The impacts of export VAT rebates on market switch and productivity: Firm‐level evidence from China

Recent heterogeneous firm literature has revised the basic assumptions of constant marginal costs; markets may thus be complements or substitutes. Using Chinese firm‐level data for 1998–2007, our study utilises the 2004 export tax rebate (ETR) cut as a quasi‐natural experiment to demonstrate how the domestic market may be a fall back for exporters when they encounter exogenous negative export shocks, leading to market‐switching behaviour and higher domestic sales. The market‐switching behaviour significantly intensifies the competition in the domestic market in the affected industries. This crowds out sales of non‐exporters and drives up the probability of market exit of non‐exporters. Consequentially, non‐exporters in industries affected by the negative export shock may enjoy a significantly larger productivity gain compared with their counterparts in other industries, as well as exporters in the same industries. Thus, the negative shocks to the export market result in an indirect pro‐competitive productivity gain for non‐exporters.