Journal of Urban Economics

Centralization and Regional Development: Evidence from a Political Hierarchy Reform to Create Cities in China

Abstract

How does centralization or decentralization in government affect regional development? This paper draws upon a quasi-natural experiment in China's political hierarchy from the 1980s to investigate the effects of centralization in a novel sub-provincial setting. In this political hierarchy reform, China created cities from groups of rural counties and centralized counties' political powers to the newly established city governments. Using a difference-in-differences approach, I show that centralization has positive causal effects on industrial productivity within the created cities. My analysis of industrial firm-level data reveals a reduction in the dispersion of marginal products, suggesting that centralization will help to reduce regional resource misallocation and improve aggregate productivity. A decomposition exercise shows that the gains are mainly contributed by extensive margin from entry and exit. I quantify the loss in productivity under decentralization by hypothetically reallocating inputs to equalize marginal products to the extent observed in centralization. Finally, he reform increases the concentration and specialization of production in space.

Keywords: Decentralization; Political hierarchy; Misallocation; City creation; Productivity

JEL classification: H11; H77; O18; P25; R11; R58