metadata: authors: 0: author: Bannister,Geoffrey Joseph
count: Mexico
docna: 0: docna: Rent-sharing in the multi-fibre arrangement
            : the case of Mexico
docty: Policy Research Working Paper
subtopic: International Trade and Trade Rules,Transport Services,Crime and Society,Natural Disasters,Trade and Multilateral Issues
teratopic: International Economics and Trade
abstracts: cdata!: The author investigates market power and
            the distribution of rents in the market for Mexico's
            exports of apparel to the United States under the Multi -
            Fibre Arrangement (MFA). Conventional wisdom holds that
            voluntary restraints, such as those under the MFA, are
            superior to other kinds of trade barriers because they allow
            developing countries to receive the scarcity rents from
            quantity restriction. Recently a number of studies have
            questioned this orthodoxy. Erzan, Krishna, and Tan (1991),
            in particular, have pointed out that if market power exists
            only on the side of the importers, they can acquire some of
            the fixed rents resulting from quotas, in a form of
            "rent-sharing". In Mexico's case, rents
            resulting from MFA restrictions are probably small, since
            few of the quotas imposed are binding. And other
            institutional arrangements - such as production sharing
            under HTS 9802 and a liberal quota regime for goods made
            with U.S. inputs - further mitigate the MFA's
            restrictiveness. Mexican exporters probably receive only a
            fraction of available rents, says the author. The welfare
            implications of MFA restrictions, and of market
            imperfections that might lead to rent-sharing, are thus not
            as significant in Mexico as they might be in countries for
            which conditions are more restrictive. But even for the few
            rents generated in Mexico's case, some rent-sharing is
            taking place. The author tests the existence of perfect
            markets and rent-sharing for six groups of Mexican apparel
            exports to the United States between 1981 and 1990;
            sweaters, trousers, men's coats, women's coats,
            woven shirts, and underwear. There are consistent
            differences between the unit value of U.S. production and
            the Mexico export f.o.b. price of apparel in the U.S. market
            adjusted for tariffs and transport costs. The adjusted price
            of Mexican exports is consistently below the price for U.S.
            production, which suggests that rent-sharing may be taking
            place. Using modifications of the methods of Erzan, Krishna,
            and Tan (1991), the author tests alternative explanations
            for the price difference - differences in composition of
            Mexican exports and U.S. production, and differences in the
            quality of Mexican exports and U.S. products. The existence
            of differences in composition between Mexican exports and
            U.S. production is rejected for three of the six groups. The
            author also controls for the existence of significant
            quality differences. The results indicate that rent- sharing
            may exist for woven shirts and underwear (two of the three
            groups in the sample that are consistently quota bound).
            U.S. importers may receive up to 49 percent of available rents.
geo_reg_key: 119228,517191
repnme: repnme: Rent-sharing in the multi-fibre arrangement
            : the case of Mexico
display_title: Rent-sharing in the multi-fibre
            arrangement : the case of Mexico
listing_relative_url: /research/1993/09/698849/rent-sharing-multi-fibre-arrangement-case-mexico
topicv3: Transport m1326661 135,Trade m1326924 698,Criminal Justice m1326993 1014,Trade Policy and Integration m1327407 775,Quantitative Restrictions m1504269 2564
publishtoextweb_dt: 2010-07-01T00:00:00Z
historic_topic: International Economics and Trade
origu: International Economics Department
no_of_pages: 41
author_keys: 0: author_key: 873166
model_extractions: lnwafAonl _Trd_ WPS 1 191 This paper- a product of the Intemational Trade Division, Intemational Economics<sup>Department- is part</sup> of a larger effort in the department to analyze the effects of the Multi-Fibre<sup>ArrAngement on developing</sup> countries. The study was funded by the Bank's Research Support Budget<sup>under research project "Licence</sup> Prices and Rent Sharing in the Multi-Fibre Arrangement" (RPO 676-69). Copies of the paper<sup>are available</sup> free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact<sup>Aban Daruwala</sup> room S7-042, extension 33713 (September 1993, 35 pages).

Bamnister investigates market power and the distribution of rents in the market for Mexico's exports of apparel to the United States under the Multi-Fibre Arrangement (MFA).

Conventional wisdom holds that voluntary export restraints, such as those under the MFA, are superior to other kinds of trade barriers because they allow developing countries to receive the scarcity rents from quantity restrictions. Recently a number of studies have questioned this orthodoxy.

Erzarn, Krishna, and Tan (1991), in particular, have pointed out that if market power exists only on the side of the importers, they can acquire some of the fixed rents resulting from quotas, in a form of "rent-sharing." In Mexico's case, rents resulting from MFA restrictions are probably small, since few of the quotas imposed are binding. And other institu- tional arrangements such as productionsharing under HTS 9802 and a liberal quota regirne for goods made with U.S. inputs - further mitigate the MFA's restrictiveness.

Mexican exporters probably receive only a fraction of available rents, says Bannister. The welfare implications of MFA restrictions, and of market imrperfecdons that might lead to rentsharing, are thus not as significant in Mexico as they might be in countries for which conditions are more restrictive. But even for the few rents generated in MeAico's case, some rent-sharing is taking place.

Bannister tests the existence of perfect markets and rent-sharing for six groups of Mexican apparel exports to the United States between 1981 and 1990: sweaters, trousers, men's coats, women's coats, woven shirts, and underwear.

There are consistent differences between the unit value of U.S. production and the Mexico export f.o.b. price of apparel in the U.S. market adjusted for tariffs and transport costs. The adjusted price of Mexican exports is consistently below the price for U.S. production, which suggests that rent-sharing may be taking place.

Using modifications of the methods of Erzan, Krishna, and Tan (1991), Bannister tests altemative explanations for the price difference - differences in the composition of Mexican exports and U.S. production, and differences in the quality of Mexican exports and U.S. products.

The existence of differences in composition between Mexican exports and U.S. production is rejected for three of the six groups. Bannister also controls for the existence of significant quality differences.

The results indicate that rent-sharing may exist for woven shirts and underwear (two of the three groups in the samnple that are consistently quota-bound). U.S. importers may receive up to 4'I oercent of available rents.

The Policy Research Working Paper Series disseminates the findings of work under way in the Bank. An objective<sup>of the series</sup> is to get these findings out quickly, even if presentations are less than fuly polished. The findings, interpretations,<sup>and</sup> conclusions in these papers do i.it necessarily represent official Bank policy.

Produced by the Policy Research Dissemination Center
Rent Sharing in the Multi-Fibre Arrangement: The Case of Mexico by Geoffrey J. Bannister The World Bank, Washington, D.C.
# Rent Sharing **in** the Multi-Fibre Arrangement:

# The Case ot Mexico

# Geolfrey J. Bannisters The World Bank, Washington, D.C.

|.itroduction<br>..|I|
|---|---|
|1. Institutional Arrangements ....................<br>|5|
|1.1 Export Licensing**.................**|**5,.......,....5**|
|1.2 Trade Regimes ..................|5|
|2. Testing for Rent-Sharing ..............................<br>,<br>,<br>,|,<br>,<br>,<br>.<br>.. 10|
|2.1 The Data ...<br>.<br>.<br>.<br>|.10|
|2.2 The Price Differences ...<br>.<br>.<br>..|.<br>.. 11|
|2.3 Testing Differences in Composition .....................|**17**........|
|2.4 Testing for Fixed Differences in Quality ..............................|,<br>.,.,.<br>23|
|Conclusions ...........|29|
|References .............|30|
|Appendix: Data Sources and Calculations .............................<br>,.|,,.,.,,.31|

*This is part of a larger project at the World Bank to examine the effects of quota restriction in the MFA on developing countries. I would like to thank Kala Krishna and Will Martin for helpful comments on ar. earlier draft.
# Introduction

Voluntary export restraints (VERs) are widespread in world trade in textiles and apparel. About 80 percent of world trade in textile and clothing, chiefly from developing to developed countries, is restricted by voluntary export restraints through various bilateral agreements which constitute the Multi-Fibre Arrangement (MF'A). The MFA allows industrialized countries to negotiate quantitative restrictions on specific toxtile and clothing items with individual developing country exporters. Exporting countries administer the quantitative restrictions, and, according to the conventional wisdom, reap the benefits of restricted supply in the importing countries thrcugh higher prices.

A number of studies have recently questioned whether such benefits are really forthcoming. One approach points out the considerable welfare costs for exporters that may arise from the imposition of VERs.<sup>1</sup> A second approach, followed in this paper, looks at the implications of imposing VERs in imperfectly competitive markets. The customary view of VERs assumes perfect competition in both the exporter's market for quota licenses, and the importer's market for each developing country's export product, with monopoly power existing only at the level of the country as a whole. The main result of these assumptions is that prices are set by the market, both for export licenses and for VER-restricted products, but are exogenous to the exporters and importers. With perfect competition in the quota license market, the level of the rent (the q'iota premium), is also given exogenously to economic agents. The assumption of perfect competition thus simplifies the analysis considerably by ignoring the institutional details of market structure and quota administration IDe Melo and Winters (1990), for example, point out that there are considerable welfare costs for exporters that arise from the imposition of VERs. The first cost is the efficiency loss due to government intervention in quota allocation rather than allowing for a straight auction of export rights. Even more significant, however, is the loss from the misallocation of resources that results in production and factor markets, even in the absence of government intervent;on in the quota allocation mechanism. The contractionary pressure on the industry subject to a VER can force factors out of industries in which they are most productive, and hence lead to significant efficiency losses for exporters. These losses must be balanced against the rent transfers from abroad. An empirical evaluation of VERs on Taiwan exports of footwear to the US. by Hamilton, De Melo and Winters (1992) indicates that they result in a net welfare loss for exporters in spite of the rent transfer. Martin and Suphachalasai (1990) also point to potential losses from depressed prices in residual markets in the context of the MFA.
2 Mexico MFA that affect the market price under imperfect competition. When<sup>we allow for imperfect competition,</sup> however, the institutional details of price setting become essential<sup>to any investigation of the quota</sup> restrictions. Allowing for the possibility of market power, either in<sup>the market for export licenses on</sup> the supply side or on the part of US. retaile:s on the demand<sup>Fide, has implications for the existence</sup> and distribution of rents that accrue from the MFA between<sup>exporters and importers.</sup> The theoretical aspects of imperfect markets in quota all3cation<sup>and the effects of VERs in</sup> imperfectly competitive markets have been studied by Krishna (1990, 1992),<sup>Krugman and Helpman</sup> (1989), and empirically investigated in Aw (1992), Erzan, Krishna and<sup>Tan (1991, 1992) and Krishna</sup> and Tan (1992). Erzan, Krishna and Tan describe the implications<sup>of imperfect competition for the</sup> distribution of reints under the MFA. They make the crucial distinction between<sup>"rent-appropriation"</sup> and 'rent-sharing." When exporters have market power, they can<sup>set product prices to appropriate</sup> scarcity rents that accrue from quota restrictions. In this case, the<sup>size of the quota premium, (equal</sup> to the value of a license to export one unit of the quota restricted<sup>good) is det;rmined by the exporLer.</sup> Erzan, Krishna and Tan call this rent-appropriation. In contrast,<sup>when market power is on the</sup> buyer's side, the quota premium is a result of conditions in the quota<sup>restricted market, and is</sup> exogenous for both the exporter and the importer. The importer can then<sup>use market power only to</sup> extract some share of the fixed quote -ent. 'Vhen this occurs, the<sup>value of a license to export one unit</sup> of the quota constrained good will fall short of the quota premium, and hence<sup>only a fraction of the</sup> possible quota rent will accrue to the exporter. This is referred to as rent-sharing.<sup>Erzan, Krishna</sup> and Tan (1991) devise econometric tests for the presence of rent-sharing<sup>under imperfect competition,</sup> and apply them to Hong Kong exports of clothing to the US. restmcted<sup>under the MFA. They</sup> estim 3 the extent of rent-sharing, and find the potential rent was split unevenly<sup>between the U.S.</sup> and Hong Kong, with the U.S. share ranging from 48 per cent for skirts<sup>to 94 per cent for play suits.</sup> This paper investigates the case of Mexico's exports of apparel to the<sup>U.S. under the MFA.</sup> As the fifth most important exporter of apparel into the U.S. market, Mexico<sup>should be part of any</sup> study that measures the distribution of rents accruing from the MFA. Because<sup>of the institutional</sup> arrangements that govern trade between the U.S. and Mexico, however, Mexico presents<sup>a particular</sup>
Mexico MFA 3 chIlenge. First, there is no organized market for export licenses in Mexico, and hence no explicit export license price.<sup>2</sup> Quota constrained exports are allocated to potpntial exporters on a historical basis. The implication of this arrangement is that there may be a high degree of concentration in the quota allocation for those products in which the quota is binding. Second, Mexican exports of apparel to the U.S. are influenced by market sharing arrangements that allow assembly of apparel in Mexico using U.S. inputs for: ,-export to the U.S. This trade may be within the same firm with operations in both the U.S. and Mexico, or may be the result of subcontracting arrangements between U.S. firms and Mexican assembly operations. Either of these ariangements has implications for export pricing strategies and market power relationships that affect rent-sharing. Third, even the quotas negotiated under the MFA have liberal provisions under an arrangement which essentially eliminates the restrictiveness of the MFA for Mexican exports produced with U.S. inputs. This arrangement, known as the Special Regime, went into effect in 1989, and clearly has some influence on whether quotas are binding and whether rents exist. Finally, it should also be noted that very few of the quotas imposed on Mexican exports are actually binding, so thLt even excluding the effects of the institutional arrangements described above, the potential rents accruing from MFA export restraints are probably very small. Thus, the welfare effects of quota restrictions on Mexican exports, and of market imperfections that might lead to rent sharing, are probably not large. Nevertheless, this case provides a suitable test for the existence of perfect markets and rent-sharing, with some bearing for a more sober assessment of the effects of MFA restrictions on developing countries.

The first section of this paper contains a description of the institutional arrangements that affect Mexican exports of apparel to the United States under the MFA and their implications for the existence and distribution of rents. The second section investigates the existence of rent-sharing more directly by comparing the price of Mexican apparel exports to the United States under the MFA with U.S. prices for similar g-:ds. Under the assumption of perfectly competitive output markets, arbitrage in the. iporter's n', (i.e. in the U.S.) will lead to these two prices being cqual 2Thc transfer of export rights is illegal, and there is no evidence of informal mnarkets for these.
t

# Mexico MFA

(assuming that impons are sufficiently close substitutes for home production), since the Mexican price of exports includes the implicit valu of a license to export the quota restricted product. Any difference between the two prices could be an indication of rent-sharing. The data indicate that Mexican export prices are consistently below the price of U.S. production. However, there are .0ternative explanations for these price differences. Chief among these is the difference in the composition of the groups of Mexican exports and U.S. production, or differences in the quality of the two products. Subsequent sections test for these differences and find that only in three of the six groups of apparel tested can differences in composition be definitively ruled out. Rent sharing estimates for two remaining groups that are quoa bound indicate that, when differences in quality are accounted for, U.S. retailers may have received up to 49 cents of every dollar in rents.
S Mexico MFA

# 1. **Institutional Arrangements**

# **1.1 Export l3censing**

Textile and apparel exports from Mexico to the U.S. under the MFA are restricted by visas which allow Mexico exports to pass through U.S. custonms. They are not restricted at the point of exit by Mexican customs officials. The export visas **aLe** distributed by Mexican officials according tc the amount of quota negotiated under the MFA. First prioritv to fill the quota is given to firms that exported in the previous year. Any left over quota is distributed to new entrants in the market. After the initial allocation, firms can increase their share of quota when there is unused quota quantity available, and when **tne** firm can show that it has alreadv exported 70 percent of -ts initial allocation. Visas are specific to a particular consignment, and are valid from the date of ibsuance until December 31 of the same year.

What are the implications of this arrangement? The fact that the initial allocation of export permits (visas) does not take place through an auction mechanism meals tiat any rent created by the export restrictions benefits the exporter rather than the government. further, since visas are distributed on a historical basis it is probable that significant concentration exists in the distribution of these rents. Although there is no market for export permits, there is an unobservable iniplicit valuation the exporter confers on the export visa, which is equal to the amount he/she would be willing to pay for the right to export. To the extent that quotas are bindIng, this shadow price is positive, although it will vary from firm to firm. If quotas are not binding, the implicit price is zero. For a binding quota, this implicit price will be equal to the quota premium or the unit rent created by the quantity restrictions, and will be included in the F.O.B. price of Mexican exports to the U.S. that are restricted under the MFA.

# **1.2 Trade** Regimes

Two different institutional arrangements operate to diminish the trade barriers to Mexican apparel exports entering the U.S. The first of these is the provision under chapter 9802.00 of the harmonized tariff schedule (HTS 9802.00) that allows for special treatment of goods assembled in
6 Mexico MFA Mexico from U.S. components. This provision<sup>allows American apparel firms to export cut cloth fcr</sup> assembly in Mexico's in-bond industry (the<sup>_maquiladora_industry) and re-import the final goods,</sup> paying tariffs only on the value added in Mexico.<sup>In most cases, the facilities in Mexico used for</sup> assembly are owned by U.S. firms, so that<sup>Mexican apparel exports entering the U.S. under HTS</sup> 9802.00 consticute movements of goods within<sup>the same firm, even though they Are registered as</sup> imperts into the U.S. under the MFA (USITC,<sup>1991). HTS 9802.00 is essentially a tariff provision,</sup> but it has implications for rent sharing. If<sup>rents exist, then U.S. firms with assembly operations in</sup> Mexico owning a large snare of the quota will<sup>be the principal beneficiaries of the quota restrictions.3</sup> The evidence in Table 1 shows that for Mexican<sup>apparel exrports to the U.S. this is probably the case.</sup> From 1988 to 1991 between 85 and 90 percent<sup>of all Mexican appare' exports under the MFA entered</sup> the U.S. under HTS 9802.00 provisions, with<sup>between 60 and 70 percent of their value added in the</sup> U.S.

Table **1.** Percentage of MFA Exports from<sup>Mexico to the U.S.</sup> Entering Under HTS 9802.00

||1988||1989||1990||1991||
|---|---|---|---|---|---|---|---|---|
|||U.S.||U.S.||U.S.||"J.S.|
||9802.00|Value<br>Added|9802.00|Value<br>Adided|9802.00|Value<br>Added|9802.00|Value<br>Added|
|AllMFA|72.2|69.3|76.87|61.5|73.2|65.7|75.5|66.2|
|Apparl|84.9|69.4|90.68|61.5|88.32|66.3|89.52|66.3|
|Other|28.3|68.9|30.08|61.5|28.01|63.5|29.27|66.01|

Source: U.S. Department of Commerce, Office of Textiles.

The second institutional arrangement affecting<sup>Mexican exports of apparel into the U.S. is a</sup> special provision of the MFA known as the Special<sup>Regime. It effectively eliminates quotas under the</sup> MFA for apparel assembled in Mexico from<sup>fabric cut and formed in the U.S. The test for eligibility</sup> for the Special Regime quota treatment is more<sup>stringent than that for HTS 9802.00 tariff provisions</sup> 3This is not a case particular to Mexico. Large U.S. importers that also manufacture and assemble appaiel overseas, such as Liz Claiborne, often<sup>have claims to large fractions of available quota in developing countries.</sup>
7 Mexico MFA since the former requires that fabric be formed and cut in the U.S. while the latter only requires the cutting to take place in the U.S. Although Special Regime quotas a, e often filled, they are administered in such a way that utilization rates have been allowed to exceed 100 percent. Thus it may appear that rents exist for those exports that entei the U.S. under the Special regime vhen, in fact, **no rents** are being generated. The special regime was instituted in 1988, although it only became effective in 1989. In 1990, **43.5** percen; of apparel exports fromn Me- ico into the U.S. under the **MFA** entered under the Special Regime.4 In addition to the special regime, there are different quota arrangements within the MFA that affect the restrictiveness of tht quotas. rhere are three types uf quotas: specific limits, desigi .ed levels, and consultation mechanisms. A specific limit quota is a quantity constraint which increases at a fixed rate per year (in most cases six percent, with the exception of cotton fiber which increases at two percent per year). If the quantity restriction is met, then a specific limit quota is binding. A designated level is an informal barrier whose restrictiveness depends oin the discretion of the administrators of the quota in the United States. Mexican officials can request an increase in the quota for a specific year which may or may not be granted depending on the 'J.S. administrator's judgment as to what effect this will have on the U.S. market.<sup>5</sup> Finally, consultation mechanisms inpose no quantitative limit, but establish a mechanism by which the U.S. can consult with Mexico when exports are perceived to be affecting the U.S. market adversely. In practice, these consultat;on mechanisms have not been binding.

The arrangements described above affect a very large proportion of Mexican exports of apparel to the United States. Table 2 shows how " ay affect the groups of apparel that have been most bound by quota arrangements between 1981 and 1990.6 The first column shows the average rate of quota utili7ation (quantity of exports/quota). In general, a consistent quota utilization rate of 90

> 4For **a** more detailed description of these arrangements and their implications for textile trade under the North American Free Trade Agreement, see Bannister and Low, (1992).

5According to officials from the Department of Commerce, there are some MFA categories in which petitions for increase of the design'ted levels have been denied, so that there is reason to believe that at least in some cases these quotas are binding also.

> **6The** composition of these groups is discussed in the Appendix.
8 Mexico MFA percent or above may be considered to indicate that the quota is binding. The groups in Table 2 are aggregations of M.FA categories, some of which were quota bound and some of which were not. In addition, not all groups were bound in all years. The most consistently bound groups were trousers, woven sh'rts and linderwear. Of the groups presented only sweaters did not have a significant component of exports entering the U.S. under HTS 9802,00; between 80 and 90 percent of the exports of all other groups entered under HTS 9802.00, with an average value added in Mexico between 43 percent for shirts and 22 percent for unierwear. This suggests that some of the rents accruing from the MFA in these producL. are captured by U.S. firms assembling apparel in wMexico. Under type of quota, all w re subject to either designated consultation levels or specific limits, except for sweaters, which were only subject to consultation mechanisms.

Trousers, woven shirts, and underwear, being the most tightly constrained groups of exports, are probably where the rents, if any, are being generated.<sup>7</sup> Yet, as shown in the last column of Table 2, a high proportion of these exports in these groups entered the U.S. under the Special Regime and thus are eftectively not bound, at least from 1989 on. Table 2 thus reinforces the contention that available rents from MFA quota restrictions are small, and under the most optimistic assumption that exporters receive all the rent, Mexican producers still capture only a portion.

7In the analysis that follows we consider these to be the quota bound groups.
Mexico MFA 9 Table 2. Summary data for Apparel Exports

|Group|Average<br>Quota|Average<br>Percent of|Average<br>Percent|Type|Average<br>Percent|
|---|---|---|---|---|---|
||Utilization|MFA under<br>9802|Value<br>Added|of<br>Quota|Special<br>Regime|
||(1981-90)|(1987-90)|inU.S.||(1988-90)|
|1. Sweaters<br>|38.10|1.20|33.00|cm|00.00|
|2.Trousers|70.70|83.10|67.30|di/sI|83.70|
|3. Men's Coats|42.90|88.20|65.50|dl|4.60|
|4. Women's Coats|51.80|80.10|70.10|di/sl|29.20|
|_5._Woven Shirts|63.40|89 70|57.70|sI|74.20|
|_6._Underwear_|59.30|82.30 _|78.30|dl/sl|59.70|

S,urce: World Bank data tapcs and U.S. Department of Commerce data.

cm-consultation mechanism; dl-designated level; sl=specific limit.
Mexico iFA 10

# **2. Testing tor Rent-Sharing**

# **2.1 The Data**

**Thc** data used for this study are similar to those used by Erzan, Krishna and Tan (EKT). Because of conflicting classification systems between U.S. data and MFA import data the categories used were aggregated in the same fashion as the EKT data, choosing groups of apparel that minimized **the** differences between U.S. production groupings and aggregate MFA category groupings. Six industry groups were examined: sweaters, trousers, men's coats, women's coats, woven shirts, and underwear.8 The data include observations for the following variables from 1981 to 1990, where j indicates the apparel group, and t indicates the year:

**pitUS=** the unit value of U.S. production.

- pjt<sup>m</sup> = F.O.B. price of apparel imports from Mexico.

- tjt = Ad valorem tariff in the U.S.

- Tit = Unit transport cost from Mexico to the U.S.

- **pitm** = Adjusted Mexico price, where pjtm = pjtm (1 +tj ) + Tjt _9_

- **QjUS** = U.S. sales of U.S. production.

- **Qitm** e Mexican exports to the U.S. market.

- Hjt = Numbers equivalent of the Herfindahl index of concentration among Mexican exporters.

- Vit = Quota level for Mexican exports to the U.S.

- Uit = Quota utilization rate defined as Ui, = Qjtm /Vit

The sources and composition of these data are found in the data appendix.

tThe composition of these groupings in terms of MFA categories is explained in the appendix. 9A further adjustment was made to the unit value of Mexican exports to take into account the lower tariff rates levied on imports with a high proportion of U.S. content under the production sharing arrangements codified in HTS 9802.00.
11 Mexico MFA

# 2.2 The **Price** Differences

As mentioned above, the implicit valuation of the quota rents is included<sup>in the Mexican</sup> F.O.B. price of exports to the U.S. Thus, we can test for rent-sharing<sup>by comparing the unit value of</sup> U.S. production with the Mexican F.O.B. price, appropriately adjusted<sup>for tariffs, transport costs,</sup> and HTS 9802 tariff concessions. Arbitrage in the U.S. market<sup>will cause these two prices to</sup> equalize if markets are competitive and all goods are homogeneous within<sup>each group. It is</sup> reasonable to assume that Mexican exporters are small, and therefore<sup>price-takers, in the U.S. market.</sup> However, if U.S. importers have monopsony power, this can lead to rent-sharing,<sup>if they can</sup> maintain a lower price for their imports than they pay for U.S. production.

Chart 1 plots the adjusted Mexican F.O.B. price on the vertical axis against<sup>the U.S. price on</sup> the horizontal axis for all six groups of products examined in this study. The<sup>arrow represents the</sup> forty-five degree line. The chart clear!y shows that there is a significant difference<sup>between the two</sup> prices. The U.S. price is above the Mexican price in almost every instance,<sup>inaicating that either</sup> sustained quality or composition differences or rent-sharing may<sup>exist. To test the significance of this</sup> difference, the following regression was run using time series data from<sup>1981 to 1990, pooled over</sup> the six apparel groups: At this point the variation over groups of apparel is not considered,<sup>and so a is maintained constant.</sup> As Erzan, Krishna, and Tan point out, in this equation, the right hand<sup>side variables can be</sup> considered exogenous to the Mexican exporter. If there is no rent<sup>sharing, and markets are perfectly</sup> competitive, and if all goods are assumed homogeneous within g,oups,<sup>then pj,m=pjtUs.</sup> In this case we expect the coefficient on the U.S. price not to be significantly different from<sup>one, and all other</sup> parameters not to be significantly different from zero. If, on the other hand,<sup>rent sharing exists,</sup> implying monopoly power on the part of U.S. importers, or the assumption<sup>of homogeneous goods is</sup> violated (by differences in quality or composition, for example), then<sup>we expect the coefficient on pul</sup>
12 Mexico MFA to be different from unity, and the coefficients on<sup>the other variables to be significant. Hjt, the</sup> numbers equivalent of the Herfindahl index, is an indicator<sup>_cf_concentration in export license holdings</sup> among Mexican exporters.<sup>10</sup> All other things being<sup>equal, an increase in concentration will afford</sup> Mexican exporters greater bargaining power vis-A-vis<sup>U.S. importers, allowing them to retain a</sup> higher share of the rent,<sup>11</sup> In this case, we expect the<sup>coefficie.,: on the Herfindahl index to be</sup> positive. The quota level VjP, and the rate of quota<sup>utilization</sup><sup>**Ujt,**reflect conditions in the supply of</sup> export licenses and the restrictiveness of the quota.<sup>All other things being equal, we expect an</sup> increase in the quota level to reduce the implicit export<sup>license price and hence for the coefficient on</sup> this tern to be negative. An increase in the utilization<sup>rate, on the other hand, will make export</sup> licenses more scarce, and hence increase their implicit<sup>price. Under the hypothesis of rent-sharing,</sup> we thus expect the coefficient on Uj, to be positive.

> 10ITe numbers equivalent of the Herfindahl index is calculated as liZ si where si is firm i's share of license holdings. In our application the shares are weighted<sup>by the number of firms in each apparel group. See the</sup> Appendix for details. IlIn the extreme case where there is one monopsonist importer in the U.S. and all import licenses are<sup>held by</sup> one exporter in Mexico, Erzan, Krishna and<sup>Tan (1991) show that if the license price is determiined</sup> by the outcome of a Nash bargaining process, the license<sup>price is proportional to the level of the exporter's bargaining</sup> power.
Mexico MFA 13 <!-- Start of picture text --> Figure 1<br>Scatter Plot, All Apparel Groups<br>Mexico (Prie per unit in U.S. dollars)<br>30.00 45 dog.<br>25.00<br>20.00<br>15.00<br>10.00 * ,E.<br>5.00-<br>0.00 I I I I<br>0.00 5.00 10.00 15.00 20.00 25.00 30.00<br>United States<br><!-- End of picture text -->
14 Mexico MFA

**Table 3a. Regression Results for Equation 1 -** Linear **Specirlcation.**

|Independent<br>Variables|All Groups|Bound Groups<br>(2,5,6)|Unbound Groups<br>(1,3,4)|
|---|---|---|---|
|Intercept|**_2.4515A _**<br>**(0.5964)**|0.6050**b**<br>**(0.3146)**|4.6597**a**<br>**(0.9263)**|
|Pjtu'<br>.______________|0.4094**9**<br> <br>**(0.0257)**|0.4676**A**<br>(0.0310)|0.4474**A**<br>**(0.0478)**|
|**ujt**<br>_______________________|-0.8343<br>**(0.9247)**|**-0.2752**<br>**(0.4502)**|-2.483**c**<br>**(1.4850)**|
|**Vjt**|-2.29 X**10-8**<br>(2 X**108)**|<br>-6.79 X**10-9**<br>**(I X lo-8)**|6.21 X**10i7**<br>**(7X 10-7)**|
|**Hijt**|**-0.0012**<br>(0.0022)|0.0029<br>(0.0011)|-0.0153**b**<br>**(0.0075)**|
|Adj. R<sup>2</sup>|0.872|0.942|0.775|
|# observations|60|30|30|
|t Test,=_1|-22.89 reject '|-17.16 reject**A**|-11.5 reject**a**|
|F Test, ,=1 and|338.71 reject '|292.09 reject&|268.81 reject '|

Standard errors in parentheses. **A** Significant **at 1** percent.

**b** Significant at **5** percent. **c** Significant at 10 percent.

Table 3a presents the results of running regression (1) on all groups, the<sup>quota bound groups</sup> and non-bound groups.<sup>12</sup> The first significant result is that for all three<sup>regressions the hypothesis of</sup> perfect competition (3=1 and a=y=5=4=0) and the<sup>hypothesis that the coefficient on the U.S. price ,B</sup> is equal to one, are both rejected. While this does not confirm<sup>the existence of rent sharing, it is</sup> consistent with the rejection of the hypothesis of perfect competition in the<sup>market for Mexican export</sup> to the U.S. in these groups of apparel. The intercept<sup>and the coefficient on the U.S. price are</sup> significant in all three regressions. In this context, the intercept<sup>can be interpreted as refiecting the</sup> effects of any fixed difference between the two prices common<sup>to all groups of apparel (the "fixed</sup> component"), and the coefficient on the U.S. price reflects<sup>the change in the Mexican price for every</sup> 12Tbe definition of the groups is based on the data in Table 2.
_15_ Mexico MFA unit change in the U.S. price, all other hings held equal (the 'marginal component"). 13 The fact that the intercept and the coefficient on the U.S. price are significant in all three regressions does not allow us to say anything about the probable cause of the price differences. It is interesting to not, however, that the fixed component on the bound group is significantly lower than the one on the unbound group, although the marginal components are similar in magnitude.1<sup>4</sup> One obvious possible interpretation for this is that at least part of the difference between the two prices is being captured by exporters in Mexico in the form of quota rents, reflected in a higher price of Mexican exports. This interpretation is supported by the coefficient on the numbers equivalent of the Herfindahl index, which is positive and significant for the bound group, but negative and significant for the unbound group.

To test the robustness of the results in Table 3a, an alternative specification of the model in the logarithms of the variables was used. Under this specification, the coefficient on the log of the U.S. price can be interpreted as an elasticity of price transmission, while the other coefficients can be interpreted as elasticities reflecting the effects of the different characteristics of the quota-license market on the Mexican FOB price. The constant term can be interpreted as a proportional shift parameter. To determine whether the log specification is superior to the linear specification in (1), a Box-Cox test for model specification was used. 1<sup>5</sup> The test consists of comparing the sum of squared residuals of the two models after performing a simple transformation of the data. The sum of squared residuals for the linear specification was 4.163. For the log-linear specification it was 2.289. We thus can conclude that the log-linear specification fits the data better.

The results of the regression in logs are presented in Table 3b. As before, the hypothesis of perfect competition (p = 1 and a;y=y-4=0) is rejected for all three regressions. However, it is

> 13Later in the paper we allow the intercept to vary across groups to explore the possibility that the fixed component can be explained by group-specific fixed differences in quality between U.S. production and imports from Mexico.

14Chow tests were run to see if the coefficients for the bound and the unbound groups were significantly different from each other. Tle tests rejected the null hypothesis that there was no difference between the groups at the one percent level.

15For a description of the Box-Cox test see Maddala (1992) p. 220 or Fombv et al. (1984) p. 423.
16 Mexico MFA interesting to note that the hypothesis for P = 1 cannot be rejected for the unbound groups. In contrast with the linear specification, the intercept terms cease to be significantly different froin zero. However, the coefficient on the log of the U.S. price is significant at the one percent level for all groups, **and** the coefficient on the log of the utilization rate is significant at the fire and ten percent level. The log of the Herfindahl index is significant and negative at the five percent level for the unbound groups. Although it is difficult to interpret the negative coefficients on **Uit** and Hjt , these results are not inconsistent with those of the linear moecification, or with the hypothesis of rentsharing for the bound groups of apparel.

**Table 3b. Regression Results for Equation 1 - Log-linear Specification.**

|Independent<br>Variables|All Groups|Bound Groups<br>(2,5,6)|Unbound Croups<br>(1,3.4)|
|---|---|---|---|
|Intercept|0.2639<br>(0.4178)|0.3082<br>(1.1384)|0.9294<br>(0.9968)|
|**logpjtus**|0.8090 A<br>(0.0491)|0.8027**a**<br>(0.0450)|0.8752**a**<br>(0.1209)|
|log Ujt|-0.0995**c**<br>(0.0660)|-0.1003**c**<br>(0.0735)|-0.1776b<br>(0.1012)|
|log**Vjt**|-0.0244<br>(0.0248)|-0.0525<br>(0.0552)|-0.0166<br>(0.0857)|
|log Hjt|-0.0211<br>(0.0583)|0.0759<br>(0.0674)|-0.2501b<br>(0.1293)|
|Adj. R<sup>2</sup>|0.939|0.976|0.735|
|# observations|60|30|30|
|**t**Test,P=1|-3.889 reject a|4.377 reject**a**|-1.031 cannot reject '|
|F Test, P=1 and|97.093 reject**a**|97.096 reject '|49.113 reject '|

Standard errors in parentheses. **a** Significant at 1 percent. b Significant at 5 percent. **C** Significant at 10 percent.
17 Mexico MFA

# **2.3** Testing Differences in Composition

Although the results in the previous section seem to indicate the possible existence of<sup>rent</sup> sharing, there are other porible explanations for the difference between the Mexican export price and the U.S. price. One possible explanation is a difference in the composition of the groups of apparel, with Mexican exports concentrating on the lower value MFA categories that make up the groups,<sup>and</sup> U.S. products concentrating on the high value end. As explained in the data appendix, each of the groups examined is an aggregation of categories in the MFA export data and different categories<sup>of</sup> U.S. production data. The problem faced when attempting to compare the unit value of U.S. production to the unit value of Mexican exports under the MFA is that at the most disaggregated levels the two category groupingc are not compatible. In aggregating Lhem to the more comparable group levels, some compositional bias is inevitable, and it may show up in the marginal rent-sharing parameter f3, the coefficient on pjtur, or in the intercept term. This section tests whether the price differences detected above can be explained entirely by this compositional bias. If composition bias cannot be ruled out, then the assumption of homogeneous product groups cannot be maintained<sup>and</sup> some accounting for product differences must be made.

The procedure for testing compositional differences follows that of Erzan, Krishna, and Tan (1991), with some modifications to allow for a more efficient estimation of the parameters<sup>and to</sup> explicitly test the assumptions underlying the test procedure. The aggregate prices can be decomposed into their production weighted components as follows: where the subscript i refers to the category belonging to apparel group j. Qijus is the quantity of<sup>U.S.</sup> output in category i of group j, and **QJUu** is total output in group j. Hence wijUs is the quantity weight cF category i in group j of U.S. production. Similarly, for Mexico: (3) pj<sup>m</sup> (Qj/Qj) = i Wij, i= ,...,n, j=1,...,6. i I
is Mexico MFA The difference between the Mexican export F.O.B. price and the U.S. unit value of production at the group level can then be expressed: Data only exist for pjm, pjus, pfm, axid wim. To get around this problem we assume that the<sup>following</sup> relationship holds for each sub-group (MFA category) i within each group j: _(5)_ pj<sup>m</sup> **=** cj + p,jPiUs + P2jXjj + edj . where Xij is a general term for the independent variables included in equation (1): the level of the quota, the utilzation rate, and the Herfindahl index of concentration in export supply. Note that we assume a, Pl, and P2 are constant over all the members of each group j. Solving for pjus and substituting into (4) yields: where yj = cj/plj , 8j = I/Plj , and<sup>**8**</sup> **2j** = P2j/Pjj . With one key assumption we can estimate equation (6) and test the coefficient on pijm to see if the composition effect is statistically significant. The assumption is that<sup>**8**</sup> **2j** = 0 for all j, that is, that the change in the Mexican export price is entirely determined by the change in the U.S. price, and variables such as quota levels, quota utilization, and concentration have no systematic effect. This seems to be a strong assumption, but it is borne out in the aggregate by the results of estimating equation (1) for all groups. Introducing this assumption, the regression equation then becomes: where 00 = (wijm - **8iwiju),** and uj = 8iIZwijuseiJ In order for E(uj) = 0 and the regression to be well specified, we have to make the additional assumption that the E(wije1j) = 0, that is , that the U.S. quantity weights and the error term are independent random variables.
Mexico MFA 19 To test for significant differences in the U.S. and Mexican category weights wUus and wijm, a compositional bias, it is necessary to impose the additional restriction that 8Si, the marginal component of the price relationship in each group, is equal to 1. 16 When this is the case, the sum of the coefficients on the p1 m terms in equation (6') is equal to zero, since wijm = wiju = 1 . We can test the validity of this restriction using a joint F test on the coefficients of the pijm terms in (6').

If the test cannot reject the hypothesis that ejj = 0, then we take this to be sufficient evidence that i

> **81j** = 1. At this point we can examine the significance of the individual 9ij coefficients for evidence of a composition effect, that is, a difference between wijm and wij". In addition, we can test the joint hypothesis that all the 90 coefficients are equal to zero for further evidence of a composition effect.

If the hypothesis that £ j = 0 is rejected, then we could bring more information to bear on the problem. In particular, we can take advantage of the fact that we know wijm to test for the difference directly. First, note that an estimate of 81i can be obtained from the estimates of the coefficients Oij:

- (7) °lj = I- ;@ i

so that for each individual category we can estimate the U.S. share as:

# (8) Wj

We want to test whether wijuS is significantly different from wijm, that is, whether

- 16Erzan, Krishna and Tan (1991) assume that this restriction holds, but do not test it explicitly.
20 Mexico MFA (9) wom - h_, eij If the hypothesis in (9) is rejected then significant compositional differences exist. Unfortunately (9) is a nonlinear hypothesis that depends on the distribution of wijm, and is very u`fficult to implement. However, evan without testing (9) we can still obtain estimates of<sup>8</sup> 1j and examine their significance.

The regressions in (6') were run together in a seemingly unrelated regression framework to correct for contemporaneous correlation of the error terms due to exogenous shocks that might affect them in a similar manner. It seems likely that in the case of Mexico during the 1980s, such correlation exists.<sup>17</sup> If contemporaneous correlation does exist, then the seemingly unrelated regression framewrrk will yield more efficient estimates of the coefficients."s Table 4 presents the results of regressions (6'). Differences in composition seem to be indicated by significant e coefficients in group 1 at the one and five percent significance level, in groups 2 and 3 at the ten percent level, and in group 4 at the five percent level. However, without testing whether 81j= 1 in each group we can have little confidence in these coefficients as indicators that a composition effect is at work. Table 5 presents the results of F tests. The first column tests for the existence of a marginal effect, that is if 81j is different from one, which is implied when the sum of the 0jj coefficients is not equal to zero. Column two tests for the composition effect, that is if each theta coefficient is different from zero. Column three tests for the existence of rent-sharing; the joint hypothesis that both the intercept (the fixed rent sharing effect) and all the e coefficients (which include<sup>8</sup> 1j , the marginal component) are equal to zero. If the hypothesis of in column one is not rejected, then we can interpret the results of the tests in columns two and three. If it is rejected, we cannot continue, since a marginal component 81j not equal to one could cause us to erroneously reject the hypothesis that no cornposition effect exists.

The hypothesis of no marginal effect (51j = 1) can be rejected for groups 2 and 4. Of the 17Economy wide events such as the debt crisis in 1982 and the subsequent imposition of exchange controls are typical events that might lead to contemporaneous correlation of the error terms. I<sup>t</sup> For a discussion of the relative efficiency of seemingly unrelated regression estimates versus OLS estimate **s** ee Fomby, Hill, and Johnson, (1984), pp. 155-166.
Mexico MFA 21 remaining groups 1, 3, 5, and 6, only in group 1 was the hypothesis that no composition effect was at work rejected. For groups 1, 3, 5, and 6, the hypothes.s that no rent-sharing was in effect could be rejected. Under the most conservative assumptions, then, we can test for rent-sharing only in groups 3, 5, and 6 with the assurance that no composition effect will bias the results.
22 Mexico MFA

**Table 4. Coefricients** on **the** Regressicns Testing **for** the Composition **Effect**

|Group 1|-4.412<br>**(4.0 61)**|1.178**a**<br>**(0.3018)**|0.638'<br>**(0.160)**|-0.537**&**<br>**(0.1536)**|0.579c<br>**(0.3496)**|0.409<br>**(1.0833)**|
|---|---|---|---|---|---|---|
|Group 2|1.131<br>(1.8777)|-0.428<br>**(0.4093)**|-0.011<br>(0.0201)|0.053<br>(0.0355)|0<sup>.</sup>88 8 <sup>**b**</sup><br>**(0.4239)**<br>_|___|
|Group 3<br>___________|2 3 <sup>.</sup>0 59 <sup>b</sup><br>**(8.3124)**<br>|-1.5 54 b<br>1**(0.8387)**|0.010<br>**(0.0484)**|||____.__|
|Group 4|22,570 A<br>**(4.1507)**<br>|4 5 <sup>72b </sup><br>**(0.2117)**<br>|0..129<br>**(0.1340)**||||
|Group 5|5.896 <br>**(3.4188)**_|0.076<br>**(0,2967)_**|-0.498<br>**(0.3835)**|-0.039<br>**(0.0299)**|0.011<br>**(0.0483)**|-0.065<br>**(0.4308)**|
|Group 6<br>____<br>|0.173<br>_<br>___(0.1608)i<br>|0.27A<br>(0.2363)<br>|-0.082<br>(0.1146)||||
|System wei<br>Standard er<br>' significan|ghted**R**<sup>**2 **</sup>**=**0.8<br>rors in parenth<br>t at the one per|142.<br>^":.<br>ce:rt level.|||||

b significant at the five percent level.

**C** significant at the ten rercent level.

Table S. F-Tests for Composition Effect

|Ho:|Ho=°<br>0ij|0|yj+<br>aO|
|---|---|---|---|
|_ _ _ _ _<br>_ _ _ _|No Marginal Effect<br>_ _ _ _ _ _<br>_ _<br>_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _E|No CoEDosition<br>ff'e ct_|No Rent Sharing<br>_<br>_<br>_<br>_<br>_<br>_<br>_<br>_|
|Group I|F(1,34) = 3.559<br>cannot reject|F(5,34) = 15.71<br>reject|F(6,34)=22.25<br>reject|
|Group 2|F(1,34)=2895<br>reject|(?)<br>__|(?)|
|Group 3|F(1,34)=3.860<br>cannot reject|F(2.34)=2.194<br>cannot reject|F(3,34)=25.111<br>reject|
|C.roup 4<br>_______|F(1.34)=7.287<br>_______________<br>reject|(?)|(7)|
|Group 5|F(1.34)=0.638<br>cannot reject|F(5,34)= 1.721<br>cannot reject|F(6,34)=40.774<br>reiect|
|Group 6|F(1,34)= 1.550<br>canmot reject|F(2,34)=0.824<br>cannot reiect|F(3,34)= 13.534<br>reject|

Note: All rejections are at the one percent level. Failure to reject **is at** the five percent level.
23 Mexico MFA

# **2.4 Testing tor Fixed Differences** In Quality

Another factor that might explain the difference between the price **of** U.S. production and the Mexican adjusted F.O.B. import price is a difference in the quality of the apparel. If Mexican imports are perceived to be of lower quality, they will receive a lower price. Mexican exports will then be imperfect substitutes for their U.S. counterparts, and the assumption of homogeneous products must **be** dropped. **A** test for the possible existence of differences in quality can be developed by first assuming that such differences are constant over time. It is then possible to control for the unrneasurable fixed difference in quality between U.S. and Mexican products in each group (that is, the proportion of the spread between the price of the two products that is d.te to fixed differences<sup>in</sup> quality), by inserting group-specific dummies in equation (1). In addition, including a time trend, Tt, captures any constant change in the quality difference between the two periods. At this stage, we drop groups 1, 2, and 4, since composition effects cannot be ruled out in these products. The regression equation for the remaining groups is: where D3 and **D5** are the dummies for the respective groups. Under this specification, the constant term **a6** is equal to _a'_ + PZ6, where a' is the fixed component net of the effects of product differentiation (quality differences), **7n** is an arbitrary constant, and Z6 is the price effect of differences in quality in group 6. The coefficients on the dummies are ai=n(Zi - Z 6), and ,'<sup>is the marginal</sup> component net of product quality differences.

The results of regression (10) for groups 3, 5, and 6 are presented in Table 6. The coefficients on D5 and D3, as well as the intercept terms a3 , a5, and a6, are significant at the<sup>one</sup> percent level, indicating that quality differences, fixed over time, may be a significant component<sup>of</sup> the difference between the U.S. and the Mexican price for these groups. The time trend coefficient<sup>is</sup> not significant. Unfortunately, we cannot distinguish between the fixed quality effect Zi and<sup>the</sup>
24 Mexico MFA fixed rent-sharing coefficient a'.<sup>19</sup> However, the coefficient on the U.S. price in Table 6 is close to zero and not significant. Only the coefficient on the Herfindahl index is significant and<sup>positive as</sup> expected.

Several tests can be performed to gauge the importance of the presumed<sup>quality difference. If</sup> the fixed quality difference can explain all the spread between the U.S. and Mexican<sup>prices then the</sup> coefficient on pjt'J would be equal to one, and all other coefficients, excluding the<sup>dummies and the</sup> intercept, would be equal to zero. Tests for this hypothesis are presented below Table<sup>6. The t test</sup> and F test for P3' = 1 are rejected at the one percent level. The F test for f' = 1 and the<sup>coefficients</sup> on all other variables except the dummies equal to zero is also rejected at the one<sup>percent level.</sup> The fact that we have one group (3) whose exports are not quota bound<sup>may be an explanation</sup> for the lack of significance of the coefficient on pjtus To see whether rent-sharing exists<sup>for those</sup> groups that are quota bound, group 3 was dropped from the sample and the regression<sup>was re-</sup> estimated. The results are presented in Table 7. The coefficient on pjtus is now positive at<sup>0.514 and</sup> significant at the one percent level. Of the other coefficients, those on the Herfindahl<sup>index and the</sup> time trend are significant. The positive coefficient on the Herfindahl index suggests that a<sup>small part</sup> of the spread between the U.S. and Mexican prices may be due to the existence of concentration among Mexican exporters. The negative time trend coefficient indicates an increasing<sup>discrepancy</sup> between the Mexican and U.S. prices over time which may be due to increasing quality<sup>differentials.</sup> The fact that neither the intercept term, a6, nor the coefficient on D5, nor the intercept<sup>a5 are</sup> significant suggests that this effect was not specilic to either of the groups in the sample.<sup>The tests</sup> presented below Table 7 also reject the hypothesis that fixed quality differences are<sup>the sole</sup> explanation for the differences between the price of U.S. production and the price of imports<sup>from</sup> Mexico.

The results of Table 7 indicate that the price difference in groups 5 and 6 cannot be<sup>explained</sup> 19Although we have been referring to this constant term as the fixed rent-sharing effect throughout the paper it is possible that other considerations aside from rent-sharing or constant quality differences<sup>may explain part of this</sup> difference between the prices. Other possible explanations might be fixed costs in<sup>the quota allocation system.</sup>
25 Mexico MFA solely by fixed quality differences between U.S. and Mexican<sup>apparel. Furthermore, while we cannot</sup> distinguish between the fixed component of rent-sharing,<sup>and the fixed quality effect, the results seem</sup> to indicate that for the quota bound group this fixed effect<sup>is not very important. One interpretation of</sup> the coefficient on the U.S. price is that for these two groups (woven<sup>shirts and underwear), an</sup> increase of one dollar in the U.S. price has led to an average<sup>increase of 51 cents in the Mexican</sup> price. This may be an indication that U.S. retailers<sup>are receiving up to forty-nine percent of the rent</sup> from the MFA quota restrictions in these two groups of<sup>apparel.</sup> Table 6. Fixed Effects Quality Difference Regression Groups 3, 5, and 6

|Independent<br>Variables|Coefficient|t Statistic|Intercepts ai|F Statistic (1,22)<br>Ho:a*=<br>0|
|---|---|---|---|---|
|a6|1.299<br>(0.4913)|2.644X|_||
|pjtus|-0.136<br>(0.1913)|-0.711|||
|Hjt|0.006<br>(0.0023)|2.603a|||
|ujt|-0.661<br>(0.4902)|-1.348|||
|V jt<br>_ _ _**_**_ _ _<br>_ _ _<br>_ _ _ _ _ _ _|-1.712x10-<sup>9</sup><br>(2<br>X10-8|-0.878|_<br>_<br>_<br>_<br>_<br>_<br>_<br>_<br>|_<br>_<br>_<br>_<br>_<br>_<br>_<br>_<br>_<br>_|
|Tt|0.082<br>(0.0809)|1.019<br>.|||
|D3<br>__________<br>_________(1.4815)|11.303|7.629 a<br>_<br>_<br>_<br>_<br>_<br>_<br>_<br>_<br>_|12.602|67.37<br>reject<br>|
|Ds<br>.___ <br>_|3.413<br> _ __ _ __ _ _<br> <br>(0.8368)|1.019 '|4.712|26.12**'**reject|

Aujusted R<sup>2</sup> 0.98, n=30. Standard errors in parentheses. **a** si-nifi:ant at one percent. **c** significant at ten percent.

# Hypothesis Tests

1. ' = 1, t statistic, -5.938 , reject at one percent.

2. ' = 1, F(1,22) = 154.778, reject at one percent.

3. ' - 1, y' = '= ' = 0, F(4,22)=48.97, reject at one percent.
Mexico MFA 26

**Table 7. Fixed Effects Quality Difterence Regression Bound Groups 5 and** 6

|Independent<br>Variables<br>|Coefficient<br>t Statistic<br>Intercepts ai<br> <br>|F Statistic (1,22)<br>Ho: a;=0|
|---|---|---|
|-a6<br>|1(o<br>5lo6.502<br>1.640c<br>(0.9162)<br>_<br>_<br>_<br>_<br>_<br>_<br>_<br>_|_|
|pjtuS|0.514<br>8.402 A<br>**(0.0612)**<br>_<br>_<br>_<br>_<br>_<br>_<br>_<br>_<br>_|<br>_<br>_<br>_<br>_<br>_<br>_<br>_<br>_<br>_<br>_<br>_|
|Hjt|0.008<br>1.788b<br>(0.0045)||
|**Uit**|**~~-0.412**<br>**_-0.451_**<br>(0.9133)<br>-0.4S___<br>_<br>||
|**Vjt**<br>__<br>__<br>_<br>__<br>_<br>__<br>__J|**87.2x10**<br>**9**<br>0.201<br> <br>X 0)<br>__<br>_<br>_<br>__<br>_<br>_<br>__|_<br>_<br>_<br>_<br>__<br>_<br>_|
|[**Tt**<br>__________________|-0.249<br>-1.956b<br>_<br>(0.1275)||
|DS|-1.293<br>-1.258<br>0.209<br>(1.0282)|0.025 cannot<br>reject|

Adjusted R<sup>2</sup> = 0.93, n=20.

' significant at one percent.

b significant at five percent.

**c** significant at ten percent.

# Hypothesis Tests

1. ' = 1, t statistic, -4.616 , reject at one percent.

2. ' = 1, F(1,23) = 63.050, reject at one percent.

3. ' = 1, y' = 8' = *' = 0, F(4,23)=83.107, reject at one percent.
27 Mexico MFA A test for the log specification of equation (10) was also run, with the bound data grovwps 5 and 6. Tle tests reveal that the linear specification fits the data better. Nevertheless, the results of the regression in logs, presented in Table 8, are consistent with the previous results in Table 7. Coefficients on the fixed effect dummies and the constan; are not significantly different from zero, suggesting no fixed quality effect was operating. These results are supported by<sup>the hypotheses tests</sup> which reject the existence of fixed quality aifferences as the sole explanation for the price differences, at the one percent level. The coefficient on the U.S. price is significant at the one percent level, with an elasticity of price transmission, all other variables held constant, of 0.59. The Herfindahl index is also significant and positive at the ten percent level. The only difference is that the coefficients on the log of the quota level Vjt and the log of the utilization rate Ujt are also significant and negative. This is the sign we would expect for the quota level effect.
28 Mexico MFA

**Table S. Fixed Effects Quality Difterence Regression Bound** Groups 5 **and 6** - **_Le_** ' Specification

|Independent<br>Variables|Coefficient|t Statistic|Intercepts a3|F Statistic (1,22)<br>Ho: a;=0|
|---|---|---|---|---|
|log a6<br>.__<br>_|0.0374<br> __ __ __ __<br> <br>(0.4339)|0.086|||
|**log pt**<br>____________<br>Pjt(0.1048)|0.591<br>**_**___<br>|**_5.6?89A_**<br>S.6?8 '|||
|log**Hjt**|0°189<br>**(0.1280)**|Ld.82**c**|||
|log**U3 t**|-0.101<br>(0.0519)|-1.1143**b**|||
|**log Vjt**|-0.186<br>**(0.0680)**|-2.734**a**|||
|log**Tt**|-0.004<br>(0.0169)|0 249|__|_|
|**DS**|0.106<br>I<br>(0.1819)|0.583<br>_<br>_|-0.068|0.056 cannot<br>reject|

Adjusted R<sup>2</sup> = 0.98, n=20.

4 significant **at one** percent.

b significant at five percent.

**c** significant at ten percent.

# Hythesis Tests

1. P' = 1, t statistic, 3.904 , reject at cne percent.

2. P' = 1, F(1,23) = 15.247, reject at one percent.

3. 1' = 1, I' = 8' = +' = 0, F(4,23)=9.854, reject at one percent.

# Test of Log Specification

Sum of squared residuals for the linear specification = 0.28936 Sum of squared residuals for the log specification = 0.34268
29 Mexico MFA

# **Conclusions**

This paper has tested for the existence of perfect markets and rent sharing in Mexican apparel exports to the U.S. between 1981 and 1990. The tests were run on six apparel groups: sweaters, trousers, men's coats, women's coats, woven shirts, and underwear. The data indicate that there are consistent differences between the Mexican export F.O.B. price of apparel in the U.S. market adjusted for tariffs and transport costs, and the unit value of U.S. production. The adjusted price of Mexican exports is consistently below the price of U.S. production indicating that rent sharing may be taking place. Alternative explanations for the price differential were tested using the methods of Erzan, Krishna, and Tan (1991) with modifications to allow for more efficient estimation of the test parameters and to explicitly test the assumption underlying the test procedure. The existence of differences in composition in the groups of Mexican exports and U.S. production is rejected for three out of the six groups mentioned. After ruling out differences in composition in three of the apparel groups, the existence of significant quality differences is also controlled for. The final result indicates that rent sharing may exist in woven shirts and underwear (two out of the three groups in the sample that are quota bound). In particular, U.S. importers may obtain up to forty-nine percent of available rents.

In addition to the tests of rent sharing, the paper reviews the institutional arrangements that exist between the U.S. and Mexico that make MFA quotas much less restrictive than they would ordinarily be. Because of these arrangements it is doubtful that MFA restrictions result in significant rents that would benefit Mexican exporters. In addition, production-sharing arrangements suggest that the small rents that are generated may be going in large part to U.S. owned firms in Mexico. The welfare effects of quota restrictions and rent sharing are thus probably not very important in this case.