The Disadvantages of Tarrifs & Quotas

by Monica Sanders; Updated June 29, 2018

One of the most debated issues in international trade is protectionism. On one hand, nations believe a certain
amount is necessary to protect domestic industries and jobs. On the other, protectionism may invite retaliation
from trading partners, foster additional protectionism and result in blocks to free trade. Two commonly used
protectionist tools are tariffs and quotas.

Tariffs and Quotas Defined

A tariff is essentially a tax. It raises the price of an imported good, making it more expensive than similar
domestic goods. The idea is to increase demand for domestic products while reducing the volume of imports.
Tariffs also provide a source of revenue for the country levying them. In the United States, about half of the
industrial goods imported are assessed a tariff. A quota is a limit on volume of imported products. U.S. quotas
are applied to select items in a range of categories, including foods and textiles. Depending on the country, this
limit may be expressed as a percentage of sales of certain products or a limit on the number of units sold.

Quota Impacts and Disadvantages

Quotas are usually employed to protect infant industries and keep market entry costs low for domestic
producers. Often the quotas last long after the industry has matured. Other uses for quotas are to protect
strategic industries such as defense and agriculture. In market environments where imports are on the rise,
quotas are more protective than tariffs. When one country uses quotas, its trading partners do the same and cite
the same reasons. The end result is less exporting opportunity for all producers and higher prices for all
consumers. Quotas are also cumbersome for the country using them. They require a lot of paperwork
indicating exact amounts of products for each country facing a quota. It is also difficult to measure the precise
degree of protection quotas offer.

Tariff Impacts and Disadvantages

Tariffs raise the price of imports. This impacts consumers in the country applying the tariff in the form of
costlier imports. When trading partners retaliate with their own tariffs, it raises the cost of doing business for
exporting industries. Some analyst believe that tariffs cause a decrease in product quality. Businesses look for
ways to cut production costs to account for tariffs. Tariffs are more transparent and easier to administer than
quotas. This makes it easier for trading partners to negotiate them down or eliminate them.

Other Problems with Tariffs and Quotas

High tariffs and quotas can result in trade wars between nations. The European Union and China were
involved in a trade dispute over textiles that delayed an agreement that expired in 2005. The United States'
high tariffs on auto parts are said to be a sticking point in a number of trade agreement negotiations. The threat
of new tariffs in 2018 on steel, solar panels and other goods has raised the threat of a new trade war. These
disagreements hurt the incomes of each country involved in the disputes. Trade only works when countries
import and export.

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KEEP LEARNING

What Are Advantages and Disadvantages of Price Discrimination?


What Are the Pros and Cons of Tariffs?


What Is a Harmonized Tariff Schedule?

FULL ANSWER
Tariffs may make local industries less efficient due to reduced global competition. They
may also lead to trade wars as exporting countries counter with their own tariffs on
imported products. When trading counterparts reciprocate with their own tariffs, it raises
the cost of doing business for exporters. This situation may also compromise the quality
of goods and services as industries look for ways to cut production costs.

A tariff refers to a tax imposed on products and services. Tariffs are used to control
trade, because they increase the price of imported products, making them more
expensive to the end consumers. A specific fee is imposed as a fixed levy based on the
product. In addition, an ad valorem tariff is imposed based on product’s value.

The objective behind tariffs is to decrease demand for imports while increasing demand
for domestic products. Governments may also impose tariffs to protect local industries
from foreign competition, because consumers largely choose imported products or
services when they are cheaper. Tariffs provide additional sources of income for the
imposing country at the expense of consumers and foreign producers.
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Quotas and tariffs

There are two types of protection; Tariffs, which are taxes, or duties, on imported goods
designed to raise the price to the level of, or above the existing domestic price, and non-
tariff barriers, which include all other barriers, such as:

Quotas
A quota is a limit to the quantity coming into a country.

With no trade, equilibrium market price in the country will exist at the price which
equates domestic demand and domestic supply, at P, and with output at Q. However,
the world price is likely to be lower, at P1, than the price in a country that does not
trade. If the country is opened up to free trade from the rest of the world, the world
supply curve will be perfectly elastic at the world price, P1.

The new equilibrium price is P1 and output is Q1. The domestic share of output is now
Q2,compared with Q, the self-sufficient quantity. The amount imported is the distance
Q2 to Q1.

Imposing a quota

In an attempt to protect domestic producers, a quota of Q2 to Q3 may be imposed on

imports.

This enables the domestic share of output to rise to 0 to Q2, plus Q3 to Q4.
The quota creates a relative shortage and drives the price up to P2, with total output
falling to Q4. The amount imported falls to the quota level. It is this price rise that
provides an incentive for less efficient domestic firms to increase their output.

One of the key differences between a tariff and a quota is that the welfare loss
associated with a quota may be greater because there is no tax revenue earned by a
government. Because of this, quotas are less frequently used than tariffs.

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Tariffs
Tariffs, or customs duties, are taxes on imported products, usually in an ad
valorem form, levied as a percentage increase on the price of the imported product.
Tariffs are one of the oldest and most pervasive forms of protection and barrier to trade.

The impact of tariffs

The imposition of tariffs leads to the following:

Higher prices
Domestic consumers face higher prices, which also means that there is a loss
of consumer surplus. However, there is a gain in domestic producer surplus as
producers are protected from cheap imports, and receive a higher price than they would
have without the tariff. However, it is likely that there is an overall net welfare loss.

Without trade, the domestic price and quantity are P & Q.

If a country opens up to world supply, price falls to P1, and output increases from Q to
Q2. As a result, domestic producers’ share falls to Q1 and imports now dominate, with
the quantity imported Q1 to Q2.

The imposition of a tariff shifts up the world supply curve to World Supply + Tariff.
The price rises to P2, and the new output is at Q3. Domestic producers share of the
market rise to Q4, and imports fall to Q4 to Q3. The result is that domestic producers
have been protected from cheaper imports from the rest of the World.

Given that domestic consumers face higher prices, they also suffer a loss of consumer
surplus. In contrast, domestic producers increase their producer surplus as they receive
a higher price than they would have without the tariff.
Increased market share also means that jobs will be protected in the domestic
economy.

Welfare loss

However, the reduction in consumer surplus is greater than the increase in producer
surplus. Even when adding the tariff revenue (area K,L,M,N) there is still a net loss. The
net welfare loss is represented by the triangles X and Y.

Distortion
There is a potential distortion of the principle of comparative advantage, whereby a tariff
alters the cost advantage that countries may have built up through specialisation.

Retaliation
There is the likelihood of retaliation from exporting countries, which could trigger a
costly trade war.

However, in the short run tariffs may protect jobs, infant and declining industries, and
strategic goods. Tariffs may also help conserve a non-renewable scarce resource.
Selective tariffs may also help reduce a trade deficit, and reduce consumption.