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ESSAYS ON ISSUES THE FEDERAL RESERVE BANK OF CHICAGO MARCH 1994 NUMBER 79 Chicago Fed Letter The impact of the auto industry on the economy While the slowdown was noticeable in most measures of overall m anufactur ing activity, it was concentrated in the motor vehicles and parts segment. Economists have consistently argued Build rates during the summer fell that durable goods are among the below plans to a seasonally adjusted primary drivers of economic activity. annualized rate of less than 10 mil The cyclical tendencies of this sector make durable goods key indicators of lion units. Adding to the weakness in production, sales slumped from cyclical turning points and trends in 14.1 million units during the second the overall economy. No industry quarter to below 14 million units better exemplifies this than the auto during the summer. Some worried industry. In the Midwest, the auto sector plays an even more central role whether that sales weakness would continue past the summer and lead because of its disproportionate con to a further decline in production. centration in the region. Yet both nationally and regionally, analysts who If this happened, it would create sig wish to use the auto industry as a bell nificant problems for the economic expansion. wether for the macroeconomy must be able to distinguish between the If viewed without an industry’s cyclical trends on the one understanding of the hand, and technical or structural adjustments occurring trends on the other. in the auto industry, This Fed Letter examines the impact of the summer statistics could have seemed to changes in the auto industry on the be cause for alarm. regional and national economy, par ticularly focusing on the unique role it Shipments of autos and parts were down played last year when events in the 15.5% in July from industry appeared to jeopardize the their March peak— current expansion. over five times the decline in total manu Summer doldrums facturing shipments. In the summer of 1993, the dispropor Even though the auto industry accounts for tionate impact of the auto sector on slightly less than 10% the economy stood out especially of total shipments, the clearly. A loss of momentum in the industry’s decline ac m anufacturing sector during those counted (on a share-weighted basis) months aroused widespread concern for half of the total decline in m anu about whether the economic expan facturing shipments and for about sion could be sustained. Factory or 85% of the decline in durable goods ders and shipments declined sharply manufacturing (see figure 1). In in July (down 2.6%), capping an al industrial production, the decline in most steady decline in both series the autos and parts com ponent in since their peak in the first quarter. Similarly, the m anufacturing compo April (-0.8%) was nearly three times greater than the decline in total man nent of industrial production, which had peaked in April, ended July 0.3% ufacturing. In addition, the slump in auto production had effects on sup lower. plier industries such as rubber, glass, and steel, that generated additional weakness in durable goods manufac turing. Thus, while there were certain ly other sources of drag on the m anu facturing sector, the weakness in auto production was the critical factor. The real question was whether it was signal ing a weakening overall market, or whether it was an aberration due to one-time factors. The auto slowdown as an aberration In fact, much of the summer slowdown in auto production was due to tempo rary supply-side interruptions—espe cially at General Motors plants—rather than a sudden downward shift in de m and for autos. A large portion of the slowdown was attributable to model changeovers, particularly in May and June, and to technical difficulties in getting plants running on schedule in August. For example, car assemblies over the first four m onths of the year averaged an annualized rate of 6.3 million units, then fell to about 5.9 million over May and June. By July and August the rate had dropped August and Novem ber. Similar strong gains in factory orders and shipments could be traced to this sec tor as well. All of these events affected the Midwest disproportionately because of the con centration of the auto industry here. The summer slump in economic activity was almost completely confined to the re gion, as it was due primarily to the tech nical problems at Midwest auto plants (see figure 2). As a result, although overall produc tion levels in the Midwest had started the year 40% above year-ago levels, during the summer they fell below year-ago levels. Similarly, the region benefited disproportionately from the auto production catch-up during the fourth quarter. *As of July 1993. Note: The Seventh Federal Reserve District includes Illinois, Indiana, Iowa, Michigan, and Wisconsin. Source: Federal Reserve Bank of Chicago. below 5.5 million. Light truck pro duction, which had averaged an an nualized rate of about 4.6 million during the first four m onths of the year, dropped to 4.2 million in May and June and 4.0 million in July. The shortage of supply caused by the pro duction problems had some impact on sales as well. Fortunately, production estimates suggested that the underbuild would not continue past the summer. The initial build schedules for the fourth quarter, announced during the sum mer doldrums, called for production of over 2.9 million units (1.6 million cars and 1.3 million light trucks), a 12% increase over the year-earlier rate. This would be the highest fourth-quarter rate since 1988. More over, tight inventories were also reas suring, indicating the need to boost output in the fourth quarter. As it turned out, fourth-quarter auto production almost exactly matched planned schedules. This output boost ed the macroeconomy substantially, contributing over one-third of all growth in gross domestic product (GDP) during the fourth quarter. In fact, the snapback of the U.S. econo my in the fourth quarter is directly correlated to the expansion in vehicle production and sales. Industrial pro duction rose 0.7% in October and 0.9% in November, both largely be cause of a 20% increase in production of m otor vehicles and parts between Fundamentals offset temporary slump After a disappointing third quarter, total car and light truck sales in Octo ber and November returned to a rela tively healthy annualized rate of 14.6 million to 14.7 million units. Total vehicle sales for the quarter reached their highest level since the fourth quarter of 1989. Some analysts within the in dustry expect 1994 sales to exceed 15 million units, though this figure may be overly optimis tic. At the other ex treme, some doubters question whether the pace of auto recovery is out of line with the subpar pace of the over all economic expan sion. If so, the current rate of vehicle sales would not be sustain able, and a slowdown in sales during 1994 could spill over into the rest of the economy. Clearly the question is, has the recent recovery in autos been abnormal, or is it largely consistent with general eco nomic conditions? To answer this question, it is useful to view the rate of expansion in vehicle sales in the con text of past expansions. Compared with the highs and lows of the previ ous three expansions (following troughs in 1970, 1975, and 1982), the recent gains since the trough in the second quarter of 1991 have clearly been subpar (see figure 3). Indeed, auto sales since that trough have been markedly below the lowest levels of any previous expansion. This pattern is similar to the recovery in both GDP and consumption expenditures (in constant dollars), relative to their previous cyclical recoveries. Thus the vehicle sales pattern in this expansion is generally consistent with the subpar nature of the economic expansion. In fact, by some measures, the expan sion in the auto industry may be even somewhat weaker than the subpar expansions in the economy or than consumption expenditures would suggest. The question is this: Has the share of consumption going to new vehicle purchases been roughly in line with past recoveries? Even if consumption is weak, consumers may be spending a greater share on autos than on other consumption goods. If so, even though vehicle sales are weak relative to past expansion standards, they may be capturing a greater share of consumption and, therefore, be Sources: American Automobile Manufacturers Association and Federal Reserve Bank of Chicago. rising. Figure 5 shows what vehicle sales would have been if the average im port share had remained at the 1986-88 level. The calculations indicate that 1.7 million fewer domestically sourced vehicles would have been sold in 1993 if im port shares had held Shifts in domestic market share constant. The Big Given the weak auto sales, why has Three gained about there been the perception that autos 500.000 of those units are leading the recovery? The answer and the rest went to is that sales have shifted away from transplants. Assuming imports and toward domestically a typical auto plant sourced vehicles. Domestic cars in produces between creased their market share from 72% 200.000 and 250,000 units, the gains in 1988 to 79% in 1993. While trans to the Big Three represent keeping plants increased their share by about 3 two plants open, while the shift to to 4 percentage points over the same transplants has supported the opera period, imports declined from nearly tion of six new transplant facilities. 20% in 1990 to less than 15% in 1993. These data illustrate how structural As a result, the auto sector has contrib shifts in the auto industry can cause uted up to half a percentage point significant repercussions in the na more to GDP growth than it would tional economy. have if im port market share had re Conclusion mained constant at 1986-88 levels. In addition to its traditional cyclical This shift has occurred along with a role, the auto industry has been pro gradual improvement in total vehicle viding a nontraditional stimulus to the sales, and has provided an additional current recovery. During 1993, the spur to the domestic industry as well as industry affected the macroeconomy to the regional and national econo through a market shift from imports mies. As a result, GDP growth rates to domestics as well as through tem have gotten an extra boost that would porary disruptions to production not have occurred in past expansions activity. Although the auto industry when im port shares were constant or contributes only 5% of total GDP, its im pact on the U.S. econ omy is far greater than that num ber would suggest. No other sector of this size has a comparable impact. Given this fact, assess ments of macroeco nomic activity must take special account of the auto industry. The challenge lies in understanding short term aberrations that may occur in the industry as well as the stronger than expected given the over all strength of the economy. However, the data indicate that the share of consumption expenditures going to new vehicle purchases was actually below the lower bound of the highlow range over past recoveries (see figure 4). Thus auto sales were in fact below what one would expect, given general economic conditions. ‘ Includes Big Three and transplants. Sources: American Automobile Manufacturers Association and Federal Reserve Bank of Chicago. Sources: U.S. Department of Commerce, Bureau of Economic Analysis, and Federal Reserve Bank of Chicago. profound structural and cyclical ad justm ents that are reshaping it. If one ignores the effects of model changeovers and increased domestic sourc ing of auto assemblies, one may draw erroneous conclusions about the un derlying strength of the economy and the sustainability of the current economic expansion. Conversely, an analysis of such events helps explain the disproportionate impact the auto industry has on the national and re gional economies. —Paul D. Ballew and Robert H. Schnorbus Karl A. Scheld, Senior Vice President and Director of Research; David R. Allardice, Vice President and Assistant Director of Research; 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 Tracking Midwest manufacturing activity Motor vehicle production, millions (saar) Manufacturing output index ( 1987= 100) Dec. Month ago Year ago MMI 127.3 124.8 116.1 IP 115.3 114.5 109.3 7 Cars Motor vehicle production (millions, saar) Light trucks Dec. Month ago Year ago Cars 6. 8 6. 6 6.1 Light trucks 5.8 5.2 4.8 Purchasing Managers’ Surveys: production index 5 3 Jan. Month ago Year ago MW 65.3 65.5 67.4 U.S. 62.7 63.7 64.6 ■ i i—i i. - L t i...i Note: Dotted lines are estimated production from auto producers. 1991 1992 Light vehicle production rose to a 14-year high in December, with strength in both car and light truck ouput. Unusually frigid weather prom pted plant closings in the second half of January, cutting an estimated 2% from planned first-quarter output. Bad weather also affected sales, but the underlying mo m entum in the m arket seemed to remain strong. After the coldest weather passed, automakers actually raised first-quarter ouput plans. If current sched ules are achieved, first-quarter production will continue to rise (on a seasonal ly adjusted basis) from the fourth quarter of 1993. 1993 1994 Sources: The Midwest Manufacturing Index (MMI) is a composite index of 15 industries, based on monthly hours worked and kilowatt hours. IP represents the FRBB industrial pro duction index for the U.S. manufacturing sec tor. Autos and light trucks are measured in annualized physical units, using seasonal ad justments developed by the Federal Reserve Board. The PMA index for the U.S. is the production components from the NPMA sur vey and for the Midwest is a weighted average of the production components from the Chi cago, Detroit, and Milwaukee PMA survey, with assistance from Bishop Associates and Comerica. IIIS-3S£ (2lg) F£80"06909 sloutllI ‘oScoito xog O d J01U33 uoueuuojui apq nj OOVOIH3 TO^MV9 3A33S33 TVTI3Q33 T u p q p a q (X c to iip )
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