Does the razor's edge exist? New evidence of the law of one price in China (1997–2012)

Abstract

AbstractThis paper revisits the market integration in China under the gradual economic reform, using a novel data set of monthly prices for 267 goods across 173 cities from 1997 to 2012 with price regulations dramatically removed. We provide new evidence to show that the Law of One price (LOP) holds in the context of China which is experiencing substantial trade liberalisation. First, by accounting for heterogeneity and cross‐sectional dependence, our results show that prices converge to the LOP for most goods, and industrial materials converge faster than non‐perishable goods. Second, in comparison with the earlier analysis with static evidence, our results with the moving window show that convergence is escalating. Third, we find that the price dispersion across products at the city level is increasing with distance, but it is decreasing with openness and economic development. Our findings show China’s market integration is going well under its ongoing market‐oriented reforms, and cast doubt on the proposition that incremental reform in China has led to the fragmentation of the domestic market.