The Stagnant Export Upgrading in Northeast China: Evidence from Value‐added Tax Reform

China's 2004 value‐added tax (VAT) pilot reform in the Northeast region, which changed the VAT from production type to consumption type, introduced a sizable tax credit for fixed investment in manufacturing industries, leading to more investment and higher productivity at firm level. This paper, however, uses difference‐in‐difference estimation and finds a negative structural effect; that is, the VAT pilot reform leads to a reduction in the export sophistication of Northeast cities relative to other cities in China, and the results hold for a battery of robustness checks. It is found that resources are reallocated towards less‐sophisticated industries. As the products with higher export sophistication are more skill and research and development (R&D) intensive, the shortfalls of skilled labor and R&D spending hinder the upgrading process. With a new round of revitalization plans in the Northeast, policymakers should be cautious with similar structural effects and focus on increasing skilled labor supply and R&D investment.