Market Failure or Institutional Weakness?

Cao Jianhai and Jiang Feitao

Chinese Economy, 2010, vol. 43, issue 4, 6-29

Abstract: Studies of the mechanisms of redundant construction formation and overcapacity commonly explain them in terms of market failure. Redundant construction policies are used as the basis for administrative control of investment and market access. This article reexamines major research that follows this line and finds that it is fundamentally flawed. Investigation shows that the main cause of enterprise overinvestment, overcapacity, and redundant construction is improper microeconomic interference by local governments under systemic distortions. This interference distorts enterprise investment behavior through the effects of cost externalization, investment subsidization, and risk externalization. Hence, redundant construction cannot be controlled administratively. The problem of redundant construction must be resolved through reforms of land-property rights and the financial system that use market competition to influence enterprise investment policies.

Date: 2010
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