In the last three decades, the Chinese economy has been characterized by persistently high investment rates and phenomenal growth rates (Song et al., 2010). Yet, considering that the Chinese financial system is poorly developed, this can been seen as a puzzle (Allen et al., 2005). Several authors have tried to find explanations for this puzzle. Among these, Ayaggari et al. (2010) focus on the role of informal finance, and conclude that it is not because of their access to informal financial sources that Chinese firms were able to grow, despite limited access to external finance.
Cull et al. (2009) conclude that access to trade credit did not play a significant role in explaining the puzzle. Guariglia et al. (2010) demonstrate that the Chinese growth miracle was driven by the highly productive private firms, which were able to accumulate very high cash flows. According to their study, it is thanks to this abundant internal finance that Chinese private firms managed to finance their high growth rates despite their limited ability to obtain external finance.
In this paper, we focus on investment in fixed capital, which is a significant determinant of growth (Bernanke and Gurkaynak, 2001; Bond and Schiantarelli, 2004; Ding and Knight, 2009, 2010). Specifically, we explore the role played by working capital management in explaining why Chinese firms were able to invest at very high rates despite significant financing constraints. Working capital is defined as the difference between current assets and current liabilities, and is often taken to be a measure of liquidity. We chose to focus on working capital management motivated by the observation that, over the period 2000-2007, the Chinese firms in our dataset were characterized by a very high mean ratio of working capital to fixed capital (66.6%).
Considering that working capital is highly reversible, and that firms can easily adjust it (Fazzari and Petersen, 1993; Carpenter et al., 1994), our aim is to investigate the extent to which, in the presence of fluctuations in cash flow, Chinese firms are able to adjust their working capital instead of their fixed capital investment, alleviating therefore the effects of cash flow shocks on the latter. Our analysis is related to Fazzari and Petersen (1993) who conduct a similar investigation on US firms, and find that these firms are indeed able to smooth fixed investment with working capital. To the best of our knowledge, no such investigation has been undertaken for a developing country. We fill this gap in the literature, by focusing on the Chinese case.
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Investment and financing constraints in China: does working capital management make a difference?
