Abstract: This paper studies whether and how market segmentation affects exports from cities of China. Some existing research found that market segmentation promotes the export performance of firms in China, which is against what the New Economic Geography theories would predict. Although explanations were provided, these studies did not distinguish between short-term and long-run effects of market segmentation on exporting firms. Neither did they identify the mechanism of such impact. This paper tries to fill this gap. Based on the Chinese Industrial Enterprises Database, we use Heckman models to analyze the micro impacts of market segmentation on firms in 2007. The regression results of Heckman selection models show that market segmentation affects firms' behavior in two ways. Firstly, severe market segmentation reduces the scale of domestic market available to firms. As a result, firms enter the international market as a complementary market to pursue economy of scale. Secondly, market segmentation also restrains firms from specialisation because of the high cost of transporting intermediate goods between different areas. The impacts of these two pathways lead to the result that market segmentation increases the probability of firms' decision to export in the export decision-making stage to pursue economy of scale. After these firms are forced to enter the international market, however, their productivity and competitiveness decrease because they give up specialised production and lose the broad domestic market and are unable to benefit from the economy of scale. The characteristics of exports emerge from the microscopic analysis of firms' exporting behaviors. Market segmentation promotes exports of cities in the short term by increasing the number of exporting firms of a city. However, in the long run, market segmentation decreases the competitive of exporting firms. That is, the effect of market division policy is unsustainable. In addition, the impacts of market segmentation depend on enterprise ownership and geographic locations. The impacts are larger for state-owned enterprises and private enterprises, implying that foreign-owned enterprises hold super-national treatments. For firms in the central part of China, the impacts of market segmentation decrease when the distance from the city where the firms are located to the surrounding cities decreases. This phenomenon does not exist in the eastern and western regions. The role geographic location plays differs between regions, but there is little difference within the groups in eastern and western China. In eastern China, the transportation infrastructure is well developed, so transportation conditions do not seem to contribute significantly to creating market segmentation and therefore improving transport does not help decrease market segmentation. In western China, political barrier may have acted as the main reason causing market segmentation. Thus, improving transportation conditions, which are equally poor across the region, may not help as much as removing political barriers for reducing market segmentation. Although market segmentation promotes export of cities in the short term, it hurts export of firms in the long run. We recommend local governments make efforts to decrease domestic market segmentation to create a healthy environment for exporting firms. Local governments may open markets to neighboring provinces, encourage firms to balance between focusing on domestic and foreign markets, and improve transportation conditions. For cities in western China, it is necessary to take all these measures. In central China, it is more important to build high-quality roads and decrease transport costs.

Key words: Chinese cities, exports, market segmentation, microscopic analysis