Tools of Trade-Quotas
Trade is about compromise. We have spent many years in a mostly free trade global economic system and now are facing interruptions to this system due to tariffs. So, does it have to be one way or the other? Restrictive tariffs or no tariffs? Of course not. Less restrictive tariffs that still create some considerations are possible. But today, lets discuss a couple of options that serve some of the same purpose as tariffs without jeopardizing international relations with drastic action.
In economics, tariffs serve as a trade barrier. These barriers exist for much of the same reason that one would damn a water source; to control the flow. Another way to control the flow is the use of quotas. A quota is a fixed minimum or maximum of a product or good that can be traded between countries. Quotas can be used to protect domestic industries, managing trade imbalances, or for limiting competition.
There are four types of quotas that are used: absolute quotas, tariff rate quotas, exclusion quotas, and voluntary export restraints (VERs) An absolute quota sets a fixed limit on the quantity of goods that can be exported or imported. The United States currently has an absolute quota on steel from Argentina, Brazil, and South Korea. This quota is in place to try and stimulate the United States steel production by cutting the supply coming in.
A tariff rate quota is a blended approach. It allows for a certain amount of goods to be imported at a reduced tariff that will raise to a higher rate once that limit is surpassed. This is not unlike when a store runs a sale. For example, let’s say the local grocery store runs a special on eggs. The eggs will be 80 percent of their normal price for the first two dozen purchased. After that first two dozen however, the price returns to the normal rate. You still have the ability to buy more eggs, but the opportunity cost to do so has just increased. You are effectively incentivized to buy two dozen eggs and gently pushed away from buying more. It requires a different mental calculus to buy additional eggs than it did the first two because the cost has now shifted in your budget. Two items that are subject to tariff rate quotas that hit close to home for me are animal feed and beef. Countries utilize this quota as a way to ensure a steady stream of a good to their citizens without allowing foreign interests to flood a market and kill domestic business.
Exclusion quotas typically apply to a single good or product. This is a tool that a government can use to ensure a steady supply of an item that they do not have a strong domestic industry for. These items are typically allowed to “steal” numbers from the next quarter or year of trade. These exclusions can be used as a trade tool in larger international negotiations and often show how strongly a country is invested in a trade war while highlighting some of their economic weak spots. We have recently experienced exclusion quotas in our trade war with Canada, as lumber was excluded from new tariffs.
The final type of quota, voluntary export restraints, is an agreement between the importing and exporting countries where the exported voluntarily limits the amount of specific exports to a lower level to avoid stricter trade barriers from the importer. This is often used to prevent quotas and tariffs. The most famous VER occurred between Japan and the United States in the 1980s when the U.S. automobile industry was experiencing poor sales as a result of an economic recession. This allowed for only 1.68 million Japanese cars to be imported in 1980 with small increases in the years after until the program ceased in 1994. While this program accomplished the intended effect of increasing U.S. automaker profits, it hurt U.S. consumers. The governmental regulation raised the price of Japanese cars and allowed U.S. auto makers to continue business as usual while increasing their profits and avoiding the process of making their business better in the face of competition.
In the end, it is estimated that it cost U.S. consumers $1200 more to buy a Japanese car when the average sales price for a new vehicle was $7200. One positive of this program was that it led to Japanese investment in United States manufacturing facilities for companies such as Toyota, Mazda, Nissan, and Honda. So why would Japan agree to something like this? It is widely assumed it was a measure to avoid tariffs or quotas, but they essentially placed a quota on themselves anyways by accepting the limits. It is an interesting thought experiment to consider where we would be today in terms of what we drive if Japan would have just accepted tariffs and sold more cars in the U.S. Would domestic automotive companies have failed sooner?
As we have covered above, quotas are a trade tool that can often be used much like a tariff and in conjunction with tariffs. While tariffs steal the current U.S. headlines, I urge you to take a couple minutes and see what goods you currently use that are impacted by quotas. Agricultural goods have been subject to quotas for decades, mainly as a negotiation tool and a way to protect domestic production. While this leads to lower prices for consumers currently, trading agricultural products internationally despite domestic capacity is not friendly to farmers or the environment. Take apples for example. Locally, we have an orchard that is a mile away from a Wal-Mart. This orchard grows the produce on farm and sells it at a shop they run there. Despite this low transportation process, they cannot compete on price at Wal-Mart for apples. High quotas or low tariffs restrict the environmentally sustainable practice from being profitable while the imported apples rack up enormous transportation bills resulting in terrible carbon scoring.
International trade is a very complicated issue. It relies on being self-aware of your own capacities while being able to correctly judge the hand your opponent holds, sort of a high stakes game of poker where the chips are the countries livelihoods. Quotas serve as a stepping stone in the stages of tariffs, but ultimately are just another tool in the belt of world leaders.
Thank you so much for taking the time to read this and stay tuned for the next installment, where we will talk about why it matters how you communicate in a world trade strategy.
