Energy costs of market integration: Evidence from city-county merger in China

This paper aims to find the relationship between market integration, industrial distribution and energy intensity. Using energy and economic data of manufacturing firms from 1998–2005 in China, we examine the effect of market integration on firms' energy intensity by using the difference-in-differences (DID) method with the help of city-county merger reform in China. We find that the city-county merger reform significantly increased the energy intensity of firms by about 2.5 percent. The reason is that the reform creates objective conditions for capacity transfer by improving infrastructure, and it also encourages a crude development behavior through the energy factors expansion under the heterogeneous energy-saving constraints within the city. Specifically, on the one hand, the city-county merger encourages firms in new districts to expand their energy factor inputs and attracts a large number of high energy-consuming firms to the new districts. On the other hand, firms, in old districts, reduce their output and expand their energy consumption, which leads to increase their energy intensity. We also finds that the city-county merger has some environmental costs. These results suggest that the division of labor can be deepened and productivity increased only when the market size is sufficiently large, which provides an empirical evidence for market construction in developing countries.