VERs Under Imperfect Competition and Foreign Direct Investment: A Case Study of the US-Japan Auto VER

This 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 United States 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.