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Industrial Policy in China: Some Intended or Unintended Consequences?

The authors explore the impact of a 2004 tax reform in China that reduced the value-added tax (VAT) on investment goods. Although the goal of the reform was to encourage upgrading of technology, results suggest there was no significant increase in fixed investment, new product introductions, or productivity. Rather, the authors find that firms shifted the composition of investment toward machinery and increased the capital intensity of production, which is consistent with a fall in the price of capital relative to labor. As a result, employment fell significantly in the treated provinces and sectors. Results are robust to a variety of approaches and suggest that the primary impact of the policy has been to induce labor-saving growth. In 2009, the VAT reform was extended to the rest of China.