The Current Financial Crisis: Why Help Autos?
by Jeanne Dangerfield Broad, Senior International Advisor for Blakey and Agnew, and former Director of International Trade Policy at General Motors

The auto industry plays a major role in the global economy by promoting economic growth, job creation and the advancement of technology and representing a key component of international trade. Yet, the industry has been one of the sectors hardest hit by the current financial crises, generating a debate on the merits of whether the U.S. government should be providing short-term financial assistance to the U.S. auto sector.
The fact is that U.S. vehicle sales have fallen from annual rates of more than 17 million units to what may be a 10.5 million-vehicle market in 2009. Global sales, including previously fast growing emerging markets such as Brazil, Russia and India, are falling as well. And, average new vehicle transaction prices, which rose in the 2004-2008 period in the U.S., fell in 2008. Clearly, consumer willingness to commit to the purchase a new vehicle plummeted along with the value of investments and the erosion of job security. Moreover, the tight credit market has meant that even those ready to purchase might be denied the credit to do so.

For automakers, whom typically face high fixed costs and low margins, this has been a disaster - with U.S.-owned automakers General Motors (GM), Ford Motor Company and Chrysler LLC being especially hard hit. In December 2008, President George Bush announced a plan to loan $17.4 billion from the Troubled Assets Relief Program (TARP) to GM and Chrysler to prevent near-term bankruptcy and to help the companies restructure into companies that are more competitive for the long term. The loans were established with an interest rate of 5%, with an additional 5% on any amount in default, and subject to a series of condition, including the requirement that the firms prove themselves "financially viable."

But, should the U.S. government be in the position of providing financial assistance to U.S. automakers? Among the reasons to say yes are the following:
" First, the motor vehicle industry represents a significant part of the U.S. economy. If U.S. automakers are allowed to fail now, the damage to the U.S. economy will far exceed the cost of short-term assistance.
" Second, demand for motor vehicles will recover. If U.S. companies do not survive, foreign automakers will be waiting to take advantage of the opportunity and foreign economies will be the major beneficiaries of a market recovery.
" Third, the U.S. auto sector is well positioned to attain future profitability and repay any loans to U.S. taxpayers -- in part because of experience gained through long exposure to the rigors of global competition.

The damage to the U.S. economy from the collapse of the U.S. auto sector will far exceed the cost of short-term assistance.

Estimates of potential direct and indirect job losses run from a million to 1.5 million jobs in the event of "retirement" of 20% of Detroit 3 production (Inforum Model of the University of Maryland) to 3 million the first year (the Center for Automotive Research). When one considers the impact of these lost jobs, U.S. personal income could be reduced by as much as $150 billion, with decreases in taxes paid of $25 billion in income taxes and $21 billion for social security.

Howard Wial of the Brookings Institution estimates that some 50 metropolitan rely heavily on Detroit 3-related auto industry employment and related services. The worst impacts of a collapse of U.S. automakers would be expected to be felt in the corridor between the Great Lakes and the Gulf of Mexico where most of the plants of U.S.-owned manufacturers are located. However, the impacts of loss of output are expected to be felt nationwide. In fact, foreign-owned auto plants in the U.S. and the communities where they operate could also suffer because of disruptions to the supply chain network caused by one or more auto company bankruptcies.

If U.S. automakers do not survive, foreign automakers will fill the gap when auto demand recovers.

U.S. sales may not reach the highs of recent years, but sales are expected to rebound quickly as consumer confidence returns, particularly if oil prices remain relatively low. In addition, the auto industry will continue to show strong growth over time as vehicle ownership expands in emerging markets. Consequently, many countries across the globe are pursuing strategies to support their local industries until the market recovers. Indeed, many foreign governments have already committed funds to help their domestic auto industries withstand the current financial crisis. Table 1 provides a partial listing:

Table 1
International Auto Programs

 

The recent support for the auto industry is not new. Many countries have identified autos as a "core" industry and provided substantial incentives and subsidies to develop their auto sectors. Prior to the adoption of the World Trade Organization (WTO) Trade Related Investment Measure Code (TRIMs) in 1984, many such policies were in the form of local content requirements and incentives or requirements for auto-related exports. In fact, 33 WTO members pledged to eliminate auto policies believed to be out of compliance with TRIMs guidelines. In their place, many countries have simply substituted more WTO-compatible programs for autos. For example, today many countries provide support for research and development -- and the promotion of green technology specifically. Others provide production incentives, tax relief, special tariff regimes or other programs.

The U.S. auto sector is well positioned for future financial viability -- in part because of experience gained through long exposure to the rigors of global competition.
Because the U.S. auto market is one of the most open and attractive in the world, it has long been a key target of global competitors. This competition has put pressure on U.S. auto firms to operate more efficiently, while at the same time stepping up the pace of product and technological development to meet the evermore exacting demands of the customer.

In fact, U.S. automakers initiated wrenching restructuring actions well before the current crisis that were well on the way to enhanced profitability. Labor contracts have been renegotiated, structural costs slashed, products and operations rationalized globally and a substantial commitment made to developing new fuel-efficient vehicles. In the current environment, these initiatives must be accelerated and expanded and new ones identified.
It is too soon to say whether the loans provided to date by the U.S. government will be sufficient to keep all three U.S. based automakers afloat. But, one advantage U.S. automakers do have is that they have re-invented themselves many times in the past to adapt to changing circumstances, and they are well positioned to do it again. To a great extent, this has been all about taking advantages of the global marketplace.

The U.S. auto industry has a long history supporting the benefits of trade liberalization, beginning in 1965 when the U.S.-Canada Auto Pact offered the opportunity for duty free movement of auto products between the United States and Canada. The Auto Pact demonstrated how a trade agreement can enhance the effective size of a market and promote better rationalization of operations across borders - to the benefit of consumers in the form of reduced prices and workers in the creation of more jobs. As such, the Auto Pact created an important precedent for the U.S.-Canada Free Trade Agreement in 1988 and the North American Free Trade Agreement in 1993-both of which have been instrumental in moving the North American auto industry towards greater competitiveness.

As trade agreements began to expand global boundaries, U.S. automakers began to change from companies with international operations to globally integrated companies with intensive interplay and coordination among its various locations and functions. This trend has helped improve the efficiency and coordination of global operations, as well as to infuse thinking with a more diverse multi-cultural perspective. And, recognizing the great market potential involved, in the late nineties U.S. automakers took an active role in supporting engagement with China and other emerging economies. Today, these markets are significant contributors to U.S. automaker revenues.

Looking Ahead

Looking ahead, the U.S. auto industry has a role to play in bringing to market the newest technologies that will help address the world's environmental and energy challenges. To that extent, the international relationships and partnerships that have been developed by US automakers will be pivotal.

The bottom line is that countries around the world are recognizing the value of their auto industries and taking steps to help them through the current crisis. If U.S. automakers fail, their competitors will be quick to step in. But, if U.S. automakers can keep afloat until the market improves, they stand an excellent chance of surviving for the long haul.

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