Costly distribution and the non-equivalence of tariffs and quotas

Abstract

When governments impose a quota or tariff on imports, it is well known that the resulting rents and revenues trigger costly rent-seeking and revenue-seeking activities, which are welfare-reducing and may be economically more significant than the efficiency losses resulting from the protectionist-induced resource misallocation. Repeated interaction among firms can eliminate wasteful rent- and revenue-seeking expenditures through cooperation. We show that while aggregate outcomes are equivalent under tariffs and quotas if cooperation arises, the conditions under which cooperation arises differ by policy. This difference arises because a firm must incur additional cost to physically import and distribute the goods associated with additional quota licenses, whereas there is no such cost when it comes to consuming additional tariff revenue. Thus, quotas and tariffs are non-equivalent. We provide a simple sufficient condition under which cooperative elimination of rent-seeking under quotas is easier than cooperative elimination of revenue-seeking under tariffs and therefore a quota is the preferred policy whenever the policy admits cooperation.