Hometown favoritism and intra-regional trade barriers under decentralization: Evidence from China

Abstract

Decentralization management in inter-jurisdictional contexts requires careful consideration. This article highlights the potential for hometown favoritism to undermine decentralization practices. China established its ambitious social credit system in the highway construction sector in 2009, where local rating agencies are responsible for the grading of firms’ social credit ratings. Using a unique dataset spanning 2010–2022, we find that local firms can achieve higher social credit ratings, helping them meet more bidding requirements. Local firms are less likely to be downgraded, and those with stronger local cultural and economic ties receive higher ratings. Hometown favoritism in credit ratings is particularly pronounced for eponymous firms, less important and lower-quality construction projects, and it varies over time, increasing during periods of poor economic performance. Further evidence suggests that local firms win more bids, although changes in local ratings are less predictive of securing new bids. These findings underscore the previously unexplored role of hometown favoritism in creating trade barriers under decentralization.