The Costs of Agglomeration: Misallocation of Credit in Chinese Cities

Abstract

In comparison to agglomeration economies, the negative externalities of agglomeration have received less attention. Based on the punishment data of illegal loans from Chinese bank branches, this paper focuses on the relationship between density and credit misallocation to enrich the study of the negative externalities of agglomeration. After controlling for city size and a variety of other possible factors, the empirical results suggest that increased density leads to increased credit misallocation, and this result passes a series of robustness tests, including IV estimation. Agglomeration causes credit misallocation primarily through rising house prices, which causes financial institutions to favor housing-related loans. During this process, the government’s reliance on land finance causes higher house prices and, as a result, more severe misallocation. However, agglomeration does not always lead to an increase in credit misallocation. There are also cases where agglomeration does not lead to an increase in credit misallocation, which suggests that we should pay attention to differences in key characteristics between cities when studying the externalities of agglomeration.