Outlook for Auto Industry

Since commercial banks and finance companies typically have a large investment in automobile loans, they have a corresponding interest in the economic outlook for the automobile industry. Fortunately, the Federal Reserve Bank of Chicago has released the report of its annual conference on the outlook for the automobile industry.

Analysts who attended last year's conference (May, 2001) were somewhat over-optimistic. Their median (middle) forecast for 2001 was for a 2.6 percent increase in business fixed investment (it fell by 3.2 percent). Whereas they predicted industrial growth at 0.4 percent, it fell by 3.8 percent. We could go on. In short, it was not a good year for predictors, in large part because they had not foreseen the events of September 11, 2001. In the days following the attack, traffic and transactions at auto dealers dropped in half. Manufacturers responded quickly. General Motors acted eight days after the attack with 0% financing on all GM models. Remarkably, we ended the year with total sales of autos and light trucks of 17.0 million units, the second strongest annual performance on record, and substantially higher than the 16.3 million units forecasted prior to September 11.

The economy rebounded strongly in the first quarter of this year. Gross domestic product climbed 6.1 percent, normally good news for durable goods industries. Offsetting that to some degree is a rising unemployment rate and greater pressures on consumers to save. The chief economist for Ford Motor Company forecast total vehicle sales (cars and light trucks) for 2002 of 16.5 million units. Worldwide sales of vehicles should also slow moderately.

Taking a longer view, participants agreed that the auto manufacturing industry faces severe long-run problems, primarily caused by rising labor costs and the fixed nature of those costs. Labor costs comprise the largest portion of manufacturing costs. The record sales of 1999 and 2000 could support the high labor costs, but they cannot do so when sales decline. Whereas one-sixth of manufacturers' production costs were fixed or quasi-fixed in the past, today they comprise one-third of total manufacturing costs. While the auto companies have tried to maintain volume by offering low- or no-rate financing, these incentives cannot generate the volume of sales needed to meet those fixed costs and generate profits as well.

Since it seems unlikely that revenues from sales will continue to rise as in the past, the alternative means of maintaining profits is to decrease production costs, especially direct labor costs. There are significant differences in labor costs among the Big Three. Since GM had a higher retirement rate than the other auto manufacturers, the smaller remaining work force has resulted in lower direct production costs. However, those savings were offset by a $47.5 billion liability for retirees' future medical benefits and a $9.1 billion liability for future pension benefits.

But free markets work. If our auto manufacturers' work forces and retirees in the U.S. are costly—both now and in the future—they can outsource production of component parts or the whole vehicle. With respect to this policy, one speaker noted "the manufacturers expect reduced costs, more product differentiation, and focus on other revenue streams from suppliers. What the suppliers can deliver is lower labor costs, advanced technology from specialization, and program management/systems integration expertise. The result is increased outsourcing and modularity, an increased portion of the vehicle's value originating with suppliers, and market penetration and gains independent of the vehicle cycle."