Do people discriminate between co-ethnics and others in cooperative interactions? In an experiment in China, we find that participants in trust games send around 15% more to partners they know to be co-ethnics than to those whose ethnicity they do not know. Receivers’ behavior is determined by amounts received and not by perceived ethnicity. In line with previous literature we find that subjects contribute more to public goods in ethnically homogeneous groups than in mixed groups. We find evidence for a new explanation that is not due to different intrinsic preferences for cooperation with ingroup and outgroup members. Instead, subjects’ willingness to punish in-group members for free-riding is reduced when out-group members are present. This leads to lower contributions and net earnings in mixed groups. Thus favoritism towards co-ethnics can hurt both those engaging in favoritism and those being favored.