Government Subsidies and Firm-Level Markups: Impact and Mechanism

This paper investigates the impact of government subsidies on the firm-level markups and its mechanism of action by measuring the firm-level markups based on a micro dataset of Chinese manufacturing firms from 2000 to 2007. The findings suggest that government subsidies significantly reduce the markups of Chinese firms. Moreover, there is significant heterogeneity in the negative impact of government subsidies among different types of firms. Furthermore, analysis of the impact mechanism based on the mediation effect model shows that the increase in rent-seeking cost is an important way for government subsidies to reduce the firm-level markups. Finally, based on the dynamic decomposition of the aggregate markup of the Chinese manufacturing industry, it is found that government subsidies significantly reduce the industry-level aggregate markup through within-firm and cross-firm effects. This study enriches the literature on government subsidies and markups, and provides a new perspective for understanding the micro-performance of government subsidies.