differences in TFP while assigning a significantly lesser role to gaps in physical and human capital stocks.2 Conclusions based on cross-country micro-data approaches to productivity measurement and comparison also confirm these results (see Baily and Solow, 2001). With regard to the difference between China and the United States, Hall and Jones (1999) estimate that Chinese output per worker would be about half that of U.S. output per worker without the large difference in TFP alone.3

A stream of research papers has focused on what accounts for such large TFP differences across countries. Systematic resource misallocation is a key theme. Restuccia and Rogerson (2008) and Hsieh and Klenow (2009), for example, find that misallocation of resources across firms can have important effects on aggregate TFP. Focusing on China, India, and the United States, Hsieh and Klenow (2009) quantify large manufacturing TFP losses from resource misallocation in the periods before China joined the World Trade Organization (WTO). Viewed from a static, standard monopolistic competition model, they show that moving to “U.S. efficiency” would increase China’s manufacturing TFP by about 30–50 percent based on 1997–98 data. The literature offers other specific mechanisms by which resource misallocation could lower aggregate TFP, such as labor market regulations (e.g., Hopenhayn and Rogerson, 1994; and Lagos, 2006), deficiency in capital allocation vis-à-vis managerial talent (e.g., Caselli and Gennaioli, 2003; and Buera and Shin, 2013), and vested interests’ ability to block firms from introducing better work practices (Parente and Prescott, 1997, 1999).

Lewis (2004a, 2004b) offers evidence from 13 emerging and advanced economies linking institutions and policy arrangements to subpar performance of industry- and economy-wide TFP. The overarching lesson from these studies is that the time path of aggregate productivity levels is highly correlated with the economic policy arrangements countries choose (specifically regarding the ability and incentives of organized forces in each society to resist the adoption of superior technology and persist in inefficient usage of currently operating ones). The main obstacles to productivity growth and economic progress in poor countries are the many policies that limit market competition.

In the case of the United States and China, the aggregate TFP gap is approximately 13 times in favor of the United States (Figure 11.1).4 Differences between the United States’ and China’s manufacturing TFP levels appear much smaller at about 1.3–1.5 times (Hsieh and Klenow, 2009). Thus, even accounting for measurement errors, most of the differences in aggregate productivity, and therefore living standards, between China and the United States have to be rooted in the inefficiency in the nonmanufacturing sectors—mostly domestic-oriented services and agriculture. In line with this observation, He and others (2012) report that China’s nontradable TFP growth has been about 2.2–2.5 percent per year lower than manufacturing-heavy tradable TFP growth during 2001–10.

Figure 11.1U.S. Income and Productivity Relative to China

Source: Hall and Jones, 1999; Hsieh and Klenow, 2009; Penn World table 7.0; and author’s calculations.

Note: PPP = Purchasing-power parity; TFP = total factor productivity.

This chapter documents the links between TFP outcomes and “monopoly rights” in the domestic market (especially in services) and subpar work practice in China, as well as the links between TFP and policy reform to encourage more competition via external trade in merchandise manufacturing and heavy industries. It finds that resistance to better work practices, which surfaces to access large opportunities for rent seeking and is more prevalent in some domestic-oriented (nontradable) industries, is likely to be a significant impediment to China’s long-term economic prospects.

The chapter also explores the extent to which reforming the monopoly-rights policy arrangement that China currently employs can enhance long-term income per capita, using a general equilibrium model with a strategic game developed by Parente and Prescott (1999). The defining feature of the model is the existence of state protection of vested interest groups and industry insiders that can undertake strategic actions against “high-technology” firms attempting to enter.

The model, once calibrated to China and U.S. growth facts, can capture discrepancies in PPP-adjusted GDP per capita between the two economies reasonably well. The discrepancy in GDP per capita is mainly accounted for by differences in TFP, consistent with cross-country work in growth and development accounting. Specifically, the model predicts that China’s long-term GDP per capita could be higher by as much as a factor of 10 under the “free enterprise” arrangement than under the protected monopoly-rights arrangement that well approximates the economy today. The increase in per capita income is driven by the 3.5-fold increase in China’s TFP (with reproducible capital share remaining at about 0.45). Over time, physical capital accumulation, as well as education and skill acquisition, will follow as their rates of return rise with higher TFP.

The model also predicts that the unit price of the goods and services produced in the sectors with barriers to entry relative to that of goods and services produced in the competitive sector is about 3¼ times higher in China under monopoly rights than in the United States with free enterprise. This is roughly the ratio of the price of investment goods to the price of consumption goods across rich and poor countries in the Aten, Summers, and Heston data (three to four times).

The principal insight from the stylized model is that these long-term gains are made through improvements in TFP rather than factor accumulation (e.g., through high fixed asset investment growth); and the gains are made by shifting away from monopoly rights to the free enterprise policy arrangement. The result should facilitate a policy discussion about the direction of ongoing corporate and financial reforms in China. Specifically, ongoing reform efforts should target productivity improvement rather than factor accumulation. Drawing lessons from the extraordinary success in Chinese manufacturing exports, China should persist with reform to weaken protection and encourage entry in all industries. Competitive pressure from multinationals and new domestic firms will help transform work practices across Chinese firms.5 More products and services will be produced at more affordable prices. Wages will rise and converge across sectors. More firms operating in China will innovate and export best practices to the world. Chinese workers and households will be made better off as rent-seeking activities fade away. As a result, the large income gap between China and leading industrial countries will eventually be eliminated.

The rest of the chapter proceeds as follows: The next section presents salient evidence of protected monopoly rights and discusses work practices at Chinese firms. It is followed by sections that give the intuition behind the model and that outline the model’s calibration and report findings.

Evidence of Monopoly Rights and Work Practices at Chinese Plants

Published empirical findings on industry- and firm-level productivity in China are rare and centered on the manufacturing sector. Existing industry-level accounts of productivity in China’s nonmanufacturing sectors are largely based on case studies done by the McKinsey Global Institute (MGI). China’s manufacturing sector enjoyed exceptionally fast productivity growth in the decades before and after China’s entry into the WTO.6 This manufacturing productivity boom follows the gradual application of zhengqi fenkai policy, which formally separates government functions from business operations. The government first applied the policy to the consumer goods industry and then to high technology and heavy manufacturing in preparation for global competition (Woetzel, 2008). After entry into the WTO, favoritism reserved for large state-owned firms began fading, and private domestic firms moved to the forefront of the rapidly changing business landscape. State-owned manufacturing plants, which used to run at 40 percent less TFP than private domestic plants, started to exit, their numbers falling from 29 percent of total firms in 1998 to only 8 percent in 2005 (Hsieh and Klenow, 2009). Regardless of ownership type, exit means survivors now run plants at a much higher average TFP. Furthermore, the rise in market competition is largely reflected in the exits of SOEs, mostly small and medium-sized, and the rapid growth of private firms (Conway and others, 2010). With improved SOE governance, SOEs are becoming more efficient and behaving more like private firms.

Successful industries have benefited from government policies, notably access to factors of production at subsidized prices, market access barriers, and policies that encourage domestic purchasing of goods and services (to guarantee revenue pools). Nevertheless, it would be a mistake to attribute the strides made in manufacturing productivity simply to government support. Not only have many government-backed projects not been successful, but there are many examples of successful firms that face competitive pressure from the global market. To cite a few, the Chinese communications equipment industry has improved its quality and gained market acceptance in advanced economies. China’s solar and wind power industries are using new manufacturing techniques to create more efficient solar panels and are already supplying sophisticated, vital components for the industry worldwide (Orr and Roth, 2012).

Indeed, the success stories in Chinese manufacturing productivity growth performance seem to fit well with other cross-country case studies. Evidence from case studies from 13 emerging and advanced economies reveals that policy arrangements that limit competition can potentially result in subpar performance of industry- and economy-wide aggregate TFP7 (Lewis, 2004a, 2004b). The success of China’s manufacturing sector confirms a clear link between pressure from global competition and powerful incentives and the ability to adopt better technology and improve work practices.

Despite this progress, influential partners, protection from competition, and extensive pricing power continue to characterize China’s business sector (World Bank, 2011; Conway and others, 2010).8 China’s services (nontradables) sectors clearly lack pressure from competition. He and others (2012) offer insights into the large discrepancy between tradables (dominated by manufacturing) and non-tradables TFP growth in China since 2000.

Overall, China’s economy is still dominated by state and state-partner monopolies, which are shielded from meaningful competition in the domestic market by state support, regulations,9 licensing, and technology-sharing rules (Figure 11.2). These firms tend to be large, capital-intensive, and well-connected; concentrated in “strategic” and “pillar” sectors; and benefit from subsidies as well as preferential access to finance, land, and other resources. They are not confined to electricity generation and distribution, natural gas, and water, but are also outside of the industrial sector, such as banking, telecommunications, and the media.10 Subsidies to these firms can work effectively to promote employment growth, deter entry, and discourage more productive work practices. Finally, murky ownership rights and unsystematically kept titles, financial records, collateral, and pledges increase due diligence costs and work as barriers against potential entrants, especially those that are smaller or not homegrown (Figures 11.3).11

Figure 11.2State Control Indicators, 2008

(minimum to maximum on a scale of 1 to 6)

Source: OECD, 2011.

Note: EM = Emerging market; OECD = Organization for Economic Cooperation and Development; US = United States.

Figure 11.3Barriers to Entrepreneurship Indicators 2008

(minimum to maximum on a scale of 1 to 6)

Source: OECD, 2011.

Note: EM = Emerging market; OECD = Organization for Economic Cooperation and Development; US = United States.

1 Network sectors include, among others, electricity generation and distribution, natural gas, water, telecommunications, banking, and the media.

Even in the externally competitive manufacturing sector, evidence indicates that policy arrangements could obstruct improvements in work practices and productivity. Significant waste occurs even at high-productivity plants run by multinational industry leaders, which reduces profits by 20–40 percent at some plants (Aminpour and Woetzel, 2006). The inefficiency arises not from a weak profit motive on the part of the plant managers, but can be partly attributed to the way foreign firms tend to gain market access, that is, via partnership with large SOEs or through business acquisitions. Although this process secured “the right locations, the right government relationships, the right joint ventures, [which] shut out other [players] from this market” for years if not a decade, multinationals have inherited “hard to change legacy work processes, employee mind-sets [as well as] manufacturing approaches” (Hexter and Woetzel, 2007, pp. 1, 2). In some cases, introducing a procurement process practiced in these multinationals’ established home markets—an “innovation” in China—could generate substantial savings for their operations in China. Nevertheless, many multinationals have been able to run plants less efficiently than in Europe and the United States and still “come out way ahead” with the advantage of relatively low costs of labor and intermediate inputs sourced locally. In this way, high profit margins and business growth can undercut the incentive to change work practices and improve operational efficiency.

To adapt best practices to local market conditions and execute superlative operating performance, a business would require reliable markets and customer data, quality suppliers, and efficient distribution networks, which are not readily available in China. These impediments clearly indicate relatively poor service sector productivity, including financial services (MGI, 2006). Manufacturing productivity, already high and close to the U.S. level, is likely to improve further, provided quality and cost of service inputs improve.

These studies help shed light on the underlying cause for TFP differences across countries. They are consistent with the idea that incentives and the ability of existing firms to dictate industry work practices can be an important mechanism by which resources are misallocated. State protection makes cost of entry by other foreign and domestic firms prohibitive, in turn generating immense value to these monopoly rights. Their lessons seem to be consistent with the theory proposed by Parente and Prescott (1999), which holds that state actions to prohibit or distort firms’ incentives to change work practices tend to be irrelevant unless the state also protects the industry from outside competition.

The Model’s Environment and Equilibria: Some Intuition12

To measure potential gains from de-monopolization, this chapter relies on the framework and model of Parente and Prescott (1999). This relatively simple, closed-economy model has a strategic mechanism that allows vested interests to impede economic progress. The vested interest groups have valuable monopoly rights that are tied to existing production technology. In every period, no take-up of better technology or work practices as well as inefficient use of existing ones is a possible outcome of a strategic game between two players: the protected coalition of factor suppliers and a potential entrant who has to pay to overcome entry resistance.

The model has two production sectors using constant-returns-to-scale technologies with no fixed costs. Industries are competitive, though they need not be private. There are economic rents in the model.

Under the monopoly-rights arrangement, coalition members can set up firms with protected rights to operate existing technology. Because of these rights, every firm in the industry employing that technology must hire coalition members. The coalition’s objective is to maximize per member income by setting membership size, compensation, and work practices levels (or productivity). In the model, coalition size acts as a deterrent to entry.

Because these protected rights have value, potential entrants must pay to overcome the coalition’s resistance to their market entry. If entry occurs, then the entrant uses a superior technology. In the game, the return to entry depends on the strength of state protection as well as coalition size. When protection is weak, entry occurs because the minimum coalition size necessary to deter entry is too large to provide adequate compensation to recruit and retain members. As a result, firms in every industry always end up adopting better work practices. At the other end of the spectrum, when protection is strong, entry cannot occur at all and every firm operates the current, inferior technology. Interestingly, when state protection is not too strong, the minimum-deterrent-coalition size is larger than the number of members required to produce competitive equilibrium output. In this case, firms not only fail to adopt better work practices, they also operate the existing inferior technology inefficiently. This is the relevant case for this analysis of China.

Under the free enterprise policy arrangement—or equivalently, a de-monopolized arrangement—there is no coalition to deter entry and all agents act in a perfectly competitive way.

The model economy consists of three sectors: household, agriculture, and industry. In any given period, a household can be one of these three: an agricultural worker, an industrial worker, or an industrial entrepreneur who adopts a technology to produce goods and services.

A household is endowed with one unit each of labor and land services. Each household values only agricultural goods and differentiated (industrial) goods. Households do not value leisure. They want to smooth consumption over time and derive enjoyment from variety.

There are three constant-returns-to-scale production technologies in the industrial sector—low, medium, and high efficiency levels, ranked according to the required amount of labor input per unit of output. An entrepreneurial household forming an industrial firm can adopt any technology without incurring any firm-specific investment.

In the agricultural sector, there is a constant-returns-to-scale, nested, constant-elasticity-of-substitution production function in which the mix of intermediate industrial goods is treated as a substitute for the composite labor-land input.13

Monopoly-Rights Arrangement: The Equilibrium and Some Intuition

In the model, monopoly rights are only relevant to the industrial sector. The agricultural sector (which may also be thought to include some services) is perfectly competitive.14 In each industry, any individual can use the low technology, and entry and exit are free for those operating with the medium technology. Entry obstruction applies only to the high-technology firms.

Workers and entrepreneurs in the industrial sector can form coalitions. Protected monopoly rights are extended only to existing firms employing the medium technology. These rights are protected throughout the life of the coalition, the length of which depends on the ability to provide surplus rents to its members.

The coalition in any industry that uses the medium technology has the right to limit its membership size, set the compensation (or wage) rate, and dictate work practices. The coalition dictates work practices by determining the productivity level, that is, up to the medium technology level, but which could be inefficiently used. A potential entrant employing the high technology has to pay an entry cost to overcome the resistance associated with the protection of the valuable monopoly rights. The entry cost, measured in units of labor services, depends on the strength of state protection and the coalition size (which, in this case, varies with its production capacity).15 The larger the residual market left over from the monopolists, the more a new firm should be willing to pay to enter.

The Monopoly-Rights Equilibrium

Next, the entry game for an industry, defined as the symmetric no-entry steady-state equilibrium, is described. There is an equilibrium for this strategic game. An equilibrium can be either that of “no-entry” or with entry in every industry in steady state. An equilibrium is characterized by utility maximization in the household sector, profit maximization in the agricultural sector, market clearing, and a subgame perfect equilibrium to the game in each industry. In this game, the two players take as given the demand for industry output and the wage in the competitive agricultural sector. These givens ensure that the equilibrium solution obtained through agents’ utility and firms’ profit maximization is consistent with players’ strategic behavior and that noncredible (e.g., entry) threats are not exercised in equilibrium.

In this game, conditional on entry, Bertrand price competition is in effect, which means that the entrant has a marginal cost that is tied to the agricultural wage and can produce any quantity demanded by consumers. The coalition has zero marginal cost up to the capacity constraint because its members are committed to working in that industry for the period.

In equilibrium, (real) factor input prices are equal to their respective marginal products; the ratio of differentiated goods prices to agricultural goods prices is equal to the ratio of the respective marginal utilities of their consumption; households exhaust their budgets; and quantity supplied must equal quantity demanded in every market. Moreover, the entrant will pick an output price such that the investment it has to make to overcome resistance and enter the market will be exactly the maximum profit generated from residual demand; hence, the minimal-deterrent entry condition. Confronted by an entering firm with better technology, the coalition maximizes per member income by choosing supply output as efficiently as it can to minimize the entrant’s profit, given the entry price set by the entrant. The coalition members would set work practices at the maximum level whenever entry threat prospects are credible.16 Finally, equilibrium profit is zero at every medium-technology firm because total revenue equals total cost, which is to say that wages paid to coalition members equal their marginal revenue product.

The Competitive Equilibrium

In this particular economy, a unique competitive equilibrium exists, characterized as follows: The price of industry output equals the marginal cost tied to high technology, because this is what a competitive firm uses. In addition, wages are equalized across sectors.

Calibration and Findings

Once the empirical counterparts of each sector are specified, preference, industrial sector technology, and farm sector parameters can be calibrated to replicate the key “stylized” relationships among model aggregates. The calibrated model can then measure the potential gains from eliminating monopoly rights in China.

The numerical results from the calibrated model are as follows: Under free enterprise, agricultural and small services firms use much fewer labor inputs, but much more differentiated intermediate goods relative to total output. Under monopoly rights, agricultural households (or equivalently, the no-barrier-to-entry and labor-intensive sector) are poorer than industrial households and consume less on a per capita basis.

Wages tend to equalize across sectors under free enterprise because there are no economic rents to be derived and protected. Prices are different across arrangements (monopoly rights vs. free enterprise). “Industrial” goods that are produced by protected firms are more expensive under monopoly rights than they would be under free enterprise. As a result, firms use less of the intermediate goods and services in the monopoly-rights economy.

In a free-enterprise economy, “agricultural” households face budget constraints similar to those faced by “industrial” households. They consume a roughly equal amount. In addition, the “agricultural” households will get to consume relatively more of the “industrial” goods and services in the free-enterprise economy (because the relative price of “industrial” goods is now much lower).

The long-term results also appear to be quantitatively sensible.17 The “industrial” sector generates the lion’s share of the total value added and wage income under free enterprise; however, “agriculture’s” shares of the total value added and wage income shrink by as much as four times. Furthermore, the unit price of “industrial” goods relative to “agricultural” goods is about 3¼ times higher in the poor country with monopoly rights than in the rich country with free enterprise. This is roughly the ratio of the prices of investment goods to consumption goods across rich and poor countries in international data.

In the long term, the effect on output from eliminating monopoly rights is substantial. GDP in PPP terms in the model increases by as much as 3½ times in steady state. Because there is no capital in the model, and labor and land services are assumed to be similar across arrangements, this number is equivalent to the difference in TFP between the two arrangements. Without a TFP difference of this magnitude (and assuming fixed aggregate capital and human capital stock for the sake of comparison), Chinese output per worker under monopoly rights would be about 45 percent of its output per worker under free enterprise, which is close to the number (50 percent of U.S. output per worker) calculated by Hall and Jones (1999).18 Inefficient operation of inferior technology in a large swath of industry and services accounts for lower aggregate TFP in China vis-à-vis the United States (which, in the model, stands for China under “free enterprise”) in the long term. In this calibration, the “industrial” sector achieves only about half of its potential productivity.

In a richer model with capital accumulation, the effect on output from increases in TFP would be amplified because capital would accumulate endogenously in response to increasing TFP to keep the long-term rate of return constant. The difference in GDP per capita (at PPP) between the two arrangements would then be equal to the factor difference in TFP (here, 3½) raised to the power of 1/(1 minus reproducible capital share). Given China’s reproducible capital share of approximately 0.45, the adjusted difference in GDP per capita at PPP would be about 10 times, roughly similar to the measured difference between U.S. and China output per capita and output per worker at PPP between 2000 and 2009 (8.5 and 10 times, respectively).

Conclusion

A large number of research papers have stressed that misallocation of resources across firms can adversely affect aggregate TFP in an economy. This chapter uses an abstract model that incorporates the strategic behavior of vested interest groups to block adoption of better work practices to measure potential gains from eliminating protected monopoly rights in China. Confronted with entering firms—domestic or foreign—armed with better technology, rational vested interest groups that are not protected will have no choice but to set their own work practices at the best standard available to compete. The same outcome would materialize whenever entry threat prospects are credible.

The numerical results in this chapter require a few caveats. The simple abstract model used could be an inaccurate approximation of China and the United States. There could well be large measurement error in the data, as well as lack of data, both of which lead to inaccuracies in the calibration exercise. Therefore, this calculation is very much a first pass. Nevertheless, the results underscore the strategic importance of competition in improving total factor productivity.

The long-term results reported here appear to be quantitatively sensible based on a comparison with long-term experience in the United States. The large gaps in TFP and GDP per capita between China and the United States today could be narrowed significantly if China transforms its inefficient monopoly-rights arrangement in the domestic market (especially in the services sector) into one that minimizes vested interest groups’ ability and incentives to discourage better technology and work practices. Should China de-monopolize its domestic market, Chinese GDP per capita could be 10 times higher than otherwise in the long term. More important, most of that increase will have originated from TFP gains. And the room for reallocation gains should come mainly from the services sector.

As China continues with reform, it can apply the same fundamental insights that have made manufacturing exports a phenomenal success to achieve world-class services and agricultural sector TFP. The reform efforts should therefore focus on productivity improvement in financial services, construction (which is by far the most labor intensive), transportation, education, health, telecommunications, and utilities. By persisting with reform to weaken protection and encourage entry, competitive pressure will help transform work practices across Chinese firms.

With these reform efforts, business strategies based on creating and sustaining privileged access will be increasingly outdated. More services will be produced at more affordable prices. Wages will rise and converge across sectors. Over time, physical capital accumulation, as well as education and skill acquisition, will necessarily follow to normalize the rates of return, which will have risen from higher TFP. More Chinese firms will innovate and export best practices to the world. Chinese workers and households will be made considerably better off than otherwise as the dead weight is removed. And the large income gap between China and today’s leading industrial countries will be eliminated.

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Based on 2000–09 real GDP per capita at purchasing power parity (PPP), chain method, and real GDP per worker at PPP from the Penn World Table version 7.0.

Measured with labor quality–adjusted TFP gap and assuming fixed aggregate capital and human capital stock.

The TFP gap size is based on 2005–07 data, after adjusting capital stock to PPP, but not adjusted for labor quality. Measured productivity levels for China could be distorted by various subsidized factor prices (capital, land, and energy, as well as intellectual property).

The reform efforts may need to be properly sequenced to manage resistance from vested interest groups, but sequencing is beyond the scope of this chapter.

He and others (2012) estimate annual tradable (mostly manufacturing) TFP growth at between 4.6 and 5.4 percent between 2002 and 2007. Guo and N’Diaye (2009) estimate manufacturing TFP growth at 6½ percent per year on average between 2002 and 2007. Bosworth and Collins’ (2007) industry TFP growth during 1993–2004 averages 6.2 percent per year.

The countries covered are Australia, Brazil, France, Germany, India, Japan, the Netherlands, Poland, the Russian Federation, the Republic of Korea, Sweden, the United Kingdom, and the United States. Each study analyzes 6 to 13 industries and compares their performance with that of the same industries in a subset of other countries. These are detailed studies of individual businesses spanning “state-of-the-art auto plants to black-market street vendors.”

Conway and others (2010) attribute this fast-paced improvement to reforms in the new company law and the new bankruptcy law, which help reduce the time needed to register or close a business, increase the recovery rate from bankruptcy, and reduce the minimum amount of capital needed to start a firm.

For instance, services, such as legal and accounting, maritime and air transport, and the postal sector could benefit from foreign providers through higher foreign direct investment (FDI) if restrictions on form of ownership, maximum equity stake, and geographic scope, and line of business restrictions as well as minimum capital requirement (not equally imposed on domestic competitors) were to be removed (OECD, 2009). Currently, much of the services sector FDI goes into real estate and banking, which is gradually opening up.

Despite the stated intention to open up these sectors to private investment, they are still dominated by public enterprises.

World Bank (2011) ranks China 79th out of 183 economies for overall “ease of doing business,” and rates China unfavorably on obstacles to “starting a business” (rank 151th out of 183 economies), “dealing with construction permits” (rank 181st) and “investor protection” (rank 93rd).

The model is developed in detail in Ahuja (2012).

See Ahuja (2012) for details.

Examples of these included services are home or market production of goods and services such as bicycle repair shops, hair salons, restaurants, and the like in developing countries.

The assumption that entry costs increase in proportion to population size (which is also the size of the coalition) also ensures that all results are population-size invariant.

The coalition will also set work practices and the wage rate so that equilibrium price equals marginal cost at every competing low-technology firm. The combined choice of work practices and wage rate set by the coalition must be consistent with an equilibrium condition that the nominal wage paid to a worker at a low-technology firm has to equal that worker’s marginal revenue product.

To allow for direct comparison across economies, a common set of “international prices” is calculated and used to compute real GDP at PPP and their values are compared, based on the Geary-Khamis method (Kravis, Heston, and Summers, 1982).

This calculation uses capital shares of 0.5 and 0.36 for China and the United States, respectively.

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