General Motors Needs to Downsize, but Not Too Much

Howard Wial
Howard Wial Former Brookings Expert

June 4, 2009

Given how far the demand for cars has fallen this year, would the failure of General Motors have put more stress on the industry, or just accelerated the “right sizing” that was already underway? In other words, was the company really too big to fail? In a three day Los Angeles Times ‘Dust Up’ series, Howard Wial, a Brookings scholar and Daniel J. Ikenson the associate director of the Cato Institute’s Center for Trade Policy Studies discuss the current state of General Motors. Read Daniel J. Ikenson’s response Automakers That Can’t Compete Deserve to Disappear.

Worldwide demand for cars has fallen precipitously this year. General Motors’ sales in May were down by 30% from last May, Ford’s were down by 21%, and Toyota’s were down by 38%.

The effects are seen especially in the traditional automaking regions of the upper Midwest due to idled plants and furloughed workers, but soon they’ll be seen nationwide due to the planned downsizing of dealerships.

But auto sales won’t stay at current levels once the most severe recession in decades ends. Neither automakers nor the federal government should base their long-term policies on what has happened to sales during the depths of the recession. Instead, they should be looking at how the post-recession demand for U.S.-made cars in the 2010s and 2020s is likely to differ from what it was during the previous two decades.

For at least several years after the recession ends, the demand for cars assembled in the U.S. will probably be lower than in the decades before the recession. Interest rates could be higher than in the past if Asian capital flows into the U.S. slowly. Credit will be more difficult to get as lenders apply stricter standards. Consumers will do less borrowing against home equity to finance car purchases. And whether because of market forces or a public policy to price carbon emissions in some way, gasoline could well be more expensive.

Not only is the demand for U.S. cars likely to fall, it will take several years for GM even to be in a position to gain a larger share of a declining market, let alone sell more cars. The company has too many brands and too many dealers. Its cars aren’t yet up to the quality standards of the best foreign manufacturers. Under these conditions, some downsizing of GM is a sensible move.

Beyond the first few years after the end of the recession, the demand for U.S.-made cars could depend more on the strategic choices of U.S. manufacturers, including GM. If U.S. companies can get their quality at least up to the levels of their best foreign competitors, they will be well positioned to raise their market shares and possibly their sales. If gasoline prices are high enough, companies that pioneer the next generation of fuel-efficient (or alternative-powered) cars could see their sales as well as their market shares rise.

Looking at the long-term future of the U.S. auto industry in this way leads me to think that GM needs to shrink somewhat over the next few years but remain in a position to grow later on. Too much downsizing is at least as much of a danger as too little if it makes future growth impossible.

If too much downsizing is a danger, a total failure of GM would have been even worse. It would have taken too much productive and innovative capacity out of the U.S. auto industry and its crucial supply base, concentrated in regions already suffering heavily from the recession.

If that’s true in the long run, it’s even truer right now. A total collapse of GM would have made the recession worse, throwing many more people out of work than the current government-assisted bankruptcy will. The economies of 50 metropolitan areas — including most of those in Michigan, Ohio and Indiana — depend heavily on the jobs and incomes generated by GM and its Detroit counterparts and their suppliers. These places can eventually adjust, but not without help and not instantaneously.

Dan, you might see the collapse of those economies as creative destruction, but to me it just looks like destruction.