Poliey, Planning, and R

WORKINlN'

Trade Polcy

Country Economics Department The World Bank

September 1988

WPS 83

WVelfare Costs of

U.S. Quotas on

Textiles, Steel, and Autos

Jaime de Melo

and

David Tarr

Protectionism is popular but costly: the United States loses $21

billion a year in welfare costs through quotas on textiles, steel,

and autos.

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Polaa Pning, and Reserc

Trad* Policy 

Nontariff baniers prevent a transition to the Removing the remaining tariffs (an average

realities of international competition, and their 3.5% in 1984) would produce a welfare gain of

welfare costs are huge. about $0.9 billion - for a net benefit of $105

billion, measured in tenns of the discounted

'Te United States loses an estimated $14 value of displarced workers' lost earnings over a

billion a year in revenues through rents lost to lifetime.

exporting countries through export quotas. Add

another $7 billion for distortionary costs.

This paper is a product of the Trade Policy Division, Country Economics Department. Copies are available free from the World Bank, 1818 H Street NW, Washington DC 20433. Pleace contact Carla Cabana, room N8-069, extension 61539.

The PPR Working Paper Series disseminnates the fio ings of work under way in the Bane s Pophcy, PlaW ing, and Research

Complex. An objective of the series is to get these fndings out quickly, even if presentations are less than fully polished.

The findings, interpretations, and conclusions in these papers do not necessarily represent official policy of the Bank.

Copyright 0 1988 by the International Bank for Reconstruction and DevelopmnentSTe World Bank
Welfare Costs of

U.S. Quotas in

Textiles, Steel, and Autos

by

Jaime de Melo

and

David Tarr

TABLE OF CONTENTS

1. Intoduction .......... 1 

2. Model .........................................................Outline 3

3 . Elasticity and Prernia Esdmates ............................. 7

4. Welfare CostEstmates ............................... 10

5'. Eployment ............................... 15

6. Conclusions ............................... 17

Footnotes ............................... 19

References ............................... 22

Appendix A: Model Equations ............ .. ................. 26

Appendix B: Data Sources and Data Preparation ............................. 34

Tables

Table i ............................ 6

Table 2 ........................... 9

Table 3 ........................... 1 1

Table4 ............................ 13

Table 5 ............................ 16

Table Al ............................ 27

TableA2 ............................ 31

The paper draws on a larger study by Tarr (1988) while he was at the US Federal Trade

Commission. We thank participants of the General Equilibrium Trade Policy Modelling Workshop at the University of Western Ontario for comments. The views are those of the

authors, not those of the USFTC, nor those of the World Bank. We thank Julie Stanton

for extremely valuable research assistance, Maria Ameal for logistic support, and Soren

Nielsen for computer support.
1

I. Introduction

The United States, along with other developed countries, is progressively abandoning its commitment to the postwar multilateral trading

system. The shift towards bilateralism is evident in the proliferation of

discriminatory trade measures, which have increasingly canceled the benefits to the world econfny since World War II ef the successive rounds of

multilateral tariff reductions on a most-favored-nation (MFN) basis. DisCriminatory trade measures are not only administered bilaterally; they are

often undertaken unilaterally (e.g. various forms of administered protection) or through multilateral arrangements (e.g. the Multi-Fibre

Agreement). Moreover, the MFN clause does not prevent countries not participating in the multilateral negotiations from facing higher average

tariffs on their exports: in spite of the Generalized System of Preferences (GSP), developing countries exports to developed countries face tariffs

that are on average twice as high as those faced by developed countries

(Balassa and Balassa, 1984).

Though accentuated by the recent macroeconomic imbalances and

resulting exchange rate imbalances among developed countries, the move

towards discriminatory trade policy practices has been on the rise for the

past twenty years. The rising protectionism in developed countries in the

form of non-tariff barriers (NTBs) retards the relocation of production of

mature industries from developed to developing countries. 1/ NTB protectiouiGm is congenial to those who seek protection because it is quick and

lacks transparency and to exporters who negotiate it because they gain the

rents. Thus, NTBs engender widespread opposition to trade liberalization.

NTBs also impose huge costs on consumers and prevent a smooth transition to

the realities of international competition.
2

Quite a few studies have been carried out to drive home the costs

of these special protection arrangements. Individual sector studies for

textiles: (Horkre (1985); Tarr and Horkre (1984); Cline (1987); Keesing

and Wolf (1980)]; for automobiles [Winston and Associates (1987); Tarr and

Morkre (1984); FeenstLa (1984, 1985a, 1985b); Dinopoulos and Kreinin

(1986)]; for steel [Tarr and Morkre (1984)] are among the most vilely known

studies thav provide estimates of the welfare costs of NTBs in the US.

Perhaps the most comprehensive recent estimates come from the 31 case

studies of special protection by Hufbauer, Berliner and Schott (1986). All

these studies, using a partial equilibrium (PE) framework. rovide a very

useful range of estimates of the costs of non-tariff px lon. These

studies are especially valuable when taken individually because the

assumptions of PE analysis provide an adequate approximation of reality

even thougk. the behavior giving rise to the demand and supply curves used

in the estimation are not always properly spelled out. But, as we discuss

below, when it comes to aggregating the costs of all restrictions taken

together, the underlying assumptions are much less tenable.

This paper deals with the problems of PE analysis by presenting

estimates from a static ten-sector computable general equilibrium (CGE)

model of the US economy calibrated to the year 1984 when QRs in textiles,

and autos were in effect, and those on steel were in negotiation. To our

knowledge, the treatment of QR-associated effects here is more satisfactory

than in previous CGE applications. 'While the US-negotiated VER on

automobiles has expired, demand for NTB protectionism in the US remains

strong and may be on the rise because of presidential campaign politics. A

new round of estJmates of the costs of protection is therefore all the more

welcome.
3

The general equilibrium (GE) approach used here accounts for three

effects omitted by PE estimates. First, the inclusion of a balance of

trade constraint (expressed In foreign currency units) removes an upward

bias present in PE analysis. Second, the effects of income transfers to

and from the rest-of-the-world (ROW) are properly accounted for so that,

unlike PE analysis, capturing quota rents affects resource allocation.

Third, ecnuomy-wide resource constraints and interindustry linkages provide

a more accurate estimation of sectoral employment effects.

The remainder of the paper is organized as follows. Section 2

outlines the model. Section 3 details the sources of estimates of premia

on preexisting QRs in 1984 and the sources for the parameters describing

demand and supply elasticities. Welfare and employment estimates of QR

removal are presented by industry and in the aggregate in section 4.

Conclusions follow in section 5.

2. Model Outline 2/

The simulation model is a static CGE model with assumptions that

correspond closely to those followed by the partial equilibrium estimates

cited above, namely a neoclassical perfect competition Walrasian model in

which a representative consumer maximizes utility subject to a budget constraint, atomistic producers minimize costs, and the government redistributes, in a lump-sum manner, tax revenues from trade policy. The economy

has a fixed endowment of labor and capital, and faces an exogenous balance

of trade constraint expressed in foreign currency units. Because we are

interested in the static welfare costs of protection, we abstract from

investment, thereby simplifying the welfare analysis. The components of

demand therefore only include consumer demand and intermediate demand.
4

Under these assumptions. it is clear that the welfare changes due

to a change in trade policy are the usual production and consumption costs

of protection referred to in the literature on the costs of protection.

Our measure of the welfare cost to the US of departures from free trade is

given by the equivalent variation (EV) measure associated with the utility

function selected for the representative consumer, i.e.,

1 1 o EV - C[IU(p ,y ), p I - ClIU(p , y ). p

where C is the cost function corresponding to the selected utility

function, superscripts o and 1 refer to the equilibrium before and after

the counterfactual trade policy experiment, p is the vector of final goods

prices, and IU is indirect utility which depends on prices and income. 3/

The structure of the ten-sector model is described in table 1. 4/

To best capture the trading possibilities at a relatively aggregated level

for an economy like the US, we have treated commodities supplied (or

purchased) abroad and domestic commodities sold on the domestic market as

imperfect substitutes. This assumption of product differentiation, which

has found considerable support at the disaggregate level (e.g. Isard,

1977), is commonly used in applied general equilibrium analysis and is also

adopted in most of the partial equilibrium estimates of the cost of

protection in the US cited above. The assumption is particulirly suitable

for the relatively high level of aggregation in our btudy and allows for

the observed cross-hauling in trade statistics. On the export side, the

assumption of product differentiation is reflected in the constant

elasticity of transformation (CET) funct.Lon between domestic and foreign
5

sales. 5/ A symmetric functional form is specified for intermediat_ demand

by sector (see below).

Table 1 shows that production possibilities are parametrized by

assuming CES furctions for vn4 -added and Leontief functions between intermediates (as a whole) and valae-addad, as well as witnwn intermediates.

However, within each sector, intermediate demand is a CES function between

the domestically produced intermediate and the compu.ting foreign intermediate. To give an example, no substitution is allowed between purchases of

steel and other manufacturing intermediates, but substitution in purchases

is allowed between domestically produced and foreign produced steel when

their relative prices change as a result of a change in trade policy.

Likewise, in consumption demand, we allow for non-unitary income elasticities of demand and non-zero cross-price elasticities of demand between

domestically produced and foreign produced consumer goods.

Finally is the issv_. of whether or not the US would face fixed

terms-of-trade for the trade policy changes envisaged here. In previous

single-country partial equilibrium estimates, authors have invariably

assumed that the US is a small supplier and demander in world markets. 6/

In our estimates, we retain this assumption except for autos where, in some

cases, we argue that differences in standards and the size of the US market

results in a non-infinite foreign elasticity of supply. When we consider a

simultaneous removal of all discriminatory protection, at times, we also

assume that the US would face a non-infinite elasticity of demand for her

agricultural exports. 7/

The description of the model is complete except for our treatment

of QRs. In the US, for the sectors considered here, there are no government controls or direct quota allocations with resale prohibition. Hence,
IBM/JDM-021 6

Table 

Model Structure

1. Substitution in Production and Demand

Domestic Supply

l.a Production and Its Allccation

Gross Output CET

!I Export Supply

Leontief

Value Added Intermediate

I I

CES Leontief

/ \ Composite Composite

Capital I.Ir Intermediate Intermediate

I I

.ES ~~~~~~CES

Domestic Imoted Domestic Imported

Intermediate Intermediate Intermediate Intermediate

l.b Consumer Demand

Consumption

I

LES

Domestic Imported

2. Imoort SuOD1Y and Foreign Export Demand

Import Supply: Infinitely elastic (except autos)

Foreign Export Demand: Infinitely elastic (except agriculture)

a
7

unlike the case of many QR allocation schemes in developing countries, the

US system of QRs allows for market-clearing prices. 8/ Since in 1984 quotas

were already in place in autos and textiles, we assume that observed

purchases were at the premia inclusive pricGs in that year. (The

estimation of premia is discussed in section 3). Finally, it is worth

noting that, following the calibration procedures in applied general

equilibrium models, we are assuming that the prices and quantities observed

in 1984 correspond to an equilibrium of the US economy with normal capacity

utilization and in which the only distortions are the QRs and tariff on

imports. This may be viewed as a strong assumption but it is implicit as

well in all other estimates of the costs of protection.

Host previous GE studies of the costs of protection (e.g.

Deardorff and Stern (1986) and Whalley (1985)) that have dealt with QRs

have done so in the context of global models where QRs have been treated by

their tariff equivalents without including the associated rent transfer

that occurs with the US QRs. Moreover, the choice of functional forms has

resulted in excessively large terms-of-trade effects for unilateral changes

in trade policy (see footnote 6). 9/ Both problems are remedied in our

approach.

3. Elasticity and Premia Estimates

The accuracy of our estimates of the welfare costs of protection

depend on the assumptions embodied in the model, on the estimates of preexisting premia due to QRs in existence and on the supply and demand elasticity estimates. With respect to the modelling assumptions, with the

possible exception of noncompetitive behavior in autos (see Winston and

Associates (1987) and Dixit (1987)), our assumptions are certainly
8

plausible and representative. Hence considerable effort was de'-c:ed to a

*parameter search' for elasticities of demand and supply and to

constructing premia estimates for existing QRs in textiles and autos. We

discuss these briefly below. (Tarr (1988, chaps. 6 and 7) is devoted to a

detailed discussion of how these estimates were derived.)

Table 2 presents all the necessary elasticities and our constructed estimates of pre-existing premia. The elasticities reported in ta>'' 2

corres mnd to the 'central' elasticities. When we report the likely %nge

of welfs e costs from removing all trade restrictions in table 4 below, we

are reporting results from the 'low' and "high' elasticities that are

derived from the 'central' elasticities in table 2 by subtracting (adding)

a standard deviation. 10/ Because much econometric work has been done to

estimate the capital/labor substitution elasticities, we are fairly

confident abcut the relative accuracy of these elasticities. We are also

fairly confident in the estimates of import demand elasticities for which a

number of estimates are available. Less confidence can be placed on export

supply elasticities. However, because these latter elasticities only enter

indirectly into our estimations, we have found that our welfare estimates

are quite insensitive to considerable changes in their values. 11/

Turning to the estimation of the premia rates estimates (expressed

as a percent of landed US imrort price inclusive of tariffs), we have

relied on Hamilton (1988) for apparel. In order to understand the problem

of the premia rate estimation, it is crucial to recognize that the existing

MPA arrangements allow a number of marginally inefficient foreign suppliers

to sell in the U.S. If the MFA were abolished, many of them would be

squeezed out of the US market by competition. The quota premium rate

earned by these inefficient suppliers, is less than the quota premium rate
Tabl- 2

Elasticity Specification (Central Case)

Elasticity of

Elasticity of Elasticity of Transformtion Price Elestieities

Substitution Substitution Dometic/Export of Final Demand Premis

ColuIn Notes Intermdiates (.) Capital/Labor Sales Dometic Imports Rates

Sector (1) (2) (3) (4) (5) (1) (2) (3) (4) (S) (6)

Agriculture a c * k f 1.4 0.6 4.0 0.76 0.3

Feed a c ' f f 0.8 0.3 3.0 0.90 1.1

Mining b b * j f 0.5 0.3 S.0 0.50 1.0

Iron and Steel a d * I f 8.0 1.0 8.0 1.0 1.4

motor Vehicles a c * h h 2.0 0.8 3.0 1.2 1.1 22.61

Toxtiles and Apparel i c * I f 2.6 1.0 8.0 0.4 3.9 40.6X

Other Manufactures a c * * t 8.6 0.3 8.0 1.6 1.8

CUher Conwusor a c t t 3.2 0.8 3.0 1.9 2.4

Traoed Services b c * g g 2.0 0.8 0.7 0.5 0.6

Noe-Traded Services b g 0.0 0.6

(.) CES and CET functions imply that the corrsponding elasticities of subatitutIon (transformation) corr eond to comp nsated

import demand (export supply) elasticities.

All price elasticities if demand defined as positive numbrs. For premla estimates, a text.

Column notes correspond to te sources from which estImtes are Interpolated. For Interpolation detilIs ao Tarr (198).

(a) ShiellI, Deardorff and Stern (1906); (b) Dixon at *l. (1962); (e) Caddy (1976); (d) kman; (e) own estimates; (t) Stern,

Francis and Schumacher (1976); (9) Houthakker and Taylor (1970); (h) Lovinsohn; (1) Crandall (1981); 0) Bohi and Russell

(1978); (k) USDA (1984); (l) Hutbauer at el (1966).
10

paid by US consumers as a result of the MFA. Thus, we had to determine the

marginal supplier to the US if the MFA were abolished. Data in Hamilton

(1988), allow us to determine that Hong Kong, which had a quota premium

rate of 47Z for apparel sold to the US in 1984, or a supplier more

efficient than Hong Kong, would be the marginal supplier if quotas were

removed. 12/ The US is much more competitive in textiles than in apparel.

Consequently, for textiles we take 5Z for the premium rate, which is much

more conservative than the one (15Z) proposed by Cline (1987, p. 167). A

positive rate, however, is indicated based on data in a study by the US

International Trade Commission (1987). For autos we relied on the qualityadjusted premia estimates of Feenstra (1985a) for Japanese car imports by

the US. For European car imports, we relied on the quality-adjusted price

increase of European cars sold in the US estimated by Dinopoulos and

Kreinin (1987). Our reaulting premia estimates, which are weighted

averages, are 40Z for textiles a-nd apparel and 23Z for autos. 13/

4. Welfare Cost Estimates

Since the restrictions are administered by the exporting

c,.untries, the premia accrue to the exporting countries rather than to the

US. One can therefore distinguish two components of the costs of the QRs:

(1) the income or rent transfer to foreigners; (2) the distortionary cost

due to the usual consumption and production costs of protection. Table 3

summarizes these costs for each of the three industries: textiles and

apparel, autos and steal. Since the restrictions on steel -- which

resulted in approximately a 15Z reduction in the imports of steel starting

in early 1985 -- were only implemented in 1985, we obtain the estimates for

steel by reducing inteznediate and final consumption of imported steel
11

Table 3

Welfare Costs and Employment Effects of QRs: Individual Sectors

Employment b/

Change in the Economy-Wide c/

Welfare a/ Industry Losing Employment

Gain Its QR Relocation

Textiles and Apparel

Remove QRs 13.06 -158.3 158.3 d/

(.15)

Capture Rents 7.07 -3.3 35.2

from Foreigners (.03)

Autos

Remove QRs 6.9 -1.14 1.27

(.001)

Capture Rents 6.2 +1.05 30.9

from Foreigners (.029)

Steel

Remove QRs 0.91 -20.7 22.3

(.021)

Capture Rents 0.78 -0.1 3.9

from Foreigners (.004)

Notess Estimates based on central elasticities.

a/ Welfare is EV measure expressed in 1984 US billion.

b/ Employment is expressed in thousand work-years.

Z/ One-half of the sum of the absolute value of the employment

changes expressed in thousand work-years.

d/ The numbers in parentheses in the third column are the percentage

of employees in the economy who must relocate. For example, (.15)

means that fifteen-hundredths of one percent of the economy's

employees must relocate.
12

products by 15Z from the observed levels in 1984. This restriction results

in a 7? premium on imported intermediate steel products. The employment

figures in column 2 are only for the industry subject to quota removal, and

the total economy-wide relocation of workers is presented in column 3.

This latter measure is a summary of interindustry effects (see. e.g.

Deardorff and Stern (1986)).

The figures in Table 3 reveal that the largest welfare costs are

due to the QRs in textiles and apparel. This may seem surprising since

that sector is smaller than autos, and imports are 314 of auto imports in

value (including premia). Furthermore the proportion of the total welfare

costs due to distortionary costs are much higher in textiles and apparel.

This is so because the price elasticity of demand for textiles and apparel

is almost four times higher than the corresponding elasticity for autos.

14/ Furthermore, the relative homogeneity of domestic and imported steel

reduce production costs of distortion.

Because elasticity estimates are not precise, we report in table 4

a range of welfare costs from removing all QRs simultaneously for low and

high elasticities. Note that because the marginal benefits to the economy

of an income transfer is a decreasing function of demand and supply

elasticities, the welfare gains from capturing the rents from foreigners is

higher in the low elasticity case than in the high elasticity case. Of

course these welfare estimate gains due to the capturing of rents from

foreigners are overestimates to the extent that rent-seeking activities

dissipate them. For this reason, an auction quota mechanism is superior to

a direct allocation of quota rights to imports. 15/ Thus our estimate of

the annual cost of QRs in these three industries for the protection levels

in 1985 is between US$21 billion and US$23 billion.
13

Table 4

Welfare Costs of QRs and Tariff Protection: Long-Run Estimates a/

Low High

Elasticity Elasticity

Case Case

Remore QRs 21.0 22.7

Capture Rents from

Foreigners (retain QRs) 16.0 13.8

Eliminate Remaining

Tariff Protection 0.59 1.34

(after QR removal)

a/ Welfare is the EV measure expressed in US 1984 billion.
14

It is quite probable that the US has monopsony power in its

purchase of imported autos and monopoly power in its sale of agriculture

products because of its relative importance in the world market for these

products. We have experimented with an export demand elasticity value of 4

for agricultural products and an import supply elasticity of 5 for autos.

Insofar as removing QRs leads to an increase in agricultural exports and an

increase in auto imports, the US terms of trade will decline and hence the

welfare main will be leas. For the medium elasticity case, including

terms-of-trade effects lowers the welfare gain from US$20.9 billion to

$19.8 billion. This effect is small because of the relative importance of

quota rents which account for two-thirds of the total welfare costs.

Obtaining the quota rents is a pure income transfer from the ROW to the US

whose effect is a real appreciation of the dollar (about 1Z) which is

accompanied by a small improvement in the terms-of-trade (the transfer gain

with terms-of-trade effect is about $100 million more in the medium

elasticity case than without terms-of-trade effects). Thus, the distortion

gains from removing QRs with terms-of-trade effects is only $5.5 billion,

about 22Z less than in the small country case. 161

It is conceivable that the US would have monopoly and monopsony

power in all the sectors in which she trades. Although this seems unlikely

because the US market share is usually small in her main import and export

markets, we have experimented with generalized terms of trade across all

sectors for the central elasticity case by assuming constant import supply

for consumer goods imports and export demand elasticities of 5 for all

sectors except autos (import supply elasticity of 3) and agriculture

(export demand elasticity of 2). 17/ The gains from QR removal are

smaller, but still substantial ($16.2 billion). However, because of the

terms-of-trade effects, which result i-n expanded trade volume at higher
15

foreign currency import prices and lower foreign currency export prices,

the share of distortionary costs in total QR costs falls from 32 percent to

8 percent of total costs. Finally, adding unilateral tariff reduction now

results in a welfare loss of $2.9 billion because of the dominating termsof-trade effect, a result similar to those found in the global simulations

mentioned in section 2.

Our welfare cost estimates are significantly higher than previous

GE estimates and than mcit PE estimates. This is so for several reasons.

First we properly account for the $14 billion transfer associated with the

US system of QRs. Second, our results are not dominated by terms-of-trade

effects. 18/ Third, in comparison with most previous PE estimates, we have

benefitted from the detailed work on premia estimates by Feenstra (1985a),

Hamilton (1986) and Dinopoulos and Kreinin (1988) which are higher than

previous estimates. 19,

5. Employment

Table 5 presents estimates of the employment effects of simultaneous removal of QRs in textiles, autos and steel for the central elasticity case. The simultaneous removal of QRe also points out to conflicting

worker interests across the three industries subject to QRs. While the

steel and textiles and apparel sectors would lose almost as many jobs when

all QRs are removed than when they are removed in their sector alone, the

autos sector gain. 1,900 jobs when the QRs on steel (and textiles and

apparel) are removed concurrently with the VER on autos. This is so

because steel, an input into auto production is cheaper and because the

income elasticity of demand for autos is high. Both effects benefit the

domestic auto industry which expands even when QR protection is removed.
16

Table 5

Employment Changes from Removing QRs in Autos, Steel and Textiles

(Central Elasticity Case)

(thousand jobs)

Agriculture 14.3

Food 1.6

Mining 4.0

Textiles and Apparel -157.6

Autos 2.0

Steel -16.2

Consumer Goods 17.5

Other Manufacturing 78.6

Traded Services 34.3

Non-Traded Services 21.6

Given that QR protection is obtained through the political

process, one can argue that the US Congress has decided to value more

highly a job in the protected sectors. Since the combined QRs preserve 174

thousand jobs in textiles, autos and steel, but comes at a cost of US$20.9

billion, the annual cost per job protected in these three sectors is about

US$120 thousand. This is approximately 8(3) times the average annual total

compensation of workers in the textile (steel) industries.

If QRs are removed, displaced workers will incur search,

relocation, and retrainivg costs (see Hussa (1978)). Net benefits from QR

removal are obtained by subtracting these costs. A proxy for these costs

is theadiscounted value of the displaced worker's earnings losses over his

lifetime. 20/ This measure allows us to estimate how much gainers will
17

have left after compensating displaced workers for their earnings losses.

Earnings losses for displaced workers last approximately six years. 21/ A

conservative estimate of net benefits, NB, is obtained as

5

NB- E (20.9 - C t]

t-0 (l+r)t t

where r - 7? is the discount rate and Ct are estimated earnings losses. 22/

NB is US$105 billion, with associated Benefit/Cost of 65. That is, for

every dollar of earnings losses saved, the economy loses $65.

6. Conclusions

In the introduction, we said that PE estimates are upward biased

because they fail to include the balance of trade constraint. An order of

magnitude of the difference between PE and GE estimates due to this effect

is obtained by solving the model with a fixed real exchange rate and hence

an endogenous trade balance. This would correspond to what is typically

done in PE estimates. For the central elasticity specification, removing

all QRs would lead to a current account deterioration of US$11 billion and

an EV estimate of US$33 billion. This estimate is about one and a half

times the estimate obtained when the balance of trade constraint is

properly taken into account. Economy-wide welfare costs estimates derived

by adding up individual industry PE estimates are likely to be

significantly upward-biased.

Perhaps the most striking result is the relative costs of

protection from NTBs and from tariffs. While this is repeatedly mentioned
18

In policy discussions, few relative estimates are available. The figures

in table 4 suggest that the welfare cost of tariff protection is between 3Z

(low elasticity case) and 6Z (high elasticity case) of the welfare cost of

QRs in textiles, autos and steel. Since there are other QRs in the US

beyond those examined here, this estimate is a lower bound.

An alternative way to evaluate the costs of QRs is to ask what

tariff structure would give the same welfare loss as existing QRs in the

three sectors. Returning to the central elasticity estimates, in that case

the total welfare cost is estimated at US$20.9 billion of which 1984 US$6.7

billion is the distortionary component. For that set of elasticities,

moving from the actual tariff structure to a uniform tariff structure

yielding the same (import weighted) average protection would represent a

welfare gain of US$0.60 billion. (Removing tariffs altogether would give a

welfare gain of US$0.94 billion.) Starting from the existing tariff

dispersion, to get the distortionary cost element of QRs would require

multiplying each tariff by 3.8 times its 1984 value, which would amount to

an average (import weighted) nominal protection of 152. Adding the loss

due to rent transfers would require multiplying tariffs by 6.9 times their

1984 value amounting to an average protection of 252. 23/ It is no

exaggeration to say that, in terms of protection costs, QRs are taking us

back to the early days of multilateral tariff negotiations, especially if

one includes the rent transfer element.
19

Footnotes

1/ See Baldwin (1984), Tumlir (1985) and Riedel (1986) on the political

and economic causes for this shift in approach to trade policy. For

the US, the shift towards discriminatory trade policy is associated

with a combination of the decline in US hegemony politics and an

increase in government intervention.

2/ Appendix A lists the equations describing the model, the endogenous

and exogenous variables and details the functional forms.

3/ Consumption demand is represented by the linear expenditure system

which is derived from the associated Stone-Geary utility function.

The welfare measure used here is described in Varian (1984), who uses

the term expenditure function rather than cost function, and Deaton

and Muellbauer (1980).

4/ The ten sectors ares agriculture (1); food (2); mining (3); textiles

and apparel (4); autos (5); steel (6); consumer goods (7); other

manufacturing (8); traded services (9); non-traded services (10).

All sectors are traded with the exception of sector (10). See

Appendix B and Tarr (1988) for details on aggregation.

5/ The CET was first introduced by Powell and Gruen (1967) and has been

adopted by Dixon et al. (1982) in the ORANI trade model.

6/ The large country assumption is always assumed in multi-country

models (e.g. Deardorff and Stern, 1985; and Whalley, 1985). de Melo

(1986) and Brown (1988) argue that the product differentiation

assumption adopted in multicountry models overstates the extent of

monopoly power countries are likely to have. Also see Deardorff and

Stern (1986, p. 61) for a similar view.

7/ The (constant) elasticities are: import supply of autos (5.0);

foreign elasticity of demand for US agriculture exports (4.0).

8/ If market clearing was not allowed one would need to use virtual

prices in Hicksian demand curves along the lines suggested by Neary

and Roberts (1980) as for example in Grais, de Melo, and Urata

(1986).

9/ An important exception is the single country model of Harris (1984)

in which unilateral free trade by Canada is shown to be welfare

improving.

10/ As the sources for table 2 detail, the estimates were obtained from

many studies. These studies generally provide standard errors of

estimates. For those elasticities taken from Stern, Francis and

Schumacher, the high and low estimates are generally the high and low

estimates from their survey which are not standard-deviation-based.

In a few cases the high and low estimates are obtained by doubling

and halving the central estimate. See Tarr (1988, ch. 5) for

details.
20

11/ For example, doubling (halving) the elaiticity estimates in column

(3) incre4ses (decreases) our estimates of the welfare gains with the

central elasticity estimates from US$20.9 billion to $21.0 ($20.8)

billion, respectively, or + 0.42.

12/ We note that estimates of quota premia, in both textiles and

automobiles, vary from year to year. We obtained estimates of quota

premia for 1984, the year for which we benchmarked the model. Thus,

our estimates apply to the conditions prevailing in that year. For

other years, the premia rates and our cost estimates may differ.

13/ If the marginal supplier is more efficient than Hong Kong, our

premium rate estimate is conservative and the associated welfare gain

estimate is downward-biased.

14/ In his study of the similar arrangement for quota right distributions

among cheese exporters to the US, Anderson (1985) comes to similar

conclusions, i.e. that the distortionary costs coming from the

bilateral quota arrangements is extremely high. Had we further

disaggregated textiles and apparel as Anderson did in his study of

cheese quotas, we would have found even higher welfare costs.

15/ See Elliott, Sohctt and Takacs (1987) for an appraisal of such a

proposal for US trade policy.

16/ If one interprets the individual welfare estimates in table 3, as

linear approximations to the nonlinear demand and supply curves in

the model, then the sum of the individual estimates will underestimate the total welfare gain. This is indeed so, but the underestimate is small: for the small country case, the underestimate from

table 3 is only $30 million. This non-linearity effect is even more

important for the relativeiy large welfare equivalent (to QRs) of

uniform tariffs reported below.

17/ It should be noted that, in the presence of a balance of trade

constraint, the export demand and import supply elasticities are not

independent (see Whalley and Yeung, 1984) and, along the offer curve

will be less in absolute value than the figures cited in the text

(see Jones and Berglas, 1977). The numerically calculated value for

the aggregate export demand elasticity is -4.6; the numerical value

for the aggregate import supply elasticity (including intermediates

with the small country assumption maintained) is 6.3.

18/ For example, Whalley (1985, table 10.2) estimates welfare losses from

US unilateral NTB removal and US unilateral tariff removal.

Deardorff and Stern (1986, table 4.6) obtain small welfare gains.

19/ See Tarr (1988, chapter 2) for a comparison of our results with PE

estimates.

20/ We call our estimate a proxy for these adjustment costs because we

have not incorporated into our model an endogenous sector that moves

resources, as suggested by the theoretical work by Mussa.
21

21/ See Jacobson (1978). To be conservative, we measure total

compensation losses, which exceed earnings losses by the amount of

fringe benefits. Morkre and Tarr (1980, Chapter 3) discuss the

merits of this measure and the alternative unemployment cost measure.

22/ The estimate is conservative since earnings losses are zero after six

years, while yearly benefits do not decay.

23/ In that experiment, we are increasing the variance of nominal

protection by 3.8 and 6.9 times the variance prevailing in 1984.

Since the distortionary costs of tariff protection is positively

related to the average level of protection and to the variance of

tariffs [see Johnson (1962)], another hypothetical calculation would

consist of computing the average tariff under the assumption of no

tariff dispersion across sectors. In that case, starting from a

uniform tariff protection (3.5Z) equivalent to the existing tariff

protection in 1984, the distortionary cost element of QRs would

require an average uniform protection of 24Z. Adding the rent

transfer loss would raise the average uniform protection to 48Z.

With linear, rather than constant elasticity demand and supply

curves, welfare calculations would yield lower estimates as the

corresponding elasticities would increase as one moves up the demand

and supply curves.
22

References

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of Labor, pp. 87-98.

Johnson, H.G. 1960. *The Cost of Protection and the Scientific Tariff,"

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Jones, R. and E. Berglas. 1977. 'Import Demand and Export Supply: An

Aggregation Theorem,' American Economic Review, pp. 183-7.

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24

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Case oE Tariffs in the U.S. Automobile Industry.' In R.E. Baldwin

(ed.), Trade Policy Issues and Empirical Analysis, University of

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D.C.

Shiells, C., R. Stern and A. Deardorff. 1986. 'Estimates of the Elasticities of Substitution Between Imports and Home Goods for the United

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25

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26

Appendix A

Model Equations

Notation

Variable subscripts indicate sectors. If double subscripts are

employed, the first subscript denotes the sector of origin, the second the

sector of destination. Upper case letters are reserved for endogenous

variables, unless they have a bar, in which case they are exogenous

variables or normalization constants. Parameters and policy variables are

denoted by Greek or lower case Latin letters. There are i,j-l,...,n

sectors, of which k-l,...,l are traded and the remainder m-l+1,...,n are

non-traded. The index k(m) is reserved for traded (non-traded) sectors.

NT refers to non-tradable sectors; T refers to tradable sectors.

Constant elasticity of substitution (CES) and constant elasticity

of transformation (CET) functions are used throughout. To save on notation,

we note first that CES and CET functions can be written analogously in the

I

form X-CES (X1, X2; al' 1-m1, p, A) whereo- p ; 1 py in the CES

1

case and o - 1 ; 1 < p c * in the CET case. To further save on notation,

we write the unit dual cost functions associated with the CES (CET)

functions as PX - CES (CET) (PX1, PX2; a, o) where PX is the price of X and

PX1 and PX2 the prices of XI and X2.

Equations Listing

Equation (1) is unit average - marginal costs under the postulated

technology (see table 1 in the text). Factor demands (equations 2-3) are

obtaified from Sheppard's lemma. The assumption of fixed factor endowments

is reflected in equation (4). Equations (5-8) describe the choice between
27

Table Al

Equations Listin:

1. Unit Cost

n

(1) CVi -CESi (W, R; ai, oi' ADi) + El aii Xi PC3i

2. Factor Markets

(2) K1 - XDi CVi (R/(l-ai))

'3) L i , XD( ¢i) CvI (W Ma)

d - d - (4) E L L S; EK -KS

i i ii

3. Intermediate Products Demand

(5) Vji CESi (VMji, VD 5 ,6 c", ACi )

(6) VD /VMj1 - ((l-6 )IU ) ac (PDIPMI ) 3

(7) VMji -O j e NT

(8) V -j aij XDi

4. Output Allocation for Tradables

(9) XDk - CETk (Ek, Dk; 7 k' °tk' Ak)

-(tk °rtk

(lO) D k/E k - ((1-70)/7k) (PD k/P k)
28

Table Al (continued)

5. Cost Prices

(11) PSk - CETk (ppk PDk; 7k' tk' kY; PS - PDm

(12) PCij CESj (PHIi PDi; 5it oci, AC ); PCj PDm

(13) PNi -PSi E ai PCji

6. Definition of Internal Prices of Traded Goods

(14) PEk - PWEk ER

(15) PWI - PVk (l+timk) (l+prki) ER

(16) PMk - P % (1+tmk) (l+prck) ER

7. Import Supply; Export Demand

_ t-" (17) PE k- PIWEk or Ek iEk (PWE k) sk k>O

(18) PWMk - PWk or Ck - Ck (PWMk) ;k > °

flk < a for agriculture; k < S for autos

S. Consumer Demand and Market Eauilibrium

(19) CD1 ' xd + Ipd PDi) (Y - COMIT)

(20) CMk . X + ( <k PHj) (Y - COMIT)

where COMIT - E d PD 1 + E PI4; EPi+EPkh1

J~ J k i 

(21) VTDi - VD : VTM -E VMk

(21) VTD1-k j

(22) D -VTD + cd I i i
29

Table Al (continued)

9. Rationing

(23) VTMk VTMk 4 PMIkj> PMIk ( k+P,)

(24) CH. - 4 PMV > PM. k - textiles, autos, steel

10. Rents on Rationed Sectors

(25) RENTCk t ( - PHk) CHk + prck PWMk CMk (l+tmk) ER

(26) RENTIk - E (PI4Ij - PHI' ) VMHk + E VMk (l+tink) prik ER

11. Government Revenue (GR), Trade Balance Constraint (B) and Income

Definition (Y)

(27) GR - E (PMVk VTMk timk + P%Ik CMk tmk) ER

k

(28) - E (PWEkEk - PWHkCMk - PWk VTMk)

k

- (RENTCk 0. + RENTI) /ER

(29) Y - WLS + RRS + GR + (1-0k) (RENTCk + RENTIk) -B R

k

12. Numeraire

(30) 1 - E PDj XD° E P XD'
30

domestically and foreign produced intermediates. The allocation of

domestic production between domestic and export sales is described in

equations (9-10). Cost minimizing prices associated with the selected

technology appear in equations (11-13). The relation between border and

internal prices is given in equations (14-16). These equations allow for

the existence of rationing in the base year in which case the premia rates

prik, prck are positive. For sectors with no rationing, prik - prck - 0.

The assumption of endogenous world prices for final import supply (for

autos) and export demand (for agriculture) is reflected in equations 17 and

18. Consumer demand is described in equations 19 and 20 and sectoral

supply-demAnd equilibrium is given in equation (22) after aggregating

intermediate demands by sector of origin.

Becauae the textiles and apparel and auto sectors were rationed in

1984, we have allowed for the presence of rationing in the base year (see

equations 15 and 16). When a sector is rationed the premium inclusive

price (denoted with a superscript v) exceeds the corresponding internal

price defined as the world price inclusive of border taxes and expressed in

domestic currency units. Thus, for example, rationing of consumer demand

for autos implies P<> > PMk, k - autos. Likewise, when total intermediate

supply of imported intermediates originating in sector k is rationed, PMI,j

> PMIk by an endogenously determined amount PRk which depends on the extent

of rationing. When there is no rationing PM4t - PMk and PMI'j - PMIk,Vj

These assumptions are reflected in equations (23) and (24). Rents on

rationed sectors are collected in equations (25) and (26). What portion of

total rents goes abroad is determined by the parameter 9k in equation (29).
31

Table A2

Number of

Endopeneous Variables Variables

CVi - Unit costs n

xi - Sectoral capital stocks n

Ldi . Sectoral employment n

Vii - Composite intermediate purchases of

sector i from sector j n2

VDji - Domestic intermediate purchases of

sector i from sector j n2

VHji - Imported intermediate purchabes of

sector i from sector j n(n-l)

XDi - Gross output of sector i n

Di - Supply for domestic sales n

Ek - Supply for export sales m

PSk - Unit price of composite domestically m

produced traded goods

PDi - Unit price of domestically sold goods n

PCij - Unit price of composite intermediate

product of sector i sold to sector j n2

PNi - value-added price of sector i n

PEk,PWEk - Domestic and border price of exports from

sector k (Notes PWEk mostly exogenous) m
32

Table A2 (continued)

PMk (PM1),PVM4 , Domestic, (premium inclusive) and border

price of consumer imports of sector k

(Note: PVHk mostly exogenous) 2m

PMIk, (PMIl) Domestic, (premium inclusive) price 2m

RENTCk,RENTIk - Rents on consumer and intermediate

imports 2m

VTDi.VTMk(PHIk) - Total domestic and import intermediate

demands; (Premium on imported 2m+n

intermediate)

CHk,CDi - Consumer demand for imports and

domestically produced goods m+n

GR,Y,ER - Governiment revenue from tariff

collection, disposable income net

of transfers and real exchange rate 3

W,R - Wage, rental rates 2

TOTAL 3n2+n(n-_)+9n+12m+5

Note: Number of endogenous variables varies according to model closure.

(See text).
33

Finally the balance of trade constraint in foreign currency units

(equation 28), the overall budget constraint (equation 29) and the

numeraire (equation (30) close the model. Note that the choice of

numeraire implies that the (endogenous) variable ER represents the real

exchange rate. Thus when we fix the real exchange rate, we fix ER to its

base year value and free the balance of trade B.

Table A2 lists the endogenous variables in the model. For our ten

sector application with nine traded sectors and inflnite trade

elasticities, the model reduces to a system of [3n2+n(n-l)++9n+12m+151-3m

simultaneous equations since premia and virtual prices minus tariff

inclusive prices are positive (zero) when quotas are binding (not binding).
34

&ppendix B

Data Sources and Data Preparation

The model is calibrated from the 80x80 interindustry (I/O) flow

matrix for 1982 commissioned by the US Forest Service. However, since 1982

was a recession year, after aggregating the 110 table to our ten-sector

aggregation, we updated the table to 1984. The updating was done by

applying the 1982 value added to gross output ratios to the 1984 value

added figures published in the July 1986 Survey of Current Business.

(Details of the mapping are provided in Tarr, 1988, Appendix). For imports

and exports, we aggregated the seven digit level data published by the US

Customs Service. For traded services, we used the data in the Survey of

Current Business of June 1986, table 4.1. Next we corrected the data where

they seemed inaccurate (e.g. we relied on US Census publication FT-990 for

import and export data for Iron and Steel). Data on tariffs was obtained

from the US Department of Commerce publication FT-990, of December 1984, p.

A-17. Finally we scaled the trade data from the Census to make it

consistent with the merchandise import and export data from the NIPA.

Next we made the necessary adjustments so that all flows are

measured in US producer prices by using the data on the share of transportation and wholesale and retail trade embodied in the export data by using

the estimates in the Survey of Current Business Table A of May 1984.

Sectoral consumption is determined residually from sectoral material

balance equations.

One final manipulation on the I/O data was required since the I/O

flow matrix is a total matrix that does not separate domestic from foreign

intermediate input use. Following the procedure suggested by Dervis, de
35

Melo and Robinson, General Equilibrium Mcoels for Develooment Policy (1982,

chapter 5) and adopted in previous studies of the US, we assume that the

domestic use ratio in each sector is the same for all components of demand.

Unfortunately, this is the closest approximation that can be achieved with

existing information.

Data on employment was obtained from the US Department of Labor

publication, Employment and Earnings, January 1985, pp. 186-9. Capital

stock estimates were constracted from the first order conditions for

sectoral labor and capital demand, an estimate of the wage rate from NIPA

data, and an estimated rate of return on capital of 5.82 obtained from

Survey of Current Business, August 1986 and July 1987. (Details are in

Tarr 1988, chapter 4).
PPR Working Paper Series

Title Author Date Contact

WPS63 Does Japan Import Less Than It Should? Kenji Takeuchi July 1988 J. Epps

33710

WPS64 Cocoa and Coffee Pricing Policies

in Cote dlivoire Takamasa Aklyama August 1988 D. Gustafson

33714

WPS65 Interaction of Infant Mortality and

Fertility and the Effectiveness of

Health and Family Planning Programs Howard Barnum July 1988 S. Ainsworth

31091

WPS66 Slowing the Stork: Better Health for

Women through Family Planning Anthony R. Measham July 1988 A. Manciano

Roger W. Rochat 33226

WPS67 Price and Tax Poiicy for SemiSubsistence Agriculture in Ethiopia Robert D. Weaver August 1988 D. Gustafson

Saad All Shire 33714

WPS68 A Comparison of Lamps for Domestic

Lighting in Developing Countries Robert van der Plas

WPS69 Does Local Financing Make Public

Primary Schools More Efficient?

The Philippine Case Emmanual Jimenez August 1988 T. Hawkins

Vicente Paqueo 33678

Ma. Lourdes de Vera

WPS70 Vocational Education and Economic

Environments: Conflict or

Convergence? Arvil V. Adams August 1988 T. Hawkins

Antoine Schwartz 33678

WPS71 School Effects on Student Achievement

in Nigeria and Swaziland Marlaine Lockheed August 1988 T. Hawkins

Andre Komenan 33678

WPS72 The Relative Efficiency of Public

Schools in Developing Countries Emmanuel Jimenez August 1988 T. Hawkins

Marlaine Lockheed 33678

Vicente Paqueo

WPS73 Taxation and Output Growth in Africa Jonathan Skinner August 1988 A. Bhalla

60359
PPR Working Paper Series

Title Author Date Contact

WPS74 Fiscal Stabilization and Exchange Rate

Instability: A Theoretical Approach

and Some Policy Conclusions Using

Mexican Data Andrew Feitenstein August 1988 A. Bhalia

Stephen Morris 60359

WPS75 Welfare Dominance and the Design of

Excise Taxation In the Cote dlIvoire Shlomo Yltzhaki August 1988 A. Bhalla

Wayne Thirsk 60359

WPS76 On the Shadow Price of a Tax

Inspector Shlomo Yitzhaki

Yitzhak Vakneen

WPS77 Incentive Policies and Agricultural

Performance in Sub-Saharan Africa Bela Balassa August 1988 N. Campbel

33769

WPS78 Economists, Institutions and Trade

Restrictions: A Review Article J. Michael Finger

WPS79 Quantitative Appraisal of

Adjustment Lending Bela Balassa August 1988 N. Campbel

33769

WPS80 Emerging Issues of Privatization

and the Public Sector Samuel Paul September 1988 E. Madrona

61711

WPS81 Reaching People at the Periphery:

Can the World Bank's Population,

Health, and Nutrition Operations

Do Better? Richard Heaver

WPS82 Microeconomic Theory of the Household and Nutrition Programs Dov Chernichovsky September 1988 S. Ainswori

Linda Zangwill 31091

WPS83 Welfare Costs of U.S. Quotas in

Textiles, Steel, and Autos Jaime de Melo September 1988 C. Cabana

David Tarr 61539

WPS84 Black Markets for Foreign Exchange,

Real Exchange Rates and Inflation:

Overnight vs. Gradual Reform in

Sub-Saharan Africa Brian Pinto