Trade Liberalization, Internal Migration and Regional Income Differences: Evidence from China

International trade and the internal movement of goods and people are closely related. China – increasingly open and with massive internal migration flows – provides an ideal setting to study these interrelationships. We develop a general equilibrium model of internal and external trade with migration, featuring both trade and migration frictions. Using unique province-level data on internal and external trade, and recent micro-census data on internal migration, we estimate international and internal trade costs and internal migration costs. We find all these costs declined substantially after China joined the WTO. We use the model to quantify and decompose the effects of liberalizing trade (international and internal) and relaxing internal migration restrictions on China’s aggregate welfare, internal migration, and regional income differences. We find tha external trade liberalization has a large impact on China’s trade to GDP ratio, but modestly increases aggregate welfare while increasing regional income differences. In contrast, reducing internal trade costs generates larger welfare gains and reduces regional income differences. While both increase migration flows, migration cost reductions are substantially more important for migration. More surprisingly, lower migration costs only modestly increase aggregate welfare, but substantially decreases regional income differences. Our results suggest that internal market liberalization is much more important than the external trade liberalization as a source of China’s post-WTO improvement in aggregate welfare and reduction in regional income inequality.