Investment Frictions and theAggregate Output Loss in China*

Investment frictions reduce, delay or protract investment expenditure that is necessary for firms to capture growth opportunities. Using an investment model with capital adjustment costs, this article estimates the gap betweenChina’s actual and frictionless aggregate output. It applies the method of simulated moments to a fully structural investment model on a panel of Chinese firms and takes into account potential unobserved heterogeneities and measurement error in the data.The estimated capital adjustment costs imply that if Chinese firms had faced a lower level of adjustment costs such as in theUS,China’s aggregate output would be 25% higher.