GDP competition and corporate investment: Evidence from China

• Date: 01 August 2020
• DOI: http://doi.org/10.1111/1468-0106.12312
• Author: Yong Du,Ying Hao,Yuning Xing,Qiang Liu
• Published date: 01 August 2020

ORIGINAL MANUSCRIPT

GDP competition and corporate investment:

Evidence from China

Qiang Liu

1

| Ying Hao

2

| Yong Du

3

| Yuning Xing

4

1

School of Economics and Business

Administration, Chongqing University,

Chongqing, China

2

Business School, Beijing Normal

University, Beijing, China

3

College of Economics and Management,

Southwest University, Chongqing, China

4

College of Humanities and Development

Studies, China Agricultural University,

Beijing, China

Correspondence

Ying Hao, Business School at Beijing

Normal University, No. 175, Xinjiekouwai

Street, Haidian District, Beijing 100875,

China.

Email: cquhaoying@163.com

Funding information

Ying Hao acknowledges financial support

from the National Natural Science

Foundation of China (grant number:

71872017,71372137,71872014 and

71772015) and Beijing Normal University

Youth Fund (grant number: 2017hao). Yong

Du gratefully acknowledges funding from

the National Natural Science Foundation of

China (grant number: 71572153)

Abstract

This study examines whether and how macroeconomic

performance competition is related to investment at firm

level. We use GDP competition as a proxy of dynamic

macroeconomic conditions. We find that the effect of

GDP competition on firm investments is significantly pos-

itive. We also find that GDP competition destroys invest-

ment efficiency significantly, especially by increasing

overinvestment. Further tests show that GDP competition

is more likely to affect the investment decisions of firms

controlled by governments and firms located in regions

with low marketization. In addition, our analyses reveal

that the provincial officials facing competitive pressure are

more likely to be promoted if firm investments accelerate.

We use alternative proxies to measure GDP competition

and find similar results that support our inference. Our

findings support the notion that GDP competition of gov-

ernments distorts investment behaviour. The present paper

also elucidates investment problems and dilemmas faced

by emerging economies.

1|INTRODUCTION

An extensive literature in economics examines whether and how investments contribute to economic

growth (Blomström, Lipsey, & Zejan, 1996; Durham, 2004Fischer, 1993Munnell, 1992Nelson &

Phelps, 1966). Under the framework of neoclassical growth theory or endogenous growth theory, the

aforementioned studies confirm the importance of different kinds of investment to macroeconomic

growth.

1

For instance, Bradford (2010) finds that the performance of equity investments is inextrica-

bly linked to economic growth. However, there is limited research examining whether changes in

Received: 12 November 2017 Revised: 2 July 2019 Accepted: 29 August 2019

DOI: 10.1111/1468-0106.12312

402 © 2019 John Wiley & Sons Australia, Ltd Pac Econ Rev. 2020;25:402–426.wileyonlinelibrary.com/journal/paer

macroeconomic growth conditions affect investment behaviour at firm level. In particular, little is

known about whether and how firms react to changes in political incentives and pressure generated

by macroeconomic development slowing. In this study, we attempt to fill this gap by exploring how

firms make investment decisions under certain macroeconomic conditions. We hypothesize that

dynamic changes in macroeconomic conditions may have an impact on investment decisions for at

least two reasons.

First, a large body of prior research has revealed that firm investment decisions are affected by

macroeconomic uncertainty, monetary policy adjustment and financial crisis (Beaudry, Caglayan, &

Schiantarelli, 2001; Ran, Ozbas, & Sensoy, 2010). In theory, the actual path of economic growth

could reflect aggregated outcomes of external shocks on economic operation precisely. Thus, com-

pared to other macro variations, changes in macroeconomic conditions could be more capable of

directly influencing firms' reaction and investment decisions. Second, an important way in which

macroeconomic conditions are hypothesized to affect investment decisions is through the channel of

regional development competition. In particular, the incentives and pressure associated with possible

downtrends in regional macroeconomic performance have implications for the behaviour of both

governments and firms. The effects of economic performance competition are especially relevant in

light of the slowing growth of regional GDP and the disadvantage of economic performance rankings

among provinces. If economic development is considered to have a close bearing on the stakes of

individuals and groups in government, investment is increased to attain higher growth.

In this paper, we examine the effects of macroeconomic performance on the investment behaviour

of firms through the channel of Chinese GDP competition, in a setting in which the performance

ranking is based on regional economic growth among the surrounding provinces or the whole nation.

The Chinese political economy setting is particularly suited to this type of study for three reasons.

First, we can use the unique economic setting, where regional development competition among paral-

lel autonomous governments became super-heated following the reform and open up,

2

to construct

rational metrics of macroeconomic conditions. We consider whether the fiscal decentralization or

political promotion dominates the incentives to promote regional economic growth (e.g., Blanchard &

Shleifer, 2001; Jin, Qian, & Weingast, 2005Li & Zhou, 2005Maskin, Qian, & Xu, 2000Qian &

Roland, 1998); both result in yardstick competition among local governments, which mainly mani-

fest as efforts to enhance regional GDP growth. Once the governments fall behind in economic

growth competition, they have a strong incentive to intervene in firms to boost GDP in the following

fiscal years, including encouraging enterprises to invest heavily. Thus, the fierce economic perfor-

mance competition among all levels of subnational governments creates an observable measure of

dynamic macroeconomic conditions. This measure not only reflects the disadvantage in economic

competitiveness but yields a plausible implication for the mechanism that macroeconomic perfor-

mance may affect micro decision-making in corporate investment.

Second, China has achieved remarkable economic growth during the past three decades, although

the authenticity and accuracy of Chinese GDP statistics has been disputed continuously. The local

governments facing GDP competition may play an active role in forming China's high economic

growth. The ongoing GDP competition provides persistent momentum for involvement of local gov-

ernments in business activities. Involvement in corporate decisions can facilitate the attainment social

and economic objectives, even if causing suboptimal behaviour.

3

Although a growing number of

studies have documented the effects of government intervention on corporate finance behaviour, few

have illustrated when and why governments are involved in corporate decisions. The Chinese GDP

competition can offer us an experimental scenario and help to capture the timing and motivation of

government intervention.

LIU, HAO, DU AND XING 403