Gains from Targeting? Government Subsidies and Firm Performance in China

This paper studies the firm-level impact of the world’s largest targeted capital import subsidy program implemented in China. Drawing on rich manufacturing firm survey data, product-level trade transactions, and a comprehensive list of capital goods eligible for subsidies, we exploit variation in firms’ exposure to the subsidy program to assess its impact on credit access, investment, sales, and trade. We find that a one-standard-deviation increase in a firm’s exposure to the subsidy leads to a 0.03% increase in total borrowing and a 0.05% reduction in financing costs. These financial benefits translate into substantial real effects, including a 0.15% rise in investment and a 1.39% improvement in the marginal revenue product of capital. The program’s benefits persist over time and are especially pronounced for financially constrained firms and non-state enterprises, indicating that targeted import subsidies can effectively alleviate market frictions and foster industrial development.

Non-Technical Summary

Governments often use subsidies to encourage specific economic activities, such as importing advanced technology to boost domestic capabilities. China implemented such a programme in late 2007, aiming to enhance firm productivity and technological development by reducing the cost of importing high-tech machinery not produced domestically. The policy offered support to all firms operated in mainland China regardless of their ownership through low-interest loans from policy banks and rebates on interest costs for qualifying imports, with eligible products listed in a government catalogue that was updated over time. Evaluating the real-world effectiveness of such targeted industrial policies is crucial for understanding their impact and informing future policy design.

To assess the programme’s impact, this study uses detailed data covering thousands of Chinese manufacturing firms from 2002 to 2013. A firm’s exposure to the policy is measured using the composition of its capital goods imports before the policy began in late 2007. Firms that imported more of the types of equipment later targeted by the subsidy were more likely to benefit once the programme was implemented. By comparing the post-policy performance of firms with different levels of pre-policy exposure, while controlling for other internal and external factors’ the analysis isolates the causal effects of the subsidy programme.

The results show a clear positive impact of the import subsidy programme on firms that were more exposed to it. These firms increased their borrowing and invested more heavily in capital equipment compared to those with lower exposure. This investment translated into improved performance: firms became more productive by generating more output, and they became more profitable. They also expanded their operations, hired more workers, and paid higher wages.

However, the benefits were not evenly distributed. Firms that likely faced greater credit constraints before the policy, especially non-state-owned enterprises, experienced larger gains than state-owned firms, which generally have better access to finance. This suggests that the subsidy was particularly effective in easing financial frictions for firms. The analysis also shows that firms benefited more the longer they were exposed to the policy, although the positive effects tended to level off over time, indicating diminishing returns.

The findings suggest that well-targeted industrial subsidies, specifically those focused on specific products (like advanced capital equipment) rather than favouring particular firms, can be an effective tool for easing financial constraints and promoting firm growth domestically. By reducing the cost of acquiring productivity-enhancing capital, this Chinese programme successfully stimulated investment and improved multiple dimensions of firm performance, especially for financially-constrained enterprises. This experience offers valuable insights into how industrial policy can be designed to effectively support and economic development.

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