The dynamics of provincial growth in China: a nonparametric approach.

Since the start of economics reforms in 1978, China's growth record has been impressive, but the contribution of its provinces to per capita income growth has been highly uneven. (See, for example, Dayal-Gulati and Husain, 2002 and Aziz and Duenwald, 2003.) Although average annual growth of real per capita GDP has picked up across all regions, coastal provinces have tended to grow faster than northern and western provinces. According to Aziz and Duenwald (2003), real GDP per capita in coastal provinces, such as Fujian, Guangdong, and Zhejiang, grew at an average annual rate of twice that of western provinces, such as Gansu, Ningxia, and Qinghai, during 1978-97. The dispersion of growth rates has not been purely a reflection of different stages of development. Indeed, among the initially poorer provinces those in the west have fallen further behind, while those on or near the coast have caught up with or even surpassed provinces that had the highest per capita incomes at the start of economic reforms. This uneven performance has been reflected in a growing income disparity across regions, posing a key challenge to policymakers in Beijing.

Several studies investigating the differences in economic performance across China's provinces conclude no tendency toward absolute convergence in terms of real per capita GDP over the past two and a half decades. Bell, Khor, and Kochhar (1993) and Jian, Sachs, and Warner (1996) find that income dispersion has declined between 1981 and 1990 as poorer provinces tended to grow faster than richer ones. When the sample period is extended, this result does not hold. The absence of absolute convergence among China's provinces is in contrast with the behavior of U.S. states, Japanese prefectures, and selected regions in western Europe, where absolute convergence appears to be the norm rather than the exception over extended periods of time (Barro and Sala-i-Martin, 2004).

However, there is evidence of conditional convergence, with provinces converging to unique steady states distinguished by structural factors and preferential economic policies, which have been part of China's dual-track approach to economic reforms. Demurger and others (2002) find that, after controlling for openness and proximity to fast-growing economies in East Asia, growth in coastal provinces benefits significantly from preferential policies, which have fostered marketization and internationalization. Dayal-Gulati and Husain (2002) show that the prevalence of state-owned enterprises and a high ratio of bank loans-to-deposits--an indication of large directed lending--are often associated with lower growth. They also find that the coastal and north/northeastern regions were able to attract more foreign direct investment (FBI) because of their relative prosperity and more developed infrastructure, which contributed to the high growth rates of these regions.

Previous studies explore the dynamics of provincial growth using the augmented Solow model. However, in this paper, we examine the evolution of three components of labor productivity growth: efficiency gains (movements toward the production frontier), technological progress (outward shifts of the production frontier), and capital deepening (movements along the production frontier). This decomposition allows us to investigate how the dynamics of each component affect the growing income disparity across provinces.

For our analysis we use a nonparametric technique known as Data Envelopment Analysis (DEA), pioneered by Farrell (1957) and Afriat (1972). For a given date in our sample period, we construct a production frontier for China as a whole using all observed input-output combinations at the provincial level. The inputs are capital and labor, and the output is GDP. After identifying the frontier, we can measure the efficiency level of each province with respect to the frontier. Having determined the evolution of capital-labor ratios and efficiency indices for each province, we can derive the contribution of technological progress to labor productivity growth in each province.

Using DEA has several advantages over standard growth accounting. First, in this approach the production frontier is directly constructed from the data. Hence, we do not have to impose any restrictions other than a functional form that satisfies a constant returns to scale technology. Second, our approach allows us to identify separately the contributions of efficiency and technological improvements to productivity growth. Finally, our approach does not impose any kind of structure on markets, whereas in the standard growth accounting framework it is assumed that markets are competitive. This assumption is possibly critical in the case of China, where government regulation of markets is still extensive.

Our results can be summarized as follows. First, labor productivity growth in China's provinces has largely been driven by capital deepening. In particular, we find that on average capital deepening accounts for about 75 percent of total labor productivity growth, whereas efficiency and technological improvements account for about 7 and 18 percent, respectively. The capital deepening is also the driving factor behind the changes in the distributional dynamics of the labor productivity over the past two decades. Second, technical change is not (Hicks) neutral. Third, while improvement in efficiency supports convergence in labor productivity between provinces, technical change contributes to productivity disparity across provinces. Finally, we find that FDI has a positive and significant effect on efficiency growth and technical progress.