Trade quotas are upper limits on the quantity of goods shipped between two nations in a particular category, for example, men’s shirts. An export quota is administered by customs officials in the export nation, while import quotas are administered by the import nation. Prospective exporters or importers must first obtain a license to ship an agreed quantity, such as one unit. In practice many export quotas are set up at the request of importing nations, in which case they are voluntary export quotas (VERs). The most prominent example of VERs is the Multifibre Arrangement (MFA) that lapsed in 2005 and that set bilateral export quotas for textile and apparel trade, affecting some 10 percent of the value of trade of rich countries.
Quotas act similarly to tariffs in that trade is reduced, domestic prices are driven up, and exporter prices are driven down. In one very special case, quotas are fully equivalent to tariffs. The equivalence case requires that the importing country set the quota and that it sell the licenses to import at a competitive auction, thereby obtaining the revenue as it would with a tariff. When other qualifications are met, the price paid for a one-unit license is equivalent to a tariff, volume of trade and domestic and export nation prices are the same, and equivalence prevails.
Quotas in practice are more inefficient than tariffs. First, quotas strengthen monopoly power. For example, a sole domestic firm becomes a monopoly in its home when foreign firms are limited to a fixed quantity of sales whereas with a tariff, that firm potentially competes with many firms. Monopoly power raises prices above cost and thus imposes a loss on the economy.
Quotas are also inherently highly discriminatory, which adds to their cost. Discrimination arises because quotas are set individually for trade partners and for product lines. Even if the quotas initially are associated with uniform tariff equivalents, changes in economic conditions introduce nonuniformity. This produces dramatic discrimination across countries. Moreover, across product lines within a country, regulations typically prevent resale of quota licenses from low-payoff to high-payoff lines of sale, similarly preventing market forces from achieving nondiscrimination. Nations also use quotas to discriminate in favor of allies or against enemies, as with the U.S. sugar quota, which allows imports from high-cost Philippines and excludes low-cost Cuba.
Quotas may increase fluctuations in prices compared with tariffs, and this is costly. A fixed specific tariff will permit fluctuating amounts of trade when there are shocks to foreign supply or domestic demand. The average volume of trade anticipated should be compared with a fixed quota of the average amount. The fixed quota will produce fluctuating tariff equivalents, which in effect discriminates across situations (states of nature) with different realized shocks. This discrimination is costly: It is more efficient to have more trade in high-tariff-equivalent states and less trade in low-tariff-equivalent states. The tariff accomplishes this perfectly compared with the quota.
The allocation of quota licenses is a potent cause of corruption, imposing further costs on the economy as resources are diverted from production to the pursuit of quota licenses: Before its reforms of the 1990s, India’s government was often called “the license Raj.”
Why have quotas been used when tariffs can also provide benefits to import-competing interests, apparently at lower cost? There must be some political advantage of quotas over tariffs in cases where they are used. Quotas are less transparent than tariffs because calculation of tax equivalents requires data on comparable domestic and foreign prices. The lack of price data often means no one outside the most closely concerned parties knows how costly the quota is. This may permit import-competing interests to obtain tighter limits on imports than they could obtain from tariffs. Because beneficiaries provide political support to politicians who set quotas, both the government and interest groups may gain from choosing quotas over tariffs.
An apparent disadvantage of quotas relative to tariffs is that the government’s potential tariff revenue is dissipated as quota rent earned by the license holders. The apparent disadvantage may, however, be a political advantage. First, with a VER, the quota rent typically gets awarded to foreign exporters who are initially being restricted in their access to the market. This compensates the foreigners for their loss and eases the problem of international trade relations with the foreign government. (This advantage is temporary. Later on, the VER will exclude exporters from other foreign countries and complicate trade relations with their governments.) Second, license holders are a very easily identified group of beneficiaries–easier to squeeze for political support than import-competing producers who may be hard to identify.
The apparent political advantage of quotas seems to argue that they should be very widespread. Politicians can play mutually beneficial games with producer groups in setting up market-share arrangements all over the international trading economy. Thus, limits on their use to a few areas of the world economy poses an important puzzle. To illustrate the importance of the puzzle, consider the MFA set of VERs that, until recently, controlled some 10 per cent of world trade. The MFA began in the 1950s and was gradually extended to cover more products and countries, so it looked durable. Yet the Uruguay Round of multilateral trade negotiations set an end date in January 2005. Despite the reversion to a temporary extension of VERs on China in fall 2005, the end of the MFA seems to be accomplished. Political economy should be able to say why. Moreover, political economy should be able to explain the use of tariffs as opposed to quotas in many other product categories.
SEE ALSO Barriers to Trade; Tariffs
Anderson, James E. 1988. The Relative Inefficiency of Quotas. Cambridge, MA: MIT Press.
Krugman, Paul R., and Maurice Obstfeld. 2006. International Economics. 7th ed. Boston: Addison-Wesley.
James E. Anderson