Growing Like China∗

We construct a growth model consistent with China’s economic transition: high output growth, sustained returns on capital, reallocation within the manufacturing sector, and a large trade surplus. Entrepreneurial firms use more productive technologies, but due to financial imperfections they must finance investments through internal savings. State-owned firms have low productivity but survive because of better access to credit markets. High-productivity firms outgrow low-productivity firms if entrepreneurs have suffi ciently high savings. The downsizing of financially integrated firms forces domestic savings to be invested abroad, generating a foreign surplus. A calibrated version of the theory accounts quantitatively for China’s economic transition. (JEL: F43, G21, O16, O47, O53, P23, P31) ∗We thank the two referees, Chong-En Bai, Francesco Caselli, Chang-Tai Hsieh, Yikai Wang, and Xiaodong Zhu for comments. We also thank participants at the LSE conference on "The Emergence of China & India in the Global Economy" (July 3—5 2008), the China Economics Summer Institute 2009, the 2009 Minnesota Workshop in Macroeconomic Theory, and the 2009 Tsinghua Workshop in Macroeconomics, and seminar participants at various departmental seminars. Financial support from the European Research Council (ERC Advanced Grant IPCDP-229883), from the Swiss National Science Foundation (100014-122636), from the Research Council of Norway (162851, 179522 ESOP, and 183522), from the 985 platform at Fudan, the Social Science Foundation of China (06CJL004) and the Natural Secience Foundation of China (70703006) are gratefully acknowledged. Any views expressed here are those of the authors and not those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System.