The gains from changes in internal trade costs: A quantitative analysis of China

We study how internal trade costs affect the Chinese economy. Combining regional and industry data with a multiregional multisector general equilibrium model, we quantify the magnitude of total trade costs and institutional trade costs, and the impact of their changes on aggregate, regional, and sectoral total factor productivity, gross domestic product, and welfare. Using unique data, we estimate the sectoral trade elasticity of internal trade in 16 tradable sectors. We use our calibrated model to perform a variety of counterfactual exercises. We find that the welfare gains are negative for a 5% reduction in total trade costs and for the elimination of institutional trade costs, which can be attributed to inherent inefficiencies in the economy. However, as total trade costs decrease further, the positive welfare effect significantly exceeds the impact of inefficiency. The regional and sectoral effects of changes in trade costs show that the spatial structure of the economy, input-output linkages, and local factors together determine the heterogeneity of sectoral and regional consequences. Finally, we infer the relative changes in China's internal trade costs from 2012 to 2017, and calculate their economic effects.