Wednesday, September 10, 2008

CAFE: Most Perverse Product Regulation in History

GM is thriving in Europe, selling small cars that get lots of miles per gallon? Buick is among the biggest selling brands in China. GM is running away with Latin America.

The Big Three's problem, to be blunt, is North America. They should have pulled out long ago. Not only did history saddle them with a UAW labor monopoly that their foreign competitors have managed to avoid. Even that might not have been fatal had Congress not enacted its "corporate average fuel economy" rules in the 1970s.

Look at gallons consumed, miles driven, barrels imported or emissions emitted: CAFE has had no significant impact on energy consumption. Its sole practical effect has been to inflict on Detroit the need to produce, with high-cost U.S. labor, millions of small cars designed to lose money. CAFE has to be the most perverse exercise in product regulation in industrial history.

Had CAFE not existed, there is no reason the Big Three today could not be competitive. As businesses do, they would have allocated capital to products capable of recovering their costs. Investments in fuel efficiency would still have taken place -- to the extent consumers valued those investments. That is, if they were profitable.

Bottom line: $50 billion won't turn CAFE into effective policy. It will do just fine, though, as an indicator of Washington's willingness to throw good money after bad rather than admit the folly of its own long-running handiwork.

~Holman Jenkins in today's Wall Street Journal

18 Comments:

At 9/10/2008 9:58 AM, Anonymous rvturnage said...

"Then how to explain that GM is thriving in Europe, selling small cars that get lots of miles per gallon"

How is it that CAFE requirements have made it unprofitable for the "Big 3" in the U.S. if they are apparently running away with profits in other markets by selling cars "that get lots of miles per gallon" (presumably more than the cars they sell domestically)? If they have cars that get higher MPG and sell them in other countries, then why not sell them here? If they choose not to sell them here, it is hardly the fault of CAFE standards.

Do Nissan, Toyota and Honda not have to meet the same CAFE standards as the "Big 3"? If so, why haven't the U.S. CAFE standards hurt their U.S. sales then? They're cars have been outselling Big 3 cars for years and get better MPG.

I think government madated CAFE standards are a bad idea, but to blame them for the Big 3's current situation seems to be a pretty empty argument.

 
At 9/10/2008 10:35 AM, Blogger Walt G. said...

rvturnage,

Let me try to answer your questions in the order you presented them:

1) The European market has demanded these types of cars for a long time. The market shifted in the U.S. when gas hit $4 per-gallon. Yes, everyone knew it was coming, but the speed in which it happened surprised almost everyone. Even Toyota was investing big $$$ in trucks and SUVs when the shift occurred.

2) To be profitable, cars are designed to meet regulations in the market where they are sold. There are presently no international standards. Making cars that meet different countries’ standards is very expensive, which translates into unprofitable.

3) GM makes more models of cars that get 30 miles-per-gallon or more than any U.S. automaker. Profits and volume are a different story.

4) The article was good, but it did not explain CAFE problems very well for those with little knowledge of the law. Automakers lost profits they could have made by producing a model mix with small cars that drained resources ($$) for the vehicles the public wanted to buy at the time (trucks, SUVs . . .) to meet a mandated corporate average. So, instead of making more trucks and SUVs when the market demanded them and building a surplus of cash to invest later, the automakers had to make cars and limit truck sales. Accordingly,the product mix and yearly volumes were determined by regulations instead of the free marketplace. So, when the market shifted, money was not available to quickly change factories from trucks to cars. Some decided to break the law and pay fines instead of complying with CAFE. However, some companies decided to comply and worry about it later. Later is now.

I hope this answers some of your questions, and thanks for your approach. Asking questions is much more informative than jumping to conclusions

 
At 9/10/2008 11:06 AM, Anonymous QT said...

You are forgetting one little thing...it is the customer who determines the product. American consumers have a preference for large, comfortable, powerful vehicles. Until gas was $4.00/gallon, consumers were buying vans & SUVs which the Big 3 did well. Europe with its inordinately high gas prices (most recently $8.00/gallon) naturally sells lots of small, fuel efficient cars.

CAFE standards will require entire production lines to be changed over to smaller cars since importing from Europe is not cost effective. The result will be small cars which will not sell when gas prices go down. Gas prices have been dropping in recent weeks.

Due to the economic slowdown, car sales of all manufacturers are down with the exception of Nissan. Even Toyota has been affected by depressed U.S. sales with profit declining 28%./toyota.results.ap/index.html
Agree that you can't blame CAFE standards for all of the Big 3's problems. CAFE standards, however, have set a very high bar at bottom of the business cycle when these 3 are struggling with massive losses, declining sales, a liquidity crisis and stock markets that are up & down like a toilet seat at a party.

How does one obtain the necessary capital investment to retool factories with massive business losses, limited access to bonds, loans and share issues, and few potential buyers for assets that might be sold?

We may not like the answer of a government backed loan but what other alternatives are there?

 
At 9/10/2008 11:14 AM, Anonymous QT said...

Toyota link for above. My first link did not work right.

Walt g,

Good post. Thanks for the background regarding international car standards and mandated average under CAFE. Helps to understand how we got here.

 
At 9/10/2008 11:27 AM, Anonymous Anonymous said...

Hi walt g

"The market shifted in the U.S. when gas hit $4 per-gallon. Yes, everyone knew it was coming, but the speed in which it happened surprised almost everyone."

I agree that "CAFE" was a bad idea. But assuming that we want to soften that which "everyone knew it was coming", would that have been a good reason to impose gradually higher taxes on gas?

After all, it would have allowed the "Big 3" to adapt gradually to something "everyone knew it was coming".

rg

 
At 9/10/2008 12:00 PM, Blogger Walt G. said...

anonymous 11:27:

Trading one government regulation for another? No, that’s a bad idea, too. Personally, I’m much more of a free-market proponent than that.

 
At 9/10/2008 12:32 PM, Anonymous rg said...

walt g.

"I’m much more of a free-market proponent than that."

I agree, I would also count myself into that camp.

However, how else could we have soften that which "everyone knew it was coming", but for which everyone now seems to look for something/someone to blame?

As I have already said, I think "CAFE" was a bad idea, but why should it have hurt the "Big 3" disproportionably? Are we not just looking for something to blame?

You say

"Making cars that meet different countries’ standards is very expensive, which translates into unprofitable."

True, but is that not true for everybody?

rg

 
At 9/10/2008 12:48 PM, Blogger the buggy professor said...

I would be just about the last person to defend the managerial decisions of GM, Ford, or Chrysler, and for a good decade or so . . . maybe longer. All three have been run, it seems, by old-boy networks, full of self-congratulatory group-think and very generous bonuses and stock options, not to mention salaries.

....

That said, the WSJ article is misleading.

Though the EU does not have CAFE, its member countries have always required much higher registration fees for either large cars or vans (save commercial ones) or by engine size . . . and more recently, in the last few years, by amount of pollution in some member-states.

This is in the Western EU-15. I can't say what the case is in the new member-states in the eastern half.

......

Nor is that all.

Gasoline has always been anywhere from 100% more expensive to upwards of three times that than in the US . . . owing to gasoline taxes.

....

The result?

Car manufacturers in Europe, including Ford and GM, have had a huge regulatory incentive --- not to mention consumer-incentives owing to the tax costs of big gas-guzzling vehicles --- to build smaller, more efficient vehicles.

Anyway one who has lived for any length of time, registering a car in the EU, could have said all this, not just me.

......

And yes, it is the case that diesel engines --- including GM and Ford --- have been far cleaner and less polluting (and less noisy) than diesels in this country.

......

Whether GM or Ford will be able to recover effectively by leap-frogging into new, alternative fuel-driven vehicles remains to be seen.

I hope so, not because I want to see the excuse-making, poorly anticipating old-boy types in charge of GM and Ford (and Chrysler, with at least a Toyota-trained co-CEO)thrive, but rather the workers at all levels who have talent and dedication and need better managerial decision-making and incentives to increase morale and cooperation across all sections of their corporate giants.

.......

Michael Gordon, AKA, the buggy professor

 
At 9/10/2008 1:10 PM, Blogger Walt G. said...

rg,

The Big Three answer to stockholders who expect to see results quarterly. The transplants don't have that pressure. It's a different culture for them. A lot of those companies are family owned by cartels that have complex involvement in foreign governments. They plan ahead for their grandchildren’s future, whereas we mortgage ours. But then again, we don't commit hari-kiri and become kamikaze pilots either.

Obviously a longer--term approach would be more prudent, but that’s not how Americans typically invest. We just gotta have it now, and borrow to pay for it, too.

 
At 9/10/2008 1:19 PM, Blogger Walt G. said...

buggy professor,

I used to have access to the quarterly conference calls between GM and their largest institutional investors, but that was eliminated for some reason (cost-cutting?).

Listening to those exchanges is enlightening. You can tell who is really in charge of the business. Money talks. You can hear steely CEOs start stuttering when asked about last quarter's performance.

 
At 9/10/2008 1:25 PM, Anonymous rg said...

walt g,

"A lot of those companies are family owned by cartels that have complex involvement in foreign governments."

Which ones?

"But then again, we don't commit hari-kiri and become kamikaze pilots either."

I think you do need to update yourself on these cultures.

With the rest of what you say here I agree ;-)

rg

 
At 9/10/2008 1:34 PM, Anonymous rvturnage said...

walt g, thanks for the reply. rg reflected my basic problem with the article. Foreign companies have had to deal with the same issues (consumer demand, varying regulations by country) as the "Big 3". And have had to deal with the same U.S. regulations since the CAFE standards started in the 70's, yet they don't appear to be in the same dire financial straights as the Big 3.

I think you hit the nail on the head with "Obviously a longer--term approach would be more prudent, but that’s not how Americans typically invest. We just gotta have it now, and borrow to pay for it, too."

But that is not a problem of CAFE standards. It's an issue with the way the companies themselves were run.

 
At 9/10/2008 1:47 PM, Blogger Walt G. said...

rvturnage,

You're correct. But complex problems are usually traced to multiple causes. Any problem-solving approach does not allow quitting when you find the first cause.

Holding people accountable for their actions is important and productive; however, endless finger-pointing does not solve problems.

 
At 9/10/2008 2:22 PM, Blogger the buggy professor said...

"Listening to those exchanges is enlightening. You can tell who is really in charge of the business. Money talks. You can hear steely CEOs start stuttering when asked about last quarter's performance." -- Walt g

....

Walt:

1) You draw attention to an important issue --- and a problem for the Big-3 auto companies, dependent as they are on quarterly reports aimed at the stock market, compared to Japanese and German companies.

Traditionally, the car and other manufacturing companies in those two countries had intimate relations with big banks, and drew their capital mainly from bank-loans . . . the bankers themselves sitting on the boards of the Japanese and German mfg. companies.

The cozy relationship went further in Japan.

There, the mfg. companies owned the stock of the banking companies that provided them with funds and sat on their boards. And vice versa.

......

2) Note though.

In the 1990s boom, it turned out that such financing by German and Japanese banks interfered with the innovative start-ups that drove the US to the lead in radical ICT technologies: in information and communications sectors.

Partly this was a result of new innovative venture capital, partly the technological ballooning in the stock market that punctured itself to smithereens by 2000.

By contrast, the bankers connected with the giant companies in Japan and Germany were reluctant to lend money to start-ups . . . compounded, in Japan, by mutual banking-mfg company share-holding. Belatedly, with government encouragement, both tried to stimulate venture-capital, but with little success.

German companies, by the way, did seek to rely more on the stock market toward the end of the 1990s, and the banks themselves found that shifting their investment loans elsewhere was more profitable. Still, the relations between banks and mfg. companies are greater there than here in 2008.

......

3) And so where are we?

With traditional and successful mfg. companies like Toyota or Mercedes, the long-term outlook of banking partners is probably an advantage in raising capital for investment purposes. By contrast, the Big-3 --- far more dependent on showing quarterly profits.

.

Oppositely, when it comes to new start-ups and early successful companies (think of Amazon and Yahoo, neither showing profits for years), US capital markets have advantages over their German and Japanese competitors.

And, undoubtedly, that's one of a bag of influences that explains why the US economy is the only one so far that has reaped all the productivity advantages of the Internet and other ICT innovations.

.....

4) Still . . . what could possibly explain the over-commitment of GM and Ford and Chrysler to big gas-guzzling vehicles after, say, 2003 or 2004 . . . when the price of oil per barrel had risen steadily by three or four-fold?

True, there was (and is) more profit in the heavy trucks and SUV and big-engine vehicles than in more fuel efficient ones, but here we are --- four or five years later, with Detroit companies selling mainly thanks to rebates to move vehicles off assembly lines and encourage sales at dealer lots --- and the Big-3 turn out to have been overtaken by market conditions . . . not just in oil and gas prices, but consumer concerns for far more efficient vehicles.

And yet both Ford and GM make such efficient vehicles abroad, not least in the EU.

Why haven't they been importing car components and engineering talent from their European subsidiaries in order to keep more abreast of market-changes?

.....

5) What follows?

I myself hope, as I mentioned, that Ford and GM will leap-frog successfully into efficient hybrids, lithium-ion batteries, clean diesel, natural-gas driven engines, and ultimately hydrogen cell-engines. To that end, I myself support the $25 billion loan guarantee (above and beyond the existing one) . . . but only if we see top management have their salaries and bonuses cut as a sign that they are fully determined to success in using tax-money for successful retooling and technological innovation of a radical sort.

.

The talent at all levels of the US car-industry is there.

So far, it's the top management that remains under suspicion.

...

Michael Gordon, the buggy professor

 
At 9/10/2008 2:39 PM, Anonymous rg said...

Interesting read to the subject

Higher pollution taxes make sense, provided the revenues are used to offset existing taxes that distort incentives.


rg

 
At 9/10/2008 5:11 PM, Anonymous Anonymous said...

People always forget that automobile travel in the Automobile travel in the US is highly subsidized. Automobile manufacturers sell products that can only be used because the government builds the infrastructure. The Federal Highway system is the largest public works program in history. Then the federal government subsidizes then energy source for those products.

I agree that CAFE standards are not the answer but conservatives who cry that we should let the free market reign and get rid of them completely conveniently forget that we basically have socialistic policies for car travel in the US.

 
At 9/10/2008 8:09 PM, Anonymous QT said...

Anon. 5:11,

With all due respect, road/rail are infrastructure provided for the benefit of all citizens and businesses not for the purpose of subsidizing the auto industry.

Using your logic (this word is used loosely), government infrastructure subsidizes farmers who need to get their crops to market, firefighters who need to get to a fire, and politicians who need to get to work (another very loosely used word).

You might try
doing a bit of homework rather than going on a put down kick.

 
At 9/11/2008 8:30 AM, Anonymous Anonymous said...

First off Dr. Perry, you posted your own graph way back that our economy was "goldilocks" and could handle $3-4 gasoline prices.

Then you posted that $3.54 gasoline is actually a bargin, and pointed out that gas as a % of disposable income was still low and gave a deceptive fleet mileage chart that did not include light trucks, only automobiles. And while that graph is indeed accurate for cars, what prompted that dramatic increase in mileage the 1980's?

CAFE. Don't believe it? Take a look. The combination of cheap microprocessors and the new standards made fuel injection the technology of choice over carburetors, and that fundamental change is what increased the fleet mileage.

So you argue that gas prices are not too high, but then you argue at the same time that we can lower oil prices by drilling. That's probably true, but why would you want to do that if you think that "gas is not even close to historical high's"?

So according to you, our cars are greatly efficient, our gas prices are not high, our economy is not in recession, there is no inflation taking place, and we are more prosperous than ever (once you 'adjust' for whatever factors).

So if that really is all the case, why are you so upset at the policies of the country if things are so good?

 

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