Impacts of Tariff Rates on Input Source Choice: Evidence from Indonesia

Abstract

This study empirically examines how a reduction in input tariffs changes firms' choices between domestic and foreign inputs. In order to do so, we employ Indonesian manufacturing surveys from 2002 to 2010 and compute the share of imported inputs among total inputs at the firm-product level. With this dataset, we examine the effect of preferential tariffs for ASEAN countries—that is, ASEAN Free Trade Area (AFTA) tariffs. Our findings can be summarized as follows: First, we found that a reduction in AFTA tariffs in Indonesia encouraged plants to raise their share of foreign inputs. Second, such an effect of AFTA tariffs was observed only for indigenous plants, or those whose primary sales market is the domestic market. Third, we found that the more productive plants experienced a greater impact of AFTA tariffs on foreign inputs. In short, the reduction in AFTA tariffs encouraged input reallocation, at least in some specific firms in Indonesia.