Tariffs are becoming widely accepted by U.S. politicians and policymakers as an important tool for maintaining and rebuilding our industrial economy. But quotas, a related tool, can sometimes work better to restrain imports and encourage growth in domestic production, investment and jobs.
Tariffs have a long history. They were first levied in ancient Greece, by the city-state of Athens around 399 BC on imported grain to raise funds for the government. As modern economies emerged in the 1600s and 1700s, the major European powers used tariffs both to raise revenue and to promote their domestic industries. Economist Adam Smith, author of The Wealth of Nations, supervised tariff collection as Customs Commissioner for Edinburgh, Scotland, from 1778 until his death in 1790. Alexander Hamilton drew on British and French experience when he recommended tariffs for the new U.S. republic, and they were legislated in July 1789 by the First U.S. Congress.
Tariffs were a logical tool to restrict imports because demanding cash payments right at the port has a strong deterrent effect on imports and delivers cash immediately. But modern technology makes quotas possible. A quota is a fixed limit on the volume of imports allowed to enter in a quarter or a year. A quota can be set in terms of units or weight or other volume measure. The computer systems of Customs and Border Protection and the U.S. Census enable data on import value or weight or other metrics to be compiled from all points of entry on a daily basis, and thus can be enforced by the power of Customs to grant or deny entry to any shipment.
Tariffs have the distinct advantage of raising revenue for the government. Last year, the U.S. government collected $80 billion in tariff revenues. But tariffs have the disadvantage that they can be nullified by price cuts by the foreign exporter. This is especially true if a foreign government is willing to subsidize its export industries. China has built its manufacturing sector through widespread subsidies, some public and some clandestine, including free land for manufacturers, cheap government-backed bank lending, and other methods. If the U.S. implements a tariff of 25% on any product line, the Chinese Communist Party government can enable its exporters to cut price and absorb the tariff through a variety of policy levers.
Even without subsidies, economies of scale can make it profitable for foreign producers to cut prices in response to a tariff. It can, for example, be more expensive to shut off a furnace or a semiconductor fabrication facility than to keep it running. Therefore, as long as the product coming off the line can achieve a price that pays for the cost of the materials, a producer can find it worthwhile to keep producing and sell the output in a foreign market at a price 25% or even 50% below the price in its home market.
Quotas avoid all these problems by setting a firm limit on the volume of imports in any product category. This enables the government to allow in sufficient imports to meet domestic demand while the domestic industry ramps up production. The quotas can be varied as industry capacity changes. This can safeguard against shortages while encouraging domestic producers to invest and ramp up production.
There are three main types of quotas: (1) absolute quotas, 2) tariff rate quotas and (3) voluntary quotas.
Absolute quotas are a firm limit on imports, typically set in volume, such as tons of imports per year. They have the advantage of allowing domestic firms to plan for the future because they can have more confidence about the market opportunity for several years to come. If imports are strictly limited by quota, then domestic producers can assess the likely size of the domestic market and can invest and hire workers to meet that expected demand. Tariffs don’t deliver that sort of predictability because in today’s world, China and many other exporting nations can react to tariffs by cutting their export prices or by challenging tariffs with legal action.
A firm quota can control imports more reliably than tariffs. The quota arrangements on steel imports agreed with South Korea, Japan, and the United Kingdom have done an effective job of keeping steel imports from those nations flat to slightly down.
Price Impacts
The impact on U.S. prices is another important consideration. As we have explained before, tariffs tend to raise U.S. prices by some 10% to 20% of the value of the tariff. In other words, a 25% tariff can be expected to raise U.S. prices in the tariffed product segment by 2.5% to 5%. The price impact of a quota is broadly similar. A U.S. International Trade Commission study of the quota on Japanese auto imports in the 1980s found that the price of Japanese imported vehicles rose by $1300 while the price of U.S. autos rose by $660. The large price impact on U.S. autos resulted from the dominant role of Japanese autos in offering competition to the U.S. Big Three which tended to set very similar prices. The Japanese imports constituted 22% of the U.S. market in 1981.
The price impact of a quota will depend on how restrictive the quota is and how much competition exists in the domestic market.
Tariff rate quotas (TRQs) work by allowing a fixed volume of imports to enter at either zero or a low tariff rate and then imposing a higher tariff rate once imports pass that threshold. The 2018 tariffs on residential washing machines used a TRQ. The first 1.2 million units entered at a tariff of 20% and any units above that paid a 50% tariff. The TRQs were effective in that they led Samsung and LG Electronics to open U.S. manufacturing facilities to ensure that they could sell all their U.S. products at zero tariff. In that case, the washing machine price, as measured by the consumer price index, rose in 2018 but fell back in 2019 until by the end of 2019 it was back at the pre-tariff level. The price impact was minimal, but the benefit of thousands of new jobs in the industry was real and still with us today.
Voluntary quota agreements vary in their effectiveness. The voluntary agreement the U.S. made with Mexico in 2019 to restrict steel imports has been largely ineffective, as we have shown in previous articles. Unless the U.S. Customs has the power to stop imports by denying entry once a quota has been reached, a voluntary quota will depend on good will on the side of the exporting nation and its companies.
One of the best examples of a successful voluntary quota was the 1981 “voluntary export restraint” (VER) agreement the U.S. reached with Japan in 1981. In this agreement, Japanese auto producers agreed “voluntarily” but under pressure from the Reagan administration to limit auto shipments to the U.S. to 1.68 million units a year (later raised to 2.3 million units). This agreement carried on until 1994. The U.S. “Big Three” auto industry was then under siege from imports, the energy crises of the 1970s and a host of other problems. The VER agreement gave the Big Three a breathing space in which to reorganize their businesses and become more efficient, changes which they achieved at least partially over the course of the 1980s.
In a well-informed, objective overview of the VER experience, two economists from Radford University pointed out that in that mid-1980s breathing space, the Big Three successfully reduced the weight and size of their new vehicles, increased fuel efficiency, forged better working relations with unions, and brought down the breakeven price of their vehicles.
Equally important, the VERs prompted Japanese producers to open auto assembly plants in the U.S., led by Honda with a plant in Marysville, Ohio, and Toyota with a plant in Georgetown, Kentucky. Mazda, Mitsubishi, Isuzu and Subaru followed. Japanese “transplant” assembly plants today account for some 3 million vehicles a year, or over a quarter of U.S. light vehicle production. Further, the “Toyota Production System” (sometimes called “lean production”) was introduced at Toyota and Honda, and U.S. Big Three were able to learn from this system, improving their production processes and their efficiency.
Conclusion
Quotas can offer greater certainty and predictability and encourage greater domestic investment in an industry than tariffs can. A major advantage of tariffs is that they deliver revenue to the government of the importing nation. Voluntary quotas have been favored for foreign policy reasons. They appear to be a mutual solution rather than one imposed by the importing nation. But unilaterally imposed quotas with the explicit aim of rebuilding domestic industry offers a more certain path for the growth of domestic production, employment, and broad economic value.
To read the article as it was published on the Coalition For A Prosperous America webpage, click here.