Japanese exchange rates, export restraints, and auto prices in the 1980s

Monthly Labor Review, Feb, 2007 by Ana Aizcorbe

Regression analysis indicates that, after 1986, Japanese exchange rates bad a significant positive effect on prices of U.S. domestically produced automobiles and, hence, that Japanese voluntary export restraints were not binding; pre-1986 results are inconclusive, but consistent with binding voluntary export restraints

Changes in Japanese exchange rates affect the prices of U.S.-manufactured light vehicles in two related steps:

1. The pass-through effect. A stronger yen increases both the prices of models produced in Japan and the landed cost (the dollar value at the point of importation).

2. The competing-goods effect. The increases in landed costs of Japanese models lead to increases in demand and prices of domestic substitutes.

Quotas, such as the voluntary export restraints that were put in place in April 1981, can influence the magnitude of these effects: under binding restraints, where the level of imports reaches the level of the voluntary restraints, cost shocks (such as exchange rate fluctuations) do not affect prices.

Using 1980s price data from the Consumer Price Index (CPI) database, this article applies reduced-form equations to quarterly observations of transaction prices. The resulting estimates of the impact of exchange rates on prices of domestically produced automobiles are an indirect test of whether the voluntary export restraints were binding. Although the results for the early 1980s are inconclusive, results for the late 1980s yield significant exchange rate effects: a 10-percent increase in the yen translates into a 1.2-percent increase in a CPI-like price index for domestically produced automobiles, reflecting both pass-through and competing-goods effects. As one would expect, the elasticities were larger for models that competed more directly with Japanese models. These significant exchange rate effects imply that the voluntary export restraints were not binding over that period.

Background

During the 1980s, sales of vehicles imported from Japan made up 17 percent to 22 percent of overall sales in the United States. Rising oil prices early in the decade and the resulting increases in demand for more fuel-efficient vehicles gave Japanese automakers an advantage over domestic producers, because Japanese vehicles were smaller and more fuel efficient: the average fuel economy of Japanese cars and trucks sold in the United States was 5 miles per gallon greater than that of American vehicles in the 1980s. (1) Moreover, within the small-car segment, Japanese vehicles tended to be more affordable; during that decade, Japanese automakers enjoyed substantial cost advantages that allowed them to sell comparable vehicles at lower prices. (2)

This intense competition from Japanese brands generated calls for trade protection. An already existing 25-percent tariff on trucks undoubtedly protected that segment. Beginning in 1981, the Japanese agreed to voluntary export restraints on their automobile imports to the U.S. market. Initially, the program allowed just 1.68 million Japanese automobiles into the United States each year. The cap was raised to 1.85 million per year in 1984 and to 2.3 million in 1985, where it remained through the end of the decade. However, the cap applied only to imports from Japan and did not include any sales of automobiles that Japanese firms produced in the United States. Beginning in 1982 with Honda's Marysville plant in Ohio, Japanese automakers began to shift production from Japan to the United States. By 1990, sales of vehicles--autos and light trucks--produced at these so-called transplants accounted for nearly 10 percent of all light-vehicle sales. Taken together, sales of Japanese vehicles produced in Japan and sales of those manufactured in the United States grew over the 1980s and by 1990 made up more than 25 percent of overall sales. (See chart 1.)

[GRAPHIC 1 OMITTED]

The shift to production in the United States also aided Japanese firms when the yen rose in the middle of the decade. From 1985 to 1988, the dollar fell dramatically and closed the period at about half of its original value. (See chart 2.) That undoubtedly raised the landed cost of Japanese imports. During this period, wholesale prices of imported autos increased 25 percent, a marked departure from the preceding 4 years. (See chart 3.) Because sales of imported Japanese automobiles represented about half of the total value of imported automobiles, the sharp rise in import prices would be expected to increase the demand for, and prices of, domestically produced automobiles. However, wholesale prices for domestic autos rose only 7 percent over the period, which was approximately the same as the trend of the previous 4 years.

[GRAPHICS 2-3 OMITTED]

Framework

An empirical demand framework developed by Jonathan Baker and Timothy Bresnahan provides a vantage point from which to examine the apparent lack of sensitivity of domestic prices to the sharp increase in import prices seen in the late 1980s. (3) The reduced-form approach of these researchers allows for the presence of market power without imposing a particular form of market structure.