Trade in Equipment and Capital Quality: Evidence from the Sino-Soviet Split

April 3, 2011 Abstract How does access to imported capital goods affect the quality of investment in poor countries? From 1949 to 1957, China imported most of its industrial plants from the Soviet Union, but in the late 1950s a series of political disputes ended their trading relationship. In 1960, China entered a period of autarky which persisted until 1978. In market settings, closure to capital goods imports should increase the investment-consumption price ratio. However, state-set prices barely moved from 1952 to 1978. When prices are fixed, quality changes provide an alternative adjustment mechanism. I analyze plant-level data for the iron and steel industry covering 1949 to 1978 to assess how the trade shock affected the quality of investment. Using a production function in which imported and domestically-supplied investment enter as perfect substitutes with different implicit prices, I estimate that the shift to domestic sources of capital goods increased investment costs by a factor of 10. The findings suggest that autarky severely constrained Chinese capital accumulation and income growth.