The auto industry is in trouble—and it could cause bigger problems.

It’s Time to Get Worried About the Auto Industry—and the Economic Havoc It Could Wreak

It’s Time to Get Worried About the Auto Industry—and the Economic Havoc It Could Wreak

Moneybox
Commentary about business and finance.
May 3 2017 5:03 PM

It’s Time to Get Worried About the Auto Industry

And the economic havoc its problems could wreak.

Detroit, Michigan.
A Dodge Viper goes through the Viper Assembly Plant on May 8, 2015 in Detroit.

Bill Pugliano/Getty Images

The poor March jobs numbers and the very weak first-quarter GDP figure are fueling concern about a slowing economy—but they shouldn’t, at least not yet. Both figures seem to be susceptible to some measurement error, are likely to revised higher by the government’s economic analysts, and will probably improve in the coming months. The trends in both employment and GDP are basically fine.

There is one area, however, where we should be worried about both the short-term numbers and the overall trend: cars.

Advertisement

The automobile industry is less influential than it once was, but it remains the largest manufacturing industry and retail sector in the United States. With deep supply chains and perhaps the highest average per-unit cost of any widely sold retail object ($32,000 in December 2016), it is a very big deal. And as a lending institution, it’s also the generator—and beneficiary—of a huge amount of credit.

Each month, we get a reading on the health of the auto industry. Since the economic turmoil of 2008 and 2009—which caused General Motors and Chrysler to seek bankruptcy, and in which only 10.4 million new vehicles were sold—auto sales have rebounded smartly. For each of the last two years, about 17.5 million new cars have been sold in the U.S. But car sales seem to have hit a wall. In April, sales of cars and light trucks were off 4.7 percent from the year before, a decline of 70,000 vehicles. That marks the fourth straight month, every month this calendar year, in which sales have declined on a year-over-year basis. So far in 2017, sales are off 2.4 percent, or by 133,000 vehicles.

Now, that means that instead of contributing to retail sales, and hence growth, car sales detract from it. But that’s a relatively small hit. Losing 113,000 in car sales at an average price of $32,000 means losing $4.2 billion in sales. Every month, U.S. retail sales are about $470 billion.

So why should we worry? Well, the decline of car sales in an era of near-full employment and continued economic expansion is an anomaly. It could mean that car sales may have hit something of a near-term plateau. Or it might be that with the rise of carsharing, the uptick in urban living, and millennials doing their millennial thing and eschewing ownership, we’re beginning to see the effects of budding structural decline in the demand for new cars.

Advertisement

It’s also possible that automakers are victims of their own success. For all the headlines about continual recalls and quality constraints, cars made and sold in America are long-lasting vehicles. It used to be quite rare for cars to be able to rack up 100,000 miles. Now it’s routine. The average age of a vehicle on the road in the U.S. has expanded dramatically in recent years, in part because people are reluctant to buy new vehicles every few years and in part because they don’t need to be replaced as quickly. For the same reason, cars that come off two- and three-year leases make compelling buys because they’re cheaper than new cars but still have plenty of life left in them.

But the real concern is that, as much as American-made cars have improved from a value and engineering perspective, the engineering of the business doesn’t seem to be keeping pace. In producing cars, manufacturers practice rely on the philosophy of just-in-time inventory: You buy and keep on hand only the parts you’re going to use today. Doing so means you avoid tying up capital, reduce storage costs, and are able to adjust more quickly to short-term swings in demand. All sorts of businesses have adopted the same mentality. And consumers, enabled by technology that delivers everything they want to them when they want it and in the quantities they need, have followed.

And yet when it comes to actually selling the cars manufactured through ultra-efficient, market-sensitive methods, automakers seem to be remarkably old-fashioned. The big auto companies don’t take reservations or deposits and then go make the number of cars that have been ordered (as Tesla does). Rather, they make forecasts about demand based on how they think the economy will do, schedule production well in advance, and try as much as they can to run their factories around the clock. (The less downtime in your equipment and labor force, the more productive the company is.) So they churn out huge quantities of shiny new cars, push them to the lots, and then rely on the dealers to move the product.

When sales don’t materialize as expected, however, inventory can pile up. Which is exactly what is happening. At the end of April, General Motors reported that it had 935,758 vehicles in inventory—which is 100 days’ worth of selling activity at the current rate. A year ago, GM had 618,000 vehicles in inventory, representing only 71 days of selling activity. Inventory, in other words, is 50 percent higher than it was a year ago. Ford, for its part, had about 72 days’ worth of selling activity in inventory in April (about the same as it did in April 2016).

Advertisement

That represents a huge amount of capital—all the parts and labor required to build the vehicles—that is effectively depreciating. A new car can’t be a new car for more than a year. When inventory builds up at the same time that sales are declining overall, dealers and automakers have to get more aggressive on sales: cutting prices, providing more incentives, pushing credit on easier terms. All of which can be damaging to short-term profit margins. And while other businesses react very quickly to short-term changes in demand, car manufacturers are often slow to ratchet back production. That’s partly because slashing production publicly signals competitive weakness and partly because running a factory at a slower rates reduces the profitability of that factory.

So what usually happens is that after several months of struggling to move product, car companies abruptly cut production. That’s bad for the companies and for their workers, who might not get as many hours or overtime as they hoped. (Which is also bad news for the retailers and restaurants in the communities where they work.) It’s bad for the vast network of suppliers who are suddenly faced with a cutback in orders. The suppliers, in turn, quickly reduce their own production, thus cutting wages and reducing the supplies they purchase. And so on.

In this massive industry, rather than tap on the brakes gently and modulate their speed, thus giving everyone behind them the ability to adjust at a leisurely pace, the vehicles at the front of the line slam on their brakes—which can lead to a cascade of fender benders, near-misses, and crashes in the broader economy. If new car sales numbers don’t improve soon, that’s precisely what we’ll see in the coming months.

One more thing

Since Donald Trump entered the White House, Slate has stepped up our politics coverage—bringing you news and opinion from writers like Jamelle Bouie, Michelle Goldberg, and Dahlia Lithwick. We’re covering the administration’s immigration crackdown, the rollback of environmental protections, the efforts of the resistance, and more.

Our work is more urgent than ever and is reaching more readers—but online advertising revenues don’t fully cover our costs, and we don’t have print subscribers to help keep us afloat. So we need your help.

If you think Slate’s work matters, become a Slate Plus member. You’ll get exclusive members-only content and a suite of great benefits—and you’ll help secure Slate’s future.

Join Slate Plus