Monopoly Power in Domestic Production, Smuggling, and the Non-Equivalence Between Tariffs and Quotas

During the last thirty years, one of the most popular research topics in international trade has been the non-equivalence among policy instruments such as specific and ad valorem import tariffs, voluntary export restraints and import quotas. The non-equivalence principle was shown to hold under revenue/rent seeking behavior (Vousden, 1990), under uncertainty (Young and Anderson, 1982), and in the presence of retaliation (Melvin, 1986; Syropoulos, 1994). Furthermore, it has been shown that different policy instruments have different effects on the stability of world prices (Zwart and Blandford, 1989) in addition to having different effects on the quality/composition of imports (Falvey, 1979; Das and Donnefeld, 1987). Perhaps the best known case of non-equivalence is the one described by Bhagwati (1965, 1969) where domestic production is controlled by a monopolist. For a given volume of imports, an import tariff generates a lower domestic price and less deadweight loss than an import quota. Casual empirical evidence from developing and developed countries alike indicates that highly distorted prices, resulting from trade and domestic taxes, provide consumers and firms the necessary incentives to engage in various types of illegal activities usually referred to as smuggling. In spite of the prevalence oft his by-product of government intervention, it is often ignored for policy analysis purposes. In this paper, we revisit Bhagwati's non-equivalence when domestic production is controlled by a monopolist and allow smuggling activities to t^e place when the differential between the domestic price and the world price is high enough.