Has Digital Finance Corrected Factor Price Distortions in China?

Abstract This paper examines the impact of digital finance on factor price distortions and its underlying mechanisms. A general equilibrium model under imperfectly competitive factor markets was constructed, and panel data for the period 2011–2019 from 285 prefecture‐level cities in China were used for empirical analysis. The findings were threefold. First, digital finance significantly mitigated price distortions in both capital and labor markets, improving the efficiency of factor allocation, with a stronger effect on capital price distortions than on labor price distortions. Second, mechanism analysis showed that digital finance reduced capital price distortions by expanding financing channels and alleviating financing constraints, but it also increased financial risks through higher nonperforming loan ratios, which partially offset these benefits. By contrast, the reduction in labor price distortions was driven mainly by narrowing income inequality, enhancing marketization, and increasing deposit returns. Third, the moderating effect of digital finance on factor price distortions was contingent upon capital deepening, factor market mobility, traditional financial development, and regional economic structure. These results provide theoretical and empirical evidence on the role of digital finance in optimizing factor allocation and offer policy implications for advancing financial market reforms.