Car Makers’ Productivity Bubble Pops

DaimlerChrysler’s sobering announcement last week that it will fire 26,000 workers caps months of bad news from U.S. auto makers. Driven by what were touted as computer-age productivity improvements, auto manufacturing was supposed to be a “new economy” triumph. The car industry’s stunning reversal of fortune, however, suggests how much of their recent boom depended on fortuitously cheap energy, money and regulatory loopholes, rather than breakthrough innovations.

According to new-economy pundits, the U.S. created the world’s most nimble, advanced Information Age economy in the 1990s. The U.S. auto industry was one of the biggest beneficiaries. After years of stagnation, U.S. manufacturing productivity suddenly accelerated, something widely attributed to magical new technologies like the Internet. Motor-vehicle sales boomed. U.S. car companies earned an unprecedented $85 billion during the decade.

But far from reflecting new computer-led design or manufacturing skills, the U.S. firms’ successes almost totally depended on making and selling lower-tech light trucks--SUVs, minivans and pickups--rather than more demanding passenger cars. For a variety of reasons, truck manufacturing shielded chronically weak U.S. manufacturers from the technological, regulatory and competitive challenges they could not otherwise meet. As soon as these fortuitous circumstances changed, the illusory nature of the car industry’s renaissance became clear.

Throughout the 1990s, U.S. companies largely gave up trying to compete with Asian and European manufacturers in producing more refined, less polluting and fuel-efficient passenger cars. Such conventional vehicles are subject to stringent and ever evolving safety, performance and environmental standards. Flexible and creative design and manufacturing skills are necessary to produce them. U.S. auto makers simply did not possess these skills.

Accordingly, from 1990-99, total annual domestic car sales fell by more than 600,000 units, almost entirely because of curtailed U.S. production of passenger cars. By 2000, foreign car manufacturers had gained nearly 50% of the U.S. passenger-car market, compared with 35% at the start of the decade.

U.S. manufacturers instead focused on marketing light trucks. This strategy offered several immediate advantages.

Most light trucks were exempt from pesky federal and state pollution and fuel-economy standards. They could be built with less sophisticated emissions, propulsion and other key technologies than found in typical passenger cars, and thus were less expensive to make. High fuel prices and narrower roadways in Europe and Asia, moreover, discouraged overseas producers from even thinking of turning large, gas-guzzling trucks into passenger vehicles and competing with U.S. companies.

Nevertheless, U.S. consumers were willing to pay about the same price for a light truck as for a better engineered passenger car. Given these economics, a single U.S. SUV assembly plant could generate as much profit as 20 conventional-car factories combined.

U.S. firms wasted no time shifting toward light-truck production. By 2000, about 70% of DaimlerChrysler’s production, 60% of Ford’s and half of GM’s was composed of SUVs, minivans and pickups. Annual U.S. vehicle sales rose by 3 million units, or 22% during the 1990s. All that growth was due to light-truck sales, which accounted for nearly 50% of U.S. new vehicles in 1999, up from 30% 10 years earlier.

In the new economy, business profitability is supposed to be gained through the use of novel, high-tech capabilities that allow for continuous product development and manufacturing, a previously unattainable goal. But U.S. auto industry growth in the last decade took an almost exactly opposite turn. By late last year, the favorable market conditions that enabled short-term U.S. manufacturing successes were rapidly eroding.

The most important condition was cheap, plentiful fuel. Light trucks are far less efficient than passenger cars. Volatile gas prices would have curtailed their sales. After the Gulf War, however, Americans could freely import as much oil as they wanted from grateful Middle East emirates. Like the 1950s, it just didn’t seem to matter if vehicles became steadily bigger and heavier, or if average U.S. fuel economy dropped to its lowest level in 20 years.

Also crucial was the continued relaxation of light-truck pollution and safety regulations. Originally intended to lower costs for farmers and small businesses, Congress never dreamed that these provisions would be used to evade more broadly applicable consumer-vehicle standards. But by avidly lobbying to retain light-truck exemptions, U.S. truck producers avoided having to deal with strict passenger-car tailpipe emission controls, crumple zones or rollover stability. They could continue to sell vehicles that were less safe and that spewed forth two to four times the pollution emanating from a conventional car.

Finally, cheap money, short-term leasing and rapid product turnover reduced consumers’ quality concerns.

All these happy circumstances began to evaporate in the last half of 2000. Increases in gas prices rekindled long-dormant fuel-economy concerns. Higher interest rates made buyers more keenly aware of long-term vehicle quality. Light-truck regulatory loopholes started to close. And foreign producers, resigned to the fact that U.S. consumers actually wanted to drive badly built trucks instead of more sensible passenger cars, flooded the market with highly competitive products.

U.S. manufacturers immediately began to suffer. Their car and truck sales fell by nearly 2% in 2000, even though total domestic-market sales reached a record level. GM’s market share dropped to a new low, just 28% of the total U.S. market, compared with 35% 10 years earlier, and it scuttled an entire car division, the venerable Oldsmobile. DaimlerChrysler rang up losses of more than $1 billion. Ford, by far the healthiest U.S. producer, suffered embarrassing product and tire recalls and was forced to take a mammoth $1.5 billion charge against earnings.

Meanwhile, “old economy” European car makers like VW/Audi were achieving the world’s most rapid sales and profit growth rates with a bevy of new, widely acclaimed vehicles. Honda’s U.S. sales rose by 6%. Toyota’s Lexus became America’s best-selling luxury car. Once troubled Nissan accomplished a nearly miraculous turnaround under the auspices of a French chief executive from Renault. Foreign sales in the U.S. surged by 12% and exceeded 30% of the total domestic vehicle market for the first time ever.

Automobiles are the heart of U.S. manufacturing and, by some measures, account for as much as 14% of the entire economy. If the Information Age had truly transformed U.S. industry, its effects should have been everywhere apparent in car production. Yet, the sobering reality is that U.S. auto makers emerged from the go-go 1990s less capable than ever compared with their supposedly “old economy” competition..

But what about the fabulous productivity numbers? Much of this improvement seems to have been the result of cutbacks in technology, safety and quality investments. Blessed with a market that did not much value engineering enhancements, U.S. firms could reduce their costs and, at least for a time, boost apparent productivity. When consumers started to become more discerning, however, the industry’s latent competitive problems worsened.

Rather than cling to an unsubstantiated sense of economic dominance, the U.S. would be better served by more realistically assessing its industrial strengths and weaknesses. Only a handful of skeptics correctly predicted that higher interest rates would severely throttle the nation’s supposedly unstoppable economy. Information Age hype blinded energy experts from the obvious fact that burgeoning computer use would push electricity demand well above previous projections.

Similarly, even the most encouraging productivity data shouldn’t have induced many observers to imagine that U.S. auto makers could long thrive on a bloated diet of gas-guzzling, low-quality vehicles. It now seems inevitable that U.S. car makers, and the communities that depend on them, face an uncertain future. We can only hope that our other new-economy fantasies are less painfully exposed.