Agglomeration and Productivity in China Firm Level Evidence

China Economic Review 33 (2015) 5066
Contents lists available at ScienceDirect
China Economic Review
Agglomeration and productivity in China: Firm level evidence

Cui HU a,, Zhaoyuan XU b, Naomitsu YASHIRO c
a
b
c
School of International Trade and Economics, Central University of Finance and Economics (CUFE), 39 South College Road, Haidian District, Beijing 100081, PR China
Industrial Economy Research Department, Development Research Center of the State Council, R.216, No. 225, Chaoyangmen Nei Dajie, Beijing 100010, PR China
Organization for Economic Cooperation and Development (OECD), Economics Department, 2 Rue Andr Pascal, Paris 75016, France
a r t i c l e
i n f o
Article history:
Received 25 August 2013
Received in revised form 2 January 2015
Accepted 3 January 2015
Available online 9 January 2015
JEL classication:
D24
R12
Keywords:
Agglomeration
Productivity
China
a b s t r a c t
This paper conducts an in-depth evaluation on the role of industrial agglomeration in productivity growth of China's industrial sector by exploiting large dataset of manufacturing rms
active in 176 three-digit industries and in 2860 counties. We also complement our analysis
with the 2004 Census data to capture the agglomeration of small rms. Unlike previous studies
that often focused on specic industries, we assess the impact of agglomeration in a comprehensive range of industries and extend the scope of analysis to upstream industries as well.
Moreover, we explore how the ownership of Chinese rms shapes their ability to benet
from agglomeration effect as well as to act as the source of externality. We nd that congestion
and ercer competition offset the benets of agglomeration for rms operating within agglomerated regions. On the other hand, a co-location of large rms contributes signicantly to productivity. We also nd a more important contribution from the agglomeration of upstream
industries than from that of the same industry. Private enterprises are the primary source of
agglomeration effects especially in upstream industries, whereas their productivity is boosted
most by the agglomeration of other private enterprises. We reckon that industrial agglomeration contributed up to 14% of the productivity growth in China's industrial sector between
2000 and 2007.
2015 Elsevier Inc. All rights reserved.
1. Introduction
Sustainability of China's competitiveness as manufacturing base is recently questioned as enterprises in China are facing rise in
labor and resource costs, currency appreciation and tighter constraints associated with environmental protection. However, if the
competitiveness of Chinese industry is mainly founded on the productivity improvement as opposed to cheaper labor cost, China is
likely to retain its position as the world's major exporter of manufacturing goods. A likely source of such productivity growth is the
industrial agglomeration which increased consistently since the mid-1990s, driven by the globalization of the Chinese economy
(Lu & Tao, 2006). The geographic concentration of industrial activities was associated with a dramatic increase in number of rms,
namely of the clustering of interconnected small rms (Long & Zhang, 2012). Case studies reported that such clustering of small
and medium enterprises (SMEs) reduced the technological barrier to entry and promoted quality upgrading of Chinese rms
(Fleisher, Hu, McGuire, & Zhang, 2010; Huang, Zhang, & Zhu, 2008). However, it is less clear whether the contribution of agglomeration can be generalized beyond the ndings on specic industries or regions.
We thank China Humanities and Social Sciences Youth Foundation of Education Ministry (Project code: 13YJC79004) and the China National Natural Science
Foundation (Project code: 71403302/G0304 & 71173058/G0301) for funding this paper.
Corresponding author. Tel.: +86 13501193242 (mobile).
E-mail address: pkucuihu@gmail.com (C. Hu).
http://dx.doi.org/10.1016/j.chieco.2015.01.001
1043-951X/ 2015 Elsevier Inc. All rights reserved.
C. Hu et al. / China Economic Review 33 (2015) 5066
51
Industrial agglomeration is often considered to generate positive externalities such as knowledge spillover, more efcient
input sharing and richer labor pooling (Marshall, 1890). On the other hand, it can be associated with negative effects on productivity due to congestion and ercer competition. Comprehensive assessments of the net effects of agglomeration in China
are still limited and their ndings remain inconclusive. For instance, Batisse (2002) reported a negative relationship between
the industrial specialization of a province and its growth in value-added, whereas Fan and Scott (2003) reported a positive
relationship between an industrial concentration and the province-level productivity. Empirical evidences at rm-level are
even more limited and are often conned to specic industries. An example is Lin, Li, and Yang (2011) which studied the
impact of agglomeration on productivity of textile industry rms and reported that initial positive externalities are
overwhelmed by diseconomies as the agglomeration intensies.
This paper provides a comprehensive assessment of agglomeration effects on productivity of Chinese rms by exploiting a
large survey data of manufacturing rms across 176 three-digit industries spanning between 2000 and 2007. Because the annual
survey data covers only the rms with sales of 5 million RMB or above, observing agglomeration effects solely based on those
data ignores the clustering of smaller rms which are found to play an important role in upgrading of Chinese industries.
Therefore, we complement our base analysis by incorporating the agglomeration of smaller rms using the 2004 Census data
that covers all the manufacturing rms.
Our analysis also comprises three notable features. First, we use the number and the average output size of rms in a spatial
unit to capture the size and the quality of an agglomeration. The number of rms is highly relevant to many aspects of
Marshallian externality. For instance, knowledge spillover within an agglomeration is proportional to the number of rms,
when each rm engages in some types of knowledge creation and the nearby rms all benet from its outcome (Henderson,
2003). Also, larger number of rms in a region increases the scale and depth of inputs demand, allowing a more efcient
input sharing. Finally, it enhances the efciency of matching between rms and workers via deeper labor pooling. On the
other hand, the average size of rms in an agglomeration not only captures the size of input demand and labor pooling for a
given number of rms, but also the co-location of productive enterprises. Firm size has often been seen as a proxy of productivity
and several studies have indeed reported signicant externalities arising from the co-location of large rms (Greenstone,
Hornbeck & Moretti,2010; Li, Lu, & Wu, 2012).
Second, we incorporate explicitly the agglomeration of upstream industries. The presence of rich supporting industries that provide high quality intermediate goods is essential for a country's industrial competitiveness. The agglomeration of upstream industries
increases the varieties of inputs supplied, and by allowing rms to specialize in their core activities while outsourcing some of inhouse production (Broda & Weinstein, 2006; Holmes, 1999). Given that sharing of specialized inputs has always been considered
as an essential element of Marshallian externality, it is somewhat surprising that previous studies did not take into account the
agglomeration of upstream industries.
Finally, we explore how a rm's ownership structure shapes its ability to benet from agglomeration effects as well as its ability to
act as the source of agglomeration effects. The difference in corporate behavior and culture can dene the extent to which a rm benets from an agglomeration (Saxenian, 1994). Chinese rms differ substantially in their performances and corporate behaviors across
their ownership (Jefferson, Rawski, Wang, & Zheng, 2000). State-owned enterprises (henceforth, SOEs) enjoy privileges in administrative treatment, good access to nance and sometimes monopolistic power, but can be driven by policy rather than prot. Private
enterprises (henceforth, PEs) are managed by vibrant entrepreneurs and are highly prot-oriented, but often face barriers to market
entry and difculty in accessing credit. Foreign-invested enterprises (henceforth, FIEs) possess advanced technologies but often engage in low value-added activities such as the assembly and re-export of imported intermediate inputs, referred as the processing
trade. Such stark differences across ownerships may not only shape the ability of Chinese rms to absorb knowledge spillovers but
also shape their ability to act as the source of spillovers.
We nd positive and sizable contributions by the agglomeration of upstream industries to the total factor productivity
(TFP) of Chinese rms. Our estimates imply that doubling the number of rms in upstream industries raises the TFP by
3.2%. On the other hand, agglomeration effects within the same industry are more complex: increase in number of rms
within the same county is seen to suppress TFP. This somewhat surprising nding suggests that severe congestion and intense competition associated with agglomeration are offsetting the Marshallian externality. The increase in number of
rms in a moderate distance is associated with smaller negative impact or even positive impact to productivity. We also
nd that increase in average rm size contributes importantly to higher TFP. This suggests that the qualitative aspect of
an agglomeration, namely the co-location of large rms possessing rich knowledge stock denes the benets of agglomeration. When looking across different ownerships, PEs seem to be the main recipient of both positive and negative agglomeration effects but this becomes less clear when the agglomeration of smaller rms is incorporated. However, we nd that
the agglomeration of PEs impacts the productivity of Chinese rms more than that of SOEs or FIEs. Especially, PEs are the
main sources of the sizable agglomeration effects from upstream industries. The agglomeration effects from PEs are selfreinforcing in a sense that the productivity of a PE is most enhanced by the agglomeration of PEs. Based on our estimated
results, we reckon that industrial agglomeration contributed up to 14% of TFP growth in China's industrial sector during
20002007.
The next section provides a non-exhaustive review of works on industrial agglomeration, especially in context of China. Section 3
describes the dataset used in our analysis, the method to construct indicators of agglomeration and to estimate TFP and our empirical
model. Section 4 lays out our estimation results and discusses the prominent feature of agglomeration effects in China. Based on the
results from Section 4, Section 5 computes the role of agglomeration in the productivity growth of China's industrial sector during the
sample period. Section 6 concludes with policy implications.
52
2. Agglomeration and productivitya brief review

2.1. An overview of studies on agglomeration
Economic activity is geographically concentrated. Previous studies on why an agglomeration occurs and how it benets economic
agents have been mainly based on the two perspectives (Rosenthal & Strange, 2004): the localization economies, which are the
Marshallian externalities arising from a concentration of rms in a same industry; and the urbanization economies, which arise
from an increase in city size that enables cross-fertilization of idea among diverse economic activities (Jacobs, 1969). While both industry concentration and city size were found to be associated with higher productivity, when assessed together, empirical evidences
tended to support the localization economies more than the urbanization economies (for example, Henderson, 2003; Li et al., 2012).
While this paper is primarily oriented toward the localization perspective, it goes beyond the concept by incorporating explicitly the
agglomeration of upstream industries.
There are several channels through which localization economies manifest: rst, an agglomeration enables the sharing of knowledge and skills through formal and informal interactions among rms or individuals (Marshall, 1890; Saxenian, 1994). Knowledge
spillovers occur mostly within proximity. For instance, Jaffe, Trajtenberg, and Henderson (1993) found that patent citations are
more likely to come from the same state or metropolitan area as the original patent. The shared knowledge may not be conned to
advanced technologies but can also be management skills and business knowledge. For example, Greenaway and Kneller (2008)
reported that a larger number of exporting rms in proximity promotes other rms' export entry, suggesting that agglomeration of
experienced exporters can reduce the entry costs of exports through spillovers of knowledge on foreign markets. Second, a concentration of an industry enables the production of specialized intermediate inputs to attain the level that is sufcient to exploit scale
economies (Marshall, 1890). This, in turn, allows rms to outsource higher share of their intermediate inputs and specialize on the
most protable activities (Holmes, 1999). Third, geographical concentration of rms and workers reduces the search frictions
between jobs and workers, allowing more efcient matching. A deeper labor pooling reduces the risks that a worker remains
unemployed and a rm cannot ll its vacancies (Krugman & Venables, 1995). Finally, there is a self-reinforcing home-market effect
that induces rms to locate near a large market, especially when an increasing return to scale and transportation costs is important
(Davis & Weinstein, 1999).
On the other hand, agglomeration can be associated with several diseconomies. A dense rm location may generate congestion
which increases business costs. Congestion may be especially severe if infrastructure is a bottleneck to economic activities. For instance, Lall, Shalizi, and Deichmann (2004) found that geographic concentration of the same industry lowers the productivity of
Indian rms, whereas access to markets through improvement in inter-regional infrastructure has favorable effect. Furthermore,
the ercer competition in product and factor markets can suppress a rm's mark-up and productivity through lower product prices
and higher inputs costs. Especially, severe competition for workers with specialized skills can result in a disproportional increase in
their wage compared to their productivity, at least in the short run. Therefore, whether the benet of agglomeration to productivity
exceeds the diseconomies is an empirical issue.
Various approaches to capture agglomerations exist, ranging from the Gini coefcients of geographical distribution of industrial
output or employment to the EG index proposed by Ellison and Glaeser (1997) which simultaneously controls for the share of an
industry's employment within a region, the share of aggregate manufacturing employment within a region, and the market concentration of an industry. While as not as popular as the EG index, the number of rms within a region has been employed by previous
studies for its tractability and straight-forward implication. For example, Henderson (2003) assessed the localization economies in
high-tech industries in the United States by observing the number of plants in the same industry. He claimed that knowledge spillover
within an agglomeration is proportional to the number of rms, when each rm engages in some types of knowledge creation and the
nearby rms all benet from its outcome. The tractability of the number of rms as a measure of agglomeration is especially benecial
when assessing agglomeration effects across numerous industries or when incorporating some aspects of distance. For instance, the
EG index does not consider the geographical proximity and distance of industrial agglomeration.
Although the sharing of specialized input has been long considered as one important aspect of localization economies, previous
studies seldom explored how an agglomeration of upstream industries affects the productivity of downstream rm. The agglomeration of upstream industries increases the varieties of inputs supplied, thereby contributing to the productivity of sourcing rms (Broda
& Weinstein, 2006). It also allows rms to specialize in their core activities while outsourcing some of in-house production (Cainelli &
Iacobucci, 2012; Holmes, 1999). Furthermore, stronger competition in upstream industries due to agglomeration can be associated
with the supply of cheaper and better quality intermediate inputs. Consistent to such view, the FDI penetration in upstream industries
is often found to improve the productivity of domestic rms (for example, Ito, Yashiro, Xu, Chen, & Wakasugi, 2012; Javorcik, 2004).
We therefore extend our analytical framework to incorporate explicitly the agglomeration of upstream industries.
A strand of research explored the effect of a co-location by large rms on productivity growth. The size of a rm, measured in output or employment, is often closely related to its productivity as well as to its intangible competitiveness such as good management
practices (Bloom, Lemos, Sadun, Scur, & Van Reenen, 2014). Locating near large rms may thus provide opportunities to absorb spillovers of advanced knowledge. For instance, Greenstone, Hornbeck, and Moretti (2010) found that the United States rms in counties
which saw new openings of Million Dollar plants realized 12% higher productivity growth after 5 years vis--vis the rms in other
counties. More recently, Li et al. (2012) observed that Chinese rms are more likely to become larger by locating with a number of
large rms than with larger number of rms. Therefore, agglomerations that include many large rms may reward larger favorable
effects on a rm's productivity. On the other hand, considering that co-location with productive rms is likely to be associated with
stronger competition, the benets of knowledge spillovers could be at least partially offset, resulting in a net impact that is not a priori
53
clear-cut. For instance, Henderson (2003) reported that the average size of plants in the same industry and the same county does not
have any signicant impact on the productivity of US plants in high-tech industries. This paper explores whether the presence of large
rms in an agglomeration has an impact of its own besides the size of agglomeration captured by the number of rms.
2.2. Studies on agglomerations in China
The industrial agglomeration in China has increased consistently since the mid-1990s, driven by the globalization of the Chinese
economy (Lu & Tao, 2006). Major exporting industries (such as textiles and electronics) as well as industries depending heavily on
imported intermediate goods (such as machinery) concentrated in coastal areas that have better access to trade routes and advanced
technology (Fujita & Hu, 2001). Long and Zhang (2012) observed that industrial concentration has been driven by the dramatic
increase in number of rms in the regions rather than the increase in size of output per rm, namely the clustering of highly interconnected small rms. Case studies reported the role of such clustering in reducing technological barriers and promoting quality
upgrading. For example, Huang et al. (2008) studied the footwear industry in Wenzhou and claimed that clustering lowered the
technical and capital barriers to entry by deeper division of complex production process, and brought a wide range of entrepreneurs
in rural areas into the industry. Sonobe, Hu, and Otsuka (2004) observed that clustering of rms producing light-volt electronic
appliances in Wenzhou promoted the fast quality upgrading and introduction of new marking strategy. Fleisher et al. (2010) reported
that rms in the Zhili Township children's garment cluster in Zhejian province have responded to the rigorous competition pressure
by investing in design, branding and quality upgrading.
More general empirical evidences on agglomeration effects in China are still limited and somewhat mixed. Early studies relied on
aggregated data. For instance, Batisse (2002) found negative relationship between industrial specialization and province-level valueadded growth, whereas Fan and Scott (2003) found strong positive relation between industrial concentration and province-level
productivity. Ke (2010) reported a positive and causal relationship from an industrial agglomeration to city-level labor productivity.
Evidences based on rm-level data are more recent and are even more limited. For example, Lin et al. (2011) explored the agglomeration effects on productivity of rms in textile industry and found an inverted-U type effect, which implies that net positive impact is
more than offset by diseconomies after certain point. Yang, Lin, and Li (2013) reported that the agglomeration of production contributes to productivity of electronics rms while the agglomeration of R&D activities has negative impact. However, not only the scope of
those studies is conned to specic industries, they are based on the above-scale survey data which does not capture the clustering of
smaller rms. Furthermore, to our knowledge, there are not yet studies that captured how the rapidly growing non-state sector is
shaping the agglomeration effects in China. Overall, there is considerable room to be lled in order to understand the role of agglomeration in China's industrial competitiveness.
3. Empirical strategy
3.1. Data
3.1.1. The Survey on above-scale manufacturing enterprises
The dataset we use for computing the productivity of Chinese enterprises is the annual survey collected by China's National
Bureau of Statistics, which covers all the state-owned enterprises (SOEs) and the non-SOEs with annual sales exceeding RMB
5 million (the Survey of above-scale industrial enterprises, henceforth the Survey). We use this above-size rm data for its
availability at annual basis and its large coverage of China's industrial output. The data have been employed by numerous
works to study the productivity growth of Chinese industries (such as Brandt, Biesebroeck, & Zhang, 2012) or factors behind
the productivity growth (such as Yu, 2014). We use the sample spanning from 2000 to 2007 to compute the productivity of
Chinese rms and the indicators of agglomeration. The number of observations for each year ranges from 162,885 (in 2000) to
336,768 (in 2007).
Quite a few observations in the Survey sample are plagued by missing information and misreporting. We therefore conduct a
data-cleaning procedure following the recent studies such as Cai and Liu (2009) and Feenstra et al. (2014). This involves deleting
the observations with the following characteristics: (1) key variables such as total industrial output, industrial added value, xed assets and employees have negative values; (2) the value of liquid assets or total xed assets are larger than that of total assets; (3) the
number of employees are less than 10; and (4) rm age is negative. This process reduces our observations to 160,868 in 2000 and to
335,616 in 2007, which still add up to more than 98% of original sample. It is shown in Table 1 that the share of retained observations is
maintained throughout our sample period.
Table 1
Description of the Survey data set.
Source: Authors' calculation.
Year
2000
2001
2002
2003
2004
2005
2006
2007
Total observations
Observation retained
Share of retained observations
162,885
160,868
98.8%
171,240
169,279
98.9%
181,557
179,706
99.0%
196,222
195,659
99.7%
276,474
275,289
99.6%
271,835
270,945
99.7%
301,961
300,908
99.7%
336,768
335,616
99.7%
54
Furthermore, the original identication codes in the Survey are sometime duplicated among several rms or are missing for some
rms, preventing us to uniquely identify each observation. We therefore assign each enterprise a new identication code based on its
name in Chinese, its original identication number and the name of its legal representative. Also, China has modied its industry
coding system in 2002, switching from GB1994 to GB2002. Because our exercise requires consistent information on industry
classication, we employ the method by Brandt et al. (2012) to prevent our observations from switching their industries due to
this administrative issue.
3.1.2. The 2004 Census

One issue about using the Survey data to assess industrial agglomeration is that it fails to capture the small non-SOE rms with
sales under the threshold. In order to take into account the clustering of SMEs highlighted by many case studies, we exploit the
2004 Census (henceforth, the Census) to calculate alternative set of indicators of agglomerations. To demonstrate the difference in
coverage between the Census and Survey, Table 2 compares the industrial output and rm number in 2004 by province. The number
of rms covered by the Census is about 5 times larger than that by the Survey, while the total industrial output covered by the Census
is only 10% larger than that by the Survey. These differences indicate the existence of a large mass of small rms. Indeed, the average
rm size in the Census is overall about one-fth of that in the Survey. The number of small rms covered by the Census but not by the
Survey is especially large in Zhejiang, Jiangsu and Guangdong where case studies and media have documented vibrant industrial
clusters. In fact, 40% of such rms are concentrated in the three provinces. Relying solely on the Survey ignores such mass of small
rms, and can result in inaccurate measurement of agglomerations in China. We therefore construct an alternative set of indicators
of agglomeration using the Census data.
The Census and the Survey share some common variables such as a rm's name, identication number, address code and industry
code. Since we construct agglomeration indicators from the Census data by a spatial unit and industry (as described later in this
section), we rely on address code and industry code to match the two datasets. However, the largest drawback of the Census data
is its limited availability: within in our sample period, it is only available in the year 2004. This constrains our empirical analysis
using the Census data to a cross-sectional exercise in one specic point of time. Therefore, we complement the base analysis using
the panel of the Survey data with an additional analysis based on the cross-section of the Census data.
Table 2
Comparison between the Census and the Survey data (year 2004).
Source: Authors' computation based on 2004 Census and 2004 Survey of Above-scale Industrial Enterprises.
Number of rms
Beijing
Tianjin
Hebei
Shanxi
Neimeng
Liaoning
Jilin
Heilongjiang
Shanghai
Jiangsu
Zhejiang
Anhui
Fujian
Jiangxi
Shandong
Henan
Hubei
Hunan
Guangdong
Guangxi
Hainan
Chongqing
Sichuan
Guizhou
Yunnan
Tibet
Shanxi
Gansu
Qinghai
Ningxia
Xinjiang
Total
Industrial output (1000 RMB)
Average rm size (output,

1000 RMB)
Census
Survey
Census
Survey
Census
Survey
31,669
25,654
64,629
28,884
11,849
54,610
16,363
20,303
55,806
188,844
188,917
39,263
49,824
29,468
120,673
76,896
29,262
43,925
137,652
19,080
2066
20,509
43,759
11,121
14,402
356
25,785
11,664
2198
4019
5807
1,375,257
6871
6462
9284
5013
2275
10,635
3280
3297
15,766
40,848
41,358
4778
11,918
4019
23,915
11,474
6232
7523
34,584
3749
588
2634
7413
2545
2332
187
3012
1927
463
662
1430
276,474
597,470,208
611,914,432
1,018,096,896
417,396,224
232,745,824
914,065,792
355,172,064
395,569,632
1,459,413,760
2,947,678,976
2,122,122,624
423,602,208
751,248,256
273,658,912
2,467,854,336
923,664,320
532,919,104
434,186,112
3,151,649,536
224,198,624
42,941,776
259,884,384
530,365,728
154,630,880
234,406,848
2,484,754
315,087,840
169,580,784
38,809,336
60,518,648
165,602,080
22,228,940,898
573,325,440
585,449,536
868,167,360
377,103,936
209,593,584
860,390,080
334,378,048
371,877,344
1,396,810,752
2,668,238,848
1,872,797,952
366,015,040
678,341,504
221,197,920
2,252,100,864
757,558,784
496,024,640
365,406,624
2,955,180,800
202,548,480
40,723,348
214,272,608
471,684,928
139,491,408
209,204,800
2,269,713
273,521,600
158,260,272
37,421,872
55,365,568
157,184,448
20,171,908,101
18,866
23,853
15,753
14,451
19,643
16,738
21,706
19,483
26,152
15,609
11,233
10,789
15,078
9287
20,451
12,012
18,212
9885
22,896
11,750
20,785
12,672
12,120
13,904
16,276
6980
12,220
14,539
17,657
15,058
28,518
16,163
83,441
90,599
93,512
75,225
92,129
80,901
101,945
112,793
88,596
65,321
45,283
76,604
56,917
55,038
94,171
419,733
79,593
48,572
85,449
54,027
69,257
81,349
63,629
54,810
89,710
12,138
90,810
82,128
80,825
83,634
109,919
72,961
55
3.2. The indicators of agglomeration

Mainland China has six layers of administrations, starting from a province and descending to a prefecture, a county, a
township and to a village. The spatial unit we use for our base analysis is a county. As of 2013, mainland China comprises
2856 counties. We observe the agglomerations of 131 3-digit China Industry Code (CIC) industries within a county. Later in
the paper, we conduct a robustness tests to show that our main nding is not sensitive to our choice of spatial unit and industry
classication.
The benets of agglomeration are likely decrease with the distance. However, we cannot capture the relation between agglomeration effects and the distance precisely because neither the Census nor the Survey provides exact geographical location of rms (such
as their longitude and latitude). As a second best approach, we compare the impact of an agglomeration within the same county the
rm is located and that of an agglomeration in other counties within the same province. We do not consider the agglomeration effects
across provinces given that the protectionism by provincial government in product and factor market is likely to limit them (Bai, Duan,
Tao, & Tong, 2004).
3.2.1. Agglomeration of the same industry
We construct four measures of agglomeration that correspond to a conventional concept of localization economies that is the
agglomerations of rms within the same industry. For a rm i operating in the industry j in the county k, such indicators are:
1. The number of rms in the same industry and the same county: agg_NCjk
This corresponds to the number of rms in the industry j and in the county k. We include the rm itself when calculating this
indicator so that it is feasible to take the logarithm of index even when there is one rm operating in a given industry and a
given county.
2. The average size of rms in the same industry and the same county: agg_YCjk
This measure captures the co-location of large rms belonging to the same industry within proximity of a given rm. It is obtained
by the following formula:
00
agg YC jk
@@
1
.

A
Y m Y i A agg NC jk 1
m j;k
where Yi is the output of the rm i. When there is only one rm in the industry j in the county k, we replace the index by 0. Although
this measure is specic to each rm, we drop the subscript i for the sake of brevity.
We construct two more indicators of agglomeration that concern the number or the average size of the rms belonging to the same
industry but that are located outside the county the rm i operates, while still within the same province.
3. The number of rms in the same industry but outside the county: agg_NPjk
This corresponds to the number of rms in the industry j but outside the county k.
4. The average size of rms in the same industry but outside the county: agg_YPjk
Unlike the second indicator, this indicator is a simple ratio between the aggregate output and number of the rms in the industry j
but located outside the county k.
3.2.2. Agglomeration of the upstream industry
In order to avoid the multicollinearity from having too many variables in our estimation, we focus on agglomerations of upstream
industries located within the same county. A rm's input coefcients from upstream industries should differ for each rm depending
on its sourcing strategy. However, because the information on inputs at rm-level is not available, we follow Javorcik (2004) and
many other studies to use the industry-level input coefcients as the proxy of rm-level input coefcients. The coefcients
are taken from inputoutput (IO) tables of China. For a given rm in industry j and in country k, the indicator of agglomeration of
upstream industries is constructed as the following:
1. The number of rms in the same county but upstream industries: Uagg_NCjk
The indicator aggregates the number of rms in other industries as the industry j located in the country k using the input
coefcients of the industry j as weights:
Uagg NC jk
jm Nmk
m;m j
Provinces also include municipality directly administered by central government such as Beijing, Tianjin, Shanghai and Chongqing, as well as autonomous regions
like Guangxi, Ningxia, Neimeng, Xingjiang and Xizang.
The CIC comprises 470 four-digit, 181 three-digit, and 38 two-digit industries, but we covered only 131 three-digit industries due to there are not sufcient observations in some industries.
Because IO table within our sample period is only available on 2002 and 2007, we obtain the input coefcients in the other years from a linear interpolation between
the 2002 and the 2007 input coefcients. We also assume that the input coefcients in 2001 are identical to those in 2002. Furthermore, input coefcients in the IO
tables are at two-digit level, implying that three-digit industries within the same two-digit industry are all assigned the same coefcients.
56
the subscript m represent industry other than j. jm is the input coefcient of industry j from industry m and Nmk is the total number of
rms in industry m in the county k.
2. The average size of rms in the same county but upstream industries: Uagg _ YCjk
The indicator is calculated as the following:
Uagg YC jk

X
jm Y mk =Uagg NC jk
m;m j
where Ymk is the sum of output of the rms belonging to industry m in the same county k as rm i.
All the indicators are transformed into natural logarithm. Table 3 provides summary statistics of these agglomeration indicators
both when using the Survey data and the Census data.
3.3. Estimation of TFP
We observe the total factor productivity (TFP) as the principle measure of productivity. TFP is obtained as the residual after
deducting the contributions by labor and capital inputs to its output. It is thus obtained from an estimation of production function.
We apply the method proposed by Levinsohn and Petrin (2003) which controls for the potential endogeneity in estimate of inputs
coefcients. Consider a rm's production function such as below:
Y t f It ; t ;
where, It are inputs used in production; are parameters; and t is error term vector, which can be interpreted as Hicks-neutral
productivity.
Because rms with higher productivity are expected to use more inputs, the input vector It may be correlated with the unobservable
productivity t. In such case, the estimates obtained from OLS are biased. Levinsohn and Petrin (2003) consider the following log-linear
production function:
yt 0 l lt k kt m mt t t
where, yt , lt , kt and mt are log of output, labor, capital and intermediate inputs, respectively; lt is deemed as free variable, kt and mt are
state variables. The error term t in the Eq. (4) is divided into two parts, namely t and t. t is the unobservable state variable which
impacts the rm's decision on inputs, whereas t is an independently and identically distributed disturbances that has no impact on
the rm's decision. Assume intermediate input's demand function is given as,
mt mt t ; kt :
Table 3
Summary statistics of the indicators of agglomeration.
Source: Authors' calculation.
Obs
Mean
Std. Dev.
Min
Max
Survey data sample

agg_NC
agg_YC
agg_NP
agg_YP
Uagg_NC
Uagg_YC
609,331
609,331
609,331
609,331
609,217
609,058
0.56
4.40
4.12
10.69
0.60
10.69
0.81
5.11
1.40
1.29
1.59
0.98
0.00
0.00
0.00
0.00
0.00
0.08
6.29
17.69
8.04
18.24
6.01
18.86
Census data sample

agg_NC
agg_YC
agg_NP
agg_YP
Uagg_NC
Uagg_YC
67,013
67,013
67,013
67,013
67,013
67,013
1.70
7.26
5.86
9.43
2.42
9.25
1.28
3.74
1.44
1.13
1.53
0.90
0.00
0.00
0.00
0.00
0.00
3.27
7.65
17.44
9.20
16.79
7.04
14.01
Note:
1. The agglomeration indicators are all in natural logarithm.
2. agg_NC is the number of rms in the same industry and same county; agg_YC is the average size of rms in the same industry and same county; agg_NP is the number
of rms in the same industry same province but outside the county; agg_YP is the average size of rms in the same industry same province but outside the county;
Uagg_NC is the number of rms in the same county but upstream industries; and Uagg_YC is the average size of rms in the same county but upstream industries.
57
If such function is monotonic in t for all kt, the unobservable t can be captured by the inverse function of intermediate input to get
t = t(mt, kt). This enables the Eq. (5) to be rewritten as,
yt l lt t mt ; kt t
where, t(mt, kt) = 0 + kkt + mmt + t(mt, kt).

Following idea of Robinson (1988), subtracting expectation of yt conditional on mt and kt, the Eq. (7) can be transformed as
below:
yt Eyt jmt ; kt l lt Elt jmt ; kt t :
Since t is independently and identically distributed errors, OLS regression of Eq. (8) yields the consistent estimate of l.
Coefcients on capital input k and on intermediate inputs m are estimated as the following: rst, it is assumed that t follows
a rst order Markov process and that capital does not immediately respond to t,the innovations in productivity over last period's
expectation, then,
t t Et jt1 :
According to the relationship of Eq. (5), we can get:

^ l k m E
^ j
t t yt
l t
t t1
k t
m t
10
^ is the estimated coefcient of labor input obtained previously.
where
k and m are the candidate values for k and m, respectively.
l

^ kt1 mt1 using weighted
^ lt kt mt on
[t|t 1] is the residual obtained from the regression of y
t
t1
quadratic least squares. The latter is therefore a function of k and m.

The following two moment conditions are required to obtain the consistent estimates:
Et t kt Et kt 0
11
Et t mt1 Et mt1 0
12
The rst moment condition requires that capital input and productivity are not correlated, whereas the second requires that the
^ and
^ are obtained by minimizing the following
past intermediate inputs are not correlated with productivity. The estimates
k
m
GMM standard equation:
Q min
X4 X XT
h1
i1
tT i0
2

^ it Z i;ht
it
13
where Zt = {lt, kt, mt 1, mt 2}. In the equation above, i represent enterprises, h the number of Z; and Ti0 and Ti1 are the second year
and the last year when enterprise i is observed in the sample. Since panel data are required for the estimation of production function,
we rely on the Survey data to estimate TFP. This implies that the recipients of agglomeration effects in this paper are SOEs and relative
large non-SOEs.
Given that rm-specic prices are not available, we follow Brandt et al. (2012) to use the 2-digit industry-level price index to
deate a rm's output and intermediate input, and the xed asset investment price to deate its capital. Furthermore, we estimate
product function separately for each 2-digit industry considering the fact that input coefcients differ substantially across industries.
The average TFP (in logarithm) for each year is shown in Table 4, indicating a clear uptrend that is in line with previous studies. It
can also be seen that the average TFP of private enterprises is generally higher than those of SOEs and FIEs although there has
been an apparent surge in the TFP of SOEs at the latter years. This is in line with the well-documented growth in protability of
SOEs as they retreat from the sectors open to competition and FDI and concentrate on highly regulated upstream industries (Du &
Wang, 2013).
3.4. Empirical model of agglomeration effects
We estimate the following model that relates the TFP of a rm i in industry j located in county k to the agglomeration of the same
industry and the upstream industries:
ln T FP ijkt 1 Horizontal jkt1 2 Horizontal jmt1 3 Upstream jkt1 X ijkt1 i t j k ijkt :
Take expectation for Eq. (4) conditional on mi and ki, we can get E[yt|mt, kt] = lE[lt|mt, kt] + t(mt, kt), so Eq. (5) is gotten.
14
58
Table 4
Summary of the estimated TFP by year.
Source: Authors' calculation based on survey data of above-scale industrial enterprises.
Sample
Statistics
2001
2002
2003
2004
2005
2006
2007
All rms
Mean
Std. Dev
Mean
Std. Dev
Mean
Std. Dev
Mean
Std. Dev
2.95
1.56
2.46
1.82
3.12
1.37
3.10
1.55
3.08
1.54
2.60
1.83
3.21
1.36
3.18
1.55
3.23
1.49
2.85
1.80
3.32
1.35
3.25
1.53
3.31
1.42
3.02
1.79
3.37
1.29
3.23
1.51
3.47
1.42
3.26
1.81
3.51
1.32
3.38
1.48
3.60
1.41
3.51
1.77
3.63
1.33
3.51
1.47
3.75
1.40
3.89
1.75
3.78
1.35
3.60
1.47
SOEs
PEs
FIEs
Notes:
1. TFP are in natural logarithm.
2. SOEs refer to state-owned enterprises; PEs refer to private enterprises; FIES refer to foreign invested enterprises.
The rst term on the left hand side is a constant, whereas the second to the fourth terms are the indicators of industrial agglomeration. The term Horizontaljkt is a vector of the indicators of agglomeration in the same industry and in the same county, agg _ NC, and
agg _ YC. The term Horizontaljmt is a vector of the indicators of agglomeration in the same industry but outside the county, agg _ NP and
agg _ YP. The term Upstreamjkt is a vector of the two indicators of agglomeration of the upstream industries, Uagg _ NC and Uagg _ YC.
Since all agglomeration indicators are in logarithm, the estimated coefcients can be interpreted as elasticity of productivity to
number of rms or average rm size in the same industry or in upstream industries.
The signs of estimated coefcients on the indicator of agglomeration Horizontaljkt are not clear a priori given that positive impacts
of Marshallian externalities are at least partly offset by congestion effects and intensied competition in product and factor markets
that suppresses product prices while driving up inputs costs. However, such negative effects to a rm's productivity can be less severe
when the agglomeration is located farther from the rm (i.e., in other counties) or occurring in upstream industries. On the other
hand, knowledge spillovers are expected to be smaller when an agglomeration is not located within the proximity or it concerns
industries using different technologies. Therefore, the signs and relative sizes of coefcients on Horizontaljmt and Upstreamjkt are
also not clear.
The fth term Xijkt is the vector of control variables. It includes the following rm characteristics that can inuence a rm's productivity: (1) the logarithm of R&D Investment; (2) the market share, which is the rm's output share in the same industry. Firms with
larger market share often enjoy stronger monopolistic power and higher mark-up; (3) debt ratio, measured as the ratio of the rm's
total liability to total assets, which we interpret as the rm's borrowing capability. Enterprises with strong borrowing capability may
realize higher productivity because their investments are less subjected to credit constraints; (4) the export intensity, measured as the
ratio of the rm's export to its total value-added. Firms that export enjoy scale economy by supplying the world's market and can also
tap into advanced technology through transaction with foreign partners (De Loecker, 2007); and (5) rm age, measured as the difference between the year in sample and the year of establishment. Longer survival reects the rm's intangible competitiveness such as
superior managerial capability. It also accounts for productivity advantage over competitors that is founded on learning by doing
effect. Furthermore, a county-level average wage is included in order to control for the quality of labor in the county the rm is located.
Firms often agglomerate in areas with abundant supply of skilled labor, the use of which is an important determinant of a rm's productivity. Controlling for the local labor quality allows us to capture the pure effects of agglomeration. Table 5 provides summary statistics of those control variables.
Because of more intense competitions in product and factor markets within agglomerated regions, rms with originally high
productivity are more likely to locate in such area (Baldwin & Okubo, 2006). We address the possibility of such reverse causality
from productivity to agglomeration in two ways: rst, we lag all indicators of agglomeration one period along with the control
variables. Thus, when using the indicators constructed from the Census data, Eq. (14) is estimated with a cross-sectional OLS which
regresses rm's TFP of 2005 on the indicators that capture agglomeration in the year 2004. Second, when using the indicators computed from the Survey data, we include a rm-level xed effect i that captures time-invariant unobservable rm characteristics
(such as superior managerial quality). Because some rms switch industries and areas over the sample period, three digits industry
xed effects and province xed effects are included in estimation. Furthermore, we include time xed effect to control for trend
growth in productivity when using panel data. Lastly, ijkt is an i.i.d error which follows N (0, 2).
Table 5
The denition and summary statistics of control variables.
Source: Authors' calculation based on survey data of above-scale industrial enterprises.
Variables
Denition
Obs
Mean
S.D.
Min
Max
R&D investment
Market share
Debt ratio
Export ratio
Age (year)
Average wage
Natural log of R&D investment

The proportion of rm' output to total output of industry
The ratio of total assets to total liability
The ratio of export to the added value
Firm age
Natural log of average wage of the county
1,303,196
1,830,664
1,830,664
1,830,664
1,830,664
1,830,664
0.61
0.00
0.59
0.16
10.00
2.70
1.84
0.00
0.35
0.33
11.40
0.49
0.00
0.00
0.00
0.00
1.00
2.36
16.14
0.80
48.50
2.00
150.00
5.74
59
The model is estimated for the whole sample as well as for the sub-samples of rms with different ownerships, namely the SOEs,
private enterprises (PEs) and FIEs. The latter specication reveals how the difference in business conditions, corporate culture and
technological endowment among the three types of rms shapes their ability to benet from agglomeration. Furthermore, we also
assess how such differences shape a rm's ability to act as the source of spillovers by estimating the Eq. (14) with the indicators
that capture an agglomeration of the rms of specic ownership.
4. Estimation results
4.1. Agglomeration effects based on the Survey data
Table 6 presents the results of base estimation and those over sub-samples of rms with different ownerships. As the most basic
setting, column 1 shows the results where only the indicator of agglomeration of the same industry in the same county is included.
The average rm size (agg_YC) has statistically signicant positive contribution to a rm's productivity, while the impact of number
of rms (agg_NC) is not signicant and negative. The insignicant coefcient on number of rms suggests that severe congestion effect associated with agglomeration is offsetting the benets from Marshallian externality. The positive coefcient on average rm size
however suggests that the co-location of large, productive rms within proximity does contribute to productivity.
As we add the agglomeration of the same industry outside the same county and that of upstream industries within the same
county in column 2, the coefcient on agg_NC now indicates a statistically signicant negative effect on productivity. It implies that
doubling the number of rms in the same industries within the same county can reduce a rm's productivity up to 1.2%. On the
other hand, the coefcient on the number of rms in the same industry outside the county (agg_NP) is signicant and positive,
implying that doubling such number raises a rm's productivity by 1.3%. This somewhat surprising nding that agglomeration is
more benecial when it is in a moderate distance indicates a specic situation in China where an agglomeration of the same industry
Table 6
Estimates of agglomeration effects based on the Survey data.
Sample
Indicators of agglomeration
(1) agg_YC
(2) agg_NC
All (1)
0.004***
(8.97)
0.002
(0.73)
(3) agg_YP
(4) agg_NP
(5) Uagg_YC
(6) Uagg_NC
RD investment
Market share
Debt ratio
Export ratio
Age
Average wage
Constant
Prob F
R-square
Observations
0.003***
(5.11)
7.065***
(19.79)
0.077***
(17.83)
0.084***
(13.76)
0.010***
(4.25)
0.156***
(28.27)
2.036***
(8.13)
0.000
0.484
849,775
All (2)
SOEs (3)
PEs (4)
FIEs (5)
0.004***
(7.99)
0.012***
(4.54)
0.010***
(5.30)
0.013***
(5.12)
0.052***
(18.31)
0.032***
(13.10)
0.003***
(5.05)
7.275***
(20.13)
0.075***
(17.56)
0.084***
(13.72)
0.011***
(4.57)
0.149***
(26.96)
1.298***
(5.13)
0.000
0.480
849,775
0.001
(0.52)
0.001
(0.06)
0.003
(0.59)
0.032***
(3.61)
0.028***
(3.11)
0.024**
(2.93)
0.009***
(4.20)
3.378***
(4.14)
0.046***
(3.92)
0.052
(1.19)
0.039***
(4.15)
0.087***
(4.28)
0.353
(0.49)
0.000
0.137
77,849
0.004***
(8.09)
0.016***
(5.37)
0.014***
(5.79)
0.008**
(2.72)
0.060***
(17.63)
0.037***
(12.52)
0.003***
(3.13)
9.452***
(15.82)
0.083***
(13.93)
0.032***
(3.97)
0.003
(1.22)
0.142***
(21.96)
2.543***
(3.01)
0.000
0.371
582,251
0.003**
(2.92)
0.001
(0.21)
0.001
(0.13)
0.009
(1.61)
0.035***
(5.16)
0.027***
(4.60)
0.004**
(2.57)
6.881***
(10.26)
0.051***
(6.38)
0.144***
(15.17)
0.030***
(3.37)
0.212***
(16.02)
1.270
(1.24)
0.000
0.289
183,863
Notes:
1. All estimations include rm, time, industry and province xed effects.
2. t-statistics are in the parentheses.
3. ***, **each corresponds to signicance at 1% level and 5% level, respectively.
4. The data used for estimation is from Annual Survey of Above-scale Industrial Enterprises.
5. SOEs refer to state-owned enterprises; PEs refer to private enterprises; FIES refer to foreign invested enterprises.
All these variables are in natural log form. Denitions of other control variables please refer to Table 5.
60
penalize rms in proximity with severe congestion and competition that overwhelm the localization economy. The negative effect of
stronger competition is also hinted by the positive coefcient on the average size of rms in the same industry but outside the same
county (agg_YP), which is larger than that on the average rm size within the same county (agg_YC). This suggests that the benet
from the colocation of large, competitive rms is partly offset when they are within proximity, because they can be formidable rivals
in the local product and factor markets.
Furthermore, the coefcients on the number of rms and the average rm size in upstream industries within the same county are
both positive and signicant. Moreover, those coefcients are considerably larger than those corresponding to the agglomeration of
the same industry. For instance, they imply that that doubling the number of rms in upstream industries or their average size raises
a rm's productivity by 3.2% and 5.2%, respectively. These results provide strong support to our view that agglomeration of upstream
industries is the important source of competitiveness of Chinese industry. Furthermore, the benet of agglomeration to productivity is
less weakened by the negative impact via ercer competition when agglomeration concerns non-competing industries. Finally, it is
noteworthy that the F-statistics indicates the joint-signicance of all those additional indicators of agglomeration. This indicates
that studies that failed to incorporate agglomeration of upstream industries were indeed prone to misspecication and may have
not captured the true contribution of agglomeration to productivity.
Columns 3 to 5 report the results for the sub-samples of rms with different ownerships, namely state-owned enterprises (SOEs),
private enterprises (PEs) and foreign invested enterprises (FIEs). Interestingly, many of the observations above are driven by the
sub-sample of PEs. For instance, the signicant and negative impact on productivity from agg_NC is only observed among the PEs.
The signicant positive coefcients on both agg_YC and agg_YP are also observed only for PEs. Such results may be reecting the
fact that PEs are most exposed to market competition and are therefore most subject to negative impacts of agglomeration. They
are also most eager to absorb knowledge spillovers given their strong prot-orientation and a large room for catch-up in production
and managerial technology (Zhang, Zeng, Mako, & Seward, 2009). Interestingly, the number of rms outside the county (agg_NP)
seems to benet SOEs more than PEs.
As for the agglomeration of upstream industries, the number of rms (Uagg_NC) and average rm size (Uagg_YC) are both associated with positive and signicant coefcients for rms with all types of ownership. This is not surprising since the benet from the
agglomeration of supporting industries such as supply of higher quality and cheaper intermediate goods should reward rms regardless of their corporate behavior. However, PEs are again enjoying the largest impact, possibly because they outsource more of their
inputs. Overall, our observation reveals that PEs are the primary recipient of both positive and negative agglomeration effects in China.
Each column also displays the contribution of control variables that is more or less consistent across ownership. Most importantly,
R&D contributes signicantly to productivity as reported by previous studies such as Wu (2006). The estimated coefcients suggest
that doubling R&D expenditure increases the rm's productivity from 0.3% to 0.9%, depending on the rm's ownership. The elasticity
is highest among the SOEs, which are observed to occupy a large share of R&D investment in China (Pilat, Yamano, & Yashiro, 2012).
This is roughly in line with the view that the return to R&D investment is shaped by a rm's capability to absorb new technology,
which is formed by previous R&D activities (Cohen & Levinthal, 1989). Contrary to our conjecture, the debt ratio and export ratio
are negatively associated with the rm's productivity. The negative relation between export ratio and productivity is especially apparent for FIEs, which engage intensively on processing trade. Firm age is also negatively associated with productivity in case of SOEs.
Lastly, county-level average wage contributes signicantly to a rm's productivity, suggesting that skilled labor is indeed an important
element of competitiveness by Chinese rms.
4.2. Agglomeration effects based on the Census data
The estimation of agglomeration effects using the indicators of agglomeration constructed from the Census data is a cross-sectional
OLS that does not control for an unobserved rm heterogeneity. This may result in biased coefcients if such heterogeneity affects
both the productivity and likelihood of locating in agglomerated region. Also, it only observes the relationship between productivity
and agglomeration in a specic point of time, the year 2005. The estimated coefcients are therefore not comparable from those obtained from the estimation using indicators based on the Survey data. Keeping those caveats in mind, we investigate whether taking
into account the agglomeration of smaller rms will alter or provide new nding on our previous results based on the Survey data.
The results from the estimation displayed in Table 7 are qualitatively similar to the results in Table 6. For instance, the coefcient on
the number of rms in the same industry within the same county (agg_NC) is negative and signicant, conrming the severe congestion and competition effect associated with agglomeration. The negative impact of agg_NC becomes more pronounced when agglomeration outside the county and that of upstream industries are incorporated (column 2). On the other hand, contrary to the results in
Table 6, the coefcient on agg_NP is also negative, albeit the limited signicance. This suggests that the agglomeration in a moderate
distance is not as benecial as previously found, possibly because the positive externality wane with distance or congestion and competition effects spreads across counties. The smaller coefcient on agg_NP than that on agg_NC is still in line with the previous nding.
As for the average rm size, the coefcient on agg_YC and that on agg_YP are both positive with the former being larger than the latter,
in line with the results in Table 6. The contribution by the agglomeration of upstream industries is conrmed by the signicant and
positive coefcient on Uagg_NC. These results support our ndings based on the Survey data. It is also noteworthy that the signs of
coefcients on control variables are also in line with the previous results except the one on export ratio.
There is abundant theoretical and empirical evidence on the self-selection of productive rms into exports (for instance, Melitz, 2003, Tybout et al., 1998). The
strong positive correlation between productivity and export intensity may be due to the inability to control for the unobserved rm heterogeneity that raises
productivity.
61
Table 7
Estimates of agglomeration effect based on the Census data.
Sample
Indicators of agglomeration
(1) agg_YC
(2) agg_NC
All (1)
0.058***
(55.90)
0.006***
(3.50)
(3) agg_YP
(4) agg_NP
(5) Uagg_YC
(6) Uagg_NC
R&D investment
Market share
Debt ratio
Export ratio
Age
Average wage
Constant
Prob F
R-square
Observations
0.129***
(99.01)
68.861***
(103.65)
0.172***
(25.20)
0.167***
(22.90)
0.011***
(4.30)
0.037***
(4.38)
5.753***
(162.27)
0.000
0.243
215,076
All (2)
SOEs (3)
PEs (4)
FIEs (5)
0.052***
(49.89)
0.023***
(9.98)
0.066***
(15.30)
0.006*
(1.65)
0.124***
(34.74)
0.046***
(16.61)
0.129***
(99.02)
67.599***
(102.07)
0.176***
(25.89)
0.151***
(20.82)
0.011***
(4.07)
0.135***
(14.28)
4.594***
(76.72)
0.000
0.249
215,076
0.054***
(17.11)
0.072***
(6.39)
0.065***
(5.74)
0.011
(0.82)
0.178***
(14.91)
0.155***
(15.49)
0.187***
(48.07)
46.829***
(28.19)
0.272***
(12.47)
0.511***
(9.02)
0.127***
(13.17)
0.045
(1.39)
3.379***
(17.25)
0.000
0.443
21,178
0.038***
(31.49)
0.004
(1.45)
0.062***
(11.96)
0.001
(0.22)
0.084***
(20.61)
0.023***
(7.24)
0.115**
(71.83)
74.325***
(72.67)
0.134***
(15.82)
0.125***
(12.98)
0.044***
(15.21)
0.197***
(18.21)
5.124***
(74.67)
0.000
0.216
147,185
0.059***
(21.90)
0.004
(0.72)
0.023**
(2.04)
0.015*
(1.67)
0.128***
(14.76)
0.020***
(2.94)
0.107**
(38.61)
70.663***
(59.67)
0.006
(0.41)
0.073***
(5.87)
0.033***
(4.75)
0.071***
(3.13)
4.927
(25.45)
0.000
0.226
46,713
Notes:
1. All estimations include control variables as well as industry and province xed effects.
3. ***, **,* each corresponds to signicance at 1% level, 5% level and 10% level, respectively.
4. The data used for estimation is from 2004 Census.
5. SOEs refer to state-owned enterprises; PEs refer to private enterprises; FIEs refer to foreign invested enterprises.
All these variables are in natural log form. Denitions of other control variables please refer to Table 5.
However, when looking across sub-samples of rms with different ownerships in columns 3 to 5, PEs are not necessarily the main
recipient of agglomeration effects. For instance, it is the SOEs that suffer the signicant negative impact from agg_NC while the coefcient is insignicant for PEs and FIEs. This is likely to reect an erosion of market shares and prots of SOEs due to competitions
against PEs and FIEs. While the coefcient on Uagg_NC is positive and signicant for both SOEs and PEs, the size of coefcient suggests
that SOEs benet more than PEs. Furthermore, the coefcients on the average rm size suggest that SOEs and FIEs enjoy larger
spillovers from a co-location with large rms than PEs.
4.3. Agglomeration effects from different ownerships
The difference in ownership may dene not only a rm's ability to absorb favorable agglomeration effects but also the extent to
which it acts as a source of agglomeration effects. For instance, FIEs has long been considered as the source of technology spillover.
Also, PEs, which are signicantly smaller than SOEs or FIEs, may be an active source of agglomeration effects to the extent that smaller
rms are more likely to interact with and outsource to other rms due to its limited resource (Rosenthal & Strange, 2001). On the
other hand, SOEs that are oriented toward government policies and enjoy policy-backed monopolistic power may generate little spillovers to other rms. In order to investigate which type of rms are the most important source of agglomeration effects, we construct
the indicators of agglomeration separately for SOEs, PEs and FIEs and re-estimate the model corresponding to the column 2 of Tables 6
and 7. We estimate the agglomeration effects to the TFP of all rms as well as to that of PEs, the latter being the main recipients of
agglomeration effects.
Table 8 summarizes the results of this exercise. For the sake of brevity, the estimated coefcients on control variables are not
displayed. Columns 1 to 3 observe how the TFP of Chinese rms is affected by the agglomeration of SOEs, PEs and FIEs. The coefcient
on agg_NC, the number of rms in the same industry within the same county, is insignicant regardless of the type of rms. This suggests that the negative coefcient observed in Tables 6 and 7 is a composite effect of agglomeration of all three types of rms. On the
other hand, the coefcient on agg_YC is positive only for the agglomeration of PEs and for that of FIEs but with limited signicance.
62
Table 8
Agglomeration effects from different ownerships (the Survey data).
Samples
All rms
The source of agglomeration
SOEs (1)
PEs (2)
FIEs (3)
SOEs (4)
PEs (5)
FIEs (6)
(1) agg_YC
0.001
(1.53)
0.012
(1.52)
0.004***
(7.26)
0.017***
(8.61)
0.002
(1.50)
0.002
(0.23)
0.000
0.482
839,791
0.002***
(4.16)
0.002
(0.74)
0.008***
(4.94)
0.016***
(6.24)
0.048***
(17.32)
0.020***
(6.51)
0.000
0.449
727,896
0.001**
(2.43)
0.004
(1.46)
0.003***
(5.20)
0.002
(0.69)
0.019***
(10.24)
0.052***
(13.88)
0.000
0.484
742,700
0.000
(0.14)
0.017
(1.60)
0.004***
(6.56)
0.021***
(8.66)
0.004***
(3.04)
0.008
(0.87)
0.000
0.322
573,801
0.027***
(16.27)
0.001
(0.25)
0.024***
(7.56)
0.012***
(3.36)
0.064***
(16.55)
0.034***
(8.28)
0.000
0.350
464,062
0.006**
(2.48)
0.016**
(2.44)
0.007*
(1.92)
0.013*
(1.97)
0.021***
(2.95)
0.015*
(1.93)
0.000
0.268
140,042
(2) agg_NC
(3) agg_YP
(4) agg_NP
(5) Uagg_YC
(6) Uagg_NC
Prob F
R-square
Observations
PEs
Notes:
1. All estimations include control variables as well as rm, time, industry and province xed effects.
3. ***, **,* each corresponds to signicance at 1% level, 5% level and 10% level, respectively.
All these variables are in natural log form.
Furthermore, the positive and signicant coefcient on agg_NP noted in column 2 of Table 6 is only observed for PEs. While the
coefcient on agg_YC is positive when agglomeration concerns all types of rms, it is largest in case of PEs. Therefore, Chinese
rms seem to benet most from the co-location of large, competitive PEs.
It is noteworthy that the important contribution from the agglomeration of upstream industries is generated primarily from PEs.
The coefcient on Uagg_NC is only positive for the agglomeration of PEs whereas it is insignicant or negative for those of SOEs and
FIEs. The coefcient implies that doubling the number of PEs in upstream industries raises the productivity of Chinese rms by 4.8%.
While it is somewhat surprising that an agglomeration of FIEs in upstream sector has a negative impact on productivity, it is possible
Table 9
Agglomeration effects from different ownerships (the 2004 Census data).
Samples
All rms
The source of agglomeration
SOEs (1)
PEs (2)
FIEs (3)
SOEs (4)
PEs (5)
FIEs (6)
(1) agg_YC
0.013***
(10.90)
0.087***
(8.96)
0.008***
(5.54)
0.008*
(1.84)
0.030***
(18.64)
0.022***
(3.22)
0.000
0.233
212,324
0.059***
(45.75)
0.012***
(5.51)
0.060***
(13.19)
0.010***
(2.58)
0.139***
(34.75)
0.039***
(13.17)
0.000
0.249
205,464
0.018***
(27.75)
0.011***
(3.30)
0.008***
(5.23)
0.004
(0.99)
0.042***
(20.39)
0.015***
(4.68)
0.000
0.228
202,179
0.002
(1.10)
0.038***
(3.13)
0.007***
(4.34)
0.016***
(3.32)
0.012***
(7.22)
0.038***
(4.67)
0.000
0.205
144,875
0.196***
(81.02)
0.022***
(9.04)
0.025***
(4.31)
0.008*
(1.82)
0.095***
(21.28)
0.029***
(8.84)
0.000
0.255
139,607
0.007***
(9.31)
0.012***
(3.39)
0.009***
(5.54)
0.018***
(4.44)
0.019***
(8.50)
0.012***
(3.32)
0.000
0.210
139,617
(2) agg_NC
(3) agg_YP
(4) agg_NP
(5) Uagg_YC
(6) Uagg_NC
Prob F
R-square
Observations
PEs
Notes:
1. All estimations include industry and province xed effects.
3. ***,* each corresponds to signicance at 1% level and 10% level, respectively.
4. The data used for estimation is from 2004 Census.
63
that it intensies competition in factor market, namely of skilled labor. On the other hand, the average size of FIEs in upstream industries has positive and signicant impact, implying that co-location of competitive FIEs in upstream industries is benecial. However,
the coefcient on Uagg_YC is even larger when it concerns PEs. Overall, we nd that PEs are the main sources of agglomeration effects
in China's industry. In contrast, neither the number nor average size of SOEs in upstream industries seems to benet the productivity
of Chinese rms.
Columns 4 to 6 observe how the TFP of PEs is affected by the agglomeration of different types of rms. The overall picture looks
fairly similar to the case of all rms. It can be noted that the positive coefcients on agg_YC and agg_YP are larger when they concern
PEs than SOEs or FIEs. This indicates that PEs learn signicantly more from the competitive PEs in proximity than from other types of
rms. Furthermore, PEs enjoy positive and signicant impact from the number of PEs in the same industry outside the county
(agg_NP) but not from that of SOEs or FIEs. Finally, like the case of all rms, only the number of PEs in upstream industries contributes
positively to the productivity of PEs, but with larger magnitude (6.4% productivity increase when doubling the number of PEs).
Overall, it can be said that PEs benet most from the agglomeration of PEs. The agglomeration effects from PEs are self-reinforcing
in that sense.
We also observe whether the indicators based on the Census data provide alternative picture. The results, summarized in Table 9,
reveal some interesting new ndings. For instance, columns 1 to 3 indicate that the negative impact from agg_NC is driven mostly by
the agglomeration of SOEs and PEs, whereas the number of FIEs in the same industry has favorable impact. This suggests that the
clustering of small domestic rms is generating substantial congestion and competition, whereas FIEs do not add strong competition
pressure in domestic product markets possibly because they are more export-oriented. PEs are also the primary source of congestion
effects across counties, for a negative and signicant sign on agg_NP is only associated with its agglomeration. On the other hand, the
coefcients on average rm size are largest in case of an agglomeration of PEs, in line with Table 8. Similarly, the positive coefcient on
Uagg_NC is still observed only for PEs.
Turning to columns 4 to 6, we nd that the coefcients on agg_NC are positive and signicant for the agglomeration of all types of
rms. This implies that the negative net impact from the number of rms in the same industry within the same county observed in the
column 2 of Tables 6 and 7 is suffered by other types of rms than PEs. However, such results should be interpreted with care, for they
may be driven partly by the unobserved rm characteristics that increase both the productivity of PEs and their propensity to locate in
agglomerated areas. Other notable ndings in Table 8 are also preserved: PEs benet most from the average size of PEs in the same
industry and in upstream industries and only the number of PEs in upstream sector contribute to their productivity.
4.4. Robustness check

We assess the robustness of our ndings based on Survey data corresponding to the column 2 of Table 6. We do so by reproducing
the estimation using alternative estimates of rm-level productivity as well as with different industrial classication and regional unit.
The results of this exercise are summarized in Table 10.
Table 10
Base estimates with alternative specications.
agg_YC
agg_NC
agg_YP
agg_NP
Uagg_YC
Uagg_NC
Constant
Prob. N F
R-square
Observations
TFP_OLS (1)
TFP_OP (2)
Labor productivity (3)
4 Digit industries (4)
2 Digit industries (5)
City level (6)
0.003***
(7.89)
0.008***
(3.45)
0.011***
(6.45)
0.015***
(6.42)
0.058***
(21.03)
0.036***
(15.23)
1.292***
(5.27)
0.000
0.062
849,771
0.004***
(7.97)
0.011***
(4.41)
0.010***
(5.36)
0.012***
(4.88)
0.052***
(18.43)
0.032***
(13.33)
1.852***
(7.36)
0.000
0.440
849,285
0.004***
(9.50)
0.013***
(5.47)
0.014***
(7.80)
0.012***
(4.96)
0.054***
(19.57)
0.029***
(12.21)
2.453***
(10.03)
0.000
0.043
847,308
0.002***
(5.93)
0.011***
(4.39)
0.005***
(4.83)
0.009***
(4.51)
0.049***
(17.18)
0.033***
(13.75)
1.580***
(6.26)
0.000
0.471
849,771
0.004***
(6.45)
0.004
(1.56)
0.031***
(7.93)
0.024***
(6.17)
0.047***
(16.32)
0.031***
(11.86)
0.939***
(3.39)
0.000
0.332
849,771
0.005***
(7.26)
0.003
(1.10)
0.005***
(6.33)
0.011***
(4.42)
0.038***
(7.47)
0.072***
(16.44)
0.999***
(3.88)
0.000
0.461
849,776
Notes:
1. All estimations include control variables as well as rm, time, industry and province xed effects.
3. ***corresponds to signicance at 1% level.
64
First, we use the total factor productivity estimated by OLS (column 1). The novel nding that agglomeration captured as the number of rms in the same industry impacts the productivity negatively when it is within the same county remains valid. Also the sizable
positive impact from the agglomeration in upstream industries, as well as the larger coefcients on agg_YP compared to agg_YC are all
preserved. We then use the TFP estimated by the method of Olley and Pakes (1996), obtaining similar results (column 2). Because the
estimated TFP may pick up the difference in prices and mark-up rates among rms, we also check if our ndings are robust to another
measure of productivity, namely a rm's labor productivity measured as value-added per employee. Again, we obtain very similar
results (column 3).
We next assess the sensitivity of our results to industrial classication. The alternative indicators of agglomeration are constructed
under ner industrial classication (four-digit) as well as rougher classication (two-digit). Column 4 displays the results of
estimation based on four-digit industrial classication, which is very similar to the base results. In the estimation based on
two-digit industrial classication, however, the coefcient on agg_NC becomes insignicant while remaining negative (column 5).
One interpretation to this change is that under a rougher classication, agg_NC may count rms that are not actually competing in
the same industry, thereby diluting the negative impact from intensied competition. All other observations are preserved.
Finally, we construct the indicators of agglomeration at alternative regional unit, namely at city level. A city is a larger regional unit
than a county, for it usually comprises several counties. The results presented in column 6 are somewhat similar to the case of
indicators constructed on basis of two-digit industrial classication. The negative coefcient on agg_NC becomes insignicant while
all other observations are preserved. One explanation to this change is that congestion is less severe under a larger geographical
scope of industrial concentration. Put differently, agg_NC in this case comprises some of rms previously counted as agg_NP, which
has signicantly positive coefcient.
5. Contribution to the industry-level productivity growth
How much did the industrial agglomeration contributed to the productivity growth of China's industrial sector? We exploit the
production function used to compute rm-level TFP we described in Section 3.3 and the coefcients on indicators of agglomeration
in column 2 of Table 6 to compute the share of TFP growth during 20002007 that is explained by agglomeration. Note that the
data used for this exercise are based on the Survey data, given the long time-span needed. First, we obtain the industry-level TFP
by plugging the employment and capital stock of each industry to the estimated production function which has different input
coefcients for each industry (see Section 3.3). We then aggregate the industry-level TFP using output shares as weights to obtain
the aggregated TFP of the whole industrial sector. The average annual growth rate of such aggregated TFP, displayed in rst column
of Table 11, is 8.23%. The same column displays the average annual TFP growth of the private sector obtained from the same exercise
but using only the sample of PEs, which is 7.71%.
The aggregate TFP growth due to agglomeration effects is computed by plugging the industry-level mean of each indicator of
agglomeration during 20002007 into the Eq. (15), holding other variables constant. The estimated coefcients are from column 2
of Table 6. This yields the predicted TFP growth for each industrial sector j:
^ agg YC
^ agg NC
^ agg YP
^ agg NP
T FP j;t
11 t
j;t
12 t
j;t
13 t
j;t
14 t
j;t
15
^ Uagg NC
^ Uagg YP
^ Uagg NP
^ Uagg YC
21 t
j;t
22 t
j;t
23 t
j;t
24 t
j;t
where the upper bar on each indicator of agglomeration indicates industry-level mean during 20002007 and the hat on each of coefcients indicates that they are estimates from the model. We once again aggregate those industry-level TFP growth using output
share as weights to obtain the aggregate TFP growth of industrial sector predicted by agglomeration effects. Such predicted growth,
shown in the second column of Table 9, is 1.16%, which is equivalent to 14.09% of the average annual TFP growth of total industrial
sector. The contribution share of agglomeration is larger in private sector, amounting to 15.43%. It is also seen that the contribution
share of agglomeration is smaller but still comparable to that of R&D investment computed following the same steps. Although not
captured by the Survey data, the private sector of China's industry consists of numerous small rms that do not engage in R&D investment due to resource constraint. For those rms, agglomeration effects can be the primary driver of productivity growth.
Table 11
Contribution of agglomeration to industry-level TFP growth during 20002007.
Average annual TFP growth rate
of industrial sector (percentage)
Agglomeration effect
Contribution to average
growth rate (percentage)
Contribution share
(percentage)
Contribution to average
growth rate (percentage)
R&D
Contribution share
(percentage)
All rms
8.23
14.09
7.71
1.88***
(25.00)
1.53***
(10.53)
22.84
Private Enterprises
1.16***
(331.81)
1.19***
(230.73)
15.43
19.84
Notes:
1. t-statistics are in parentheses.
2. *** indicates signicant at 1% level.
3. The data used for computation is from the coefcients on indicators of agglomeration in column 2 of Table 6 and Annual Survey of Above-scale Industrial Enterprises.
65
6. Conclusions
This paper conducted an in-depth evaluation of the contribution of industrial agglomeration to the productivity of Chinese
enterprises. Such analysis is essential for evaluating the sustainability of China's industrial competitiveness in the era of rising labor
costs and tighter environmental constraints. We exploited large dataset of manufacturing rms to capture the agglomeration across
176 three-digit industries and in 2860 counties. Furthermore, we complemented our analysis with the more comprehensive 2004
Census data which capture smaller rms not included in annual survey data.
Our empirical analysis revealed several novel features about the nature of agglomeration effects in China. First, we nd that
increase in number of rms in the same industry within the same county suppress the TFP of Chinese rms. We interpret this as an
evidence of severe congestion and intense competition that offset the localization economy. The negative impact form the increase
in number of rms is weaker or even turns positive when it occurs outside the same county. Second, we nd that a larger average
rm size contributes to productivity, which we interpret as the benet from co-location of productive rms within an agglomeration.
The quality of an agglomeration, namely the room for knowledge spillovers from competitive rms rather than the size of agglomeration (captured by the number of rms) seems to dene the contribution to productivity. Third, we nd a sizable positive impact from
the agglomeration of upstream industries within the same region. The importance of upstream industries suggests that Chinese industry is moving up the global value chain by strengthening capabilities to produce higher value-added goods using sophisticated intermediate inputs. Fourth, a Chinese rm's ability to benet from agglomeration as well as to act as the source of agglomeration effects is
importantly shaped by its ownership structure. Private enterprises (PEs) are seemingly the type of rms which productivity
responded most to the agglomeration effects. However, it is less clear which types of rms are the largest beneciary once when
we incorporate the agglomeration of smaller rms. However, we nd that the agglomeration of PEs impacts the productivity of
Chinese rms more than that of SOEs or FIEs, for good or bad: our observation based on the Census data indicates that the agglomeration of PEs generates substantial congestion together with that of SOEs. On the other hand, the sizable positive effects from the
agglomeration of upstream industries are mainly generated from PEs. The agglomeration effects from PEs are self-reinforcing in a
sense that the productivity of a PE is most enhanced by the agglomeration of PEs.
Our ndings provide some important policy implications for China to make best of industrial agglomeration as the engine of productivity growth. First, given the primary role of private enterprises as the source of agglomeration effects, it is desirable that barriers
to market entry and entrepreneurship are further reduced, especially in upstream industries. This requires drastic reforms in product
market regulation to increase competition and reduce state-monopoly. Measures to support further development of PEs, such as
facilitation of access to credit for small and median enterprises are also desired.
Second, the severe congestion effect that prevents Chinese rms from benetting fully from industrial agglomeration must be
alleviated. Aside from investing on better infrastructure, promising policy is to increase the supply of skilled labor through
well-designed vocational education and training and better access to higher education. Reducing institutional barriers to labor mobilitysuch as the Hukou Systemis also important for mitigating the shortage of skilled labor.
Third, knowledge sharing and innovation within agglomerations should be stimulated by promoting business alliance and joint
venture among entrepreneurs. Actual policy measures may include incentives such as R&D tax credit but more importantly establishing better business rules that support collaboration, such as an effective protection of intellectual property rights.
Our estimates suggest that industrial agglomeration contributed up to 14% of TFP growth in China's industrial sector during
20002007. As China aim for a sustainable economic growth led by productivity improvement, industrial agglomeration, especially
that of vibrant private enterprises will be the essential source of China's industrial competitiveness.
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China Economic Review 33 (2015) 5066

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China Economic Review

Agglomeration and productivity in China: Firm level evidence

C. Hu et al. / China Economic Review 33 (2015) 5066

C. Hu et al. / China Economic Review 33 (2015) 5066

2. Agglomeration and productivitya brief review

C. Hu et al. / China Economic Review 33 (2015) 5066

C. Hu et al. / China Economic Review 33 (2015) 5066

3.1.2. The 2004 Census

Industrial output (1000 RMB)

Average rm size (output,

C. Hu et al. / China Economic Review 33 (2015) 5066

3.2. The indicators of agglomeration

C. Hu et al. / China Economic Review 33 (2015) 5066

Survey data sample

Census data sample

C. Hu et al. / China Economic Review 33 (2015) 5066

where, t(mt, kt) = 0 + kkt + mmt + t(mt, kt).

According to the relationship of Eq. (5), we can get:

^ is the estimated coefcient of labor input obtained previously.

quadratic least squares. The latter is therefore a function of k and m.

C. Hu et al. / China Economic Review 33 (2015) 5066

Natural log of R&D investment

C. Hu et al. / China Economic Review 33 (2015) 5066

C. Hu et al. / China Economic Review 33 (2015) 5066

C. Hu et al. / China Economic Review 33 (2015) 5066

C. Hu et al. / China Economic Review 33 (2015) 5066

The source of agglomeration

The source of agglomeration

C. Hu et al. / China Economic Review 33 (2015) 5066

4.4. Robustness check

Labor productivity (3)

4 Digit industries (4)

2 Digit industries (5)

City level (6)

C. Hu et al. / China Economic Review 33 (2015) 5066

C. Hu et al. / China Economic Review 33 (2015) 5066

C. Hu et al. / China Economic Review 33 (2015) 5066

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