By Jingyu Lu
As well known, imposing either tariffs or quotas on imported goods is the conventional approach to set trade barriers and protect pertinent domestic industries. However, what if a country has a tariff and a quota on certain good at the same time? Does it mean even more strict protection and further distorted trade? The answer, surprisingly is no. The combination of these two protective instruments, in the form of tariff-rate quota, is prevailingly utilized to liberalize quantitative restriction.
How is this conclusion drawn? Firstly, we ought to be aware that quantitative restrictions, like quotas, can result in rationing, which means the limited permitted imports would be distributed based on not only productivity of each country but also some other factors, such as political consideration and first-come, first-serve rule. Thus, quotas can cause greater trade distortions than tariffs can. To improve the efficiency of trade, it is ideal to convert quotas into tariffs. Tariff- rate quotas, consisting of tariff and quota elements, can be regarded as the intermediate step of the reform.
Now we need to address the question what a tariff-rate quota is. A tariff-rate quota is a quota for a volume of imports at a particular tariff rate. Once the quota is filled, a higher tariff is applied on additional imports. Differing from the traditional “absolute” quota, a tariff-rate quota allows imports to exceed the applied quota level, as long as the excess pay over-quota tariff. In practice, many over-quota tariffs are so high that they effectively exclude imports in excess of the quota and reproduce the volume of trade of an absolute quota.
Compared to a tariff or a quota per se, a tariff-rate quota has more controllable variables to determine its effect on limiting imports, which specifically are in-quota tariff (t), over-quota tariff (T) and quota volume (Q). Straightforwardly, the loosening of Q will liberalize free trade and enhance market access. But for t and T, the conclusion is not that explicit. Using quota fill rate as the measurement of market accessibility, high in-quota tariffs are found serving to reduce quota fill rates, which means that further reducing in-quota tariffs will improve market access. However, over-quota tariffs have a positive effect on fill rates.
Besides hindering free trade, tariff-rate quotas also create biased trade in the supply side. Assume that only two types of firms can supply a market: least-cost and higher-cost. Least- cost firms have a cost of production less than or equal to PL. Higher-cost firms have a cost of production greater than PL. If there is no quota on trade, least-cost firms supply the entire market at the price PL. Higher- cost firms will not enter the market. When a quota is imposed, the demand price increase to PH. If only least-cost firms supply the market, they would fill the quota and gain a rent of PH-PL on each unit sold. However, if the market access is granted to whoever sells first, that is, on a first-come, first-served basis, the higher-cost firms would join the market, which is an inefficient use of resources and reduces global welfare.
Also any tariff-rate quota that increases quota rents can increase the risk that high-cost suppliers will displace low-cost suppliers. In the figure below, in-quota tariff revenue is collected from foreign exporters who have the granted quota. Quota rent is the gain generated from that they are being able to sell goods without a higher tariff. Whereas, over-quota tariff revenue is from the imports that are beyond the quota. When quota rent increases with a given quota volume, PH must go up and even to the level, at which, it is profitable for higher-cost firms to enter the market. Therefore, global economic welfare would be undermined.
In summary, tariff-rate quotas act as a useful tool for transition from quotas to tariffs for the sake of efficient trade. Due to its features of both quota and tariff, more variables (t, T, Q) can be controlled for a country to determine the market openness to foreign exporters. However, when applying those elements, policy makers should notice implied distortion of trade and try to reduce the welfare loss from biased supply.