CHAPTER 7
Nontariff Distortions to Trade
CHAPTER OUTLINE
I.
II.
III.
IV.
V.
VI.
Introduction
Nontariff Barriers to Trade

Figure 7.1
Quotas

Table 7.1

PASSPORT: U.S. Sugar Quotas
The Economic Effects of a Quota

Figure 7.2

tariff equivalents

demand increases — Figure 7.3
Other Nontariff Distortions
A.
Industrial Policy

PASSPORT: Strategic Trade Policy
B.
Government Procurement

PASSPORT: Corruption and International Trade
C.
Technical Barriers to Trade
D.
Subsidies

PASSPORT: The Scope of Trade Negotiations
E.
Labor and Environmental Standards

PASSPORT: Sweatshops?
Transportation Costs and Trade

Figure 7.4
TEACHING NOTES AND TIPS
I.
Introduction
Notes
This chapter continues the discussion started in Chapter 6. Protection has tended to move from
tariffs to various Nontariff Barriers to Trade (NTBs). The chapter starts with a basic definition
of NTBs and then moves on to the welfare implications of a standard quota. The last part of the
chapter deals with some of the more important administrative and technical barriers to trade and
ends with a discussion of transportation costs and trade.
Teaching Tip
141
142 Chapter 7
The students have caught a glimpse of something akin to an NTB. When crossing the border
into another state there is frequently a place where truck drivers have to stop before they can
continue to drive into the state. This minor annoyance increases the cost of interstate trade.
NTBs are just this kind of thing writ large.
II.
Nontariff Barriers to Trade
Notes
This section gives a basic introduction to NTBs. The important point is Figure 7.1. Notice that
the U.S. uses NTBs more frequently than either the EU or Japan.
Teaching Tip
Be sure to mention that NTBs are not uniformly distributed among all product categories and
heavily influence trade in some product categories.
III.
Quotas
Notes
The section starts out by defining a quota. It then lists the reasons they still exist such as World
Trade Organization (WTO) membership, WTO accession schedules, defiance of WTO rules, and
the MFA. The final part of the section covers Voluntary export restraints (VERs).
Teaching Tip
Clothing is frequently an important part of the student's budget. Mention that they are impacted
by the MFA anytime they buy virtually any article of clothing.
IV.
The Economic Effects of a Quota
Notes
This section presents the standard analysis of the effects of a quota. Figure 7.2 shows the effects
of a quota and the boxed feature, "Passport: U.S. Sugar Quotas", puts some numbers behind this
concept. The use of an auction quota as a means for the government to recover the lost revenue is
covered. How to calculate a tariff equivalent is covered as many countries are now in the
process of doing this to comply with WTO rules. Figure 7.3 shows the difference between a
tariff and a quota when demand increases. The final part of the section discusses the reaction of
exporters to quotas. Quotas may induce FDI and/or encourage exporters to increase quality.
Teaching Tip
In the early 1980s, the chief economist at Ford, William Niskanen, strongly argued that the
company's policy of pursuing quotas on imports of Japanese cars was dumb. The reaction of
management was to fire him. Use Toyota as an example of the reaction to quotas. They
upgraded the quality of the cars exported from Japan (Lexus) and built plants in the U.S.
Nontariff Distortions to Trade 143
V.
Other Nontariff Distortions
Notes
This section covers some of the major NTBs outside of quotas and VERs. Government
industrial policy, procurement laws and technical barriers to trade are the major problems. The
box on corruption considers the problem as another NTB that may affect trade. The section ends
with a discussion of subsidies and the controversy over labor and environmental standards that
sound superficially plausible. The box on sweatshops is given as an example of why this is true.
Teaching Tip
Government procurement sounds like such a dull issue. However, globally government
purchases of goods and services are a sixth of GDP and close to a quarter of GDP in high-income
countries. For a firm like IBM or Dell this issue is a big deal.
VI.
Transportation Costs and Trade
Notes
The section covers transportation costs on international trade. With transportation costs included
the quantity of goods traded decreases and acts as a barrier to trade. When transportation costs
become so large that international trade becomes unprofitable these goods are called nontradable
goods.
Teaching Tip
It is important to point out the transportation costs impact trade just like tariffs and quotas. As
transportation and communications costs decline international trade increases (i.e., the
outsourcing of service industries to India).
BRIEF ANSWERS TO PROBLEMS AND QUESTIONS FOR REVIEW
1.
The major nontariff trade barriers include quotas and voluntary export restraints (VERs).
2.
Quotas restrict imports of a good to a certain quantitative level. An import quota differs
from an import tariff in that a quota restricts imports of a good to a certain quantitative
level and a tariff is a tax on the imported good. In the case of a tariff, the amount of tariff
revenue the government collects can be spent on the provision of public goods. In the
case of a quota, the higher price received by the foreign firms creates additional revenue
that accrues to the foreign producers and makes them more profitable. As a result, the net
welfare loss to the quota-imposing country is larger under a quota than a tariff.
3.
A tariff equivalent to a quota has identical short run static effects except that tariffs tend
to reward the most efficient foreign producers while quotas may be allocated arbitrarily.
However, a tariff is much less restrictive in the domestic market than a quota when the
domestic demand for the product increases. In the case of a tariff, an increase in
domestic demand would be supplied by imports at the current price. When a quota is
present, the domestic producers supply the increase in domestic demand. In this case, the
144 Chapter 7
losses for consumers and society are much larger in the case of a quota than in the case of
a tariff when the demand increases.
4.
Assume that this country has a comparative disadvantage in the production of steel, and
decides to open its borders to trade. In this case, the country will import steel at price Pw. Under conditions of free trade, the domestic price of steel would fall to Pw, with Qs
amount of steel being produced domestically and the amount Q1 to Q5 being imported.
Remember, if a tariff were imposed in this market, the domestic price would rise,
domestic production would expand, and imports would decline. Identical effects on the
domestic price, domestic production, and the amount imported could occur if the
government imposed an import quota. Let's assume the government imposes an import
quota that restricts the supply of imported steel to Q2Q4 units. Because the supply of
imported steel is reduced, the price of steel will begin to rise until a new equilibrium is
reached. Domestic consumers are harmed as consumer surplus declines by areas, a + b +
c + d. Domestic producers benefit as producer surplus rises by area a. As in the case of a
tariff, there are efficiency losses of areas b and d. Who receives area'c is the only
difference between a tariff and a quota. In the case of a tariff, area c is the amount of
tariff revenue the domestic government collects. In the case of a quota, area c accrues to
the foreign producers and makes them more profitable. The net welfare loss to the quotaimposing country is larger under a quota than a tariff. With a tariff, the domestic
government gains revenue, area c, which can be spent on the provision of public goods.
With a quota, area c is lost to the foreign producers.
P
S
P
P'
Quota Constrained Price
a
b
c
d
Pw
World Price
D
Quota
Q1 Q2 Q3 Q4
5.
Q5
Q
If the demand for the imported good increases after a quota has been placed in the
market. The quantity imported cannot increase when there is an increase in demand. As
a result, the price of imports rises. In the case of a tariff, the price would remain constant
and the additional demand for the good would be supplied with additional imports.
However, when a quota is present in the domestic market, the domestic producers supply
the increase in demand. The foreign producers also gain in this case as the price they
receive for their product increases. The important point is that the losses for consumers
and society are much larger in the case of a quota than in the case of a tariff when
demand increases.
Nontariff Distortions to Trade 145
6.
There are two methods available for a government to capture area c under a quota. First,
the government could auction quotas to foreign producers in a free market. The
advantage to this auction quota method is that the domestic government would gain area
c which now accrues to foreigners, and the limited quota supply would go to those that
importers most in need of the product who would pay the highest prices. Another method
available to a government or society to capture area 'c' is to convert the quotas into an
equivalent tariff. The conversion of quotas into a tariff has several advantages. First,
tariffs are legal under the WTO and quotas are not. If foreign firms find the quota
sufficiently onerous, they can perhaps get their government to complain to the WTO for a
remedy. Second, calculating a tariff equivalent for an existing quota is easy to do. To
calculate a tariff equivalent, take the difference between the good's world market price
and the good's quota constrained domestic price and divide that difference by the good's
world market price.
7.
Although quotas reduce foreign competition in the short run, the long-run anticompetitive effects may be greatly diminished for several reasons. First, quotas may
entice foreign firms that are exporting to the domestic market to engage in foreign direct
investment. If the domestic market in the importing country is large enough and the
barriers to exporting are sufficiently high, foreign firms may find it profitable to build
production facilities within the importing country. This effect is analogous to firms
building plants to jump over high tariffs. Second, when an importing country enforces a
quota, the quota is stated as a specific number of units without regard to their price. In
this case, the exporters have a clear incentive to export the highest quality and most
expensive versions of the product.
8.
Differences in industrial policy have created some interesting issues in international
trade. As tariffs have declined, national differences in industrial policy have a greater
chance of altering the pattern of world production and trade. This is especially true given
the increasing number of free-trade agreements between countries. Once countries have
entered into a free-trade agreement that abolishes tariffs and quotas, then differences in
business regulations among the countries become more important. For example, as
Canada and the U.S. have abolished trade restrictions, resulting differences in each
country's regulation of an industry can have noticeable effects on the trade flows between
the two countries. If Canada decides to heavily regulate an industry that the U.S. does
not, then the industry will likely shrink in Canada and expand in the U.S. The result is
that as traditional trade barriers fall, industrial policy takes on increasing importance.
9.
One of the most obvious cases of government rules and regulations that distort trade is in
the area of government procurement. Government procurement laws are laws that direct a
government to buy domestically made products unless comparable foreign-made
products are substantially cheaper. Government purchases of goods and services are
subject to constraints and frequently governments have regulations that give preferences
to domestic firms. The rationale for these regulations is that buying domestic is more
beneficial to the country than buying an imported product. The issue of government
procurement has become important because in most countries government purchases
account for 10 to 15 percent of GDP.
146 Chapter 7
10.
The two types of government subsidies that effect international trade are a direct export
subsidy and a domestic subsidy as part of a country's industrial policy. The domestic
subsidy is more difficult to deal with and these subsidies are being given to the firm or
industry to accomplish some domestic policy objective. Trying to eliminate the domestic
subsidy is an extremely difficult problem as it requires that a country adjusts its industrial
policy objectives.
11.
Labor and environmental standards have become issues in international trade because in
many developed countries, there is a concern over the ability to compete with countries
that have lower labor standards for wages, working conditions, and occupational safety.
The fear is that countries with "low" standards will enjoy an "unfair" advantage over
countries with higher standards. However, developing countries view the drive to impose
developed country's labor standards on them as a condition of exports as nothing more
than thinly-veiled protectionism. The same type of argument applies to national
differences in environmental standards, laws that apply environmental standards to
manufactured products. Many countries with high environmental standards fear that
countries with low standards and/or enforcement may enjoy an "unfair" advantage in
industries that are relatively pollution intensive. So far the WTO has ruled that countries
cannot attempt to impose their domestic labor or environmental standards on other
countries by limiting imports.
12.
With positive transportation costs, the quantity of goods traded declines as the price of
imported goods increase and the price of exported goods falls. In addition, in the
importing country, the consumption of imports declines while the domestic production of
import competing goods increases. For the exporting country, the consumption of the
export good increases while the production of the exported good decreases. Thus, the
effect of transportation costs is to move the price of cloth and the quantities traded
partially back toward the no trade situation. As such, transportation costs act as a barrier
to trade much like tariffs and other nontariff barriers.
MULTIPLE-CHOICE QUESTIONS
1.
*
2.
*
Quotas are a greater threat to competition than tariffs because:
a.
quotas allow imports but only at a higher price.
b.
tariffs are voluntary but quotas are not.
c.
quotas preclude additional imports at any price.
d.
tariffs do not reduce imports and quotas do.
An example of a nontariff barrier (NTB) is:
a.
a tax on imports.
b.
a tax on exports.
c.
a physical limit on imports.
d.
a tax on trade in services only.
Nontariff Distortions to Trade 147
3.
*
4.
*
5.
*
6.
*
Nontariff barriers (NTBs) include all of the following except:
a.
quotas.
b.
tariffs.
c.
subsidies.
d.
health standards.
Quotas:
a.
are a form of protectionism.
b.
restrict imports of a product to a certain quantitative level.
c.
are banned under the WTO.
d.
all of the above
Once a country joins the WTO:
a.
all quotas must by immediately be eliminated.
b.
all quotas are allowed under the WTO.
c.
quotas must be slowly eliminated over a given period of time.
d.
all quotas are allowed since the WTO does not pay attention to this trade issue.
Quotas exist because:
a.
not all countries are members of the WTO.
b.
some countries that are members of the WTO are allowed to maintain quotas
during a transition period.
c.
many industrial countries implement quotas in defiance of WTO rules.
d.
all of the above
7.
Which of the following is not one of the reasons countries have quotas?
a.
Non-WTO member
b.
New WTO member
c.
Protection of agricultural production
d.
Membership in the UN
8.
A VER is:
a.
a tariff that is imposed by the exporting country.
b.
a tariff that is imposed by an importing country.
c.
a voluntary quota imposed by the importing country.
d.
a voluntary quota imposed by the exporting country.
*
9.
*
10.
*
Which of the following is not an NTB?
a.
A quota
b.
A VER
c.
A technical rule calculated to exclude imports
d.
An MFN tariff
Nontariff barriers include all of the following except:
a.
buy domestic requirements.
b.
tariffs.
c.
technical standards.
148 Chapter 7
d.
11.
*
labor standards.
Nontariff barriers include all of the following except:
a.
buy domestic requirements.
b.
technical standards.
c.
environmental standards.
d.
the corporate income tax.
12.
*
Which of the following statements is true?
a.
A VER is essentially the same thing as a quota.
b.
A VER and a quota have nothing in common.
c.
Quotas are legal under WTO rules.
d.
VERs enhance consumer welfare whereas quotas do not.
13.
A VER is imposed by:
a.
the domestic government.
b.
the foreign government.
c.
the domestic producers.
d.
the domestic consumers.
*
14.
*
Which of the following countries has a quota on imports of sugar?
a.
Germany
b.
Mexico
c.
The U.S.
d.
The Dominican Republic
The following figure illustrates the demand and supply curves for PCs in a small country.
P
S
a
P
b
P'
Pw
Quota Constrained Price
c
g
d
e
f
World Price
D
Q 1 Q2
15.
*
Quota
Q3 Q4
Q5
Q
Which of the following is true for the above quota?
a.
Consumers lose area a.
b.
The government would receive area e if it auctions the quota.
c.
Domestic firms gain areas 'b + d.
d.
There is no loss to the country's overall welfare.
Nontariff Distortions to Trade 149
16.
*
17.
*
18.
*
Suppose the government used a tariff to achieve the same level of protection as the quota
illustrated above. Comparing the two outcomes (quota vs. tariff) we can conclude:
a.
consumers lose area a.
b.
the government can collect the tariff or sell the quotas to receive area e.
c.
domestic producers gain under both a tariff and a quota.
d.
all of the above
With no trade the amount of domestically produced PCs is:
a.
Q1.
b.
Q2.
c.
Q3.
d.
Q1 to Q3.
With no trade the country's producer surplus is:
a.
area a.
b.
area b.
c.
areas b + c.
d.
areas b + c + g.
19.
*
With no trade the country's consumer surplus is:
a.
area a.
b.
area a + b.
c.
area b.
d.
area a + b + c.
20.
With free trade the country imports:
a.
Q1.
b.
Q2.
c.
Q3.
d.
Q1 to Q5.
*
21.
*
22.
*
With free trade the country's producer's surplus is:
a.
area a.
b.
area b.
c.
area c.
d.
area g.
With a quota imposed on PCs, the country imports:
a.
Q1.
b.
Q2.
c.
Q3.
d.
Q2 to Q4.
150 Chapter 7
23.
*
The loss of consumer surplus due to the quota is:
a.
area c.
d.
area c + d.
c.
area c + d + e.
d.
area c + d + e + f.
24.
*
The amount of producer surplus domestic producers gain as a result of the quota is:
a.
area c.
b.
area c + d.
c.
area d.
d.
area c + d + e.
25.
*
When a quota is imposed in a domestic market:
a.
domestic producers capture all of any future increase in demand.
b.
foreign producers capture all of any future increase in demand.
c.
the government captures all of any future increase in demand.
d.
none of the above
26.
For the government, a quota is worse than a tariff because part of the lost _____ surplus
is not transferred to the government.
a.
consumer
b.
producer
c.
dead-weight
d.
tariff
*
27.
*
28.
*
29.
*
Like tariffs, quotas result in:
a.
additional government revenue.
b.
an increase in consumer surplus.
c.
a higher imported price.
d.
more imports.
When a quota is imposed, the losers include:
a.
consumers and domestic producers.
b.
consumers and foreign producers.
c.
consumers and the domestic government.
d.
consumers.
Suppose a quota on foreign-produced cars is enforced by the U.S. government. Which of
the following groups is most like to oppose this action?
a.
American automobile manufacturers
b.
Consumers
c.
American Steel Workers
d.
United Auto Workers
Nontariff Distortions to Trade 151
30.
*
31.
*
32.
*
When a quota is imposed:
a.
foreign firms may gain by selling the imported product at a higher price.
b.
foreign firms may lose by selling fewer imports.
c.
domestic firms lose by selling fewer products.
d.
both a and b
Like tariffs, quotas generally lead to:
a.
an increased amount of consumer surplus.
b.
a reduced amount of producer surplus.
c.
higher prices and fewer imports.
d.
increased government revenue.
If a government auctions its quota:
a.
domestic producers gain additional producer surplus.
b.
consumers gain additional consumer surplus.
c.
foreign firms pay an additional cost.
d.
foreign firms gain additional revenue.
33.
*
To calculate a tariff equivalent for a quota one must:
a.
take the difference between the world market price and the quota
constrained domestic price and divide by the world market price.
b.
take the difference between the world market price and the quota constrained
domestic price and divide by the quota-constrained price.
c.
take the difference between the tariff and domestic market cost divided by the
domestic market costs.
d.
take the sum of all quotas and divide by the number of units imported.
34.
*
When demand increases for a good subject to a quota:
a.
imports would stay the same but the price would rise.
b.
the price would stay the same but imports would increase.
c.
the supply curve shifts outward at the world price.
d.
the price wouldn't change since imports ensure consumption.
35.
*
If imports are constrained by a quota and demand increases then:
a.
prices will rise.
b.
prices will fall.
c.
the quantity imported will increase.
d.
the quantity imported will fall
36.
*
Which of the following statements is true?
a.
If demand increases in the presence of a tariff, then prices will not increase
because the amount of imports will increase.
b.
Businesses always prefer tariff protection to quota protection.
c.
Exporters never engage in FDI because of quota protection.
d.
Quotas have no discernible effect on imports or domestic production.
152 Chapter 7
37.
*
38.
*
39.
*
40.
*
41.
*
42.
*
With a quota, as the domestic demand for a product rises:
a.
losses for domestic firms increase.
b.
losses for domestic consumers decrease.
c.
losses for the domestic government decrease.
d.
losses to society increase.
After a quota has been imposed in a market, suppose that the demand for the product
increases, this would cause the quota price to _____ and the amount imported to _____ .
a.
remain the same, remain the same
b.
fall, fall
c.
rise, rise
d.
rise, remain the same
Which of the following statements is false?
a.
If demand increases in the presence of a tariff, then imports will increase.
b.
If demand increases in the presence of a quota, then the price will rise.
c.
The government always receives the same revenue with either a
tariff or a quota.
d.
If the government auctioned off quotas they would get the same revenue
they would get if there were a tariff.
In moving from free trade to a quota, _____ is likely to occur.
a.
an increase in the volume of trade
b.
transshipping from the importing country to the exporting country
c.
a quality upgrading of the traded good
d.
an increase in imports
Which of the following describes the use of government policy to enhance exports in
specific industries?
a.
VER
b.
AVE
c.
Strategic trade policy
d.
NTB
The U.S. policy that requires the government to buy from a domestic supplier unless the
domestic supplier's price is more than 6% higher than the foreign price is called:
a.
the Buy American Act of 1933.
b.
the Discriminatory Policy Act of 1988.
c.
the Protection of Domestic Industries Act of 1994.
d.
the Foreign Policy Act of 2001.
Nontariff Distortions to Trade 153
43.
*
44.
*
45.
*
The Buy American Act of 1933 gives American suppliers a _____ percent margin of
preference over foreign suppliers and a _____ percent margin of preference for military
or defense related goods.
a.
6; 10
b.
5; 20
c.
6; 50
d.
10; 20
Using various government policies to increase exports is frequently called:
a.
labor standards.
b.
environmental policy.
c.
MITI.
d.
strategic trade policy.
Which of the following is a source of government regulation related to international
trade?
a.
Administrative regulations
b.
Technical regulations
c.
Industrial policy
d.
All of the above
46.
*
The impact of transportation costs on international trade causes:
a.
import prices to rise
b.
export prices to rise.
c.
imports to increase
d.
import prices to fall
47.
The impact of transportation costs on international trade causes:
a.
imports to increase
b.
imports to decrease
c.
export price to increase
d.
import prices to decrease.
*
TRUE FALSE QUESTIONS
1. T
A quota restricts the imports of a product to a certain quantitative level.
2. T
Between 10 and 20% of the tariffs lines of the EU, Japan, and the U.S. are affected by
nontariff barriers to trade.
3. F
Tariffs over the last two decades have increased as foreign competition has increased.
4. T
While tariffs have been falling over the past several decades, nontariff barriers have
increased.
5. F
The U.S. currently has no quotas on imported products.
154 Chapter 7
6. T
Quotas are not a legal method of restricting imports under GATT and the WTO.
7. F
The net loss to a country as a result of a quota is smaller than the net loss of an equivalent
tariff.
8. T
A quota or a VER is usually applied so that a specific number of units can be imported
without regard to the price of the product.
9. F
A country that is a member of the WTO by definition does not use quotas as a form of
protection.
10. T Some countries, such as the U.S., maintain quotas in defiance of WTO rules.
11. F The Multifibre Arrangement (MFA) is a fair system and minimizes welfare losses by
allocating quotas based on traditional market shares.
12. T The EU and the U.S. severely limit the exports of apparel from developed countries
through the use of quotas.
13. T The practical difference between a quota and a VER is the name.
14. F Tariffs and quotas are essentially identical in their effects.
15. T Quotas redistribute income from consumers to domestic producers.
16. T When a country voluntary agrees to limit its exports to another country, it is called a
voluntary export restraint.
17. T Quotas redistribute consumer surplus to domestic and foreign firms.
18. F Like tariffs, quotas tend to increase the government's tax revenue.
19. T A quota is a form of commercial policy.
20. T Quotas tend to increase producers surplus.
21. T Converting a quota into a tariff is easily accomplished by calculating what the ad valorem
equivalent tariff (AVE) needs to be to achieve the same level of protection.
22. T If the demand for a product increases, then a quota will lead to an increase in the price of
the product because the amount imported cannot increase.
23. F A quota will sometimes encourage exporters to lower the quality of their product in order
to export less.
Nontariff Distortions to Trade 155
24. T A quota will encourage exporters to increase the quality of the goods that they are
exporting.
25. F A quota will encourage exporters to increase the quality of the goods that they are
exporting in order to reduce the revenue they receive from exports.
26. F As tariffs have declined, national differences in the regulation of business have less of a
chance to alter the pattern of world production and trade.
27. T Trade restrictions can occur when a country imposes additional technical requirements
that are written in a manner so that foreign firms cannot comply.
28. F Business regulations within a country do not impact international trade flows when there
is a free-trade agreement between the two countries.
29. F Since governments buy just like private consumers and businesses, government
procurement has no noticeable impact of world trade.
30. F Government procurement practices normally create a level playing field for foreign and
domestic firms.
31. T Most countries have some form of policy to favor domestic producers in the area of
government procurement.
32. F The WTO has been very successful in negotiations concerning government procurement.
33. F Corruption is never a problem if the importer is the government.
34. F The developing countries strongly support international trade rules which would impose
the labor standards prevalent in developing countries on all countries.
35. F The developed countries such as the EU are not interested in linking environmental
standards to international trade.
36. F There is a lot of empirical evidence to indicate that differences in labor and
environmental standards have a substantial impact on international trade.
37. F The governments of developed countries set environmental policy for the developing
countries as a result of WTO rules.
38. F The WTO has ruled that countries can impose domestic labor and environmental
standards on other countries by limiting their imports.
39. F Evidence shows that differences in national labor standards have a significant effect on
international trade flows.
156 Chapter 7
40. F Low environmental standards in developing countries seriously distort the world pattern
of trade.
SHORT ANSWER ESSAY
1.
Describe the various reasons that some countries still have quotas.
2.
Show why an "auction quota" would tend to raise an amount of government revenue
equivalent to that generated by a tariff.
3.
You are the trade minister of a new member of the WTO. As a result, you must convert
all of the quota protection in the country to tariff protection. How would you decide what
the ad valorem tariff would be that would give an amount of protection equal to the
quota?
4.
Show why a quota is worse than a tariff if the demand for the product increases.
5.
Consider a choice between a quota and a tariff on Japanese autos, each of which reduces
Japanese auto imports to the U.S. by the same amount. How would the following
individuals view the choice?
a. The CEO of Ford Motor in Detroit
b. The CEO of Toyota in Osaka
c. A member of the UAW
d. An American auto consumer
6.
Explain why the abolition of "sweatshops" in developing countries would make those
countries and their citizens worse off.
7.
Describe strategic trade policy. Does this type of policy actually increase exports?
8.
Explain the effects of transportation costs on trade.
BRIEF ANSWERS TO SHORT ANSWER ESSAY
1.
Quotas are considered such a harmful form of protectionism that they are banned by the
WTO. Nevertheless, quotas still exist in various forms for four reasons. First, not all
countries are members of the WTO. Countries that have not joined are free to impose
quotas. Second, countries that are WTO members are allowed to maintain their
previously existing quotas for a specified period of time. As such, all of the newly joined
members are in the process of eliminating their quotas. Third, some countries implement
quotas on some goods in defiance of WTO rules. The U.S. quota on sugar is an example.
Fourth, international trade in textiles and apparel is profoundly distorted by the Multifibre
Arrangement (MFA). For each developed country, the MFA manages trade in these two
industries by enforcing a quota by product and by country for imports of textiles and
apparel.
Nontariff Distortions to Trade 157
2.
P
S
P
P'
Quota Constrained Price
a
b
c
d
Pw
World Price
D
Q1 Q2
Quota
Q3 Q4
Q5
Q
Because the supply of imported cloth is reduced, the price of cloth will begin to rise until
a new equilibrium is reached. Domestic consumers are harmed as consumer surplus
declines by areas 'a + b + c + d'. Domestic producers benefit as producer surplus rises by
area a. As in the case of a tariff, there are efficiency losses of areas b and d. Who
receives area c is the only difference between a tariff and a quota. In the case of a tariff,
area c is the amount of tariff revenue the domestic government collects. In the case of a
quota, area c accrues to the foreign producers and makes them more profitable. The net
welfare loss to the quota-imposing country is larger under a quota than a tariff. With a
tariff, the domestic government gains revenue, area c. With a quota, area c is lost to the
foreign producers. The government can capture area c under a quota by auctioning the
quotas to foreign producers in a free market. The advantage to this auction quota method
is that the domestic government would gain area c which now accrues to foreigners, and
the limited quota supply would go to those importers most in need of the product who
would pay the highest prices.
3.
Another method available to a government to capture area c is to convert the quotas into
an equivalent tariff. The conversion of quotas into a tariff is easy to do. To calculate a
tariff equivalent, take the difference between the good's world market price and the
good's quota constrained domestic price and divide that difference by the good's world
market price.
158 Chapter 7
4.
P
S
P
New Quota Price
Quota Constrained Price
P'
a
b
c
d
Pw
World Price
D
Q 1 Q2
Quota
Q3 Q4
Q5
D'
Q
This is illustrated above, where we have assumed that the demand for the product
increases from D to D' after a quota has been placed in the market. As a result of the
quota, the quantity imported cannot increase when there is an increase in demand. As a
result, the price of the product continues to rise. In the case of a tariff, the price would
remain constant at P' and the additional demand for cloth would be supplied with
additional imports of cloth. However, when a quota is present in the domestic market,
the domestic producers supply the increase in domestic demand. The foreign producers
of cloth also gain in this case as the price they receive for their product increases. The
important point is that the losses for consumers and society are much larger in the case of
a quota than in the case of a tariff when the demand increases. These losses are shown by
the shaded area, and as the figure indicates, losses to society increase as the demand for
the product increases.
5.
Consider a choice between a quota and a tariff on Japanese autos, each of which reduces
Japanese auto imports to the U.S. by the same amount. How would the following
individuals view the choice?
a. The CEO of Ford Motors in Detroit would prefer the quota.
b. The CEO of Toyota in Osaka would prefer the tariff.
c. A member of the UAW would prefer the quota.
d. An American auto consumer would prefer the tariff.
6.
Although many workers in developing countries may be poorly educated, they are not
irrational. They are there because their next best opportunity is worse. Attempts to
impose wages and working conditions equivalent to those in developed countries would
reduce these countries' comparative advantage in the production of products intensively
employing unskilled or semiskilled labor. Such an imposition might make some in the
developed countries feel better, but it would not make developing countries or their
citizens better off. When asked if he were concerned about sweatshops in Africa, the
economist Jeffrey Sachs offered the following: "My concern is not that there are too
many sweatshops but that there are too few. Those are precisely the jobs that were the
stepping stones for Singapore and Hong Kong and those are the jobs that have to come to
Nontariff Distortions to Trade 159
Africa to get them out of their backbreaking rural poverty." For many of these workers,
the alternative employment is even poorer paid and harder agricultural labor.
7.
In general, strategic trade policy refers to industrial policies that exporting countries
pursue. Such policies are aimed at maximizing a country's exports. A country's strategic
trade policy requires that the trade ministry of a country identify an industry in which the
country has a comparative advantage. The country then nurtures this industry by
subsidizing its development and protecting it from imports. Once the industry has
developed, the industry can export the product to the world market devastating similar
industries in the target countries. With foreign competition disposed of, the industry now
has the monopoly power to raise prices and earn excess profits. The effective use of
strategic trade policy is often applied to Japan and its Ministry of International Trade and
Industry (MITI) during the 1980s, when Japanese imports of automobiles, steel, and
semiconductors were flooding the U.S. market. In an article in The Economist, the
authors show what economists have long suspected. Japanese industrial policy does not
work much better in Japan than anywhere else. The empirical test to determine this was
that there should be a positive correlation between how fast Japanese industries grow and
the government's support of the industry. In fact the authors found a negative correlation.
Japanese trade bureaucrats do what most governments do, which is support industries that
are having a hard time competing with imports.
8.
With positive transportation costs, the quantity of goods traded declines as the price of
imported goods increase and the price of exported goods falls. In addition, in the
importing country, the consumption of imports declines while the domestic production of
import competing goods increases. For the exporting country, the consumption of the
export good increases while the production of the exported good decreases. Thus, the
effect of transportation costs is to move the price of cloth and the quantities traded
partially back toward the no trade situation. As such, transportation costs act as a barrier
to trade much like tariffs and other nontariff barriers.