Labour market flexibility and domestic value‐added trade: Evidence from the hukou reform in China

Chinese manufacturing firms have seen an intriguing rise in domestic value‐added content in exports (DVAR) despite their deepening engagement in global value chains (GVCs) since 2001. This article investigates whether the rise of DVAR in China can be attributed to changes in labour market flexibility by using the staggered relaxation of Chinese hukou policies across cities and time as a quasi‐natural experiment. Using combined firm‐level data and transaction‐level trade data from 2000 to 2013, this article finds that the relaxation of labour market flexibility through hukou reform has significantly increased the domestic value‐added exports of Chinese firms. Firms exposed to hukou reform tend to allow for more employment adjustment and substitute domestic materials for imported intermediates, which raises the DVAR of Chinese manufacturing firms. This effect is more prominent for non‐SOE firms, foreign‐invested firms, processing firms, coastal firms and firms in the upstream sectors of GVCs.