Next, this new spatial configuration of population across the urban and rural parts of all 331 prefectures changes each location’s real market access and thus its real wages. To capture these changes, we numerically resolve for the equilibrium urban and rural wages and price levels based on equations [A1] – [A5] and the new population levels in each location. These new real wages in turn may affect migrants’ location choice, and so on. We repeat these steps iteratively until convergence is reached (i.e. real wages, and population shares no longer change between iterations). Upon convergence<sup>35</sup> , we have obtained our counterfactual “no NEN + Hukou” spatial equilibrium.

Comparing it to the 2007 “NEN + Hukou” situation reveals the general equilibrium impact of the NEN on China’s spatial economy making the more realistic assumption of restricted labor mobility instead of the “extreme Hukou” assumption of no labor mobility used in earlier papers (Roberts _et al._ , 2012, or Faber, 2014). By allowing for more realistic migration dynamics, we can assess the possible mitigating effect of labor mobility on the increase in regional inequality, associated with the construction of the NEN found in Roberts _et al._ (2012).

# <u>Scenario 2: The impact of abolishing the Hukou system</u>

Our second scenario focusses on the effect of the complete abolishment of the Hukou system on China’s spatial development.<sup>36</sup> It does so by comparing the observed 2007 “NEN + Hukou” spatial equilibrium to the counterfactual “NEN + no Hukou” spatial equilibrium. We simulate a counterfactual scenario under a complete abolishment of the Hukou system as follows. In the 2007 “NEN + Hukou” spatial equilibrium condition (5) or equivalently (5b) holds. In a spatial equilibrium where the Hukou restrictions are abandoned, everyone is now a potential migrant, and equilibrium is defined instead by (4). Using (8) and our calibrated real wages in 2007, we can easily verify whether (4) holds. If it does not, we update each location’s population according to the following equation that now takes all Chinese citizens as potential migrants: As in Scenario 1, this new spatial configuration of population across the urban and rural parts of all 331 prefectures changes each location’s real market access and thus its real wages. To capture these changes, we numerically re-solve for the equilibrium urban and rural wages and price levels based on equations

> 35 To be precise, we define convergence to be reached when the squared difference between iterations in urban, rural and total population is smaller than 0.00001 for each of these three variables respectively. 36 A complete abolishment of the Hukou system is unlikely to happen in the near future. In principle, we could also look at scenarios involving a partial abolishment of the Hukou system (e.g. allowing free migration to all but the already largest cities, or in particular provinces only). However, such results will depend quite heavily on the specific “partial-Hukou system” considered. Moreover, a complete abolishment allows us to most clearly contrast the effects of infrastructure investment vs. migration restrictions on China’s economic geography.

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