The Impact of Local Trade Barriers on Export Activities, Firm Performance and Resource Misallocation

Established: November 1, 2014


It is well known that various forms of non-tariff barriers exist among Chinese provinces. Empirically, it is difficult to measure these barriers because they can take many forms. This research takes advantage of an export VAT rebate policy reform in 2004 as a natural experiment to identify the existence of internal trade barriers and study the impacts on TFP and resource allocation. In particular, as a result of shifting tax rebate burdens, the 2004 reform leads to a greater incentive for the provincial governments to block the domestic flow of non-local goods related to exporting. I find that foreign trade companies in the coastal region have become more “inward-looking” in the years after the reform, consistent with rising local trade barriers. The value of exports through intermediaries grows less in the inland region relative to the coastal region, and the negative effect is larger in inland provinces with greater exposure to the reform, measured using baseline reliance on trade through intermediaries. I extend the standard open-economy heterogeneous firm model by adding an intermediary sector as in Ahn, Khandelwal, and Wei (2011), but with a new focus on the intermediary’s role of domestic sourcing. The model can be used to perform general equilibrium analysis, examine firm entry and exit into exporting, and quantify the distortion on TFP.