Between 1981-84, the US and Japanese governments reached an agreement whereby Japan would `voluntarily' restrain its exports of autos to the United States. This bilateral trade agreement is an example of Voluntary Export Restraints (VERs) which have grown considerably throughout the 1980s. In Discussion Paper No. 1173, Research Fellow Jaime de Melo and David Tarr estimate the sensitivity of the welfare costs to the structure of the US auto market and the developments that followed the imposition of the VER.

The paper simulates the costs of the US–Japan auto VER: under a standard constant returns to scale (CRTS) formulation, the costs are estimated at about $10 billion. It then sequentially introduces important features of the auto VER: endogenous rent premium determination, wage distortions in autos, the US capturing some of the rents of the VER, US monopsony power in autos, increasing returns to scale, pure profits and entry, foreign direct investment, and endogenous conjectures. In the preferred monopolistic competition, initial profit model, the estimated costs are about 10% less than under the assumption of CRTS, but costs remain high at over $200,000 per job protected in autos. Compared with exogenous rent determination, endogenous rent determination results in significantly lower estimated costs of the VER because domestic entry reduces the rent premium. Foreign direct investment with initial profits is shown to lower the costs of the VER if, and only if, the rent premium is endogenous.

VERs Under Imperfect Competition and Foreign Direct Investment: A Case Study of the US–Japan Auto VER
Jaime de Melo and David G Tarr

Discussion Paper No. 1173, May 1995(IT)