To some extent, the role of the variable _GAW_ echoes that of the GDP per capita in the location choice of the activities. As table 5 shows, the role of _GAW_ differs: in the coastal region, the electronic industry tends to concentrate in the provinces with dynamic neighbors; while the chemical industry tends to concentrate in the provinces with less dynamic neighbors. It suggests that, hightech industries tend to concentrate in the provinces that are more developed and surrounded by dynamic neighbors.

In addition, the concentration of the high-tech industries in the coastal provinces may be associated with the growing supply of the active population.

# **3.5. Policy suggestions**

The limited diffusion of the labor intensive activities within the coastal region confirms the general principle of the bell curve of the spatial inequality for a country at the 2<sup>nd</sup> stage of development. It is also resulted from the policies of the Chinese government after the reforms. Catin and Van Huffel (2004) argue that the persistence of the numerous institutional constraints is one major factor that limits geographic diffusion of the activities. In particular, the inter-regional mobility of goods and services is relatively low. The residence registration system ( _Hukou_ )<sup>23</sup> seriously limits migration. The industrialization in the coastal region, to some extent, is fueled by the inflow of the labor from rural areas to urban areas. A recent study of the World Bank estimates the large potential gains from a greater labor market integration – using 2001 as a baseline, with a mere 1% labor relocation from rural areas to urban areas, the overall economy will gain by 0.5%. If the share of labor outflow reaches to 5% and 10%, the GDP will grow by 2.5% and 5% respectively (The World Bank, 2005). In addition, the gains are much higher in the western and central regions compared to the east and north-east regions. The _Hukou_ system also results in the sub-optimal size and underagglomeration in Chinese cities. Au and Henderson (2002) suggest that 85% of the Chinese cities are undersized and 43% are significantly undersized, which leads to economic welfare loss. The pace of urbanization is very slow in the central and western provinces, which limits their potential in reaping the fruit of the rapid economic growth through the economy of scale. Appropriately alleviating the restrictions of the rural-urban mobility across regions may strongly improve economic efficiency and reduce inequality.

The decentralization widens the gap of fiscal space between local authorities. The inland provinces disproportionately suffer from the local protectionism and the “border-effects”. Multiple discriminations, such as the customs and the attribution of the “entrance-ticket” to local market, impede the penetration of the products from other provinces or from other countries. Although regional protectionism and product fragmentation have declined over the past decade, it is important that the authorities further reduce the barriers and encourage the domestic market integration in favor of the inland provinces.

> 23 In China, non-residents have limited access to certain types of employments, housing, medical care, and children education, although the constraints began to soften in the recent years with the deepening of the marketization.

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