Productivity and Firms’ Sales Destination: Chinese Characteristics

Abstract

In the trade literature, it is often assumed that there is little or no trade cost within a country's borders, but large trade costs across a country's borders. Thus, productive firms self-select into exporters and the less productive firms can only serve domestic consumers. This paper presents a similar but different case in China, whose domestic markets are segmented by provincial borders mainly owing to the various (hidden) protective measures favoring local firms. These discriminative measures are de facto trade barriers. It applies the heterogeneous trade theory to examine the effects of firms’ productivity on their sales choices in both the international and domestic markets, in the presence of intra-national and international trade costs. We find that productive firms not only self-select into exporters, but also into sales in other provincial markets. This pattern is sensitive to firms’ locations and ownerships. For foreign direct investment (FDI)-controlled firms, increases in productivity are associated with a higher probability of selling into other provincial markets, rather than into international ones. Productivity increases for firms operating in the inland area exhibit different patterns than those in the Eastern area.