As earlier said, since we have not discussed production, market
structure, etc., the demonstration here of the explanatory power of the law of
demand is only precursory instead of flexing all muscles. Yet my November 26,
2003 article, “Quota: No Lessons Drawn from Previous Examples?”, is a
very good demonstration of the might of the law of demand. Readers do not have
to wait till Volume II to comprehend. The concept of monopoly rent, a
wonderful plot that I introduced in that article’s latter part, was also
comprehensible. For readers to realize the mightiness of the law of demand, a
translation of that article is set out below:
With the
signing of the agreement of the World Trade Organization (WTO) two years ago,
the quota system for textile and garment imports into the United States has
been progressively banned, with quotas for some of them already abolished. Due
to the abolition of quotas, imports of three kinds of products into the U.S.
rose sharply. This led to the U.S. deciding to re-introduce quotas early next
year. China voiced its opposition, claiming the U.S. has violated the WTO
agreement. The U.S. insisted there was no violation, erupting a dispute between
the two countries. I have no idea which country is right, but whichever is
right is not an issue to be explored here.
Often can
we find analyses of economists on the effect of quota. They generally follow
textbook approach, shifting a few curves to and fro, adding a few changes with
reference to legislation, and then compile quantitative analyses using
statistical tools like regression. Such analyses are not wrong, but since too
much emphasis is put on mathematical equation and import/export figures, the
most imperative implication of quota for manufactured goods is overlooked. In
other words, the most imperative content is being disregarded. Let me
elaborate.
In the
1970s, Hong Kong became the world’s largest exporting “country” of garments
(textile products). Why? The reason was since the mid-1960s, the U.S. and other
developed countries used quotas to restrain the import of textile products from
Hong Kong!
I in those
days was in the U.S. and saw that myself. In the 1960s, textile products from
Hong Kong, of low quality and cheap prices, were only sold in basements of
lower-class shopping outlets. So shady were they that they were displayed
together with products of other developing countries. After the imposition of
quota restriction, there was a dramatic rise in the quality of Hong Kong
garments. Within just a few years, they rose through the ranks from basement to
the floor selling top-quality products, with prices rising sharply as well.
Many high-class U.S. brands lost grounds as a result or were eliminated. In
fact, in the late 1970s, when well-off ladies from Hong Kong flew to the U.S. for
shopping at posh shopping centers, the clothes they bought were all made in
Hong Kong.
Is this at
all surprising? Forty years ago, some states in the U.S. changed the levy of
tobacco tax to a per-pack basis. Cigarettes were instantly made longer. And some
years ago, the garbage collection agency appointed by a certain district
council in Seattle went out of its mind to charge garbage fee on a per-bin
basis. Garbage bins in that council were instantly made bigger and stuffed to
their fullest possible. Parents asked their kids to jump on garbage to make
additional room, resulting in garbage bins too heavy to be lifted!
Quota is
valuable. One piece of garment requires one quota for export, so there is no
reason why a manufacturer would not improve the quality of garment. This is
similar to the U.S. apples and oranges which get imported into Hong Kong. Since
the same freight applies irrespective of quality, exporters would definitely
choose high-quality ones. Suppose I, without the knowledge of my wife, take a
lady like a young Song Meiling out to the Amigo Restaurant for dinner, I would
not be so stupid to ask the waiter for a burger.
Suffice it
to explain is the same law of demand. The answer that Form 6 students in Hong
Kong will be able to provide is, with the inclusion of freight charges, the
prices of high-quality apples and lower-quality ones are both increased, but
from the perspective of relative price, the price of high-quality apples has
gone down. Prices in the law of demand are always relative. By the same token,
improving the quality of garment raises its price, yet when the same value of a
quota is added onto a piece of high-quality garment and a lower-quality one,
the relative price of the high-quality one will go down, therefore the quality
of exports shoots up.
Form 6
students who can provide this analysis would get full marks, while
post-doctoral fellows would merely get 60, a bare pass, as it is only roughly
correct. A more correct, or more thorough analysis, has to interpret “quantity”
in a pretty complicated manner. My book, “The Science of Demand”, deals with
this issue in Section 5 of Chapter VI.
With
quantity restricted by quota, why, then, did Hong Kong become the world’s
largest exporting “country” of textile garments? The answer is a combination of
two reasons. First, higher quality escalates price, and export is calculated on
price. Second, higher-quality garment, being more durable, indirectly reduces
the export quantity of other countries.
Another
issue arises. In those days, other Asian countries or regions all faced the
same quota restrictions, why was it mainly Hong Kong that came out in front?
The answer utilizes the same law of demand: only Hong Kong in the whole Asia
allowed free-trading of quotas in the market. This freedom of transfer not only
permitted quotas to fall into the most efficient or appropriate hands, but also
allowed the value of quotas to heighten, which in turn enabled the relative
price of Hong Kong’s high-quality garments to drop further. It is believed that
there is also a quota-transfer market in the mainland for textile products, but
since it is illegal, the market has invented certain transfer schemes to
circumvent the rules. This results in increased transaction costs. However, it
is generally observed that quota transfer is commonplace in the mainland, its
impact on product quality, therefore, should be similar to that of Hong Kong in
those days.
Any
manufactured product can have different grades of quality. In free-trading
international market, different regions will choose to produce goods of such
quality level that suit their comparative cost advantage. Manufacturers which
make the wrong choice will be eliminated by the market. It is not that Hong
Kong manufacturers were unable to produce high-quality, high-grade garment
before the introduction of quota, but that they believed, under free
international competition, their cost would have been no match for developed
countries had they invested in high-grade products.
The
introduction of quota has altered the quality-grade rankings in free market.
Why was it possible? Before the quota system, garment manufacturers in Hong
Kong believed that the cost in producing high-grade garment was too high to
succeed. Did such cost drop with the quota system? Certainly not. The answer
was: the introduction of quota restricted competition among garment
manufacturers, rendering each quota holder a certain degree of monopoly. The
value of quota represented monopoly rent, and the existence of this rent
allowed the quota holder to increase cost, thereby permitting a dramatic rise
in garment quality. With competition among quota holders, equilibrium would be
reached when, at each and every margin, the cost increase in improving quality
equaled the quota rent. The dramatic increase in garment quality therefore can
be viewed from two perspectives: first, the law of demand compels the choice of
improving quality; second, quota rent makes room for increase in cost. This is
economics.
So ill-advised
is protectionism that it is hardly imaginable. In those days, the U.S. and
other developed countries, in order to protect their own garment manufacturers,
imposed quota restrictions on Hong Kong textile products that were lagging
behind with poor quality. Given the protection of quota, Hong Kong
manufacturers had on hand considerable quota rent that allowed them room to
raise cost and improve product quality, resulting in the downfall of quota
advocates. This is called lifting stone to stone one’s own feet.
In recent
years, mainland China’s garment industry, joined by many Hong Kong
manufacturers, has been producing goods of a wide range of qualities and
grades, with no lack of top-grade products. Following China’s accession to the
WTO and the abolition of quota, these garment manufacturers have been facing
surging competition. Under such circumstances, with the return of quota system
driving them to further excel, even the most glamorous suit may be produced.
Innocent yet implicated, the famous brands in Europe will see disaster coming!
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