Auto Industry on the Line

Clifford Winston and Robert W. Crandall
Robert W. Crandall Adjunct Senior Fellow - Technology Policy Institute

May 23, 2005

The recent downgrade of Ford’s and General Motors’ long-term debt was but the latest in a series of public indications that the once-dominant U.S. motor-vehicle companies have failed to turn their operations around since signs of weakness surfaced in the 1970s. For decades, the U.S. manufacturers have been able to rely on government protection and robust economic growth to mask their fundamental problem: American consumers increasingly believe that other companies produce better vehicles — cars and light trucks — for the money.

As the Japanese and European automakers expand their production facilities in the United States and Canada, trade protection can no longer shield the U.S. producers from this unpleasant reality. U.S. government policymakers can do little to help them, and as a result DaimlerChrysler, Ford and GM may find that even a strong economy is not sufficient to keep them profitable.

Thirty years ago, the Japanese automobile companies were just beginning to make inroads in the U.S. market. The high gasoline prices caused by the first OPEC oil imbroglios led American consumers to look seriously at the small, fuel-efficient Japanese cars for the first time. What they saw was not only fuel efficiency but reliability. Japanese cars, even in the 1970s, would have fewer repair problems than their American-produced counterparts. As a result, even after oil prices began to fall, Japanese car imports continued to grow. By the early 1980s, the U.S. companies were experiencing financial distress and turned to the government. The Reagan administration was persuaded to negotiate “voluntary export restraints” with the Japanese producers, limiting their shipments of cars to the United States.

Did government intervention give the Big Three time to improve their vehicles or did it just protect them from foreign competition? When the trade restrictions were imposed on the Japanese companies, the 1985 models were just being introduced. In April 1985, Consumer Reports’ annual auto issue showed that the probability that U.S. consumers who purchased cars produced over the last six years by the U.S. producers would experience “worse than average” or “much worse than average” repair problems was six times as great as that probability for Japanese cars purchased by U.S. consumers. Twenty years later, this year’s Consumer Reports shows precious little narrowing of the U.S.-Japanese reliability gap as U.S. cars are still five times more likely than Japanese cars to show serious repair problems.

Despite the problems with the relative quality of their vehicles, the U.S. automakers were able to withstand the competition from the Japanese firms, largely because of the strong U.S. economy since 1985, relatively low gas prices, and a shift in consumer preferences to SUVs, vans and pickup trucks that happened to be shielded from foreign competition because the United States has had a 25% tariff on light trucks since the 1960s. Moreover, the Japanese companies were not particularly adroit in developing light trucks because their home market consumers had little interest in them. In the last few years, however, the Japanese producers have begun to develop highly competitive trucks, vans and SUVs, and they now produce them in the United States, thereby avoiding the 25% duty. Thus, even this niche is no longer a safe haven for the U.S. companies.

Today, Toyota sells about 2 million vehicles in North America and produces 1.3 million of them in the United States and Canada. Honda produces 1.2 million vehicles in the United States and Canada, about 80% of its North American sales, and Nissan produces about 800,000 vehicles in the United States out of the 1 million vehicles it sells in the United States per year. Subaru, Mitsubishi and Mazda also have significant production capacity in the United States. The Europeans and Koreans, though less threatening than the Japanese, have also expanded their share of the U.S. market over the last 20 years and have begun to build plants in the United States.

American producers now account for only about 56% of U.S. vehicle sales, and their share is falling steadily. Within the next three or four years, it is possible that foreign companies will produce and sell more vehicles in the United States and Canada than the American companies do, a result that surely would have been viewed as inconceivable when the Japanese export restraints were negotiated 20 years ago.

If the Japanese and Europeans can produce high-quality vehicles, many in the United States, and can do so profitably, why are the U.S. companies struggling? In a recent paper, one of us found that the U.S. manufacturers’ loss in market share over the past decade can be explained almost entirely by changes in basic vehicle attributes: price, size, power, operating cost and body type. That is, while the U.S. manufacturers have improved their vehicles along these lines, they have not narrowed the gap with the Japanese and European manufacturers. This finding suggests that the American firms face serious problems in product design, engineering and management-labor relations that they simply have not been able to solve.

Detroit cannot look to Washington to mask these problems. In 1984, the federal government could slow the imports of cars from Japan. Today, it cannot slow the imports of Japanese or European cars and trucks from Kentucky, Ohio, Tennessee or Alabama into the rest of the country without a constitutional amendment to repeal the Commerce Clause.

The federal government tried to help by subsidizing development of new fuel-savings technologies, but this project came up empty when the U.S. companies used the money on trying — thus far unsuccessfully — to develop electric cars and fuel cells while the unsubsidized Japanese companies developed hybrid vehicles.

Whatever the government does to reform health care may help the U.S. companies, but it will also benefit the Japanese companies who now use American labor to produce most of the vehicles they sell here.

Obviously, a strong economy will help the U.S. companies’ balance sheets even as their market share continues to decline. But the U.S. automakers certainly cannot hope to remain profitable by continuing to lose market share, and the U.S. government is out of options to help them.

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