Local Protectionism, Market Structure, and Social Welfare: China's Automobile Market

While China has made great strides in transforming its centrally-planned economy to a market-oriented economy, there still exist widespread interregional trade barriers, such as policies and practices that protect local firms against competition from non-local firms. This study documents the presence of local protectionism and quantifies its impacts on market competition and social welfare in the context of China’s automobile market. This market exhibits a salient feature that vehicle models by joint ventures (JVs) and especially state-owned enterprises (SOEs) command much higher market shares in their headquarter province than at the national level. Through spatial discontinuity analysis at provincial borders, falsification tests, and consumer surveys, we first confirm protective policies such as subsidies to local brands as the primary contributing factor. We then set up and estimate a market equilibrium model to quantify the impact of local protection, controlling for other demand and supply factors. Counterfactual simulations show that local protection leads to significant choice distortions, resulting in 18.7 billion yuan of consumer welfare loss, amounting to 40% of total subsidy. Provincial governments face a prisoner’s dilemma: according to our estimates, local protection reduces aggregate social welfare, but the provincial governments have no incentive to unilaterally remove local protection.