Free Trade Agreement, Upgrading Quality, and Economies of Scale

The production of high-quality products is often seen as a prerequisite for successful export and economic development. Quality inputs are needed to produce quality products, so it would be difficult for developing countries to improve their quality product if accessing imported input is too costly. This chapter discusses the impact of reducing tariffs on the quality of imported and exported products in the Automotive Industry. Quality is measured by the unit value approach. Using data from Indonesia customs declaration documents, this chapter captures the causality of firm-level tariff reduction on import and export prices using the difference-in-difference (DiD) method. In the last decade, the tariff changes have been greater due to bilateral/regional trade agreements under the Free Trade Agreement (FTA) scheme, so this chapter is concerned with the reduction of the tariff under the FTA scheme. Companies can take advantage of reduced tariffs to buy higher-quality production inputs to produce higher-quality output. The results show that the tariff reduction does not affect import price. Tariff reductions from low-income countries will lower export prices. It indicates the occurrence of economies of scale. Meanwhile, tariff reductions from high-income countries do not impact on improving the quality of export products.