Government procurement and resource misallocation: Evidence from China

Government often acts as the largest buyer in an economy through government procurement. The allocation of procurement orders however is often distorted. We build a model with heterogeneous firms endogenously seeking government favors in procurement to show that misallocation of procurement orders further leads to misallocation of production factors. Using the enactment of the <Chinese Government Procurement Law> in 2003 as a natural experiment, we find that tighter regulation of procurement in China lowers the extent of resource misallocation in industries that rely more on government procurement. We further provide firm-level evidence in support of our model.