Saving the Domestic Auto Industry: Why and How

Why the Domestic Auto Industry Cannot be Allowed to Fail:

The plight of the “Big 3” (GM, Ford and Chrysler) has dominated the news for the last couple of days.  All three are on the verge of bankruptcy.  All three are burning through cash at an incredible rate, the result of sales volume falling far below that necessary to support their infrastructure and legacy costs.  GM stock is now worth less than a 1-1/2 week inventory of the cars it builds. 

There seems to be a consensus that the domestic auto industry cannot be allowed to fail.  Yet, there are those who say “Let them fail.”  “It’s their own fault.  Their labor costs are far too high.  They build gas-guzzling inefficient vehicles.  Who needs them?  The Japanese, Korean and German carmakers can easily meet Americans’ need for vehicles.  Everything else we buy is imported and we get along just fine.  Why should cars be any different?”

Well, first of all, while everything else we buy does seem to be imported, we’re not really getting along fine, are we?  Take a look around.  Check your 401(k) statements.  Read the financial pages.  Our economy is in complete collapse, and the trade deficit is the root cause.  The trade deficit has drained away $9.1 trillion from our economy in the last three decades, and it’s all been financed by selling off American assets, even our homes, through selling mortgage-backed securities to our foreign creditors.  When we ran out of assets to sell them, the whole thing collapsed.

Imagine what would happen if the domestic auto industry collapsed, as it surely would if even one of the Big 3 goes under, taking the supplier base out from under the remaining two.  In a normal year, domestic car sales total about 16 million vehicles.  About half of these (a hair less) is built by the Big 3, about 8 million vehicles.  At an average cost of $25,000 per vehicle, that’s $200 billion per year added to our GDP of about $14 trillion per year.  Take that away, and our GDP falls to $13.8 billion.  Now, import those cars to make up the difference, and our GDP falls to $13.6 billion, because imports are subtracted from GDP.  (Even the government acknowledges that imports are a drag on the economy.)  At the same time, our trade deficit rises to $900 billion per year.  And, of that $200 billion cost of domestic cars, about $140 billion is labor cost.  Eliminate those jobs and, on average, every worker in America will take a pay cut of almost $1,000 per year.  Declining incomes is the real reason that home values are falling.  Take $1,000 per year out of everyone’s incomes and home values will drop another 10% automatically.  Looking for a sure-fire way to finally finish off the American economy?  This is it! 

Regarding the claim that their labor costs are too high, their legacy costs (pensions and health care for their retirees) are extremely high.  But remember, these benefits were promised at a time when domestic auto makers thought they could always count on having the domestic market to themselves, or later thought that free trade would provide them with export markets equivalent to any loss of domestic market.  They were suckered by economists who didn’t understand the real consequences of free trade, which was nothing more than an untested 18th century theory.  But they soon discovered the bind they were in and, since then, they’ve done a great job of working with the unions to slash labor costs and improve productivity. 

And regarding the claim that they only build gas-guzzlers:  they were crowded out of the small car market by imports and forced to specialize on the seqment of the market where they could still make a profit – light trucks and SUVs.  The only reason they build these vehicles is because that’s what Americans wanted.  Every big, gas-guzzling SUV on the road is there because that’s what the owner demanded. 

Now everyone wants fuel efficiency, but the small car market is glutted with overcapacity from all over the world.  The Big 3 simply cannot be cast into that glut and be expected to survive. 

The following article is a good summary of why the domestic auto industry can’t be allowed to fail.

http://www.time.com/time/business/article/0,8599,1858702,00.html?xid=feed-rss-netzero

“If GM were to go into a free-fall bankruptcy and didn’t pay its trade debts, then the entire domestic auto industry shuts down,” says Rodriguez. The system — the domestic auto plants and their interconnected group of suppliers — is far bigger than GM. It includes 54 North American manufacturing plants and at least 4,000 so-called Tier 1 suppliers — firms that feed parts and subassemblies directly to those plants. That includes mom-and-pop outfits but also a dozen or so large companies such as Lear, Johnson Controls and GM’s former captive Delphi. Beyond those are thousands of the suppliers’ suppliers.

Although the Detroit Three directly employed about 240,000 people last year, according to the industry-allied Center for Automotive Research (CAR) in Ann Arbor, Mich., the multiplier effect is large, which is typical in manufacturing. Throw in the partsmakers and other suppliers, and you have an additional 974,000 jobs. Together, says CAR, these 1.2 million workers spend enough to keep 1.7 million more people employed. That gets you to 2.9 million jobs tied to the Detroit Three, and even if you discount the figures because of CAR’s allegiance, it’s a big number. Shut down Detroit, and the national unemployment rate heads toward 10% in a hurry.

Even if just one of the Detroit Three — and GM is the most likely, as Ford is in better shape and Chrysler is much smaller — spiraled into a free-fall bankruptcy, the systemic effects, at least initially, would be huge. The whole industry would not be able to build cars in the U.S., because of the lack of parts. “Unlike the airlines or steel, when you look at the automobile industry and the fact that the whole supplier base is connected — to Ford, Chrysler, Toyota — it will have a ripple effect on the entire industry,” says Nicole Y. Lamb-Hale, a bankruptcy expert at the Detroit office of Foley & Lardner, a law firm that represents some GM suppliers.

And consider this:  the tool and die industry, critical to all of manufacturing, not just the auto industry, is utterly dependent on the auto industry for survival.  If the auto industry vanishes, so too will the tool and die makers.  If they go, the entire manufacturing sector of our economy is toast. 

How to Save the Big 3:

There’s no way that any of the Big 3 can survive even six more months without some kind of federal assistance.  And, just as the government is doing with the banks, it makes no sense to use taxpayer money to bail them out without taking a stake in the company.  So the first step is to provide whatever cash is needed to keep them going and take a 90% ownership stake in each.  It’s not such a crazy idea.  As the following article attests, that’s exactly what’s being considered.

http://www.usatoday.com/money/autos/2008-11-11-pelosi-autos_N.htm

Frank’s legislation would carve out a portion of the $700 billion financial rescue program for the Big Three automakers, letting the government take an equity stake in them in exchange for the loans, said Frank’s spokesman, Steven Adamske.

The Treasury could take warrants to share in a portion of future profits and would have to be paid back before any other shareholder. The car companies would face tougher restrictions on awarding pay packages to executives and dividends to their shareholders than the financial companies that get a piece of the original bailout.

Secondly, as I mentioned above, the Big 3 can’t survive in the glutted small car market.  At best, they would become the “Little 3,” not as bad as failing altogether, but not much better.  So the time has come to carve out a sufficient share of the domestic market to assure their survival.  This means that tariffs should immediately be imposed on every Japanese, Korean, German and Mexican car imported into the U.S.  Any tariff structure would help, but the one I proposed in Five Short Blasts, based on population density, would be ideal.  Such a tariff structure would impose a 5% tariff on cars from Mexico (even if they carry a “Big 3” brand), a 25% tariff on cars from Germany, a 40% tariff on Japanese cars and a 55% tariff on Korean cars.  The same tariffs should be applied to imported parts as well.  The result would be an explosion in demand for domestic cars and, within a few short years, the government could begin selling its stake in these companies at at least a 1,000% profit.  And don’t forget the tariff revenue that could be used to offset income taxes, providing a tax break to consumers. 

It’s time to abandon the blind faith that we’ve put in economic theories that pre-date electricity and steam engines, a time when the world’s population was one seventh of today’s and vast regions of the world remained unexplored.  It’s time to evaluate the results of free trade and globalization and make some adjustments to our theories.  The United States will be of little benefit to the global economy if it’s own domestic economy is in shambles, and there’s no hope of correcting the damage done to our economy without restoring a balance of trade.  Of course tariffs will impose severe hardships on nations dependent on exports to support their bloated labor forces, but how else will they be forced to come to grips with the effects of overpopulation?  Why should the U.S. function as a relief valve for their problems?  We’ve tried and it doesn’t work.  A global economy will work when each nation tends to its own problems first instead of looking for someplace to dump them. 

 

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9 Responses to Saving the Domestic Auto Industry: Why and How

  1. Robert says:

    Pete,

    Excellent commentary, but what are the odds the U.S. will make the changes needed? Why is it that your book and theory(which I agree with) have not garnered much press or serious attention? It seems all of the pundits are searching for a reason to explain the current economic crisis and yet they all fail to even consider the correlation between population and trade. The fact is that the word “population” is a taboo in our society and I fear it will never be addressed by our politicians.

  2. FJ says:

    I have to go the other way here. I own foreign vehicles and am a bit of a car nut, and you simply can’t unscramble that egg. People have a taste for great foreign cars now because they are SO much better than most of what Detroit has to offer. Remember, regulation was the problem to begin with – giving the big 3 automakers a loophole with the SUV craze that allowed them to put off the problems with their sedans, coupes, and sports cars (clearly inferior to imported products) until “a rainy day”. Now that a rainy day has finally arrived in the form of high oil prices and a bad economy, they want a bailout and you want tariffs so they can continue peddling the same junk on consumers who left behind an industry that left them in the dirt 30 years ago…? The message from detroit in recent decades has been clear: “We don’t care about cars, we’re going to keep selling pickups and SUVs”. I don’t want my taxpayer dollar going to fund a buyout OR bailout of these companies after they screwed up. For the record, I also don’t “want” these companies to go under completely, but there has to be accountability, and not in the form of more government spending and power via a takeover of the industry. All this takeover nonsense is going to end up turning this country into Soviet Russia; it’s unacceptable.

    We own a used lexus that had 90K miles on it when we bought it, and a used Mercedes that had 77K miles on it when we bought it. The engines in most Japanese and German cars last so long and the rides are so much better – better steering, better drivetrains, better transmissions. Unless you have this silly idea that you’re being patriotic by buying American (check out how Toyota, Honda and Mercedes have factories in the south to build SUVs when most American car companies are building many cars in Mexico and even Canada!), why would you buy an American car w/ the competition out there (except a Vette, maybe, or some other luxury car like a Cadillac)?

    If your tariff structure became policy, I would just continue to find used foreign vehicles that were for sale here in the US after someone else already bought them, as I do now. Parts would be expensive but my happiness as a consumer would probably outweigh that.

    As for tariffs offsetting income taxes…won’t happen. We can say that in theory but we all know that’s wishful thinking. I voted YES on question 1 here in Mass in november and was saddened to learn that 70% of my fellow Massachusetts residents voted No on the measure to repeal the state income tax. Our House Speaker, DiMasi, had even said that the legislature would ignore the measure had it passed, so it would only have been a symbolic vote anyway. We’re the 4th highest taxed state in the country and they still have the state going bankrupt – any new revenue streams would not come with a corresponding decrease in taxation elsewhere, that much can be promised (even at the federal level).

  3. Pete Murphy says:

    Good question, Robert. Sometimes I just want to scream when I hear pundits or politicians or economists talk about our problems with absolutely no mention of the trade deficit. Believe it or not, there seems to be no understanding of the role of the trade deficit even here in the Detroit area. Before the election, the Detroit Free Press published a voter guide, most of which was dominated by a comparison of Obama’s and McCain’s positions on the issues. Would you believe that trade wasn’t even mentioned? I was flabbergasted!

    Actually, this is another reason why I’d like to see the government take a stake in the automakers. It may help them to get an inside look at the problems the industry faces instead of hearing the sanitized version that they get from the globalization cheerleader CEOs.

    And I think the chances of the trade deficit being addressed by the government have gone up at least a little with the election of Obama. In a brief interview of Rahm Emanuel, his chief-of-staff, on “Face the Nation” last Sunday, Emanuel observed that “… sending $700 billion per year to foreign countries can’t continue,” or something pretty close to that. It was a relatively brief interview, so it’s obviously something paramount on his mind. Maybe nothing will happen, but at least I can hope, right?

  4. Pete Murphy says:

    Robert, I forgot to address your comment about population. I think that the chances of overpopulation becoming an issue are still low, but are rising fast, thanks primarily to the climate change and energy issues. More and more people are realizing that there are no solutions to these that don’t begin with at least stabilizing and probably reducing our population.

  5. Pete Murphy says:

    FJ, I simply have to disagree. I don’t think you’re giving American cars a fair shake. Yes, imports still dominate the upper end of the quality rankings, but the differences between number one on the list and number 10 or number 20 is a matter of splitting hairs.

    I remember when Japanese cars first hit the American market in the mid-70s. I believe Honda was the first. They were the crappiest cars you can imagine, about on the same level with the cars in Russia. Dealers painted them in paisley designs and sold them as novelties. Despite the poor quality, Americans happily snapped them up, because they were dirt cheap and they just wanted to have something to be different. Thanks to American Edward Deming, who went to Japan to teach them statistical quality and process control techniques, the quality of their cars slowly improved. I bought a new ’75 Toyota Corolla and, while it ran like a top, the steel used for the uni-body was so poor that, in spite of being rustproofed, it literally rusted out from underneath me by the time it was seven years old.

    I currently drive a ’99 Chevy Astro with 156,000 miles on it, and a 2001 Buick Regal with 103,000 miles. Both of these cars are running great with hardly any non-routine maintenance. I previously owned an ’86 Astro that was totaled when it had 186,000 miles and it was still running great.

    By the way, I have a friend who still drives a ’78 Chevette. He parks it for ten months out of the year and disconnects the battery cable. When he returns in the summer, he reconnects the cable and it fires right up!

    Have you driven a new Chevy Malibu?

    You mentioned the Corvette and Cadillacs as examples of good American cars. GM uses many of those same components throughout their product lines. By the way, the first car I ever owned was a new ’73 Corvette. Today, a Corvette will outperform virtually every sports car on the market at half the price of many of them.

    By the way, the foreign cars aren’t without their problems. Mercedes Benz has sunk to near the bottom of quality ratings. And the Japanese have had their problems with engine recalls due to inadequate lubrication systems. And Korean cars? After having one as a rental car, I swore I’d never get in one again.

    My tariff structure would restore profitability to the Big 3 once again, something they haven’t had in years, giving them the funds they need to refurbish their product line.

    All of us will soon be asked by our new president to make some significant sacrifices. I think that buying American would be the very least we can do.

  6. FJ says:

    I think American car companies are getting better, which I believe is all the more reason to let them continue to get better on their own, not allow them to drop the ball via protectionist tariffs that give them no reason to continue innovating and catching up to foreign car companies – which have been kicking their butts for quite some time. Now they’re getting better with their backs to the wall, which is the best way to allow them to innovate.

    You actually bring up a good counterpoint to your own argument when you mention that Vette and Caddy use similar components down the line – yes, that’s in vogue now with many companies, but why does GM need FIVE brand names (Buick, GMC, Chevy, Cadillac, Pontiac, as well as Hummer, Saturn, etc.)? I never understood why Ford sold the same car in THREE different brands – Ford, Mercury and Lincoln. They need to streamline production, and Oldsmobile going out of business should have straightened them out in that regard, but the SUV craze still allowed them to profit by selling trucks to people who only needed cars. This isn’t the same as an Audi A4 being on the same chassis as a Volkswagen Passat – Ford and GM only play the brand name game because their buyers are typically older and much more brand loyal than buyers of foreign autos – that’s starting to dry up.

    We have to look at the root cause of the problem before offering solutions: union labor that became too expensive, a government that subsequently allowed the US companies to find manufacturing facilities abroad, and regulations that allowed trucks like the Ford Explorer to be sold as cars without that pesky fuel efficiency requirement that real cars (sedans) had to live by. So American automakers drop the ball by not innovating, and foreign companies should be punished that have sold here for decades on their own merits? I don’t see that working out for the American people – and if American cars are as sophisticated as you feel they are, they will quickly lose some of that sophistication without incentive to compete as much with foreign cars. Don’t forget how many foreign companies now have manufacturing facilities here, helping the economy, particularly for SUVs which Americans can’t get enough of. This idea evolved naturally precisely because Japanese and German car companies could do business here without huge tariffs, and were able to view trends over a period of time, then later decided it was worth it to invest in manufacturing facilities here (about the time American companies were chasing their manufacturing overseas or to Mexico).

    In my experience – the prior generation Chevy Malibu (haven’t yet driven a new one), the Pontiac Vibe, the Chevy subcompact hatch (forget the model name), Pontiac Trans Am, and the Ford Five Hundred (all rentals, and all relatively new model years) – all were inferior in terms of handling, steering, acceleration, and interior quality than foreign cars I’ve driven in the same respective class. If this wasn’t true for many buyers, foreign cars simply wouldn’t be doing so well. The W210 (1997-2002) Mercedes e-class is a work of art, even if it has its quirks (like all cars do). It’s also not fair to compare it to non-luxury fords and GMs as it’s a luxury vehicle. We also owned a 2002 VW Passat wagon, bought it aftermarket like always, and it felt as sure-footed on the road as an Audi. As for Mercedes sinking, they have had trouble with more recent models but are rebounding pretty quickly (JD Power gave them tops in initial quality for the 2009 E-class). VW/Audi went through the same thing, but every review I’ve read of them recently has indicated a big turnaround and great quality. When we speak of quality here, we’re also speaking of interior fit and finish and the occasional electrical glitch, not engines – those engines don’t leave you stranded (not that American car companies do, just noting it). It should also be noted that Ford uses Mazda engines in many of its own cars now, and GM’s dealings with Subaru, Saab, and other car companies have helped it in terms of chassis-sharing across brands. Even the Pontiac Vibe is built in the same factory of the Toyota Matrix.

    It might have been the case in the 70s that one would buy a Honda as a novelty, but from the mid-80s on, they simply outdid American manufacturers by a large margin. The Taurus was great for a while, and then the Camry, Accord, etc. came along and were just so much better in terms of driving feel and quality that they couldn’t be ignored by buyers – how do you account for that? My parents went through this exact scenario – they couldn’t justify buying another Taurus after going to two showrooms – Honda and Ford – and seeing how much better the Accord drove and how much better it looked (consistent gaps between body panels, more streamlined design), and tighter suspension and better construction. Why weren’t the US automakers leagues ahead of Honda, if you say that Hondas and Toyotas were glorified tin cans back in the day? It was because the US automakers weren’t thinking of the future and were still trying to pass off models like the ElDorado on people in 1984 – that 84 ElDorado V8 was woefully sluggish; similar examples abound.

    Plus, haven’t we been through this before? Chrysler got bailed out for a $1billion and that made the problem worse, as Chrysler couldn’t get their collective “stuff” together, needed to be bought by Daimler; Daimler couldn’t even take a decade of owning that company, and now GM was going to buy it out before they’re once again asking for another bailout. Give them tariffs if you want, but don’t expect the quality of their cars to get better or their desireability in the market to increase. You’d see people like me holding onto my foreign car for a much longer period of time, visiting salvage yards for expensive parts if those were tariffed too, and saving up after paying my car off to fork over the $$ for the tariff when I did decide to buy a foreign car. That will slow down economic activity in the market, won’t give the US manufacturers any reason to innovate without money coming in, etc. I think we’ll be worse off than today.

    I want to be patriotic about American industry, I really do, but I think they shot themselves in the foot here, and more favoritism is only going to keep them from crawling out of the hole they dug for themselves. Let Caddy and other brands continue to innovate and get better as they seem to finally be turning that corner with production mid-level cars…the Ford Five Hundred/Taurus finally got a decent, competitve V6 – after I rented it, of course!;Caddy is coming back big, and if the new Chevy Malibu is so much better than the last one, all the better. This is one example of a trend that these companies CAN do it when forced to by the market.

  7. Pete Murphy says:

    FJ, you obviously know cars. But I’m not here to split hairs about the merit of cars. My concern is the steady erosion of the American economy through ill-conceived trade policies that fail to take into account the most critical factor – population density. The fact of the matter is that, over the past few decades, we have steadily given away access to our market to nations who have nothing to offer in return. They have nothing to off because their markets are so badly stunted by overcrowding and low per capita consumption. For example, even Japanese auto manufacuturers have trouble selling into the Japanese market because their market is, for all intents and purposes, non-existent. Korea is worse. Germany is little better. These nations are so crowded that nearly everyone commutes by mass transit.

    It simply makes no sense to provide free access to our market to nations with labor forces in gross oversupply. The loss of manufacturing jobs will be automatic and no amount of cost-cutting, productivity improvement, quality improvement or exchange rate improvement will change that scenario one iota. With each new manufacturer entering our market from an overpopulated nation, we can simply kiss goodbye more of our manufacturing jobs. If we let Chinese manufacturers start marketing cars in the U.S. without applying tariffs, it’ll be the end of the domestic auto industry.

    I, for one, am not willing to sacrifice the future of our economy and nation because I like the feel of an import over the feel of an American car. We’ve been playing poker against a stacked deck for far too long. Today’s economic collapse has been the end result. Enough is enough.

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