Does equity market openness increase productivity? the dual effects of Shanghai-Hong Kong stock Connect program in China

This study investigates the dual effects of equity market openness on aggregate total factor productivity (TFP) growth and finds that gains in aggregate TFP can be driven by within-firm and reallocation effects across firms. Using a quasi-natural experiment based on China’s Shanghai-Hong Kong Stock Connect program, we find that equity market openness has a positive effect on firms’ TFP. Stock price efficiency is the mechanism underlying this improvement. Equity market openness reduces firms’ stock mispricing and improves corporate governance and investment efficiency through the feedback effect, thereby increasing TFP. Finally, we argue that equity market openness induces significant growth in capital stock and employment among high-TFP firms, driving them to achieve rapid growth and greater market share. The reallocation effect of equity market openness translates into aggregate productivity gains. This empirical study considers stock pricing as a mechanism to shed light on the dual effect of equity market openness on TFP growth.