The Impact of Intranational Trade Barriers on Exports: Evidence from a Nationwide VAT Rebate Reform in China

Intranational trade barriers affect firms’ performance in international trade. It remains an empirical challenge to measure these barriers and quantify their impacts. We take advan- tage of a nationwide VAT rebate policy reform in China as a natural experiment to identify the existence of intranational trade barriers and study the impacts on exports and exporting firms. As a result of shifting tax rebate burden, the reform leads to a greater incentive of the provincial governments to block the domestic flow of non-local goods to local export intermediaries. We develop an open-economy heterogenous firm model that incorporates multiple domestic regions and multiple exporting technologies, including the intermediary sector. Consistent with the model’s predictions, we find that rising intranational trade barri- ers leads to a reduction in interprovincial trade, more “inward-looking” sourcing behavior of the intermediaries, and as a result a reduction in manufacturing exports. The identification relies on subnational variations in the exposure to the reform, exploiting the heterogeneity in the baseline trading network as well as the changing tax rebate policy. Analysis using micro firm-level data further shows that private companies with greater baseline reliance on intermediaries are more adversely affected.