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LOCAL PROTECTIONISM AND
MARKET MECHANISM: THE CASE OF
THE CHINESE STEEL INDUSTRY
Chia-Lin Chang
∗
Research Center for Humanities and Social Sciences
Academia Sinica
Wan-Wen Chu
Research Center for Humanities and Social Sciences
Academia Sinica
Keywords: Chinese industry, Steel industry, Local protectionism, Market mechanism,
Entry and exit
JEL classification: D24, H11, H25
∗
Correspondence: Chia-Lin Chang, Research Center for Humanities and Social Sciences, Academia
Sinica, Taipei 115, Taiwan. Tel: (02) 2789-8181; Fax: (02) 2785-4160; E-mail: [email protected].
We would like to thank the Editor and the two anonymous referees for their valuable comments and
suggestions, and thank Prof. Ji Chou for providing helpful comments as we presented the paper in the
2014 Annual Meeting of the Taiwan Economic Association. In addition, we are grateful to Prof. Bih-Jane
Liu, Tain-Jy Chen, An-Chi Tung, and Shi-Shu Peng for their valuable suggestions. We are responsible
for any remaining errors.
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ABSTRACT
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In this paper we investigate the impacts of local protectionism on the development
of the Chinese steel industry. We find that the entry and exit rates of the enterprises
in the Chinese steel industry from 1998 to 2007 are much higher than those of other
countries, which shows that this industry is highly competitive. There has, however, been
an overcapacity problem in China’s steel industry for a long time. Hence, we try to account
for the contradiction between the two phenomena.
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We assume that the above situation results from the way the Chinese local gov-
ernments promote the steel industry. That is, the Chinese local governments would offer
preferential loans, land at low prices, and other favors to attract firms to enter the steel
sector. They would also provide tax breaks or subsidized loans to certain targeted firms, so
that these firms would be less likely to exit the industry when they incur losses. This policy
tends to raise the exit threshold for the favored firms. We hence argue that the way the
Chinese local governments promote the steel firms may have different effects on the entry
and exit thresholds of different kinds of firms. We then examine how the entry and exit
rates differed for different kinds of steel enterprises in terms of scale and ownership from
1998 to 2007, and test if an increase in the enterprise’s productivity increased its market
share and whether enterprises with low productivity exited the market more easily, in order
to see if the market mechanism in China’s steel market was working during this period.
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Our results reveal that private and smaller firms were more likely to enter the steel
industry, and large-scale firms, no matter whether they are state-owned or private firms,
were less likely to exit the industry. Furthermore, the market mechanism in China’s steel
sector was able to work effectively among the existing firms, but the mechanism weeding
out backward firms was impeded. These results are consistent with our hypothesis that the
way the Chinese local officials promote the steel firms leads to long-term overcapacity in
the Chinese steel industry, while the market remains highly competitive.
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