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Automobile Industry

Michael Smitka

Professor of Economics

Williams School of Commerce

Washington and Lee University

Lexington VA 24450 USA

Automobiles—both trucks and passenger cars—are but one of a long line of nineteenth-century transportation innovations that shaped modern society, stretching from shipping, canals, and roads to railroads, streetcars, subways, and finally motor vehicles, followed in the early twentieth century by aircraft. Though early suburbs developed along streetcar routes in some U.S. cities, the real growth occurred with the spread of motor vehicles, which over time eliminated the need to locate production near railheads or ports and hence undermined the need for a central business district in most older cities. The sheer size of the automobile industry in modern economies also means that scattered regional economies revolve around the industry, either in manufacturing or in supplying the energy that vehicles consume. Recent shifts in the geography of production can thus have a devastating impact on local communities—the theme of Michael Moore’s semidocumentary Roger & Me (1990).

Consumers (and businesses) highly value the flexibility and independence that car transport affords. Cars are now a core part of modern culture, and as fashion goods they affect perceptions of social status. Upton Sinclair commented on that in Babbit (1922), and Tom Wolfe’s “new journalism” pieces in Esquire captured car customization in “There Goes (Varoom! Varoom!) That Kandy-Kolored (Thphhhhhh!) Tangerine-Flake Streamline Baby (Rahghhh!) around the Bend” (November 1963) and the rise of NASCAR racing in “The Last American Hero” (March 1965). Modern art captured the new visual world (Giacomo Balla, Speeding Automobile, 1912), as did Diego Rivera’s Detroit Industry murals at the Detroit Institute of Arts (1932–1933), while vaudeville’s Keystone Kops carried the car chase into film. Automobile associations sprang up around the world.

In the United States and Canada, car ownership is nearly universal and dominates the rhythm of life. The same is increasingly true in Europe, while in Japan the doubling of car ownership since 1980 is leading to a revolution in retailing, with large-scale stores along roads displacing neighborhood shopping streets with their mom-and-pop stores. By 2006 ownership was expanding at double-digit rates in India and China—where McDonalds now has drive-in restaurants. Not including such retailers, in the developed world one in twelve jobs is tied to the automobile industry, from manufacturing to sales, insurance, repairs, fueling stations, and transport itself (Table 1). The industry has been a source of innovations in technology, manufacturing, and management, including the growth of multidivisional firms and franchising. Finally, the industry is affected by and affects policy and politics.

Vehicles contribute to localized air pollution, but earlier horse-based transportation also generated significant negative externalities, with more than a thousand of tons of manure a day and fifteen thousand horse carcasses a year accumulating in the streets of late-nineteenth-century New York City. Similarly, safety and other issues need to be approached in a comparative context, as does the geopolitical role of petroleum extraction, given the long history of the pursuit of silver, sugar, and other commodities. Cars account for a fourth of carbon dioxide emissions in the developed world; new technologies can lower that, but they will be offset by increased motor vehicle usage in the developing world.

Early Cars and Carmakers. The dream of an automobile dates from antiquity, but commercial production began only in the 1890s. In 1899 the leading European firm Benz turned out a mere 572 vehicles, and in 1901 the U.S. leader Oldsmobile turned out 425. Internal-combustion engines were in their infancy—Daimler’s gasoline engine was patented in 1885, and Diesel did not invent his engine until 1897. Early vehicles were mere horseless carriages, but they soon came in a wide array of configurations, including three-wheelers and four-wheel-drive models, powered variously by electricity, steam, internal combustion, and even hybrid power trains; other than automatic transmissions and air-conditioning, most of the features found in vehicles in 1970 had been used on one or another commercial car by the early 1910s.

Cars remained, however, playthings for the elite and for technophiles, though there were enough of both to encourage many companies to try their hands; there are three hundred known producers in the United States alone during 1896-1926. As technology matured and designs standardized, volumes increased, entry slowed, and consolidation began; a hodgepodge of assemblers and parts firms, for example, were incorporated as General Motors (GM) in 1908. Henry Ford revolutionized the industry that same year with his Model T, explicitly aimed at the mass market. Drawing on multiple innovations—vanadium steel, quick-drying paint, and assembly lines—Ford steadily reduced the price from $850 to $300 and briefly dominated the global industry, with exports around the world and, in response to protectionism, local production in such places as England (1911), South Africa (1924), and Japan and Germany (1925).

With rising incomes, consumers were able and willing to buy cars that offered more amenities and style than the Model T did, but the aging Henry Ford refused to meet this latent demand. GM in 1920 was still an assemblage of firms with no common management systems and precious little coordination. Alfred P. Sloan, brought in by the DuPont family to revive the firm, made virtue of necessity, consciously realigning the product range to provide an array of carefully segmented models, a car for every pocket. To coordinate the many divisions he used standardized reports that allowed executives to compare the return on assets, so that the company could decide where to focus its limited financial and management capabilities. He also clarified line and staff functions, in an elaborate system of committees. In addition, he actively developed the franchised dealership system, including marketing support and finance to both dealers—for floor plan or inventory—and final consumers. These management innovations, though not necessarily unique to GM, proved extremely influential, both because of Sloan’s efforts to communicate what GM did and because for several decades GM was the world’s most profitable (and in some periods the largest) manufacturing enterprise, earning an average 15 percent on sales into the 1970s.

Active—in hindsight, “excess”—early entry into the automotive field was followed by a shakeout. In the United States most firms exited by the early 1920s; for the next sixty years, the only successful new entrant into manufacturing was Chrysler (in 1925), while Ford was slow to expand its model range and remained far smaller than GM. All three left product niches to outsiders, including heavy trucks and small cars. The market functioned as a tight oligopoly, dominated by an annual new product cycle and price leadership by GM, which had roughly half the market. With cars that dominated individual segments, GM’s product plans were explicitly conservative: there was no upside to experimenting with a successful model. So although GM undertook extensive research and development, it was by intent never the first to market with product innovations. Manufacturing also stagnated, for although there were gradual improvements in metallurgy and processes, all players faced the same structure of wages and work rules, imposed through pattern bargaining with the United Auto Workers from 1937 onward. Given the divisional structure and stable market, by the 1960s the path to senior management was primarily through finance, and never through the factory.

Fall of the Big Three. That “Big Three” oligopoly—that of GM, Ford, and Chrysler—was upset by a series of innovations. First, the American market went through a small-car fad once every eight to ten years; the Big Three resisted entering the fad, but they could not ignore the Volkswagen Beetle’s status as the top-selling car in 1968. To counter this, the Big Three turned to imports, with OEM (“original equipment manufacturer,” or contracted) production from Japanese firms and (less successfully) from their own European subsidiaries. That provided profits and market access to a set of foreign firms that were otherwise highly parochial in their operations. Second, the environmental movement led to the imposition of emission mandates and the need to develop catalytic converters. Honda, however, was able to meet the initial standards with its CVCC (Compound Vortex Controlled Combustion) engine—hence the Civic car—providing a substantial cost and performance advantage. Third, safety concerns—highlighted by Ralph Nader’s 1965 book Unsafe at Any Speed—made consumers sensitive to quality, which was sorely lacking in Detroit’s products. Fourth, the 1973 and 1978 oil crises reinvigorated the market for small cars, which as in the past was already fading by the time the Big Three responded to Volkswagen in 1971. Consumers found the early Japanese cars basic but efficient, inexpensive, and of quality that was noticeably better even to the casual observer.

Policy then cemented this advantage, when the Reagan administration, by imposing “voluntary” export restraints on Japan in April 1981, reversed Jimmy Carter’s refusal to protect the Big Three. This proved immensely profitable to both the American producers and the Japanese producers, who had been competing against each other but now could raise prices without fearing a loss of market share. Policy then cemented this advantage. The Reagan administration imposed “voluntary” export restraints on Japan in April 1981, reversing Jimmy Carter’s refusal to protect the Big Three. This proved immensely profitable to the Japanese producers, who had been competing against each other but now could raise prices without fearing a loss of market share. The quantitative ceiling on sales also gave the Japanese producers an incentive to move upscale, and they now had the funds to design cars larger than those demanded in their home market. That shift proved fortunate, because the subcompact segment (B class in Europe) soon shrank from a peak 30 percent of sales to a single-digit share. Finally, local assembly of imported parts provided a way to avoid the quotas. By 1984, Honda, Toyota, and Nissan all had “transplant” factories; others followed. For the first time in sixty years, there was new entry, permanently breaking the long-standing oligopoly of the Big Three.

Subsequent technological trends accentuated this. Increasing demands for safety (mandates for seatbelts and then airbags, and crashworthiness tests), fuel efficiency (in the United States, the complex corporate average fuel economy, or CAFE, rules), and consumer features, the development of new model segments (Chrysler’s revolutionary minivan and Ford’s SUV, the Explorer, leading a light-truck boom), and the digital revolution all intersected to facilitate developing more and increasingly sophisticated vehicles. Firms also faced a larger market, as incomes rose, auto-oriented suburbs replaced urban living, and NAFTA integrated the Canadian, Mexican, and U.S. economies. Models proliferated, with more than six hundred nameplates and countless variations on sale in North America in 2007, including those produced locally by the major German, Japanese, and Korean firms—fifteen new entrants in all.

By 2007 no single firm dominated the North American market, and though the “Big Six”—in order of North American car sales, GM, Toyota, Ford, Honda, Chrysler, and Nissan—were far larger than the reset, the market was characterized not by oligopoly but by monopolistic competition. Profits were declining for all, and the new entrants were profitable only because of the price umbrella resulting from the need for the incumbent firms, particularly GM and Ford, to try to cover the “legacy” costs that stem from the United States’ idiosyncratic lack of a national health-care system.

Worldwide Patterns. This shift from entry and shakeout, to an oligopoly, and finally to monopolistic competition is not unique to NAFTA. No mass-market producers make a large profit in either Japan or the European Union; new entry is too easy. However, varying national histories give different markets a somewhat different flavor. First, there are the OECD (rich country) markets, which outside the United States developed behind significant trade barriers. In Japan the post-1945 recovery facilitated entry by numerous small producers; of an initial thirty-odd firms, twelve remained in 1965. A shakeout process then began (Nissan absorbed Prince in 1966), only to be postponed as domestic growth continued and as exports took off. Since then the industry has consolidated, with, for example, Toyota absorbing Daihatsu and Hino, and then in 2006 buying large stakes in Subaru (FHI) and Isuzu from GM. Meanwhile Ford controlled Mazda, and the French firm Renault controlled Nissan, while DaimlerChrysler first acquired and then divested a controlling stake in Mitsubishi Motors and Chrysler.

The European Union saw a similar pattern, except that national markets were smaller and pre–World War II incumbents did better. As in the United States and Japan, the sector was also unionized and politically visible, which encouraged a “national champion” mentality. In general, Germans bought “German” cars (including those made by Ford of Germany and Opel, a subsidiary of GM), the French bought the products of their own producers, the Italians had Fiat, Spain had SEAT, and the Scandinavians had Saab and Volvo. In the 1960s and 1970s there was some flux in individual markets—for example, Chrysler bought the French Simca, which itself had bought Ford’s French operations and subsequently sold them to Citroën, which merged with Peugeot. All this changed dramatically when the formation of the European Union lowered barriers among these markets, though a “block exemption” prevented consumer purchases from dealerships in neighboring countries. As a result, all the national firms exited or were absorbed by others in the United Kingdom (Rover and Rolls Royce were the last to go), in Scandinavia (GM now owns Saab, and Ford owns Volvo), in Spain (Volkswagen owns SEAT), and in Eastern Europe. Less visible, Ford and GM consolidated their once-autonomous European subsidiaries to operate as EU-wide entities, while Japanese and Korean companies have entered directly or in neighboring regions such as Eastern Europe and Turkey that have access to or are now part of the European Union.

Developing countries went through a similar process. High tariffs—part of the “import substitution industrialization” strategy that most of these countries adopted by the early 1960s—led to multiple firms entering their markets, though in most cases there were no purely domestic incumbents. As a result, a market such as Malaysia’s saw thirteen firms from the European Union, Japan, and the United States all vying for a share in a small market, with production averaging a mere two thousand units per model. The Malaysians did support a “national champion,” Proton—though it initially licensed designs and bought production facilities from Mitsubishi Motors—but hopes for an ASEAN common market proved vain, and with production in 2005 of fewer than two hundred thousand cars Proton lacked the scale to support new vehicle development, much less develop hybrid cars. In contrast, the trend since the 1990s has been toward the consolidation of smaller firms into global producers with a scale topping 4 million units; see Table 3. India’s Maruti faced similar problems until it sold a controlling stake to the Japanese firm Suzuki. It quickly became the country’s dominant producer—and highly profitable—a story repeated in China at Beijing Jeep and Shanghai Volkswagen, which initially faced a hundred-plus small local producers that dated from the local self-sufficiency era under Mao.

One partial exception is Korea, which began with licensed production but unlike its tutor Japan kept new entry to a minimum. Still, three smaller domestic players have been purchased either by foreign firms or by the more successful Hyundai. At the same time, two countries that were quick to open their markets, Turkey and Thailand, have both done relatively well in attracting a variety of firms to become net exporters, as have several Eastern European countries, particularly the Czech Republic and Poland. Thailand, in particular, is the only substantial producer of pickup trucks outside of NAFTA, and it is the base for such production by a number of firms.

In general, then, attempts to foster national champions have failed miserably, and so it is certainly for the better that the new WTO trade rules preclude direct resort to the protectionist policies of the past. This will not prevent the growth of local production; over the last century the industry has exhibited a strong preference to produce where they sell. A variety of reasons underlie this, including transport costs and foreign exchange risk. Also, even today individual markets remain idiosyncratic: pickup trucks are a major segment only in the United States and Thailand, while Japan’s minicar market is a function of domestic tax and licensing policies. Trade in finished vehicles is important within regions—inside NAFTA and the European Union, for example—but the United States is idiosyncratic in having significant imports of finished vehicles from outside the region, which is probably a function of the near-collapse of GM and Ford.

Finally, without delving into the local variation in fueling stations, dealerships (the top twenty-five in the United States each sell more than $1 billion in cars and services a year), and local regulations and politics, it is important to remember that most employment is outside of assembly. Even in manufacturing, two-thirds of jobs and value added are from parts production; assembly accounts for only a tenth of the manufacturing cost of a vehicle. Parts production is also widely dispersed; many components are both labor-intensive and light, which encourages production for export outside of the high-wage developed markets. In addition, particularly with the shifts in materials science and microelectronics, parts production is often technology-intensive. As a result, the market for individual components such as airbags, fuel injectors, and electronic components, and even wire harnesses, is in some cases dominated by three firms; in 2007 the top five parts firms each had global sales of more than $20 billion, more than all but the top eleven vehicle producers. Like their customers, however, they now operate on a global basis, with plants in all major regions to supply the great variety of local needs and to meet the just-in-time requirements of the modern economy. Despite globalization, then, auto manufacturing—which is the tip of the broadly defined motor vehicle industry—maintains a strong national component.

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