Tariff Rate Quotas

Several weeks ago, when I wrote a column on the language of trade and listed many of the acronyms that populate trade wonks’ vocabularies, I forgot one, which is taking on new importance—TRQ, or tariff rate quota (not to be confused with TRO, which is a temporary restraining order). This week, I will explain TRQs, but that requires a bit of background first.

Tariffs have long been the most popular instrument of protection in the trade policy toolbox. While some of them are specific, for example, 50 cents on a dozen eggs, most are now ad valorem, which means based on a percentage of the import’s value, for example, 2.5 percent on autos. The transition from the former to the latter took place after World War II as policymakers realized specific tariffs could vary significantly in impact as prices change. For example, if eggs are $2.50 a dozen, a 50-cent tariff is 20 percent. But if the price of eggs goes up to $5.00 a dozen, the 50-cent tariff becomes only 10 percent. As prices rose gradually, specific tariffs would become less effective in providing protection, while ad valorem tariffs would retain their impact.

It’s important to note at this point that the purpose of tariffs is to raise prices, so no one should be surprised when that happens. If you want to protect a domestic industry from foreign competition, making the foreign product more expensive is a good way to do it. The dirty little secret, however, is that when you do that, domestic producers often raise their prices as well in order to fatten their profits. They don’t raise them as high as the imports’ price because they want to maintain a competitive advantage, but they do tend to go up.

Another way to provide protection is with quotas. A quota is a quantitative limit on the volume of imports that can enter the country, for example, limiting autos from Japan to 500,000. Quotas provide a higher degree of market certainty than tariffs, and they have a similar price effect—if you restrict supply and demand does not change, prices will go up as consumers will pay more to get a limited supply of the product. They can, however, be more disruptive in the marketplace than tariffs if consumers scramble to buy a product before the quota limit is reached and create panic and shortages.

Quotas also differ from tariffs in how the benefits are distributed. Tariffs are taxes, and the revenue goes to the taxing government. Quotas are not a tax and provide no direct revenue to the government imposing them. Instead, they create a revenue opportunity for the exporting country. For example, if the United States imposed a quota of 500,000 autos on Japan, it would be left to the Japanese government to decide how to allocate that quota among the various Japanese manufacturers. The government could auction the quota, allowing manufacturers to bid on the right to export. In that case, the revenue accrues to Japan, not the United States.

A tariff rate quota is a hybrid of the two approaches. The government sets a quota on imports but then allows imports to enter the country above the quota at a higher tariff. The most recent example of this can be found in the U.S.-UK trade agreement, where the United States agreed to a TRQ of imports of 100,000 autos with a 10 percent tariff, with auto imports above that limit allowed entry with a 25 percent tariff. A TRQ provides more flexibility than a quota but also a bit more market certainty than a tariff.

This is not a new concept—the U.S. sugar program has imposed TRQs for decades—but it has not been used much lately. Now they may be coming back. In addition to the U.S.-UK agreement, there is ongoing negotiation with Mexico about a similar arrangement for steel, and we should expect more of them to show up in some of the other trade agreements being negotiated.

TRQs may be an attractive approach for the Trump administration because they can be viewed as a compromise that gives something to the other side while maintaining the basic outline of a protectionist policy. In the case of the UK agreement, for example, the quota was roughly comparable to the number of cars imported from the United Kingdom last year. So, from the United Kingdom’s point of view, they have gotten a better deal—10 percent tariffs rather than 25 percent on what they would normally be exporting (ignoring the fact that the U.S. most-favored-nation tariff on autos is 2.5 percent). Since the quota is just about the number of actual exports in the prior year, it will not be difficult to allocate it among the UK manufacturers. From the U.S. point of view, the tariff on British cars is quadrupling, which no doubt pleases the president.

Is this a better approach than tariffs? I have no idea. The economic impact in each case is not likely to be much different, but optically, TRQs may be easier for the other country to swallow and to sell to its citizens.

Separately, on a personal note, I spent last weekend at two memorial events for people who labored in the trade vineyard for years. They weren’t famous; they did not have high government positions, but they both devoted their careers to advancing U.S. interests through trade liberalization, and they both made their mark in ways both visible and invisible. And they were both genuinely nice people. RIP Phyllis Bonanno and Dan O’Flaherty.

William A. Reinsch holds the Scholl Chair in International Business at the Center for Strategic and International Studies (CSIS) in Washington, D.C.