Academic journal article Chicago Fed Letter

After the Perfect Storm: What's Next for the Auto Industry?

Academic journal article Chicago Fed Letter

After the Perfect Storm: What's Next for the Auto Industry?

Article excerpt

Amid the global recession in 2008-09, the U.S. auto industry experienced its worst downturn in recent memory. While conditions have improved in 2010, questions about which factors will shape the industry's competitiveness remain. The Chicago Fed hosted a conference on May 10-11, 2010, at its Detroit Branch to explore the industry's past, present, and future.

The conference brought together auto industry leaders, analysts, academics, and policymakers to discuss the challenges and opportunities facing the industry as it emerges from the global recession. The program was organized around three questions: What did we learn as the industry went through its "perfect storm"? What is the status of ongoing efforts to regulate vehicle performance and stimulate innovation in the auto sector? What are the competitive challenges facing the industry in the decade ahead?

Recap of the past two years

Steve Rattner, former counselor to the Secretary, U.S. Department of the Treasury, opened the conference with a keynote speech on the intervention by the federal government to save General Motors (GM) and Chrysler. He argued the government had little choice but to intervene at the time. An uncontrolled bankruptcy for these two companies was not a viable option, economically or politically. Rattner, who was one of the two senior advisors in President Obama's auto industry task force, explained that the initial proposals of the two automakers for restructuring their businesses came up short, so the Obama administration imposed a series of "extraordinarily tough" conditions. If the companies could not meet those, they were told they would have to file for bankruptcy.1 Ultimately, the government committed $81 billion in total to the auto industry, of which $50 billion went to GM. The balance went to Chrysler, the two automakers' financing companies (General Motors Acceptance Corp. and Chrysler Financial), and insurance of obligations to suppliers and of customer warranties. While it is still early to judge the success of that intervention, Rattner said that GM and Chrysler have been given a fresh start and every tool they need to become profitable again.

Related to the government intervention, the Detroit Three (Chrysler, Ford, and GM) were able to bring hourly labor costs in line with those of their foreignbased counterparts, according to Sean McAlinden, chief economist and vice president, Center for Automotive Research. An important step on the way to regaining competitiveness for the Detroit Three was their 2007 labor contract agreements with the United Auto Workers (UAW). The 2007 contracts established a two-tier system of salaries and benefits, significantly lowering the automakers' costs for new hires; transferred retirees' health liabilities to separate entities (voluntary employees' beneficiary associations, or VEBAs) in 2010; and eliminated the post-retirement health benefits and defined pension benefits for all future hires. The Detroit Three and the UAW subsequently renegotiated these contracts to adjust for the industry's downturn, as Chrysler, Ford, and GM shed nearly 120,000 workers, representing a 40% decline from their 2006 employment levels. McAlinden pointed out, however, that as the industry recovers, significant hiring of secondtier workers by the Detroit Three would have to wait until the overhang of laid-off workers with recall rights has been accommodated.

To put the current downturn in context, Thomas Klier, senior economist, Federal Reserve Bank of Chicago, compared the most recent auto industry recession with the one experienced in 1979-80.

While similar in severity, the two downturns played out against very different industry backdrops. Auto manufacturing has become more fragmented in the past 30 years, in large part because foreignbased producers have established a significant presence in North America. Detroit has lost one-third of the U.S. market in terms of sales, as well as over 40% in terms of production, during this time. …

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