Impact of special economic zones on firm performance

•Firms in SEZs have better performance on average than firms outside SEZs.•Both the selection effect and the agglomeration effect drive the productivity advantage.•There is a selection of firms with higher productivity to enter the zone and firms with lower productivity to exit the zone.•Firms in SEZs gain more significant spillovers than firms outside SEZs.•Firms gain larger agglomeration effects from a cluster of the same industry than across industries. The establishment of special economic zones (SEZs) is one of the critical policies to promote economic growth. However, the relationship between SEZs and firm performance is still unclear. Using China Industrial Enterprise Database (CIED) from 1998 to 2007, this paper investigates the influence of firm location on its performance mainly from two channels: selection effect and agglomeration effect. The results suggest that firms in SEZs have better performance on average than firms outside SEZs. One reason for the productivity effect is selecting firms with higher productivity to enter the zone and firms with lower productivity to exit the zone. Agglomeration is another critical channel, and the effects are heterogeneous. Both firms in the zones and firms outside the zones gain spillovers from the zones, with the former being larger than the latter. Firms gain larger agglomeration effects from a cluster of the same industry than across industries.