Understanding regional price convergence clubs in China

This paper aims to explore the existence of price convergence clubs for various goods in China and to understand the determinants of their formation. The study uncovers novel empirical patterns in the domestic cross-city price mechanism using individual goods retail price data for 36 major cities in China. Employing a nonlinear factor model, the paper shows that there is no evidence of national price convergence across Chinese cities for more than half of the goods in the sample (52 out of 102 goods), yet cities may form regional convergence clubs. These clubs emerge due to regional differences in the cost and share of traded and non-traded inputs used in the production of goods. The data show that China has been moving towards a nationally integrated market up until the early 2010s, while in the last decade, China's domestic market has become more fragmented. Thus, further economic reforms may be necessary to reinforce the process of domestic market integration.