An Application of the Melitz Model to Chinese Firms

When the Melitz model is implemented in practice, the industrial productivity distribution is often assumed to be of Pareto form. In this case, a fundamental relationship κ > σ − 1must hold to guarantee the convergence of the industrial average productivity, where κ is the concentration degree of the industrial productivity Pareto distribution and σ is the substitution elasticity across varieties in the industry. This paper estimates the concentration degrees of the Pareto distribution in industrial productivity and industrial substitution elasticities using firm-level data of 40 Chinese manufacturing industries from 1998 and 2007. However, the paper shows that the above fundamental assumption κ > σ− 1 does not hold for nearly all the industries for Chinese firm-level data. An explanation is proposed due to the distorted firm size and productivity for Chinese characteristics.