A rising Asian power challenges domestic manufacturers with cheap exports. Americans stew over inflation and tepid growth with an unpopular Democrat in the White House. A shiny new Datsun 210 whizzes past.
In 1980, Japanese auto imports occupied more than 20 percent of the U.S. market. Throughout the 1970s, cars made by Toyota, Honda, and Datsun (now Nissan) had surged across the Pacific. American automotive giants, outpaced and outmaneuvered, had failed to adjust to market changes. Detroit’s Big Three—Ford, GM, and Chrysler—saw sales crater and lost a collective $4 billion in 1980, prompting lay-offs for 300,000 plant workers and, indirectly, a half-million workers at parts suppliers. None of this helped Jimmy Carter’s bid for reelection, as Michigan and Ohio voted for Ronald Reagan by six- and ten-point margins.
When the Reagan administration entered office in January 1981, its first economic dilemma was whether to use policy to stanch Detroit’s bleeding or to let international-trade dynamics continue unabated. Though Reagan would build a legacy as a crusading free trader, he had signaled that he viewed the American auto industry as too central to society to be left vulnerable to international competition. On the campaign trail, candidate Reagan told plant workers in Michigan: “I think government has a role that it has shirked so far—and that is to convince the Japanese that, in one way or another and in their own best interest, the deluge of their cars into the United States must be slowed while our industry gets back on its feet.”
The tension was impossible to miss—and his critics knew it. “The United States and Japan find themselves caught up in a drama of stylized euphemisms,” Clyde Farnsworth wrote for the New York Times on March 26, “all designed to let the Reagan Administration maintain its public image of free trade while getting the Japanese to curb their exports of automobiles to this country.” Ultimately, Reagan opted for protectionist measures designed to shore up American auto manufacturing. The legacy of that program should counsel caution to today’s industrial-policy advocates.
Republicans and Democrats in Congress were ready to legislate a formal quota on Japanese cars. Instead, the Reagan administration in short order cajoled Japan’s Ministry of International Trade and Industry (MITI) to impose its own limit on automobile sales to America. The resulting Voluntary Export Restraint (VER) agreement between the U.S. and Japan took effect on May 1, 1981.
Under VER, Japanese planners capped the number of vehicles Japanese manufacturers could export to the United States. Some 1.68 million exports were permitted from 1981 to 1983, a figure that rose to 1.85 million in 1984. In 1985, Japan would agree to extend VER through 1992 at a threshold of 2.3 million cars annually.
What followed was textbook economics. The price of Japanese cars in the U.S. climbed considerably as demand for them outstripped the quota. The price of American cars climbed, too, as domestic manufacturers faced less competition. Japanese firms began investing in the U.S. directly to avoid the export restraints by building here.
In the estimation of today’s industrial-policy advocates, the VER arrangement was a resounding success. American policymakers encountered a problematic global trade outcome, acted boldly, and achieved the aims of giving Detroit “breathing room” and shoring up auto employment, argues an American Compass report.
The truth, however, is not so clear. Even the deal’s ardent supporters acknowledge that it resulted in a decade of high auto prices for American car-buyers. “[VER] raised prices for consumers by an average of 8%, costing American consumers an additional $5.1 billion,” American Compass wrote in 2022. It believes these imposed costs were justified, however, because “within the decade it had prompted nearly three times that much in foreign direct investment and brought 26,600 new auto-assembly jobs to the American South and Midwest.” Compass founder Oren Cass again lauded VER in July on The Ezra Klein Show, calling the Toyota Camry “the most American car on the market.”
But VER’s imposed costs, their distribution effects, and the economic benefits they purportedly brought to America require more attention. First, VER’s real-world effects contradicted the rhetoric the Reagan administration offered to the American people when it pushed Japan to accept the policy in 1981. As Steven Berry, James Levinsohn, and Ariel Pakes unearthed in an analysis for the American Economic Review in 1999, U.S. Trade Representative Bill Brock told the New York Times the day after the agreement was reached that while it would help the domestic industry, it would not restrict car sales “enough to affect the price.” In fact, VER “increased Japanese prices fairly dramatically,” Berry found.
Damningly, the VER policy’s implicit tax fell disproportionately upon the most cost-conscious car buyers. Japanese carmakers had found such success in America in the 1970s and early 1980s because they offered affordable vehicles with good fuel economy, while Detroit continued to churn out inefficient land yachts. In 1980, the year before VER was established, the average Japanese car was sold in the U.S. for $6,585, while the average domestic car was sold for $7,758.
The cost-conscious car buyers interested in Japanese cars and the savings they offered—and the even more cost-conscious buyers on the used market as the effects of the policy filtered down—were precisely the Americans who paid for Detroit’s “breathing room.” By 1986, the fifth full year under VER, the cost of a Japanese car had risen to $8,229 and that of a domestic car to $9,223. The additional cost for new cars took money that Americans could have invested or spent elsewhere in the economy in the absence of VER. The total effect of the policy, Berry estimated, was a net national welfare loss of close to $3 billion.
Adding insult to injury, it took two decades for the quality of the Japanese vehicles made in America to match the quality of their Japanese-made equivalents. According to a 2015 paper in the Review of Economics and Statistics by Nicola Lacetera and Justin Sydnor, it was not until 2002, 21 years after the implementation of VER, that Toyota’s “Japanese-built advantage disappeared.” Though Americans were able to buy Toyota Camrys made domestically following the VER agreement, they were not getting what would have otherwise been available.
VER supporters justify these costs by arguing that the policy induced foreign direct investment and yielded 100,000 jobs or more in the long run. But foreign firms were already exploring U.S. production prior to VER. Germany’s Volkswagen, not a Japanese firm limited by VER, was the first modern foreign carmaker to set up shop stateside. When American consumer preference shifted after the first oil shock in 1973, Volkswagen responded decisively: it purchased a plant from Chrysler in 1976 in New Stanton, Pennsylvania. By 1978, VW was finishing 800 units of its Rabbit model per day to meet the booming demand in America for small cars that Detroit’s Big Three failed to capture. Japanese firms’ later success at making cars in the U.S. only affirms that Volkswagen was onto something when it moved into Pennsylvania in the 1970s. (Like the Japanese carmakers, Volkswagen would later make cars in southern states with more flexible, less union-dominated labor-market arrangements.)
Meantime, the Reagan administration’s fixation on the auto industry entrenched domestic car makers, despite their diminished dynamism. Berry et al. figured that VER gave Detroit a cumulative profit boost over the 1980s of $10 billion. Allowing Detroit to feel more pain would have been difficult politically, but it may have disabused U.S. manufacturers of bad habits. Instead, the Big Three lumbered on, fell back into the pattern of producing gas guzzlers when oil prices were again low in the 1990s, and went back to Washington hat in hand amid the 2008 Financial Crisis.
The 1981 VER agreement is, at best, a partial success. It accelerated the arrival of Japanese auto manufacturing in America. But it came at great cost to consumers and to national welfare while failing to reset either American automotive industry norms or the U.S.-Japan trading relationship, broadly speaking.
Perhaps the agreement’s biggest failure is that it did nothing to expand opportunities for American firms in the auto industry or others across the Pacific. “What the VER agreement did not achieve,” Carl H. Tong and Allen L. Bures wrote in a 2003 Economic and Business History essay, “was reciprocal access to the Japanese market for American producers. The U.S. government was guilty of negligence for not forcing Japan to truly open its auto market. Consequently, American auto firms did not have an opportunity to compete with Japanese auto firms on an even basis.” On that theme, Donald E. Peterson, president and chairman of Ford in the 1980s lamented in his 1991 book, A Better Idea: Redefining the Way Americans Work, that Japan “resorted to a highly developed system of impediments that still make it very difficult for Americans to export products to Japan or set up facilities there.” Instead of voluntary export restraints, the Reagan administration should have pursued voluntary import expansions. Such a policy could have better leveraged America’s advantages in the industries where they existed and put more money in the accounts of American car buyers.
As the federal government spends billions today to induce foreign manufacturers to set up shop in America, we ought to remember the mixed experience from the 1980s. Yes, slowing imports changes incentives and can yield some narrow benefits. But those benefits often come, as was the case in the VER example, at significant cost.
Photo by Kaku KURITA/Gamma-Rapho via Getty Images