to access credit will decrease (Beck, Demirguc-Kunt, and Maksimovic, 2004). With the new micro firm-level data from China, it seems this argument is even stronger that compared with SOEs, even large non-SOEs are disadvantaged in accessing credit at the county level.

# **_Does capacity matter?_**

Even though the city-level outcome does not show that cities with a bigger scope of power outperform their similar counties, we are worried that the reason we observe this result was because city governments do not have the capacity to carry out these new powers, and not because the new powers themselves are not useful. In urban governance literature, the powers of a city government for managing economic development depend on factors of not only its operational scope, but capacity as well (Davey, 1993). We therefore want to test and see whether newly promoted cities with higher capacity help firms perform better. Regional disparities in human capital are vast in China, and we include province fixed effects to offset partly this regional difference when evaluating firm-level outcomes, in addition to the time and industry fixed effects we have controlled for.

Since there is not a unified measure of city capacity, we propose using two proxies to measure capacity to conduct this analysis due to data limitation and availability. We propose using the percentage of public employees supported by public finance out of total city population as a measure of city capacity. Adequate and institutionalized human capital is often cited as one of the key factors in determining city capacity (World Bank, 2009). A recent paper by Acemoglu, García-Jimeno and Robinson (2014) also used a similar measure to measure capacity: the number of municipality-level bureaucrats e xcluding police officers, judges, all other judicial employees, and public hospital employees.

Alternatively, we propose using the total tax revenues collected, excluding land sales revenues, out of total city GDP as a proxy of city capacity.<sup>5</sup> Fukuyama (2013) proposed using tax revenues out of GDP as a proxy for state capacity, as the ability to extract tax not only indicates a government’s capability, but also means the government has revenues to carry out public functions and hence tax extraction can be a good proxy for capacity.<sup>6</sup> From previous results, we have shown that at the aggregate firm level, simply being located in a newly promoted city does not help firms perform better. However, from Table 11, after taking into account capacity as measured by more institutionalized human capital available to public services, firms located in newly promoted cities with higher capacity seem to perform better in terms of sales, profits and wage rate of employees.

> 5 The two proxies of city capacity are by no means perfect. In an ideal world, proper understanding and measurement of capacity would require a combination of quantitative proxies supplemented by qualitative data.

> 6 We are interested in whether city-upgrading itself leads to a jump in capacity post-upgrade.  Plotting the two proxies against time period of 1996 to 2004 shows us that city capacity does not change much after the upgrade.  Therefore, we are essentially comparing cities with different initial capacity levels here and report how capacity matters.

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