Duty drawbacks, competitiveness, and growth - are duty drawbacks worth the hassle?

Duty Drawbacks, Competitiveness and Growth: Are Duty Drawbacks Worth the Hassle? Elena Ianchovichina The World Bank Abstract Many countries use duty drawbacks on exports, yet they have been given little attention in the literature and there is no consensus whether countries should embrace or abandon them. This paper asserts that the answer depends on a country's development priorities and economic conditions. An increase in the drawback has a positive impact on export competitiveness and employment, but could lead to exports with low domestic value added. The welfare effects of duty drawback reform are ambiguous. An increase in the drawback is more likely to be welfare improving if the economy is small with high input tariffs, low initial drawback, low administrative costs and leakages in the tariff collection system. In China duty drawback removal after meeting its WTO commitments will deepen domestic supply chains and improve welfare, but will hurt China's economic efficiency, export competitiveness and real factor incomes. Further liberalization could mitigate these negative effects. Keyword: Duty drawback; Competitiveness; Tariff reform; China; JEL classification: F11; F13 World Bank Policy Research Working Paper 3498, February 2005 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 represent the view of the World Bank, its Executive Directors, or the countries they represent. Policy Research Working Papers are available online at http://econ.worldbank.org. The author is Senior Economist with the Economic Policy Department, PREM Network, The World Bank, 1818 H Street, NW, Washington DC 20433; email eianchovichina@worldbank.org. This paper has not undergone the review accorded to official World Bank publications. The author thanks William Martin and Deepak Bhattasali for encouraging this work and Li Yan from Customs General Administration, People's Republic of China, for her advice and data on export processing arrangements and trade. The author appreciates comments from Marcelo Olarreaga, Mary Amiti, William Martin, Deepak Bhattasali and Bernard Hoekman.  Executive Summary Many countries use duty drawbacks on exports, yet they have been given relatively little attention in the literature and there is no consensus whether countries should embrace or abandon them. This paper asserts that the answer depends on the country's development priorities and economic conditions. An increase in the duty drawback has a positive impact on export competitiveness and employment in the export-oriented industries, but could lead to exports with low domestic value added. The welfare effects of duty drawback and trade reform in the presence of a drawback are ambiguous in general. An increase in the drawback is more likely to enhance welfare if the economy is small with high input tariffs and intensity of imported input use in the export-oriented sectors, low initial drawback, low administrative costs and leakages in the tariff collection system. In such an economy liberalizing intermediate good markets can be welfare enhancing if the cost share of the imported input is higher in the export-processing than in the import-competing sector. This is more likely to be true for a lower duty drawback and higher intensity of import use in the export-oriented sector. If there is a complete duty drawback, liberalizing intermediate input markets is unambiguously welfare reducing. In China duty drawback removal after meeting its WTO commitments will deepen domestic supply chains and improve welfare, but will hurt China's economic efficiency, output growth, export competitiveness in key manufacturing industries and real factor incomes. Further liberalization could mitigate the negative effects. 2  1. Introduction Economic theory traditionally considers trade liberalization to be the reduction or complete removal of existing trade restrictions and economists typically endorse it as a `first-best' type of trade liberalization. While removal of existing trade barriers is the most direct way to free trade, many economies have chosen more gradual and flexible approaches. These involve `concessional' trade liberalization instruments including intra-industry liberalization via duty drawback schemes, sub-national liberalization through the development of export processing zones (EPZs), firm-specific liberalization by negotiating import rights with individual firms or expanding eligibility for import permits, and regional trade liberalization by forming regional free trade blocs. This paper focuses on one type of `concenssional' trade instruments