The automobile industry and monetary policy: an international perspective

Business Economics, Oct, 1994 by Paul Ballew, Robert Schnorbus, Helmut Hesse

CENTRAL BANKS in the U.S. and Germany place a high premium on understanding conditions in the automotive industry. In fact, in terms of influencing changes in economic activity, few sectors, except perhaps housing, are a primary driver of economic activity to a greater extent than autos. The cyclical tendencies of the sector make autos a key indicator for turning points in the economy and other short-term developments in national activity. For regional central banks, like the Federal Reserve Bank of Chicago and the Land Central Bank in Lower Saxony, the disproportionate concentration in their geographical areas of responsibility magnify the importance of the industry beyond that of the national impacts.

THE AUTO INDUSTRY AND THE BUSINESS CYCLE

One factor that directly contributes to the industry's disproportionate impact on economic activity is its cyclical nature. Detailed information on the automotive industry illustrates its disproportionate impact on regional and national economic activity. For example, the U.S. automotive sector directly contributes approximately 4 percent of total output as measured by gross domestic product (GDP). However, on a quarterly basis the sector can account for more than 40 percent of the change in GDP. The frequent changes in the industry affect many downstream industries and can influence national manufacturing, sometimes to an overwhelming extent. For example, in the U.S. during the 1993 summer slowdown, almost the entire weakness could be attributed to the sector.

In the case of the third quarter of that year, production and sales for the industry slumped, and the impact on the manufacturing sector and the overall economy was rather startling. The declines in shipments and industrial production of the motor vehicles and parts component of manufacturing were several times larger than the overall declines in manufacturing. Shipments of autos and parts were down 15.5 percent in July from the March peak -- over five times the decline in total manufacturing shipments. Even though the auto industry accounts for slightly less than 10 percent of total shipments, the industry's decline accounted (on a share-weighted basis) for half of the total decline in manufacturing shipments and for about 85 percent of the decline in durable goods manufacturing. In industrial production, the decline in the autos and parts component from April to July (-0.8 percent) was nearly three times greater than the decline in total manufacturing. In addition, the slump in auto production impacted supplier industries, such as rubber, glass and steel, that generated additional weakness in the durable goods sector of manufacturing.

Not surprisingly, the slump in the industry was directly translated into more than just poor manufacturing statistics. The third-quarter drag in the auto sector had a substantial impact on GDP for the quarter, which came in below widespread expectations. The auto drag on GDP for the quarter was almost a full percentage point, and adjusting the reported GDP for this factor facilitates a better understanding of the weak reported number. Fortunately, this drag was temporary due in large measure to short-term developments that subsequently corrected themselves.

As the U.S. economy picked up momentum in subsequent quarters, the auto industry also provided a large share of the boost. Motor vehicle activity increased well above overall production gains, especially in the fourth quarter. This pickup translated into a large contribution to GDP during the fourth quarter of 1993 and the first quarter of 1994. The auto contribution for the fourth quarter was in excess of 2 percentage points, while the first quarter was above 1.6 percentage points (or almost half of the GDP increase of 3.4 percent).

The German automotive industry exerts a similar macroeconomic impact on German national economic activity. Its share of gross added value in manufacturing, including the correspondent upstream and downstream activities in production, distribution and services, amounts to about one-fifth of the national economy. At the end of the first quarter of 1994, 760,000 people were directly employed by the industry, approximately 12 percent of total manufacturing employment. The automotive industry is therefore one of the biggest industrial branches in Germany.

The pattern of the latest cycle in the German car industry differed somewhat from that in other auto-producing countries. German reunification delivered a strong push to demand, starting in 1990 and lasting into early 1992. Having been restrained for decades, the release of demand in East Germany, affordable due to the generous terms of the exchange rate set between the two German currencies, more than compensated for a subsequent slack in exports. In spite of the worldwide recession and the industry's high dependence on exports, production, capacity utilization and sales all were boosted to all-time highs.

Once the backlog of demand in East Germany was satisfied, domestic sales activity fell back to more or less normal levels. Together with an already steep decline in exports, these developments resulted in a sharp decline in activity in the industry. Incoming orders fell by 34 percent from their high in the first quarter of 1992 to the trough in activity in the third quarter of 1993. The corresponding steep fall in production resulted in the industry accounting for more than a quarter of the total decrease in manufacturing activity during 1992-93. The impact on other economic activity was substantial, including the effects on employment. Since the end of 1991 the German auto industry shed 150,000 jobs, or one in six of the jobs held prior to the recession.