Chapter 1

INTRODUCTION

Trade barriers are government-induced restrictions on international trade.[1] The barriers can

take many forms, including the following:

Tariffs and Non-tariff barriers to trade

Import licenses, Export licenses, Import quotas, Subsidies, Voluntary Export Restraints,

Local content requirements, Embargo, Currency devaluation, Trade restriction

Most trade barriers work on the same principle: the imposition of some sort of cost on trade

that raises the price of the traded products. If two or more nations repeatedly use trade

barriers against each other, then a trade war results.

Economists generally agree that trade barriers are detrimental and decrease overall economic

efficiency, this can be explained by the theory of comparative advantage. In theory, free trade

involves the removal of all such barriers, except perhaps those considered necessary for

health or national security. In practice, however, even those countries promoting free trade

heavily subsidize certain industries, such as agriculture and steel.

Trade barriers are often criticized for the effect they have on the developing world. Because

rich-country players call most of the shots and set trade policies, goods such as crops that

developing countries are best at producing still face high barriers. Trade barriers such as

taxes on food imports or subsidies for farmers in developed economies lead to

overproduction and dumping on world markets, thus lowering prices and hurting poor-

country farmers. Tariffs also tend to be anti-poor, with low rates for raw commodities and

high rates for labor-intensive processed goods. The Commitment to Development Index

measures the effect that rich country trade policies actually have on the developing world.

Another negative aspect of trade barriers is that it would cause a limited choice of products

and would therefore force customers to pay higher prices and accept inferior quality.

OBJECTIVE OF STUDY

NON TARIFF BARRIERS

Non-tariff barriers to trade (NTBs) are trade barriers that restrict imports but are not in the

usual form of a tariff. Some common examples of NTB's are anti-dumping measures and

countervailing duties, which, although they are called "non-tariff" barriers, have the effect of

tariffs once they are enacted.

Their use has risen sharply after the WTO rules led to a very significant reduction in tariff

use. Some non-tariff trade barriers are expressly permitted in very limited circumstances,

when they are deemed necessary to protect health, safety, or sanitation, or to protect

depletable natural resources. In other forms, they are criticized as a means to evade free trade

rules such as those of the World Trade Organization (WTO), the European Union (EU), or

North American Free Trade Agreement (NAFTA) that restrict the use of tariffs.

Some of non-tariff barriers are not directly related to foreign economic regulations, but

nevertheless they have a significant impact on foreign-economic activity and foreign trade

between countries.

Trade between countries is referred to trade in goods, services and factors of production.

Non-tariff barriers to trade include import quotas, special licenses, unreasonable standards

for the quality of goods, bureaucratic delays at customs, export restrictions, limiting the

activities of state trading, export subsidies, countervailing duties, technical barriers to trade,

sanitary and phyto-sanitary measures, rules of origin, etc. Sometimes in this list they include

macroeconomic measures affecting trade

Six Types of Non-Tariff Barriers

1. Specific Limitations on Trade:

1. Quotas

2. Import Licensing requirements

3. Proportion restrictions of foreign to domestic goods (local content requirements)

4. Minimum import price limits

5. Embargoes

2. Customs and Administrative Entry Procedures:

1. Valuation systems

2. Anti-dumping practices

3. Tariff classifications

4. Documentation requirements

5. Fees

3. Standards:

1. Standard disparities

2. Intergovernmental acceptances of testing methods and standards

3. Packaging, labeling, and marking

4. Government Participation in Trade:

1. Government procurement policies

2. Export subsidies

3. Countervailing duties

4. Domestic assistance programs

5. Charges on imports:

1. Prior import deposit subsidies

2. Administrative fees

3. Special supplementary duties

4. Import credit discrimination

5. Variable levies

6. Border taxes

6. Others:

1. Voluntary export restraints

2. Orderly marketing agreements

Examples of Non-Tariff Barriers to Trade

Non-tariff barriers to trade can be:

Import bans

General or product-specific quotas

Rules of Origin

Quality conditions imposed by the importing country on the exporting countries

Sanitary and phyto-sanitary conditions

Packaging conditions

Labeling conditions

Product standards

Complex regulatory environment

Determination of eligibility of an exporting country by the importing country

Determination of eligibility of an exporting establishment (firm, company) by the importing

country.

Additional trade documents like Certificate of Origin, Certificate of Authenticity etc.

Occupational safety and health regulation

Employment law

Import licenses

State subsidies, procurement, trading, state ownership

Export subsidies

Fixation of a minimum import price

Product classification

Quota shares

Foreign exchange market controls and multiplicity

Inadequate infrastructure

"Buy national" policy

Over-valued currency

Intellectual property laws (patents, copyrights)

Restrictive licenses

Seasonal import regimes

Corrupt and/or lengthy customs procedures

TYPES OF NON TARRIF BARRIERS

There are several different variants of division of non-tariff barriers. Some scholars divide

between internal taxes, administrative barriers, health and sanitary regulations and

government procurement policies. Others divide non-tariff barriers into more categories such

as specific limitations on trade, customs and administrative entry procedures, standards,

government participation in trade, charges on import, and other categories. We choose

traditional classification of non-tariff barriers, according to which they are divided into 3

principal categories.

The first category includes methods to directly import restrictions for protection of certain

sectors of national industries: licensing and allocation of import quotas, antidumping and

countervailing duties, import deposits, so-called voluntary export restraints, countervailing

duties, the system of minimum import prices, etc. Under second category follow methods

that are not directly aimed at restricting foreign trade and more related to the administrative

bureaucracy, whose actions, however, restrict trade, for example: customs procedures,

technical standards and norms, sanitary and veterinary standards, requirements for labeling

and packaging, bottling, etc. The third category consists of methods that are not directly

aimed at restricting the import or promoting the export, but the effects of which often lead to

this result.

The non-tariff barriers can include wide variety of restrictions to trade. Here are some

example of the “popular” NTBs.

Licenses

The most common instruments of direct regulation of imports (and sometimes export) are

licenses and quotas. Almost all industrialized countries apply these non-tariff methods. The

license system requires that a state (through specially authorized office) issues permits for

foreign trade transactions of import and export commodities included in the lists of licensed

merchandises. Product licensing can take many forms and procedures. The main types of

licenses are general license that permits unrestricted importation or exportation of goods

included in the lists for a certain period of time; and one-time license for a certain product

importer (exporter) to import (or export). One-time license indicates a quantity of goods, its

cost, its country of origin (or destination), and in some cases also customs point through

which import (or export) of goods should be carried out. The use of licensing systems as an

instrument for foreign trade regulation is based on a number of international level standards

agreements. In particular, these agreements include some provisions of the General

Agreement on Tariffs and Trade and the Agreement on Import Licensing Procedures,

concluded under the GATT (GATT).

Quotas

Licensing of foreign trade is closely related to quantitative restrictions – quotas - on imports

and exports of certain goods. A quota is a limitation in value or in physical terms, imposed

on import and export of certain goods for a certain period of time. This category includes

global quotas in respect to specific countries, seasonal quotas, and so-called "voluntary"

export restraints. Quantitative controls on foreign trade transactions carried out through one-

time license.

Quantitative restriction on imports and exports is a direct administrative form of government

regulation of foreign trade. Licenses and quotas limit the independence of enterprises with a

regard to entering foreign markets, narrowing the range of countries, which may be entered

into transaction for certain commodities, regulate the number and range of goods permitted

for import and export. However, the system of licensing and quota imports and exports,

establishing firm control over foreign trade in certain goods, in many cases turns out to be

more flexible and effective than economic instruments of foreign trade regulation. This can

be explained by the fact, that licensing and quota systems are an important instrument of

trade regulation of the vast majority of the world.

The consequence of this trade barrier is normally reflected in the consumers’ loss because of

higher prices and limited selection of goods as well as in the companies that employ the

imported materials in the production process, increasing their costs. An import quota can be

unilateral, levied by the country without negotiations with exporting country, and bilateral or

multilateral, when it is imposed after negotiations and agreement with exporting country. An

export quota is a restricted amount of goods that can leave the country. There are different

reasons for imposing of export quota by the country, which can be the guarantee of the

supply of the products that are in shortage in the domestic market, manipulation of the prices

on the international level, and the control of goods strategically important for the country. In

some cases, the importing countries request exporting countries to impose voluntary export

restraints.

Agreement on a "voluntary" export restraint

In the past decade, a widespread practice of concluding agreements on the "voluntary" export

restrictions and the establishment of import minimum prices imposed by leading Western

nations upon weaker in economical or political sense exporters. The specifics of these types

of restrictions is the establishment of unconventional techniques when the trade barriers of

importing country, are introduced at the border of the exporting and not importing country.

Thus, the agreement on "voluntary" export restraints is imposed on the exporter under the

threat of sanctions to limit the export of certain goods in the importing country. Similarly, the

establishment of minimum import prices should be strictly observed by the exporting firms in

contracts with the importers of the country that has set such prices. In the case of reduction of

export prices below the minimum level, the importing country imposes anti-dumping duty

which could lead to withdrawal from the market. “Voluntary" export agreements affect trade

in textiles, footwear, dairy products, consumer electronics, cars, machine tools, etc.

Problems arise when the quotas are distributed between countries, because it is necessary to

ensure that products from one country are not diverted in violation of quotas set out in second

country. Import quotas are not necessarily designed to protect domestic producers. For

example, Japan, maintains quotas on many agricultural products it does not produce. Quotas

on imports is a leverage when negotiating the sales of Japanese exports, as well as avoiding

excessive dependence on any other country in respect of necessary food, supplies of which

may decrease in case of bad weather or political conditions.

Export quotas can be set in order to provide domestic consumers with sufficient stocks of

goods at low prices, to prevent the depletion of natural resources, as well as to increase

export prices by restricting supply to foreign markets. Such restrictions (through agreements

on various types of goods) allow producing countries to use quotas for such commodities as

coffee and oil; as the result, prices for these products increased in importing countries.

Quota can be of the following types:

1) Tariff rate quota

2) Global quota

3) Discriminating quota

4) Export quota

Embargo

Embargo is a specific type of quotas prohibiting the trade. As well as quotas, embargoes may

be imposed on imports or exports of particular goods, regardless of destination, in respect of

certain goods supplied to specific countries, or in respect of all goods shipped to certain

countries. Although the embargo is usually introduced for political purposes, the

consequences, in essence, could be economic.

Standards

Standards take a special place among non-tariff barriers. Countries usually impose standards

on classification, labeling and testing of products in order to be able to sell domestic

products, but also to block sales of products of foreign manufacture. These standards are

sometimes entered under the pretext of protecting the safety and health of local populations.

Administrative and bureaucratic delays at the entrance

Among the methods of non-tariff regulation should be mentioned administrative and

bureaucratic delays at the entrance which increase uncertainty and the cost of maintaining

inventory.

Import deposits

Another example of foreign trade regulations is import deposits. Import deposits is a form of

deposit, which the importer must pay the bank for a definite period of time (non-interest

bearing deposit) in an amount equal to all or part of the cost of imported goods.

At the national level, administrative regulation of capital movements is carried out mainly

within a framework of bilateral agreements, which include a clear definition of the legal

regime, the procedure for the admission of investments and investors. It is determined by

mode (fair and equitable, national, most-favored-nation), order of nationalization and

compensation, transfer profits and capital repatriation and dispute resolution.

Foreign exchange restrictions and foreign exchange controls

Foreign exchange restrictions and foreign exchange controls occupy a special place among

the non-tariff regulatory instruments of foreign economic activity. Foreign exchange

restrictions constitute the regulation of transactions of residents and nonresidents with

currency and other currency values. Also an important part of the mechanism of control of

foreign economic activity is the establishment of the national currency against foreign

currencies.

The transition from tariffs to non-tariff barriers

One of the reasons why industrialized countries have moved from tariffs to NTBs is the fact

that developed countries have sources of income other than tariffs. Historically, in the

formation of nation-states, governments had to get funding. They received it through the

introduction of tariffs. This explains the fact that most developing countries still rely on

tariffs as a way to finance their spending. Developed countries can afford not to depend on

tariffs, at the same time developing NTBs as a possible way of international trade regulation.

The second reason for the transition to NTBs is that these tariffs can be used to support weak

industries or compensation of industries, which have been affected negatively by the

reduction of tariffs. The third reason for the popularity of NTBs is the ability of interest

groups to influence the process in the absence of opportunities to obtain government support

for the tariffs.

Non-tariff barriers today

With the exception of export subsidies and quotas, NTBs are most similar to the tariffs.

Tariffs for goods production were reduced during the eight rounds of negotiations in the

WTO and the General Agreement on Tariffs and Trade (GATT). After lowering of tariffs, the

principle of protectionism demanded the introduction of new NTBs such as technical barriers

to trade (TBT). According to statements made at United Nations Conference on Trade and

Development (UNCTAD, 2005), the use of NTBs, based on the amount and control of price

levels has decreased significantly from 45% in 1994 to 15% in 2004, while use of other

NTBs increased from 55% in 1994 to 85% in 2004.

Increasing consumer demand for safe and environment friendly products also have had their

impact on increasing popularity of TBT. Many NTBs are governed by WTO agreements,

which originated in the Uruguay Round (the TBT Agreement, SPS Measures Agreement, the

Agreement on Textiles and Clothing), as well as GATT articles. NTBs in the field of services

have become as important as in the field of usual trade.

Most of the NTB can be defined as protectionist measures, unless they are related to

difficulties in the market, such as externalities and information asymmetries information

asymmetries between consumers and producers of goods. An example of this is safety

standards and labeling requirements.

The need to protect sensitive to import industries, as well as a wide range of trade

restrictions, available to the governments of industrialized countries, forcing them to resort to

use the NTB, and putting serious obstacles to international trade and world economic growth.

Thus, NTBs can be referred as a “new” of protection which has replaced tariffs as an “old”

form of protection.

Chapter 2

INTRODUCTION

VOLUNTARY EXPORT RESTRAINT

It is defined as an agreement by exporters not to export to a certain country, usually under

threat of tariff barriers being imposed by that country. A voluntary export restraint (VER) or

voluntary export restriction is an imposed limit by the government on the quantity of goods

that can be exported out of a country during a specified period of time

Typically VERs are generated when the import-competing industries seek protection from a

surge of imports from particular exporting countries. The exporter offers the VERs to

appease the importing country and to deter the other party from imposing even more explicit

(and less flexible) trade barriers

VERs are implemented on a bilateral basis, that is, on exports from one exporter to one

importing country. In use, since the 1930s VERs have been applied to products ranging from

textiles and footwear to steel, machine tools and automobiles. They became popular during

the 1980s perhaps in part because they did not violate countries' agreements under the GATT

Some interesting examples of VERs happened with the auto exports from Japan in the early

1980s and with textile exports in the 1950s and 1960s. In May 1981, with the American auto

industry mired in recession, Japanese car makers agreed to limit exports of passenger cars to

the United States . This "voluntary export restraint" (VER) program, initially supported by

the Reagan administration, allowed only 1.68 million Japanese cars into the U.S. each year.

The cap was raised to 1.85 million cars in 1984, and to 2.30 million in 1985, before the

program was terminated in 1994

Over the period of 1986-1990 the restraints (in essence, quotas) caused the prices of Japanese

cars sold in the United States to average about $1,200 higher (in 1983 dollars), some 14 per

cent above than without the restraints.

The higher prices for caused some consumers to defer purchases and others to switch to

American autos. In fact, the negative impact on sales of the Japanese automakers completely

offset the profit-enhancing effects of higher prices. Hence, Japanese firms were no better off

than if unrestrained trade had prevailed.

Matters were different for American firms, however. The consumers who switched to

domestic cars tended to be price-sensitive, so the American makers were able to raise prices

by only about 1 per cent. American car buyers were the biggest losers, particularly those who

opted to purchase Japanese vehicles even in the face of their higher prices. Overall, American

consumers suffered a loss of some $13 billion, measured in 1983 dollars.

Agreement by an exporting country to limit exports to a specified importing country, for a

price. The World Trade Organization prohibits discriminatory arrangements in international

trade, and has led to a substantial reduction in tariff barriers. The resulting intensified

competition among manufacturing producers often leads to painful industrial dislocation,

generating a political dynamic which many governments have difficulty resisting. One way

around the problem is to negotiate Voluntary Export Restraint Agreements with those

countries which are a source of rising import penetration. The successful exporter, such as

Japan, ‘voluntarily’ agrees to restrict exports to the country whose products it is displacing.

Japanese and other successful exporters tolerate VERs first because they risk facing the

closure of the market in question, but also because despite making fewer sales than under

free trade, they make more profit per sale. The resulting subsidy from the citizens of the

protectionist country to Japan is unnoticed and therefore uncontroversial, although the flows

can be enormous. It has been estimated that the VER between Japan and British car

producers in the 1970s and 1980s involved a flow of some £50 per head per year from

Britain to Japan.

As VERs do not involve any formal violation of WTO rules, they have provided an

extralegal channel for dealing with tensions in the international trade regime. However, their

discriminatory character cannot be denied, and partially successful attempts were made in the

context of the Uruguay Round (December 1993 agreement founding the WTO) to remove

them. The most prominent VER arrangement, discriminating against textile and clothing

exports from developing countries and known as the Multi-Fibre Arrangement, was to be

dismantled over a ten-year period. US and EU-imposed VERs against Japan were likewise to

be removed.

HOW VOLUNTARY EXPORT RESTREAINTS AGRTEEMENT WORKS

VERs actually work much like import restrictions. In a system of import restrictions, Country

A might impose a quota on steel from Country B and stop further shipments from crossing its

borders. In a VER scenario, Country B agrees to limit exports to Country A, even though

Country B's steel industry can out-compete Country A's. Country B might voluntarily cut its

steel shipments to Country A because, as one economist explains, "the importing nation

[Country A] can threaten to establish quotas or raise tariffs at a later date." Country B might

prefer to compete less aggressively to avoid duties and tariffs that would drive up its prices to

its customers in Country A.

ECONOMIC EFFECTS OF AGREEMENTS

By agreeing to limit steel exports to Country A, Country B essentially agrees to what

economist Robert J. Carbaugh calls a "market sharing pact." Country B keeps some of the

market share it earned through competition, and Country A's less efficient industry stays

alive.

However, Country B will actually profit most from the agreement. When it exports less steel

to Country A, consumers in Country A will pay more per unit because they will have to buy

more steel from less efficient domestic manufacturers. Meanwhile, Country B's producers

now can hike their prices to customers in Country A, and every penny of increase represents

pure profit to Country B's steelmakers.

VOLUNTARY EXPORT RESTRAINT AGREEMENT

Voluntary Export Restraint (bilateral basis)

A voluntary export restraint (VER) or voluntary export restriction is a government imposed

limit on the quantity of goods that can be exported out of a country during a specified period

of time.

Typically VERs arise when the import-competing industries seek protection from a surge of

imports from particular exporting countries. VERs are then offered by the exporter to

appease the importing country and to deter the other party from imposing even more explicit

(and less flexible) trade barriers.

Also, VERs are typically implemented on a bilateral basis, that is, on exports from one

exporter to one importing country. VERs have been used since the 1930s at least, and have

been applied to products ranging from textiles and footwear to steel, machine tools and

automobiles. They became a popular form of protection during the 1980s, perhaps in part

because they did not violate countries' agreements under the GATT. As a result of the

Uruguay round of the General Agreement on Tariffs and Trade (GATT), completed in 1994,

World Trade Organization (WTO) members agreed not to implement any new VERs and to

phase out any existing VERs over a four year period. Exceptions can be granted for one

sector in each importing country.

Some examples of VERs occurred with auto exports from Japan in the early 1980s and with

textile exports in the 1950s and 1960s.

Examples of Voluntary Export Restriction Agreements

One of the most famous VERs involved Japan's agreement to capture car exports to the U.S.

in the early 1980s. As American automakers struggled to compete against Japanese

companies, the U.S. Congress debated strict quotas to limit Japanese market share. Japan

avoided a quota by cutting a three-year deal with President Ronald Reagan. The U.S.

protected jobs in its auto industry, consumers paid more for American and Japanese cars and

the VER ultimately encouraged Japanese companies to locate plants in the U.S. to avoid the

export restrictions.

In the 1950s the U.S. negotiated similar agreements on textiles from several Southeast Asian

countries that produced these goods more cheaply than American textile manufacturers

could. During the late 1960s, the U.S. State Department used VERs to protect the domestic

steel industry against unprecedented foreign competition from Japan and Europe.

The End of Voluntary Export Restraint Agreements

The 1994 Uruguay Round of the General Agreement on Tariffs and Trade led to what one

commentator called "the final nail in the coffin" for VERs. In keeping with the World Trade

Organization goal of eliminating trade barriers, participating nations agreed to stop making

new VERs and sunset existing agreements.

A voluntary export restraint is a decision by one nation to reduce the export of a product to

another nation. The emergence of voluntary export restraints came after World War II to

stave off international economic tensions and to perhaps level the playing field. A somewhat

more recent example is Japan's voluntary restraint of auto exports to the United States in the

early 1980s. A nation initiating voluntary export restraints does so in the hope of avoiding

economic retribution from the importing nation. Exporting nations can circumvent these

restraints by investing in foreign factories and/or finding new markets.

Nations increased tariffs and forbade foreign imports as a way to strengthen their own

domestic industries prior to 1945. The harsh repayment plans and lending policies set by

Allied nations after World War I contributed to the start of World War II according to some

historians. The end of World War II encouraged world leaders to encourage worldwide

commerce by decreasing formal economic barriers. This market boost would come from

voluntary agreements between nations about minimizing the effect of foreign competition.

These agreements would then allow nations to develop their own industries without

interference from similar imported products that might undermine domestic industry.

Chapter 3

THE JAPNESE AUTOMOBILE

Case study

An oft-cited example for voluntary export restraints is the one that emerged between the

Japanese and the United States in the 1980s. Japanese automakers had been exporting cars

and trucks to the United States that were cheaper and more popular than American vehicles.

Executives from the U.S. automaking industry lobbied President Ronald Reagan to establish

import quotas on Japanese cars. These American automakers were concerned that Japanese

automobiles were permanently drawing consumers away from U.S.-made vehicles. The

Reagan administration was successful in convincing the Japanese government to temporarily

halt auto exports to the U.S. in 1981.

In general, an exporting nation in this situation might agree to voluntarily comply because it

may want to avoid damaging its relationship with a foreign government and the consumers of

the country. For example, imported goods could significantly cost jobs in and damage the

economy of the recipient country; as a practical matter, out-of-work persons have less money

to spend on cars or other imported goods. Another reason why a nation might restrain is

exports is that requesting nations may pursue retribution ranging from increased tariffs, taxes,

or quotas on on imported goods to an outright ban on foreign products, among other things.

An exporting nation could avoid voluntary export restraints by producing goods within the

foreign market itself. This approach would require purchasing factories, hiring local workers,

and shifting machinery from domestic to overseas facilities. For example, some Japanese

automakers now produce cars at United States plants. Each product from these factories

would be delivered directly to the consumer rather than through the more complicated import

process. Another option for getting around voluntary export restraints is to locate another

foreign market to offset potential losses in a current market.

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 (ORIGIN)

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 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.

ANALYSING 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.

Reagan's About-face

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 CompanyMITI Announces

VER(4/21/81)

Reagan Announces Non-

renewal (3/1/85)

AMC N/A N/A -16.5 -4.1%

Chrysler $47.6 10.5% -51.1 -1.2

Ford 106.5 3.8 -149.8 -1.9

GM 1,448.0 9.1 -598.5 -2.4

Honda 277.5 12.0 -182.6 -3.6

All Companies $1,879.7 8.8 -$998.5 -2.4%

* 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 JAPENESE 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.

Chapter 4

REMOVEING VOLUNTARY EXPORT RESTRAINT

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.

CONCLUSION

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.