Optimal Spatial Industrial Policies in a Spatial Production Network : An Application in the Context of China

Place-based policies are well justified to mitigate regional disparities, though with the concern of misallocation. In this paper, we characterize the properties of optimal spatial industry policies that result in lower efficiency loss while reducing spatial inequity in a general equilibrium model featuring spatial input-output linkages. Applying our model to the context of China, we find that the optimal spatial industrial policies should have a lower tax on an industry-city that is more upstream in the spatial production network such that the tax burden is less propagated through the spatial production network. By shifting from the current spatial industry policies to the optimal level, the total welfare improves by 4.99% in 2008. In addition, we analyze two regional policies implemented in China. Compared to uniform tax reduction, an optimal industrial policy generates substantially higher welfare for the targeted area and the rest of the country does not suffer a loss