An Application of theMelitz Model to Chinese Firms

When the Melitz model is implemented in practice, the industrial productivity distribution is often assumed to be of Pareto form. In this case, a fundamental relationship $\kappa>\sigma-1$ must hold to guarantee the convergence of the industrial average productivity, where $\kappa$ is the concentration degree of the industrial productivity Pareto distribution and $\sigma$ is the substitution elasticity across varieties in the industry. This paper estimates the concentration degrees of the Pareto distribution in industrial productivity and industrial substitution elasticities using firm-level data of 40 Chinese manufacturing industries from 1998 and 2007. However, the paper shows that the above fundamental assumption $\kappa>\sigma-1$ does not hold for nearly all the industries for Chinese firm-level data. An explanation is proposed due to the distorted firm size and productivity for Chinese characteristics.