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ESSAYS ON ISSUES SEPTEMBER 1994 NUMBER 85 THE FEDERAL RESERVE BANK OF CHICAGO Chicago Fed Letter Assessing the auto recovery The Federal Reserve Bank of Chica go recently held its Auto Outlook Symposium on June 3 in Detroit. Besides generating a consensus eco nomic forecast, the m eeting provides a forum for in-depth discussions on the economy and the auto industry. This year’s m eeting provided a pro file of the surging activity in the in dustry as well as a critical assessment of its ongoing structural adjustments. Although rapid sales gains and the improved position of the domestic industry have significantly bolstered the regional and national economy, the optimism at the m eeting was somewhat tem pered. This Fed Letter reviews the highlights of the Auto Outlook Symposium and the extend ed outlook provided by participants. The consensus outlook is upbeat Like most other forecasts, the con sensus from forecasts subm itted for the m eeting was relatively upbeat. Whereas in December, participants had produced a consensus GDP fore cast for the year just below 3%, the more recent consensus was 3.6%. The increased optimism extended to all segments of the economy, with the exception of international trade, but seemed to stem especially from the continued growth in certain core segments (see figure 1). Personal consum ption expenditures are expected to increase modestly during 1994-95, although the rate of growth is expected to slow in 1995. Business investment should increase through mid-1995, although once again tem pering in 1995. An added plus is expected from growth in in ventories and residential construc tion. il!11®:::P : :■;$;: - 1. Consensus forecast* 1993 1994 1995 percent GDP (real) 3.0 3.6 2.8 P ersonal c o n s u m p tio n e x p e n d itu re s 3.3 3.5 2.6 In v e s tm e n t 11.8 11.3 7.5 R e sid e n tia l c o n s tru c tio n 8.7 10.9 2.6 G o v e rn m e n t p u rch a se s -0 .7 -0 .4 0.5 b illio n dollars C han ges in b u sin e ss in v e n to rie s 14.3 23.4 21.2 N et e x p o rts -7 6 .5 -1 0 7 .7 -1 0 9 .4 *Based on the mean of 30 forecasts submitted prior to the June 3 m eeting. One of the primary causes of the increased optimism has also been the resurgence in durable goods, espe cially the m otor vehicle industry. The sales surge in late 1993 and early 1994 was somewhat unexpected by participants. In their initial assess ments last December, they projected 1994 light vehicle sales at 14.7 mil lion units. Although discounting the strong pace of the first four m onths somewhat, participants continued to be relatively upbeat, projecting strong build activity from late 1994 through 1995. The consensus for light vehicle sales was 15.4 million for 1994 and 15.7 million units in 1995. Although a few forecasts were m ore cautious, almost all were above 15 million and the m edian was 15.5 million in 1994 (see figure 2). One key to resurgence has been the rebirth of the Big Three. They are expected to gain m arket share t-ei: mM during the rem ainder of the year, partly because Japanese nameplates have not fully incorporated the ap preciation of the yen into pricing (see figure 3). In spite of the grow ing pricing disadvantage of Japanese nameplates, com petition should remain intense. Some participants argued that the surge in the domes tic industry should not be exaggerat ed, as Japanese nam eplates have perform ed well despite a substantial price disadvantage. In the current environm ent, offsets in the form of rebates and leasing are assisting Japa nese m anufacturers in attem pting to m aintain m arket share. Also the continued substitution of U.S.-pro duced vehicles at transplant facilities for imports has boosted the position of major m anufacturers. Overall, however, the m otor vehicle sales m arket remains fragmented. Some segments such as light trucks have soared, while others, including many passenger car lines, have only crawled forward. One by-product of this fragm entation has been the in creasing imbalance between sales 2. Car and light truck sales millions of units 18 ------------------------------------------------------------ seasonally adjusted annual rate 16 ** Forecast 12 -------------------------------------------------------- __i____ i____ i____ i____ i____ i— 1990 ’91 ’92 ’93 ’94 ’95 Note: Shaded area represents range of forecasts. and producdon capacity. Conse quently, although the m arket contin ues to improve, a primary concern remains that light truck capacity constraints may limit sales gains (see figure 4). A nother im portant question is what impact capacity constraints will have on sales heading into 1995. Domes tic m anufacturers have increased efforts to expand light truck capacity, but it will take some time before they can alleviate current supply difficul ties. In the meantime, tight supplies may constrain sales; the supply short age appears to have been one of the key causes of the drop-off in sales in May and June. (Figure 5 tracks the capacity utilization rate for m otor vehicles and parts during the last decade.) The outlook for the third quarter was assessed by participants as likely being constrained substan tially due to supply difficulties. Al though once again the consensus view expects sales to rebound as in creased production occurs during the fourth quarter, in the near term the statistics on the industry may appear confusing. With the exception of some concern over interest rates, oil prices, and a weak stock market, most external economic developments look favor able for the auto industry. Among the more bullish factors are modest income growth, reduced consum er debt, positive consum er attitudes (especially toward purchasing a vehicle), and most im portant, pent-up dem and. Although estimates vary some what, pent-up dem and probably stands be tween 4 million and 6 million vehicles. Dur ing the economic cycle the num ber of net vehicle additions above scrappage has been well below previ ous behavioral pat terns; it now appears that the industry has turned the corner and pent-up dem and is being satisfied. In this regard, the entry of consum ers into the m arket to replace aged vehicles should boost growth through 1996. In the extended term, the ongoing realignm ent of the m arket will con tinue to pose challenges. Dark clouds on the horizon include a num ber of unresolved issues, the largest one being the uncertainty about future governm ent regulatory actions. Nevertheless, some partici pants rem ain bullish on the long term outlook as well. Given buying propensities, population growth, and scrappage levels, the U.S. auto mar ket is projected to continue expand ing throughout the decade. Domes tic m anufacturers are expecting a peak in sales after 1995, with a sales level in excess of 17 million vehicles. Finally, the continuing changes in sourcing of vehicles have also boost ed the industry. T hroughout the economic cycle, imports as a share of sales have fallen because of the Big Three recapture of m arket share and the proliferation of transplants. An additional spark to regional and national economic activity is being provided especially by the substitu tion of transplant-produced vehicles for imports. Additionally, transplants are increasingly using U.S.-produced content and buying from increasing num bers of U.S. suppliers. The in crease in domestic content provides an added boost to Midwest economic activity in particular. Despite improvement, structural adjustments continue Although all participants stressed that improved sales have benefited the industry and the national econo my as a whole, num erous questions still linger. Primary are those relat ing to the ongoing restructuring of the industry, especially the rela tionships between finished producers and suppliers. The current improve m ent in sales may somewhat lessen the pressure to adjust these relation ships. However, the increasing com petition within the industry that motivated such adjustments is con tinuing and may even be accelerat ing. Thus, despite the recovery, auto m anufacturers can be expected to continue making adjustments. The main question facing suppliers remains pricing pressures. Although the immediate pressure to reduce prices substantially has dissipated, constraints on price increases are still very prevalent. In fact, price cuts are not uncom m on, although perhaps less frequent than a few years ago. The pricing process now follows a different format, incorpo rating long-term agreem ents and new pricing mechanisms. Interna tional com petition strongly con strains price increases, to the extent of producing reductions in some segments of the industry. The result ing im pact on profitability is of 4. Vehicle sales percent 16 ------------ 1993 year/year 1994 year-to-date j the domestic indus try. The recent increase in sales has boosted suppliers as well as finished-goods pro ducers. Shipments for most segments of the industry increased in excess of 10% dur ing the last few quar ters, including not only first-tier suppli ers but those further downstream includ ing steel and machine tool producers. One course considerable, necessitadng unique current problem , at least in gains in producdvity to yield accept the context of recent history, is ca able results. pacity constraints. Some segments of the industry are running at full ca The impact of pricing difdculties is pacity including overtime, and some com pounded by other operational adjustments occurring downstream. observers believe this will provide Suppliers must not only accept price some cover for price increases. If so, it m ight be m ore accurate to call constraints but also increase their them a “recapture of past price re responsibility in the m anufacturing process. The increase in responsibili ductions.” Additionally, competitive pressures and surplus capacity ty stems drst from the proliferation of outsourcing of products to suppli abroad continue to constrain pric ers. Suppliers now must provide the ing. Imports of key materials such as steel have increased dramatically capacity to produce and accept the over the last quarter and must still be risk of having excess or unused ca pacity. They must also take on more factored into any assessment of the market. The m arket will continue to of the tasks of design and engineer be shaped by growing com petition, ing. These shifts not only involve risk but also added costs to suppliers and profit increases will have to be when their com pensation levels may generated through cost reductions be falling. Given these pressures, it is and gains in productivity. not surprising that the supplier base continues to consolidate, a trend that Assessing the extended term will likely continue. The future will probably bring still further pressures Observers expect the m arket to con tinue growing until 1997 and likely because of the increasing globaliza slow from there. For the longer tion of the industry. term, however, a num ber of ques O f course there is an upside to the tions rem ain about the underlying intense competitive pressures and strength of sales. Key to long-term continuing operational changes; as a sales growth is an increase in vehicles result of this restructuring, the do in operation greater than the under mestic downstream industry has re lying scrappage rate. Such increases gained its competitiveness interna can be generated by increased house tionally. A num ber of external hold pentration a n d /o r increases in opportunities are surfacing, especial the num ber of households. Al ly growth in sales to foreign nam e though there is some potential for plates, mostly transplants. Part of growth in all of these areas, it does this renewed competitiveness is due not appear robust. to the depreciation of the dollar, but m uch is due to the stream lining of In fact, observers expect a num ber of developments to continue affecting the rate of expansion of vehicle sales. O lder vehicles and a reduction in the scrappage rate due to improved qual ity and vehicle life expectancy is one factor. More fundamentally, there remains some concern over consum ers’ ability to afford vehicles. On the basis of num ber of weeks of family income to purchase an average vehi cle, vehicles have become less afford able over the last twenty years. Al though this may be offset partially by extensions in maturity an d /o r, more recently, leasing, whether or not the industry has fundam entally corrected the imbalance remains an issue. Ad ditionally, many segments of the population have experienced a sub stantial erosion in their ability to purchase a vehicle beyond the aggre gate num bers. Nontraditional house holds in particular have experienced a substantial decline with regards to vehicle affordability. This develop m ent in conjunction with extensions in the operating age of vehicles raise substantial concerns for the industry as it moves beyond the immediate surge. Participants cited all of these factors as concerns that will undoubt edly be discussed at future sympo sium meetings. —Paul D. Ballew and William A. Strauss David R. Allardice, Vice President and Director of Regional Economic Programs Janice Weiss, Editor. Chicago Fed Letter is published monthly by the Research Department of the Federal Reserve Bank of Chicago. The views expressed are the authors’ and are not necessarily those of the Federal Reserve Bank of Chicago or the Federal Reserve System. Articles may be reprinted if the source is credited and the Research Department is provided with copies of the reprints. Chicago Fed Letter is available without charge from the Public Information Center, Federal Reserve Bank of Chicago, P.O. Box 834, Chicago, Illinois, 60690, (312) 322-5111. ISSN 0895-0164 Light vehicle output has been declining rather sharply during recent months. Production difficulties associated with model changeovers and new introduc tions have proceeded at a higher pace than the seasonal norm. In addition, automakers have been bum ping up against capacity constraints for some model lines (particularly light trucks) at a time of the year when seasonal factors anticipate production gains. C urrent assembly schedules suggest that output will flatten out over the balance of the third quarter. Sources: The Midwest Manufacturing Index (MMI) is a composite index of 15 industries, based on monthly hours worked and kilowatt hours. IP represents the Federal Reserve Board industrial production index for the U.S. manu facturing sector. Autos and light trucks are measured in annualized physical units, using seasonal adjustments developed by the Board. The purchasing managers’ survey data for the Midwest are weighted averages of the produc tion components from the Chicago, Detroit, and Milwaukee Purchasing Managers’ Associa tion surveys, with assistance from Bishop Associ ates and Comerica. ins-sse (ste) ^£80-06909 S!0U!III ‘oSeoiqo f>£8 xo9 O'd J91U03 uoqnuuojui aijqnj OOVOIH3 TO HNY9 TAtfTSM TW TClTi i s * s ifiis mmmmmmm.mm mmmfflm mmmsmmmk paq obioiip)
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