What it means
Governments sometimes want to shield a local industry from imports without openly breaking trade rules. Under a VER, the importing country asks its trading partner to cap its exports, often as a number of units or a share of the market, and the exporter agrees.
The cap is set for a period, such as three to five years. Exporters accept for practical reasons.
They fear that refusing could lead to import duties or quotas that would be worse for them. A famous historical example is the limit on car exports from Japan to the United States and other markets in the 1980s.
The economic effects are well studied. Because supply is held down, prices in the importing country rise, and consumers pay more for fewer choices.
Local producers benefit from higher prices and more sales, and the exporting firms that hold the permits to sell often earn extra profit on each unit. That extra profit is called quota rent, meaning the premium earned because supply is deliberately limited.
Under an ordinary tariff the importing government would collect this money as tax revenue. Under a VER the benefit goes to the foreign exporter, which is a major reason economists often view VERs as a costly form of protection.
Exporters also respond in predictable ways. Because a cap on quantity does not cap value, they tend to shift to higher-priced, higher-quality models, and they may move production into the importing country or a third country to avoid the limit.
Both responses were visible in the car trade. VERs have fallen out of favour since international trade rules were tightened to discourage such grey-area arrangements.
For managers, the concept is still useful because it explains why trade restrictions can show up in prices, product mix and investment decisions.
In practice
Real-world examples.
Example
A country with a struggling steel industry persuades a major exporting nation to hold its steel shipments to a fixed tonnage. Domestic steel prices rise by 6%, and local mills increase output. Construction firms that buy steel face higher costs and pass some on in their quotes.
Example
A television maker in an exporting country is told by its government to limit sales to a large foreign market. The maker responds by shipping fewer basic models and more expensive premium ones, so its revenue falls by less than its unit sales.
Example
A car company decides to build an assembly plant inside the importing country after a VER limits its exports. By producing locally, it avoids the cap, creates local jobs and keeps its market share, although the plant requires a large capital investment.
Formula
Calculation
Quota rent = (Price with restraint - Price without restraint) x Quantity exported under the restraint
Suppose exporters agree to cap shipments of a product at 500,000 units a year. Without the cap, the market price would be $20,000 per unit, but with the cap it rises to $21,500. The price gain per unit is $21,500 - $20,000 = $1,500. Quota rent = $1,500 x 500,000 = $750,000,000. This amount goes to the exporting firms, not the importing government, and it is paid by consumers in the importing country through higher prices.Case study
Seen in the real world.
Meridian Motors is an illustrative, fictional car maker that exported 300,000 vehicles a year to a neighbouring country. When its government agreed a VER limiting exports to 240,000 vehicles, the finance director had to rebuild the sales plan.
Prices of its cars in the neighbouring market rose by $1,000 each, so on 240,000 units the company earned an extra $240,000,000 in revenue from the higher prices, but lost the margin on the 60,000 vehicles it could no longer sell. The team shifted its quota to larger, more profitable models, which raised the average profit per car.
The board then approved a $400,000,000 factory in the importing country to serve that market without limit. The illustrative lesson is that a quantity cap changes product mix and investment strategy, not just volume.
Watch out
Common mistakes.
- Believing a VER is truly voluntary, when it is normally agreed under pressure from the threat of tariffs or other trade barriers.
- Assuming that the importing country's government collects the benefit, when the quota rent usually goes to the exporting firms.
- Thinking a cap on units reduces export revenue by the same share, when exporters often move to higher-priced products.
Questions
People also ask.
How does a VER differ from a tariff?
A tariff is a tax collected by the importing government on each unit, while a VER limits the quantity and leaves the extra profit with exporters.
Are VERs still used?
They are now rare, because international trade rules discourage them, though similar informal limits can still appear.
Who loses from a VER?
Consumers and businesses in the importing country, who pay higher prices, and potentially exporters who are prevented from selling more.
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