It was reported last week that ailing auto giant, General Motors, is considering the importation of thousands of lower-cost cars manufactured at GM plants in China for sale to the North American market. This ‘rumored’ proposal has created a firestorm of controversy and opposition from the United Auto Workers [US labor union, ed.] and created a significant political problem for the Obama administration since it has provided more than $15.4 billion in loans to the company in an effort to prop up its struggling operations and preserve more than 90,000 US jobs at current levels of compensation and benefits. “GM should not be taking taxpayers' money simply to finance the outsourcing of jobs to other countries," wrote Alan Reuther, the union's Washington lobbyist, in a letter to U.S. lawmakers.
GM, on the other hand, has been under a lot of fire, and for years. They have been harshly criticized for not paying attention to the evolving auto market that has been demanding high quality, fuel efficient cars… a demand satisfied by the Japanese [especially Honda and Toyota] and now too, the Korean auto makers.
A common mantra for the criticism has been that GM is very good at producing exactly the wrong cars at precisely the right time… except perhaps in China where, surprisingly, its Buick brand is well regarded.
GM executives will not comment directly on these reports, saying only that they generally do not speculate on future product strategies beyond what has been publicly released at auto shows. But let’s think this through from an economist’s perspective. So what do we know?
GM is rapidly running out of cash. It faces a June 1st deadline to restructure itself or go into Chapter 11 bankruptcy [where the company is protected from its creditors while it reorganizes under a judge’s supervision. Ed.] And GM has asked for another $11.6 billion in bailout funds to stay afloat. That would bring the total to more than $27 billion in ‘taxpayer’ funding.
There is a lot of truth to the criticism that GM has not done a good job in offering the kinds of cars that people want in the North American market, and when fuel prices climb sales of GM’s leading, profit generating products, like pickup trucks and SUVs decline. That’s a no-win formula.
So after reading the tea leaves of the auto markets GM decides to beef up its fuel-efficient lower-cost entry level offerings in the US by sourcing cars offshore from its Chinese assembly plants. The howls of protest are still echoing through the halls of Congress.
Why is GM considering such a bold and maybe too-late initiative, at least by GM standards? Well GM is at a crossroads… the ‘brink’ might be a more accurate term. They are days away from bankruptcy and management needs to find ways to cut costs and offer competitive cars that people want to buy. If they don’t, then the company, as we know it, will dissolve into insolvency… a memory of another once-great American corporation.
The cost of US labor for the domestic automakers is among the highest in the world. The typical hourly cost for a UAW worker in a GM plant is more than $73 per hour including all benefits. The same kind of worker in a US Toyota plant costs $48. That’s 34% less. In China that average auto assembly line worker earns a little more than $2 for the same hour of work![1]
It doesn’t take a vast storehouse of business sense to understand that sourcing from more competitive labor offerings overseas is an essential component in GM’s strategy for its return to profitability and indeed, its very survival.
Unintended Consequences
So here’s the scenario… Asian auto manufacturers see a huge market in North America. It’s pretty obvious to everyone that with the economy on the ropes, gasoline prices climbing steadily upward and the continuing political instability in the Middle East the market is demanding lower cost fuel efficient vehicles. But not everyone is welcoming these ‘econoboxes’ with open arms. The ‘big three’ car companies, the UAW and their congressional allies see these cars for what they are… a ‘threat to American jobs.’
If these Asian brands gain any more ‘traction’ they will continue to erode the market share of the domestic auto makers. So they and the union appeal to Congress. There’s debate back and forth as to what type of ‘protection’ they can offer Detroit. It’s clear to them that the Asian car makers have an ‘unfair’ advantage in that they pay their workers far less in the way of wages and benefits. So how is it considered ‘fair’ competition when the playing field is so clearly tilted towards the offshore brands? If US jobs are lost to Asian workers then US votes are lost too. Many in Congress are swayed by the demagoguery and they mull a response that includes the imposition of heavy tariffs [import taxes, Ed.] on these cheap but reliable imported cars.
Clearly alarmed, these Asian car companies decide that they can’t afford to fuel a protracted trade-war with the US. After all, their entire goal is to carve out market share, not to be crushed by the weight of the 800 lb. congressional gorilla. So they rethink their strategy. Rather than compete with GM, Ford and Chrysler by end-running them with sturdy and cheap alternatives at the low-profit end of the market they decide to improve their quality, broaden their product lines and move upscale into the mainstream of the US car business. In other words, the plan is to take on the domestic giants head-on and beat them at their own game.
This scenario was played out nearly forty years ago. The Asian car makers were Toyota, Honda, and Datsun [now Nissan]. The cars included the Civic and Accord, the Corolla and the Camry, the Sentra and the Maxima. It even included whole new luxury brands like Lexus, Infiniti and Accura. The strategy proved to be wildly successful.
So the threats and the reality of protectionism, the erecting of artificial barriers to competition and trade by legislative fiat backfired big time. It not only deprived the American consumer of the freedom of choice to select from multiple product alternatives when shopping for a car it pushed ‘Japan Inc.’ to create Lexuses from Corollas… a huge unintended consequence that has directly led to the near and maybe eventual demise of the domestic auto industry as we know it. And guess what… it’s happening all over again.
[1] Although Chinese labor is cheap by US, European and Japanese standards the cost of assembling a car in China is not as cheap as you would suspect since the cost of parts and raw materials are very high.
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