Empirical studies have shown that regional markets in China are highly fragmented. The observation leads to the conclusion of interregional trade protection. In this paper, we develop a model in which a country has two regions and faces import competition to examine how and when interregional trade protection may arise. We find that domestic fiscal decentralization, particularly tax reform, together with high external trade protection, cause interregional protection. This finding, which is generalizable, not only helps explain the rise of interregional protectionism in China but also predicts that external trade liberalization, particularly the country's WTO accession, can help tear down existing interregional trade barriers.
Bibliographical noteThis paper benefits from presentation at the conference ‘‘WTO, China and the Asian Economies’’ (held in Hong Kong, 2002) and comments from Stephen Ching, Gregory Chow, and the referees. We are grateful to financial support from the Research Grant council of Hong Kong (HKUST6214/00H) and National Natural Science Foundation of China (NNSSFC10131030).
- Tax reform
- Trade liberalization
- Interregional protection