China’s Internal Borders: Evidence from the Business Cycle Correlations across Chinese Cities

We measure the correlations between two cities’ real GDP growth rates (a measure of business cycle correlations) to capture the degree of segmentation across China’s provincial and regional borders. This type of segmentation can be caused by local protectionism as well as other economic and geographic factors that affect business cycle correlations between two cities. After controlling these other factors, we are able to pin down the border effect that is due to local protectionism: administrative border effect. We find that the inter-provincial administrative border effect first rose and then gradually declined in the period between 1991 and 2007. Further, its increase coincided with the introduction of the Tax Sharing System reform, which started in 1994. This administrative border effect declined steadily in recent years as the tax reform was fully instituted. Our analysis shows that China’s reform path (under market-preserving federalism) did not create a persistent provincial “administrative border effect” that debilitated market forces.