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

It is well known that various forms of non-tariff trade barriers can exist within a country. Empirically, it is difficult to measure these barriers as they can take many forms. This research takes advantage of an export VAT rebate policy reform in China in 2004 as a natural experiment to identify the existence of local trade barriers and study the impact on export activities and resource misallocation. In particular, as a result of shifting tax rebate burden, the 2004 reform leads to greater incentives of the provincial governments to block the domestic flow of non-local goods to local intermediaries for indirect exporting. We find that trade intermediaries become more “inwardlooking” in the years after the reform, especially in province-industries with higher predicted rebate burden, consistent with rising protectionist incentives. The value of total exports and exports via intermediaries grow less in province-industries with greater exposure to the reform, measured using a province-industry’s baseline reliance on intermediaries interacted with the predicted rebate burden. We extend the standard open-economy heterogeneous firm model by adding an intermediary sector following Ahn, Khandelwal, and Wei (2011) but with a new focus on the intermediary’s role of domestic sourcing. The model can be used to recover the spatial distribution of wedges as a result of the rising local trade barriers and quantify the distortion on TFP. ∗Contact information: Bai: Harvard Kennedy School, e-mail: jie [email protected]; Liu: Harvard Kennedy School, email: jiahua [email protected]. We thank Nikhil Agarwal, Abhijit Banerjee, Panle Jia Barwick, Arnaud Costinot, Dave Donaldson, Benjamin Olken, Robert Townsend for helpful discussions and comments. All errors are our own.