(ii) Protection to some domestic industries and employments etc. [This may be for defence or strategic reasons also].
In achieving these goals, quotas have a comparative advantage over other means of restricting imports, in the following manner:
i. Of all the alternative ways of restricting imports, quota system is the most direct and effective method of ensuring that imports do not cross prescribed upper limits.
ii. Success of quota system does not depend upon the response of the market forces. In contrast, tariff duties work through a response by the market forces and an increase in the import prices.
iii. Tariff duties may take a long time in reducing imports. Quotas are designed to bring about a time-bound success.
iv. Monopoly profit associated with scarcity of the imported item can be appropriated by the authorities either by auctioning the quotas to the highest bidders or by taxing the scarcity profit of the importers.
v. Quota system is an efficient system of providing protection to domestic industry. To that extent, therefore, it can be of great help in encouraging economic growth, provided it is used judiciously.
However, use of quotas is not a situation of an unmixed blessing. The system has its own drawbacks and limitations including the following:
i. Quota system necessitates a large set of decisions and it is not always possible to base them and coordinate them on objective criteria.
For example, the set of decisions include the quantity of import, allocation of import permits, determining the sources of imports, and so on.
There is, therefore, a risk of creating and protecting vested interests. Moreover, criteria on which these decisions should be based differ from one country to another and, over time, even for the same country.
ii. Quota system necessitates administrative machinery for dealing with the issues and problems associated with it.
In contrast, an import duty can be handled by the existing revenue department. In other words, the quota system inflicts an additional resource cost on the government.
iii. The decision-making authorities have to continuously monitor and assess the changing situation so as to decide whether the system needs modification or not.
iv. Quota system encourages creation and perpetuation of monopoly elements. This happens because supply of the quota-item is deliberately restricted.
v. The quota holders have to import the item within a prescribed period of time and, in some cases, only from specified sources.
This weakens their bargaining strength vis-a-vis suppliers. Also, the supplier countries may levy export duties and make the importers bear their incidence.
vi. Some critics argue that investors are never confident about long-term stability of a quota system and, therefore, they are unable to assess the extent of long term protection to the domestic industry. Consequently, quotas do not encourage long term investment and economic growth.
vii. If the imported item under a quota system is an essential one, its restricted availability causes a loss of welfare to the consumers. They are forced to divert their expenditure to less preferred substitutes.
viii. Consumers may shift their expenditure to exportable goods. To the extent they do so, there is an adverse impact on the country’s balance of payments.