International Trade and Economics of Less: Instruments of Protectionism

Instruments of Protectionism: Import Quotas An import quota is a limit on the quantity of foreign goods that can be sold in a nation's domestic markets. Voluntary exports restraints (VERs) are a way of establishing import quotas through informal negotiation between two governments. A VER was negotiated between the United States and Japan by President Reagan in the early 1980s to establish import quotas on Japanese cars. Import quotas can protect domestic industries just as tariffs do, but they don't generate any revenue that can be used to reduce government reliance on taxes. The import quotas were used from 1981 to 1984 to protect U.S. automobile producers. There are also import quotas on certain textiles, and special interests in a variety of industries continually seek to use their political influence to protect their interests with import quotas. Supply and demand analysis can be used to show the impact of import quotas. Suppose, as before, in the absence of any restrictions on international trade, the price of foreign cars average $10,000 and 3 million foreign cars per year are sold at that price. The initial equilibrium is at point E in the graph in Box 16. Now suppose a strict import quota of 2.5 million foreign cars per year is imposed. No matter what the price of foreign cars or the willingness of foreign producers to sell in domestic markets, no more than 2.5 million foreign cars will be permitted to enter U.S. markets each year. In effect, the quota truncates the foreign supply curve at point 1, as shown in Box 16 which corresponds to 2.5 million cars per year. The quantity supplied cannot increase beyond the quota limit. The upward-sloping supply curve beyond point / is no longer relevant to the domestic market. Instead the supply curve is vertical beginning at point 1. The supply of foreign cars is therefore perfectly inelastic after 2.5 million cars per year are imported. Given the new supply curve, the new market equilibrium corresponds to point E'. At that point the price of foreign cars increases to $10,800 per year. This corresponds to the point at which the demand curve intersects the vertical portion of the new supply curve. At that price the quantity demanded falls from 3 million to 2.5 million cars per year. If the import quota is established at the same quantity that results from the $1,000 tariff, the impact of the quota on the price of foreign cars is exactly the same as that which results from the tariff. An import quota can therefore protect domestic producers in the same way as a tariff can. As a result of the import quota, the demand for domestic cars will increase, just as it did with the tariff as shown in Box 14. Domestic producers will gain, and owners of specialized inputs used in domestic production will also gain. However, there are important differences between a tariff and an import quota: 1. An import quota does not raise any revenue for government authorities; a tariff does. 2. An import quota raises the market price paid by consumers of foreign cars but does not reduce the net price received by foreign sellers. Foreign sellers and their U.S. dealers will therefore gain revenue as a result of a quota, because they will receive higher prices per car. However, this gain is offset by the reduction in revenue as sales volume declines by 500,000 cars per year. The increase in revenue from the price increase can offset the decline in revenue from the sales decline when demand is very inelastic. If demand for the foreign goods is very inelastic, then foreign sellers and their U.S. dealers may actually be better off with a quota than they will be under free trade! The Problem of Retaliation Playing with tariffs is a bit like starting a war. Foreign governments whose citizens are harmed by tariffs or quotas may very well retaliate against the United States by placing tariffs or quotas on U.S. exports to their nations. They can also try to counter the effect of U.S. trade restrictions by subsidizing domestic producers. These subsidies may reduce the costs of selling in the United States and can be effective in increasing supply to counteract the effects of tariffs. However, this increase in supply will not have any effect if import quotas are used, because the quotas limit the quantity that can be sold in the U.S. market. The problem of retaliation must be considered by policymakers when tariffs and import quotas are used. The gains from tariffs and other trade restrictions in some industries may be offset by losses in others when foreign governments retaliate.