Assessing global auto trends

Paul D. Bellew andRobert H. Schnorbus

The global automobile indus-try has gone through over-whelming restructuring duringthe last twenty years. Thisrestructuring has produced,

among other effects, massive downsizing andrelocation for the Midwest, the birthplace of themass production of vehicles. Assessment ofcurrent and future changes in the industry pre-dict further adjustments, especially within theregion. The factors prompting these adjust-ments are frequently depicted dramatically asemanating in large part from economic forcesendemic to the U.S. market. Although thisdomestic emphasis is understandable, one sub-ject that has received less attention is how theU.S. market has been impacted by the rapidlyevolving global environment. For instance, theU.S. market constitutes only 25 percent of newvehicle sales in the world and its growth isslowing relative to the rest of the world. In-deed, an expanding portion of future economicgrowth and increases in consumer spending onautos is likely to originate abroad.

A current assessment of the domestic U.S.industry within this global marketplace indi-cates that the Big 3 (GM, Ford, and Chrysler)are almost exclusively concentrated in theNorth American and European markets. Asales dependency ratio for each of the Big 3 ofNorth American sales to worldwide sales ispresented in Figure 1. As indicated, Chryslerhas the highest concentration in North Americawith a ratio of .96. This ratio has been increas-ing throughout the latter half of the 1980s,although the recent expansion of Chrysler in

Europe should offset part of this concentration.Ford's North American ratio is .63, while GM'sis slightly higher at approximately .67. Both ofthese levels are significant improvements overChrysler. However, their North American andEuropean to world sales ratios provide evidenceof the degree of concentration and the depen-dency of Ford and GM in these markets collec-tively, with GM's combined ratio over .90 andFord's combined ratio almost .95.

A major factor in this dependence is thelimited presence of the Big 3 in developingmarkets, with the possible exception of LatinAmerica. Of particular concern is the Big 3'sabsence in Asian markets where their combinedsales are still less than 500,000 units annually.Eastern and central Europe are two potentiallykey emerging markets for the Big 3. However,competition from VW, Fiat, and, eventually,Japanese manufacturers will be intense. Thesemarkets are unlikely to achieve rapid growth inauto purchases before the end of the decade.

In an attempt to achieve an integratedanalysis for the auto industry, this article ana-lyzes each major and emerging market for

Paul D. Ballew is an economist and information coor-dinator at the Detroit branch of the Federal ReserveBank of Chicago. Robert H. Schnorbus is seniorbusiness economist and research officer atthe Feder-al Reserve Bank of Chicago. The authors wish to thankProfessor Don Byrne of the University of Detroit forproviding access to much of the data used in thisstudy. The authors would also like to thank DavidAllardice, Assistant Director of Research at the Feder-al Reserve Bank of Chicago, and Roby Sloan, SeniorVice President of the Detroit branch, for helpful com-ments and support in completing this study.

FEDERAL RESERVE BANK OF CHICAGO 15

FIGURE 1

Dependency ratio—Big 3 sales

percent (sales in region/total sales)100 —

75

50

25

0

Chrysler

GMFord

North America North America +western Europe

SOURCE: U.S. Department of Commerce andFederal Reserve Bank of Chicago.

vehicles first individually and then in aggre-gate. The purpose of this systematic approachis to reach some comprehensive insights andconclusions into the prospects for the U.S.nameplates in a marketplace where they mustcompete with foreign nameplates not only intheir own backyard but also in markets through-out the world, most of which are less than hos-pitable. This article will also emphasize howthese global developments impact auto produc-ers in the Midwest, a region where the domesticindustry is still highly concentrated.'

Global demand for vehicles inperspective

Global sales of motor vehicles today arenearly 50 million units annually. In the last fewyears, sales have been approximately 4 to 5million units below trend annually, with salesin the U.S. accounting for roughly half of thisdeficiency. This trend level of roughly 55million units is well above the ten year averageof 41.5 million units; and in fact, growth in theoverall vehicle market has been significant inthe last ten years, up almost 25 percent duringthe 1980s. Furthermore, market forecasts antic-ipate vehicle sales in excess of 60 million bythe turn of the century.'

Currently, the market can be segmentedinto three mature markets and three importantemerging markets. The mature markets collec-tively account for over three-quarters of the

world's production and sales of vehicles. Ofthese markets the U.S., Japan, and Germany arethe most important. However, because of thedegree of integration between the U.S. and Can-ada and among the seventeen major nations ofwestern Europe, these markets have beengrouped into U.S.-Canada, Japan, and westernEurope. All three major markets are large pro-ducers with similar market shares. One differ-ence is that Japan is export oriented, while U.S.-Canada and western Europe are domesticallyoriented. Western Europe and U.S.-Canadarepresent over 60 percent of all vehicle sales inthe world, with Japanese domestic sales beingsignificantly less, approximately 15 percent.

U.S.-CanadaAmong the mature markets, average light

vehicle sales in the U.S.-Canada market over thepast decade have reflected cyclical patterns aswell as trend growth of the U.S. economy. Salesdropped significantly in 1981 and 1982 andrebounded to record levels in the 1984 to 1987period. Since 1989, sales have declined as theU.S. and Canadian economies have slowed sig-nificantly, with combined sales declining to 16million units in 1990 and bottoming out in 1991with a decline to 14.5 million units. Further-more, the sharp decline since 1989 had beenpreceded by a slow decline from the peak of 18million units in 1986 toward a rate below the tenyear average of just over 16 million units.'

The U.S.-Canada market has experiencedsignificant competition over the last 20 years asforeign nameplates have eroded the strangleholdthat the Big 3 once had on the market. 4 Themarket share for the Big 3 has steadily declinedfrom over 90 percent to its current levels of 70percent for light truck and cars combined and 65percent for passenger cars. GM has been thebiggest loser in the passenger car market with aloss in market share of more than 10 percentover the last decade. This erosion has beenlargely the result of market penetration of for-eign nameplates, of which the Japanese brandshave been most successful, with a market sharetoday of approximately 25 percent in NorthAmerica. This market share equals approxi-mately 4 million units in annual sales.

Despite setbacks in the passenger car mar-ket, domestic nameplates have done extremelywell in the growing light truck segment. Thissegment, increasingly dominated by Ford andChrysler, represents, in large part, a shift in con-

16 ECONOMIC PERSPECTIVES

sumer preference from cars to passenger lighttrucks, such as minivans and sports utility vehi-cles. During the past decade the number of lighttrucks sold annually has doubled, reaching al-most five million in 1992. This growing market,along with product strength, traditional know-how of the segment, and trade restrictions, hasallowed the Big 3 to maintain a market share ofapproximately 85 percent (even in 1991). Cur-rent vehicle introductions and redesigned ver-sions have further stimulated sales at the expenseof Japanese producers in particular. However,Japanese and domestic producers are respondingto this growing demand with increased productdevelopment. For example, the recent introduc-tion of Nissan's minivan, the Quest model, hasbeen well received by auto critics. And Toyotahas recently entered the mid-sized pickup truckmarket, perhaps as a stepping stone to the intro-duction of a full sized model.' Therefore, thecontinued dominance of even this segment bydomestic producers is not guaranteed.

Expansion of foreign nameplates into luxuryand sport cars as well as minivans and pickuptrucks will continue to put pressure on domesticnameplates to retain market share.° Productdevelopment schedules are decreasing in length,price containment pressures are intense, andquality and safety improvements continue toaccelerate. The pressure is intense for all pro-ducers and significant restructuring is prevalenteven for Japanese nameplates. In fact, Isuzu hasannounced its intention to exit the light truckmarket in the U.S., and Mazda has delayed itsentry into the luxury car segment by cancellingthe Amati. The prospects for a North Americanfree trade area or customs union may dampensome external competition due to domestic con-tent requirements. However, it should fosterintraregional competition, including transplantoperations. Therefore, the U.S.-Canada marketwill likely continue to be one of the most com-petitive markets in the world, despite its relative-ly slow growth.

Western EuropeUnlike the U.S.-Canada market, the western

Europe market—the second largest in theworld—continues to have significant vehiclesales. Although sales declined slightly in theweaker economic environment in 1992, saleshave trended steadily upward in the last 5 years.With access to central and eastern Europe, thismarket is rapidly becoming one of the most

important areas of growth in the industrializedworld. With prospects for economic unificationstrong in the region, the presence of numerousfirms, both local and foreign, continues to be adominant character of the market. Thus, thekey question concerns the consequences ofeconomic integration for all auto manufacturersinvolved in western Europe.

Sales in the market, due primarily to a onetime boost from German unification, wererobust in 1990 and 1991. Sales in 1991 reached15 million units and, although sales in 1992-93are being depressed by the economic difficul-ties in Germany, the outlook is for sales ofmore than 15 million units annually into thelate 1990s. Continued growth in certain Euro-pean Community (EC) countries (notably Spainand Portugal) and the economic stimulus fromfurther integration in the EC are expected tosupport these sales levels. Some of the demo-graphics of a mature market that exist in theU.S., such as an aging population with modestincome growth, are also present in Germany,the U.K., and France. However, these factorsshould be offset by further market integrationand stronger economic growth.

Current sales in western Europe are divid-ed among six major producers, with limitedJapanese imports (approximately 12 percent),and a second tier of product or market specificmanufacturers. Unlike other major markets, noproducer has even marginal dominance of thewestern European market. Volkswagen, themarket leader, comes closest with a westernEuropean market share of 17 percent, a strong-hold in Germany (over 25 percent marketshare), and a significant share in every othermarket in Europe. Fiat and PSA (Peugeot-Citroen) are next with market shares of approx-imately 13 to 14 percent. Both producers areheavily concentrated in their domestic markets.PSA is more diversified than Fiat, but Fiat hasincreased its efforts in central Europe in recog-nition of this fact. A large portion of Fiat'sdependency on the Italian market is due to theItalian government's decision to limit foreignimports.' Ford and GM both have significantsales presences in Germany and the UnitedKingdom and each has a market share above 12percent. Both companies have been rapidlyexpanding in other markets; Ford in Italy andGermany and GM in Spain and the UnitedKingdom (a long time stronghold of Ford).

FEDERAL RESERVE BANK OF CHICAGO 17

State owned Renault rounds out the major man-ufacturers with a market share of approximately10 percent. The company focuses almost ex-clusively on the French market with only limit-ed sales in other European markets. Recently,Renault has attempted to expand its reachthrough joint operating agreements, especiallyin Scandinavia.

A number of companies with significantmarket presences in specific markets recentlyhave been acquired wholly or in part by largerfirms. For instance, Saab has been partiallyacquired by GM, and Jaguar by Ford. Japanesemanufacturers are also trying to increase theirshare of the market, but face a quota of 16percent in the EC. Therefore, transplants haveincreased, although additional limits on thesedevelopments, labor costs, and other concernsmay dampen this movement somewhat.

JapanAnnual vehicle sales in Japan currently

constitute the second largest single countryvehicle market in the world. Sales in the late1980s and in 1990 approached almost 8 millionunits a year. The continued growth of the mar-ket throughout the post-war era has resulted inper capita vehicle registration level comparableto the U.S. However, a variety of factors arecurrently reducing sales growth, including thecurrent economic slowdown, an aging popula-tion, low population growth, parking and regu-latory difficulties, and a maturing market.'

The domestic Japanese sales market isdominated by Toyota (35 percent), Nissan (20percent), Honda (10 percent), Mazda (7 to 8percent), and Mitsubishi (more than 5 percent),with other Japanese producers active in specificmarket segments. The bulk of the remainingmarket is comprised of foreign nameplates,although they have not reached any significantmarket penetration. In the past, trade restric-tions limited foreign nameplate penetration. Inrecent years, other barriers, such as limiteddistribution networks and adaptation to localcustomers' tastes, have limited penetration.Annual sales volumes by foreign producers arestill below 250,000 units (approximately 3percent), and most of this activity is concentrat-ed among European nameplates.

Overall, the market is currently in flux andthe two dominant producers, Toyota and Nis-san, have recently experienced significant salessetbacks. The current economic slowdown in a

mature and potentially stagnant market willcontinue to pose problems for these producers,although they will probably continue to domi-nate the market for the foreseeable future.Smaller Japanese manufacturers have experi-enced greater difficulty because they do nothave the financial wherewithal to wage a com-petitive battle in multiple market segments.

Asia-Pacific region (excluding Japan)Overall sales in 1991 in the Asia-Pacific

market, excluding Japan, were slightly less than4 million units. This level is not significantrelative to mature markets. However, the po-tential for growth is phenomenal. Sales inSouth Korea, for instance, are currently in ex-cess of 1 million units and have more thandoubled in last 15 years. Sales in Taiwan havealso experienced strong growth in the 1980s:total vehicle sales annually are almost 500,000units. Overall in the 1980s, non-Japanese salesin Asia grew in excess of 8 percent annually, atrend which is widely expected to continue inthe 1990s. The remaining parts of the regionrepresent an underserved, emerging marketwith strong income and population growth. 9

Additionally, economic reforms in the two mostpopulous countries of the world, China andIndia, could potentially provide significantgrowth in consumer product sales.

In the early stages of development, con-sumers typically do not buy vehicles. Howev-er, gains in income eventually produce signifi-cant gains in vehicle purchases in underservedmarkets such as Asia. An estimate of thesepotential sales gains for China is indicated byFigures 2 and 3, which compare income levelsand vehicle sales in South Korea during itsphenomenal economic acceleration in the1970s and 1980s to projected levels for China.As shown, growth in vehicle sales and all con-sumer durables in South Korea exploded onceper capita income reached approximately$3,500 a year. That is, at this level vehiclesales begin an upward swing which acceleratedas income continued to gain. If China mirrorsthis trend, the gains in vehicle sales in the nexttwenty years may be surprisingly strong. Forinstance, if China's vehicle concentration issimilar to the Korean experience, total vehicleregistrations in China may approach 40 millionunits early in the next century. Current vehicleregistrations in China are only 5 million.

18 ECONOMIC PERSPECTIVES

FIGURE 2

Income growth versus vehicle sales in South Korea

thousands of dollars-^

Per capitaincome Vehicle

registrations

0

5

4

3

2

FIGURE 3

Projected income and vehicle registrationsgrowth in China

millions of registrations— 40

Vehicleregistrations

20102005

30

20

10

0

thousands of dollars4

with this growth in sales the mar-ket will continue to be under-served, given an estimated popu-lation of 1.3 billion people by2010. Consequently, future salesgrowth may be more rapid, al-though other constraints, such asspace and regulations, may even-tually set limits on the market.

Similarly, other nations in theregion may achieve substantialgrowth in vehicle sales in the nextfew decades. For instance, percapita registrations in India areeven lower than in China. Eco-nomic reforms are still in theirinfancy in this country, however,and remain a concern. OtherAsian markets, principally Thai-land, Indonesia, and Malaysia,

appear well on their way to reform and shouldboost sales of vehicles significantly in the yearsahead. 10

Market concentration is actually higher insome Asian markets than in the more estab-lished markets. The Korean market, for in-stance, is dominated by Hyundai Motors (over50 percent), Kia Motors (over 20 percent), andDaewoo Motors (over 20 percent)." However,other markets are more diverse, with foreignnameplates active in Taiwan, where Ford has astrong market presence, and Thailand, whereToyota and other Japanese automakers are

active. One trend affecting mar-ket concentration is governmentactivity. Besides trade barriers,many Asian markets have govern-ment sponsored companies orpartnership programs that discour-age market penetration. Japanesemanufacturers have been the mostsuccessful at entering these mar-kets through unconventionalmeans. Partnerships as well astransplant facilities continue toprovide Japanese manufacturersaccess to the market.

Eastern and central EuropePerhaps the most important

emerging market is in eastern andcentral Europe. This market cur-rently is going through a massiverestructuring phase with existing

Therefore, assuming some replacement, totalsales could approximate 35 to 40 million unitsover the next 10 to 15 years, resulting in annualsales on average growing at four times theircurrent sales rate.

If this growth seems unbelievable, it shouldbe noted that mean income levels in the Guang-dong Province in southern China, one of themost successful provinces, are currently esti-mated at above $2,000 a year. Income growthis currently projected at more than 7 percentannually, with southern regions experiencingmuch more rapid growth. Furthermore, even

FEDERAL RESERVE BANK OF CHICAGO 19

state owned firms failing and/or being disas-sembled and western firms rapidly entering themarket. Sales in the last decade have laggeddue to limited income growth on the part ofindividuals. Overall the market is currentlyunderserved with vehicle registrations wellbelow western European levels. Pent up de-mand has been exhibited in many product mar-kets since liberalization, as indicated by recentrapid sales growth.

While the near term sales outlook is some-what bleak, with incomes falling and unem-ployment rising, the economic transformation isbeginning to take shape and, as the recoverybegins, higher income levels will result in in-creased demand in this underserved consumermarket over the long term. Consequently, salesin Hungary, Czechoslovakia, Poland, and theBaltics should accelerate throughout the mid-1990s. Furthermore, the 280 million consumersin the Commonwealth of Independent States(CIS), a collection of former Soviet republics,will likely experience significant income gainsin the late 1990s and, therefore, provide anadded boost. These developments should sig-nificantly enhance the overall European mar-ket. A conservative estimate of vehicle sales of6 million units annually seems likely by the endof the first decade of the next century, exclud-ing a rapid economic transformation in the CIS.It is important to keep in mind that such a saleslevel would exceed annual sales in Germany.Furthermore, even given this sales level, themarket will not be close to western standards.

Latin AmericaLatin America is another emerging market

that is experiencing a significant economictransformation. Reform efforts have solidifiedgrowth in Mexico, Argentina, Chile, and Vene-zuela, and will eventually stimulate demand fordurables in a market of 125 million consumers.Successful economic reform in Brazil and theAndean nations, which appears possible if notprobable, could further stimulate the market.Although political instability is a major con-cern, democratic reforms and trade liberaliza-tion have increasingly solidified the gains madeto date.

Current vehicle sales of almost 2 millionunits annually reflect the potential in the region.Given the economic hardship of debt restructur-ing and economic austerity programs, the cur-rent sales levels reflect positively on the de-

mand for vehicles in the region. The Interna-tional Monetary Fund and World Bank estimatethat the GDP of the region should continue toaccelerate throughout the decade, averaging 4.5to 5 percent annually. If the economies expandat such a rate, the recent annual sales growth inautos of over 20 percent may not be replicated,but growth should continue.

Potential growth in Latin America shouldboost Big 3 sales as well as European manufac-turers' sales (especially Volkswagen), as theseproducers have significant presences in Mexicoand Brazil. Recently, Japanese nameplateshave begun to penetrate the market. However,the efforts have been limited. One wild card isthe outcome of the various trade talks ongoingin the region. Modifications in domestic con-tent restrictions and other trade barriers couldsignificantly alter production and sales activityfor various producers. The general effort toliberalize existing trade policies will likelyaccelerate investment, export activities, anddomestic sales.' 2

Current and future production activity

Production activity mirrors sales activitywithin markets as well as export and relocationactivities or producer trends. Changes in pro-duction activities in regions and between pro-ducers has been relatively dynamic in recentyears. There has been continued movementtoward lower cost production, an effort to closeexcess facilities in some market segments andexpanded production in others in order to ac-cess new and growing markets. These trendsare often a response to shifts in sales and com-petition among producers. To understand thefuture implications, it is important to under-stand the current production environment.

The global marketplace is comprised of 12major manufacturers with annual productioncapacity above 1 million units and a second tiergroup comprised of manufacturers with produc-tion capacity below 1 million units, many ofthem specializing in specific market segments.The top six manufacturers account for over halfof global production and the top 12 account forover three-quarters of all production. But incomparison to the 1960s and 1970s, the level ofconcentration is less and has become moregeographically diverse. For example, GM isstill the number one automaker, but its marketshare has fallen below 20 percent, Ford is sec-

20 ECONOMIC PERSPECTIVES

and with a 13 percent share, and Toyota is cur-rently third with a 11 percent share.

Most manufacturers still have a core base intheir traditional markets. Although one wouldnot classify this core as stable, it still provides adegree of support and is a major consideration inmost decisions affecting company operations.The major question for firms in the future maybe whether or not they can maintain their posi-tion in their traditional market while at the sametime penetrating new markets. 13

U.S. and CanadaProduction during the last decade has aver-

aged approximately 12 million units annually inthe combined U.S.-Canada market with signifi-cant growth occurring in two primary segments:light trucks and transplants. Light truck produc-tion, for instance, has more than doubled sincethe late 1970s and early 1980s.' 4 Transplantproduction in the U.S. and, to a lesser extent,Canada, has also soared. Transplant productionin 1982 was only a token level from Honda; by1991 transplant production exceeded 1.6 millionunits annually and new capacity continues to beadded, especially in light trucks.

Within this expansion of production therehas been a change in mix of firms, led by thecontinued downsizing of GM, Ford, and Chrys-ler, especially in the U.S. By the mid-1990s,Big 3 employment will be more than 400,000jobs lower than its level in 1980. Production bythe Big 3 exceeded 11 million units in the mid-1980s, however, since that time, production hasconsistently headed downward, and is currentlynear 8 million units. GM is currently planningto close at least 4 assembly plants totaling over 1million units of capacity. Gains in market shareby foreigners coupled with the general competi-tive pressures to do more with less continue toshape the production decisions of the Big 3 aswell. Future developments in production ofunits in North America should reflect the contin-ued development of transplants, some additionaldownsizing of existing domestic nameplateoperations in the U.S. and Canada, and someshifting of domestic nameplate production toforeign markets.

Western EuropeWestern European production in the last

five years has exceeded 13 million units. Capac-ity is currently estimated at more than 14 millionunits, with new facilities coming online. Current

production is concentrated in four principalcountries: Germany, France, Italy, and the Unit-ed Kingdom. Germany, where one in six jobsare linked to the auto industry, easily outstripsall other production areas, with production inexcess of 5 million in 1991. French and Italianproducers generally comprise a second tier ofcompanies and are concentrated heavily in theirdomestic markets. British production increas-ingly involves U.S. and Japanese transplants orwholly owned subsidiaries, and production ismixed between domestic units and productsexported to the continent.

Western Europe has six large firms and asecond tier comprised of specialized and/ormarket specific firms, transplants, and imports.Volkswagen, PSA, GM, Ford, Fiat, and Renaultare the top producers in this market representing85 percent of production. The second tier isdominated by luxury car makers like BMW andMercedes and single product firms like Volvo.Recently, mergers and consolidations have re-duced the number of independent companies.Furthermore, competition has also redistributedmarket share among the largest firms, with GMand VW on the ascendancy 15 and Fiat and, to alesser extent, Ford struggling somewhat. Non-U.S. transplant production initially involvedNissan's entry into Britain. However, Toyotaand Honda have also recently established facili-ties. By the mid-1990s, Japanese transplantproduction capacity in Europe will exceed500,000 units annually. A primary concern inthese transplant locations is the continuing threatof trade retaliation and a stated EC policy tolimit Japanese nameplates to a market share of16 percent or less. (Current sales levels arestill below this target.) The Big 3 have alsoadded capacity due to stronger sales or, in thecase of Chrysler, reestablishing a position inthe market. 16

JapanJapan is the largest single country producer

in the world in combined car and light truckproduction. Annual production levels by 1991exceeded 13 million units annually. Almost 45percent of this production (over $65 billion ayear) is exported and, consequently, Japan is theworld's largest exporter of vehicles. Toyota,Nissan, Honda, Mazda, and Mitsubishi are theprimary, but not necessarily the dominant, pro-ducers. Altogether, the domestic market actual-ly is comprised of 10 manufacturers with pro-

FEDERAL RESERVE BANK OF CHICAGO 21

duction above 500,000 units annually. Of great-er significance is the fact that certain manufac-turers, like Fuji and Daihatsu, have significantinfluence in important market niches.

In the extended outlook, Japanese produc-tion will be influenced by three primary trends.First, production of parts and some finishedassembly are becoming more mobile, for exam-ple, moving toward offshore sites in Asia andother developing markets. Due to labor shortag-es and rising costs in Japan this trend seemsinevitable as an alternative to domestic produc-tion. Additionally, offshore facilities provide ameans of entry into an expanding global con-sumer market. Production can then includeexports back to Japan, as well as some produc-tion for the local market. The potential growthof these non-Japanese Asian markets may besignificant in the years ahead, and companieslike Toyota and Nissan have attempted to antici-pate their development.

Second, transplant operations in the U.S.,Canada, and western Europe continue to in-crease capacity and plans for further expansionare in the works. Concern over political pres-sure, trade barriers, and economic considerationscontinue to push Japanese producers towardlocal production. As this trend continues, pro-duction in Japan will be reduced by falling ex-ports which are being replaced by Japanesenameplate production in the States and westernEurope. Unless exports from Japan find newmarkets, the impact on domestic Japanese pro-duction may be severe.

Finally, domestic Japanese production isevolving technically and moving increasinglytoward luxury, mid-size, and sports models tosuit the changing preferences of consumers. Inan economically mature and aging domesticmarket, Japanese producers not only must grap-ple with sales stagnation but a changing productmix. Their technological gains in these areasalso influence their export product mix and willcontinue to do so in the foreseeable future.

Asia-Pacific region (excluding Japan)Non-Japanese Asian production in 1991 was

almost 4 million units, a level which has in-creased tenfold in the last decade. 17 The fastestgrowing production area has been South Koreanfacilities, which produce almost 1 5 millionvehicles annually. The birth of the Korean in-dustry is relatively recent. The industry did notbegin in earnest until almost 1980. However,

production has grown from 100,000 annually inthe 1980s to a projected level of over 1.6 mil-lion in 1992. Production in Taiwan has alsogrown and now approaches half a million unitsannually. Assembly and parts facilities arealso well established in Malaysia, Indonesia,and Thailand. Additionally, major facilitieshave been and are being added in India andChina. Currently, production in these twomarkets exceeds 1 million units. Recent expan-sion in China, in particular, bodes well forproduction capacity.

Overall production in Asia has traditionallyhad an export flavor, with one-third of the pro-duction in this region destined for exportation.The trend is still strong in spite of the establish-ment of Japanese nameplate production facili-ties in Europe and North America. Non-Japa-nese markets are not as export oriented as Ja-pan, although they are becoming more so.South Korea may be a reflection of the future;net exports of vehicles for the country are al-most 400,000 annually, almost 30 percent oftotal production. Other nations in the regionhave not experienced such a share of exportorientation. However, there does seem to be alearning curve, and once facilities are estab-lished, some export potential will likely exist.'$

Eastern and central EuropeAlmost all current production in eastern

and central Europe involves inefficient stateproducers who are or will likely be disbanded.Current annual production has fallen to approx-imately 2.5 million units, with the CIS respon-sible for over 70 percent of combined vehicleproduction. The severe economic slump, com-bined with the break up of the centralized man-ufacturing system, has produced a contractionin production in the last two years that is likelyto continue in the near term. The civil war inYugoslavia and decline of the Yugo has alsoadversely affected the Yugoslavian economy,which was the second largest producer in theregion prior to 1992. Over the long term, pro-duction will likely continue its trend away fromstate owned production to the private sector.One element is the inefficiency and qualityconcerns with traditional products like theYugo, Trabants, and Ladas. 19 Increasingly,however, private sector production has comefrom western firms that have established basesin the region. BMW, Volkswagen, and GM allhave major expansion efforts in former commu-

22 ECONOMIC PERSPECTIVES

nist countries and production from these facili-ties should maintain or at least partially offsetthe decline in state companies which are beingliquidated and/or downsized. Volkswagen'spresence in Czechoslovakia is indicative ofwhat the future may bring. The company isadding facilities to expand production to per-haps over 200,000 units annually; of this total,a portion will be exported to the West. Thistrend will likely continue as the relativelycheap skilled labor and the opening of newmarkets provides a magnet to U.S., European,and Japanese firms.

Latin AmericaCurrently, Latin America is an important

producer, both for domestic consumption aswell as for exportation. Of course, domesticcontent restrictions and other trade barriershave produced some distortions in domesticproduction. However, current production inexcess of 2 million units annually generallyreflects the comparative advantage of theseareas as a low cost production base. Most ofthese units are produced in two markets, Mexi-co and Brazil, with a limited amount of assem-bly occurring in other markets. In Mexico, amillion units are assembled annually, of whichover 500,000 units are exported. 20 In Brazil, acombination of vehicle sales and exports areresponsible for almost 1 million units annually.Brazilian production is not quite as export ori-ented as Mexico, primarily due to a larger do-mestic market as well as economic problems inthe last twenty years.

Current production activity is increasingdue to the rapid expansion of facilities. In fact,capacity estimates indicate that future expan-sion plans are accelerating, and productionshould continue to grow, especially in Mexicowhere a trade agreement with the U.S. shouldprovide a stimulus to the market. Mexicancapacity and, therefore, production have dou-bled in the last ten years. This expansion re-flects the economic reforms in the country aswell as the development of Mexico as an exportcenter of certain models to the U.S. market.The competitive position of the Mexican pro-duction environment bodes well for expansionof production facilities in North America, espe-cially due to the continued importance of thesales market.

U.S. and European firms are expected tocontinue the trend of the last twenty years by

increasing their production capacity in thisregion in order to breach the local market aswell as provide exports to established markets.The potential for future growth also includesJapanese nameplates, which to date have hadonly a minimal presence (with the possibleexception of Nissan). The domestic contentprovisions of the North American Free TradeAgreement may provide a strong impetus forauto plants locating in Latin American markets,principally Mexico.

Global trends and implications forMidwest auto producers

Sales data for 1991 indicate the diversity ofactivities throughout the world and highlightthe environment U.S. nameplates face as thedecade progresses. In 1991, total vehicle salesin the world broke down as follows: 33 percentof all sales occurred in western Europe, 30percent in North America, 15 percent in Japan,8 percent in Asia, 7 percent in eastern and cen-tral Europe, 3 percent in Latin America, and theremaining 3 percent in the rest of the world.Prima facie, it would seem that the Big 3 wouldbe well positioned in the world, given thatalmost two-thirds of all sales occur in NorthAmerica and western Europe, their two tradi-tional strongholds. Unfortunately, such a con-clusion ignores developments discussed in thisarticle. The most important concern is the factthat sales growth is accelerating in Asia (ex-cluding Japan), Latin America, and eastern andcentral Europe where the Big 3 generally arenot active, and decelerating in traditional Big 3strengths: the U.S. and western Europe. At thesame time the current market standing for firmsin traditional markets is under stress from for-eign competitors and, with the integration ofthe EC, competition should accelerate.

The prospects of a sluggish domestic vehi-cle market with intensifying competition at thesame time developing markets are expandingabroad poses many questions for the Midwest.Whether restructuring and downsizing of do-mestic operations continue is, of course, at theforefront of these questions, especially if theBig 3 fail to penetrate new markets throughexpansion programs. Moreover, even foreignmarket penetration may be insufficient to sup-plement U.S. domestic development and em-ployment, unless this penetration involves ex-ports of U.S. made products.

FEDERAL RESERVE BANK OF CHICAGO 23

FIGURE 4

Hourly wages in the auto industry-1990

Ger. U.S.SOURCE: U.S. Department of Commerce.

Of greatest concern is the further employ-ment and income erosion in the Midwest as Big3 facilities are streamlined. Current employ-ment in auto manufacturing is estimated atslightly over 800,000 jobs in finished and partsassembly. Projections of white collar supportstaff and retail distribution employees includean additional 500,000 workers. A large portionof these workers are in the Midwest, which isstill responsible for nearly 60 percent of theassembled U.S. vehicles and is home to theheadquarters of the Big 3. There is a strongprobability of further economic restructuring inaddition to the overwhelming adjustment whichhas occurred already. Since 1979 the domesticindustry has closed numerous U.S. plants, paredproduction costs throughout the entire manufac-turing process, and will eliminate more than400,000 jobs by 1995. The impact of this re-structuring has been especially severe in theMidwest. In Michigan alone, the Big 3 reducedtheir work force by more than 150,000 between1979 and 1991. GM's planned job cuts through1995 will reduce the work force in the state byan additional 25,000 jobs.

A weak sales environment intensifies theneed to restructure and will likely prompt fur-ther efforts to speed up the adjustment. Thisfactor will also likely encourage all producers,domestic and foreign, to explore new opportu-nities, many of which will be external to theU.S. market. Whether or not these opportuni-ties are or will be available is likely to becomea major issue which each manufac-turer will have to address.

Future prospects resulting inadjustment of the current tradeflow and stimulation of exports willbe influenced by a variety of fac-tors. Of primary concern are thefollowing:

1) Continued improvements in U.S.manufacturing competitivenessrelative to the international mar-ketplace: U.S. manufacturingwages relative to the developedworld have declined in the lastdecade. Additionally, productiv-ity gains have been strong and,therefore, unit labor costs haveimproved in relative terms.However, the automotive seg-ment has not experienced the

same improvement as other manufacturingsectors. As indicated in Figure 4, U.S. mo-tor vehicle wages in 1990 were still one ofthe highest in the world and may not be fullyoffset by productivity differentials. Higherbenefit costs push this differential higher,especially health care which is currentlyestimated at 20 percent of overall payrollcosts for the Big 3.

2) Competitiveness relative to the developingworld: as emerging markets reform theireconomies and integrate into the internation-al marketplace, competition will intensify,especially in the new sales markets. Thesenew markets are also a source of competi-tion, and their wage rates may give them acompetitive advantage compared to theindustrialized nations. Overall wages inMexico are currently one-seventh the U.S.level for workers in the motor vehicle indus-try, rates in Korea are still only one-fifth,and so on. Of course, productivity differen-tials and other factors are considerations inthis environment. However, it is question-able whether or not the productivity differ-entials can or will account for such a widedifference of compensation?'

3) Regional and multilateral trade agreements:successful completion of the North Ameri-can Free Trade Agreement (NAFTA) andthe General Agreement on Tariffs and Trade(GATT) round will impact the developmentof the industry by shifting some productionactivities between nations, and also by influ-

24

ECONOMIC PERSPECTIVES

encing income growth, job creation, andother macroeconomic developments. Ofcourse, the primary concern for workers inthe industry is the potential increase of pro-duction shifting to Latin America whichmay be facilitated by NAFTA. Unfortunate-ly, the impact of the agreement is not thateasy to quantify; for example, the agreementwould also open the Mexican market to U.S.exports and remove many of the currenttrade distortions. It is likely, however, thatsome labor in certain segments would beadversely affected, especially in the semi-skilled categories where the compensationdifferentials are the greatest. Segmentsaffected may include the assembling of lighttrucks (which currently face a relatively highbarrier) and some parts components. Ofcourse, export potential also exists in morevalue added components.

4) Other trade developments: from an exportstandpoint, U.S. growth will be influencedsignificantly by domestic content rules,tariffs, quotas, and other political restric-tions. Developing nations prefer to increasedomestic production in lieu of importingsignificant quantities. The 2-for-1 rule ofexports to imports which has been imposedin Mexico is an example of such policy.Future expansion into other non-NorthAmerican markets, especially in Asia, willhave to deal with such policies. Additional-ly, U.S. trade policies will influence thedegree of competition in the U.S. from

abroad. Japanese voluntary export restraintsare being bypassed by transplant production,but are such policies mandatory on Koreanor other Asian production? These issues willimpact nameplate activities in the U.S.,especially the Midwest.

Over the long run, location of manufactur-ing facilities in the Midwest for domesticand/or export production depends on the costsof production, including shipping, trade restric-tions, and location concerns, relative to othermarkets. In a competitive marketplace thesepressures are felt much faster and to a greaterdegree than in insulated markets. Consequent-ly, when evaluating further global integrationand its impact on the Midwest one should alsoconsider taxation, education and training, regu-lation, shipping fees, transaction costs, andoverall production costs. These elements deter-mine the competitiveness of the firm and will,in the long run, play an important role in deter-mining location, production activity, and exportgrowth for any industry. Overall, externalgrowth and domestic restructuring will continueto be the dominant issue for the domestic autoindustry, especially in the Midwest. The futurefor the motor vehicle industry is increasingly aglobal one, both in terms of production andsales, and hopefully U.S. industry can benefitand get in the game. Otherwise, change and theresulting economic pain for the Midwest inparticular may be severe.

FOOTNOTES

'The Midwest is defined as the East North Central censusregion which includes Illinois, Indiana, Michigan, Ohio,and Wisconsin.

2Among other estimates the University of Michigan, Euro-motor, and the Commerce Department all conservativelyestimate sales growth at this level. Estimates provided inthis analysis have come from these sources.

3The recent sales declines may be a reflection of the generaldownward adjustment in the trend in auto sales. Demo-graphic shifts, minimal income growth, and price increasesmay mean that further expansion in the market is unlikely.These factors may cause multiple problems for manyproducers, especially given the level of competition thatalready exists in the market.

°The expression "foreign nameplate" refers to vehiclesproduced by a company headquartered abroad. Productionactivity may well, and in fact does, occur in the U.S. For-

eign transplants refer to U.S. facilities of foreign name-plates. The initial development of transplant facilitiesbegan in 1982 when Honda established U.S. assemblyfacilities in Ohio.

5Domestic competition is also increasing. For example,Chrysler recently unveiled the first full sized model in twodecades to compete with the highly popular Ford (F series)and GM (Chevy truck) models.

6 Light trucks in this discussion exclude vehicles classifiedas Class 5 and greater.

'Recent EC rulings have encouraged the removal of autotrade restrictions within the community. These revisionsare forcing significant changes within the Italian market.

°Regulatory procedures, specifically emission require-ments, do encourage a higher replacement rate for autosthan would otherwise be expected in a mature economy.

FEDERAL RESERVE BANK OF CHICAGO 25

However, reduced prices for slightly used vehicles arebeginning to put pressure on new car sales. Along withother adverse trends, one would expect only modest salesgains in the future.

Domestic nameplates' market share have also been helpedby import quotas and the 25 percent tariff levied on import-ed light trucks.

'Conservative estimates of gross domestic product (GDP)in the dynamic Asian economies places growth at approxi-mately 7 to 8 percent per year throughout the decade.Southeastern China, with a population equal to the U.S.,has an economy growing at a 12 to 14 percent annual ratewith industrial production growing in excess of 20 percentper year.

10 Other elements are also important to support an expand-ing consumer market for vehicles. Infrastructure, especial-ly roads and parking facilities, is an important factor.Additionally, there may be constraints on specific marketswhich will hamper growth. Hong Kong, for instance,because of space difficulties, has a very small vehiclemarket in spite of its relatively high income levels.

"One qualification to the claim of apparent market domi-nance by domestic producers to the exclusion of othermanufacturers is that cross ownership stakes are significantand therefore other manufacturers successfully permeatedmarkets through equity stakes. For instance, GM has a 50percent equity stake in Daewoo, while Ford has a 10 per-cent equity stake in Kia Motors.

12 See Ballew and Schnorbus (1992).

13 Recent acquisitions have reduced the number of indepen-dent automakers, especially in Europe, where intenserestructuring appears to be occurring. These acquisitionshave not dampened the degree of competition in the mar-ketplace. If anything, competition has become moreaggressive recently.

'Note that U.S. nameplates have been relatively aggressivein developing light vehicles that combine the strengths oftrucks with the ride and comfort of cars. Minivans andmany sports utility vehicles possess these characteristics.

15 The expansion by VW and GM has recently added capac-ity in excess of 500,000 units annually.

'Chrysler is building built a facility in Austria and istargeting production of at least 150,000 units annually.

17 Overall, production in this region (including Japan)currently exceeds 17 million units annually and estimatesof additions to current capacity indicate that, by the mid-1990s, production will be well in excess of 18 million units.An increasing portion of this production originates in morediverse areas, including Japanese transplant facilities inAsia. Additional capacity in mainland China, Thailand,and Indonesia may increase capacity above 18 million unitsby the mid-1990s. Given the difficulties in measuringexisting capacity and additions to capacity, a reasonableforecast would place the level at more than 18 million unitsby 1995.

°As illustrated by South Korea, emerging producers mayhave difficulties in exporting to mature markets due toquality problems, trade restrictions, and other factors.However, low labor and other production related costs arean offsetting factor in export growth to other emergingmarkets.

°Production of the Yugo and Trabant has been disruptedby current events. Production of the Lada is still occurringat the Nizhny Novgorod facility, an industrial behemothemploying 160,000 workers.

20 Some Mexican exports are the result of 2-for-1 importrequirements. However, in general the exports reflect thecost effectiveness of Mexican labor.

21 Note that product quality is a major concern with regardto foreign manufacturing locations. These concerns mayoffset other competitive disadvantages.

REFERENCES

Automotive News, 1992 Market Data Book,Crain's Communications, Detroit, MI, 1992.

Ballew, Paul, and Robert Schnorbus, "NAFTAand the auto industry: boon or bane?," ChicagoFed Letter, Federal Reserve Bank of Chicago,December 1992.

Berry, Steven, Vittorio Grilli, and FlorencioLopez-de-Silanes, "Automobile industry and theMexican free trade agreement," NBER WorkingPaper, Cambridge, MA, 1992.

Caldwell, Philip, Berry Eichengreen, andCharles Parry, "International competition in theproducts of U.S. basic industries," The UnitedStates in the World Economy, NBER, 1988.

Commission of the European Communities,"The European motor vehicle industry: situation,issues at stake, and proposals for action," Brus-sels, May 8, 1992.

Economic Strategies Institute, The Future ofthe Auto Industry, Washington D.C., 1992.

Ministry of Trade and Industry, Profile andProspects for the Mexican Automotive Industry,Mexico, September 1990.

Ward's Communications, 1992 AutomotiveYear Book, Detroit, MI, 1992.

U.S. Department of Commerce, U.S. IndustrialOutlook, Washington, D.C., 1992.

26 ECONOMIC PERSPECTIVES