Tariffs, Quotas, or Both? A Q&A on Remedies to Overproduction and Imbalanced Trade

Trade Q&A with Jeff Ferry

How can U.S. industry, small and large, compete against countries with much weaker currencies, lower labor and environmental regulatory costs, and the overproduction and dumping that come from Asia? 

For some, the idea was the U.S. would just be a services economy – whether in the high end of the scale, like creating intellectual property or working in investment banking, or the middle-class services jobs like health care and construction, or in the part-time, low-wage world of retail and Disney World jobs. 

For others, it was all about innovation. The U.S. could compete by building a better mousetrap. 

The only problem there is that countries, led by China, would eventually get their hands on that innovation, copy it, steal it, or simply win out bids to produce what came from American ingenuity and R&D thanks to China’s scale and unmatched cost factors. It may take years, as is happening now with China’s Commercial Aviation Corporation’s C919 aircraft which will one day eat into Boeing’s market share in Asia. Or it may happen instantly, like Owl Labs near Boston, which invented a 360-degree camera system for office meetings. Their Meeting Owls are all made in China. 

How does one compete with that kind of scale, labor, currency, and environmental mismatch? And in the case of China, how does one compete against a country whose main goal is full employment, of which the best way to reach that goal is to be a market leader, if not the dominant market leader?

Until around 2017, when the Section 301 tariffs went into place against China, tariffs were seen as blasphemous. The U.S. was a free trade-loving nation, after all. But tariffs have become a hot topic since then, and it has surprisingly not taken long for them to be more embraced than ever before. Even Congress is busy writing tariff bills now, something unheard of until this past year.

When Trump left office and Biden came in, he kept all of the Trump-era tariffs and renegotiated the Section 232 steel and aluminum tariffs to include tariff rate quotas on countries like Japan – whose Nippon Steel has been fined for dumping products into the U.S. almost every year since 2014. 

Which is better? Tariffs? Quotas? Or a combination of both? CPA’s chief economist Jeff Ferry answered some questions about this topic last week. The takeaway: none of this is easy. Companies and their lawyers often find ways around trade rules whether it’s a tariff or a quota. Trade enforcement is key; another topic, for another time.

“Senator Hawley’s proposed 100% tariff on EVs from China may not be enough to seriously impact potential imports because the level of subsidy from the Chinese government is so high that Chinese carmakers could be willing to price their EVs at such a level that they would still sell well even with a 100% tariff slapped on top,” Ferry said. “It’s not just the subsidy. It’s also the way China stimulates many companies and provincial governments to build out capacity which then creates such a burden of overcapacity that companies are ready to slash prices to uneconomic levels just to keep their factories working.”

China is the easy target, of course. But in terms of the goods trade, the U.S. has large and growing deficits with rich Europe, Japan, and Mexico has surpassed China as our leading source of imports.


KENNETH RAPOZA: In the case of overproduction, what is the better trade remedy: tariffs or quotas on how much volume can be let in?

JEFF FERRY: A flat quota on imports, such as a number of units calculated as keeping the import share below any level deemed acceptable can be more effective, including better resistance to cheating or workarounds by the foreign nation. That’s different from the tariff rate quotas we have on steel and aluminum, whereas a tariff kicks in if you import over an allowable amount. One good example of how this worked in the past was Ronald Reagan’s voluntary restraint agreements in the 1980s. That agreement was mostly for machine tools, steel, and cars coming from Japan at the time. The deal reduced the volume of Japanese car imports and gave some breathing room for our car makers to invest in modernizing the U.S. industry away from the big gas-guzzling sedans of the 70s. That undoubtedly saved thousands of jobs.

In 1980, the United States was experiencing an economic recession, and demand for passenger vehicles was down by 16% compared to the previous year, with sales slumping at 8.98 million units. Of that figure, Japanese vehicles accounted for 1.91 million units, an increase of 9% over the previous year, marking an expanded market share of 21.3%.  General Motors, Ford, and Chrysler were losing money. Chrysler, now owned by a European company, was hit particularly hard, and needed a bailout. 

Poor sales forced the U.S. automakers to expand layoffs, leading the nationwide United Auto Workers (UAW) and hardline anti-Japan members of the U.S. Congress to increasingly claim that Japan was “exporting unemployment”. By February 1980, UAW President Douglas Fraser visited Japan to encourage Japanese automakers to impose voluntary restraints on their exports and invest in the United States, Toyota noted as part of its history on its website.

Worth noting, an $8,000 entry-level car in 1980 went for around $9,600 by 1985, roughly five years into the restraint agreement. That was a 3.71% per annum increase, less than the inflation rate in those years.

RAPOZA: Prices of cars rose once the export limits were imposed on Japan, but nothing out of the ordinary. Why is that?

FERRY: The U.S. carmakers continued to compete for customers and market share amongst themselves so prices were held down to win them back from the Japanese models. The Japanese also moved to more expensive sedans like the Lexus, which was an expected result of quotas denominated in units of cars. They could make more money off the luxury sedans. But the final benefit was that the Japanese carmakers all opened up U.S. factories, including Honda, Nissan and Toyota who all make numerous models here today. 

The problem of people cheating tariffs also applies to quotas. We see that often with products like steel. A dishonest foreign exporter can relabel something as a different product with a different HTS code to escape a tariff or a quota. 

RAPOZA: Any examples of this?

FERRY: You have conduit for electric wires for construction projects that can be made of steel or be made of plastic. It can be galvanized tin or be plastic with rubber inside. All of them have different HTS codes. Companies play these games with the codes. It is fraudulent to do so and U.S. companies can call them out and file anti-dumping cases against them, but this is very expensive and time consuming. 

RAPOZA: Explain the difference between the two best-known quota systems.

FERRY:  You have flat quotas that say you can only export a thousand widgets and no more; and you have tariff rate quotas that say you can only export a thousand widgets, and if you sell us more we are going to hit you with a high tariff. Usually that tariff is very high so it is unusual that a company will export above their quota, which is a low tariff or no tariff at all.

RAPOZA: Competition between domestic companies, or between domestic and foreign rivals, can lower prices of a good even in the case of tariffs. So you can have a 20% tariff but that is mitigated by other factors, like currency, and like competition. Talk about that for a bit, because we know prices are not falling for solar in Asia strictly because of competition.

FERRY:  Solar module prices are falling because of competition, but also because of overproduction and subsidies and all the financial support  China throws into the industry. But the general rule is that prices in the U.S. market are set by a wide variety of factors, including domestic competition and import competition and short-term supply and demand. The March 2023 study by the International Trade Commission looked at 12 industries and found that tariffs  caused a rise in each product category by only between 10% and 20% of the nominal value of the tariff.  So a 25% tariff rate would mean a roughly 2.5% to 5% price increase in the product here in the U.S. So the effect of tariffs on prices is far less than many economists and commentators assume. The same is likely to be true for quotas. Wherever there is competition between American companies, you have pressures holding prices down. 

RAPOZA: When is it appropriate to use quotas?

FERRY: In any case where we think a reasonable tariff won’t’ work. By reasonable I mean under 50%. If Sen. Hawley’s 100% tariff on Chinese EVs is not palatable to most members of Congress, as I would suspect, then a quota can be more effective when imports have a very large price advantage.

RAPOZA: And then you can adjust them over time?

FERRY: You could. I think imports should not have much more than a 20% share of some critical finished goods markets like cars; imports do add to competition and variety but for a product that is responsible for so much labor and industrial demand it would be a travesty to see most of our auto market be supplied by foreign labor. When you face a Chinese industry that has been subsidized and built up to the point where they could supply the entire world’s demand, you need to think about whether or not you want an automotive industry in the U.S. or not. 

RAPOZA: If you put a quota or tariff on a country for a particular product, but don’t do that worldwide, they can just turn to outsourcing partners elsewhere or set up shop someplace else themselves. Should quotas be global?

FERRY: If it’s not global, you are asking for the transshipment problem, which is what we are seeing now with Mexico.

RAPOZA: Do quotas avoid some of the anti-free trade arguments used against proponents of tariffs?

FERRY: Free trade types do not like tariffs or quotas. Neither are good in their eyes. In the free trade doctrine taught in universities, tariffs are better because they generate revenue for the tariffing government where quotas do not. A quota allows the foreign exporter to raise prices to make up for the loss of lower volume. But if you apply tariffs or quotas where the domestic industry can increase capacity and employment, the gains in domestic production outweigh the modest cost of any price increases. 

RAPOZA: Would you say that both tariffs and quotas help American businesses understand their competitive landscape better, and allow them to invest with more certainty? Is one better than the other?

FERRY: They absolutely help companies plan better and invest. A hard quota, accompanied by a commitment to enforce it, will definitely help producers and their customers plan and negotiate long-term contracts.  I would not say one is better than the other. They are different strategies and tools for trade remedy and for a high-wage affluent economy like the U.S., both have their place and should t be used if you want any sort of industry to strive and grow within the U.S. long term.


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