Most studies of voluntary export restraints (VERs) focus on the restricted market, tending to assume that the exporting countries will gain from being able to raise their prices in that market and so accrue an economic rent. In Discussion Paper No. 383, however, Research Fellow Jaime de Melo and Programme Director L Alan Winters investigate the costs of VERs to exporting countries. As well as raising the price of the export in the restricted market, a VER will also probably induce exporters to divert some of their products to other markets and create some contractionary pressure on the industry concerned.
De Melo and Winters model an industry that sells in two export markets goods which may differ but are produced using the same factor of production. The effects on profits of a just-binding VER (fixing exports just below their free-trade level) in one market depend on the differences between the marginal revenues on sales in the two markets and between these and marginal costs. Where competition between exporting firms prevents exploitation of market power, the conditions for profit maximization depend on product demand and factor supply elasticities and the nature of firms' cost functions. Either export diversion or industry contraction must occur, and most likely both.
Turning to the VER's effects on the exporting country's national welfare, if the affected industry employs a significant fraction of the total supply of the factors it uses, its contraction will drive down factor rewards in all uses of these factors. Sector-specific skilled workers will particularly suffer. If all industries in the exporting country are competitive, the cost of the VER distorting the country's productive structure must be set against the increase in the VER-afflicted industry's profits.
De Melo and Winters estimate the key parameters of demand and supply for the case of leather footwear exports from Taiwan to the United States, which were subject to an Orderly Marketing Agreement during 1977-81. Initial estimates of a model explaining demand in the United States and in the rest of the world and the allocation of Taiwanese exports between the two markets indicate that Taiwan's export allocation was quite sensitive to relative prices in that period. They then add an equation for the level of employment in the industry, which responds to the wage relative to product prices. These estimates suggest very high elasticities of demand but rather less price sensitivity in export allocation. Both sets of results are consistent with the existence of both export diversion and industry contraction.
Simulations of the theoretical model for a small industry facing fixed factor prices reveal that a higher elasticity of export supply makes the VER less harmful to efficiency, more favourable to profits, but more harmful to employment. If factor prices are variable, the harm caused by the VER is also related negatively to the elasticity of factor supply to the VER-afflicted industry and positively to the size of the pool of affected factors (relative to the industry's size). De Melo and Winters find that, for most reasonable combinations of size and elasticity, VERs divert exports, reduce industry size and cause overall national welfare losses, especially if the affected industry is large.
This indictment of VERs challenges the complacency with which economists have treated their consequences for exporters, de Melo and Winters conclude. Though less harmful to exporters than equivalent import quotas, VERs can nonetheless impose notable welfare losses when they restrict industries which account for significant shares of economic activity or which use industry-specific, relatively immobile factors

Do Exporters Gain from VERs?
Jaime de Melo and L Alan Winters

Discussion Paper No. 383, March 1990 (IT)