Spatial Misallocation: Evaluating Place-Based Policies Using a Natural Experiment in China

Using the mass closure of development zones in 2004 as a natural experiment, we examine the causal effect of development zones on firm level TFP in China. The difference-in-difference estimator shows that on average, loss of development zone policies results in 6.5% loss of firms’ TFP. Locational heterogeneity is important. Within 500 kilometers from the three major seaports in China, closure of zones reduced firm-level TFP by 9.62%, whereas closure of zones farther away did not show significant effects. Market potential and local within-industry spillover effects can explain much of this locational heterogeneity. We conclude that China’s strategy of using development zones as a place-based policy to encourage inland development may have led to spatial misallocation.