The effects of import quotas on national welfare: does money matter?

• Author: Palivos, Theodore

1. Introduction

   Recent evidence shows that there is an increasing use of non-tariff barriers to trade (NTBs), and especially of quantitative restrictions, such as import quotas, in the world economy to protect import-competing industries (see Table I).(1) International trade theory, however, has traditionally focused on the welfare effects of tariffs as well as on the equivalence between tariffs and quotas, with little attention paid to the welfare implications of quotas. The latter have basically been restricted within the traditional Heckscher-Ohlin trade model, where, for the case of a small open economy, import quotas always reduce welfare.

   A few recent studies have attempted to fill in this gap in the literature. For instance, Young [19] compares optimal tariffs and quotas for a large country in a stochastic environment. Neary [14], on the other hand, investigates the welfare implications of tariffs, quotas and voluntary export restraints under different assumptions on capital mobility. Finally, Chao, Hwang and Yu [3; 4] examine the welfare effects of import quotas under variable returns to scale.

   Although the existing literature has generated important policy implications, most of the analysis has been conducted within a barter-exchange framework. It is well known, however, that the introduction of money can alter results obtained within a non-monetary environment.(2) Accordingly, this paper attempts to re-examine the welfare effects of import quotas for a small monetary economy. We develop a two-sector trade model in which money enters the economy [TABULAR DATA FOR TABLE I OMITTED] through a generalized cash-in-advance constraint. Building on previous work, we allow for non-uniform monetization across sectors. Put differently, the share of purchases which must be made using cash varies across goods (markets). Interestingly, we find that if the consumption of the exportable commodity requires larger cash balances than the consumption of the importable, then contrary to standard results, an import quota may promote national welfare. Moreover, we characterize the optimal level of import quotas by deriving a formula for the computation of the optimal domestic-price ratio.

   We then extend our basic framework to allow for economic growth, induced by technical progress, to explore the possibility of immiserizing growth in the presence of import quotas. Johnson [10] has shown that growth can be welfare-reducing in a small open economy with a tariff distortion. Bhagwati [2] generalizes this theory of immiserizing growth to the case of alternative types of distortions. Nevertheless, as shown in Alam [1], an important exception to this generalization is the case of a quota, where growth is always welfare-enhancing. Chao and Yu [5] elaborate further on this important exception, by examining the welfare implications of growth for a quota-distorted small economy under variable returns to scale. This paper continues this line of research by studying the issue of immiserizing growth in the context of a small monetary economy with quota distortions. We find that growth always improves welfare if the growing industry displays a higher degree of monetization than the static one. If the converse is true then, contrary to Alam's results (obtained for a barter economy), growth can be immiserizing.

   The organization of the paper is as follows. The next section develops the analytical framework and section III examines the welfare implications of quotas. Section IV characterizes the optimal quota level and section V investigates the issue of immiserizing growth. Section VI concludes the paper.

2. The Analytical Framework

   Consider a standard two-sector trade model of a small open economy. The representative agent's preferences are described by a strictly quasi-concave utility function

   U = U([D.sub.1], [D.sub.2]) (1)

   where [D.sub.1] and [D.sub.2] denote, respectively, the consumption of the exportable and importable commodities. In trying to maximize this utility function, the agent faces a standard private budget constraint

   [Mathematical Expression Omitted], (2)

   where [p.sub.j] and [X.sub.j] denote, respectively, the domestic nominal price and the production level of good j, [Mathematical Expression Omitted] is the nominal money holdings (money supply), and S represents the quota revenue in nominal terms, which is assumed to be re-distributed to households (private agents) in a lump-sum fashion.

   Table IIa. Developing Countries' Outstanding Trade Credits as a Percentage of 1987 Exports Traditional exports 16.7 Non-traditional exports, of which: 155.1 * capital goods 403.2 * consumer durables 17.7 * other manufactures 44.0 Total 81.9 Table IIb. Average Maturity of Trade Credits (Months) in Selected Developing Countries Traditional exports 1.9 Non-traditional exports, of which: * capital goods 48.4 * consumer durables 2.1 * other manufactures 5.2 Notes: Non-traditional goods refer mainly to manufactured goods excluding steel, fertilizers, pulp and paper, which have been traditionally traded on the same basis as primary commodities. They include consumer durables, capital goods and other manufactures. Source: [21]. Money serves as a medium of exchange. Hence, building on Stockman [17] and Lucas and Stokey [12], we introduce a generalized cash-in-advance (CIA) or liquidity constraint which captures the transactions role of money, that is,

   [[Phi].sub.1][p.sub.1][D.sub.1] + [[Phi].sub.2][p.sub.2][D.sub.2] [less than or equal to] M, (3)

   where [[Phi].sub.j] [element of] [0, 1], j = 1, 2, denotes a constant share of purchases of good j. This constraint requires the individual to hold sufficient money balances to finance at least a certain part of consumption purchases. In general, consumption of one good requires larger cash balances, per unit of value, than consumption of the other good and hence [[Phi].sub.1] [not equal to] [[Phi].sub.2].(3) This may be justified in a number of different ways. First, it can be considered as the outcome of existing (a) regulations regarding the terms of payments of imports and the obtaining and use of credit (foreign and domestic) to finance imports [11]; and (b) export credits (as Tables IIa and IIb indicate even export credits alone differ across sectors). Second, one can actually view [D.sub.1] and [D.sub.2] as...