Growing Like China
China has been growing at a high rate and has at the same time accumulated a staggering foreign surplus. We construct a theory that explain these seemingly puzzling observations, while being consistent with salient features of the Chinese growth experience since 1992: high output growth, sustained returns on capital investments, extensive re-location within the manufacturing sector, falling labor share and accumulation of a large foreign surplus. The theory makes only minimal deviations from a neoclassical growth model. Its building blocks are financial imperfections and reallocation among firms with heterogeneous productivity. Some firms use more productive technologies than others, but low-productivity firms survive because of better access to credit markets. Due to the financial imperfections, high-productivity farms which are run by entrepreneurs must be financed out of internal savings. If these savings are sufficiently large, the high-productivity sector outgrows the low-productivity sector, and attracts an increasing employment share. During the transition, low wage growth sustains the return to capital. The downsizing of the financially integrated sector forces a growing share of domestic savings to be invested in foreign assets, generating a foreign surplus. We test some auxiliary implications of the theory and robust empirical support.