New Economic Climate Requires New Responses from Auto Makers

The critics have never tired of telling us that Americans spend too much and save too little. Well folks, there's good news tonight: after hitting bottom in 1987, saving is on the increase. What does it mean for the economy now and in the future?

In the long-run, an increase in the rate of savings means lower interest rates, greater capital formation, higher productivity, and a higher standard of living for future generations. The only problem is that in the short-run an increase in the rate of savings has its price: when savings rise relative to disposable income, consumer spending falls. Sellers who fail to take account of this development may find themselves in serious trouble.

The Tax Reform Act of 1986 initiated a process designed to eliminate the deductibility of consumer interest payments in computing taxable income. At the time of its passage this economist predicted that although it would take time, the effect of the change in the tax code would be to increase the rate of saving relative to disposable income and thereby reduce demand for consumer durable goods.

In the last half of 1988, consumer spending began to grow more slowly relative to the growth in disposable income than had been the case in the past. The result appears to be that many people are now trying to reduce their debt for the simple reason that, compared to the old tax rules, it now costs more to be in debt. There is a new trend away from debt and a new environment facing our largest and most important consumer durable goods industry--automobiles.

the purchase of an automobile--virtually always by way of consumer credit--is the biggest of all big-ticket consumer expenditures. Like it or not, the change in the tax code has hit the automobile industry hard. Automobile and truck sales are running 8% below a year ago and are expected to continue falling through 1990; and up to 2,000 of the nation's 23,000 automobile dealerships are expected to be driven out of business over the next 18 months.

One would think that automobile manufacturers would read this turn of events as a definite trend toward a reduction in the rate of growth in demand for credit to
finance the purchase of cars and trucks and would respond by cutting both output and price, at least for the short-run. They are cutting output, but not price. Indeed the manufacturers have announced price increases on optional equipment for current models and, apparently, plan to increase the base price of the new 1990 models.

To reduce output and avoid inventory build-up, manufacturers are preparing for prolonged factory shutdowns this summer. But the next logical step, cutting price sufficient to drastically reduce inventories and keeping price lower on new models, is not in the works. Moreover, manufacturers have decided to shift the current burden of reduced demand to dealers--the primary customers of manufacturers--by eliminating the traditional 5% discount for dealers to help sell cars left over at the end of the model year.

The shift to higher savings need not spell permanent losses in output and jobs for both manufacturers and dealers. Indeed, higher savings should help provide the capital for the automobile industry to improve future labor productivity and, hence, lower its costs of manufacturing. Therefore, sufficient reductions in the base price of cars and trucks, and improved labor productivity in the auto industry will result in a relatively smooth transition to the age of higher saving now and permanently lower transportation costs in the future. After all, there is a price low enough to generate an increase in quantity demanded sufficient to overcome the higher cost of financing a car.

During the 1981-82 recession, auto firms, with the cooperation of the UAW, reduced costs enough to weather that economic downturn. That's history. The current situation is not a recession, but represents a fundamental change in people's buying behavior. New responses are required which allow dealers as well as manufacturers to weather the transition period from a low savings to a high savings environment.

The auto makers in Detroit don't seem to have a clue as to what a higher rate of personal savings means for them and the economy. They seem to think that their past cost cuts will allow them to survive this transition. They're wrong. The past is past; what we're on the verge of experiencing now is new, and new strategies are required.