Price Convergence and Market Integration in China

Abstract

Whether China has successfully transformed from a formally centrally-controlled economy to a market economy is an issue of immense interest and considerable debate. The current study complements the received literature by testing price movements in China using panel data of monthly price indexes across 36 major Chinese cities over a thirteen-year period. By so doing, it extends the early work by Fan and Wei (2006) and thereby adds to the literature in four main aspects. First, price index data provide a wider coverage of all goods traded in the market than a group of individual commodity prices. Thus, it has more relevant implications for monetary and other macroeconomic policies. Second, as Taylor (2001) notes, there are crucial differences of methodologies in the study of price convergence between individual commodity data and index data. Thus, the present study not only further examines market integration in China, but also provides a comparative study of price index movements in a major transitional economy with for example the study for the US by Cecchetti, Mark, and Sonora (2002). Third, a recently developed new nonlinear unit root test is applied in this paper, which is more relevant to our study than other traditional linear unit root tests. Fourth, we developed a new nonlinear half-life estimation procedure that is consistent with the concept of the linear counterpart. We find that not only price indexes do converge to the law of one price in China but also the half life of price index convergence is relatively quick (about 5 to 16 months in the linear cases, and 7 to 24 months in the nonlinear situation).