Does decentralization improve allocative efficiency? Evidence from the Province-Managing-County Reform in China

This paper investigates the impact of bureaucratic decentralization on allocative efficiency by leveraging China's Province-Managing-County (PMC) reform between 2002 and 2013. We find that input and product market distortions declined significantly in reformed counties, with capital and labor reallocated towards firms with higher initial productivities. These reallocation effects appear to be driven by the enhanced incentives and informational advantages of county-level governments. Our findings highlight the potential for well-incentivized local authorities to improve allocative efficiency, offering new insights into the productivity gains from decentralization in transitional economies.