On textbook explanations of import quotas

Abstract

In the international economics textbook literature, one commonly sees the administration of import quotas explained by government auction of import licenses [R. Caves and R. Jones, World Trade and Payments, 1978]. These explanations usually assume the quota restricts imports to a level obtained from previous analysis of a tariff. With the quota filled, auction revenue equals the tariff revenue generated by the aforementioned tariff. Unnoted in this discussion is that whether the quota is actually filled under an auction regime depends on the import level which maximizes the value of the import licenses. Should an import level below quota result in the licenses being worth more than with a filled quota, then even with all licenses auctioned, the high bid will not utilize the licenses to their statutory limit. The latter occurrence is not unexpected, given standard assumptions employed in tariff and quota analysis. Assume import supply is perfectly elastic. Given a linear import demand, if the quota exceeds one-half the free trade level of imports, the high bid for licenses will be one which does not fully utilize the licenses. In particular, the import level which will maximize the value of the licenses will occur at the intersection of the supply schedule and a function which is marginal to the demand schedule. Since this marginal schedule is equidistant between the price axis and the demand schedule when the latter is linear, a competitive auction for the assumed quota will enable the high bidder to enforce this optimal import level, leaving a portion of the licenses unused. For textbook analysis to hold, a constraint on the auction must exist whereby the licenses are widely distributed among the importers despite the auction format. Only if the quota is less than one-half the free trade import level will textbook analysis hold without constraint on the auction process. It is curious this point has been uniformly ignored in the recent texts. J. Bhagwati's celebrated 1969 article on the equivalence of tariffs and quotas [Trade, Tariffs, and Quotas, p. 264] makes the same general point, without noting, however, the importance of whether the quota is greater or tess than one-half the free trade import level. While it is well-known that textbooks lag the literature, when the lag approaches ten years it would seem the lag has become an oversight.