Heterogeneous production functions and regional disparity

On explaining regional differences, the current literature emphasizes the difference in factor accumulations. This paper suggests an additional possibility that regions may differ in parameter values in their production functions. In terms of the Cobb–Douglas production function, regions may differ in the share of capital in income. Using the province-level data in China, this paper shows that capital shares have a very significant and positive effect on per capita GDP. In particular, the differences in production functions explain 46.6% of the difference in per capita output between the East region and West region in China. Further, using the firm-level data, we show that the differences in regional production function are likely due to different industry compositions.