A Structural Estimation On Firms’ Exit Mechanism Of Chinese Steel Industry

Steel industry is a pillar industry of a country’s economy.Its healthy development is of great importance.Chinese steel products are subject to anti-dumping and antisubsidy tariffs from different countries.Currently,Chinese steel industry suffers from severe problems such as overlapping/redundant construction and excessive competition.Many inefficient firms that have negative profits have difficulty in exiting the market.Meanwhile,Capacity compression has become a focus of macro policies.Chinese central government has been putting forward capacity control policies in the form of administrative orders on total production.However,the capacity control and compression policies on steel industry since 1994 have been proved ineffective.Therefore,it is of great importantce to study firms’ exit mechanism of Chinese steel industry,for making effective policies.I investigate steel firms’ exit mechanism from the perspective of structural estimation on firm dynamic model for the first time in literature.A dynamic model of heterogeneous firms is presented and estimated that captures firms’ optimal decision on exiting,production,investment,employment adjustment,etc.Utilizing simulated method of moments(SMM),I estimate the model to match individual firm data of Chinese steel industry from year 1998 to 2004.From the estimation I back out key parameters of steel firms’ cost structure,which,including variable cost,fixed cost,factor adjustment cost,as well as exit cost.The model with estimated cost structure therefore explains firms’ exit mechanism.First of all,by estimating the model,I find that in Chinese steel industry,SOEs and big firms have different cost sturture with POEs and small firms.Compared to POEs and small firms,SOEs and larger firms have 7% to 11% lower intermediate input cost,25% to 30% lower investment cost,20% to 90% lower capital adjustment cost,but 100% to 167% higher exit cost,and 282% to 464% higher fixed cost.It implies SOEs and large firms have significant advantage in production cost,while they face larger pressure on exit.Anecdoctal evidence suggests that SOEs and large firms’ cost advantages come from local government subsidies.Secondly I conduct two counterfactual tests based on the model.Counterfactual tests on the model provide possibility to make policy implications on multiple capcity compressing policies.I first examine the effect of exit subsidy policies.An exit susidy policy took into place in 2016.According to the policy,Chinese central government would give out 100 million to help steel firms exit and resettle their employees.I take the policy into the model and find that it could not urge firms to exit.The reason is as following.When firms make dynamic optimizations,their exit decision depends both on direct exit cost in the current period,and expectation of future income.Reducing exit costs not only lowers direct cost on exiting in the current period,but also lowers potential exit cost in the future which is equivalent to raising expected future income.It indicates the policy tring to urge firms exit through subsidies would not be successful in the end.In the second counterfactual test,I eliminate SOEs and large firms’ cost subsidies in the model.I find that the exit rate doubles after eliminating SOEs and large firms’ cost advantages on investment cost and intermediate input cost.Particularly,firms with lower productivity are more likely to exit.It suggests that removing cost subsidies from local government is a more effective way to impel inefficient firms to exit.