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%From: Neil Gandal <gandal@econ.tau.ac.il>
%Date: Mon, 27 Nov 1995 10:26:53 +0200 (IST)

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\begin{document} 
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\begin{titlepage} 
 
 
\title{\large \bf \sc 
The Effect of the Arab Boycott 
on Israel:  The Automobile Market} 
 
 
\author{Chaim Fershtman \\ 
and \\ Neil Gandal \\  \\ 
Eitan Berglas School of Economics \\ 
Tel Aviv University \\ e-mail correspondence: 
gandal@econ.tau.ac.il} 
 
\date{\today} 
 
\maketitle 
 
\begin{center} 
 
 
\vspace{ 3 mm} 
 
Abstract 
\end{center} 
\vspace{3 mm} 
 
 
Recent progress towards a 
comprehensive peace in the Middle East has 
led to a relaxation of the enforcement of the Arab economic boycott
of Israel.  This in turn has led to the entry of all the major 
Japanese 
and Korean automobile manufacturers into the  Israeli market.  In 
this 
paper, we examine the effect of the Arab economic 
boycott on this market.  Using recent advances in
estimating discrete-choice models of 
product differentiation, we estimate that had the 
boycott continued, the welfare loss per purchaser  would have been 
approximately \$790 in 1994.  This benefit 
can 
be interpreted as a {\em peace dividend}.  Since 
approximately 113,000 new automobiles were sold in 1994, the 
welfare gain to consumers was more than \$89 million that year. 

\vspace{0.1in}\noindent 
\begin{description} 
\item {\bf Keywords:} Economic Sanctions, Boycott 
\item {\bf JEL Classification Numbers:} D6, F1, L62 
\end{description}

 
\vspace{5 mm} 
 
\noindent  We are grateful to the Pinhas Sapir Center for 
Development for financial support and to Sarit Markovich for 
outstanding research assistance.  We thank seminar participants at
the University of Maryland, the University of Michigan, 
Stanford University, and Tel Aviv University for helpful comments
and also thank Steve Berry, Jim Levinsohn, and Ariel Pakes for
provision of data on product characteristics of automobiles sold in
the U.S. 
 
 

 
 
\end{titlepage} 
 
\renewcommand{\thefootnote}{\arabic{footnote}} 
 
\baselineskip=0.3in 
 
\section{Introduction} 
 
The Arab economic boycott of Israel is probably one of the most
enduring and comprehensive cases of the use of 
economic sanctions.\footnote{Sarna (1986) provides a thorough
historical account of the 
Arab boycott against Israel, qualitatively assesses its 
impact on Israel, and discusses countermeasures undertaken by third
party governments.  In the 1970s, the U.S., for example, enacted
legislation prohibiting compliance with the boycott.  In order to
downplay the boycott's effect, Israel did not enact anti-boycott
legislation.  For work on 
Israel's anti-boycott policies, see Rolef
(1989).}$^{,}$\footnote{There is a fairly large literature on the
use of 
international economic 
sanctions.  See for example, Leyton-Brown (1987), a conference
volume 
consisting 
of fifteen papers on the use of 
economic sanctions as a policy instrument, and 
Hufbauer, Schott, and Elliot (1990), a detailed  case study 
of the use of economic sanctions in this century.} In 1922, the
Fifth Palestine Arab Congress
 passed a resolution 
calling on Arabs to boycott Jewish businesses in Palestine.  The 
boycott was institutionalized with the establishment of the Arab 
League in 1945.   Following the establishment of Israel, the Arab
League banned 
all commercial and financial transactions between Israel and  the 
Arab states. 
In 1951, the Arab League set up a central boycott office (CBO) in 
Dasmacus, Syria with branches in member states to administer the 
boycott.   The formation of the CBO institutionalized two
additional
aspects of the boycott:
\begin{itemize}

\item The {\em secondary boycott}, in which
foreign firms were prohibited from operating in Arab countries if
they had 
trade or commercial dealings with Israel.  The CBO maintains and
updates 
a {\em blacklist} of firms that are banned from the Arab World.

\item The {\em tertiary} boycott, which prohibits foreign firms
from acquiring technology from, and 
establishing partnerships or joint ventures with 
blacklisted foreign companies.  Boycott resolutions also contain a
provision  banning the purchase of components that exceed 10
percent of 
the total cost of production from blacklisted firms.

\end{itemize}

 Although the 
boycott officially continues to this day, recent progress toward
peace in the Middle East has 
led to a relaxation of the enforcement of the Arab economic boycott
of Israel.\footnote{According to the Far Eastern Economic Review,
(Trofimoc, Yaroslav, ``Peace Dividend," {\em Far Eastern Economic
Review," 157, 46: p.74,} Persian gulf countries stopped enforcing
the boycott following the
Middle East Peace Talks in 
Madrid in 1991. On October 1, 1994, the Gulf Cooperation Council
officially announced that it would no longer enforce the {\em
secondary} and {\em tertiary} boycotts.}   The ending of the Arab
Boycott (and the resulting
economic
benefits) is 
viewed by the Israeli public as one of the important {\em peace
dividends.}
While no one doubts that the boycott has caused significant damage
to the
Israeli 
economy, structural economic models have not been employed to
estimate
its magnitude. 
Recently some numbers were thrown into the public debate, but they
were not based on any formal analysis.\footnote{In a recent article
(``Boycott Close-Up," {\em Chemical
Business}, 11 
18-19 Nov 1993,) Danny Gillerman, president of the Israeli Chambers
of Commerce and Danny Lipkin, an economic analyst estimate the 
financial loss to Israel as a result of 
the   Arab boycott at somewhere between \$45 and \$49 billion since
1950.} 
The public debate has so far focused on the effect
of the boycott on foreign investment, and on the closure of export
markets. 

The {\em secondary} and {\em tertiary} boycotts also had a
significant effect on local product markets.  The dearth of product
variety and the pattern of competition within Israel during the
long period in which the boycott
was
enforced may have resulted in 
significant welfare losses.
The purpose of this paper is to examine one particular market, the
automobile market,
and to estimate the welfare loss due to the economic boycott.  In
principal, the boycott
likely affected the equilibrium price of the cars sold in Israel,
the variety of cars available,
the type of cars that were purchased, as well as the total number
of cars purchased.
All these factors affect consumer welfare.\footnote{There has 
never been any significant domestic automobile production in
Israel.} 
 
In the automobile market, the 
boycott was quite successful in insuring that the leading 
Japanese automobile manufacturers (Toyota, Honda, 
Nissan, Mazda, 
and Mitsubishi) and all the Korean automobile manufacturers stayed 
out of the Israeli market.  The first major Japanese manufacturer
(Mitsubishi) entered in late 1988, while the remaining
Japanese manufacturers waited until the peace process began; the
Korean
manufacturers followed the Japanese and only entered the Israeli
market
in 1994.

The effect of the Arab
economic boycott was not limited to the Middle East; compliance
with the boycott often went beyond agreeing not to sell 
automobiles in Israel.  In 1981, for example, Toyota announced
plans to a undertake a
joint venture with  the {\em blacklisted} Ford Motor
Company;\footnote{Ford Motor 
Company was blacklisted in 1966 for licensing an Israeli firm to 
assemble Ford trucks and tractors. 
Ford continued doing business with Israel and 
was banned from selling its automobiles in all 
Arab countries.}  The venture was to produce cars at Ford's unused
plants in the U.S.  Saudi Arabia's Minister of 
Commerce warned that his country would ban all Toyota automobiles 
if the deal with Ford went through.\footnote{Sarna, p.170, notes
that in 1980, Toyota sold 256,000 
cars in the Middle East; approximately fifty percent of these 
were sold in Saudi Arabia.}  Indeed, following the warning, the
joint venture was canceled.

In our analysis, we employ recent advances in estimating 
discrete-choice models of product differentiation.  These
techniques, developed by Berry (1994) and Berry, Levinsohn, and
Pakes (BLP) (1995),  enable structural estimation of both the
demand and oligopoly pricing aspects that characterize 
differentiated product
markets.  The techniques yield estimates of own and cross price
elasticities as well as estimates of cost-side parameters.  BLP
(1995) employ their model in order to estimate equilibrium in the
U.S. automobile market.  The  automobile
industry is especially attractive to study because (1) important
characteristics are identifiable and easy to measure and (2)
because product level data (quantities, prices and product
characteristics) are readily available to the researcher. 
Verboven (1995) extended the model developed
in Berry (1994) to multiproduct firms and to markets in
which import quotas exist.\footnote{A multiproduct
firm takes into account how the price of one product affects the
demand for the other products that it sells.}  Verboven then
employed the model in
order to 
examine international price discrimination in European automobile 
markets.\footnote{Other important contributions to this literature
include Bresnahan (1987) and Goldberg (1995). Bresnahan (1987) was
the first to employ a structural model to estimate both the demand
and oligopoly pricing aspects that characterize differentiated
product markets. He employed a vertical differentiation
model to examine whether U.S. automobile manufacturers colluded in
the mid 1950s.   Goldberg (1995) used both micro (individual
household)  and market level data in her study of the automobile
industry.  See BLP (1995) and Verboven (1995) for detailed 
reviews of the rich literature on the automobile
industry.}$^{,}$\footnote{Dinopoulos and Kreinin (1988) 
employ ``hedonic" price regressions to empirically estimate the 
effect of Japanese automobile voluntary export restrictions (VERs)
on automobile prices and welfare in the U.S.   Our approach differs
from theirs in that we employ a structural (rather than an reduced
form) model.}

Estimating the economic effects of the Arab boycott poses
some inherent difficulties.  One strategy  would be to estimate a
dynamic model
using a period that covers both ``boycott" and ``post boycott"
equilibria and assess the gains over time.  Although such an
approach
is appealing, there were many significant changes in Israel (such
as rapid income growth and major reforms in automobile taxation
policies) over the last few years that make it virtually impossible
to isolate the effect of the boycott or its removal. An alternative
strategy is to evaluate or simulate the equilibrium that would have
obtained in the market had the boycott not existed, given the
information on  the market equilibrium when the boycott existed. 
Given the available data we conduct a similar exercise, but in the
opposite direction.  Using data for 1994, we estimate the market
equilibrium in the Israeli automobile market and then simulate the
equilibrium that would have existed had the boycott continued.  We
chose 1994 because by then all the major Japanese and Korean firms
had entered the Israeli market.\footnote{We also chose 1994 (the
latest year for which data were available) in order to avoid
measuring ``pent up" demand for the new varieties.}
The simulation reveals that had the boycott continued, the market
would have been 
approximately 12 percent smaller in 1994  and that there would have
been a leftward shift in the distribution to smaller (less
expensive) vehicles.


The main finding of this paper is that had 
the boycott continued, the welfare loss  would have been 
on the order of  \$790 per purchaser 
in 1994.  This benefit, primarily from increased variety, 
can  be interpreted as a {\em peace dividend}. 
Since the average (sales-weighted) price of a new car in Israel was
approximately \$ 21,000 in 1994,\footnote{Consumers paid 128
percent in taxes on automobiles sold in Israel in 1994.}     the
welfare gain is 
approximately 3.7 percent of the price of a new car. 
Since 113,000 private automobiles were sold in the
Israeli market in 1994, had the boycott continued, the cost to
consumers would have been more than \$89 million in that year. 
 
 
 
 
 
 
\section{The Boycott and the Automobile Industry} 
 

Sarna (1986) writes that among the leading economic powers, Japan
had the ``most consistent 
record of compliance with the discriminatory and restrictive trade 
practices of the Arab boycott of Israel."\footnote{Sarna, p. 165. 
He denotes a whole chapter to what he calls ``the surrender of 
Japan."  Reingold and Lansing (1994) examine the reasons behind
Japan's strict compliance with the Boycott.}     The boycott was
especially 
successful in the Japanese automobile industry.  In 
particular, the  five major Japanese automobile manufacturers 
(Toyota, Honda, Nissan, Mazda, and Mitsubishi) fully 
complied with the Arab boycott.\footnote{See Chart 1 for detailed 
information on world production and market shares of 
Japanese automobile manufacturers.} 
 
In 1968, the three largest Japanese automobile manufacturers, 
Toyota, 
Honda,  and Nissan, were explicitly warned by boycott 
officials not to sell their products in Israel.  The firms 
complied.  Indeed, requests by potential Israeli 
importers to sell Toyota, Honda,
Nissan, Mitsubishi, and Mazda automobiles were continually 
rejected.   The manufacturers claimed that there was a ``shortage
of production."\footnote{Sarna, p.172.} 
 
 
In contrast to the ``big five," in 1968, Subaru (Fuji Heavy
Industries) did
not sell any automobiles outside of  Japan. 
  Given that there were no Japanese automobiles in 
Israel at the time, in 1969 Subaru selected Israel as its initial 
export market.  Without 
competition from other Japanese manufacturers, Subaru  succeeded 
far beyond its expectations.  Subaru accounted for slightly more
than 27 percent  of the new automobiles sold in Israel during the
1986-1990 period.
Until late 1988, the only Japanese 
competition to Subaru in Israel came from other small Japanese 
manufacturers:  Daihatsu, which entered in 1983  and Suzuki, which 
entered in 1985.
 
In 1988, Mitsubishi  granted the 
``Kolomotor" agency in Israel the rights to sell Mitsubishi 
automobiles.  Saudi Arabia and other Arab states put pressure on 
the Japanese company (there was even a meeting between the Saudi 
and Japanese economic liasons in Washington) but Mitsubishi 
automobiles arrived in Israel in late 1988 (model year 
1989).\footnote{We thank Moshe Kobi, a senior member 
of the group in charge of Boycott affairs at the Israeli Ministry 
of Finance, for these details.} 
 
Shortly after the peace process began, the other major Japanese 
automobile manufacturers (Honda, Mazda, Toyota, and Nissan) began 
to sell in Israel.\footnote{Honda entered the Israeli shortly 
before the peace process began.  In 
the  early 1980s, Honda began producing automobiles in America.  By
the late 1980s, there was pressure by Jewish groups to export 
Hondas produced in America to 
Japan.  (U.S. law prohibits cooperation with the boycott). 
In 1990, Honda opened a dealership in Israel.  Until 1993, the 
Hondas sold in Israel were all produced in the U.S.}  No action has
been taken 
by the Central Boycott Office or any individual Arab state. 
 
According to the Israeli Ministry of Finance (see footnote 16), the
Koreans were even 
more subservient to the Central Boycott Office than the Japanese. 
Indeed there were no Korean automobiles in Israel until 1994.  In
that year, Daewoo and Hyundai entered the Israeli market and
immediately attained a combined 14 percent market.  The
other major Korean manufacturer (Kia) began selling its products in
Israel in 1995. 
 
 
The threat of {\em blacklisting} had less success with European 
and American automobile firms.    Renault was blacklisted in 1955, 
and in 1959 it stopped selling its products in Israel.  When the 
expected sales to the Arab world did not materialize, Renault 
returned to the Israeli market.   In 1966, 
 General Motors was warned not to open an assembly plant 
in Israel; G.M. continued to trade with Israel, but did not open an
assembly plant.    By 1969, 
all European and American automobile manufacturers were selling 
their products in Israel.\footnote{This information is from the
Israeli Central Bureau of Statistics.  The Japanese dependence on
Middle East oil likely made it more susceptible
to the boycott.  Nevertheless, the enforcement of the boycott was 
uneven and did not solely depend in which country the firm was 
located.  It is likely that the optimal strategy of the CBO
was not to punish all firms that were blacklisted.  It is possible 
that some firms were punished to insure that the threat of 
{\em blacklisting} was credible.} 
\vspace{4 mm}
 
 
\section{The Model} 

We model the automobile industry as an oligopolistic market in
which firms compete through prices.  There are $n$ firms, many of
which sell several types of cars.  N represents the number of car
models available.  Our model of the automobile
market closely follows Berry (1994);  the multiproduct aspect is as
in Verboven (1995). 
 
 
\subsection{Demand} 

The utility of product $j$ to consumer $i$, denoted $u_{ij}$, 
depends on both product
and consumer characteristics.  Following Berry, we employ a random
utility model of the form 

\begin{equation}
u_{ij}= x_j \b - \a p_j + \xi_j + \e_{ij} + x_j (\b_i - \b),
\label{utility}
\end{equation}

\noindent where the first two terms are the mean valuations of
product $j$'s
observed characteristics; $x_j$ is a vector of
observable 
product characteristics (such as engine size, weight, etc.) and
$p_j$ is the observed price of 
automobile $j.$  The parameters $\a$ and $\b$ represent the mean
valuations of the observable characteristics.
The final three terms are the decomposition of
the error term:\footnote{This decomposition and discussion follows
both Berry (1994) and Bresnahan, Stern, and Trajtenberg (1995).} 
\begin{itemize}

\item  $\xi_j$ represents the average value of product $j$'s
unobserved characteristics;

\item $\e_{ij}$ is the deviation of buyer preferences around this
mean;

\item $x_j (\b_i - \b)$ captures buyer heterogeneity in the
valuation of the observable characteristics; $\b_i$ is buyer $i's$
valuation for the observable characteristics.


\end{itemize}

The final two error terms introduce heterogeneity and the
distribution of these terms determines the substitution patterns
among products.  The multinomial logit model assumes that
there is no buyer heterogeneity: in particular, the logit assumes
that (1) $\b_i = \b$ for all $i$, and that (2) $\e_{ij}$ are 
identically and independently distributed across consumers and
choices  with the extreme value (Weibull) distribution function.
 
Given the discrete choice set, under these two
assumptions, it can be shown that the probability 
of choosing product $j$, (the market share of product $j$) is 
 
\begin{equation} 
s_j = { e^{\d_j}  \over (\sum_k e^{\d_k)} }, 
\label{logit} 
\end{equation} 


\noindent where 

\begin{equation} 
\d_j = x_j \b - \a p_j  + \xi_j, 
\label{meanutility} 
\end{equation} 
 

\noindent is the mean utility level from product $j$.  Despite its
unrealistic substitution
patterns among products, the logit distribution is popular because
of the closed form 
solution (equation (\ref{logit})).

In order to overcome the implausible substitution patterns among
products, 
many authors employ the ``nested" multinomial logit model.  In this
model, 
products fall into certain (predetermined) classes.  This yields a
much more reasonable
pattern of substitution among products.\footnote{It is assumed that
there is a 
separate class that contains only the outside good, with a mean 
utility normalized to zero.}  For example, if
automobiles are nested according 
to class, the introduction of a new compact car will reduce demand
for other compacts by
more than for cars in other classes.
Using the nested multinomial logit model, the probability of
choosing
product 
 product $j$ 
belonging to group $g$ is 
 
\begin{equation} 
s_j = { e^{\d_j /(1 - \s)}  \over D^{\s}_g (\sum_g 
D^{1-\s}_g)}, 
\label{demand} 
\end{equation} 
 
\noindent where $D_g = \sum_{[j \in G_g ]} e^{\d_j /(1 - \s)}$,
$G_g$ denotes the set of automobiles of type g,  and 
$0 \leq \s <1$ measures the degree of substitution among the 
products in the classes or groups.  If $\s =0,$ the cross 
elasticities among products do not depend on the particular 
classification of the 
products; in such a case,  the simple (non-nested) multinomial 
logit model is appropriate.  In the case in which $\s$ approaches 
one, the cross elasticity between any two products that belong to 
different groups is zero. 
 
We use the 
nested (multinomial) logit model to 
estimate the equilibrium in the Israeli automobile market.  As 
Berry notes, this model is appropriate when the substitution 
effects between products primarily depend  on 
pre-determined classes of products.  This assumption seems quite 
reasonable in the case of automobiles; indeed industry groups 
employ a standard classification system (small, compact, medium, 
large, luxury/sport).\footnote{Goldberg (1995) and Verboven (1995) 
also employ variants of the nested logit model in their studies of 
the automobile industry.  Bresnahan, Stern, and Trajtenberg (1995)
note that
if there is more than one level of nesting, the order of the
nesting gives rise to undesirable
patterns of substitution.   In our setting there is a single
(natural) nesting.}
Berry showed that by inverting the 
market share equation (\ref{demand}), one obtains\footnote{The 
details are in Berry (1994).} 
 
 
\begin{equation} 
ln(s_j/s_0) =  x_j \b - \a p_j + \s ln(\bar{s}_{j/g})  + \xi_j,
\label{demand2} 
\end{equation} 
 
where $\bar{s}_{j/g}$ is the share of product $j$ in group g (the 
within-group share), and
$s_0$ is the proportion of consumers that choose the outside good,
that is, choose not to purchase a new car. 
Since prices and group shares 
are endogenous, estimates of the parameters ($\a , \b,$ and 
$\s$) can be obtained by an instrumental variable regression on 
(\ref{demand2}).\footnote{Since the proportion of consumers
choosing 
the outside good ($s_0$) 
appears on the left hand side of (\ref{demand2}), this number must 
be estimated or assumed.  For example, 
Greenstein (1994) estimates the share of the outside good. 
Following Verboven (1995) and  Berry, Levinsohn, and Pakes (1995), 
we assume that the size of the potential market is known. 
Extensive experimentation reveals that only the estimate of the
constant $\b_0$ 
changes when we change the size of the potential market.   This is 
intuitive; a larger potential market means that more consumers 
chose the outside good than one of the available automobiles. 
This reduces the mean utility of all inside goods relative to the
mean utility of the outside good.} 
 
\subsection{Multiproduct Oligopoly Pricing} 
 
Following the literature, we assume that the marginal cost of 
producing each product is independent of the output levels and 
linear in a vector of cost 
characteristics.\footnote{The model was also 
estimated using marginal costs that were log-linear in the vector 
of cost characteristics and there were no qualitative changes.} 
Since there is no domestic production, the assumption of constant 
marginal cost is quite realistic in the 
case of the Israeli automobile market. 
Thus the marginal cost of 
good j is 
 
\begin{equation} 
mc_j = w_j \g + v_j, \hspace{3 mm} 
\label{marginalcost} 
\end{equation} 
 
\noindent where $w_j$ is a vector of observable characteristics,
$v_j$ is an 
unobserved cost characteristic and $\g$ is a vector of unknown 
parameters.   The profits of a  multiproduct firm  $f$ selling $F$
products are 
 
\begin{equation} 
\p_f = \sum_{k=1}^F (p_k/(1+t) - mc_k)q_k, 
\label{profits} 
\end{equation} 
 
\noindent where $p_k$ is the retail price of product k, $q_k$ 
is the corresponding quantity sold, t is the tax rate, and $mc_k$ 
is the marginal cost of producing automobile k. 
 Assuming that the firms compete on prices and that they only 
take into account the cross elasticities among their products 
within a 
 group, we have the following first order 
condition for product $j$:\footnote{This useful representation is
from Bresnahan, Stern, and Trajtenberg (1995).  Using
a relatively general demand model, Caplin and Nalebuff (1991) have
established the existence of a pure strategy Nash equilibrium in
the case of single product firms.  For the nested logit model of
demand, Anderson and de Palma (1992)
have established that a pure strategy Nash equilibrium exists in
the case of multiproduct firms.} 
 
\begin{equation} 
{p_j \over (1+t) } +  \sum_{k \in 
f_g } 
(p_k/(1+t) - 
mc_k) \n_{kj}  { q_k \over q_j} = 0, 
\label{firstorder} 
\end{equation} 
 
\noindent where $f_g$ represents the set of products that firm $f$
is selling
in group $g$, and 
$\n_{kj}$ is the cross price elasticity between products $k$ 
and $j$. 
Transformation of the first order 
conditions (\ref{firstorder}) and
substitution of (\ref{marginalcost}) yields the 
following pricing equation for product $j$:\footnote{The 
derivation is tedious.  For the details, see Verboven (1995).  Note
that our model is a special case of his, in which there is a single
classification (or nest) and that the mean utility is {\em linear} 
in prices.} 
 
\begin{equation} 
p_j/(1+t) = w_j \g +  { (1- \s) \over \a (1+t) [1 - \s 
\sum_{k\in f_g} q_k / Q_g - (1-\s) \sum_{k \in f_g } 
q_k / M]} + 
v_j, 
\label{pricing} 
\end{equation} 
\vspace{4 mm}

 
\noindent where $Q_g$ is the total number of sales in group $g,$
and $M = \sum_{i=0}^{N} q_i.$ 
Instruments are also needed in order to estimate the 
pricing equation, since the last term on the right hand side is 
endogenous. 
 
\section{Estimation} 
 
The two equation system to be estimated consists of 
the demand (\ref{demand2}) and pricing (\ref{pricing}) equations. 
It is likely that $\xi_j$ 
(unobserved demand characteristics) and $v_j$ (unobserved cost 
characteristics) are 
correlated.\footnote{A characteristic that might be contained in 
both error terms is style.}   Additionally, two 
parameters ($\a$  and $\s$) appear in both equations.  Finally, 
some 
of the parameters appear non-linearly.  This suggests 
that the appropriate method of estimating the full system is via 
the general method of moments (GMM).   We use the GMM software 
package.\footnote{The software was written by Lars P. Hansen, John
C. Heaton, and Masao Ogaki. 
See Hansen and Singleton (1982) for the theoretical foundations.} 
 
 
\subsection{Instruments} 
 
In order to identify our two equation system, we  need to find 
instruments for within-group shares 
($\bar{s}_{j/g} \equiv q_j/ Q_g$) and firm shares within a group
($\sum_{k\in G_g } q_k/Q_g)$, in addition to prices.  It is
clear that some, or all, of the product characteristics ($x_j$) 
will be included in the vector of the cost characteristics ($w_j$);
hence we do not try to identify the system via cost shifters. 
Rather we  follow the literature and use the characteristics of
other models as instruments. 
 
First consider instruments for the within-group shares.  As
Bresnahan, Stern and Trajtenberg (1995) note, within-group share is
negatively correlated with the number of other
products in a 
group.  Similarly, as the sum of the characteristics of the other
products in the group increases, the other products become 
much stronger competitors and the within-group share of product $j$
falls. 
 
Now consider instruments for firm shares within a group.  Clearly 
the firms' share in a particular group is increasing in the number 
of other products it sells in the group and decreasing in the 
number of products sold by competitors.  Further, firms' shares 
in the group are increasing in the sum of the characteristics of 
the other products it sells in the group and decreasing in the sum 
of the  characteristics of products sold by competitors in the
group. 
 
Finally consider instruments for price.  From the first 
order condition (\ref{firstorder}), the number of other products 
that a firm sells within the  group and the sum of the
characteristics of the
other products sold by the firm in the group will 
be positively correlated with price.\footnote{All of the
instruments that we have discussed are
included in the set of
``optimal" instruments suggested by Pakes (1995) and discussed by
BLP (1995).} 
 
\subsection{Data} 
In 1994, approximately 113,000 private automobiles were sold in the
following four classes: small, compact, medium, and 
large.\footnote{In the case of the Israeli market, the luxury/sport
class is extremely small, and hence only the first four classes are
employed.} 
Despite the relatively small size of the Israeli market, there were
more than 170 different products available.\footnote{Models with 
different engine sizes are considered to be different products.} 
Many of these brands had only a few sales.  We restricted the 
sample to brands that had more than 80 sales.  This left a sample 
of 101 brands; these brands accounted for 111,192 or more 
than 98 percent of the total market in 1994.\footnote{Chart 2 shows
how the Israeli Market has grown
over time.} 
 
In Israel, all import licenses are exclusive.  For example, the 
``Kolomotor" agency has the exclusive rights to import Mitsubishi 
automobiles, etc.  Prices are set centrally by the exclusive dealer
and retail price maintenance is strictly enforced.  Hence, 
our prices are 
transaction rather than list prices. 
Our price data comes from the Yitzhak Levi pricebook (May 1994),
which provides comprehensive coverage of the Israeli car 
market.  The retail price includes a 128 percent tax. 
The prices are in New Israeli Shekels.\footnote{The exchange rate
in May 1994 was 2.95 New Israeli Shekels = \$ 1.00.}
 
Since Israel is a small market, for each model available, many 
premium features are 
either included as standard equipment or not available.  For
example, dual 
airbags were standard equipment on all Honda Accords sold in
Israel.
In the case of GM, only the top of the line automobiles are 
imported to Israel; automatic transmission, air conditioning, 
power steering and ABS braking systems were included as standard 
equipment in these automobiles. 
In addition to the prices, the Levi pricebook 
includes the car features described above; hence for each price 
observation, we know what additional features were 
available.\footnote{In the case in which options are available, the
Levi pricebook will list the price with and without the options. In
such a case, we took the observation with the fewest options.}  We
now describe the other data.
 
The variable ENGINE is the engine size in liters.\footnote{We also
have data on size (length and width), horsepower and weight.  There
is a high degree of correlation between these characteristics and
for that reason we only included one of these characteristics in
our model.  Data on these physical characteristics were obtained
from 
three sources: 
Katalog Der Automobil Review (1994), Hallwag Publishers, Berne, 
Switzerland (this source has data on all automobiles sold in 
Europe) , Automotive News Market Data Book (1994) (this source has 
data on 
all automobiles sold in the U.S.), and in some cases the 
importers themselves.  This is because some of the automobiles sold
in Israel are not sold in the U.S. or in European markets.}   The
dummy variables
SMALL, COMPACT, MEDIUM, and LARGE each take on the value one if the
automobile falls into one of these predetermined classes. 
Similarly, the dummy variables 
JAPAN, KOREA, USA, WESTERN EUROPE, and EASTERN 
EUROPE take on the value one if the automobile is produced in that
country or region.\footnote{Similar to other authors, we include
Hondas produced in America as Japanese automobiles.} 
 
The dummy variable AIRCONDITION (AUTOMATIC) takes on the 
value one if the model has air conditioning (automatic
transmission)
and zero otherwise. 
The variable AIRBRAKE takes on the value two if
the model has both airbags and ABS (non-locking) brakes.  If the 
model has only one of the features, the variable takes on the value
one.  If the model has none of the features, the variable takes on 
the value zero.\footnote{Since most of the models that have one of 
these features also have the other feature, it seemed best to 
define the variable in this fashion.} 

Table (\ref{descriptive.t}) (in the appendix) contains descriptive
statistics on the available data. 
The three models
with the greatest sales per model 
(the Mitsubishi Lancer (11447), the Daewoo Racer (10658) and 
the Subaru Grand Leone (Impreza) (6834) were all in the compact
class. 
Together those three models account for more than  25 
percent of our sample.   Table (\ref{sales.t}) shows the sales of
automobiles according to group.

\begin{table}[ht] 
\begin{center} 
\begin{tabular}{r||c|c|c|c|c||} 
                 \\ \hline 
  & Small     & Compact     & Medium & Large &  Total   \\ 
\hline 
\hline 
Total Sales   & 25026 & 58075 & 19004  &9087 & 111192   \\ 
\hline 
Models & 19 & 37 & 20 & 25 & 101 \\ 
\hline 
J \& K Sales & 3733 & 36773 & 13031 & 1579 & 55116 
\\ \hline 
J \& K Models & 5 & 11 & 10 & 6 & 32 
\\ \hline
\end{tabular} 
\end{center} 
\caption{Automobile Sales by Group.} 
\label{sales.t}\end{table} 
 
\subsection{GMM Estimation} 
 
Our preferred model includes engine size, and whether the car has
air conditioning, automatic transmission, ABS brakes and Airbags;
these features appear 
both in $x_j$ and $w_j$. 
In addition, we have included a dummy variable in the $x_j$ (demand
side characteristic) vector for 
Japanese and Korean ($J \& K$) compact
automobiles. 

 
The results of the general method of moments estimation using our 
preferred model are shown in Table
(\ref{regression.t}).\footnote{Although a 
regression of within-group shares on the set of instruments yields 
the expected signs, the instruments are not highly correlated with 
within-group shares.  Hence we add the following set of variables 
that are positively correlated with within-group shares to the list
of instruments: a dummy 
variable which is the product of WESTERN EUROPE and SMALL, a dummy 
variable which is the product of (JAPAN+KOREA) and COMPACT, a dummy
variable which is the product of JAPAN and MEDIUM and a dummy 
variable which is the product of USA and LARGE to the list 
of instruments.  The other instruments are the sum of the engine
sizes of the other
products in the group, the
number of other products in the group, and the number of other
products
that a firm sells in the group.  Residual regressions show that all
the instruments are exogenous.} 
The model  fits the data reasonably well.  Indeed, the 
estimates of the marginal cost of air conditioning and automatic
transmission  are in line with the option prices that are
occasionally listed separately in the Levi
pricebook.\footnote{AIRBRAKE likely is a proxy for other
premium features such as 
power locks, power windows and metallic paint; hence its estimated
marginal cost is quite high.} 
 
The
correlation 
between actual and predicted prices is approximately .95 regardless
of whether we employ the preferred model or a model with the 
demand side dummy variable for Japanese and Korean compact vehicles
removed.  There is a significant difference, however, in the 
correlation between actual and predicted sales.  In the case of the
preferred model, the correlation is a relatively reasonable 
.40, while in the 
alternative model without a dummy variable for Japan and Korean 
compact cars, the 
correlation between these two measures falls to .17. 
Further, in the case of the alternative model, there is a
significant positive correlation between the estimated error term
of the demand equation and
the dummy variable for Japan and Korean compact cars.

The estimated model predicts that there is a significant 
degree of 
competition in the 
Israeli automobile market.  In particular, our estimates yield 
relatively high price elasticities and relatively low price-cost 
margins.  The mean (sales weighted) 
price-cost margin is close to five percent. 
 This corresponds to the conventional wisdom.  A recent article in
a local daily newspaper\footnote{Salel, Ya'acov, ``The Pie Shrinks
and Changes," {\em Ha'aretz}, 7/27/95, section B p.4.}  commented
on the fact that there is not a great deal of brand loyalty in the
Israeli market.  This makes sense, given that there are no local
players in the market.  A dramatic example is the case of Subaru. 
In 1994, Subaru's share of the market was seven percent, a far cry
from the 27 percent of the market that it held during the 1986-1990
period. 
 
 
\pagebreak
 
 
\begin{table}[ht] 
\begin{center} 
\begin{tabular}{r||c|c||c|c||} 
\\ \hline 
& \multicolumn{2}{c||}{Both Equations:} & & 
\\ \hline 
 Variable   & Coefficient  & Standard Error  & & 
\\ \hline 
$1/ \a$ & 12718 & 3581 & & 
\\ \hline 
$ \s $ & 0.62 & 0.83 & & 
\\ \hline 
\\ \hline 
& \multicolumn{2}{c||}{Demand Equation:} 
& \multicolumn{2}{c||}{Pricing Equation:} 
\\ \hline 
 Variable   & Coefficient  & Standard Error &  Coefficient  & 
Standard Error 
\\ \hline 
CONSTANT & $-2.66$ & $0.50$ & $-478$ & $2135$ 
\\ \hline 
ENGINE & 1.97 & 0.75 & 13536      & 1696 
\\ \hline 
AIRBRAKE & 1.31 & 0.51 & 9768      & 1098 
\\ \hline 
AUTOMATIC & 0.80  & $0.28$ & $3538$ & 1188 
\\ \hline 
AIRCONDITION & $0.37$ & $0.31$ & $2451$ & $1778$ 
\\ \hline 
Jap/Kor COMPACT & 0.61 & 0.20 & & 
\\ \hline 
GMM OBJ & 3.78 & & & 
\\ \hline 
\end{tabular} 
\end{center} 
\caption{GMM Results:  Preferred Model} 
\label{regression.t}\end{table} 
\vspace{5 mm} 
 
 
\section{Simulation: The Effect of the Boycott}

 
In order to conduct our experiment, we now compare two simulated
oligopoly equilibria: (1) the full choice set or ``post boycott
equilibrium" and (2) the reduced choice set or ``boycott
equilibrium."   In the case of the ``post boycott" equilibrium,
this
amounts to solving two hundred and two non-linear 
equations, i.e., (the demand (\ref{demand2}) and pricing
(\ref{pricing}) 
equations for each model without the error terms).\footnote{This
system was
solved using the 
GAUSS non-linear simultaneous equations subroutine.} 
In the case of the ``boycott" equilibrium, this amounts to solving
the
78 demand and pricing 
equations for each model that would have been available had the
boycott continued.  In this simulation, we include the Subaru,
Daihatsu, and Suzuki models, since these firms did not 
participate in the boycott. 

A comparison of the two simulations yields the following results:

\begin{itemize}

\item The new car market in israel would have been approximately 12
percent smaller in 1994 had the boycott continued.

\item Had the boycott 
continued, there would have been a leftward shift in the 
distribution to smaller (less expensive) vehicles.  Table
(\ref{simulation.t}) shows the ``predicted" distribution of new car
sales according to group for the ``post boycott" and
the ``boycott" equilibria. 


\begin{table}[ht] 
\begin{center} 
\begin{tabular}{r||c|c|c|c|c||} 
                 \\ \hline 
  & Small     & Compact     & Medium & Large &  Total 
\\  \hline 
Post Boycott Equilibrium (101 models) & 0.25 & 0.43 & 0.20 &
0.12
& 1.00 
\\ \hline
Boycott Equilibrium (78 models) & 0.29 & 0.38 & 0.20 & 0.13
& 1.00 
\\ \hline 
\end{tabular} 
\end{center} 
\caption{Distribution of Automobile Sales by Group.} 
\label{simulation.t}\end{table} 
 
\item A comparison of the predicted prices reveals that 
prices would not be much higher had the boycott continued in 
1994.  This is due to the fact that the Israeli market is 
relatively competitive and that close substitutes exist for nearly
every model in the market. 
 
 
\end{itemize} 
 
 
\subsection{Welfare} 

Trajtenberg (1989,1990) recently developed a methodology for 
measuring the gains from product innovation; he used the 
methodology to estimate the benefits associated with 
Computed Tomography Scanners.  We employ
his methodology to estimate the benefits associated with the entry
of the Japanese and Korean 
automobiles into the Israeli market.

The equations in  (\ref{demand}) are a system of probabilistic
demand functions for 
individual $i.$  Trajtenberg shows that the demand system exhibits
all the properties of
deterministic demand functions; therefore consumer surplus can be
calculated. 
 In the case of
the nested logit model, Trajtenberg (1989) shows that consumer
surplus (per consumer) up to a constant is given by 
\begin{equation} 
W = { log [ \sum_g D_g^{(1 - \s)} ] \over \a} + C, 
\label{welfare} 
\end{equation} 
 
\noindent where C is the constant of integration.
It can easily be verified that indeed $ - { \partial W \over 
\partial p_j} $ equals the expression for market share (demand) in 
({\ref{demand}) above.    Hence using Roy's identity, $s_j = {-
\partial W  \over  \partial p_j} / 
{\partial W  \over y}$, we see that $C \equiv y$, where $y$ is
income.  Our measure of  the welfare gain from the end of the
enforcement of the boycott is simply
\begin{equation}
W(101) - W(78),
\label{gain}
\end{equation}
where $W(101)$ is the  per person consumer
 surplus associated with the ``post boycott equilibrium" 
(equation (\ref{welfare})), and $W(78)$ 
is the per person surplus associated
with the ``boycott equilibrium."  In order to 
compute these welfare measures, we need equilibrium 
prices for the ``boycott" and ``post boycott" equilibria. 
We employ the prices from our simulations. 
 
The calculations reveal that the 
welfare gain associated with the end of the Arab economic boycott 
amounted to \$790 per purchaser in 1994.  The simulations
predict that the prices would not have increased 
significantly had the boycott continued; nearly 90 percent of the
welfare gain comes in the form of increased variety.   Recall that
the
(sales 
weighted) average price of an automobile sold in Israel in 1994 was
approximately \$21,000; hence the associated welfare gains are 
approximately 3.7 percent of the price of the average car.  Since 
there were approximately 113,000 automobile purchases in 1994, the 
welfare gain to consumers totaled more than \$89 million. 
 
In order to examine whether these results were robust to the
assumption that the firms sell multiple products and only take into
account the cross elasticities among their products in the same
class, we re-estimated the model under the alternative assumption
that each firm sold a single product.  Under this assumption,
equation
(\ref{pricing}) becomes

\begin{equation} 
p_j/(1+t) = w_j \g +  { (1- \s) \over \a (1+t) [1 - \s 
 q_j / Q_g - (1-\s) q_j / M]} + 
v_j. 
\label{pricing2} 
\end{equation} 

The estimates using this model are qualitatively similar and the
estimated welfare gain is of a similar magnitude.  In the case
of single product pricing, we estimate the welfare gain associated
with the end of the Arab economic boycott to be \$870 per purchaser
in 1994.   Thus our results are not
dependent on the assumption of multiproduct pricing. 
 
\section{Concluding Remarks: The Effectiveness of the Boycott}

The boycott clearly was effective in that the major Japanese and
all of the Korean firms stayed out of the Israeli market during the
period in which the secondary and tertiary boycotts were strictly
enforced.  Our analysis  suggests that consumer welfare loss due to
the boycott was not insignificant.

On the other hand, the effectiveness of the boycott was mitigated
by the incentive that it created for small Japanese firms to enter
the Israeli market.  In the case of Subaru, Daihatsu and Suzuki,
the choice was between becoming small players in the large Arab
automobile markets and being very large
players in the small Israeli market.    We estimate that had none
of these
Japanese firms entered the Israeli market, the size of
the``boycott" market would have been 20 percent smaller than the
size of the ``post boycott" market; further we estimate that the
gain in consumer surplus from the end of the Arab boycott would
have been  approximately seventy percent larger, that is on the
order of magnitude of \$1280 per purchaser in 1994.  Since there
will typically be incentives for some firms to enter markets that
others are boycotting,  the effectiveness of boycotts will to a
large extent depend on the ability of the sponsors of the sanctions
to enforce the prohibition
on trade. 
\vspace{6 mm}

\section*{\bf References} 
\baselineskip=0.2in 
\begin{description} 

\item {\sc Anderson, Simon, and Andre de Palma} ``Multiproduct
Firms: A Nested Logit Approach," \underline{The Journal of
Industrial Economics,} XL: 261-276, 1992. 
 
\item {\sc Berry, Steven}  ``Estimating Discrete-Choice Models of 
Product Differentiation," \\ 
\underline{RAND Journal of Economics,} 
25: 334-347, 1994. 
 
\item {\sc Berry, Steven, James Levinsohn, and Ariel Pakes} 
``Automobile Prices in Market Equilibrium,"
\underline{Econometrica,} 63: 841-890, 1995. 
 
\item{\sc Bresnahan, Timothy} 
``Competition and Collusion in the American Auto Industry: The 1955
Price War," \underline{Journal of Industrial Economics}, 35:
457-482, 1987. 
 
\item{\sc Bresnahan, Timothy, Scott Stern, and Manuel Trajtenberg} 
``Market Segmentation and the Sources of Rents from Innovation: 
Personal Computers in the late 1980s, mimeo, 1995. 

\item{\sc Caplin, Andrew and Barry Nalebuff,} ``Aggregation and
Imperfect Competition: On the Existence of Equilibrium," 
\underline{Econometrica,} 59: 26-61, 1991. 
 
\item  {\sc Dinopoulos, Elias and Mordechai Kreinin,} 
``Effects of the U.S.-Japan Auto VER on European Prices 
and on U.S.\ Welfare," 
\underline{Review of Economics and Statistics,} 70: 484-491, 1988. 
 
 
\item {\sc Goldberg, Pinelopi} ``Product Differentiation and
Oligopoly
in International Markets: the Case of the U.S. Automobile
Industry," \underline{Econometrica}, 63: 891-952, 1995.

\item {\sc Greenstein, Shane} ``From Super-Minis to 
Super-Computers: 
Estimating Surplus in the Computing Market," NBER working paper 
4899, 1994. 
 
\item {\sc Hansen, Lars and Ken Singleton} ``Generalized 
Instrumental Variable Estimation of Nonlinear 
Rational 
Expectations Models," \underline{Econometrica,} 
50: 1269-1286, 1982. 
 
\item{\sc Hufbauer, Gary, Schott, Jeffrey, and Kimberly Elliot} 
``Economic Sanctions reconsidered: History and Current Policy 2nd 
edition," Institute for International Economics, Washington, D.C., 
1990. 
 
\item{\sc Leyton-Brown, David} editor, ``The Utility of 
International Economic Sanctions," St. Martin's Press, New York, 
1987. 
 

\item {\sc Pakes} ``Dynamic Structural Models, Problems and
Prospects:  Mixed Continuous Discrete Controls and Market
Interactions," in {\em Advances in Econometrics: The Sixth World
congress of the Econometric Society, Vol II}, ed. Jean-Jacques
Laffont and Chris Sims, Cambridge University Press, New York,
1995.
 
\item {\sc Reingold, Ruth and Paul Lansing} ``An Ethical Analysis
of Japan's Response to the Arab Boycott of Israel,"
\underline{Business
Ethics Quarterly,} 4: 335-353, 1994.
 
\item{\sc Rolef, Susan Hattis} ``Israeli Anti Boycott Policy," 
Davis Institute of Policy Studies (Hebrew University) Working Paper
28-1989. 
 
\item{\sc Sarna, Aaron} ``Boycott and Blacklist," Roman \& 
Littlefield Publishers, New Jersey, 1986. 
 
\item {\sc Trajtenberg, Manuel} ``The Welfare Analysis of Product 
Innovations, with an Application to Computed Tomography Scanners," 
\underline{Journal of Political Economy,} 94: 444-479, 1989. 
 
\item {\sc Trajtenberg, Manuel} ``Economic Analysis of Product 
Innovation: The Case of CT Scanners," Harvard University Press, 
Cambridge, MA., 1990. 
 

 
\item {\sc Verboven, Frank} ``International Price Discrimination in
the European Car Market," \underline{forthcoming, RAND Journal of 
Economics,} 1995. 
 
\end{description} 

\pagebreak

\begin{center}
Appendix\footnote{Except for the variable quantity, the mean values
in Table (\ref{descriptive.t}) are weighted by sales.  Recall that
in the case of options (air conditioning, automatic transmission),
we took the model with the fewest features. 
Hence the associated means are not the percentage of new
automobiles with these features.}

\end{center}

\begin{table}[ht] 
\begin{center} 
\begin{tabular}{r|c|c|c||} 
\\ \hline 
Variable & Mean &  Maximum & Minimum 
\\ \hline 
\\ \hline 
PRICE & 62962 & 176700 & 29999 
\\ \hline 
QUANTITY & 1101 & 11447 & 83 
\\ \hline 
ENGINE  & 1.60 & 3.8 & 1.00 
\\ \hline 
AIRCONDITION & 0.87 & 1.00 & 0.00 
\\ \hline 
AUTOMATIC & 0.12 & 1.00 & 0.00 
\\ \hline 
AIRBAGS  & 0.08 & 1.00 & 0.00 
\\ \hline 
ABS BRAKES & 0.07 & 1.00 & 0.00 
\\ \hline 
SMALL & 0.23 & 1.00 & 0.00 
\\ \hline 
COMPACT & 0.52 & 1.00 & 0.00 
\\ \hline 
MEDIUM & 0.17 & 1.00 & 0.00 
\\ \hline 
LARGE & 0.08 & 1.00 & 0.00 
\\ \hline 
WESTERN EUROPE & 0.42 & 1.00 & 0.00 
\\ \hline 
JAPAN & 0.36 & 1.00 & 0.00 
\\ \hline 
KOREA & 0.13 & 1.00 & 0.00 
\\ \hline 
USA & 0.05 & 1.00 & 0.00 
\\ \hline 
E. EUROPE & 0.04 & 1.00 & 0.00 
\\ \hline 
\end{tabular} 
\end{center} 
\caption{Descriptive Statistics} 
\label{descriptive.t}\end{table} 
 

\end{document} 
 
 
------------------------------------------------------------------------------
Neil Gandal					Fax: 972-3-640-9908
Assistant Professor				Tel: 972-3-640-9604
Eitan Berglas School of Economics
Tel Aviv University
69978 Tel Aviv
Israel

E-mail: gandal@econ.tau.ac.il
------------------------------------------------------------------------------


