The liberalization of Tariff Rate Quotas under oligopolistic competition 1. Margherita Scoppola

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1 The lberalzaton of Tarff Rate Quotas under olgopolstc competton 1 Margherta Scoppola Dpartmento d stud sullo svluppo economco Unverstà d Macerata (Italy) scoppola@unmc.t Abstract: The paper uses a two-stage capacty constraned model to nvestgate the mpact of dfferent lberalzaton optons of Tarff Rate Quotas (TRQs). The results show that the mpacts of the varous lberalzaton optons - the reducton n the n-quota and out-of-quota tarffs, mprovements n the TRQ admnstraton system - are rather dverse from those predcted by models assumng perfect competton. Keywords: tarff rate quotas, olgopoly, trade lberalzaton JEL code: Q18; F13; L13 DRAFT January I wsh to thank Govann Anana and Luca Salvatc for helpful comments on an earler draft of the paper. Fnancal support receved by the New Issues n Agrcultural, Food and Bo-energy Trade (AGFOODTRADE) (Small and Medum-scale Focused Research Proect, Grant Agreement no ) research proects funded by the European Commsson, and by the European Unon polces, economc and trade ntegraton processes and WTO negotatons research proect funded by the Italan Mnstry of Educaton, Unversty and Research (Scentfc Research Programs of Natonal Relevance 2007) s gratefully acknowledged..

2 1. Introducton A growng share of agrcultural trade occurs wthn Tarff Rate Quotas (TRQs). In 2004, 1,429 TRQs were notfed to the WTO (WTO, 2006); more than 15% of agrcultural tarff lnes n the EU are currently covered by TRQs, and other countres use TRQs even more ntensvely; n Norway, for example, almost 40% of agrcultural tarff lnes nvolve TRQs. TRQs are two-tered tarffs, wth a lower tarff appled to n-quota mports and a hgher tarff appled to addtonal out-of-quota mports. The Uruguay Round Agreement on Agrculture has ntroduced several TRQs n order to guarantee mnmum market access where there had prevously been no sgnfcant mports because of hgh protecton, or to mantan access opportuntes where tarffcaton would otherwse have reduced them. Whether or not the mplementaton of TRQs has really mproved market access s an open queston (Abbott, 2002) and several proposals for lberalzng agrcultural TRQs have been brought to the WTO n the Doha Development Agenda (DDA). Three maor topcs dealng wth the ssue of TRQ lberalzaton are currently under dscusson n the DDA negotatons (WTO, 2008): the reducton of MFN tarffs, as ths mples a decrease also n out-of-quota tarffs; the reducton of the n-quota tarffs for exstng TRQs; and the reform n the TRQs admnstraton method. TRQs are also ntensvely used under preferental trade agreements, especally by developed countres to lmt preferental access to products from developng countres. One of the core ssues n negotatons between (potental or actual) members of preferental trade agreements s how to lberalze agrcultural trade when TRQs are n place. In both contexts, multlateral and preferental agreements, a key ssue s whch strategy for TRQ lberalzaton s more desrable from the trade and welfare ponts of vew. The lterature on TRQs has provded several hnts about the possble mpact of a reducton n the n-quota or the out-ofquota tarffs, of an expanson of the quota or of an mprovement n the effcency of TRQs admnstraton (e.g. Boughner et al, 2000; Skully, 2001a, 2001b; Rude, Gervas, 2006). Most contrbutons rely on the assumpton that nternatonal markets for agrcultural products are compettve, even though ths s often not the case. There are several cases n whch nternatonal markets are domnated by olgopolstc traders. Ths paper ams at contrbutng to the lterature on the economcs of TRQs by nvestgatng the mpact of TRQs and of dfferent lberalzaton optons n olgopolstc markets. Olgopolstc models used n the analyss of tarff and quotas, by and large, assume a pror the mode of competton ether to be à la Cournot or to be à la Bertrand, even though there are good reasons to expect both types of behavour dependng on market condtons. As a consequence, comparatve statcs s generally performed by keepng the mode of competton fxed; however, the nature of the strategc nteracton between frms may be affected by trade polcy. Ths paper develops a two-stage capacty constraned model n whch the mode of competton s endogenous and s affected by the trade polcy; n ths settng, the mpact of TRQs lberalzaton depends also upon whether and how the polcy change affects the strategc nteracton between frms. The model s based 1

3 on Magg (1996) who developed a duopoly capacty constrant model n whch the constrant s flexble and the mode of competton s endogenous to address strategc trade polcy ssues. Frms n the frst stage choose capacty whle n the second stage, after observng the rvals capacty, compete on prce. The capacty constrant faced by frms s flexble as frms can always ncrease quanttes above the capacty chosen n the frst perod, albet at a hgher cost. The model predcts that the game moves from a pure Bertrand outcome to a Cournot outcome as the effectveness of the capacty constrant ncreases. Ths depends upon the value of the costs of adustng capacty n the two perods; the greater the gap between the cost of adustng capacty between the two perods, the hgher the effectveness of the capacty constrant. Ths knd of models appears to be suted to analyse TRQs: n the case of TRQs the capacty s gven by the amount of lcences that frms acqure to mport wthn the quota; the cost of adustng capactes n the frst perod s gven by the cost of obtanng lcences plus the n-quota tarff; n the second stage frms may adust capactes only by mportng out-of-the quota at the cost of a hgher tarff. The framework s here extended to the N frms case and used to examne and compare the mpact of dfferent TRQ lberalzaton optons on the mode of competton, trade and welfare. The results emphasze how the consderaton of strategc nteractons between frms may provde some unconventonal conclusons on the mpact of the dfferent TRQ lberalzaton strateges. The paper s organsed as follows; the next secton presents the model, the thrd analyses how dfferent lberalzaton scenaros affect frms strategc nteractons and the fourth llustrates, by means of numercal examples, the trade and welfare effects together wth the mpact on frms market power. The last secton offers some concludng remarks. 2. The model The model consders N symmetrc frms mportng a dfferentated product n one country. The assumpton that products are dfferentated appears reasonable n the context of many products covered by TRQs; a large part of them are processed goods whch may be qute smlar, though not perceved as dentcal by consumers; also when consderng trade n raw products, there s no agreement about ther homogenety and some papers have emphassed the mportance of product dfferentaton even n the case of commodtes such as cereals and beef (e.g. Carter, Mac Laren, 1997; Lavoe, 2005; Ramos et al. 2007). Each trader mports the quantty q and faces the followng nverse demand functon: p = α βq λ q (1) wth p beng the prce, and β > λ. The drect demand functon s: q = a bp + c p (2) 2

4 α β + ( N 2) λ λ wth a =, b =, c = β + ( N 1) λ ( β + ( N 1) λ)( β λ) ( β + ( N 1) λ)( β λ) (3) The mportng country employs a TRQ, wth Q, t and T beng the mport quota, the n-quota tarff and the out-of-quota tarff, respectvely. In order to obtan the rght to mport wthn the quota, each trader s assumed to face the unt cost l. Ths s because traders very often face certan costs n order to obtan the quota lcences. When they are allocated on demand or on a frst-come-frst served crtera, frms spend resources n rent-seekng actvtes n order to obtan the quota rents (Hraanova, de Gorter, 2005). Under the hstorcal allocaton system, n most cases lcences are transferable and frms have to purchase lcences on the market f they wsh to ncrease mports above ther hstorcal level. 2 Fnally, wth aucton quotas - a method whch s hardly ever used, accountng for less than 1% of agrcultural TRQs n force (WTO, 2006) - traders purchase the lcences drectly from the government. The cost of the lcence plus the n-quota tarff s always lower than the out-of-quota tarff,.e. l+ t < T.The N frms face dentcal margnal costs, m, whch are assumed to be constant.. The profts of the trader are: f q Q then Π = q ( p t l m) Π = f q > Q then Π = q p ( t+ l+ m) Q ( q Q )( T + m) wth Q Q =. There are two stages n ths game. In the frst stage frms choose capacty,.e. N they choose the amount of lcences they wsh to obtan. By dong ths, they commt themselves to mport a certan volume of the product n the second stage of the game. In the second stage, after observng the capacty that ther rvals have chosen n the frst stage, frms compete on prce. In ths stage frms may stll choose to ncrease ther capacty, but only by mportng out of the quota. In other words, t s assumed that the amount of product to be mported wthn the quota can be chosen only n advance (n the frst stage). Ths reflects reasonably well the way n whch the allocaton of lcences works under most commonly used allocaton methods; n fact, lcences are allocated well n advance wth respect to the date of the effectve entry of the product nto the mportng country, and most traders consder that the only way to ncrease capacty afterwards s to mport out of the quota. Thus, n ths model, the amount of lcences obtaned n the frst stage works as a commtment of the frm to mport a certan amount of the product n the second stage. Magg (1996) has shown that n ths settng the prevalng mode of competton and the outcome of the game depend upon the effectveness of ths commtment; as the effectveness of the commtment ncreases, the game moves from a pure Bertrand outcome to a Cournot outcome. The effectveness of the capacty commtment depends upon the relatve costs of ncreasng capactes n the two stages. We can dentfy two possble benchmarks for 2 We assume that frms face the cost l for each unt of product mported wthn the quota. Under the hstorcal allocaton method frms face the cost of purchasng lcences only f they mport above ther hstorcal level. Ths specfc case s addressed n Scoppola (2008). (4) 3

5 the soluton of ths game. On one hand, f the cost of ncreasng capacty n the second stage s equal to that ncurred by frms n the frst stage, then the capacty chosen n the frst stage does not work as a commtment devce; n ths case, the capacty constrant s neglgble and frms compete on prce,.e. the outcome of the game s Bertrand. On the other hand, f the cost of ncreasng capacty n the second stage s very hgh, then the capacty commtment becomes relevant and frms compete on quanttes,.e. the outcome of the game s Cournot. The subgame perfect equlbrum mples that (Magg, 1996): wth B p ( m, T) f l+ t T < T* p = (5) C p ( m, t, l) f T T* B p e p C beng the Bertrand and Cournot equlbrum prces, respectvely, and T * beng a crtcal value of the out-of-quota tarff defned mplctly by B C p ( m, T) = p ( m, t, l). As aforementoned, when the value of the out-of-quota tarff s equal to the cost of ncreasng capacty n the frst stage ( l+ t = T < T* ) there s no capacty constrant and the outcome of the game s Bertrand wth long run cost equal to l+ t+ m. If l+ t < T < T * then the equlbrum can be dentfed as the outcome of a one-shot Bertrand game n whch frms compete on prce and have long run costs equal to m+ T. The basc ntuton s that when the cost of ncreasng capacty n the frst stage s lower than n the second stage (, nvestment n capacty n the frst stage sustans a hgher prce ( B B p ( m, T) ), than the one that would preval n a pure Bertrand one-shot game ( p ( m, t, l) ). Fnally, l+ t < T) when T > T* the capacty commtment s effectve and frms compete à la Cournot. It s worth notng that ths s the outcome of the game f q cannot be the equlbrum when q Q. Conversely, equaton (5) > Q. Ths s because when demand and cost condtons are such that there are out-of-quota mports, frms acqure all avalable lcences and mport addtonal quanttes at the prce of the out-of-quota tarff. Under these crcumstances, the amount of purchased lcences, whch s always Q, does not represent the capacty chosen by frms and, thus, does not work as a capacty commtment. The capacty constrant s neffectve and ths mples that the outcome s always the Bertrand one. Ths s a relevant dfference wth respect to the settng of the paper by Magg (1996); n that paper frms can ncrease capacty at lower costs n the frst stage wthout lmt; under the TRQ ths happens when the equlbrum quanttes are lower than the quota and the lcences work as the chosen capacty. However, when the equlbrum quanttes are hgher than the quota, the margnal cost of adustment n the frst perod s equal to that of the second perod (.e., the out-ofquota tarff) and the capacty constrant becomes neffectve. Frms perceve the polcy as a pure tarff regme wth the tarff beng equal to T. Thus when q mples always that p = p B ( mt, ). Q the subgame perfect equlbrum 4

6 The Bertrand prce p prce, when costs are mt, : p1 B ( m, T) may be obtaned by maxmsng (4) by holdng fxed the rvals max Π = p q ( m+ T) q 1 (6) whch yelds the followng reacton curve: a+ c p + b( T + m) p = 2b Gven the symmetry assumpton, the equlbrum prce s: B a+ b( T + m) p = 2 b c( N 1) (7) (8) The Cournot equlbrum prce s obtaned by solvng the maxmsaton problem: max Π = qp ( m+ t+ lq ) (9) q from whch the reacton curve s: α ( t+ l+ m) λ q q = 2β (10) C The Cournot equlbrum prce p ( mtl,, ) s: C αβ ( t+ l+ m)( β + λ( N 1)) p = + 2 β + λ( N 1) 2 β + λ( N 1) The crtcal value of the out-of-quota tarff T * above whch the mode of competton shfts to Cournot may be obtaned from (8) and (11) and depends upon the values of the demand parameters, of margnal cost, and of lt, and (11) N. 3 Whle l and t, as expected, both postvely affect the value of the crtcal tarff the hgher ther values, the weaker the capacty commtment, the hgher T * - the mpact of the number of rvals depends upon the value of N, as t wll be shown n the next secton by means of a numercal example. The lterature on TRQs has shown how the equlbrum depends upon whch nstrument s bndng: the quota tself, the n-quota or the out-of-quota tarff. Import demand and the level of Q, t and T ontly determne whch of the three nstruments s bndng. In a perfect compettve framework, the n-quota tarff s bndng when the world prce plus the n-quota tarff s greater than the domestc prce determned by the mport quota alone; n ths case, mports are lower than the quota. The out-ofquota tarff s bndng when the world prce plus the out-of-quota tarff s lower than the domestc prce determned by the quota alone; mports are thus hgher than the quota. The quota s bndng when the world prce plus the n-quota tarff s less than the domestc prce determned by the mport quota and the world prce plus the out-of-quota tarff s greater than the domestc prce determned by the 3 More detals are provded n the Appendx. 5

7 quota; n ths case, mports are equal to the quota (Boughner et al. 2000; Skully, 2001). Under perfect competton, when mports are lower than the quota, both T and Q are redundant, as the prce s determned by another nstrument,.e. t. Ths may not be always the case n the model developed n ths paper. The outcome of the game - for gven values of demand parameters and - depends frst, upon the maxmum amount of lcences avalable to each operator ( Q ); and second, upon the values of lt, andt whch ultmately determne the effectveness of the capacty commtment (.e. whether or not the out-of-quota tarff s greater than the crtcal tarff) (Table 1). When ( B C Q > q p ), q ( p ), then the outcome of the game s (5): f T > T* a Cournot outcome prevals and, as expected, the prce s determned by the n-quota tarff, whle T s redundant (equaton 11); but when T < T* the equlbrum s Bertrand (equaton 8) and the prce s determned by the outof-quota tarff; ths means that, although mports are lower than the quota, the n-quota tarff s redundant, whle T determnes the level of the prce. B C Conversely, when Q < q ( p ), q ( p ), frms operate as f there s no capacty constrant and the outcome s always Bertrand, wth long run margnal costs equal to T m + m (equatons 5). In ths case, as expected, the bndng nstrument st, whle t and Q are redundant. Fnally, when B C q < Q < q and T > T* nether Cournot nor Bertrand are Nash equlbrum. Ths s because f frms B choose the capacty q, mports are lower than the quota; but n ths case, frms are n equlbrum by choosng the Cournot capacty; however, f they choose C q they mport a volume whch s hgher than the quota; but n that case the equlbrum s Bertrand whch mples the capacty B q. 3. Lberalzng TRQs: the mpact on the mode of competton To nvestgate the mpact of lberalzaton on the mode of competton fve possble optons are here taken nto account; 4 n addton to the reducton nt and t and the ncrease n Q, two further scenaros are consdered. Frst, the government may reform the TRQ regme by mprovng the effcency of the allocaton system and ths results n a reducton of the cost l for obtanng lcences for frms 5. Second, reforms of TRQs may also result n the entry of new frms (an ncrease n N ). Ths occurs when, for some reason, traders whch are as effcent as ncumbents do not entry nto the 4 The ssue of the TRQ tarffcaton, that s, the elmnaton of the TRQ and ts replacement wth a tarff equvalent under olgopoly, s addressed n Scoppola (2008). 5 Other types of cost due to neffcences n the admnstraton system, such as admnstratve and other transacton costs are not consdered here. It s worth notng that n ths settng, the assumpton of symmetry rules out the possblty of neffcences due to the msallocaton of lcences to hgh-cost traders. 6

8 market because they face barrers n obtanng lcences; the removal of these obstacles may mply an ncrease n the number of rvals on the market. When under the TRQ > Q, frms behave as under a tarff and the mode of competton s always Bertrand. In general terms, none of the lberalzaton optons affects the mode of competton, although they have trade and welfare effects. Only f the expanson of the quota leads to a change n the bndng nstrument ( Q becomes greater than q and thus the bndng nstrument s t ) then the mode of competton may shft from Bertrand to Cournot. q Thngs are dfferent when ntally there are no over quota mports ( q Q ). Out of the fve possble lberalzaton methods, n four cases the lberalzaton of the TRQ may affect frms behavour. The mode of competton depends upon the value of the crtcal tarff T * wth respect to the out-of-quota tarff T. An ncrease n Q does not affect ethert * or T and, thus, does not change the behavour of frms. Conversely, an ncrease n the number of frms, and the reducton n t or l nfluence the value of T * and, thus, may mply a change n the mode of competton. The reducton of T, f T > T*, may also change the mode of competton. Fgure 1 reports the values of the crtcal tarff, as a functon of N, the number of frms. 6 In ths example, wth a low number of frms ( N < 13) the quantty mported by each frm s hgher Q than and, thus, there are out-of-quota mports and Bertrand competton prevals. When N 13, q < Q and the mode of competton s determned by the value of the crtcal tarff, whch, n our example, for low values of N s lower than the out-of-quota tarff; thus, frms compete on prce. As N ncreases, the crtcal tarff decreases; f the number of new operators s hgh (n the Fgure ths happens f N > 30 ), the crtcal tarff may become lower than T and the equlbrum shfts to the Cournot one. Hence, the model suggests that f N s hgh enough, then, everythng else held constant, an ncrease n the number of rvals makes stronger the capacty commtment and more lkely the Cournot outcome. 7 Ths s due to the fact that when N s very hgh the market share of frms becomes very lmted and ths renforces the capacty commtment; a smlar effect s determned by an overall decrease n market sze, whle keepng constant the number of frms. 8 It s worth notng that, as a consequence of the ncrease n the number of frms, market power n any case decreases, but less than 6 In Fgures 1, 2 and 3 and n the Tables (baselne scenaro) the followng values for varables and parameters are assumed: α = 400, β = 0.8, λ = 0.1 l = 3, m = 2, t = 5, T = 15, N = 15. As for the ndvdual quota, ths B C s assumed to be Q = 140 whch, n the baselne, s hgher than both q and q. Dfferent values for parameters, whle affectng the changes n the varables, do not nfluence the drecton of changes and, thus, the man conclusons of the paper. 7 The shape of Fgure 1 s stable across dfferent values of demand parameters and costs satsfyng the model s constrant. 8 As equaton 12 reported n the Appendx shows, a decrease nα, whch mples a reducton n frms market share, results n an ncrease n T * 7

9 f a fxed mode of competton (.e. Bertrand) s assumed. In the lmt case n whch N, then T* 0 and the Cournot prce approaches the perfect compettve equlbrum prce. The mpact of a reducton n t on the crtcal tarff s shown n Fgure 2. The reducton of the n-quota tarff n ths model mples, everythng else held constant, an ncrease n the effectveness of the capacty commtment, and thus a move towards the pure Cournot outcome. As the n-quota tarff decreases, the crtcal tarff also declnes and may become even lower than the out-of-quota tarff. In Fgure 2, the shft to a pure Cournot equlbrum occurs when t < 3.5. In contrast to lberalzaton by means of ncreasng N, the market power of frms n ths case always ncreases, as a consequence of the reducton n costs. The reducton n l has a smlar effect (Fgure 3), as t also strengthens the effectveness of the capacty commtments and, thus, may shft the mode of competton toward Cournot. Fnally, a decrease n T, everythng else held constant, reduces the gap between the costs of adustng capactes n the two perods and, thus, reduces the effectveness of the capacty commtment. Ths s shown n Fgure 4: whent become lower than T * there s a shft from Cournot to Bertrand. The model shows that n four out of fve polcy optons for TRQ lberalzaton, frms market power s affected; n general terms, ths declnes f the reform mples an ncreased n the number of frms, but market power ncreases f lberalzaton nvolves a reducton n frms costs, ether by reducng the n-quota or the out-of quota tarff or by mprovng the effcency of the allocaton system. Ths mpact on frms market power can be amplfed or mtgated by possble changes n the mode of competton among frms, as wll be seen n more detal n the next secton. 4. Trade, welfare and competton effects of TRQs lberalzaton Trade and welfare effects under the varous optons for TRQs lberalzaton are reported n Table 2 together wth frms market power, measured by the Lerner ndex. In the numercal example, the bndng nstrument n the baselne scenaro s always the n-quota tarff. As aforementoned, when the bndng nstrument s the out-of-quota tarff, frms behave as under a tarff; thus, lberalzaton does not change the mode of competton and trade and welfare effects are those due to the smple reducton of the tarff. Further, the case of an ncrease n the quota Q s not reported because there are no effects on trade, welfare and competton. The reducton n t, when the n-quota tarff s bndng, s usually mentoned as an example of effectve lberalzaton, as under perfect competton the prce s determned by the margnal costs, t + l + m(boughner et al 2000; Skully, 2001b). In ths model, the reducton of the n-quota tarff may or may not affect mports dependng on the mode of competton: f the outcome of the game s C Cournot, then the equlbrum prce p s negatvely affected by a decrease n t (equaton 11) and mports ncrease; however, f the outcome s Bertrand then a reducton oft has no trade effect, as the 8

10 equlbrum prce s determned by the costs n the second stage of the game (T ). In our example, as Table 2 shows, a small reducton n the n-quota tarff (up to 20%) has no trade effects, because the mode of competton s Bertrand. However, a larger reducton makes the capacty commtment effectve and shfts the outcome of the game to the pure Cournot soluton. Under ths mode of competton, frms behavour s drven by the margnal costs of ncreasng capacty n the frst perod and, thus, a decrease n t reduces prces and ncreases mports. A small reducton of the n-quota tarff, even n the absence of trade effects, mproves the welfare of frms whle taxpayers are worseoff; frms market power ncreases as a consequence of the reducton n the costs. Wth a larger decrease n t, the prce declnes, mports ncrease and market power contnues to ncrease; nevertheless, consumers and frms gan because of the decrease n the prce and costs, respectvely. Despte the consderable losses n government revenues, total welfare mproves as a consequence of TRQ lberalzaton. In perfect compettve models,the reducton of the out-of-quota tarff s neffectve as the prce s determned by the margnal costs, t + l + m(boughner et al 2000; Skully, 2001b). Ths may not be the case n ths model. The reducton of the out-of-quota tarff may have trade effects f the mode of competton s Bertrand, whle f ntally frms compete à la Cournot s neffectve. In Table 2, whent s hgh and the outcome of the game s Cournot, a reducton n T does not affect prce and mports; however, a 30% reducton shfts the mode of competton away from Cournot and, thus, further reductons ncrease mports and decrease prces. Unlke the predctons of perfect compettve models, ths model suggests that, f the capacty constrant s weak, a reducton n the out-of-quota tarff may ncrease mports, even f there are no out-of-quota mports. There wll be welfare effects anyway, wth a shft of resources from taxpayers to frms that wll beneft from an ncrease n profts. Reforms resultng n an ncrease n the number of rvals on the market always have sgnfcant postve effects, whatever the mode of competton. Table 2 shows how an ncrease n the number of frms, everythng else held constant, always reduces prce, ncreases mports, mproves overall welfare and reduces market power. Thus, reforms mprovng the ablty of frms to access lcences, by ncreasng the number of frms and the degree of competton on the market, may be more effectve n lberalzng trade than the reducton of tarffs. Ths provdes a further argument to the dea that trade lberalzaton to be effectve should be mplemented along wth an mprovement of competton on nternatonal markets. Fnally, mprovements n the admnstraton of the TRQ by lowerng the cost l do not have any mpact on trade f the mode of competton s Bertrand. In our example, ths happens f l s reduced by less than 30%; the prce and the quanttes do not change, but market power and frms profts ncrease; taxpayers and consumers are not affected by lberalzaton and, as a consequence, global welfare mproves. On the contrary, when frms compete à la Cournot, that s, when l s so low that the gap between the cost of adustng capactes n the two perods s very wde, then a reducton 9

11 n l reduces prce and ncreases mports. As can be seen n Table 2, f l s reduced by more than 60%, frms, consumers and taxpayers all beneft from lberalzaton and overall welfare mproves consderably, despte an ncrease n market power from the reducton n costs. Thus, the man mplcaton of the model s that lberalzaton by means of an mprovement n the admnstraton of TRQs that leads to a reducton n frms costs may be effectve only under certan crcumstances,.e. when the out-of-quota tarff s hgh enough - wth respect to the n-quota tarff plus the cost of obtanng lcenses - to make the capacty commtment effectve and frms competng à la Cournot. Alternatvely, TRQ lberalzaton has no trade effects and yelds only an ncrease n frms profts Conclusons The am of ths paper was to nvestgate the mpact of TRQs and of ther lberalzaton when nternatonal agrcultural markets are domnated by olgopolstc traders. A two-stage capacty constraned model has been used n whch the mode of competton s endogenous and the constrant s flexble; the presence of a TRQ, n fact, ntroduces a capacty constrant to traders the quota whch, however, s flexble, as traders can always ncrease ther mports out of the quota, albet at a hgher tradng cost. Buldng on Magg (1996), the paper has shown how the mode of competton between frms and the fnal equlbrum depend upon the costs of adustng capactes n the two perods, that s, the values of the n-quota and out-of-quota tarffs and the cost of the lcences to mport wthn the quota. Despte all the smplfyng assumptons, ths paper has shown how the lberalzaton of TRQs may have rather dverse results when olgopolstc competton s taken nto account. The most promnent fndng of the paper s that the consderaton of strategc nteracton between traders could undermne some of the usual conclusons about the (n)effectveness of the varous lberalzaton optons. The paper has shown, for example, how under certan crcumstances (e.g. a weak capacty commtment), even f mports are lower than the quota, a reducton n the out-of-quota tarff s effectve, whle the reducton n the n-quota-tarff does not ncrease trade. These unconventonal results bascally are the consequence of the consderaton of strategc nteractons between frms. Although the olgopoly framework here used s a two-stage (fnte) game and cannot be consdered as a pure dynamc game, the two-stage structure, nevertheless, represents an ntermedate step toward dynamcs (Vves, 2001, p. 199). It s ths nherent, although lmted, dynamc whch explans the results; for example, the fndng that a reducton n the out-quota-tarff could be effectve even when there are no out-of-quota mports, s due to the fact that, f the capacty constrant s weak, then a frm s prcng decson s affected by the margnal cost rvals face n the second perod of the game, that s, the cost of mportng out of the quota, rather than those of the frst 9 The consderaton of other costs due to the neffcency of the admnstraton method those whch are pad not only by frms, lke the admnstratve costs - would not change the results as for the trade effects, even though t would modfy the welfare mpact of reforms. 10

12 perod (the cost of mportng n quota). Ths result would not be obtaned n statc games, assumng ether Bertrand or Cournot. A second feature of the model here developed, whch helps to explan the results, s the endogenety of the mode of competton. Trade polcy may affect the nature of the strategc competton among frms by changng the effectveness of the capacty commtment. Ths means that by changng certan trade polcy nstruments namely, the n-quota and out-of-quota tarffs, and the cost of the lcences the government nfluences the strategc nteracton between frms. Ths has a number of nterestng mplcatons; frst, trade lberalzaton affects frms market power and, n some cases, t may even ncrease t; second, even f before lberalzaton a certan polcy change mght be effectve, t may become neffectve as a consequence of the lberalzaton tself, f ths leads to a change n the mode of competton. Overall, the fndngs of the paper suggest that, when dealng wth markets where traders are concentrated and when there are good reasons to beleve that they exert market power, then lberalsng TRQs by reducng the tarffs may not produce the desred results n terms of mprovement n market access; ths paper has shown that there are many cases - more than those suggested by the lterature under perfect competton - n whch ths s not the case. Further, the model has shown how polcy removng barrers to the entry of newcomers may be more effectve n lberalsng trade than a reducton of tarffs. Ths adds a further argument to those already supportng the vew that trade lberalzaton to be effectve should proceed along wth an ncrease of competton on the nternatonal markets. References Abbott, P., (2002) Tarff-rate quotas: faled market access nstruments? European Revew of Agrculture Economcs 29, 1, Boughner, D., de Gorter, H. and I. Sheldon The Economcs of Tarff-Rate Quotas n the Agrcultural Agreement n the WTO, Agrcultural and Resource Economcs Revew 20, Carter, C., Mac Laren, D., Prce or Quantty Competton? Olgopolstc Structures n Internatonal Commodty Markets, Revew of Internatonal Economcs 5, 3, De Gorter, H., Kluaga, E., Reducng Tarffs versus Expandng Tarff rate Quotas. In: K.Anderson, W.Martn (eds), Agrcultural Trade Reform and the Doha Development Agenda, Palgrave Macmllan and the World Bank: Washngton DC.; Hraanova, J., De Gorter H., Rent Seekng wth Poltcally Contestable Rghts to Tarffrate Import Quotas. Revew of Internatonal Economcs 13(4), Hraanova, J., De Gorter H., Falck J., The Economcs of Admnsterng Import Quotas wth Lcence-on-demand n agrculture. Amercan Journal of Agrcultural Economcs 88, Lavoe, N Prce dscrmnaton n the context of vertcal dfferentaton: An applcaton to Canadan wheat exports. Amercan Journal of Agrcultural Economcs 87: Magg, G., Strategc Trade Polces wth Endogenous Mode of Competton. Amercan Economc Revew 86,

13 Ramos, MP., Bureau, J.C., Salvatc, L Shppng The Good Beef Out: EU Trade Lberalzaton to Mercosur Exports, WP Tradeag proect, Rude, J., Gervas, J-P Tarff-Rate Quota Lberalzaton: The Case of World Prce Uncertanty and Supply Management, Canadan Journal of Agrcultural Economcs 54, Scoppola, M Tarffcaton of Tarff Rate Quotas under olgopolstc competton. The case of the EU mport regmes for bananas, WP Tradeag proect, Skully, D. 2001a. Economcs of Tarff-Rate Quota Admnstraton. Washngton DC: Unted States, Department of Agrcultural, Economcs Economc Research, Servce Techncal Bulletn Number 1893, Aprl. Skully, D. 2001b. Lberalzng Tarff-Rate Quotas, n Mary E. Burfsher (ed) Agrcultural Polcy Reform n the WTO - The Road Ahead, Economc Research Servce, U.S. Department of Agrculture. Agrcultural Economc Report No Vves, X., Olgoply prcng. Old deas and new tools. The MIT Press: Cambrdge Mass. WTO Tarff rate quota admnstraton and methods and tarff quota fll, Note by the Secretarat TN/AG/S/22, 27 Aprl 2006; WTO: Geneva. WTO Revsed draft modaltes for agrculture, TN/AG/W/4/Rev.3 10 July 200, WTO: Geneva. 12

14 Table 1: Trade polcy nstruments and the outcome of the game Mode of competton Bndng Instrument Q = Q /N Q > q C B, q C B q < Q < q Q < q C B, q B Q =q C Q =q T>T* T<T* T>T* T<T* Cournot Bertrand t T - Bertrand - T Bertrand Bertrand t T - Bertrand - T Cournot - t - Table 2: Trade, welfare and competton effects of lberalzaton Increase n N Baselne 20% 40% 60% 80% 100% Prce Total mports Total profts Consumers' welfare Taxpayers' welfare Total welfare Market power Reducton n the n-quota tarff Baselne 20% 40% 60% 80% 100% Prce Total mports Total profts Consumers' welfare Taxpayers' welfare Total welfare Market power Reducton n the out-of-quota tarff Baselne 10% 20% 30% 40% 50% Prce Total mports Total profts Consumers' welfare Taxpayers' welfare Total welfare Market power Reducton n l Baselne 30% 60% 100% Prce Total mports Total profts Consumers' welfare Taxpayers' welfare Total welfare Market power Note: n yellow when frms compete à la Cournot 13

15 Bertrand Cournot T* T bndng T t bndng N Fgure 1: The crtcal tarff as a functon of the number of frms 20 Cournot Bertrand 15 T T* t Fgure 2: The crtcal tarff as a functon of the n-quota tarff 14

16 T* Cournot Bertrand 14 T l Fgure 3: The crtcal tarff as a functon of the cost of obtanng lcences T Bertrand Cournot T * 5 Fgure 4: The out-of-quota tarff and the mode of competton 15

17 Appendx a) The Cournot equlbrum The maxmzaton problem s the followng: max Π = q ( α βq λ q t l m ) q Frst order condtons are: Π = α 2 βq λ q ( t + l + m) = 0 q From whch we obtan the reacton curve α ( t+ l+ m) λ q q = 2β The equlbrum quantty s gven by: q = α ( t+ l) λ from whch: q C α ( t+ l) λ q 2β ( α ( t+ l+ m) ) = 2 β + λ( N 1) 2β By substtutng the equlbrum quanttes n the demand (2) the Cournot prce (11) s obtaned. b) The Bertrand equlbrum The maxmzaton problem s: max Π = ( a bp + c p )( p T m) p Frst order condtons are: Π = a 2 bp + c p + b( T + m) = 0 p from whch we obtan the reacton curve: p = a+ c p + b( T + m) 2b Gven the symmetry assumpton: 16

18 a+ c( N 1) p+ b( T + m) p = 2b from whch B a+ b( T + m) p = 2 b c( N 1) c) The crtcal tarff The crtcal out-of-quota tarff T * s defned mplctly by B C p ( m, T) = p ( m, t, l). The closed form expresson for T * s: T* = 2 Kl ( + t) + λ (1 + N)( m α) + λnzl ( + t) W (12) wth K = 2β 5βλ+ 3λ, W = β(2 β + λ(3n 5) + λ (2 + N( N 3)), and Z = 3 β + λn 4λ. Gven that β > λ, KZ>, 0. A suffcent condton for W > 0 s N > 1. 17