Protectionism and Local Production: Tales of Excess Entry
EV Proponents, Be Careful What You Wish For!
Introduction
My wife and I were shopping for my first new car in spring 1981, just at the Voluntary Export Restraints negotiated with Japan went into effect. The car we priced at just over $4,000 jumped a full $1,000 in price before we could complete our purchase. With limited supply, I also had to agree to pay for the dealership to apply an aftermarket paint sealer. Ouch. Insult was added when the sealant immediately started peeling, while a move out of state rendered the dealer's warranty moot.
But other than to the pocketbooks of consumers such as myself, how did that matter? The answer: quite a bit. It's important to look back on that history to try to understand the potential impact of the evolving set of automotive tax and subsidy policies in Europe and the US. In Europe, for example, there are 38 proposed battery gigaplants. Most will never progress beyond hiring a small staff to put together slide decks to pitch potential investors. It does reflect one typical side effect of such trade and subsidy policies: lots of new entry into manufacturing.
Editorial note: With the occasional exception, I do not provide citations. Instead, the endnotes remove digressions, er, future topics, from the main text. Contact me if you really want bibliographic details.
The US VER with Japan
Small cars are un-American. There was a boom around 1958, dominated by imports and then Studebaker's Rambler. The small car fad didn't last long, and neither did Studebaker. Toyota also entered the market, only to later withdraw when consumers realized that their cars couldn't manage US highway speeds. Subcompacts disappeared from the market, until another such boom a decade later, when the VW Beetle surged in popularity.
Now the Detroit Three weren't uninterested in small cars, because as global companies they were well aware they were what most of the world outside the US bought. GM and Ford had full manufacturing operations in Europe dating back to the 1910s for Ford, which set up local production in England, France and then (in 1925) Germany. As in the US, GM expanded through acquisitions, Vauxhall in England in 1925 and Opel (then Germany's largest car company) in 1929. Chrysler only entered Europe in 1964, with the acquisition of Rootes and Simca. But for a variety of reasons, they never made a serious effort to export those cars, either to the US or elsewhere.
They thus needed product for the growing Asian markets. To that end, GM invested in the truck maker (and car wannabe) Isuzu in 1972, while Chrysler bought a stake in the newly formed Mitsubishi Motors in 1971 and Ford expanded an initial 1971 product licensing deal to investing in Mazda in 1974. All intended to acquire a controlling stake – effectively 33.4% under Japanese corporate law – but Chrysler ran out of money before they could finish acquiring MMC. In any event, that meant that come the 1973 and 1978 oil shocks, the Detroit Three had sources of small cars.
Japanese Protectionism, Japanese New Entry
The Japanese market they encountered was highly competitive. Japan faced no opposition from the US in the waning days of the post-WWII Occupation to prohibitive tariffs on new cars, which were soon extended to cover the loophole of importing used cars. GM and Ford had local assembly operations until 1936, when following a military coup d’etat the new government forced them to shut down. However, they chose not to reenter, believing that Japan would remain too poor to be a meaningful market. Of course, the civil war in China had just ended, and that in Korea was winding down. It wasn't just Japan that seemed a poor prospect, it was Asia as a whole.
That however didn't deter 30-odd Japanese firms from entering the market, including former aircraft manufacturers and other factories that lost their market at war's end. These firms variously made 3- and 4-wheel compact vehicles, both for passengers and as trucks, sometimes combining that with scooter production. Most soon failed. The last exit of that era came when Nissan acquired Prince Motors in 1966. New entry also ceased in 1966, when Honda added a small car to its line of motorcycles. That left Japan with 11 players, 9 of which made passenger vehicles and 4 that made large trucks and buses. (At that time everyone except Honda made small trucks.)1 Life was hard, because in 1965 Japanese consumers bought only 586,000 cars, while companies big and small purchased 1.07 million trucks and buses. To survive, car companies had to come out with a stream of new and updated models, adding features common in the wealthier markets, all while improving quality and lowering costs.
That dynamic reflected more than just an internal competitive imperative, for by the second half of the 1960s the Japanese government made it clear that protection from imports (and direct foreign investment in the industry) would end, sooner rather than later. In fact, the end came in 1971, when Mitsubishi Motors announced the Chrysler investment, presenting the government with a fait accompli.
Foreseeing the direction if not the details, all in the industry benchmarked against potential foreign competitors and domestic rivals. All knew that they were still high cost, and that their cars lacked many of the features then standard in the US and increasingly in Europe. Then there was quality. Malcolm Bricklin began importing Subaru's in 1968, providing test cars to Consumer Report's. In the initial test, a driver inadvertently pulled off a door.2 Those early cars were also noisy, had poor acceleration, seats that were too small, on and on.3
But they kept improving, while the leadership at the Detroit Three focused on internal politics, seldom denigrating themselves to visit factories. (That oligopoly thing I talked about in my first post.) Exports to the US increased steadily in the 1970s, concentrated in California, which again was beyond the pale to which Detroit execs would travel.
The VER and Japanese Entry into the US
Then came the second oil crisis, on top of the sharp recession when under Paul Volcker the Fed raised rates to stem inflation. (I was a banker at that time, and remember LIBOR peaking at 21.5%, while the overnight Fed Funds rate briefly hit 22.3%.) Car imports didn't increase so much as overall car sales crashed, leaving imported Japanese subcompacts as the only affordable option. The share of small cars, at modest single digits prior to the second oil crisis, peaked at just over 30% of the market. That touched off a political firestorm, which Ronald Reagan, the incoming president, wanted to extinguish ASAP.
The dénouement was the May 1981 VER, under which the Japanese government agreed to restrict car exports to the US to no more than 1.68 million units a year (the VER format was a legal step to avoid sanctions US antitrust law). Remember, though, all those players in the Japanese market eager to export, and. The negotiations on the Japanese side were messy, because every firm wanted a big share, and existing market shares weren't acceptable because Isuzu (under GM control) was just launching production of cars intended for sale in the US and had no market share. Eventually a deal was reached, to form a cartel to screw the US consumer.
Because a cartel it was, as my opening anecdote indicated: limiting exports allowed immediate and large price increases. Furthermore, because of intense competition, exports to the US hadn't been particularly profitable. The VER changed that overnight, earning Toyota the moniker Toyota Bank.
A cartel does more than just allow – force! – price increases. It also encourages producers to move upmarket: if you can only export (say) 100,000 cars to the US, you want them to be compact and midsized models, not subcompacts with puny prices and thus puny per-unit profits. Furthermore, the profits generated by the VER gave the Japanese carmakers the cash to invest in new, more upmarket models.
There was a second effect: investment in production in the US to avoid the VER, which only covered finished vehicles.4 The first to announce a plant was Honda in 1982, for a "greenfield" factory in Marysville Ohio.5 Others followed, with Nissan, Toyota, Mazda, Mitsubishi, Subaru and Isuzu setting up plants in the US, and Suzuki in Ontario. VW also set up a plant in Pennsylvania. That's right: instead of the Detroit Three, within the space of few years the US and Canada suddenly had 11 players.6 By the end of the decade the longstanding price umbrella held up by GM collapsed.
And then there was exit
However, the Japanese entrants weren't immune to the competition that ensued. Isuzu, Suzuki, Mitsubishi Motors and eventually Mazda all exited US production (as did Hyundai, which opened a plant in Canada in 1989 that closed in 1993). VW shut its plant as well. Among the smaller Japanese players, only Subaru survived, in part because it specialized in 4WD vehicles, a market ignored by everyone else besides Jeep, and in the 1980s and 1990s Jeeps were also idiosyncratic.
Fast forward to today. In the US and Europe EVs carry a price premium, plus enjoy direct and indirect subsidies in the US and Europe. Part of that reflects trade barriers, as happened for compact cars in the 1980s under the US VER. Part is a function of mandates to lower emissions, where carmakers are forced to sell EVs or buy credits from others such as Tesla. Going forward, mandates for domestic content in batteries add to the mix. There's also the dream of stock multiples that come from simply being an EV maker, and not necessarily being a profitable one – call it the Tesla effect.
In Europe the direction the industry is moving is already clear. On the one hand, there are those 38 battery gigafactory projects. Too many, as projects already in production are curbing planned capacity additions. On the other, there are a stream of announcements of direct foreign investment in Europe by Chinese EV producers, including BYD, the global EV leader. They come with an advantage of leadership, as European producers are on their first pure EV platform, while BYD is on its fourth or fifth. They also purchase batteries in a volume that no firm besides Tesla can match. However, they are likely to have to purchase batteries made in Europe, which the German and French incumbents are slowing increasing their EV sales towards a level that will garner the lower cost accruing to economies of scale.
As with the entrants in the US following the VER, expect considerable churn. Some of that will likely come from the Chinese side, because most of the "pure EV" entrants into car production in China have insufficient sales to keep plants running at capacity, or to finance future product. So far, however, this is a European issue, as the US IRA bill that creates a very restrictive local content regime may keep Chinese DFI out. Or not, because Mexico provides a more welcoming environment for foreign investors, who over time can increase the USMCA content needed to sell into the US market.
Conclusion(s): The EV Market
A lot of money will be flushed down the drain, and not much money earned. There will multiple losers, but no big winner. The barriers to entry in automotive are simply too low. That’s the China story, reserved for later posts ditto fleshing out points in the endnotes below.
A list, for 1966: Hino, Nissan Diesel, Mitsubishi (as Fuso) and Isuzu primarily made large trucks. Toyota, Nissan, Isuzu, Mazda, Mitsubishi, Subaru (as a division of FHI), Suzuki, Daihatsu and Honda made passenger vehicles. As per the text, all made small trucks, because that market was still larger than that for cars. To be precise, there were 3 different Mitsubishi firms, a result of the dissolution of the wartime "zaibatsu" conglomerates into multiple firms. The 3 merged in 1971 to form MMC, coinciding with the Chrysler investment.
For Malcolm Bricklin see Jason Vuic, The Yugo. He knows Serbian, and so traced the (then) Yugoslav side of the story, as well as Bricklin’s multiple ventures.
Even in 1981, a gear in my new Toyota's transmission failed within the first couple months, and never worked quite right thereafter. But then a high school classmate had an even worse experience with his first car, from one of the Detroit Three, a cracked engine block meant he only got a mile or so from the dealership, and the replacement leaked oil and caught fire before he could even pick it up. No model from the early 1980s would pass muster today, even if many individual vehicles proved reliable.
What constituted a car was up to US Customs, and longstanding practice was that "kits" of parts were not cars and so did not count against VER quotas. Things were not always so clear-cut. An example of the complexity of hands-on trade administration was the classification of vehicles tied to the 1963 Chicken War retaliatory measures that had resulted in a "temporary" tariff of 25% on imported trucks. That was innocuous at the time, because the only imported truck in the US market was the VW van, and there weren't many. It did though get newspaper headlines in Germany, which was the intent. Anyway, in the 1980s that led to US Customs administrative court cases on what constituted a truck. If a vehicle had a full complement of seats, then it was a car and not a truck, and so should pay only the standard 2.5% import duty. That the seats were then removed so it could be sold as a truck...wasn't that sort of modification within the rights of the dealership that purchased the vehicle, and so outside the purview of Customs? I forget the details, but I think a way was found to split the difference, so that depending on minor differences some were counted as trucks, and some not, leaving no one happy – proof that a hard bargain was struck.
Oh, and as to that temporary 25% tariff: it's still the law of the land in 2024, sixty-plus years later.
That decision was made before the VER, reflecting a century of industry practice to build where you sell. That reflects standard economic geography issues, because cars are expensive to ship, even with the advent in the 1980s of roll-on, roll-off vessels built specifically to carry cars. Similarly, within a country plants tend to be in the geographic center of the market (as determined by local sales density and domestic transportation networks). Engines and transmissions and seat plants are likewise located near assembly plants. All of this will away a later post that will introduce geographic considerations (and open questions) in more detail.
Firms based in Mexico didn't count pre-NAFTA, as they suffered from the many-entrants, small market cost issue that plagued Japan's carmakers into the early 1970s. At least in automotive, the big change under NAFTA was in the removal of Mexican trade barriers that allowed imports from the US and Canada, which forced domestic players to rationalize, or exit. That's another tale for a later post.