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Global Economic Crisis May Doom Detroit Automakers

December 21st, 2008 Comments off
Despite the ideologically counter-intuitive decision by the Bush administration, in its final days, to transfer some of the TARP money as a bridge loan to GM and Chrysler, the prospects regarding the survival of the domestic automobile industry in the United States are gloomy at best. While the political leaders in Washington have concluded that the economic reverberations from the bankruptcy and liquidation of the automakers would be calamitous, they have not yet drawn the proper conclusion amidst the ravaging global economic crisis.
During the 1920s, more than 300 automobile manufacturing companies existed in the United States. The Great Depression of the 1930s killed off almost all of these manufacturers, leaving just the big three and a handful of independents. Among the firms that vanished was the Pierce Arrow motor company of Buffalo, New York, which made the first cars to become the official mode of transportation by the American president. Even the relatively prosperous 1950s saw the disappearance of the one-time superstar of American motordom, Packard, after its disastrous merger with Studebaker, which itself went extinct in the 1960s.
The lesson of history is that it is extremely expensive to maintain a viable major automobile maker, unless it is sustained by huge demand. Small niche manufacturers can survive, such as Ferrari, since they are structured to be profitable on small volume due to exceptionally high unit prices for their vehicles. However, volume manufacturers struggle to maintain profitability during an economic downturn, since their manufacturing infrastructure, including fixed labor costs, cannot be sustained by the thin margins extracted from each vehicle sold.

Contrary to the image politicians and critics have created regarding GM, Ford and Chrysler, all three have sharply reduced their payrolls, while increasing productivity through enhanced use of robotics in manufacturing. While the domestic manufacturers are criticized for producing fuel wasting SUVs, the critics conveniently ignore the fact that supposedly more professionally managed foreign rivals, including Toyota, Honda and Nissan have also introduced large SUVs. BMW and Mercedes-Benz built assembly plants in the Southern United States for the sole purpose of building large, expensive luxury SUVs.

The primary reason why Detroit is facing extinction is the ongoing global economic crisis, which has created vast demand destruction throughout the consumer economy, especially regarding hard durable items such as cars. The concomitant world financial crisis has created a credit crunch that inhibits the ability of the big three American car producers to weather the impact of the global economic crisis until it has receded to the point where consumer demand for automobiles has sufficiently recovered.

The only government solution that would work would be to substitute for the demand destruction of the current economic crisis with hundreds of billions of dollars in direct purchases related to infrastructure. The precedent for this is World War II, when the U.S. government required the automakers to stop all civilian car manufacturing, while retooling to fill vast government orders for defense equipment. It was the direct government purchases from major American manufacturers, in particular the auto industry, which not only ended the Great Depression, but also led to the long-term ascendancy of the U.S. economy.

Anything short of a World War II style government mass purchasing program will doom the automobile industry to financial implosion, kept on life support only as long as the government is prepared to borrow money it cannot generate from current revenue. With the worsening global economic crisis, it is unlikely that perpetual government deficit spending to prop up failing industries is a sustainable economic model.

For both the auto industry and the U.S. economy in general, the outlook for 2009 is becoming increasingly dark and gloomy. Short of radical governmental intervention similar to what occurred during the Second World War, Detroit’s once-proud automobile industry may be fated to being the iconic casualty of the global economic crisis.