# 1) Introduction

Tariff policy reform is a policy lever for countries seeking to increase consumer welfare, boost productivity, and attract greater inward investment in the medium to long‐term. When asked how these outcomes materialize, economists typically distinguish between two channels. First, as protection levels on the production of final goods decline, tariff reform induces pro‐competitive forces among domestic producers, which now face tougher import competition, and incentivizes them to become more productive. Second, with lower tariffs, the costs of intermediate inputs decline, allowing firms to shift to new or better‐quality inputs, access better technology and integrate into increasingly important global value chains.

Although these benefits are widely acknowledged in academia, in policy‐making spheres, policy makers will often have to deal with short‐term adjustment costs, possible distributional consequences that may be politically sensitive, and other policy trade‐offs of tariff reforms. They will therefore want to consider these issues before embarking on a comprehensive tariff reform. Similarly, high levels of protection accorded to some sectors may make the sudden removal of tariffs unfeasible. Policy makers may hence seek more gradual reform approaches. In addition, many countries may have in place complex ‘cascading’ tariff structures intended to reconcile the desire for lower input tariffs with a policy of continued protection accorded to downstream activities. In this case, policy makers will be interested to know how different activities intertwine with a set tariff structure and how they affect effective protection levels across sectors.

1 This paper presents a Microsoft Excel‐based tool – “UTAS” (Upstream Tariff Simulator) to help policy makers assess the impact of tariff reforms on production costs and effective protection across a variety of sectors in a flexible and time‐efficient manner. The tool allows policy makers embarked on a tariff reform to answer key policy questions such as: What is the impact of tariff changes on production costs downstream? What are the key input tariffs that could be reduced to lower production costs in priority sectors taking into account sectors’ backward linkages? How will a tariff reform affect effective as opposed to nominal protection rates across the sectors of an economy?

Recent evidence shows that the consideration of such questions is important to maximize the potential benefits of a tariff reform.

First, a growing body of evidence shows that the productivity gains arising from lower tariffs on intermediate inputs are particularly large. In fact, two seminal studies by Topalova and Khandelwal (2011) and by Amiti and Konings (2007) show that, in India and Indonesia, the impact of trade reform on productivity was larger on account of the impact on the cost of inputs than due to the pro‐ competitive effects it unleashed through reductions of tariffs on final goods. Moreover, a reduction in tariffs on intermediate inputs can also play a very important role in boosting firms’ exports. Recent research shows, for example, that China’s well‐known export success story is at least in part attributable to cheaper imports of intermediates. Feng et al. (2016) find that Chinese firms that benefitted from lower tariffs on intermediate inputs after China’s accession to the World Trade Organization (WTO) exhibited stronger export growth than those that did not benefit from the decline in input tariffs. They also find that these effects were larger for firms that were not involved in any

> 1 Also, importantly, many developing countries rely heavily on trade taxes to pay for public expenditure, as customs duties and other trade‐related taxes provide a relatively easy and straightforward source of revenue. Policy makers will thus need to consider how much customs revenue a country can afford to lose in the short‐ run.

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