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Opinions expressed in this newsletter do not
necessarily reflect the views of the management
of the Federal Reserve Bank of San Francisco,
or of the Board of Governors of the Federal
Reserve System.
worsen the inflation spiral as indexation
formulas transform the price hikes into higher
private spending for payrolls and higher
government spending for transfer payments.
In a word, "import fighters" don't automatically translate into "inflation fighters."

when American consumers recognized the
meaning of the latest OPEC price shock and
domestic price decontrol.
And the price of the Japanese product was
right. Even after paying high transportation
and insurance costs when shipping into the
U.S market, Japanese producers boasted a
major production-line cost advantage of perhaps $1 ,000 to $1 ,500 per car, primarily
because of wage differentials. The average
Japanese auto worker makes only about half
as much per hour as his American counterpart (compared with a two-thirds ratio in
manufacturing generally). Given 1978 levels
of hourly wage rates, and given an estimated
125 manhours of production time for a subcompact car, the comparative U.S. and Japanese production-labor costs in 1978
amounted to $1,581 and $817, respectively-a differential of $764 for labor costs

Detroit's failure and . . .
How did Detroit get into its present fix? A
partial answer is provided by columnist
George Will-"ln
1973 Egypt attacked Israel
and devastated Detroit." The massive change
in the world petroleum market after 1 973
favored auto producers who made fuelefficient cars (Japan)and worked against
those who made gas-guzzling monsters
(Detroit). Until 1973, the North American
market was the province of the large V-8, and
the economies of large-scale production
effectively protected this country from substantial import sales. But the enforced shift to
small cars then reversed that advantage.
Detroit generally fai led to meet the challenge
until after the second (Iranian) oil shock, for
several reasons. The industry required long
lead times (and massive amounts of money)
for engineering and design of new models
that were major departures from existing
models. Also, its customers, with Detroit's
encouragement, showed a continued preference for traditional models. And more importantly, Detroit responded somewhat slowly to
the growing demand of some buyers for fuelefficient models, simply because fuel didn't
seem like much of a problem after the initial
price shock. The pump price of gasoline (in
real terms) remained practically stable for a
half-decade, because of a government policy
which kept gas prices artificially low through

Japan's market share has not grown steadily,
however, but rather in fits and starts since
1 973, reflecting the changes in the relative
strengths of the Japanese and American currencies. When the yen declined against the
dollar in late 1 979 and early 1980, the Japanese share of the U.S. market rose to a new
peak; but when the yen turned around and
rose against the dollar, Japan's auto-market
share dropped from 23 to 16 percent between,
JuIy and October 1980. From Detroit's
point, a cheaper dollar thus would be welcome-although
that factor appears secondary in light of the major long-term cost
advantages in Japan's favor.

Detroit's response
Detroit is moving to meet the challenge with
the greatest restructuring of operations in the
industry's history, featuring automated factories, downsized cars, and the latest forms of
computer technology. By 1 984, the industry
plans to build 30 new engine lines, 19 new
transmission lines, and 89 new assembly
lines-and this will require more than $70
billion that is hard to find in today's depressed
market. But as a resuIt, by 1985 everyone of

. . . Japan's opportunity
Japan meanwhile offered a growing supply of
products which offered high quality (with
flawless paint jobs, for example) as well as
reliability (with a low rate of warranty claims).
With high gas mileage, plus those other seIling points, Japan offered products which
were perfectly positioned in the marketplace