The dynamic behavior of quota license prices : theory and evidence from the Hong Kong apparel quotas

Empirical studies of the welfare consequences of quotas often assume perfect competition everywhere. If this assumption is not valid, welfare estimate and policy recommendations may err dramatically. The popular press often argues that market power is being exercised in markets constrained by import quotas. The authors develop a framework for testing the hypothesis of perfect competition in the market for apparel quota licenses. Drawing on simple models, they predict the behavior of license prices, taking into account four influences on prices: scarcity value, option value, renewal value, and asset value. They explore the effect of imperfections in the license market on license price paths. They test allegations that there is price fixing in the market for Multi-Fibre Arrangement (MFA) apparel quota licenses in Hong Kong. (Hong Kong often serves as a benchmark case for the welfare consequences of the MFA.) They use monthly data on license prices and use rates to test for the presence of imperfect competition. They argue that a concentration of license holding could affect both the supply side and the demand side, by affecting the costs of search. These results accord well with the authors theoretical discussion, in which they point out that license use and price paths with imperfect competition in the license market may be quite different from the corresponding paths in the case of perfect competition - even though the total use of licenses is the same. The authors estimate the structural demand and supply equations of the model, which provide further evidence of imperfect competition in the license market. In particular, the intra-year path of quota license prices and of quota use are found to be affected by concentration in license holdings. The results, in short, suggest that market power exists in Hong Kong's quota license market. Hong Kong is often considered the prime example of perfect competition, so this has major implications for other developing countries.