The Cato Review of Business & Government
Arthur T. Denzau is professor of economics and a research associate
at the Center for the Study of American Business, Washington University.
In May of 1981, at the urging of the U.S. government, the Japanese government organized a cartel for the export of motor vehicles to the United States. The government of Japan imposed a voluntary export restraint (VER) on its automakers, administered by the Ministry for International Trade and Industry (MITI). Over the past seven years, the VER has extracted billions of dollars of tribute from American car-buyers to the benefit of Japanese autoworkers and the stockholders of Japanese auto makers.
Coming in the wake of the oil price hikes of 1979 and record losses in 1980 by US auto makers, the VER was intended to halt the growth of Japan's share of US car sales, and to provide the United States time to catch up with the Japanese in producing smaller, more fuel-efficient cars. Japanese manufacturers, it was said, viewed the VER as a violation of free trade. They spoke of it critically and suggested that their government had forced it upon them in order to undercut attempts by American protectionist interests to get still more onerous trade restraints.
According to my research, the idea that the Japanese would be hurt by the VER was fundamentally wrong. The VER promised large benefits to the stockholders of automakers in Japan, and Japanese investors were well aware of this when the VER was imposed. Rather than improving our competitive edge, the VER has encouraged the Japanese to begin producing larger, more expensive cars, thus making them an even greater competitive threat for the future.
The Genesis of the VER
When the Organization of Petroleum Exporting Countries tripled the price of barrel of crude oil in 1979, the US gasoline prices jumped to $1.40 per gallon, car buyers reacted in predictable ways. They reduced their purchases of new cars and dramatically altered their purchases toward smaller, more fuel-efficient cars. Small foreign cars, particularly imports from Japan, sold at a record rate. The Japanese share of the US market, just 12 percent in 1975, jumped to 27 percent in 1980. In that year the "Big Three" US automakers lost $4 billion: Ford had a record annual loss of $1.5 billion. By the end of the year, an estimated 210,000 US autoworkers had been laid off, and both the United Auto Workers union and industry management were pushing for protectionist relief.
The Election of Ronald Reagan in November 1980 seemed initially to be a blow to protectionist forces. But there were indications that the new Commerce Secretary, Malcolm Baldrige, would recommend a meeting with Japanese government officials to discuss voluntary limits on auto imports. Shortly thereafter, it became known that Transportation Secretary Drew Lewis was preparing a task force report that was expected to pave the way for a voluntary export restraint. There were also rumblings on Capitol Hill; Senators John Danforth and Lloyd Bentsen announced their intentions to introduce a bill to restrict the entry of Japanese cars.
Although Japanese spokesmen indicated that their government would not act to limit automobile exports unless specifically asked to do so, it was only a matter of weeks until MITI announced it was preparing a "compromise" plan. On April 30, 1981 the US and Japanese governments announced an agreement to restrain Japanese auto exports to the United States for a three-year period. The quota for the first year was set at 1.68 million cars, which was 120,000 lower than actual imports in 1980. Further details were still to be negotiated, including how the quota would be allocated among Japanese auto firms.
In June it became public information that MIII had told each Japanese auto maker how many cars it would be allowed to sell in the United States. Each firm's assigned market share (for the 12 months ending on March 31, 1982) was proportional to its 1979 sales.
The original VER agreement expired in 1985. However, it has been voluntarily extended by the Japanese government each year since, and remains in effect today. Remarkably, there is still no clear consensus about what the effects of this policy are, or why the Japanese government chooses to continue these limits. The dominant view is that the quotas were accepted by the Japanese because they were judged to be less onerous than legislation pending in Congress. Presumably they are continued because of an ongoing concern about possible legislative action. This view needs to be analyzed further.
The Making of a Cartel
I believe the VER effectively cartelized the Japanese automobile industry
by limiting the number of firms which could supply cars to the United States
and by allocating export assignments to these firms. To the extent that these
limits were binding, the VER prevented effective price competition among Japanese
auto makers, enabling them to raise prices and increase their profits. If
this is correct, the expected boost for business should have been reflected
in the price of the common stock of Japanese auto makers as soon as the news
about the VER became available.
A casual look at the data on stock prices suggests that Japanese investors expected the VER to have a positive effect on the automobile industry. The bar chart on the opposite page provides information on the price of the common stock of each of the six major Japanese auto makers. The dates selected are April 1, 1981, before any formal announcement about a VER; May 1, after the preliminary announcements; and July 1, after MITI announced the allocation of the quota among individual firms. As shown, between April 1 and May 1, stock prices jumped 23 percent for Nissan, 33 percent for Toyota, and 35 percent for Honda. Overall, the six firms gained an average of 24 percent, or about $1.85 billion in total value. Not all of this rise can be attributed to the first MITI announcement on April 21. Clearly something happened in April that caused investors to view the Japanese automobile industry as a much better investment at the end of April than at the beginning. Between May 1 and July 1, stock prices rose another 20 percent on average. The total rise in market value for the six firms in these three months was $3.8 billion, or 49 percent.
It would appear from these data that Japanese investors knew that the VER was a cartel that would help the auto makers. But in order to draw any solid conclusions, the data on stock prices must be more carefully analyzed.
Analyzing the 1981 VER
Finance analysts have developed an empirical technique called an event study to examine the effects of government actions on the prices of sensitive assets. The value of a firm's common stock is expected to reflect all the factors affecting the future profitability of that firm. Any change in a firm's valuation between two dates must be adjusted for changes in the market rate of return. The remaining so-called excess (or net-of-market) returns should reflect matters relating to the specific firm and its industry. Applied to the 1981 auto VER, an event study makes it possible to determine whether auto stock prices moved differently from the rest of the market around the date of each important event in the VER's creation and continuation.
To determine this I studied common stock prices for the six large Japanese auto makers receiving allocations: Daihatsu Diesel Manufacturing Company (a Toyota supplier), Fuji Car Manufacturing Company, Honda Motor Company, Mazda Motor Corporation, Nissan Motor Company, and Toyota Motor Corporation. These firms produced 93 percent of total Japanese auto exports to the United States in 1980, and were engaged almost exclusively in assembling motor vehicles. The event study analyzes the excess returns of these companies in the two market trading days beginning on the day the events were announced in the United States.
The key events in the creation of the VER are as follows: April 21, 1981, MITI's first announcement of a VER; April 30, the US and Japanese governments' joint announcement; June 10, MITI's announcement of the quota allocations; and June 24, the announcement of a similar VER between Japan and the Federal Republic of Germany. The results of the analysis of net-of-market changes in stock prices for the April 21 announcement are illustrated in the chart below.
As shown in the chart, Japanese auto stock prices jumped substantially when MITI announced the imposition of the VER in April 1981. The net-of-market increase in stock prices ranged from 6.1 percent for Mazda to 14 percent for Nissan. The total stock value of the six firms rose $915 million in just two days, April 21 and 22, representing an average increase of 11.8 percent. Thus approximately half of the gains during April appeared as a prompt response to the VER announcement. Stock prices remained at the new higher price level. This large permanent increase in stock prices for Japanese auto makers suggests that the profit implications of the VER were well understood by Japanese investors.
American Auto Stocks
Given the large immediate effect of the VER on the value of Japanese auto makers, it is reasonable to ask whether shareholders of US firms also benefited. The VER is a quota which, by reducing the availability of Japanese cars, should have raised the price of both Japanese and American cars and increased the number of American-made cars sold.
To determine the effect of the VER on US firms, I examined common stock prices for our five big auto makers-American Motors Corporation (AMC), Chrysler Corporation, Ford Motor Company, General Motors Corporation (GM), and Honda-in the five-year period 1981 through 1985. All except American Motors showed substantial share price increases between April 16 and 24, 1981. By May 1, however, these increases had vanished for both Chrysler and Ford.
The initial increase in stock prices is consistent with the view that the VER was a protective device aimed at improving the health of these firms and restoring employment. But why did only GM and Honda sustain the increase? A simple explanation is available. AMC and Ford were very weak and seemed headed for bankruptcy. Even if the VER promised to help the profitability of these firms eventually, an intervening bankruptcy could have wiped out the equity owners. Chrysler had already gone through a reorganization equivalent to a bankruptcy in order to qualify for a federal government bailout loan in 1979. Its finances were still fragile.
Within eight days of the announcement of the VER, these three struggling firms issued their regular quarterly earnings reports. While poor performance was probably anticipated by some investors, the losses were large enough to shake the confidence of many in the continued viability of these firms. Chrysler had lost $298 million during the first quarter, at a time when its common stock was worth only $452 million. Ford's situation was only slightly less desperate, with losses of $440 million compared to a stock valuation of $2.8 billion.
The table below shows the effect of the VER on the market value of US auto firms. (Because the announcement of AMC's - gloomy quarterly report coincided with the announcement of the VER, AMC was excluded from this portion of the study.) Each firm gained at least 3.8 percent in value due to the VER announcement. Overall, the stocks of these four firms rose 8.7 percent, representing a gain of $1.9 billion for shareholders. The largest gainers were Chrysler and American Honda, the two firms with the largest proportion of sales in small cars.
Apparently, from the standpoint of automobile company managers, political lobbying for a VER had been a profitable use of their time. But one must remember who paid the price. Japanese automobile manufacturers were not harmed by the VER-they gained over $900 million in value. It was the American car-buying public that had to face an artificially restricted supply of Japanese imports and at the same time pick up the tab for higher prices on all automobiles.
On March 28,1985, the Reagan Administration announced that the United States would not seek to have the automobile quotas extended for another year. The decision came on the heels of two good years for US auto makers. With the general economic recovery in 1983, car sales in the United States rose 18 percent, and all of the gains went to US firms. Sales by US firms, flat in 1981 and 1982, jumped 26 percent in 1983. This was the first sign that American firms were actually gaining market share under the VER. Profits rose substantially, reaching over $6 billion, and employment rose somewhat. Profits rose again in 1984, reducing support for the VER's continuations.
Changes in Value of US Auto Companies Due to Ver Announcements*
($ amounts in millions)
|US Auto Company||
MITI Announces VER(4/21/81)
Reagan Announces Non-renewal (3/1/85)
|* Value of outstanding common stock based on net-of market changes in stock prices during April 20-24, 1981, and March 1-2, 1985.|
The president's announcement had the expected effect on the stock values of US auto firms, which is shown in the table for all five of the publicly traded firms, including AMC. All firms dropped in share price, with the portfolio dropping 2.4 percent. This drop represented a loss in share value of almost $1 billion, over half of the increase generated by the original MITI announcement in 1981.
The Japanese Response
Unfortunately for American car-buyers, the VER was voluntarily extended by the Japanese government in 1985 and continued each year since. This government action protects the auto cartel from the antitrust objections it would otherwise be subject to in US courts. The quotas were set at 1.85 million for the fifth year (same as the fourth year) and 2.3 million for the sixth and seventh years.
Apart from enjoying the higher profits on their small exported cars, the Japanese have also been moving into new markets, causing new problems for US auto makers. Under the VER, the Japanese have shifted from the economy end of the automobile market to luxury compacts and sports cars. Between 1980 and 1984 alone, large and sporty models increased from 45 percent of Japanese exports to 57 percent. This shift is consistent with the finding of economist Rodney Falvey that any quantitative limitation on imports, such as a quota or VER, can be expected to result in exporters shifting to higher priced, higher quality units. Removing the VER today would find Japanese imports competing almost across the board with Detroit's products, a situation that stands in marked contrast to that of the 1970s.
Japanese profits have risen dramatically under the VER. For example, excluding its American sales corporation, the after-tax profits of Honda rose from 30 billion yen to 44 billion yen between the year ending February 1981 and the year ending February 1986. Profits in the Japanese domestic market, by contrast, have been poor; one analyst has concluded that even though less than 20 percent of Japanese production is shipped to the United States, these sales are responsible for over 75 percent of profits.
Prices of Japanese cars sold in the United States also have risen substantially (and the rise began even before the rise in the yen). Robert Feenstra of Columbia University estimates the per-vehicle price increase at $1,100 between 1980 and 1984 while Robert Crandall of the Brookings Institution estimates a $940 increase between 1981 and 1982. In stead of being guilty of dumping, as US manufacturers sometimes complain, the Japanese actually charge lower prices for automobiles in the domestic market than in the US market.
This information on price increases, coupled with published estimates of the responsiveness of foreign car sales to price, can be used to estimate the quantitative effect of the VER. I estimate that absent the VER, 2.3 65 million Japanese cars would have been sold in the United States between April 1, 1984 and April 1, 1985, as compared to the quota of 1.92 million cars. Thus the net effect of the quota in that year was 445,000 fewer Japanese cars sold in the United States. As Japanese auto sales in the United States have slacked off in the last year, the effect of the VER on imports has been diminishing.
Removing the VER
What would occur if the VER were removed? At this point, the removal of the VER would have a rather small effect on total imports. The reason is that for the first time since 1981, Japanese car sales in the United States have actually fallen somewhat, down 5 percent in 1987; recent price increases due to the yen revaluation should continue this decline. Most Japanese auto makers sold fewer vehicles than permitted under their quota limits last year, and for these companies, removing the quotas would have no effect on price and sales. However, several firms (including Daihatsu, Toyota, and Honda) could easily sell more cars in the United States. In these cases the quotas are restricting the availability of cars and raising their prices.
While removal of the VER would have a relatively limited effect on total imports, it nevertheless would accomplish two goals. First, it would eliminate the excessive profits earned by Japanese and American companies under the VER, and management could devote more of its attention to competitive strategy and less to lobbying. Second, it would eliminate the distortion of relative prices and the resulting interference with consumer preferences.
Voluntary vs. Mandatory Trade Rules
A VER had been viewed by many economists and free-trade oriented politicians as superior to legislative remedies. The rationale is that legislation is inherently inflexible because it can only be removed by new legislation. This difficulty is exacerbated by the decentralization of decision-making power within Congress: committees make the key decisions. Unless the committees with jurisdiction in both houses of Congress want to change a law protecting the auto industry, the law is not likely to get changed. Fears about the difficulty of marshaling the necessary forces to get a bill through Congress makes these analysts favor an administrative remedy, such as a VER.
The history of the auto VER suggests that these concerns may be misplaced. Certainly the VER leaves discretion in the hands of the President, not Congress, but it creates a foreign pro-protection interest group over which we have no direct control. Japanese auto makers can lobby their government to extend their cartel voluntarily while labeling the policy "sensitivity to the needs of American workers and firms." Getting rid of the cartel cannot be accomplished by administrative action by the President. It cannot be removed by congressional action. It is far from obvious why it is better to leave our economic policy in the hands of a foreign government than in the hands of Congress.
Trade restrictions such as the VER are ultimately ineffective in enabling domestic industry to prepare itself better for foreign competition. The foreign competition never sits still. Further, such restrictions relieve domestic firms and labor unions from the greatest impetus for making the difficult choices necessary to adapt to changing market conditions-the push of free competition and its substantial rewards and penalties. Circumstances now favor American firms competing with the Japanese. If American car-buyers are ever going to be allowed to make free choices among competitively priced Japanese and American cars, this is the time to remove the protective barrier. Absent compelling foreign policy reasons to the contrary, the US government should insist on the removal of the VER.
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