Midwest Economy Blog

Automotive Outlook and the Regional Economy

January 24, 2012

On Thursday, January 19, 2012, the Detroit Association for Business Economics (DABE) held its annual Automotive and Economic Outlook luncheon. This event is held each January at the Detroit Branch of the Federal Reserve Bank of Chicago in memory of Robert Fish—a past president and founding member of the DABE. Meeting in the Detroit area since 1975, the DABE is a chapter of the National Association for Business Economics (NABE). The DABE meets six times between September and May, and members and guests have the opportunity to hear from experts on various sectors of the economy. As the DABE’s premier event, the annual January luncheon always coincides with the Detroit International Auto Show, and it featured two experts on the automotive sector.

The speakers at this year’s event were Kristin Dziczek, who is the director of the labor and industry group at the Center for Automotive Research (CAR), and George Magliano, who is the senior principal economist for IHS Automotive. Both speakers have more than 20 years of experience in researching the automotive industry and manufacturing. Dziczek’s presentation titled 2011 Detroit 3 – UAW Labor Contracts was an in-depth review of the results of the 2011 UAW (United Auto Workers) contracts and their impact on the labor costs and competitiveness of the Detroit Three automotive manufacturers (Chrysler, Ford, and General Motors). Magliano’s presentation titled US – Light Vehicle Outlook was just that—a concise analysis of what to expect in the coming years from the U.S. automobile industry, particularly in terms of sales of light vehicles (cars and light trucks).

Dziczek provided automotive employment forecasts for the United States and Michigan, as well as an overview of the 2007 UAW contracts and details on the final 2011 UAW contracts. Additionally, she provided insights into issues that the Detroit Three and the UAW will need to address through 2015. Dziczek said that the Detroit Three’s U.S. automotive employment numbers had started falling years before the 2008–09 recession; Detroit Three domestic employment appeared to bottom out in 2009, at about 170,000 employees. She explained that by 2009 the Detroit Three had shed almost 240,000 employees in the U.S., or 58% of their domestic work force, in just eight years. In Michigan, the Detroit Three had seen their employment fall by 112,000, or 52%, over the same period. The good news is that CAR projects total Detroit Three employment in the U.S. to increase by 18%, or 31,000 employees, over the period 2009–15, reaching a level of 201,000. Also, Detroit Three employment in Michigan is predicted to jump by 32%, or 33,000 employees, over the same period, totaling 135,000 by 2015. Based on these forecasts, we can see that CAR is expecting U.S. automotive jobs to reconcentrate in Michigan—at least to a certain degree.

In 2007, the Detroit Three and the UAW were able to agree on labor contracts that Dziczek considered “a game changer.” Important aspects of the contracts included the use of voluntary employee beneficiary associations (VEBAs1); a two-tier wage structure that lowered the entry-level hourly wage to $14.00; and no pay increases. To compensate workers for no annual pay increases, the Detroit Three agreed upon a signing bonus of $3,000; lump-sum profit sharing distributions as a percent of an employee’s base pay of 3% in 2008, 3% in 2009, and 4% in 2010 (the last two were suspended in 2009); a cost-of-living adjustment, or COLA (also suspended in 2009); pension increases; and some product guarantees2 (some of which were never fulfilled). The most significant result of the new labor agreements was that the average hourly labor cost was reduced from $72–$78 per hour to about $50–$58 per hour. All of these changes set the stage for the 2011 labor contracts, which involved some additional changes to the previous contracts that Dziczek called “evolutionary, not revolutionary.” These changes included such cost containment strategies as the elimination of the jobs banks (which paid laid-off workers a high percentage of their salaries for an indefinite period); the continuation of the suspension of the COLA; and no pension increases at this time. Like the 2007 contracts, the 2011 contracts helped keep the Detroit Three’s costs competitive with those of other major automotive manufacturers. Dziczek pointed out that one important issue that bears watching in 2015 is how the two-tier wage structure is addressed. The initial agreement had a cap on the number of entry-level workers—more specifically, only a certain percentage of total employment could be made up of such workers. The UAW would like to see that cap kept in place, while the auto companies would like to see it either increased or removed altogether. Other critical issues include limiting pension liabilities; pushing to increase employees’ share of health care costs; and staying the course on variable compensation (profit sharing versus wage increases).

George Magliano provided a detailed and informative macroeconomic outlook, on which he based his light vehicle forecasts. Magliano explained that, of course, the major risk to his economic forecast is the European debt crisis. According to IHS and Magliano, even though Europe is in a recession, the U.S. economy is expected to continue to grow slowly over the forecast horizon. Magliano’s forecasts for 2012 are as follows: Real gross domestic product (GDP) will grow about 2.0%, employment will rise by 1.2 million, Consumer Price Index (CPI) inflation will remain at 1.5%, oil prices will settle at about $91 per barrel, and housing starts will remain weak (at around 730,000 units). Long-run real GDP growth is expected to settle at 2.5%–3.0%, and payroll employment is predicted to remain below its previous peak (in 2007) until 2015. The slow growth in employment will keep income growth down while households will continue to save more, keeping the long-term trend for consumption at around 2.0 percent.

Even with these somewhat conservative assumptions about the economy, all is not doom and gloom for the auto industry. Light vehicle sales are expected to continue to increase over the coming years, driven by the pent-up demand that has been created over the past few years. Another positive for the automakers is that retail vehicle sales, rather than fleet vehicle sales, remain the main driver of growth. This is an important part of the industry’s recovery in that margins on retail sales are greater than those on fleet sales. This factor—along with stronger used vehicle prices, lower vehicle incentives, and reduced cost-pressures on the manufacturers—should help to keep the automakers profitable, even in the face of a slow-paced economic recovery. Magliano said that IHS predicts light vehicles sales will be about 13.5 million in 2012 and 16.2 million in 2015. Going forward, the mix between car sales and light truck sales will move back in favor of car sales (54% car sales versus 46% light truck sales), as the manufacturers deal with impending higher fuel economy standards. With the recent UAW contract concession discussed above and other capacity restructuring, the auto industry has become more profitable, as evidenced by the fact that it is already making money at volumes well below the peaks reached back in the early 2000s. The bottom line is that the auto industry is in the best shape it has been in many years and is therefore well positioned to withstand economic adversity, claimed Magliano.

As evident in these two presentations, there is much to be optimistic about when it comes to the U.S. auto industry—even the prospects for the original domestic manufacturers look better. The domestic auto industry should come out of this latest recession a lot stronger than it was in 2007, as long as the industry’s stakeholders are willing to continue to work together to keep costs in line with those of foreign competitors.

Footnotes

1 A voluntary employee beneficiary association (VEBA) is a type of trust fund that can be used to provide employee benefits. The UAW agreed to a form of VEBA with the Detroit Three thus removing the liability for health care from the accounting books of the Detroit Three.

2 A product guarantee is a type of commitment that identifies where future vehicles or components will be produced.

The views expressed in this post are our own and do not reflect those of the Federal Reserve Bank of Chicago or the Federal Reserve System.

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