Quotas Can Work Better Than Tariffs to Reshore Production

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.