In this article we will discuss about the merits and demerits of restricting imports through quotas.
Merits of Quota:
Two main merits of restricting imports through quotas are:
1. Foreign exchange implications:
In fact, the main advantage of a quota is that it keeps the volume of imports unchanged even when demand for imported articles increases. It is so because a quota makes the completely elastic (horizontal) import-supply curve completely inelastic (vertical). But a tariff permits imports to rise when demand increases.
Thus a quota leads o greater foreign-exchange saving compared to tariff (which may even lead to an increase in foreign exchange spending because imports may rise even after tariff). So a tariff may lead to a deterioration in a country’s balance of trade.
Another advantage of quota is that its outcome is certain but the outcome of a tariff is uncertain. This is so because the volume of imports remains unchanged when a quota is imposed. But this is not so in case of a tariff.
Demerits of Quota:
Two main demerits of quotas are the following:
1. No revenue effect:
A quota generates no revenue for the government. Of course, if the government auctions the right to import under a quota to the highest bidder the quota could be used to raise revenue for the government.
2. Monopoly profit:
Secondly, a quota creates monopoly profits for those holding import licences. This means that consumer surplus is converted into monopoly profit. Thus a quota is likely to lead to a greater loss of consumer welfare. If a tariff is imposed domestic price will be equal to import price plus tariff. If demand increases even after tariff, price does not rise further because the supply curve of imports is likely to be completely elastic.
3. Non-working of the price (market) system:
Another disadvantage of the quota system is that it removes links between domestic and international prices. So domestic consumers cannot derive the benefit of technological progress occurring in a foreign country.
Cost of Tariff:
The most forceful argument against import restriction is that it raises domestic prices of imported items. So there is loss of consumer welfare. A prohibitive tariff may remove imports altogether and consumers may be forced to curtail consumption of the imported item. So, consumers will be made to pay higher prices for the limited amount of the commodity that is available. Thus the consumption effect of tariff always negative. This is why it is also known as the cost of the tariff.
No doubt free trade is better than no trade. But sometimes some (restricted) trade is better than free trade, even though most economists prefer free trade to either tariffs or quotas. If they have to choose, a tariff is usually considered less harmful than an equivalent quota. A tariff permits imports to increase when demand increases, and the government is able to raise revenue.
In India, for example, customs duties are the second most important source of revenue of the Central Government, next only to central excise. The revenue raised by the government can be used to improve social welfare by setting up hospitals, schools or by constructing bridges, highways, etc. Moreover, a tariff is more visible and therefore is easy to get rid of. In contrast, a quota is less obvious and more likely to remain in force for an indefinite period.