China’s Unification from Within: Dismantling Local Protectionism

When the Chinese people commemorate former premier Li Keqiang, who passed away in October 2023, they often cite a term from his 2014 profile in state media—"a calm and tough wall-breaker." Among the many growth-hindering walls Beijing set out to break since 2013, an important one is local protectionism, a force creating trade barriers between provinces. Even with Li Keqiang’s retirement in 2022, Xi Jinping persists in advancing the reforms aimed at overcoming localism and constructing a "unified national market” (全国统一大市场) with significant momentum.

Why is the Chinese Market not “Unified”?

Many of China’s provinces, prefectures, and counties sometimes shield local firms from outside competition through protectionist policies. These policies divide the market of the factors of production, preventing goods, labor, and capital from moving freely across the provinces. Additionally, sectoral regulations vary from region to region, creating extra barriers for companies from other provinces or foreign countries to enter new markets.

In 1978, to create growth momentum from the bottom-up, China decentralized its “administrative powers” in taxation and began evaluating local officials’ performance based on GDP growth and tax collection. This structure, while effectively engaging local officials in attracting investments, created an incentive for them to show preference towards local companies due to their higher tax contributions. In a CSIS Pekingology podcast, Wei Cui, an expert in China's fiscal policy argues that instead of sticking to the tax laws, local officials favor case-by-case tax settlements with large corporates. Local officials customarily provide market-distorting benefits for these "major tax contributors" (纳税大户) in exchange for steady fiscal income. To outcompete their peers and gain promotions, local officials offer preferential treatment to projects that provide high profits and high tax incomes in the short term, contributing to “repetitive low-level construction” and vicious competition among regions.

For example, many real estate construction projects were initiated because local governments favor their short payback period and high tax contribution, with little regard to the actual market demand. Protectionist policies are often utilized to stimulate infrastructure projects within markets that are already densely saturated. Some top Chinese scholars, such as Lu Ming, have started to argue that this structure prevents fair inter-regional competition and cannot bring about sustainable growth.

Rule of Law and Market Power in Beijing’s “Opinions”

The issue of local protectionism (地方保护主义) has persisted structurally for decades, yet there has been a notable increase in the political will in Beijing to prioritize this issue and instigate real changes since 2020. As China's export sector suffers shrinking global demand, trade disputes, and businesses attempting to de-risk from reliance on China, leadership in Beijing prioritizes a "strong domestic market" as a pivotal element for China’s sustained growth. In a speech in 2020, Xi expressed that the domestic market should become the “mainstay” amidst the “sluggish world economy and shrinking global market.” As a milestone effort to break down protectionist practices at the local level, China issued the Opinions on Accelerating the Construction of a Unified National Market (henceforth, the Opinions) in April 2022. By creating a unified domestic market, Beijing expects competition to be fairer and investments to be more efficient.

To implement the reforms outlined in the Opinions, two instruments stand out in China’s toolkit. One approach is enhancing the rule of law. Beijing is attempting to strengthen its anti-monopoly laws and market access regulations against protectionism. For example, the Anti-monopoly Law of the People's Republic of China, updated in 2022, stipulates that provincial governments “may not abuse their administrative power to restrict or put implicit restrictions on the operation, purchase or use of designated commodities.” Another article in the law specifies the circumstances that impede the free flow of commodities between regions. If Beijing can carry out these laws effectively, it can prevent local governments from arbitrarily restricting entry into local markets.

Another approach harnesses market power as the engine for change. Beijing encourages the growth of digital and logistical networks, which can lower the costs for transactions and thus strengthen the supply chains on a national (instead of local) scale. For example, Yunnan, a landlocked southwestern province famous for its flowers, used to struggle to sell its products to major cities in Eastern China due to its location. However, with China having developed advanced cold chain technology, logistical infrastructure, and e-commerce platforms over the past decade, next-day delivery is now accessible to most urban consumers, facilitating substantial growth in the sector. The case of the flower market exemplifies the rationale behind the Opinions: if the market can be consolidated and economies of scale achieved, China’s economy will have higher productivity and be more competitive internationally. Some scholars argue that sustained higher growth will ultimately benefit local governments in developed and underdeveloped regions alike.

The energy market is an example of such reforms. Building a unified national market of energy can contribute to both energy security and carbon neutrality, a vision President Xi promised to achieve by 2060.  Prior to 2020, many factories were incentivized to choose local coal-fired power due to price advantages and other incentives, often overlooking renewable sources from neighboring provinces. This is hindering China’s path to become greener. However, since 2020, China has embarked on pilot programs for interprovincial and regional spot markets, a system that facilitates the exchange of electricity-related goods and services. One notable initiative is the integration of four southern provinces into a unified "Southern” trade platform centered in Guangdong, inspired by the Greater Bay Area concept. By incorporating the diverse structures of provincial electricity production, China aims to bolster its resilience and efficiency by constructing a more robust market framework.

Possible Challenges: Can Beijing Make It This Time?

The expectations are high. Some leading economists hope the unified market will become China’s new “dynamic comparative advantage,” as population dividends are waning. In June 2023, a year since the launch of the Opinions, Beijing actively sought public input on the Fair Competition Review Regulations, which aims at strengthening legal measures against protectionist local practices. Scholars argue that the goal of this law is to mobilize market-based allocation of capital, land, labor, and R&D investment across provinces, and thus foster a conducive business environment to stimulate innovation. This, they hope, would ultimately make China more competitive on the global market.

Despite the determination and progress made, a significant journey of reform lies ahead, particularly in the tax and official promotion structures of local governments. The State Council recognizes "further improving the fiscal, taxation, statistics and local [officials’] performance evaluation systems” as the key to building up long-term institutional mechanisms in the unified national market. Although such reforms will touch on the deep-rooted vested interests of local officials and local firms, as Xi has consolidated power through anti-corruption campaigns and Party supervision, the momentum for concrete reforms should not be underestimated.

While dismantling local protectionism could yield positive outcomes on the institutional level, overcoming other obstacles obstructing the free movement of capital, land, labor, and R&D investment still requires substantial reform efforts ahead. Take, for instance, the hukou system, which hinders the settlement of individuals, particularly those with lower skill levels, in major cities. There is considerable distance yet to be traversed in achieving the "unification from within" and unleashing the full potential of a unified Chinese market.

Stanley Wu

Former Intern, Freeman Chair in China Studies