Does the Law of One Price hold? A cross-regional study of China

Abstract

This study considers the price convergence in different regions of China, which is the largest developing country in the world and a country in which the regional difference is much larger between provinces. Whether there is price convergence between regions in one country is an important economic issue according to the Law of One Price (LOP) theory. Compared to previous studies, this article operates with the Sequential Panel Selection Method (SPSM) to explore the non-stationary properties of the LOP in China’s regions. We provide robust evidence to specify that the LOP holds true for two-thirds of the provinces in China, mainly in the Western and Central regions. This means that the Eastern region’s price fluctuation is non-stationary and that the consumer price index (CPI) levels of the Western, Central and Northeastern regions are relatively convergent in China. The conduction path of the CPI level is from the Eastern region to the other regions. It shows that prices can converge with each other by LOP and the values of the same goods in the Western and Central regions are equal and if there is a price difference, then it can be eliminated by interregional trade.