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market economies.142 In the labor market, local governments protect their local residents from competition posed by migrants by forcing firms to favor local residents in their hiring and by increasing the costs for migrants seeking employment through the imposition of fees, the requirement of residence permits, and the need for certifications of skills. China’s internal capital markets are fragmented as well because local political interference has impeded the flow of domestic capital and transfer of corporate control. Local authorities habitually limit outflow of local capital and restrict investment by nonlocal firms and their acquisition of local firms. 143

Chinese enterprise managers report widespread practices of local protectionism. A survey of 3,539 enterprise managers nationwide conducted by the official Development Research Center in 2002 showed that local protectionism was prevalent in all provinces. Respondents singled out Henan, Shanghai, and Beijing as jurisdictions with the most discriminatory policies against nonlocal firms, followed by Hubei, Shandong, Hebei, and Hunan. Local protectionism was found to have no relationship with the level of economic development—the poorer agrarian provinces in the central region were as guilty as the more industrialized coastal provinces. The survey also found that local protectionism was costly for Chinese firms. Thirty-four percent of the managers reported that such practices affected their operations “a great deal or quite significantly,” and 35 percent reported a “fair impact.” Only a third said such practices had small or negligible impact. Local protectionism appeared to hurt the firms in the poorer western and central provinces more than those in the more prosperous coastal regions, except for firms in Shanghai, Beijing, and Shandong. Among various industrial sectors, the most seriously affected were tobacco, pharmaceuticals, petroleum refining, printing, food processing, plastics, and electrical machinery. The least affected were textiles and garments, synthetic fibers, and electronic communications equipment. Ironically, SOEs, which relied on other provinces for markets and raw materials, were more negatively affected than private firms, which were small in size and did little business in other localities. The least affected were foreign-invested (including Hong Kong and Taiwan) firms, apparently because such firms relied more on the international market for exports and imports.144

The fragmentation of local markets creates large distortions and inefficiencies, especially when local governments engage in investment activities that duplicate manufacturing capacities and generate negative returns. An analysis of regional industrial structures shows that duplication of capacity remains a core feature of the fragmentation of internal markets in China. For example, in 1989, the industrial structure of twenty-two provinces was 90 percent identical to that of China as a whole. In 1994, the industrial structure was 90 percent identical in thirteen provinces and 80 percent identical in twenty-one. Such data suggest massive duplication of industrial capacities regardless of local comparative advantages. This characteristic persisted through the 1990s, as most provinces continued to build up their own capacities to chase new demands. In 2001, twenty-three provinces manufactured washing machines, twenty-nine made television sets, twenty-three produced refrigerators, and twenty-seven assembled automobiles. Without changing the underlying incentives for local governments, duplication of capacity will remain a structural feature of the Chinese economy. In envisioning their long-term industrial goals, twenty-two provinces listed automobile manufacturing as a pillar industry, twenty-four listed electronics as a pillar industry, sixteen listed machine-building and the chemical industry as a pillar industry, and fourteen listed metallurgy as a pillar industry. 145

Duplication has led to low capacity utilization. In 1996, textile and oil refining industries operated only at 70 percent