Government Procurement and Resource Misallocation: Evidence from China

Abstract

Government often acts as the largest buyer in an economy through government procurement. The allocation of procurement order however is often distorted. We build a model with heterogeneous firms endogenously seeking government favors in procurement to show that misallocation of procurement orders further lead to misallocation of production factors. Using the enactment of the Chinese Government Procurement Law in 2003 as a natural experiment, we find that tighter regulation of procurement in China lowers the extent of resource misallocation in industries that rely more on government procurement. We further provide firm-level evidence in support of our model.

Keywords: government procurement, resource misallocation, corruption

JEL Classification: H57, O43, O47, O53