From Production to Retail

There has been large literature investigating the barriers to firm growth and their resulting misallocation in developing and emerging economies. Most of the literature has so far focused on production-related frictions. This paper studies the role of product market friction as another source of barriers to growth. Specifically, reaching consumers is costly and producers have to reply on sales channels to sell their products. We build a theoretical framework to capture the rich interactions between production and sales. A unique survey of around 300 Chinese footwear producers is designed and conducted to measure and quantify the importance of several key elements of the model. Using the survey, we documented several novel empirical regularities that motivate our focus on producer's retail capitals. We then formulate and compute an equilibrium model of firm life-cycle where entrepreneurs have permanent heterogeneity in sales and production efficiency. The model is estimated by simulated method of moments to match the joint distribution of physical capital and production capital in our data. We find that product market friction significantly impacts the pattern of firm growth by limiting each producer's sales. At the industry level, we are able to explain the changing composition of production and sales activities in Chinese footwear industry and the gradual rise of the retail sector.