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Adjustment in the Japanese Automotive Industry

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Adjustment in the Japanese Automotive Industry



A Microcosm of Japanese Cyclical and Structural Change?



Michael J. Smitka

Professor of Economics

Williams School of Commerce

Washington and Lee University

Lexington, VA 24450-2232

MSmitka@wlu.edu


The Japanese economy is in its 3rd recession in a decade. Economists (and, less
intelligently, policymakers) argue over whether the cause is one of secular slowdown,
structural rigidities, or merely a larger-than-normal business cycle. This paper carries
this debate over to the microeconomic realm through a case study of the automotive
industry. It highlights the presence of all three of these elements at the industry and firm
level. Data are presented showing slow but steady adjustment in the auto industry.
Large-scale strategic change, however, is both unusual and recent; twelve years after
the slowdown began, substantial excess capacity remains. As in the United States, firms
find it very difficult to alter their internal organization and strategic framework.

Introduction

Japans was the miracle economy for the three decades of the 1960s through the 1980s. But
the 1990s turned into a lost decade, and the economy has yet to regain momentum. It suffers from
three interlocking diseases. The most obvious, of course, is the bubble and its bursting, a
macroeconomic shock that among other things left an overhang of excess capacity. The second is
secular stagnation, as an aging society lowers potential growth while increasing the demand for low-
productivity services. The third is a system that soured, symbolized by a political economy still oriented
towards agriculture and construction, and wooden management tied to structures better suited to the
high growth era, such as interfirm keiretsu links and the lifetime employment system.

To someone outside Japan, the auto industry might seem immune to these problems. In early
2002 Japanese marques accounted for 27% of the US market, the highest total ever; Honda and
Toyota were both busy ramping up production at new European assembly plants while adding to
capacity within NAFTA.
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In most of Asia, one or another Japanese firm dominates the local scene,
albeit in most cases through joint ventures with local firms. Even in China, where Volkswagen has over

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50% of the passenger car market, a Toyota joint venture in Tianjin and a Honda plant in Guangdong are
gradually increasing their output and market share.

Yet the domestic industry is in fact a microcosm of Japans larger problems. First, during the
bubble, industry leaders both inside and outside Japan believed Japanese firms would dominate the
global automotive market. Consistent with that, at the peak of the boom, assemblers and parts makers
were busily boosting capacity, from 13.5 million to 15 million units. Second, with an aging population
and a strong yen, this was beyond any conceivable growth of the market; the secular trend was one of
declining exports and stagnant domestic demand.
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Third, the industrys structure reflected the political
economy of the 1950s and 1960s, which insulated the domestic makers from foreign competition.
During the 1960s this small and fragmented market allowed multiple niche producers to coexist; out of a
large number of entrants, 9 passenger car producers and 4 makers of medium and large trucks as the
industry survived into the 1990s. Management was also rooted in the past; even after the bubble
burst, the industry continued as though at most incremental adjustment was needed. Despite the passage
of a full decade, Toyota and its affiliates still maintain one million units of excess capacity. While Nissan
began closing plants in the mid-1990s, it was slow to address problems of poor dealerships, high parts
costs and stodgy product design.

Individual industries are also subject to shifts in technology and regulation that are independent
of the above factors. Overall, the pace of technical change in the auto industry is greater than at any time
since the 1920s. Heightened quality expectations, demands for safety and convenience, and a likely
mandate for alternative propulsion systems have made designing and building vehicles far more
dependent than in the past on integrating complex systems, with a consequent increase in fixed costs and
potential economies of scale. Twin revolutions in IT and materials enabled this, while the former holds
forth the promise that automotive firms can actually manage themselves as global businesses,
coordinating engineering across oceans. Suppliers are affected even more, since they are now being
asked to operate in multiple countries and take on design, engineering and testing; no longer can they be
simple manufacturers. Restructuring is the by-word at automotive companies in the EU, the US and
throughout the developing world. It is useful to remember that in 2001 these pressures were not unique

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to Japan; in the US and the EU Ford, DaimlerChrysler, GM and Fiat all lost money, even while Peugeot
and BMW were enjoying record years.

Restructuring is evident. Nissan, the former Japanese national champion, debated strategy
until it was at the verge of bankruptcy, only to be bailed out by a firm whose dominant shareholder is the
French government.
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Mazda and Mitsubishi Motors are likewise run by non-Japanese executives, from
Ford and DaimlerChrysler, respectively. Indeed, during the past several years all but two of the 11
incumbents have fallen under the control of, or entered into shareholding alliances with, other firms.
Several suppliers have also been gobbled up by others, foreign and domestic.

What, then, is the status of the industry as a whole? Why was change so long delayed? Has the
domestic Japanese industry turned itself around Nissan, after all, has already returned to profitability
under the leadership of a Lebanese-Brazilian Frenchman. I argue below that slow change is the norm,
and not just in Japan. After all, despite its brush with bankruptcy in 1980, Chrysler did not launch
thorough-going reforms until 1989; General Motors lost market share every year between 1980 and
2001, before hiring the individual who engineered Chryslers turnaround. Little fundamental happens in
the auto industry in under a decade.

First and foremost, the difficulty of strategic reform is not merely because of the Japanese
context, but is generic to large firms and complex institutions. After all, the strength of their core
bureaucracies is handling large-scale, recurring tasks and coordinating group efforts.
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The natural
response to hard times is to try to handle those tasks more efficiently and to make other incremental
changes rather than to disband and lose accumulated organizational capital. Second, change is also
hampered by the dynamics of the automotive industry, which operates on an 8-year product planning
cycle. Plants have varying degrees of flexibility, so that 2 plants operating at half capacity cannot be
readily combined into one; unless a model line is dropped permanently, that may not allow cutbacks in
engineering or purchasing. Introducing a new model likewise may require delaying the replacement of
another, with the gains from capturing an apparent new trend largely offset by the poor sales of a design
that becomes long in the tooth. Furthermore, only hindsight lets one distinguish short-run swings from
long-term shifts in the competitive environment. In addition, even in a down market certain segments will
grow, so that the experience of individual firms will differ from the industry average.

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Heterogeneity is the norm, not the exception, and that makes generalization difficult. Given that
proviso, the evidence suggests that, at the industry level, overall employment has fallen slowly but
steadily since 1991, at about the same rate as revenue declined. However, wages continue to rise, so
that the wage bill has only fallen slightly. Fixed capital, furthermore, rose by 80%, and remains high.
Other measures suggest that, on average, incremental change has dominated at the industry level. This
hides considerable variation at the firm level. Honda, for example, is enjoying record sales, with a strong
showing in the SUV and minivan segments; in contrast, Nissans are down by 40%,. In 2001, Honda
was hiring contract workers; both Mitsubishi and Mazda were trimming their permanent workforce with
early retirement programs. Even more dramatically, the full-sized truck has collapsed, with sales off by
60% on average. By and large, however, announcements of dramatic restructuring including
corporate takeovers have only come