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TESTING the THEORY of TRADE POLICY: EVIDENCE from the ABRUPT END of the MULTIFIBER ARRANGEMENT James Harrigan and Geoffrey Barrows

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TESTING the THEORY of TRADE POLICY: EVIDENCE from the ABRUPT END of the MULTIFIBER ARRANGEMENT James Harrigan and Geoffrey Barrows TESTING THE THEORY OF TRADE POLICY: EVIDENCE FROM THE ABRUPT END OF THE MULTIFIBER ARRANGEMENT James Harrigan and Geoffrey Barrows Abstract—Quota restrictions on United States imports of apparel and anticipated, easily measured, and statistically exogenous textiles under the multifiber arrangement (MFA) ended abruptly in Janu- ary 2005. This change in policy was large, predetermined, and fully change in trade policy provides the natural experiment that anticipated, making it an ideal natural experiment for testing the theory of we use in this paper to test some simple theories about the trade policy. Prices of quota-constrained categories from China fell by effects of quotas. 38% in 2005, with smaller declines from other exporters. Prices in unconstrained categories from all countries changed little. We also find We test two fundamental predictions: binding quotas substantial quality downgrading in imports from China in previously raise prices and lead to “quality upgrading,” that is, a shift constrained categories. The annual cost of the MFA to U.S. consumers was in the mix of products under a given quota toward more $63 per household. expensive goods. These predictions are resoundingly con- firmed: when the MFA ended, prices and quality of U.S. I. Introduction imports in previously quota-constrained categories fell dra- HE economic analysis of trade policy is as old as matically, especially on quota-constrained goods from Teconomics, but the ratio of convincing evidence to China. By contrast, nonconstrained imports showed no theory remains small.1 The reason is simple: trade policies systematic changes in prices or quality. These results are generally change gradually, making it hard to untangle the highly robust, and require no restrictive assumptions on effects of policy from the effects of other factors that functional form or exogeneity. influence trade. A related empirical problem, highlighted by We are also able to estimate what the end of the MFA Trefler (1993), is the political endogeneity of protection, meant to U.S. consumers in 2005: the equivalent variation which creates the need for valid instrumental variables for was approximately $7 billion, which amounts to an annual protection in most analyses of the effects of trade policy. gain per household of over $60. Most of this welfare gain This paper uses a natural experiment in U.S. trade policy was due to the dramatic drop in prices, and increase in to get around these thorny inference problems. The system quantities, from China. of bilateral quotas long known as the multifiber arrangement The end of the MFA, and the consequent unleashing of (MFA) regulated global trade in apparel and textiles for China’s vast potential for producing cheap labor-intensive many decades, and a major achievement of the Uruguay textile and apparel products, was widely predicted to lead to Round concluded in 1995 was that members of the World calamity for other developing-country textile and apparel Trade Organization (WTO) agreed to phase out MFA quotas exporters. We show that these fears were not borne out, at no later than January 1, 2005.2 Like most big importers, the least for big exporters to the United States. The reason is United States delayed the bulk of MFA liberalization until that most of the big exporters were also quota constrained in literally the last moment, with hundreds of binding quotas 2004, and were able to sharply increase their exports when still in place until midnight on December 31, 2004. As the the MFA ended despite intensified competition from China. new year dawned, a veritable tsunami of cheap textile and The major exception is Mexico, whose privileged access to apparel products from China and other developing countries the U.S. market ended with the end of the MFA. started to swamp U.S. ports. This large, sudden, fully II. U.S. Trade Policy in Apparel and Textiles Received for publication September 26, 2006. Revision accepted for publication November 9, 2007. A variety of restrictions have long affected trade in textile Corresponding author is James Harrigan, Department of Economics, and apparel products.3 One of the broadest sets of policies, University of Virginia. Geoffrey Barrows is with University of California Berkeley ARE. This paper is a substantially revised version of our October however, became effective in 1974. The MFA established a 2006 NBER working paper no. 12579 of the same name. We thank system of quotas, negotiated bilaterally, that limited imports Deirdre Daly for help with the data, and Yue Li, Amit Khandelwal, and of textile and apparel products. seminar participants at the World Bank, the New York Fed, and the NBER China Working Group for helpful comments. This paper was written while Participants in the Uruguay Round of trade talks agreed both authors were employed in the International Research Department of to phase out the MFA beginning in 1995. The MFA was the Federal Reserve Bank of New York. The views expressed in this paper replaced by the Agreement on Textiles and Clothing (ATC), are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. which put in place a system for gradual elimination of 1 The ratio is not zero, however. See Feenstra (1995) for an excellent quantitative restrictions. The ATC incorporated a series of survey. Much high-quality work on the effects of trade policy is done at stages, with phaseouts occurring at the beginning of 1995, the World Bank; see for example Laird and Yeats (1990) and Kee, Olarreaga, and Nicita (2006). The NAFTA agreement has occasioned 1998, 2002, and 2005, at which time all remaining quotas some fine ex post analyses, including Trefler (2004) and Romalis (2005). were eliminated. Between 1995 and 2005, remaining quotas 2 When the Uruguay Round was agreed, the MFA was replaced by the were progressively enlarged, using agreed-to increasing Agreement on Textiles and Clothing, or ATC. To keep acronym profusion in check, we will continue to use the older term MFA in the remainder of this paper. 3 The analysis in this section is based on Evans and Harrigan (2005). The Review of Economics and Statistics, May 2009, 91(2): 282–294 © 2009 by the President and Fellows of Harvard College and the Massachusetts Institute of Technology Downloaded from http://www.mitpressjournals.org/doi/pdf/10.1162/rest.91.2.282 by guest on 30 September 2021 TESTING THE THEORY OF TRADE POLICY 283 growth rates. The agreement also established a special Regional liberalization efforts have also affected the de- safeguard mechanism for protection against surges and a gree to which quantitative restrictions constrain trade. The monitoring body to supervise implementation. main regional agreements affecting the period that we When the MFA first came into effect, China was not a examine are the Caribbean Basin Initiative/Caribbean Basin member of the WTO, so it was not a part of the initial MFA Economic Recovery Act (CBI/CBERA) and the North phaseout process. However, upon accession to the WTO at American Free Trade Agreement (NAFTA).6 The CBI/ the end of 2001, China became eligible for participation in CBERA programs, initially enacted in the mid-1980s, pro- the MFA quota elimination process. Thus, the United States vided preferential treatment for imports from 24 countries in generally implemented the first three stages of “integration” that region.7 (that is, into the MFA quota liberalization program) for China in the first part of 2002.4 When it joined the WTO, III. Theory: Price, Quality, and Welfare Effects of Quotas China also agreed to a special safeguard on its textile and apparel exports. Under this safeguard mechanism, if a WTO The specification of MFA quota limits always had two member felt that textile and apparel imports from China features: (i) They were fairly broad, potentially including threatened to “impede the orderly development of trade in many different products. Some examples are “womens’ and these products,” it could request that China limit its exports girls’ dresses, cotton” and “mens’ and boys’ sweaters, to that country, generally for no more than one year. If wool.” (ii) They were specified not in terms of value but in consultations did not lead to a different solution, China terms of physical quantities (such as numbers of dresses, would agree to hold its exports of the given product “to a square meters of fabric, dozens of pairs of socks). What level no greater than 7.5 per cent (6 per cent for wool does economic theory predict about the effects of such product categories) above the amount entered during the broad, quantity-specified quotas?8 first 12 months of the most recent 14 months preceding the Trivially, a binding quota will reduce the quantity of month in which the request for consultations was made.” imports, but beyond this the effects depend on details of This safeguard mechanism remained in place until Decem- demand and market structure. Numerous authors have ber 31, 2008. As we will discuss below, there was one such pointed out that no simple “tariff equivalents” exist for safeguard quota in effect on U.S. imports from China in quotas except in the simplest of cases; for example, see 2005 even after all MFA quotas were eliminated on January Anderson (1988) and Feenstra (2004, chapter 8). Some of 1, and twelve new safeguard quotas were imposed in mid- the more interesting analyses of the economics of quotas 2005. For more on how the ATC was implemented, with a occurs when markets are imperfectly competitive; see, for particular focus on China, see Brambilla, Khandelwal, and example, the celebrated paper of Krishna (1989). What Schott (2007). virtually any model predicts is that binding quotas will raise The MFA was not the only U.S.
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