Susan Helper: Understanding the U.S. Auto Industry

Last weekend’s post was my attempt to help readers, if they were having a hard time like I felt most folks were, understand what was going on with AIG, bonuses and bailout money. This weekend’s post is my attempt to help folks better understand what’s going on with the auto industry and the auto bailout plans.
Susan Helper is AT&T Professor of Economics at Case Western Reserve University’s Weatherhead School of Management. She is also a Research Associate at the National Bureau of Economic Research and MIT’s International Motor Vehicle Program. Here’s Susan…

For readers having trouble following all of these different bailouts. What happened earlier this week with the auto industry’s proposed second bailout and does bankruptcy look imminent?
Just before leaving office, the Bush Administration loaned $17 billion to GM and Chrysler, and $7.5 billion to the two automakers’ credit affiliates (GMAC and Chrysler Financial). Further assistance depended on the companies’ submitting plans that showed how they were going to become “viable” companies. On March 30, 2009, President Obama’s Auto Industry Task Force determined that the companies’ plans did not meet this condition. So, the administration asked GM’s CEO to step down and gave the company 60 days to develop a more aggressive restructuring plan. The administration determined that Chrysler could not continue as a stand-alone company; it was given 30 days to negotiate a partnership with the Italian automaker Fiat; if successful, up to $6 billion in federal assistance would be provided to the partnership.
From the Task Force’s point of view, the key way to get to viability is to cut costs. The biggest costs are payments to people who hold the automakers’ bonds, and money owed for retirees’ health care. The Task Force also points to costs that result from the companies’ having more dealers than they need for their current reduced market share. Bankruptcy is useful to the companies because it means that contracts (such as those with bondholders, the United Auto Workers, and the dealers) can be torn up. While the United Auto Workers (UAW) has agreed to substantial concessions on the amount of money to be paid for retiree health care, the bondholders (many of whom are quite wealthy) have not agreed to any concessions. The dealers are protected by strong state laws which make it difficult for automakers to reduce their numbers (it cost GM $2 billion in payments to dealers to close down the Oldsmobile brand). So, to get the creditors to negotiate, the Task Force wants to have a credible threat that the companies might be taken into bankruptcy, where the creditors might get very little.
From your work on economic research and the auto industry, what do you consider to be the bigger picture issues behind the fall of the auto industry? Should we have seen this fall coming or is the auto industry crisis part of the country’s overall economic crisis?
There are three key issues. The first issue is indeed the economic crisis. Cars are a purchase that people can put off, so if they are uncertain about the future, they don’t buy cars. Car sales from January to March of this year are 40% below where they were in the same period last year, and even Toyota is cutting the hours and pay of its workers.
But GM and Chrysler are being hit harder by this crisis due to their failure to learn from their Japanese and European competitors. (Ford has done somewhat better.) The average U.S.-made car sells for $2-3,000 less than a Japanese car of the same size. While the U.S. companies have improved the quality of individual parts dramatically — on a widely-watched index compiled by the JD Power Company, they are very close to the Japanese — they still lag on more systemic qualities like, how quiet is the car? Does the interior look cheap?
This is a different analysis of the industry’s problems than many people would give. A lot of people have blamed the UAW for having high wages. I think this is wrong, for several reasons. The cost of UAW labor in a car (including the “legacy costs,” which I’ll explain in a minute) is less than 10% of the total. And, to the extent that UAW wages are high, regular people like us should thank them — UAW organizing played a key role in creating a middle class in which ordinary people could afford cars, among other things. When UAW workers’ wages fall, employers can justify paying other workers less, too. The automakers were saying that workers made $75 per hour including benefits. But this is just wrong. A current worker makes about $25/hour, plus maybe another $20-25 in benefits. The rest of the money is the “legacy cost,” the money contractually owed to past workers.
This brings up the third problem that the industry has, which is poor public policy choices. Unlike other industrialized countries, we don’t have very good benefits for retirees — social security payments are low, and national health care doesn’t start until age 65. So responsible companies like GM and Chrysler, that provide for their retirees, find themselves at a disadvantage when they start to shrink. Many of the foreign competitors provide these benefits, but because they are new, they have few retirees. Also, because they are growing, they don’t have the problem that the Detroit automakers face, which is a high ratio of retirees to active workers. Another public policy problem is that we’ve priced gas too low, which led to an unsustainable model of production.
How does the American auto industry model differ from global competitors?
First, U.S. automakers make far bigger cars. A mass market for SUVs and minivans just doesn’t exist in most other countries, where gas is $5-8 per gallon because other countries add taxes on so people pay the true cost of their driving (e.g. including pollution, road congestion, accidents). These taxes stabilize the price, so that when crude oil prices fluctuate, gas prices don’t vary by 100% as happened in the U.S. last year. These huge fluctuations in price make it very hard for the auto companies to plan, since it takes four years to design a new model, and eight years or so to design a new engine.
The problem is compounded by the lack of flexibility of the U.S. automakers. Most other companies can make several different types of cars (“platforms”) in the same assembly plant, but the U.S. firms are just starting to be able to do this.
A key additional problem is the automakers’ relationships with their suppliers, who account for over 60% of the cost of the vehicle. The automakers have tried to cut costs with suppliers by squeezing suppliers’ margins — the difference between the suppliers’ cost and its selling price. They’ve been successful at this, to the point that many suppliers are in bankruptcy. But this method doesn’t produce good cars — it doesn’t even produce cheap cars, since the price per piece of the component is only a small part of the true cost associated with a part. Also important are the cost of installing that part, of fixing production problems as they arise, and of repairing finished cars should the parts fail while still under warranty. Most automotive components aren’t modular; they don’t simply snap together like Lego pieces. They are part of a tightly integrated machine — they must be designed for a particular car model, and often a problem with one part will mean that several other parts have to be redesigned to make everything fit.
The Detroit Three’s approach to suppliers stands in stark contrast to the approach Honda and Toyota have taken. These automakers make very strenuous performance demands on suppliers. But they do so in ways that reduce defects, improve design features to make products more attractive to consumers, and yield profits that sustain suppliers throughout the business cycle. The process starts with a rigorous joint examination of each step in the design and production process: Is this step necessary? Could it be done more cheaply? The information that surfaces during this process yields far greater savings than does multiple rounds of competitive bidding by suppliers. (I talk about this more at http://www.tnr.com/politics/story.html?id=8c381173-66fe-4e60-9c44-6acee7350e1c.)
What folks in Washington do you think are working towards a more sustainable, progressive view on auto economics?
For the last decade or more, people in the federal government have been averse to anything that smacks of “industrial policy.” As a result, there are few people in the government with expertise in specific industries. (For example, no one on the Auto Task Force had previously studied or worked in the industry.) This is a problem, because real markets simply don’t work the way they do in textbooks. We have a lot of big firms, and if they fail (regardless of how deserved this failure might be) it has a big impact on the rest of us. In the case of the auto industry, failure of GM could mean the loss of at least temporarily of 2-3 million supplier jobs, and permanently of the ability to do in the U.S. a lot of important research and development regarding fuel efficient cars. (I discuss this more at http://dissentmagazine.org/online.php?keyword=+Susan+Helper .)
But I think there are some good ideas out there. Some of these ideas help the industry directly. Some measures (such as a retooling tax credit) help the auto industry develop more fuel-efficient cars. My colleague John Paul MacDuffie and I have some ideas about how to improve relations with suppliers (e.g., have meetings with suppliers involved in the top 10 warranty problems, come up with action plans, and then have future aid be conditioned on following through on those plans). (See http://www.tnr.com/politics/story.html?id=8c381173-66fe-4e60-9c44-6acee7350e1c and http://blogs.tnr.com/tnr/blogs/the_plank/archive/2009/02/17/the-grade-on-detroit-s-bailout-proposals-incomplete.aspx.)
Other measures help firms (particularly auto suppliers, where most of the employment is) diversify out of the auto industry, which will not grow much in coming years. Sen. Sherrod Brown (D-Ohio) has introduced the “SECTORS” bill, which provides funding to help manufacturers (including auto suppliers) incorporate new technologies and new ways of working together. The stimulus bill has money to help firms begin to produce parts for wind turbines and solar panels; these green products use skills and equipment that many auto suppliers already have.
Finally, a third set of measures help firms in general make profits without undercutting workers’ well-being, and therefore would help the Detroit automakers a great deal. These measures include national health care, and proposals to make it easier for workers to unionize.
Going forward, what should readers keep in mind when trying to decide whether they support an auto bailout or not?
I think readers should think about the implications of losing U.S. automakers. It’s good that the Auto Task Force has been tough with GM and Chrysler (and toughness is an approach they might try more with the banks, which have received literally 100 times as much in loans as have the automakers, but have not been asked to provide any kind of plan for their operations going forward).
In judging future bailouts, I’d suggest that readers think about the reasons for having a U.S.-owned auto industry, and then ask whether the bailout plan is likely to promote these goals. In the short term, I think it’s clear that a collapse of the industry would be disastrous — we’d lose millions of jobs at a time when unemployment is already very high. In the longer term, perhaps foreign automakers would expand in the U.S. and use some of the same firms — but this transition would take years to accomplish. And, since companies typically do most of their research and development in their home countries, we’d lose a U.S.-based capability to design fuel-efficient cars and a supply chain that can support innovation in other manufacturing. Without the unionized U.S. automakers, we’d also lose a source of high-wage jobs, since the foreign firms are non-union in the U.S. (though not in their home countries). So, I’d ask — does the bailout plan preserve high-wage jobs? Help automakers close the revenue gap with foreign automakers? Develop their capability to make fuel-efficient cars?
Where did your interest in economics and the auto industry originate? And how has your experience been thus far as a woman in this industry? I couldn’t help but notice that there were no female auto executives at the auto hearings.
I started graduate school at Harvard in the early 1980s, at the time of the previous crisis in U.S. manufacturing. I had gone to grad school to become a development economist, but because of this crisis, came to feel that “my people” in the Midwest also needed help (I felt kind of like a foreign student in Boston sometimes).
The lack of women in the auto industry has had some insidious effects. When airbags were first introduced in the U.S., regulators held that they had to be powerful enough to restrain a male not wearing a seat belt, which meant the airbags were forceful enough to cause injury to small women. (Now we have airbags that operate at variable speeds depending on the weight of the vehicle’s occupant.)
The auto industry is still pretty male, but has changed a lot over the decades I’ve been studying it. While there has not been a female CEO of an automaker, women production workers, engineers and division heads are not unusual in the US. (In Japan it is a different story.) Like many women, I’ve had some struggles in being taken seriously, and have benefited from the support of other women; things are getting better.
Looking ahead, what would your ideal American car look like — product-wise and industry-wise? Back to reality, how much of this vision is dependent on consumer interests and priorities?
I’d like to see lots of fuel-efficient cars with a variety of power trains — gas, diesel, gas-electric hybrids. I’d also like to see the U.S. provide better transportation alternatives, so it’s easier to not drive so much — e.g. bike lanes, high-speed rail, more buses. To get there however we need to work on the demand side, not just on the supply side. Consumers need to pay the true cost of their driving. I think we need to have gas prices similar to those in Europe; we can avoid harm to poor people by phasing in the higher taxes over time, and by directing the money raised to reducing other taxes, and improving public transit — so that people who drive less than average are better off than before.