Tariff Rate Quotas with endogenous mode of competition: The liberalization of Tariff Rate Quotas under oligopolistic competition (alias: “paper TRQs”) Tariff Rate Quotas with endogenous mode of competition: the case of the EU import regimes for bananas (alias: “paper bananas”) Margherita Scoppola Università di Macerata I Workshop 29-30 gennaio 2009, Roma

Background More than 15% of agricultural products imported by the EU are covered by a TRQ (10% in Japan and US); The extensive use of TRQs in multilateral and preferential agreements has raised questions; How to liberalise TRQs?

The key issues in the debate about TRQs liberalisation Maintaining TRQs: reduction of the in-quota or out-of-quota tariffs or expansion of the quota: which option is (more) effective? Tariffication of TRQs: what is the tariff equivalent?

Literature Most contributions on agricultural TRQs and on their liberalization assume perfect competition; Literature on quota-tariff (non) equivalence under oligopoly has shown that strategic interactions under quotas and tariffs are different (e.g. Harris, 1985; Krishna, 1989); But most papers assume exogenously the mode of competition: Cournot or Bertrand

Literature This means that they implicitly assume that a change in the trade policy (i.e. liberalisation) does not modify the mode of competition; Further, models predictions are dependent on the ex-ante assumption about the mode of competition

Motives and aims of the papers 1. To consider the presence of oligopolistic traders in modelling TRQs and their liberalisation; 2. To use an oligopoly model in which the mode of competition is endogenous and depends upon the trade policy;

One basic framework… Both papers use a two-stage capacity constrained model in which the mode of competition (MOC) is endogenous and the constraint is flexible; They are both based on Maggi (1996): in the first stage firms choose capacity; in the second compete on price, they can adjust capacity even if at a higher cost (flexible constraint); The outcome of the game (from Bertrand to Cournot) depends upon the effectiveness of the capacity commitment in the first period;

One basic framework… Capacity constraint models are the natural framework to analyse quantitative restrictions to trade; TRQs and the model by Maggi (1996): in the first stage firms choose capacity: they choose the amount of licences to import within the quota; in the second compete on price; they can adjust capacity even if at a higher cost : firms can only import out-of-the quota at the out-of-quota tariff;

… two different issues and settings Policy issues TRQs paper: which liberalisation option is more effective and when? By means of numerical examples Bananas paper : what is the tariff equivalent? Application of the model to the case of EU TRQ on bananas

Setting Market structure: Allocation of licences: TRQs paper: N symmetric firms Bananas paper: duopoly with a competitive fringe; Allocation of licences: TRQs paper: FCFS, licences-on-demand, auctions, no market for licences Bananas paper : historical criteria with a market for licences;

The liberalization of TRQs under oligopolistic competition First paper The liberalization of TRQs under oligopolistic competition

The model N symmetric firms importing a differentiated product; Linear demands and constant marginal trading costs, m; Q is the import quota and t and T are the in-quota and the out-of-quota tariffs.

Licences to import within the quota There is no initial allocation of licences Firms face a constant cost to obtain the licence (e.g. rent-seeking in FCFS/licence-on-demand methods; the price in auctions); No market for licences The maximum amount of licences available to each importer is

First stage: firms choose capacity, i. e. the amount of licences First stage: firms choose capacity, i.e. the amount of licences. By this way they commit themselves to import a certain quantity in the second period. Second stage: firms compete on price. They can increase imports, but only out-of-quota; The marginal cost of increasing capacity is: in the first period in the second period; with

The outcome of the game may be Bertrand or Cournot depending upon the effectiveness of the capacity commitment…. … which depends upon the gap in the marginal costs of adjusting capacity in the two periods

If this gap is low or zero, then the commitment is weak or ineffective and the equilibrium is the outcome of one-shot Bertrand game with long run costs equal to second period marginal costs If the cost of adjusting capacities in the second period is very high, then the commitment is strong and the outcome is the one-shot Cournot game with long run costs equal to first stage marginal costs

Unlike Maggi (1996) (and the “bananas paper”) here firms may face the constraint in expanding capacity in the first stage; Whether or not depends upon demand, costs and the quota When there are out-of-quota imports the amount of purchased licences is which does not represent the capacity chosen by firms and, thus, does not work as a capacity commitment.

Firms perceive the TRQ as a tariff equal to T: the outcome is always Bertrand; This means that the subgame perfect equilibria in this case implies:

T* is the critical value of the second stage marginal costs (out-of-quota tariff) above which the MOC shifts to Cournot and depends upon t , l and parameters

The main implication is that in this model the “binding/redundant” instrument under the TRQ may be different from perfect competitive frameworks according to which: If the binding instrument is t; If the binding instrument is T; In this model the binding instrument varies according to the MOC, i.e. whether or not and

Unconventional results: With no out-of-quota imports if in equilibrium and the binding instrument is T; With out-of-quota imports if the equilibrium is Cournot and the binding instrument is t;

The impact of TRQs liberalization Liberalization options: Increase in Q; Reduction in t or T; Improvements in licences administration resulting in: Reduction in l , i.e. the cost faced by firms to obtain licences; Increase in the number of firms N accessing licences

The impact of TRQs liberalization on the mode of competititon Increase in Q: does not affect the value of T* with respect to T and thus does not affect the MOC; Reduction of t ,T, l and increase of N may affect the MOC

The impact of a reduction of t The reduction of t increases the gap between first and second period costs and reinforces the capacity commitment

The impact of a reduction of l The reduction of l increases the gap between first and second period costs and reinforces the capacity commitment

The impact of a reduction of T The reduction of T reduces the gap between first and second period costs and weakens the capacity commitment

The impact of an increase of N

If N is high enough, an increase in N makes stronger the capacity commitment and more likely the Cournot outcome; This is because the market share of firms reduces and this reinforces the capacity commitment Firms’ market power anyway reduces but less than under Bertrand;

Trade, welfare and competition effects Reduction of the in quota tariff t: No trade effects (!!) under Bertrand; trade effect only under Cournot (strong liberalization) Market power and firms profits always increase

Reduction of the out-of-quota tariff T: Trade effects (!!) under Bertrand (strong liberalization) Market power decreases with strong liberalization Firms profits decrease with strong liberalization

Reduction in firms’ cost l: No trade effects with weak liberalization Market power and firms’ profits always increases Welfare always improves as a consequence of the increase in firms profits

Increase in the number of firms N: Always positive trade effects Market power always decreases Welfare always improves

Conclusions A two stage framework may lead to unusual conclusions about the (in) effectiveness of the various TRQs liberalization options. Unconventional results basically are the consequence of the consideration of: strategic interactions between firms: equilibrium is determined by the marginal costs of the first or the second period depending on the strength of the capacity commitment

Trade policy instruments affect the nature of the strategic competition among firms and thus the effectiveness of the capacity commitment.

TRQs with endogenous mode of competition: Second paper: TRQs with endogenous mode of competition: the case of the EU import regimes for bananas

The model Two symmetric oligopolistic trading firms importing a differentiated product in one country ; A large number of less efficient traders behave competitively;

Quota licences are allocated on an historical basis: each duopolist holds qio licences, while small operators qso with Licenses are transferable Small operators are in equilibrium when the price of the licence is equal to the value of using it (i.e., the product price less the marginal costs).

If small operators face increasing marginal trading costs, then their supply of licences is:

The duopolists exert market power in the licence market. They are in equilibrium when their residual marginal revenue, net of other costs, is equal to The marginal cost of increasing capacity is: in the first period in the second period;

Sub-game perfect equilibria (Maggi, 1996):

What is the tariff equivalent of a TRQ? With a tariff, there is no capacity constraint: The solution of the game is always Bertrand Thus, the tariff equivalent varies according to the MOC under the TRQ

Case A: Under the TRQ the equilibrium is Bertrand (the capacity commitment is weak/not effective) Tariffication does not change the MOC; The tariff which leaves unchanged the imports of the duopolists is the tariff satisfying: Thus the tariff equivalent is the out-of-quota tariff T;

The tariff equivalent includes t, L and oligopsonistic rents

Case B: Under the TRQ the equilibrium is Cournot (the capacity commitment is effective): Tariffication shifts the MOC from Cournot to Bertrand; The tariff equivalent is the tariff which satisfies , that is, the critical tariff T* satisfying This tariff includes t, L, oligopsonistic rents, and part of oligopolistic rents

The value of the tariff equivalent depends upon the MOC: i.e. whether or not with The greater the amount of licences allocated to more efficient operators The lower the in-quota tariff; The higher the out-of-quota tariff The higher the probability of a Cournot outcome and the tariff equivalent being T*

The case of EU imports of bananas A calibrated version of the model is applied to the EU TRQ for non-ACP countries; This TRQ has been replaced by a tariff in 2006: what is the tariff equivalent? Market structure: Two firms account for more than 50% of non ACP imports; They differentiate their product by means of a well developed brand; A high number of small operators sell the licences to the two large firms

The tariff equivalent as a function of the degree of differentiation

The tariff equivalent as a function of the initial allocation of licences

Main findings For a wide range of parameters the mode of competition under the TRQ was Cournot; The tariff equivalent is higher than the one estimated by other studies and always higher than the tariff introduced by the EU in 2006; Oligopolistic rents accounted for the 70% of the market price of bananas

Grazie!

Inverse demand function: Degree of brand differentiation: