Road investment and inventory reduction: Evidence from a large developing economy∗

Using information on firms’ inventory, we introduce a novel approach to estimate the causal effect of transport infrastructure on the economy. We apply this approach to China, where the length of road has tripled and the inventory-sales ratio has declined by three quarters since 1978. Our identification tests suggest that these two phenomena are causally linked (with data covering medium and large manufacturers in China): the road investment has contributed to a half of the decline of raw material inventories since 1998. The saved capital is equivalent to 1.25 percent of industrial output. The implied return is comparable to that of the US in the 1980s. This effect has occurred through two channels: reducing inventory within firms and increasing the share of firms with more efficient inventory management. Moreover, evidence suggests strong spillover effect of road investment on firms in neighboring provinces. JEL classifications: H54, R3, R4