ENTRY BARRIERS AND GROWTH: THE ROLE OF ENDOGENOUS MARKET STRUCTURE

• Published date: 01 August 2024
• Author: Helu Jiang,Yu Zheng,Lijun Zhu
• Date: 01 August 2024
• DOI: http://doi.org/10.1111/iere.12695

INTERNATIONALECONOMIC REVIEW

Vol. 65, No. 3, August 2024 DOI: 10.1111/iere.12695

ENTRY BARRIERS AND GROWTH: THE ROLE OF ENDOGENOUS MARKET

STRUCTURE∗

By Helu Jiang, Yu Zheng, and Lijun Zhu

Shanghai University of Finance and Economics, China; Queen Mary University of London

and Centre for Economic Policy Research, London, U.K.; Peking University, China

We use China’s growth experience as a laboratory to study how reductions in administrative and regula-

tory entry barriers contribute to growth. We develop a model of endogenous productivity and market struc-

ture with heterogeneous firms and frictional entry and calibrate it to Chinese manufacturing firms. We show

that the reduction of entry barriers brings about 1.05 percentage points of productivity growth over the 1990–

2004 period, accounting for 18.3% of the productivity growth in the 2004–7 period. A decomposition exercise

shows that entry mainly affects growth through promoting a more competitive market structure, which more

than offsets the negative Schumpeterian effect.

1. introduction

Growth in an economy might be stifled if entry is limited and incumbents, facing no com-

petitive pressure, lack incentives to improve and grow. Writing on the rise of the Western

world during 1500–1700, North and Thomas (1973) ascribe the stagnation of France to the in-

dustrial regulation and the guild system that granted monopoly to insiders and restricted en-

try of outsiders. In England, in contrast, new rules like the Statute of Monopolies introduced

in the early 17th century stroke down monopolistic privileges and barriers to entry, which pre-

viously circumscribed profitable opportunities in trade and commerce, and eventually set the

stage for the industrial revolution. This historical view is echoed by many observers of China’s

reforms and industrialization since the late 1970s when state monopoly was cut back, private

firm entry permitted, and state-owned enterprises (SOEs) privatized. The force of incentives

and competition released in the process is deemed to be a critical pillar underpinning the suc-

cess of the reforms (Brandt et al., 2008; Groves et al., 1994; McMillan and Naughton, 1992;

Qian, 2002; Zhu, 2012).

In this article, we use China’s growth experience as an example to study how reducing en-

try barriers contributes to economic growth through strengthening competition. Although the

output and productivity growth experienced since the start of the economic reforms is well-

documented, the accompanying changes in the market structure and level of competition are

∗Manuscript received May 2022; revised September 2023.

We thank the handling editor, Dirk Krueger, and four anonymous referees for their valuable comments and sug-

gestions. We also gratefully acknowledge helpful comments from Sina Ates, Paco Buera, Wei Cui, Tuo Chen, Han-

ming Fang, Ying Feng, Chad Jones, Pete Klenow, Justin Yifu Lin, Rachel Ngai, Michael Song, Ping Wang, and

Shangjin Wei as well as the seminar and conference participants at NASMES, ABFER Annual Meeting, CICM,

ESEM, ESSIM, SAET, China Macro-Finance Study Group, Bristol, UCL, Essex, Jinan University, Fudan Univer-

sity, Hunan University, and the 7th NSE International Conference. The article was previously circulated under the

title “Growing through Competition: The Reduction of Entry Barriers in Chinese Manufacturing.” All remaining er-

rors are ours. Helu Jiang thanks research support sponsored by Shanghai Pujiang Program [21PJC053]. Lijun Zhu ac-

knowledges financial support from the National Natural Science Foundation of China (72373005). Please address cor-

respondence to: Yu Zheng, School of Economics and Finance, Queen Mary University of London, Mile End Road,

London E1 4NS, U.K.E-mail: yu.zheng@qmul.ac.uk.

1221

© 2024 The Authors. International Economic Review published by Wiley Periodicals LLC on behalf of the Economics

Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research

Association.

This is an open access article under the terms of the Creative Commons Attribution License, which permits use, dis-

tribution and reproduction in any medium, provided the original work is properly cited.

1222 jiang, zheng, and zhu

Notes: This figure shows aggregate entry rates constructed from the Industrial Census and the Business Registry

Records (Panel (a)), normalized HHI (left axis) and top 10 firms’ revenue share (right axis) constructed from the

Census and Annual Survey of Industrial Enterprises (ASIE), respectively, (Panel(b)). The construction of the series

is detailed in Online Appendix A.4.

Figure 1

entry and competition in the chinese industrial sector, since 1980

less recognized in the growth literature on China. The left panel in Figure 1 presents the entry

rate, that is, the new firms’ share in total active firms, in China’s industrial sector since 1978.

Before the 1990s, entry of private firms was strictly prohibited. As shown, firm entry rate rose

dramatically from 1% in the 1980s to above 10% in the late 1990s and early 2000s. Panel (b)

shows the trends of two measures of competition: the normalized Herfindahl–Hirschman In-

dex (HHI), which adjusts for the total number of firms, and the revenue share of the 10 largest

firms averaged across four-digit industries, since 1995 when our firm-level data sets start. Both

display a clear declining trend from 1995 to 2013. Over the same time period, the Chinese

economy evolved from almost stagnation before the reforms to an average annual growth rate

of GDP per capita of over 8% in the post-reform era (Zhu, 2012).

To allow entry to affect competition as well as growth, we build on the endogenous growth

model of step-by-step innovations (Aghion et al., 2001), which features endogenous produc-

tivity and market structure, and enrich it with frictional entry and ex ante heterogeneous firms

to study the entry-competition-growth nexus. The economy consists of a continuum of sym-

metric industries, where in each industry, a leader and a follower produce imperfectly substi-

tutable goods, engage in Bertrand competition, and incur costs to advance on a quality ladder

in order to expand their market shares. A key feature of the model is that the closer the qual-

ity gap between the leader and the follower is, the tighter the competition, and therefore both

have a stronger incentive to advance on the ladder and expand their businesses. As the ag-

gregate productivity growth is fueled by such expansion efforts, an economy with more com-

petitive industries also achieves higher productivity growth. We introduce ex ante firm het-

erogeneity in the model, whereby firms can have high or low cost of expansion, and frictional

entry, whereby there is a potential entrant in each industry, who makes costly attempts to re-

place the follower subject to probabilistic entry approval, which we interpret as the entry bar-

rier.

As the entry barrier is lowered, entrants, faced with easier access, increase their expansion

effort, a positive direct effect on growth. On the other hand, incumbents, faced with higher

threats, tend to decrease their expansion effort, resulting in a negative Schumpeterian effect.

Both the direct and Schumpeterian effects on growth are essential in step-by-step models. The

firm heterogeneity enacts a third channel whereby aggregate growth is affected by the type

composition of the active firms. As young entrants replace old incumbents who may not be

as efficient in expansion, the type distribution can be improved in the stationary equilibrium,