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Journal of Chinese Economic and Foreign Trade Studies

Economic growth and resource allocation: the case of China


Kar‐yiu Wong,
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of Chinese Economic and Foreign Trade Studies, Vol. 1 Issue: 2, pp.105-121, https://
doi.org/10.1108/17544400810885933
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Growth and
Economic growth and resource resource
allocation: the case of China allocation
Kar-yiu Wong
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Department of Economics, University of Washington, Seattle, 105


Washington, USA

Abstract
Purpose – This paper aims to examine the factors of growth of a developing country such as China.
Because of the existence of domestic distortions, the traditional approach of using the growth of gross
domestic product (GDP) to represent economic growth of the economy is not appropriate. This paper
seeks to estimate how a change in resource misallocation may affect the measured growth rate of GDP.
Design/methodology/approach – Using provincial data for four southern provinces of China for
the years from 2000 to 2004, the paper considers two hypothetical cases, one in which labor allocation
is fixed, and one in which labor allocation is assumed to be optimal both before and after growth. The
growth factors for GDP in these two hypothetical cases are compared with the observed growth
factors.
Findings – This paper argues that the growth rate of GDP has overestimated the growth rate of the
economy in this period. It can thus be said that the degree of the distortion caused labor misallocation
decreases over time in this period.
Research limitations/implications – Because of limitations of data, this study treats each
province as one sector, producing one homogeneous product, although the same methodology can be
applied to more than one sector in each province. Furthermore, the present work assumes constant
external prices.
Practical implications – The present study shows the importance of removing distortions in the
economy, and how an improvement in the efficiency may raise the GDP of the economy.
Originality/value – The methodology and approach introduced here are quite new and are useful in
assessing the implications of distortions on production and welfare.
Keywords Economic growth, Gross domestic product, Production management, Process efficiency,
Labour mobility, China
Paper type Research paper

1. Introduction
China opened up its economy to the rest of the world at the end of the 1970s. Since then,
its economy has been growing spectacularly, with growth rates much higher than the
corresponding world’s averages. The gross domestic product (GDP) of China grew
from US$183 billion (at constant US$2,000) in 1980 to US$ 1,885 billion in 2005, with a
compounded annual growth rate of 9.78 percent. The annual growth rate over this
period was much higher than that of the world as a whole. For example, the GDP of the
world grew from US$ 17,623 billion (also at constant 2000 US dollar) in 1980 to US$
36,411 billion in 2005, which implies a compounded annual growth rate of 2.95 percent.
With these high growth rates, the percentage of the Chinese economy in the world Journal of Chinese Economic and
economy has increased from 1.04 percent in 1980 to 5.18 percent in 2005. What is more Foreign Trade Studies
Vol. 1 No. 2, 2008
impressive is that the growth of the Chinese economy has been nearly uninterrupted, pp. 105-121
even during the years when many other Asian economies were hit hard by the Asian q Emerald Group Publishing Limited
1753-4408
financial crisis[1]. DOI 10.1108/17544400810885933
JCEFTS The growth of an economy refers to an expansion of its production possibility set
1,2 (PPS). However, since the PPS is not observable, it is natural to express economic
growth in terms of the growth rate of some observable variables such as GDP or per
capita GDP[2]. The question is, if the objective is to determine the growth of an
economy, is the use of the growth rate of GDP an appropriate approach? In other
words, could the growth rate of GDP overestimate or underestimate the growth of the
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106 economy?
To answer the above questions, it is important to note that the use of the growth
rate of GDP is sensitive to the pre- and post-growth commodity prices. For example, in
theoretical analysis, it is usually assumed that domestic (and also international) prices
do not change in the period considered, but this assumption is usually not valid,
especially if period of time considered is sufficiently long[3]. Furthermore, even if
domestic and international prices are constant, the growth rate of the GDP will depend
on what the prices are. Choosing a different set of prices could give a different growth
rate of the GDP.
In this paper, we argue that if domestic distortions are present so that production is
not efficient, the use of the growth rate of an economy’s GDP to represent the
economy’s growth is even more unreliable. Based on our analysis, explained in more
detail in the next section, one needs to be careful when trying to measure the growth of
the Chinese economy, because, like many other developing countries, domestic
distortions are common and widespread[4].
In this paper, we try to provide an answer to the above question by focusing on a
distortion that is considered to have substantially affected the production of the
economy. It is the inefficient allocation of resources (including labor and capital).
Before the opening up of its economy, the Chinese government had strict restrictions on
the movements of capital and labor across firms, sectors, and geographical locations.
As the government permitted more and more trade and other economic relations with
other countries, it was also liberalizing the movements of labor and capital.
Furthermore, as the economy grew, the government was loosening its control on the
movements of the primary factors. Nowadays, workers have more freedom and choice
in terms of taking up a job in another firm, another industry, or even another city,
either legally or illegally. At the same time, capital owners can more easily move their
capital to other places. It is also important to note that previous growth of the Chinese
economy occurred in a very uneven way, in terms of both industries and locations.
This uneven growth of the economy thus creates bigger incentive to primary factors to
move. The resulting movements of factors help shift the production point closer to the
production possibility frontier.
This paper examines the growth factors of the Chinese economy from 2000 to 2005,
and the contribution of more efficient resource allocation to the growth of the economy.
The Chinese government publishes statistical yearbooks and census statistics of 27
provinces and four municipalities/cities: Beijing, Tianjin, Shanghai, and Chongqing[5].
The statistical yearbooks provide statistical data for estimating the aggregate
production functions of the provinces and cities.
The estimated production functions can be used to determine the output levels in
two hypothetical cases:
(1) Fixed resource allocation (FRA). In this case, the labor and capital endowments
in various provinces and cities in the year 2000 are used as bases, and then all
provinces and cities are assumed to have the same growth rates in the period for Growth and
labor and capital in 2001 to 2005. This case is used to find out how resource resource
allocation in the previous years may have contributed to the economic growth
of different provinces and cities. allocation
(2) Optimal resource allocation (ORA). In this case, factors are assumed to be
redistributed among the provinces and cities in each of the years to maximize
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the aggregate GDP of the economy at given commodity prices. The production 107
of the provinces and cities are then re-estimated, and the production points are
efficient. The growth rates of the provinces and cities are then better measures
of the economic growth of the economy.

In this paper, we will develop a methodology to estimate resource allocation and


economic growth in the above two hypothetical cases. In the present exercise, we will
focus on the following four provinces: Guangdong, Guangxi, Hunan, and Yunnan[6].
These four provinces are located in the southern part of China, and the first three are all
adjacent to each other, while Yunnan has a common border with Guangxi.
The rest of the paper is organized as follows. In Section 2, we argue that in the
presence of distortions on the production side of an economy, the common practice of
using the growth rate of its GDP to represent the economic growth rate of the economy
is misleading. Section 3 explains the methodology used in this paper to estimate the
growth rate of an economy when the distortion present is the misallocation of
resources. It is one of the distortions present in the Chinese economy, and one that the
government is taking steps to reduce after its decision to liberalize its economy. Two
approaches will be suggested and explained: the FRA approach and the ORA
approach. A way to simplify the computation procedure in the estimation of ORA
approach has been suggested. Section 4 explains the estimation used in this paper.
Section 5 presents and analyzes the results. Section 6 concludes.

2. The theoretical background


Economic growth of an economy refers to the expansion of its production possibility
set, as a result of accumulation of primary factors such as labor and capital (physical
and human), or improvement of production technologies. However, because the
production possibility frontier (PPF) of an economy is not observable, economic growth
is usually measured in terms of the growth rate of some observable variables such as
real GDP or real per capita GDP. Such practice is acceptable if the production of the
economy is efficient. Figure 1 shows such a case of a two-sector economy. Curve SS is
the original PPF. Suppose now that the economy grows with more primary factors or
technological progress so that its PPF expands to TT. How can the growth of the
economy be measured?
Suppose that the price ratio faced by the economy before and after the growth is
represented by the (negative) slope of lines AB and CD[7]. Line AB is tangent to the
pre-growth PPF at point Q 1 while line CD is tangent to the post-growth PPF at point
Q 2. Suppose further that the pre-growth production point of the economy is Q 1 while
the post-growth production point is Q 2. Then lines AB and CD represent the values of
GDP before and after the growth. In this case, the growth rate of the economy’s (real)
GDP, which is equal to BD/OB, is a good measure of the expansion of the PPF, and thus
a good measure of the economic growth.
JCEFTS
1,2
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108

Figure 1.
Measurement of economic
growth

The above GDP approach, which assumes efficient production points, is more
applicable to developed countries. This approach has been used in a number of
empirical studies of the factors of economic growth. For developing countries such as
China, however, this approach may not be so appropriate. The main reason is that the
economies of developing countries usually involve many distortions, and production
points are most likely not efficient. To see how the presence of distortions may distort
the measurement of economic growth, suppose that the observed pre-growth
production is represented by R 1 in Figure 1 while the post-growth production by R 2.
Both production points are below the corresponding PPF, thanks to the distortions. In
this case, the pre-growth GDP of the economy is represented by line EF, while the
post-growth GDP of the economy is represented by line GH. The observed growth rate
of the GDP is equal to FH/OF and can be measured empirically. However, the growth
rate of the GDP is in general no longer a good measure of the economic growth rate of
the economy. In particular, if the distortions present in the economy are diminishing so
that the production point is getting closer to the PPF, then the measured growth rate of
the GDP will overstate the growth rate of the economy:
FH BD
. : ð1Þ
OF OB
The difficulty of applying the above GDP approach to measure the growth of the
economies of developing countries is that distortions and market failure are common in
these economies. Then the important question is: How can the growth rates of these
economies be measured? It is also interesting and important to know how the change in
distortions may have affected the observed growth rates when the growth rates of GDP
are used.
If the distortions that lead to inefficient production in an economy can be identified
and somehow measured, this paper suggests two alternative approaches to measuring
the growth of the economy, both of which require a careful estimation of two
hypothetical cases. The first approach assumes that the magnitude of a distortion
remains fixed during economic growth. Then the growth rate of some observable Growth and
variables is determined and used to represent the growth rate of the economy. The resource
second approach is to examine another hypothetical case, in which the distortions are
removed. The growth rates of some appropriate variables such as GDP and per capita allocation
GDP are then measured and used to represent the economy’s growth.
In the first approach, even if the distortions can be identified and fixed, the
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measured growth rate of an observable variable may not be the same as that of the 109
economy, although it attempts to minimize the impact of the distortions. The second
approach will give us an appropriate measure of the growth of the economy, but it is
more difficult and requires more information.
In the present paper, we focus on one type of distortion: misallocation of resources,
especially labor, among sectors. This type of distortion is regarded to be severe and
widespread in China because of the government’s traditional restrictions on internal
migration. After China opened up its economy to the rest of the world, the government
took gradual steps to remove or reduce some of the restrictions on labor migration.
Furthermore, the rising gap between the per capita income levels of different geographic
locations and different industries had led to bigger and bigger incentives to workers to
move, legally or illegally, to places with more and better-paid job opportunities. Overtime,
labor migration has been increasing. Therefore it is believed that the magnitude of the
distortion caused by inefficient labor allocation is decreasing, and because of this, the
observed growth rate of GDP tends to overstate the growth rate of the economy[8].
The objective of this paper is twofold:
(1) To identify the two factors of the observed growth of GDP: the expansion of the
PPF and the rise in factor mobility.
(2) To measure the true growth rate of the economy. To achieve this objective, we
first need to determine how labor and capital should be allocated optimally. The
resulting growth rate of aggregate GDP can be interpreted as the growth rate of
the economy.

3. Methodology
Suppose that there are N sectors in the economy. In each of them, a homogeneous
product is produced using two primary factors, labor and capital, and the following
production function:
 
Y i ¼ f i hi L i ; K i ; A ; ð2Þ

where Li and Ki are the labor and capital inputs, respectively, hi the amount of human
capital, and Ai a technological index in sector i, i ¼ 1, 2, . . . , N. In the production
process, hiLi can be interpreted as the effective labor input. The production function is
assumed to be linearly homogeneous and increasing in effective labor and capital,
concave, and stationary over time[9]. Totally differentiate both sides of (2) and
rearrange the terms to give:
 
^ i;
Y^ i ¼ fiL h^ i þ L^ i þ fiK K^ i þ fiA A ð3Þ

where the operator “ˆ” represents the percentage change of a variable, and fji is the
output elasticity of input j; for example, Y^ i ; dY i =Y i and fKi ; ð›Y i =Y i Þ=ð›K i =K i Þ.
JCEFTS Equation (3) explains the factors of growth of the sector’s output. If the production
function is known and statistical data are available, one can estimate these growth
1,2 factors. Since the technology index is not observable, it is measured as a residual:
 
^ i ¼ Y^ i 2 fiL h^ i þ L^ þ fiK K^ i :
a^ ; fiA A ð4Þ
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110
One can extend this approach to the whole economy, with the aggregate output (real
GDP) defined as
!
X
N
Y¼ pi Y i =p; ð5Þ
i¼1

where p is a price index[10]. As explained, in the presence of distortions, the growth


rate of the aggregate output may not be a good measure of the growth of the economy.
In this paper, we examine how inefficient resource allocation may have affected the
growth of the Chinese economy. In particular, we want to estimate whether in the
presence of inefficient resource allocation, the observed growth rate measured in terms
of GDP is a good measure of the growth rate of the economy, where the latter
represents the expansion of the production possibility set. In the presence of factor
misallocation, two approaches to measuring the growth of the economy is suggested in
this paper. They can be termed the FRA approach and the ORA approach. In both of
these two approaches, we assume that only more efficient allocation of labor is
considered, while the observed capital stocks in the sectors are taken as given[11].

3.1. The FRA approach


Under this approach, a hypothetical case is considered in which the movement of labor
among sectors is not allowed. The sectors can still have changes in the amount of the
labor force due to, say, natural birth and death, but not through inter-sectoral labor
movement. If statistical data are available, one can consider in this hypothetical case
the reversal of all labor movement. If no reliable statistical data are available, an
approximate case can be considered in which the shares of the labor force in the sectors
remain fixed as those in the base year. In other words, the sectors keep the same shares
of the total labor force over time. The outputs of the sectors and thus the aggregate
output are then estimated, and the growth rates of the outputs are compared with the
observed growth rates. Any difference between these two sets of growth rates can be
attributed to the expansion of the PPF of the economy.
This approach will be easier to carry out, especially fixing the labor shares at those
in the base year. However, the resulting growth rates of the aggregate output may not
be the same as the growth rate of the economy because efficient labor allocation may
require something different from fixed labor shares.

3.2 The ORA approach


Another approach is to consider an alternative hypothetical case in which labor is
distributed among the sectors optimally both before and after a growth. The resulting
outputs of the sectors and thus the aggregate output are then determined. Since labor is
allocated optimally, the growth rate of the aggregate output can be interpreted as the
growth rate of the economy. The most difficult job using this approach is to find out Growth and
how labor should be optimally re-distributed. resource
To determine efficient allocation of resources, let us try to maximize the GDP of an
economy, i.e. allocation
X
N
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max pY ¼ pi Y i ; ð6Þ 111


i21

subject to the given amounts of sector-specific capital stocks and

X
N
Li ¼ L; ð7Þ
i21

by choosing L1, L2, . . . ., LN, where L is the given labor endowment. Differentiate both
sides of (6) with respect to Li, using constraint (7), to give:
›Y i
pi ¼ l; ð8Þ
›L i
where l is the Langrange multiplier. The N equations in (8) plus the one equation in (7)
can be solved for the optimal labor distribution among the sectors[12]. This system can
be slightly simplified as follows. From equations (8), l can be eliminated, and the
remaining N 2 1 equations can be solved for the N 2 1 labor inputs, with the last
labor input obtained from (7).
The above way to determine the optimal labor allocation, however, could be difficult
if the number of sectors is big because the equations in (8) is usually highly non-linear.
There is an alternative way, described as follows.
First, with efficient allocation of labor, denote the unit cost function of sector i by
ci ¼ ci ðw; r i ; K i ; Bi Þ, where w is the wage rate (i.e. the amount each unit of labor
receives), ri the rental rate of capital in the sector, and Bi the technology index, which is
related directly to Ai and the amount of human capital, hi. Note that the unit cost
function of each sector depends not only on Ai and the amount of human capital, but
also on the sector-specific capital. Note further that with efficient (and optimal) labor
allocation, the wage rates in all sectors are equalized. The GDP function can be given
by:

  X
N  
g p; K; L ¼ min wL þ r i K i : ci w; r i ; K i ; Bi $ pi for all i; ð9Þ
i¼1

choosing the optimal values of {w; r 1 ; r 2 ; :::; r N }; where p ¼ ½p1 ; p2 ; :::; pN  and
K ¼ ½K 1 ; K 2 ; :::; K N . If all goods are produced, all the weak inequality signs in (9) are
replaced by equality signs. The first-order conditions are (assuming an interior
solution):

X
N  
L¼ mi aLi w; r i ; K i ; B ð10Þ
i¼1
 
JCEFTS K i ¼ mi aKi w; r i ; K i ; Bi ; ð11Þ
1,2 where aji is the amount of factor j used per each unit of output; mi is the Lagrangian
multiplier, aLi ¼ ›ci =›Li , and aKi ¼ ›ci =›K i . The system of equations can be
simplified as follows. First, from equation (11), mi can be expressed as:
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112 Ki
mi ¼  : ð12Þ
aKi w; r i ; K i ; Bi
 
Second, using the zero-profit condition, ci w; r i ; K i ; Bi ¼ pi , we can express the rental
rate in sector i as follows:
 
r i ¼ r i pi ; w; K i ; Bi : ð13Þ
Substitute (12) and (13) into (10), we have:
   
X N
K i aLi w; r i pi ; w; K i ; Bi ; K i ; Bi
L¼     : ð14Þ
i¼1
aKi w; r i pi ; w; K i ; Bi ; K i ; Bi

In equation (14), there is only one unknown, w, when given the factor endowments and
the output prices. It can be solved for the equilibrium wage rate, w.
~ Once this wage rate
is obtained, the optimal labor allocation and the resulting outputs can be obtained.
The advantage of the way as described by equation (14) is that it is much simpler
because the number of equations to be solved is equal to the number of mobile factors,
M. In the previous approach as represented by (7) and (8), the number of equations to
be solved is equal to (the number of sectors minus one) multiplied by the number of
mobile factors, M ðN 2 1Þ.

4. The estimation
The present project covers four southern provinces in China, Guangdong, Guangxi,
Hunan, and Yunnan. This paper examines the growth of these four provinces and the
role of resource allocation on output and economic growth.

4.1. Some basic information of these four provinces


Guangdong is next to Hong Kong, and has been the gateway for many years for
foreign investors and business people to the southern part of China. Since China
opened up its economy to the rest of the world at the end of the 1970s, Guangdong has
been given a lot of economic freedom and flexibility. Being the only province in China
with three special economic zones, Shenzhen, Zhuhai, and Shantou, Guangdong has
received a lot of foreign direct investment and has been trading intensively with other
countries. Its prosperity and development have not only greatly improved the income
of local people but also attracted workers from neighboring provinces. Hunan is the
province on the north side of Guangdong while Guangxi is on Gunagdong’s west.
Yunnan is on the other side of Gunagxi, the only province covered in this study not
sharing a common border with Guangdong. Both Yunnan and Hunan are inland
provinces, with no access to the sea.
Table I presents some basic economic information about these provinces from in
2004. Yunnan is the biggest province while Guangdong is the smallest, yet Guangdong
Growth and
Guangdong Guangxi Hunan Yunnan
resource
Area, sq. km 117,900 236,700 211,800 394,100 allocation
Population, million 83.0 48.9 67.0 44.2
Real GDP, billion yuan 384.6 80.6 123.5 77.6
Employed people, million 46.8 26.5 37.5 24.0
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Capital stock, billion yuan 2,912.70 1,383.70 930.20 940.4 113


Average education years 8.24 7.93 7.25 6.70
Note: These are 2004 figures, except for the population of Guangdong (2005) Table I.
Sources: Statistical Yearbooks of the provinces; Wikipedia, the online encyclopedia; author’s Basic information of the
calculation four provinces

is the most populous while Yunnan has the smallest population. Similarly, Guangdong
has the biggest labor force[13].
Guangdong has the largest amount of capital stock, thanks a lot to the inflow of
foreign direct investment, mainly from Hong Kong. Its capital stock is more than twice
of that in the next one, Guangxi. The sizes of the capital stock in Hunan and Yunnan
are comparable and less than one third of that in Guangdong. Guangdong also has the
highest level of human capital, as measured by the average education years. The
educational level in Yunnan is the lowest.
Despite its size in terms of area, Guangdong has the biggest economy, with its real
GDP much higher than those in the other provinces. The ratio of Guangdong’s output
to those of the other provinces is higher than the corresponding ratios as expressed in
terms of labor force, showing the higher productivity of the labor force in Guangdong.

4.2. The model


We assume that each of these provinces produces a homogeneous product using labor
and capital. Within each province, labor and capital are employed efficiently, but
across provinces, labor is not allocated efficiently. Capital is sector specific, and we
assume that the capital stocks in the sectors are given exogenously[14]. The prices are
also given exogenously. This means that labor reallocation will not affect the amounts
of capital stocks in the sectors and the price levels.
We first hypothesize that the production function of sector i is given by

Y i ¼ Ai ðhi LÞai K 12
i
ai
; ð15Þ

where the variables are defined in equation (2), and the capital stock is given
exogenously. Since we allow the possibility that the technology may be improved over
time, and because only statistical yearbooks for these four provinces are available
online for five years, 2000 to 2004, we avoid estimating the production function using
any econometric techniques[15]. For each province, variable ai is assumed to be the
percentage of labor compensation in the sum of the payments to labor and capital
depreciation in the province over these years[16]. The amount of human capital is
given the following formula

hi ¼ ð1:07Þsi ð16Þ
JCEFTS where si is the average education level in the province. The capital stock is computed
using the perpetuality method, assuming an annual depreciation rate of 5 percent and
1,2 using the series of investment on fixed assets from 1978. The capital stock is then
deflated by the price index of investment on fixed assets[17]. The output is the GDP at
current prices, deflated by the general retail price index with 1978 as the based
year[18].
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114 For these provinces for the years from 2000 to 2004, the values of Yi, Li, hi, and Ki
can be computed or estimated. So the value of Ai is obtained from equation (15):
Yi
Ai ¼ : ð17Þ
ðhi Li Þai K 12
i
ai

The technology index obtained in equation (17) is used to determine the outputs of the
provinces under the FRA and ORA approaches.
4.2.1. The FRA approach. Under this approach, labor is distributed among these
four provinces according to the observed percentages in 2000. In other words, it is
assumed that labor does not move across provinces from 2001 to 2004, and any labor
force increase will be distributed among the provinces according to their shares in
2000. Both the physical and human capital stocks in each sector remain unchanged.
The output is obtained by using the production function in (15). The new output series
of each province is then compared with the observed series in order to reveal the
impacts of resources allocation. The growth rates of the output levels are also
computed and compared with the observed ones.
4.3.2. The ORA approach. We first note that for sector i, the unit cost function
corresponding to the production function in (15) is equal to ci ¼ Bi w ai r 12
i
ai
; where:
" ai  12ai #
1 1 2 ai ai
Bi ¼ ai þ : ð18Þ
A i hi ai 1 2 ai

The labor-output and capital-output ratios of the sector are then given by:
 12ai
aLi ¼ ai Bi r i =w
 a
aKi ¼ ð1 2 ai ÞBi w=r i i :

The two first-order conditions (10) and (11) for the determination of the GDP functions
can be combined together to give:
X
N
ai r i K i
L¼ : ð19Þ
i¼1
1 2 ai w

Making use of the zero profit condition, (19) reduces to:


"  1=ð12ai Þ #
X N
ai K i pi 1
L¼ 1=ð12ai Þ
: ð20Þ
i¼1
1 2 a i B i w

Equation (20) is solved for the equilibrium value of w. Once it is obtained, the
corresponding distribution of labor and the outputs of the sectors can be determined.
5. Results Growth and
The growth factors of the output levels of these four provinces from 2000 to 2004 in the resource
following cases are presented below: based on the observed data, in the hypothetical
case in which there is no resource allocation, and in the hypothetical case in which allocation
resources are optimally allocated[19].
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5.1. The observed case


115
Table II presents the growth rates of these four provinces and the contributions of each
of the factors. For example, in panel (a), the growth rates of Guangdong and the
contribution of each of the growth factors are presented. From 2000 to 2001, the output
of Guangdong grew at a rate of 11.65 percent, of which 3.67 percent was due to capital,

2001 2002 2003 2004 2000-2004

(a) Guangdong
Y^ 11.65 11.90 16.11 14.40 13.50
ð1 2 aÞK^ 3.67 3.68 3.50 2.53 3.34
aL^ 1.29 1.39 4.72 4.85 3.04
ah^ 0.31 0.32 0.36 0.35 0.33
A^ 6.37 6.51 7.54 6.66 6.78
(b) Guangxi
Y^ 11.28 12.18 11.17 16.83 12.84
ð1 2 aÞK^ 3.16 3.65 3.78 3.26 3.46
aL^ 0.35 0.32 0.35 1.38 0.60
ah^ 0.42 0.45 0.48 0.45 0.45
A^ 7.36 7.76 6.57 11.74 8.34
(c) Hunan
Y^ 9.19 9.86 6.22 16.44 10.37
ð1 2 aÞK^ 3.40 3.32 2.77 2.05 2.88
aL^ 0.68 0.81 1.10 1.13 0.93
ah^ 0.47 0.47 0.49 0.52 0.49
A^ 4.64 5.27 1.86 12.73 6.07
(d) Yunnan
Y^ 7.84 9.68 10.55 14.66 10.65
ð1 2 aÞK^ 3.29 3.70 3.25 1.98 3.05
aL^ 0.88 0.60 0.38 1.53 0.85
ah^ 0.45 0.46 0.47 0.46 0.46
A^ 3.22 4.91 6.44 10.69 6.30
(e) Aggregate
Y^ 10.65 11.24 12.84 15.09 12.44
ð1 2 aÞK^ 3.45 3.55 3.30 2.42 3.18
aL^ 0.85 0.86 2.01 2.53 1.56
ah^ 0.41 0.42 0.48 0.46 0.44
A^ 5.94 6.41 7.05 9.68 7.26
Table II.
Notes: (i) Columns 2 to 5 give the growth rates of the province and the growth factors in these years Observed growth rates of
over the previous year, while the last column shows the compounded annual growth rates from 2000 to the provinces and growth
^ is calculated as a residual; i.e. it is equal to the observed growth rates of the province minus
2004; (ii) A factors, 2001-2004
the contributions of various growth factors; (iii) Aggregate represents the four provinces as a whole (percent)
JCEFTS 1.29 percent due to labor accumulation, while 0.31 percent due to human capital
1,2 accumulation. Technological improvement, which is the residual, is 6.37 percent. The
next three columns show the corresponding growth rates in 2002 to 2004 (annual rates
over the previous years). The last column gives the compounded annual growth rates
over 2000 to 2004 (four years).
The table compares the performance of the four provinces. It is clear that
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116 Guangdong had the highest growth rate of the real GDP. Another interesting feature is
that out of the 13.50 percent growth rate, more than 3 percent came from the labor
force, which was much higher than the corresponding contributions of labor force in
other provinces. The reason is obvious: Because of its higher growth rate and bigger
economic flexibility, Guangdong had been a magnet to labor force from other provinces
in China. The contribution of physical capital to Guangdong’s growth was also
significant, but what is a bit surprising is that Guangxi had experienced an even bigger
contribution from its capital stock. This seems to suggest that Guangxi had also
experienced substantial capital accumulation. Another feature of the table is that the
contribution of human capital to each province’s growth in these years was small as
compared with what other factors did. It is probably because human capital
accumulation through education takes much more time to have a significant impact on
growth.
We now examine how a region consisting of these four regions would grow over
these years. First, let us aggregate the variables. The aggregate output is the sum of
the nominal GDP deflated by a price index, which is the weighted average of the retail
price indices of these four provinces, with weights given by the share of the nominal
GDP. The aggregate labor force and the aggregate physical capital stock are the sum of
the corresponding stocks of the provinces. The average education years is the total
education years divided by the total labor force. The production function given by (15)
is again used to determine the contribution of each of the factors. The results are given
in panel (e) of Table II.
It is shown that the main contribution to the growth of this region is the residual,
which is often interpreted as technological progress. The contribution of physical
capital was around 3 percent, and that of labor was about 1.6 percent, while that of
human capital was less than 0.5 percent.

5.2. The FRA case


In this case, no labor movement was allowed in these years. Since no data about actual
labor movement among these provinces are available, we assume that the labor shares
of these provinces remained constant in these years. This means that over these years,
all provinces had the same labor force growth and no labor movement existed. In the
provinces, the capital stock, the average education years, and the technology index
remain unchanged. The present exercise is to investigate how the observed labor force
distribution may have affected the growth rates of the provinces.
Table III shows how the employment and resulting output levels in the present case
are compared with the corresponding observed levels. The numbers in the two panels
are the percentage changes of the employment/output levels from the observed levels.
A negative value, for example, represents a drop in the level from the observed one; i.e.
in the observed case, the province has gained in terms of employment/output. For
example, as shown in panel (a), Guangdong in 2001 to 2004 had a net inflow of labor
Growth and
2001 2002 2003 2004 2000-2004 Sum
resource
(a) Percentage change in employment allocation
Guangdong 20.61 2 1.33 2 4.75 27.59 2 3.03
Guangxi 0.65 1.35 3.55 5.06 2.14
Hunan 0.27 0.38 1.63 3.55 1.19
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Yunnan 20.06 0.26 2.38 3.67 1.27 117


(b) Percentage change in output
Guangdong 20.46 2 0.99 2 3.56 25.71 2 2.53
Guangxi 0.48 1.01 2.63 3.75 1.81
Hunan 0.21 0.31 1.30 2.83 1.07
Yunnan 20.05 0.19 1.77 2.73 1.08
Agg. output 20.16 2 0.36 2 1.32 21.98 2 0.89
(c) Percentage changes in growth rates
Guangdong 24.36 2 5.07 2 18.70 2 17.73 212.27
Guangxi 4.75 4.81 16.04 7.53 8.12
Hunan 2.52 1.04 16.98 10.67 7.45
Yunnan 20.65 2.70 16.54 7.35 7.01
Agg. output 21.66 2 1.96 2 8.46 25.10 24.50
Note: The employment and output levels of the provinces in this hypothetical case are compared with Table III.
the corresponding observed levels. A negative (positive) value means that the computed level under Impacts of no labor
the restriction on labor movement is lower (higher) than the observed level mobility

force, which confirms the common belief that Guangdong had served as a magnet to
labor force from other provinces. What is interesting is that all other provinces had a
negative outflow of labor force to Guangdong.
The changes in employment led to similar changes in outputs, as panel (b) shows. If
with labor mobility restrictions a province experiences a drop in its labor force, there
will also be a drop in its output level. A more interesting result is the changes in the
aggregate output of the region consisting of the four provinces. In all these years, a
restriction on labor mobility will cause a drop in the aggregate output, which suggests
that the observed movement of labor among the provinces had led to a more efficient
allocation of labor.
Panel (c) of Table III presents the changes in the growth rates of the provinces as a
result of the restriction on inter-provincial labor movement. Because of the loss in labor
inflow, Guangdong experienced a drop in its growth in GDP. On the other hand, all
other provinces got a rise in their growth in GDP. The more important result is the
change in the aggregate GPD of this region. The last row shows that the aggregate
GDP had low growth rates, showing that restricting labor mobility had caused a drop
in production efficiency.

5.3. The ORA case


We now investigate the ORA case, in which labor distribution is efficiently reallocated
so that the aggregate income is maximized. First, equation (20) is solved for the
efficient wage rate, which is then used to determine the employment level in each of the
provinces. Panel (a) of Table IV shows the efficient employment levels in the provinces
JCEFTS
2000 2001 2002 2003 2004 Sum
1,2
(a) Percentage change in employment
Guangdong 199.00 196.45 200.38 187.15 175.73 191.21
Guangxi 2 96.16 297.73 2 95.94 2 95.88 294.68 2 96.07
Hunan 2 91.91 289.54 2 97.55 2 94.03 291.71 2 92.95
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118 Yunnan 2 95.10 295.73 2 95.90 2 95.99 295.07 2 95.56


(b) Percentage change in output
Guangdong 126.21 125.80 129.26 127.60 125.85
Guangxi 291.19 2 94.07 2 90.91 290.96 2 89.17
Hunan 285.75 2 82.63 2 94.07 288.54 2 85.51
Yunnan 289.49 2 90.50 2 90.81 291.10 2 89.72
Agg. output 31.17 32.00 32.08 33.54 30.31
Table IV. Note: The employment and output levels of the provinces in this hypothetical case are compared with
Impacts of efficient labor the corresponding observed levels. A negative (positive) value means that the computed level under
allocation the restriction on labor movement is lower (higher) than the observed level

as compared with the corresponding observed level. The table shows that labor will be
used more efficiently in Guangdong than in the other three provinces. On the whole,
Guangdong should have its labor force roughly doubled, while the labor force of the
other provinces should be reduced by more than 90 percent. That a substantial
redistribution of labor force is needed for efficient production is due to three factors:
Guangdong has a much larger capital stock, a much longer average education period,
and a much higher technological index.
The changes in labor force in these provinces lead to changes in outputs. Panel (b) of
Table IV presents the estimated output changes. Guangdong gains in output at the
expenses of the other three provinces.
We also determine how the aggregate output may be affected by the labor
reallocation. The output of the region is obtained as a weighted average of the real
GDPs of the provinces, where the weights are equal to the shares of the nominal GDPs.
The aggregate GDPs are then compared with the aggregate GDPs obtained from the
observed data. The result is presented in the last column of panel (b) of Table IV. The
result clearly shows the effects of the efficient labor reallocation: The aggregate output
level in each of the years is more than 30 percent higher than the corresponding
observed one. In other words, inefficient labor allocation alone has caused a substantial
drop in the aggregate output.
Another interesting result that will be presented is the growth rates of the region
under the condition that labor is distributed efficiently. The result is presented in Table V.

2001 2002 2003 2004 2000-2004

Table V. Y^ 11.07 11.66 13.25 15.51 11.70


Aggregate growth rates ð1 2 aÞK^ 3.45 3.55 3.30 2.42 3.18
with efficient labor aL^ 0.85 0.86 2.01 2.53 1.56
allocation, 2000-2004 ah^ 0.79 0.80 0.85 0.83 0.35
(percent) A^ 5.98 6.45 7.09 9.73 6.62
Row 2 shows the growth rates of the four-province region in these years with efficient Growth and
production. These rates are higher than 11 percent per year, with a compounded annual resource
growth rate 11.70 percent. This growth rate, which is a better measure of the growth of
the region, is lower than the observed compounded annual growth rate of 12.44 percent in allocation
the same period. What this suggests is that in the presence of labor misallocation, the
observed GDP levels of the provinces do not accurately reflect the growth rate of the
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region. Furthermore, as we showed, because labor allocation is getting more and more 119
efficient, the observed growth rate of the aggregate GDP over-estimates the growth rate
of the region.

6. Concluding remarks
In this paper, we provided a way to examine the common practice of using the growth
rates of the real GDP (or real per capita GDP) of an economy to represent the economy’s
economic growth rates. We argued that this is not an appropriate approach when
distortions are present, as the production of the economy may not be efficient. To see
the extent of any possible inaccurate estimation of the growth rate of an economy, we
investigate four southern provinces of China from 2000 to 2004. We considered one
type of distortion in the region, labor misallocation, and examined how this distortion
may have distorted the production of the region. Such distortion then makes the use of
the growth rate of GDP an incorrect representation of the growth rate of the region.
We use two approaches to determine the impacts of labor misallocation on growth
rates: fixed labor allocation and optimal labor allocation. We showed that if labor
movement in that period was not allowed, the GDP of the region dropped, suggesting
that actually labor allocation is getting more and more efficient over time. We also
estimated the efficient labor allocation, the one that maximizes the value of GDP of the
region, in each of the years. With the efficient labor allocation, the outputs of the
provinces and the region were determined. It was found that the estimated economic
growth rate of the region is less than the growth rate of GDP of the region based on the
observed data.
Although the present paper covers only four provinces of China due to limitations of
time and research resources, the methodology can be extended to the whole Chinese
economy and to other developing countries. At the same time, the present approaches
are based on some assumptions, such as the assumed production functional form, and
they may be relaxed in future research.

Notes
1. The figures in this section were taken from the WDI Database of the World Bank.
2. The use of the growth rate of GDP to represent the growth of an economy is common in the
literature. See Long and Wong (1997) for a survey on the endogenous growth theory.
3. Bhagwati and Hansen (1973) analyze whether domestic prices or international prices should
be used when calculating the growth rate of an economy. In reality, GDP is usually
computed using domestic prices, but they argue that when distortions are present, using
international prices may give more reliable results.
4. See Dekle and Vandenbroucke (2008) for a recent estimate of the growth factors of China.
5. The four municipalities are administered directly by the Central Government.
JCEFTS 6. In the present paper we consider only four provinces but the methodology can be extended to
the entire country.
1,2
7. This can be the case of a small open economy under free trade facing given world prices.
8. When labor moves to a new location, it is assumed that the labor is able to acquire the
prevailing human capital in the new sector for free. Such an assumption of course is a strong
one, but it allows us to avoid considering explicitly workers with various levels of human
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120 capital in each sector.


9. Such a production function is usually the starting point in many theoretical and empirical
studies; See, for example, Collins et al. (1996) and Bosworth and Collins (2003). What is new
here is that equation (2) applies to a sector/province, and we will examine the effects of
resource allocation on the aggregate production.
10. The price index can be a weighted average of the prices of the sectoral outputs.
11. In the ORA approach, we will allow factors to move optimally across provinces. One of the
factors in the production process is assumed to be immobile, or it is possible that optimal
resource allocation will require all factors to leave some of the provinces and move to some
others.
12. The endogenous variables are the N labor inputs in the sectors plus the Lagrange multiplier.
13. These are official figures of the number of employed people. In Guangdong, there could be a
substantial number of illegal employed people not counted by the government.
14. This means that this paper is not to explain saving and investment.
15. The census statistics for these provinces are also available online, and are used in the present
estimation.
16. For some provinces, the figures for 2004 are not available yet, and in those cases, only the
figures for 2000 to 2003 are used.
17. Ideally, the investment levels should be deflated first before adding them up. However, for
most provinces no appropriate deflator is given that goes back to 1978. Furthermore, to make
the capital stock more comparable to the real GDP series, the capital stock is re-scaled by
setting the value of the investment price index in 2000 to be 354.54, which is the national
general retail price index for that year (with 1978 ¼ 100).
18. There is no GDP deflator available. So the general retail price index is used.
19. The online site provides the statistical yearbooks of these provinces for the years 2001 to
2004 plus the census yearbooks in 2000.

References
Bhagwati, J.N. and Hansen, B. (1973), “Should growth rates be evaluated at international prices?”,
in Bhagwati, J. and Eckaus, R. (Eds), Development and Planning: Essays in Honour of Paul
Rosenstein-Rodan, MIT Press, Cambridge, MA, pp. 53-68.
Bosworth, B. and Collins, S.M. (2003), “The empirics of growth: an update”, mimeo, Brookings
Institution, Washington, DC.
Collins, S.M., Bosworth, B.P. and Rodrik, D. (1996), “Economic growth in East Asia:
accumulation versus assimilation”, Brookings Papers on Economic Activities, No. 2,
pp. 135-203.
Dekle, R. and Vandenbroucke, G. (2008), “Whither Chinese growth? A sectoral growth
accounting approach”, mimeo, University of Southern California, Los Angeles, CA.
Long, N.V. and Wong, K.-Y. (1997), “Endogenous growth and international trade: a survey”, in Growth and
Jensen, B.S. and Wong, K.-Y. (Eds), Dynamics, Economic Growth and International Trade,
University of Michigan Press, Ann Arbor, MI, pp. 11-74. resource
allocation
About the author
Kar-Yiu Wong is a Professor of Economics at the University of Washington. He serves as
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Director of the Research Center for International Economics (RCIE), and President of the 121
Asia-Pacific Economic Association (APEA). Professor Wong’s research interests cover
international trade, economic development and growth, and Asia studies. He is the author of
International Trade in Goods and Factor Mobility (MIT Press), and has published widely in
international journals, including Journal of Economic Theory, Journal of International Economics,
Journal of Development Economics. Kar-yiu Wong can be contacted at: karyiu@
u.washington.edu

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