Not Our Fathers’ Auto Industry

Not Our Fathers’ Auto Industry by • May 1, 2009 • Printer-friendly

The U.S. automotive industry operates in a highly regulated environment, a fact largely overlooked in recent congressional hearings over federal loan guarantees to domestic firms.  These regulations affect more than three million American blue- and white-collar workers employed in the industry, along with shareholders and other investors, including retirees (and their spouses) vested in pension funds.

The industry’s burden of regulation is explained to investors in corporate annual reports filed with the U.S. Securities and Exchange Commission.  General Motors, the largest publicly traded domestic automaker, is explicit in detailing the “risk factors” created by government regulation, as it explains in its 2008 10-K report: “We are affected significantly by a substantial amount of governmental regulations that increase costs related to the production of our vehicles.  We anticipate that the number and extent of these regulations, and the costs to comply with them, will increase significantly in the future.”

In looking back at the record of several decades of government standards for the auto industry, one trend that emerges is the tendency of Democratic-controlled Congresses and Republican presidents to increase the industry’s regulatory burden.  Among these onerous constraints are the Corporate Average Fuel Economy (CAFE) standards.  CAFE was passed in 1975 by a Democratic Congress and signed into law by Republican President Gerald R. Ford.  GM’s report specifically mentions that “the CAFE requirements mandated by the U.S. government pose special concerns.”

CAFE requirements include mandates added in 2007 by another Democratic Congress and Republican President George W. Bush in the Energy Independence and Security Act (EISA):

In December 2007, the United States enacted the EISA, a new energy bill that will require significant increases in CAFE requirements applicable to cars and light trucks beginning in the 2011 model year in order to increase the combined U.S. fleet average for cars and light trucks to 35 mpg by 2020, a 40% increase.  The estimated cost to the automotive industry of complying with this new standard will likely exceed $100 billion, and our compliance cost could require us to alter our capital spending and research and development plans, curtail sales of our higher margin vehicles, cease production of certain models or even exit certain segments of the vehicle market.

GM’s report also describes burdensome regulation at the state level.  California has led regulatory assaults on the auto industry, a trend that has escalated under Republican Gov. Arnold Schwarzenegger:

In addition, a growing number of states are adopting regulations that establish CO2 emission standards that effectively impose similarly increased fuel economy standards for new vehicles sold in those states.  If stringent CO2 emission standards are imposed on us on a state-by-state basis, the result could be even more disruptive to our business than the higher CAFE standards discussed above.

Ford, the second-largest domestic automaker, notes in its 2008 10-K:

Many governmental standards and regulations relating to safety, fuel economy, emissions control, noise control, vehicle recycling, substances of concern, vehicle damage, and theft prevention are applicable to new motor vehicles, engines, and equipment manufactured for sale in the United States, Europe and elsewhere.

Annual reports filed by Chrysler while it was still a public company make the same point about government regulations.  The smallest of the Big Three, it was acquired in 2007 by Cerberus Capital Management LP, a private firm.
These regulations are also troublesome for foreign producers.  Toyota, the largest Japanese automaker, explains in its 2008 report that the company “has incurred, and expects to incur in the future, significant costs in complying with these regulations.  New legislation or changes in existing legislation may also subject Toyota to additional expenses in the future.”

Honda, the second-largest Japanese firm, notes:

The automobile, motorcycle and power product industries are subject to extensive environmental and other governmental regulation.  Regulations regarding vehicle emission levels, fuel economy, noise and safety and noxious substances, as well as levels of pollutants from production plants, are extensive within the automobile, motorcycle and power product industries.  These regulations are subject to change, and are often made more restrictive.  The costs to comply with these regulations can be significant to Honda’s operations.

One aim of this ever-growing list of government regulations is to force automakers to produce safer vehicles with fewer emissions.  Another policy goal, as expressed by CAFE, is to reduce the nation’s trade deficit by decreasing U.S. dependence on imported oil.

Ralph Nader’s Unsafe at Any Speed (1965), which strongly criticized GM’s Corvair and pollution in Southern California, is sometimes credited with launching the drive toward safer, cleaner cars.  But automotive pioneers had advocated safety measures for decades.  Joel W. Eastman’s 1984 book Styling Vs. Safety: The American Automobile Industry and the Development of Automotive Safety, 1900-1966 profiles Michigan plastic surgeon Dr. Claire L. Straith, an advocate for safety belts and padded dashboards.  Automotive entrepreneur Preston Tucker took Straith’s ideas seriously, although his vehicles never went into mass production.  Safety belts were optional in vehicles produced by the Big Three (GM, Ford, Chrysler) and American Motors by the mid-1950’s, and standard by the mid-1960’s.  Ford offered padded dashboards in a 1956 safety package.  Consumer response was tepid, but this feature was widely accepted by the 1970’s, and air bags followed.  Since 1975, U.S. motor-vehicle deaths have ranged from 39,250 (1992) to 51,093 (1979), according to National Highway Traffic Safety Administration (NHTSA) statistics.

The goal of lowering the U.S. trade deficit has not been achieved with CAFE’s smaller, fuel-efficient vehicles.  The U.S. goods and services deficit was $677.1 billion in 2008, according to the Census Bureau.

At present, two polar opposites define the parameters of the regulatory debate: the libertarian and socialist approaches.  In general, libertarians reject government regulation of industry, while socialists call for state or worker control of the means of production.  The libertarian approach was ascendant in the early decades of the 20th century when hundreds of U.S. automakers vied for consumers.  These hundreds were reduced to a mere dozen by mid-century.  Our fathers witnessed the industry’s transformation into the Big Three oligopoly, with Chrysler’s 1987 acquisition of American Motors as the final act.  Auto executives complain about government regulations (former Chrysler President and CEO Lee Iacocca once termed it “the relentless lash”), but in the current crisis few legislators, including Republicans, are advancing even a quasilibertarian approach: a temporary freeze on current or pending regulations.  Likewise, the socialist approach is merely a stopgap measure, not a credible, permanent solution in the eyes of most policymakers.  George W. Bush provided emergency funding to the auto industry, and Barack Obama may buy preferred shares for Uncle Sam, but Washington is not about to launch an automotive IPO.  European governments experimented with state ownership and ultimately rejected it.  Few, save socialists, wish to be identified with the embarrassment of another Trabant.

The regulatory center oversaw our fathers’ auto industry.  Democrats proposed new regulations, and Republicans generally agreed (when they weren’t expanding government on their own initiative).  The Department of Transportation was created under Lyndon B. Johnson, signer of the National Traffic and Motor Vehicle Safety Act (1966).  NHTSA, part of the Department of Transportation, was established as a separate unit under Richard M. Nixon.  A December 1969 address at the Harvard Business School by Henry Ford II illustrates the industry’s pragmatic acceptance of this centrist regulatory regime:

The most effective way to encourage business to serve new public needs is to rely, when possible, on market incentives.  The reduction of motor vehicle emissions is an excellent example of what I have in mind.  Prior to the establishment of government emission standards, there was no market for emission control features.  Although many people wanted cleaner air, individual customers would not have been willing to pay the extra cost of a low emission car because the benefits would have been imperceptible unless all customers were required to pay this cost.  When the need for abatement of air pollution was recognized, the government established realistic emission standards.  By doing so, the government created a market and the auto industry has moved quickly to supply it.

The auto industry is aware that “market changes [are] caused by shifts in consumer preferences,” Ford explained.  “Now we face a new phenomenon—market changes caused by legislation and regulation.”  Today, President Obama is proposing that the government stimulate a new “green” demand for the auto industry.  This is a call from the same centrist playbook referenced by Ford.

Both the libertarian and the socialist extremes still influence regulatory policy in one key area: the realm of mergers and acquisitions, overseen by federal antitrust regulators.  Any serious student of the business cycle and the Motor City understands that recessions catalyze consolidation within the industry.  In the two years surrounding a single recession (July 1953 to August 1954) the following mergers and acquisitions occurred: Hudson and Nash-Kelvinator, creating American Motors; Kaiser and Willys-Overland; and Packard and Studebaker.  This was the auto industry our fathers understood—a reality expressed by an old Chrysler annual report in a single sentence: “[T]he automotive industry historically has been highly cyclical and the duration of these cycles has been difficult to predict.”  That sentence is still misinterpreted by Wall Street MBAs, though it was comprehended by factory workers with high-school diplomas.

Our fathers who toiled for decades in auto plants knew these names: Auburn, Cord, Duesenberg, H.H. Franklin, Marmon, Pierce-Arrow, Ruxton, Stearns-Knight, Stutz—all casualties of the Great Depression (August 1929 to March 1933) and the Roosevelt Recession (May 1937 to June 1938).  More recently, the Chrysler loan-guarantee drama occurred against the backdrop of two recessions (January to July 1980, and July 1981 to November 1982), and the firm’s 1987 purchase of American Motors (“Little Four”) helped Chrysler survive the recession that followed (July 1990 to March 1991).  The auto industry’s business model often proves terminal in recession.  “The executives at GM, Ford and Chrysler have never been overly interested in long-range planning,” Lee Iacocca explained in Iacocca: An Autobiography (1984).  “They’ve been too concerned about expediency, improving the profits for the next quarter—and earning a good bonus.”  Men like Iacocca understood the cycle, and planned accordingly, which is how they survived recessions that occurred, on average, every four years between 1945 and 1982.  I learned more about the cycle from my father, a 43-year Chrysler veteran, than I did from my graduate-school professors—save one, Harry C. Veryser (University of Detroit).  Dad started as a skilled tradesman and ended his career as a production foreman, while Harry worked for his family’s stampings business.  Much knowledge has passed from the industry in the last quarter-century, a period marked by two brief eight-month recessions.  The Big Three entered this recession with weak balance sheets, unrealistic sales forecasts, and bloated inventories.  Detroit would be faring better if the Big Three had pooled their resources to hire a lone historian steeped in the business cycle’s destructive nuances.  Instead, management hires teams of economists who are forced to cut their estimates at the first hint of real trouble.

The historian can improve the incomplete portrait sketched by economists.  Economists use four basic models to illustrate market competition: pure competition, monopolistic competition, oligopoly, and monopoly.  All four were applicable to the automotive industry in the 20th century.  One characteristic of pure competition is “ease of entry.”  Entry was so easy early in the century that thousands of small entrepreneurs, like Henry Ford, were building motor vehicles in garages.  “Before 1905, 445 different makes of cars were being produced in 175 separate locations from New York to California,” Walter Hayes wrote in his 1990 biography, Henry: A Life of Henry Ford II.  “Yet by 1914,” Hayes continued, “three-quarters of all vehicle production in America was based in Detroit, and Ford accounted for more than half.”

In the 1920’s, the automotive industry was characterized by monopolistic competition, a market with many producers without the power to control price.  Dozens of firms produced automobiles in the Roaring Twenties, the decade in which General Motors overtook Ford in domestic market share.  The brutal recessions of the 1930’s narrowed the field in a Schumpeterian process of “creative destruction,” and by decade’s end the U.S. automotive industry was evolving into an oligopoly, characterized by “fewness.”  Historical analysis was central to Schumpeter’s work, which explains why he is scorned by econometricians, who place their faith in mathematical models.

The industry resembled an oligopsony during World War II, with the Big Three selling materiel to various government entities—a fact that has been obscured in recent hearings.  GM was the postwar price leader with a market share exceeding 40 percent in the 1950’s, and 50 percent in the 1960’s.  Price leadership, another characteristic of oligopoly, means one firm is so strong that it influences the pricing decisions of others.  GM was so strong in the 1960’s that economists seriously debated whether its divisions (Buick, Cadillac, Chevrolet, Oldsmobile, and Pontiac) should be broken up in an antitrust action.  The argument seems quaint today.  GM’s domestic market share is less than half its postwar peak, and the combined Big Three domestic share is lower than 50 percent.

Since the mid-1960’s, government regulation of the auto industry has stayed in the center between the poles of libertarianism and socialism.  If the center’s recent actions fail to produce the desired results, an opportunity will be created for movement toward the poles.  Noncentrist options would include a temporary freeze on some regulations and relaxed enforcement of antitrust law, which would allow the Big Three to merge into two smaller domestic firms, or one giant one.  Democrats would favor an Employee Stock Ownership Plan and a federal-government stake in the new firm or firms, while Republicans would prefer bankruptcy (an unattractive option) or private equity.

Some economists will object to these measures, but historians can point to European examples in which both were employed around another recession (November 1973 to March 1975), one of the longest since the Depression.  A Labor government nationalized British Leyland (Austin-Morris, Jaguar, and Leyland).  French Conservatives brokered a merger between Citroen (which was in bankruptcy) and Peugeot.  The Conservative Thatcher government later privatized Jaguar, while PSA Peugeot-Citroen is Europe’s second-largest automaker.  The models are less important than an historical understanding of the cycle.

The automotive enterprise that entered this recession is not our fathers’ auto industry.  The cycle, with its recurring pattern of death and rebirth, has always altered motor vehicles and those who build them.  History and tradition help us understand and conserve the industry that three million American workers depend on, which is a better option than bankrupting it.

This article first appeared in the April 2009 issue of Chronicles: A Magazine of American Culture.

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