William A. Strauss

English

Research Papers in Economics

ESSAYS ON ISSUES THE FEDERAL RESERVE BANK SEPTEMBER 1997
OF CHICAGO NUMBER 121
Chicago Fed Letter
1. Actual 1996 and median forecasts of GDP and related items
1996 1997 1998
GDP, chained 1992 dollars (%) 2.4 3.3 2.2
Personal consumption expenditures (%) 2.5 3.4 2.2
Business fixed investment (%) 7.4 8.5 4.8
Residential construction (%) 5.3 1.6 0.0
Change in business inventories ($bil.) 14.0 33.6 25.6
Net exports of goods and services ($bil.) –113.6 –130.3 –124.3
Government purchases of goods and services (%) 0.8 0.3 0.5
Industrial production (%) 2.8 3.8 2.4
Car and light truck sales
   (mil. per calendar year, including imports) 15.0 15.0 14.8
Inflation rate (Consumer Price Index, %) 2.9 2.8 2.9
Unemployment rate (%) 5.4 5.2 5.3
Note: Data as of May 30, 1997.
Auto industry cruises on
In 1996, light vehicle (car and light
truck) sales totaled a very respectable
15.0 million units.1 This matched the
highest yearly light vehicle sales rate
of the current expansion, which oc-
curred in 1994. In the fourth quarter
of 1996, light vehicle sales averaged
14.8 million units and it appeared
that the auto sector was set for a slight
retrenchment. Instead, what followed
in the first three months of this year
was the strongest consecutive three-
month period for light vehicle sales
since the current expansion began
six years ago. The surprisingly strong
showing for the auto sector was fol-
lowed by extremely anemic light vehi-
cle sales in April. Sales for the month
fell to an annual rate of 14.2 million
units, the lowest monthly sales rate
in two years.
On May 30, 1997, shortly after these
numbers were reported, the Federal
Reserve Bank of Chicago held its
fourth annual “Auto Outlook Sympo-
sium.” Thus, the conference was poised
to try to assess whether the sales pace
in the early part of this year was an
aberration, reflected by April’s sales
moderation, or whether 1997 was in-
deed going to be a very strong year for
the auto industry. This Chicago Fed
Letter presents the consensus outlook
from the symposium and summarizes
individual presentations by vehicle
producers, suppliers, dealers, and
vehicle research organizations.
Consensus outlook for the economy
In the first half of 1997, the economy
was a tale of two quarters. First quarter
economic performance was stronger
than most people anticipated. This
was followed by a dramatic slowdown
during the second quarter. The sym-
posium participants expect the overall
economy, as reflected by real gross
domestic product (GDP), to grow by
3.3% for 1997 and then slow to 2.2%
next year (see figure 1). They forecast
average real GDP growth of nearly
4.0% for the first half of this year, in-
dicating that a slower pace of growth
is expected in the second half of the
year. The unemployment rate is ex-
pected to decline 0.2 percentage
points to 5.2% in 1997 and then rise
by 0.1 percentage points next year.
The consensus forecast for light vehicle
sales for this year is 15.0 million units,
matching last year’s pace. Given that
when these forecasts were made, sales
had already averaged 15.1 million
units (annualized) for the first four
months of the year, the group was
expecting sales to slow only slightly
for the remaining two-thirds of the
year. Next year, vehicle sales are ex-
pected to slow to 14.8 million units.
Even with this strong performance by
the economy, the participants do not
see a rise in the rate of inflation. Infla-
tion for the next two years is expect-
ed to average just under 3%, in line
with last year. What is most striking
during this period of strong light vehi-
cle sales is that not only is inflation
under control, it is actually declining
for new vehicles. In June, new vehicle
prices were 0.5% higher than a year
ago (see figure 2). This is the lowest
rate of price increase for new vehicles
since September 1973.
World vehicle market
An economist from one of the major
auto producers presented the com-
pany’s outlook for the auto industry.
One important point that the econo-
mist made was that while North
America and Western Europe will con-
tinue to be very important markets
given their volume, most of the growth
in vehicle sales will occur outside of
these markets. Growth in vehicle sales
is very closely tied to growth in real
GDP. In Asia Pacific, Latin America,
and Central and Eastern Europe, real
GDP is projected to grow at twice the
2.5% average rate forecasted for the
next ten years in North America and
Western Europe. As a result, the share
of real world GDP will shift from0
2
4
6
1990 ’91 ’92 ’93 ’94 ’95 ’96 ’97
percent change from year ago
0
2
4
6
0123456
vehicle sales growth, 1996-2006
real GDP growth, 1996-2006
N. America
W. Europe
Mideast/Africa Asia
Pacific
Latin America
Central/E. Europe
2. Consumer Price Index, new vehicles
3. Vehicle sales and real GDP
North America and Western Europe to
Asia Pacific, with some slight increase
in Latin America and Central and East-
ern Europe. Vehicle sales growth
should reflect this shift (see figure 3).
U.S. vehicle market
In the U.S. market, while new vehicle
unit sales in 1996 were about 5% lower
than the level achieved ten years ago,
real revenue per vehicle was up 14%.
This increase in real revenue per vehi-
cle is due to the fairly dramatic move-
ment from car to truck sales that has
taken place over the past ten years.
In 1986, truck sales comprised 30.2%
of the new vehicle market; last year
their share had grown to 44.8%. The
average transaction
price of trucks is
higher than that of
cars, driven by the
movement toward
sport utility vehicles
and full-size pickup
trucks. The econo-
mist indicated that
the shift to trucks is
likely to continue,
with most consum-
ers expressing a pref-
erence for more
trucks and fewer cars
in the future. The
forecast for vehicle
sales over the next
year and a half is for
a good sales rate due to solid real
GDP growth, moderate inflation,
larger vehicle incentives, and strong
consumer confidence.
Used vehicle outlook
Ownership rates of 1.9 vehicles per
household and 1.07 vehicles per driver
have held steady for the past five years.
In addition, vehicle quality has in-
creased over time and scrappage rates
have been declining. This leaves the
consumer with more choices when it
comes to transportation.
In this context, an analyst from an
auto consulting firm said that the
current vehicle market is at satura-
tion level and focused his presenta-
tion on the used car market. The age
of the oldest vehicles in operation,
excluding the oldest 10%, increased
from 14.0 years in 1987 to 18.3 years
in 1996. This analyst estimated that
while the number of new vehicles sold
has been averaging 15 million units
per year, the number of used vehicle
transactions is more than twice that
amount, around 35 million units.
However, the battle being waged by
the newly created used-car superstores
is over “cream-puff” cars, late models
with low mileage, and is on a much
smaller scale. Subtracting the num-
ber of leased vehicles sold to the lessee
and those that the dealer sells off the
lot (expired lease vehicles or trade-ins)
leaves about 784,000 vehicles for the
used car superstores, or approximately
5% of the new car market. With vehicle
transaction demand growth remaining
stagnant and new competitors with
different marketing techniques enter-
ing the market, consumers will have
more choices and the vehicle sales
market will have greater competition.
Dealers’ perspective
A representative of the automobile
dealers group presented an analysis
of how dealers’ costs of operation are
doing in this increasingly competitive
market and how they vary by the size
of dealership. There does not appear
to be a relationship between dealer-
ship size and overall costs and net
profit. This was true for both new and
used vehicle sales. The representative
pointed out that consumer confidence
in May hit a record high for the past
28 years. However, the representative
was concerned that if one looked at
past peaks, when the index was no
longer rising, the economy went into
recession. Dealers are maintaining
an upbeat outlook on profitability.
Vehicles of the future
A consumer research consultant ad-
dressed developments of alternative
system vehicles. The consultant point-
ed out that the development of these
products is not consumer-driven, but
is being prompted by government
regulations to lower vehicle emis-
sions. Electric vehicles are the only
viable technology currently available
that will meet zero-emission standards.
Consumers approach an electric ve-
hicle purchase with a certain degree
of skepticism. The consultant does
not believe that these alternative sys-
tem vehicles will be able to simulta-
neously satisfy the government’s
zero-emission standards and achieve
the performance, in terms of operat-
ing range and features of existing
combustion engines, demanded by
consumers. Consumers continually
expect more features and higher qual-
ity in their vehicles, and they expect
to be able to purchase them at a lower
price. Alternative system vehicles will
provide fewer features at a higher
price. These vehicles are currently
being sold at prices comparable to
those of luxury cars and high-end
sport utility vehicles.
Source: U.S. Department of Labor, Bureau of Labor Statistics (1990–97).
Source: Presentation by an economist from a
major automaker at the fourth annual “Auto
Outlook Symposium,” held on May 30, 1997,
at the Federal Reserve Bank of Chicago.Michael H. Moskow, President; William C. Hunter,
Senior Vice President and Director of Research;
Douglas Evanoff, Assistant Vice President, financial
studies; Charles Evans, Assistant Vice President,
macroeconomic policy research; Daniel Sullivan,
Assistant Vice President, microeconomic policy research;
William Testa, Assistant Vice President, regional
programs; Helen O’D. Koshy, Editor.
Chicago Fed Letter is published monthly by the
Research Department of the Federal Reserve
Bank of Chicago.  The views expressed are
the authors’ and are not necessarily those of
the Federal Reserve Bank of Chicago or the
Federal Reserve System.  Articles may be
reprinted if the source is credited and the
Research Department is provided with copies
of the reprints.
Chicago Fed Letter is available without charge
from the Public Information Center, Federal
Reserve Bank of Chicago, P.O. Box 834,
Chicago, Illinois 60690-0834, tel. 312-322-5111
or fax 312-322-5515.  Chicago Fed Letter is also
available on the World Wide Web at http:/ /
www.frbchi.org.
ISSN 0895-0164
4. Distribution of assembly plants
No. of plants
Region 1979 1996
Midwest 27 31
Southeast  6 13
West 14  9
Northeast  9  5
Total 56 58
I-65/I-75 Corridor 27 39
Non I-65/I-75 Corridor 29 19
This consultant believes that hybrid
vehicles, those that combine an inter-
nal combustion engine with an alter-
native energy device, will be the choice
alternative system vehicles over the
next ten years. Fuel cell technology
will most likely be the long-run winner
among the multi-alternative delivery
devices. Furthermore, the consultant
believes that most alternative system ve-
hicles will be bought for fleet use rath-
er than personal use until at least 2010.
Supplier changes
An analyst from an auto supplier con-
sulting firm indicated that there are
several significant trends placing the
auto suppliers in a new environment.
Some positive trends for auto suppliers
are: 1) increasing supply base consoli-
dation, which will lead to greater le-
verage for auto suppliers; 2) continued
globalization, which will widen the
customer base available to the sup-
pliers; and 3) manufacturing process
innovations that have led to improve-
ments in suppliers’ profit margins.
Several negative trends for auto sup-
pliers are: 1) very large price con-
straints being exerted by the original
equipment manufacturers (OEMs)
that have led to profit margin tight-
ening; 2) segment shifts between types
of product being manufactured, i.e.,
cars versus light trucks; and 3) sub-
stantial increases in resource require-
ments in terms of fixed costs, especially
for first tier suppliers. According to the
analyst, the risks for auto suppliers in-
clude increased product development
responsibilities in terms of project
management, purchasing coordina-
tion, and engineering support; glo-
balization of suppliers in marketing,
manufacturing, and currency ex-
change rate risk; strategic partnering,
joint ventures, and technology; and
accountability in terms of warranty
and product liability being placed on
suppliers. The potential rewards in-
clude greater leverage from supplier
network management; moving from
transaction-based purchasing to value-
based purchasing; greater capacity
utilization; and process simplification
and stabilization. The OEMs are still
in the driver’s seat when it comes to
the automotive suppliers. There has
been a reallocation of risk from the
OEMs to the suppliers and the re-
wards that should be associated with
the greater risks have not been passed
along to the suppliers.
Geographic considerations
A university professor presented a
geographic analysis of vehicle assem-
bly and supplier production facilities
in the U.S. The professor found that
vehicle assembly plants had returned
to the middle of the country. However,
the boundaries of where these firms
are located cut across the traditional
regional classifications, such as the
Midwest and the Southeast. Most facil-
ities in the interior of the country
are located between Interstate high-
way 65 (I-65), running south from
Chicago, and Interstate highway 75
(I-75), running south from Detroit
(see figure 4). These locations help
vehicle manufacturers minimize
transportation costs.
Suppliers have also located in the
middle of the country, with differen-
tiation taking place between the north
and south. High-value-added supplier
components requiring highly skilled
workers are most likely to be located
in the Midwest. The Southeast has a
higher percentage of facilities making
bulky, low-value-added components.
The drift to the Southeast has been
due to the influx of foreign-owned
assembly plants. These companies
seem especially eager to avoid the
unionized, high-cost northern labor
market. Within the Midwest, new
manufacturing facilities are likely to
be in southwestern Michigan, north-
eastern Indiana, and western Ohio.
Especially favored are smaller com-
munities in nonmetropolitan counties
without a tradition of vehicle produc-
tion, such as those along Michigan’s
Lake Michigan shore.
Conclusion
The auto industry is expected to
continue to produce at a level of ap-
proximately 15 million units this year
and 14.8 million units next year. The
industry is still in the midst of great
change. World demand is becoming
a more important factor, as the U.S.
vehicle market reaches its saturation
point. The production, distribution,
product mix, and even propulsion of
vehicles are undergoing tremendous
change, and businesses that operate
in such an environment need to re-
main flexible and adaptable to meet
the challenges that lie ahead for the
vehicle market.
—William A. Strauss
Senior economist
Source: Presentation by a university professor
at the fourth annual “Auto Outlook Symposium,”
held on May 30, 1997, at the Federal Reserve
Bank of Chicago.
1Data are as of May 30, 1997. These data formed
the basis for the forecasts delivered at the
Federal Reserve Bank of Chicago’s fourth
annual “Auto Outlook Symposium.”3.8
5.0
6.2
7.4
Motor vehicle production (millions, seasonally adj. annual rate)
Cars
Light trucks
Motor vehicle production
(millions, seasonally adj. annual rate)
June Month ago Year ago
Cars 5.8 5.8 6.7
5.4 5.4 5.8 Light trucks
1994 1996 1997
Manufacturing output indexes
(1992=100)
June Month ago Year ago
CFMMI 121.1 121.2 116.8
116.4 121.3 121.7 IP
Purchasing managers’ surveys:
net % reporting production growth
July Month ago Year ago
MW 58.7 56.0 51.1
52.6 56.0 64.4 U.S.
1995
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Tracking Midwest manufacturing activity
Sources: The Chicago Fed Midwest Manufacturing
Index (CFMMI) is a composite index of 16 industries,
based on monthly hours worked and kilowatt hours.
IP represents the Federal Reserve Board’s Indus-
trial Production Index for the U.S. manufacturing
sector. Autos and light trucks are measured in an-
nualized units, using seasonal adjustments devel-
oped by the Board. The purchasing managers’
survey data for the Midwest are weighted averages
of the seasonally adjusted production components
from the Chicago, Detroit, and Milwaukee Purchas-
ing Managers’ Association surveys, with assistance
from Bishop Associates, Comerica, and the Uni-
versity of Wisconsin–Milwaukee.
The CFMMI decreased 0.1% in June, following a revised 0.4% decline in May.
By comparison, the Federal Reserve Board’s industrial production index (IP)
for manufacturing increased 0.3% in June. June was the second consecutive
month in which every CFMMI sector had slower growth than its national
counterpart, suggesting that the economic slowdown in the second quarter
had a somewhat greater impact on the Midwest than on the nation as a whole.
The U.S. purchasing managers’ survey for production increased from 56.0%
in June to 64.4% in July. The Midwest purchasing managers’ survey also in-
creased from 56.0% to 58.7%. Motor vehicle production (seasonally adjusted
annual rate) increased from 5.4 million units in May to 5.8 million units in
June for light trucks and remained constant at 5.8 million units for cars.

Auto industry cruises on

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Auto industry cruises on

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