Can duty-drawbacks have a protectionist bias? Evidence from MERCOSUR

Duty drawback (or rebate) systems, reduce or elimi nate 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 anti0trade 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. The authors 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 counter-lobby 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 block, alters the incentives by eliminating duty drawbacks on intra-regional exports, which leads to lower tariffs for goods that intra-regional exporters use as inputs. Evidence from MERCOSUR suggests that eliminating duty drawbacks for intra-regional exports, would lead to increased counter-lobbying against protection of intermediate products. The authors estimate that without this mechanism, the common external tariff would have been 3.5 percentage points (25 percent) higher on average.