Quotas, Spillovers, and the Transfer Paradox in an Economy with Tourism

Abstract

This paper examines the welfare implications of quotas for an economy that is small in terms of traditionally traded goods and has monopoly power over the trade of goods consumed by tourists. Inbound tourism converts local nontraded goods into tradable goods, creating a tourism terms‐of‐trade effect for the tourist‐receiving economy. Through this effect, quotas result in a spillover to the nontraded sector. Hence, in the presence of tourism, the traditional free‐trade prescription for the small open economy is no longer valid. This lends support to the setting of import quotas. Using the optimal quota as a benchmark, we further examine the welfare effect of tied aid. If tied aid brings about an excessive supply of importable goods, then the transfer paradox of the immiserization of the tourist‐receiving economy may occur.