Tariff-Rate Quotas: Difficult to model or plain simple?

Phillip M. Bishop, Charles F. Nicholson, James E. Pratt, Andrew M. Novakovic
JEL codes: 
Working Paper 2001/7

The difficulty of reliably and accurately incorporating tariffrate quotas (TRQs) into trade models has received a lot of attention in recent years. As a result of the Uruguay Round of GATT negotiations, TRQs replaced an assortment of tariff and nontariff instruments in an effort to standardise trade barriers, and facilitate their future liberalisation. Understanding the nuances of TRQs is now particularly crucial for New Zealand because of the preferential access arrangements that New Zealand has for a number of products in highly protected markets such as the European Union, Japan, and the United States.

It has been argued that TRQs are complex instruments and are difficult to model because for any trade flow between two countries, one of three regimes may be applicable:
1. The import quota may not be binding and the within-quota tariff applies;
2. The quota may be binding, the within-quota tariff applies, and a quota rent is created; or
3. Trade occurs over and above the quota, in which case an over-quota tariff applies
(although, even in this regime, someone is still able to collect the quota rent on within-quota trade).

But even this characterisation, which many claim is too complex to model, is a major simplification of reality. Bilateral preferences are ubiquitous, and such preferences are usually included in the determination of multilateral market access quotas. It is usual, therefore, that the TRQ instrument has several tiers to the quota schedule, plus a number of within and over-quota tariff rates applicable on either a bilateral or a multilateral basis.

Further trade liberalisation creates something of a dilemma for New Zealand. Any decrease in over-quota tariffs and/or increase in quota levels potentially reduces the value of quota rents, many of which accrue to New Zealand due to the bilateral preferences. It is important, therefore, that New Zealand trade negotiators understand how much additional trade is required to offset the loss of New Zealands quota rents. Modelling trade in the presence of TRQs is the only way to ascertain this knowledge. The purpose of this paper is to show that complex TRQs can be modelled very easily and precisely. The only catch is that the model must be formulated as a complementarity
problem rather than the more conventional linear or nonlinear optimisation problem. The concept will be demonstrated using a simple 3-region, single commodity spatial price equilibrium model of trade.