I POLICY RESEARCH WORKING PAPER 2523

# Summary findings

Duty drawback (or rebate) systems reduce or eliminate the duties paid on imported intermediate goods or raw materials used in the production of exports. When a firm imports an intermediate product for use in the production of an export good, tariff payments on the imported intermediate good are either waived (duty drawback) or returned to the producer once the final product is exported (rebate). These incentive systems are often justified on the grounds that they tend to correct the anti-trade bias imposed by high tariff levels.

The problem with this line of reasoning is that it assumes that tariffs are predetermined policy variables; if they were, the easiest way to reduce their anti-trade bias would be to eliminate them. But this is rarely done because existing levels of protection correspond to a political economy equilibrium difficult to modify in the presence of lobbying pressures.

Cadot, de Melo, and Olarreaga show that in a political economy setting where tariffs and duty drawbacks are endogenously chosen through industry lobbying, full duty drawbacks are granted to exporters that use imported intermediate goods in their production. This in turn decreases their incentives to counterlobby against high tariffs on their inputs. Indeed, under a full duty drawback regime, tariffs on intermediate goods are irrelevant to exporters because they are fully rebated. In equilibrium, higher tariffs will be observed on these goods.

Creating a regional trading bloc alters the incentives by eliminating duty drawbacks on intraregional exports, which leads to lower tariffs for goods that intraregional exporters use as inputs.

Evidence from Mercosur suggests that eliminating duty drawbacks for intraregional exports would lead to increased counterlobbying against protection of intermediate products. Cadot, de Melo, and Olarreaga estimate that without this mechanism, the common external tariff would have been 3.5 percentage points _(25_ percent) higher on average.

This paper-a product of Trade, Development Research Group-is part of a larger effort in the group to study the political economy of trade policy. The research was funded by the Bank's Research Support Budget under the research project "The Anti-export Bias of Duty Drawbacks." Copies of the paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Lili Tabada, room MC3-333, telephone 202-473-6896, fax 202-522-1159, email address ltabada@worldbank.org. Policy Research Working Papers are also posted on the Web at www.worldbank.org/ research/workingpapers. The authors may be contacted at olivier.cadot@hec.unil.ch, demelo@ibm.unige.ch, or molarreaga @worldbank.org. January 2001. (33 pages) _The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represen_ **_t_** _he view of the World Bank, its Executive Directors, or the countries they represent._ Produced by the Policy Research Dissemination Center