Firm Productivity and the Current Account: One Country with Two Financial Markets∗

This paper relates China’s current account surplus, as well as productivity differential between state-owned (SOEs) and privately-owned enterprises (POEs), to differences in access to finance. I consider an open-economy DSGE model of the Chinese economy with two productive sectors. I model SOEs and POEs as start-ups which need to borrow in order to begin production. Following a policy-induced asymmetric shock to the borrowing constraints, SOEs are on average less productive than POEs. Because of the lower hurdle rate for investment they face, SOEs end up creating more investable assets than POEs, while, due to more constrained credit availability, POEs save more and invest less than SOEs. In aggregate, this simple mechanism implies investment (driven by less productive SOEs) does not keep up with savings (driven by more productive POEs), resulting in a current account surplus. Furthermore, the savings of Chinese POEs owners in search of investable foreign assets put downward pressure on the world long run real interest rate. Earlier literature either discusses China’s current account and productivity differentials separately, or assumes one phenomenon to explain the other. My paper shows that they could jointly be explained in general equilibrium by preferential access to credit for government backed firms. JEL CLASSIFICATION: E44,F14,F32 ∗With ineffable thanks to my supervisors Danny Quah and Oliver Linton for their encouragement and support throughout my research at LSE. I thank Kevin Sheedy for advice on this paper. I also thank Pol Antras, Gianluca Benigno, Giancarlo Corsetti, Wouter Den Haan, Mathias Hoffmann, Marcel Fratzscher, Rodrigo Guimaraes, Athar Hussain, Patrick Imam, Keyu Jin, Ruth Kattumuri, Nobuhiro Kiyotaki, Kalina Manova, Albert Marcet, Gian Maria Milesi-Ferretti, Stephen Millard, Maurice Obstfeld, Emanuel Ornelas, Matthias Paustian, Ricardo Sousa, John Sutton, Giuseppe Vera, Alwyn Young, and seminar participants in LSE, Bank of England and Deutsche Bundesbank for the many discussions, comments and suggestions that have improved this paper. All remaining errors are my own. †Department of Economics and Asia Research Center, London School of Economics and Political Science, Houghton Street, London WC2A 2AE, United kingdom. email: [email protected]