Tcont’d from previous page)

Trade. London 1950. As was shorn by Marshall (Money Credit and Commerce. 1923 ed., Appendix J.2, pp.

336

7

curve to be tangential, at any point along the inelastic part of the curve, to the tariff imposing country*s indifference curves; their general direction of slope is diagonally opposed and they will, in fact, intersect. Of course, the optimum tariff will appear to be indefinitely large until imports have been reduced to zero, or until the elasticities change. In either of these cases the answer in the model will be positive.

1.

See I.A. MacDougall, "Optimum Tariffs Reconsidered", to be published.

two methods is the point at which the tariff or corresponding import restriction is at the optimum. Up to the point of the optimum

tariff or import restriction, it will pay, in terms of the welfare criterion used here, to use import restrictions to redirect demand; any import restriction imposed beyond this point will result in a

greater loss of welfare than is involved in a variation in the exchange rate.

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Some Theoretical Considerations* II: Internal Effects of Quantitative Import Restrictions

Attention so far has been centred on the use of direct controls as an instrument of balance of payments policy. In this chapter, the effects that may be expected from the quantitative control of imports insofar as they affect the internal economy will be considered.

Consider what happens when a restriction is placed on imports. This may be seen quite simply in the diagram (Fig. IX). It is assumed that no change in the demand for imports on the part of the restricting country will affect the world price for those imports, and that after the imposition of the controls the price of restricted goods is the free market price, i.e. importers and/or processors do not operate some form of unofficial rationing, but charge what the market will bear. (This assumption will be examined more fully below) •

Before any barriers to trade are introduced, the world price and the domestic price (ignoring transport charges etc.) are the same and are shown as WP. At this price, OC will be produced domestically

1.

The subject matter of this chapter is discussed generally in: H. Reuser, Control of International Trade. London, 1939, partic. Chapts. XI and XII; J.M.Meade, Balance of Payments: Ibid. The

Theory of International Economic Policy.Vol. II, Trade and Welfare. London, 195$, partic. Part II; Johnson, o p.cit.: Hemming and

Corden, op.cit. For a discussion of the general effects of

tariff protection on the Australian context see A.J.Reitsma, Trade Protection in Australia. Brisbane, I960, partic. Chapt. V.

U '

and CH will be imported* If imports are restricted to GF (i*e* cut by HF), the domestic price initially will rise to DP, (WP, by assump­ tion, remaining unaltered).

In the short run, assuming local industry is operating at full capacity, there can be only very limited increases in output* Both the local producers and importers will receive a monopoly rent* In Fig* IX, the importers1 rent is NQRT, and local producers receive a rent of DP.NKWP* Importers are, by definition, unable to influence the supplies of imports available; local producers, however, will

120

output. As output increases, the price level will fall but, with increasing costs, the equilibrium price level in the new situation will still be above that which existed before imports were restricted. In Fig. IX the price level in the long run, i.e. after local product­ ive capacity has been expanded, is shown as D P 1. At this point, local output is OS and imports EG (=CF).

The difference between the world price and the domestic price of imports is initially NQRT reducing to JKLM as local output is increased. It would, if the restriction of imports were by means of a tariff, be the amount of tariff revenue collected by the government. In the case of the quantitative restriction on imports, however, the difference between world prices and local prices is not collected by the government (unless, of course, it auctions the licences to

importers or imposes a tax on importers equivalent to the monopoly profits), but is a redistribution of income in favour of importers.

The extent to which prices would rise within the restricting country would depend upon the elasticity of demand for the domestic­ ally produced substitutes for the restricted imported item and the elasticity of supply of domestic production. The slower the increase in the marginal costs of domestic production in a given demand

situation, the lower the ultimate price rise in the domestic market. Thus the extent to which the restriction of imports will

encourage the expansion of local industry will tend to depend, as one might expect, upon the rate of increase in marginal costs. In

Fig. IX a second supply curve SS* has been drawn representing a more rapidly rising level of marginal costs than in the case of the supply curve SS. The extent to which the cut in imports enables the local industry to expand is clearly less than in the previous case. With imports restricted by CF (=EG), local production, in the case of supply curve SS will increase from OC to OE. In the second case with supply curve S S ’ the increase would be from OC to OC*. It should be noted that, even though the local price has increased sub­ stantially, local production costs will be above the supply price of imports at any point above WP, and so local production will not increase beyond the point where the full amount of the imports permitted is, in fact, imported.

It will be seen that protection from import competition afforded by the controls enables domestic producers to increase unit profits

(raise prices) at the existing level of output, or to increase output at the existing unit profit rate - any change in prices in the latter case simply reflecting changes in unit costs. Supply is likely to be relatively inelastic in the short term; some increase in price is therefore probable unless producers are prepared to allocate (ration) their output - which, at existing prices, is insufficient to meet demand. In the longer term, resources can be attracted to the indust­ ry, capacity can be expanded and output increased. In practice, we might expect some combination of both price increase and output expan­ sion. The extent to which producers will expand output rather than

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maintain high scarcity profit rates will depend upon the competitive position of the industry.

The situation in Fig, IX relates to the domestic industry as a whole; it may consist of one or many producers. It is certain that,

given the existence of protection under the import licensing system, the industry as a whole is able to take advantage of the situation. The form in which benefits will be exploited, however, will also depend upon the market organisation and the degree of competition within t he industry.

The manner in which the controls on imports are implemented will also affect the supply position of the domestic producer both in res­ pect of production costs and the speed at which output may be expanded. Similarly, the extent of the reduction of import competition will

differ from industry to industry according to the particular method of control applied to directly competitive imports. We shall consider these and other particular aspects of the methods of control used in the Australian system in subsequent chapters.

In the example illustrated in Fig. IX, it was assumed that the difference between the marginal costs of imported goods and the market price in the restricting country would go to importers and/or process­ ors, and that the supply price of imports would remain unchanged. It was seen earlier that, given competitive conditions in the restricting and supplying countries, the change in prices, if any, will be in favour of the restricting country, i.e. the price of imports will tend

to become cheaper. If import supply prices fall, or remain unchanged, then the margin between supply price and selling price will all be taken within t he restricting economy* The market condi­ tions in the two countries and the f orm of licensing employed will, in fact, determine in which country the margin between costs and prices will be appropriated.

The imposition of the controls may enable exporters to the res­ tricting country to combine; alternatively, quotas may be given to the

2

exporting country, or the operation of country discrimination in the licensing system may debar competitors from supplying to the market. In these circumstances, exporters will be able to appropriate to themselves the margin by increasing their selling prices up to the

1

1.

One other argument of relevance in this context should be noted; Metzler has argued that the effect of a tariff on the terms of trade might be sufficient to more than offset the internal price movement caused by the tariff, a nd suggested that it might have relevance for the Australian situation. L.A. Metzler, ’’Tariffs, the Terms of Trade, and the Distribution of National Income”, Journal of Political Economy. Vol.LVII, Feb. 1949, pp.1-29; Ibid. ’’Tariffs, International Demand and Domestic Prices”, Ibid. Aug. 1949, pp.545-551* Reitsma,

o p.cit., p p .114-116. pointed out that Metzler was arguing invalidly

from the elasticities of the offer curve (elasticities of reciprocal demand), and it has subsequently been demonstrated that the c onditions under which Metzler’s conclusion is true are sufficiently unlikely to occur as to be justifiably ignored. I.A.Macdougall, ’’Tariffs Protection and the Terms of Trade”, Economic Reoord. Vol.37, No.77,

(March 196l), pp.77-81. Metzler1s conclusion implied that a tariff need not protect. Had his conclusion been valid it may have been relevant here; it would have been necessary to consider whether a value quota would, in fact, have provided incidental protection.

2.

As, for example, in the case of the current quota arrangements controlling imports of butter into the United Kingdom. In this case exporters receive the domestic selling price for butter which has included a ’scarcity’ element.

level of the selling prices in the restricting country. If the limitation is placed on the value of imports, the total value of imports will be reduced but import prices will move against the res­ tricting country.

If the elasticity of demand for imports is less than unity and if the controls are in terms of the volume which may be imported, it is possible that, not only will the movement in the terms of trade.be

1

unfavourable, but that the balance of payments will be worsened. If the importing trade were monopolisticaHy organised prior to the restriction, and assuming profits were being maximised, imports would have been restricted to the point where the importer*s marginal revenue and marginal cost curve intersected. The imposition of a control on imports which reduced imports further would merely reduce the monopoly profit being taken although domestic prices would rise.

If importing becomes monpolistically organised as a result of the control of imports the intersection of marginal revenue and

1.

This may be illustrated by the following example taken from Professor Meade. Assume that the restriction of imports is set

in terms of the number of cars that may be imported and that this number is reduced from a total of five, which were imported before the imposition of the restriction at a unit price of £100, to four. The demand for cars is assumed to be sufficiently inelastic for the domestic prices after the restriction to rise to £133*3 per car. If exporters of cars to the restricting country combine monpolistic­ ally they will be able to set the price at £133*3 per car hence appropriate the full margin of profit. The cost of the reduced quantity of motor cars imported is now £533*3 instead of the £500 which was paid for a larger quantity of cars before the restric­ tion. Meade, The Balance of Payments, p.277.

marginal cost curves may indicate that increased profits will be

obtained by importing less than the quantity permitted by the control, (This implies that there is no adequate substitute available from local production,)

It is possible now to consider in what respects a tariff and a quantitative import control differ. When market conditions both before and after the introduction of the controls are completely competitive, it was seen that there is no difference between the two in their effect on the price paid to the exporter. If importers of restricted goods are acting as monopolists, a tariff will increase the monopolists1 cost curve, reduce the quantity of imports which maximises profits and increase the price to local consumers. Under competitive conditions, a fee per unit of imports (a tariff or

licence fee) and a lump sum tax on importers are theoretically equiv­ alent in their effects. When monopolistic importing conditions exist this is no longer the case; a fee per unit of imports raises costs so that the monopolist will gain by reducing imports and raising selling prices. A monopolist, however, would be unable to pass on a lump sum payment; it would not pay him to vary the total amount of imports

1

and he would not gain by raising selling prices.

With quantitative controls there is no automatic mechanism which limits the price which might be charged by importers or by domestic

TT

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producers acting together. Action may be taken to issue additional licences where it appears that domestic prices are too high; with a fixed import ceiling this can only be done by further reducing imports of other items. Alternatively some form of price control might be introduced. Under a tariff the price which can be charged internally is limited to that of the import price plus duty.

If exporters are not monopolistically organised, the price they receive will be the same with either method. Should the exporters be in a monopolistic position, however, and able in the case of a quantitative restriction, to appropriate to themselves some or all of the margin between the pre-restriction import price and the new

internal selling price, this could be taken back from them by a tariff equivalent to the share of the margin going to the exporter.

A major difference between the two forms of import restriction is that the direct control of imports by licence redistributes income in favour of the holder of the licences. A tariff which restricted imports to the same extent as a direct control would redistribute income to the government sector as well as to the local producers of substitutes for the restricted imports. The desirability of a redist­ ribution of income in one direction or another is largely an argument of equity rather than of economics. However, in the case of balance of payments difficulties, where a reduction in the level of internal expenditure is required, the increase in tariff revenue, providing it is not spent or otherwise offset, is one means

of achieving this* While the importer is thus placed in a favourable position there are two offsetting factors, First, the decline in volume of the importer’s turnover will increase the ratio

2

of overhead costs per unit of turnover* Second, the importer will

3

generally be unable to increase his volume of business* By seeking more favourable sources of supply he may increase the volume which can be imported under a value quota or the profit to be obtained from a fixed volume of imports. Some incentive to increased efficiency in purchasing will therefore be present but there will be limited incen­ tive for efficiency in the domestic market* The assured market and high profit rate on existing sales may offset any incentive for increased purchasing efficiency. In the case of the tariff rewards for competitive efficiency in the domestic market would still remain.

The discussion so far has been based largely on the assumption that the restricted supplies of imports are sold at their free market price, i*e. they are sold at the price which the market will bear.

1

1.

There may be some increase in savings due to the increased profits accruing to importers under the direct controls if their propensity to save out of increased profits is higher than that of the consumers at whose expense the redistribution of incomes is made.

2.

This may be more important in the short term since labour would probably constitute much of the overhead cost. On the other hand costs associated with the licensing controls themselves may not be small.

3.

Of course, in his existing lines it may not pay him to increase his volume of turnover but he will also be unable to expand into new lines.

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It may be argued that in fact importers and/or processors etc., do not raise their prices as a consequence of the shortages brought about by the restriction of imports. In a later part of this study some attempt will be made to assess what actually happened in the case of t h e restrictions imposed in Australia in the ’fifties. At this point all that is being attempted is ihe consideration of the theoretical implications of either situation.

If the supply of imports is restricted, i.e. if the controls are effective, then prices within a restricting country will either

increase up to the point where supply and demand are equated or there will be shortages, queues, long order lists etc*, i.e. some form of official or unofficial rationing scheme is inevitable. This may be either on the basis of allocations in proportion to previous sales, or on some other basis, such as the quantity of other goods that the customer buys from the licence holder. In the latter case the price may include an indirect price increase element; to obtain sufficient of the goods restricted in supply he may have to purchase more than he needs in total or from that supplier of the other goods