viewed as inferior to low uniform tariffs, since it attempts to do for a subset of the economy what low uniform tariffs do for the entire economy; (3) Republic of Korea and Taiwan (China) are examples of economies that successfully developed but they started with significant and diverse import protection. These countries, however, progressively lowered protection. Moreover, since import protection implicitly imposes a tax on exports, Republic of Korea and Taiwan (China) implemented complicated programs (like **indirect** duty drawback)<sup>5</sup> to provide exporters with incentives equivalent to sectors that received import protection. Their programs required a very competent and non-corrupt government bureaucracy to administer. Two country case studies in this book, Japan and Republic of Korea, both explain the key role of an efficient regulatory regime in offsetting the anti-export bias of the trade regimes of Republic of Korea and Japan. In most developing countries, exporters complain that the mechanisms for provision of tariff free access to imported intermediate products do not work. Notably, they do not receive the payments that are due to them under duty drawback programs. In general, the evidence suggests that most developing and transition countries do not possess the required efficient non-corrupt bureaucracy to effectively administer the complicated Republic of Korea or Taiwan (China) type regulatory regimes. Thus, we recommend great caution in countries trying to emulate the Republic of Korea or Taiwan (China) trade policy model of development.

A key theme of this Handbook is that import protection imposes a tax on exports.<sup>6</sup> By imposing a tariff on imports, a country may believe it is only helping an import competing industry. But all export sectors are hurt by an import tariff. A key reason is that a tariff reduces the demand for foreign exchange and therefore appreciates the real exchange rate. This makes exporting less profitable in domestic currency. Another reason is that the cost of inputs increases when exporters use the taxed good as an input. The general equilibrium nature of tariff policy regarding its impact on exports is a crucial point that we hope will be clarified through this Handbook. Since import protection penalizes exporters, it appears that lowering protection is a crucial necessary (but not sufficient) condition for sustained rapid economic development in transition countries.

An open trade regime must be complemented by behind the border policies and institutions to foster development. In chapter 10, we argue that a stable macroeconomic environment conducive to business development with a clear, transparent regulatory environment with neutral incentives to all firms and industries are also crucial. Clear, transparent and neutral incentives (those which do not distinguish by sector or firm) are crucial in the Transition countries so that scarce entrepreneurial talent is rewarded for innovation and is not diverted away by higher rewards for rent-seeking activities, which are typically associated with corruption. Sound competition policies (including especially avoiding barriers to entry and investment), flexible labor market policies and adequate infrastructure are also very important. We must also recognize that historical conditions and geography will also affect the development

> Working Paper 2238, The World Bank. Available at http://econ.worldbank.org.

> 5 An example of indirect duty drawback is where an automobile producer exports cars that use **domestic** steel; but domestic steel uses imported iron ore on which tariffs are paid. With indirect duty drawback the automobile producer will receive a rebate of the imputed value of the tariffs on the iron ore embodied in the automobile. With conventional duty drawback no rebate would be allowed since the steel is domestically produced.

> 6 This is known in international trade theory as the Lerner symmetry theorem.

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