The allocative and welfare effects of disrupting supply chains: The case of local content requirements in China

Abstract

Local content requirement (LCR) protects local interests and disrupts buyer-supplier chains since it requests local firms to buy the outputs of other local firms as inputs. Hence, it affects firms' location choices, as buyer-supplier chains affect cost-effectiveness. I find that LCR shapes the spatial distribution of firm entry and exit through this mechanism. Favoritism by local career-driven leaders under economic decentralization is the driver of the effects. A novel spatial quantitative model indicates that eradicating LCR enhances welfare, by reducing mismatch between buyers and suppliers and mismatch between firms and locations.

Keywords: local protectionism, production networks, spatial allocation of firms, favoritism, internal trade barrier, non-cooperative game, welfare

JEL Classification: D22, D73, F13, L5, L14, L98, P16