How supply restrictions can protect domestic industries
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Import quotas are government-imposed limits on the quantity of a certain good that can be imported into a country. Generally speaking, such quotas are put in place to protect domestic industries and vulnerable producers. Quotas prevent a country’s domestic market from becoming flooded with foreign goods, which are often cheaper due to lower production costs overseas.
Certain foreign manufacturers may purposely try to drive domestic producers out of business by selling large quantities of a product at below cost, thus capturing the entire domestic market and crippling local vendors. However, quotas are generally harmful to consumers since they prevent them from accessing goods that are more competitively priced than local alternatives.
How do Import Quotas Work?
Governments are responsible for putting quotas into place in order to protect domestic interests. Following the law of supply and demand, imposing quotas that limit the supply of particular goods will cause their prices to increase. The graph below illustrates this concept:
As we can see, the quota imposed here restricts the supply, which causes the supply curve to shift to the left. Consequently, we observe a new equilibrium quantity at Qq, which is lower than what the natural equilibrium would have been in the absence of the quota.
Quotas cause an increase in the price of the good, which eats away at the cost competitiveness of the foreign supplier. We can also see how a system like this is harmful to consumers, as it restricts the number of alternatives available to them and forces them to pay higher prices for certain goods.
Voluntary Export Restraints
Voluntary export restraints (VERs) are voluntary quotas that nations place on their exports to partner nations. When two nations share a trade agreement, the imposition of trade quotas will likely be seen as a protectionist or hostile move, which may dampen trade relations. To avoid such situations, trade partners can negotiate VERs in a promise not to flood the partner’s market with cheap goods.
Such agreements are negotiated at the time the trade agreement is initially negotiated and are generally an effective tactic that prevents trade disputes from developing. VERs typically come in the form of a set maximum numerical quantity of units that one nation may export to the other. As the economic climate changes, VERs have to be updated in order to keep them effective.
In certain circumstances, nations may limit the supply of imported goods without explicitly placing trade quotas on other nations. For example, governments may place strict quality control restrictions on all goods that enter the country. While it may seem a simple best-practices move, hidden quotas could stop a large number of foreign goods from entering a nation due to lack of quality. Thus, the supply of that good will be restricted, and the government would have achieved a similar outcome if it had placed an import quota on foreign imports.
Another type of hidden quotas is propaganda campaigns that aim to reduce demand rather than restrict supply. For example, a government may spread propaganda about how certain food imports from certain nations have been proven to cause health problems. While such accusations may not necessarily be grounded in science, they may cause demand to slump in the short run.
In other cases, demand or supply may increase or decrease due to various economic factors. Such events cannot be planned by governments but may deter importation, increase prices or decrease quantities sold. Thus, they can have the same effect that an import quota would have. However, governments rarely rely on shifts in demand and supply to protect domestic industries, due to their unpredictability.
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