In recent years, China has experienced a new wave of international industrial relocation. Unlike Japan’s regionally homogeneous industrial structure, China exhibits a distinct east-west economic gradient, which creates a unique dual economic structure with vast potential for domestic industrial transfer. As a critical vehicle for this shift, the processing trade in eastern China faces dual pressures from eroding comparative advantages and accelerating outward migration of industrial orders. Investigating how the Hukou reform affects the scale expansion and quality upgrading of processing trade therefore holds significant theoretical and policy relevance for facilitating gradient industrial transfer and accelerating China’s transition into a strong trading nation.

Based on the city-product-level panel data from 2010 to 2016, this paper treats the 2014 Hukou reform as a quasi-natural experiment and employs a DID approach to assess how relaxed household registration restrictions affect processing trade development. The results show that: First, the reform significantly increases the export scale and share of processing trade, with a stronger effect in smaller cities. Second, the reform attracts low-skilled labor and facilitates high-skilled talent settlement, reducing relative labor costs and promoting the co-agglomeration of manufacturing and producer services, thereby driving export growth in processing trade. Third, the reform enables central and western cities to significantly expand their extensive margins, secure more processing trade orders, and access new export markets. Fourth, the reform enhances the technological sophistication of processing products, and capital-intensive and high-tech products show stronger export growth, indicating that it fosters both scale expansion and quality upgrading.

The marginal contributions of this paper are as follows: First, while existing literature typically examines trade issues from the perspective of the demographic dividend’s decline, this paper reveals how labor spatial reallocation through the Hukou reform drives processing trade. Second, it establishes a theoretical link between the Hukou reform and the gradient transfer of processing trade, thereby expanding the research scope in international trade and institutional economics. Third, by decomposing export growth from the dual perspectives of product and market diversification, it uncovers the latent patterns of domestic industrial transfer. These findings provide targeted policy insights for promoting the transformation and upgrading of China’s processing trade and regional coordinated development.