Tariffs vs. export quotas

Tariffs vs. export quotas

Yeong-Her Yeh

Tariffs vs. Export Quotas

It has been shown by James R. Melvin [1986] that no tariff equilibria can be duplicated by import quotas when tariffs have been assumed to exist in both the home country and the foreign country. However, they can be duplicated instead by export quotas. The purpose of this paper is to show that while tariff equilibria can be duplicated by export quotas, tariffs and export quotas may not have the same effect on domestic prices.

First, examine the case where the tariff revenue and export quota revenue are spent by the private sector.(1) In Figure I, OH and OF are the offer curves of the home country and foreign country, respectively. After both countries impose tariffs, the offer curves shift to OH’ and OF’. Q is the trade equilibrium point under tariffs. Now, if the home country imposes an export quota equal to OA, the home offer curve will become OEC. On the other hand, if the foreign country imposes an export quota equal to OB, the foreign offer curve will become OGD. The offer curves OEC and OGD intersect at Q. This shows that the trade equilibrium point Q under tariffs can be generated by export quotas.(2)

Under both tariffs and export quotas, line OQ (not drawn) measures the equilibrium terms of trade and the slope of the trade indifference curve, It9, at Q measures the domestic price ratio in the home country. The welfare of the private sector is represented by It9 under both tariffs and export quotas. In other words, in the case where the tariff revenue and export quota revenue are spent by the private sector, export quotas not only can generate tariff equilibria but also have the same effect on domestic prices as tariffs.

Next, consider the case where the tariff revenue and export quota revenue are spent by the government. For simplicity, suppose that OH’ in Figure I is the home offer curve derived under the assumption that the tariff revenue is spent by the government partly on the exportable good X and partly on the importable good Y [Lerner, 1936; Yeh, 1983]. The domestic price line will be OP1 and the private sector reaches point S on the trade indifference curve It5. The government spends the tariff revenue partly on the exportable good (RS of good X) and partly on the importable good (RQ of good Y).(3) Q is the trade equilibrium point for the economy as a whole, including the private sector and the government.

Now, assume that the home country imposes an export quota equal to OA and the foreign country imposes an export quota equal to OB. The home offer curve, OEC, would intersect the foreign offer curve, OGD, at Q. This shows that the trade equilibrium point Q under tariffs can be duplicated by export quotas. However, under export quotas, the domestic price line is OP2, but not OP1. The private sector reaches point E on the trade indifference curve It3. QE is the export quota revenue which is consumed by the government.(4) 1It is assumed that the government raises export quota revenues by selling export licenses through competitive auctions. When tariff revenues and export quota revenues are redistributed to the private sector, it is done in the form of lump-sum transfers. See Meade [1952]. 2If the home country imposes an import quota equal to OB, the home offer curve becomes ODB. On the other hand, if the foreign country imposes an import quota equal to OA, the foreign offer curve becomes OCA. The offer curves ODB and OCA also intersect at Q. However, Q under import quotas is an unstable trade equilibrium point. 3In the domestic market, the private sector uses OS’ of good X to exchange for S’S of good Y. In the international market, the home country uses OA of good X to exchange for AQ of good Y.

Thus, for the case where the tariff revenue and export quota revenue are spent by the government and where the government spends the tariff revenue partly on the exportable good and partly on the importable good, export quotas will not have the same effect on domestic prices as tariffs. One will obtain the same conclusion if the government spends the tariff revenue entirely on the exportable good. This can be explained as follows.

Assume that OH’ in Figure I is the home offer curve derived under the premise that the government spends the tariff revenue entirely on the exportable good. The trade equilibrium point Q again can be generated by export quotas. However, in this case, the domestic price line will be OP3 and the private sector will reach D on It7 under tariffs, whereas the domestic price line will be OP2 and the private sector will reach E on It3 under export quotas. 4In the domestic market, the private sector uses OA of good X to exchange for EA of good Y. In the international market, the home country uses OA of good X to exchange for QA of good Y.

For the last case, where the tariff revenue and export quota revenue are spent by the government and where the government spends the tariff revenue entirely on the importable good, tariffs and export quotas will have the same effect on domestic prices. Suppose that OH’ in Figure I is the home offer curve derived under the assumption that the government spends the tariff revenue entirely on the importable good. In this case, the domestic price line will be OP2 and the private sector will reach E on It3 under both tariffs and export quotas.

In conclusion, it has been shown above that even though tariff equilibria can be duplicated by export quotas, tariffs and export quotas may not have the same effect on domestic prices.

First, for the case where the tariff revenue and export quota revenue are spent by the private sector, export quotas and tariffs will have the same effect on domestic prices.

Secondly, for the case where the tariff revenue and export quota revenue are spent by the government and where the government spends the tariff revenue either on both the importable good and the exportable good or entirely on the exportable good, export quotas and tariffs will not have the same effect on domestic prices.

Lastly, in the case where the tariff revenue and export quota revenue are spent by the government and where the government spends the tariff revenue entirely on the importable good, tariffs and export quotas will have the same effect on domestic prices.

COPYRIGHT 1989 Atlantic Economic Society

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