The shadow price of capital in China

Abstract

The shadow price of capital is the present value of the stream of future consumption generated by current marginal investment. This paper derives an estimate of the shadow price of capital for China based on estimations of the marginal productivity of capital, the marginal propensity to save and the consumption rate of interest. Macro-economic data from independent accounting units of state industrial enterprises is compared to micro-economic data from World Bank project reports to produce a more realistic estimate. Using a simple model with no reinstatement, where the shadow price of capital depends only on the marginal productivity of capital and the consumption rate of interest, a lower limit for the shadow price of capital of 2.1 is estimated. Using a more complex aggregate function approach, an upper limit of 4.2 is estimated. The mean value of 3.2 is chosen as the shadow price of capital or the value of public investment in China. This estimate indicates that opportunity cost of capital is two times of its market price. In other words, the use of capital in China is subsidized. To exploit its labour-intensive comparative advantage and to correct capital market distortions, capital should be made more expensive to the user in China.