In the days following release of the June employment report for the United States, the financial markets and the business media have been buzzing about the issue of whether the US economic expansion might be losing steam. This new debate replaced the earlier and more familiar one about whether the US economy would continue to accelerate, a view held by many private sector economists, or whether growth would merely level off at a relatively good rate, at least for the rest of 2004, as we anticipate.
A key feature of the new debate centers on the current condition and future prospects of the US motor vehicles industry. A $3.3 billion (or 4.7%) slide in auto sales in this weeks retail sales report for June and then the news today in the Feds industrial production report that motor vehicle and parts output plunged 11.6% per annum in the second quarter is a reminder that this sector has been the most volatile segment of the US economy for a long time. Both the demand for and the supply of vehicles has fluctuated more widely from month to month and quarter to quarter than any other major industry.
Consequently, recent data have to be taken seriously since they suggest the industry faces renewed difficulties. Auto inventories are up by over 9% from a year ago, raising inventory sales-ratios considerably, while automakers seem to have encountered a lot more buyer resistance than last year, not too surprising given the tremendous increases in gasoline prices over the past year, much of which have stuck. As a result, auto companies have once again had to resort to lavish financing incentives or other price discounts in order to stimulate sales and bring down unwanted inventories. When these are briefly suspended, as in June, sales tend to fall off immediately.
From a longer-term perspective, questions abound about the changing role of the motor vehicle industry in the US economy. What is the best way of defining what activities should be included in the auto sector in order to form a solid conceptual basis for estimating the size of the industry? How many jobs depend on it? What influence does the sector have on the standard price indexes? How much influence does it have on the business cycle and is that influence increasing or decreasing? And perhaps most critical, is the auto sector a source of strength for the US economy or a critical vulnerability? Despite the massive amount of data collected by official statisticians in several government agencies, these questions are not readily answerable, even by the leading experts in the field. Some of the figures even seem to directly contradict each other. But it is important to have some grasp of the magnitudes involved before reaching any firm conclusions about the US economic outlook. Here is a brief review of what the various data sources tell us about what has been happening to the auto industry.
How big is the motor vehicle industry? According to the most recent tabulation of real GDP, output of the industry amounted to $386 billion at a seasonally adjusted annual rate, accounting for 3.5% of total value added in 2004 Q1. Twenty years ago, the sector was bigger. It accounted for 4.1% of real GDP in the mid-1980s. The share of imported vehicles and parts has greatly increased.
Is the industry growing or contracting? This is no easy question to answer. In the GDP accounts, motor vehicle output plunged by an annualized 8.2% in 2004 Q1. But that followed a moderate 3.2% rise in 2003 Q4 and a truly astounding 26.6% surge in the preceding quarter. It is hard to imagine a more erratic growth pattern. Are faulty seasonal adjustments responsible? Only in part, according to the experts. Modern automobile and truck factories are highly automated and capable of huge monthly swings in output, they say. But that does not address the basic fact: motor vehicle production has long been extraordinarily volatile.
Do the Federal Reserves industrial production statistics help clarify the puzzle? Not at all. They make it even harder to determine what is happening in the industry. The following table contrasts the quarterly changes in recent Fed data on motor vehicle assemblies with the GDP account version of motor vehicle output. They bear faint resemblance. The differences have to do with how the two agencies, the BEA and the Fed, define the industry and how they define output. Each defends their own methodology. Private sector analysts cross their fingers and hope that the differences even out over time. Lately, they havent.
Motor Vehicle Production: Two Versions
% change, seasonally adjusted annual rates
The erratic swings in motor vehicle production have significant effects on GDP growth. For example, the 8.2% annualized drop in production in the first quarter of 2004 shaved fully ½ a percent from GDP growth. The BEA calculated that GDP excluding the motor vehicles sector grew at an annual rate of 4.4%, compared to the 3.9% growth rate inclusive of the sector. The following table shows that the divergence can be large.
Motor Vehicle Production: Two Versions
% change, seasonally adjusted annual rates
GDP excl. motor
GDP incl. motor
Employment in the motor vehicle industry is declining, but no more than in other manufacturing sectors. In June 2004, there were 1,765,000 workers employed in the transportation equipment sector. This is just 10,000 fewer than a year ago. The motor vehicle and parts industry is a little over half the total, just under 1 million employees. The main development is that the mix of employment in the industry is continuing to change remarkably. That reflects continuing upgrading of process technology, which requires far fewer production workers but more specialized computer, robotics, and quality control technicians. These are trends that originated in the Japanese and German industries, but US firms have been trying to catch up. In the past year, automakers have expanded the number of hours their employees work, in order to meet higher production targets. Average hours worked in the transportation equipment sector have increased by almost a full hour, to 42.7 hours from 41.9 a year ago. Productivity has risen dramatically in the meantime.
New and used auto prices have a major influence on short-term movements in consumer prices. New motor vehicles have a 4.8% weight in the CPI that is almost the same as the ratio of personal consumption expenditures on autos to the GDP. [But that is purely a coincidence given the vastly different methodologies used in the two calculations!] Used vehicles, which dont enter in to the GDP calculation except for the distribution and sales activities involved in reselling them, have a 2% weight in the CPI. New car prices are about ½% lower than a year ago, but used car prices have fallen 11% in the past twelve months. They have been rising this year, however. This swing in used car prices has been the largest single factor in the shift this year from disinflation to inflation for the core CPI as a whole.
Is the motor vehicle industry a source of strength or vulnerability for the economy in the period ahead? Automaking is a cyclical business and it is a highly unionized industry. Thus, profitability varies enormously over the business cycle. It is also an industry in which global competition is fierce and getting fiercer. That makes it especially sensitive to foreign currency movements. These factors have left the US industry extremely vulnerable and barely unprofitable, even during the past twelve months in which real GDP has grown by almost 5%.
Profits of Motor Vehicle & Parts Industry
Billions of Dollars, seasonally adjusted annual rates
What are the policy implications? The next US President will be faced with some difficult issues, many of which swirl around the motor vehicle industry to an exceptional degree. One is health care policy. The automakers have huge unfunded liabilities for the medical expenses of their retired workers. Providing for those benefits adds significantly to the cost of building an auto in the US. Similarly, the auto companies have long maintained expensive defined benefit pension plans. Their competitors do not have those plans. Auto companies, their employees, and their shareholders would love to shift some, if not all, of these burdens on to the taxpayer.
Furthermore, auto companies are quietly building a case for a more aggressive foreign exchange policy. The goal would be an international agreement, perhaps modeled on the Plaza Agreement negotiated during the Reagan administration, to lower the value of the dollar against Asian currencies. Their focus would be on the Japanese yen and the Korean won, while other American companies, as well as the Bush administration, have been concentrating primarily on the Chinese exchange rate regime.
What are the likely implications for the financial markets? Investors are split on their views of auto industry. Over the past five years, GM has managed to track the S&P 500 index relatively closely on average, although it has lagged in recent months. But Ford has done far worse. While the stock price has doubled from the lows reached early in 2003, it is still down 40% from June 1999 levels. By comparison, GM is down only about 25%, while the S&P 500 is down 18% during that time. Bond markets have similarly built in fairly large risk premiums into the yields of the securities issued by the two major US auto companies. Hence, both equity and bond investors are cautious about future prospects.
Would the special circumstances of the auto industry influence the course of monetary policy? This cannot be known with any certainty. But to the extent that the Federal Reserve expresses more optimism about the rate of inflation in the US, it must be at least partly based on the view that continuing pressures on the auto prices will keep the rate of inflation from rising substantially in the near-term. Whether this would continue to be a tenable position should the next US President seek a more sweeping depreciation of the dollar in the foreign exchange markets is yet to be seen.