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China's economy grew by an impressive 10 percent per year over four decades. Productivity improvements within sectors and gains from resource reallocation between sectors and ownership groups drove that expansion. However, productivity growth has declined markedly in recent years. This paper extends previous macro and firm-level studies to show that domestic factors and policies contributed to the slowdown. The analysis finds that limited market entry and exit and lack of resource allocation to more productive firms were associated with slower manufacturing total factor productivity growth. Earlier reforms led to state-owned enterprises catching up to private sector productivity levels in manufacturing, but convergence stalled after 2007. Furthermore, the allocation of a larger share of credit and investment to infrastructure and housing led to lower returns to capital, a rapid buildup in debt, and higher risks to growth. China's growth potential remains high, but its long-term growth prospects depend on reversing the recent decline in total factor productivity growth.

Using macro- and micro-level data, this article examines China's productivity growth slowdown after 2007. The authors find that strong investment in infrastructure and housing led to lower returns to capital. Firm-level evidence suggests that limited market entry and exit and a lack of resource allocation to more productive firms were associated with slower manufacturing total factor productivity (TFP) growth. Earlier reforms had led to convergence in productivity between state-owned and private manufacturing companies, but this process stalled after 2007. China's growth potential remains high, but its long-term prospects depend on reversing the decline in TFP growth. (China/GIGA)