Journal Issue

United States: Selected Issues

International Monetary Fund
Published Date:
July 2006
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VI. Structural Change and Competition Among Auto Manufacturers and Airlines37

A. Introduction and Summary

1. The weak performance of the U.S. auto manufacturing and air transportation industries has raised questions regarding their systematic importance. Two of the major domestic car manufacturers and their financing subsidiaries account for about 10 percent of outstanding high-yield debt (J.P. Morgan, 2005). The automotive industry also accounts for nearly 6 percent of single-employer, defined-benefit pension plan participants insured by the Pension Benefit Guaranty Corporation (PBGC), while the air transportation industry accounts for 2 percent (PBGC, 2005a).

2. The macroeconomic significance of these sectors has fallen, in part reflecting heavy losses. The two industries each account for about ½–1 percent of total value added, and similar shares of employment. Both industries have experienced especially difficult times in recent years. Profitability in the auto industry has continued its decades-long downward trend; airline profits, which have been below average for some time already, also took a sharp dive in the last few years (Figure 1). Although the overall macroeconomic impact of further decline in these sectors would likely be limited, further wage, benefit and employment losses among auto and airline workers could intensify a debate regarding the rising exposure of individuals to economic and financial risks.

Figure 1.Pre-tax profits as share of value added

Sources: Haver Analytics; and Fund staff calculations.

B. An Anatomy of Losses

3. Several factors have contributed to recent losses among auto manufacturers and airlines:

  • Employee compensation (Figure 2). Compensation growth mirrored robust revenue growth in the early and mid-1990s. However, firms found themselves unable to slow compensation growth when revenues stagnated, in part because of their reliance on multi-year agreements negotiated with labor unions. As a result, the share of employee compensation in value added, which was already high by economy-wide standards, rose further in recent years. With an aging workforce, the auto sector was hit especially hard by rising employee/retiree benefits, which grew from a quarter of overall compensation in the 1990s to a third since 2000.

  • Declining market share. Competition has prevented firms from raising prices to maintain profitability, given their loss of market share. The market share of the once-dominant “Big Three” automakers has dropped from 75 percent in the mid-1990s to less than 60 percent at present, mainly vis-à-vis foreign automakers (Figure 3).38 Meanwhile, the market share of legacy airlines fell from over 90 percent in the early 1990s to less than 80 percent currently.39

  • Falling relative output prices. Competition has also prevented firms from raising prices to maintain profitability. After a period of relative stability, auto prices have fallen 20 percent relative to the GDP deflator since the mid-1990s (Figure 4). The price of air travel declined in the early 1990s, and, after a slight rebound through 2000, dropped 25 percent relative to the GDP deflator in the last five years. Real revenue per passenger per mile has been cut in half since 1990.

Figure 2.Employee compensation as share of value added

Sources: Haver Analytics; and Fund staff calculations.

Figure 3.U.S. market share of major auto manufacturers and airlines

Sources: Bloomberg, LP; Department of Transportation; and Fund staff calculations.

Figure 4.Relative prices of motor vehicles and air travel

Sources: Haver Analytics; and Fund staff calculations.

4. Despite new sources of competition, spare capacity doesn’t appear to be an industry-wide problem in either sector. Capacity utilization among auto manufacturers has been higher than in overall manufacturing, while among airlines, capacity utilization as measured by the “passenger load factor”—the percent of seats filled by paying passengers—has risen by 20 percentage points since the early 1990s, at both legacy and low-cost airlines (Figure 5).

Figure 5.Capacity utilization

Sources: Haver Analytics; Department of Transportation; and Fund staff calculations.

5. In response, both sectors have cut payrolls and raised productivity, but not enough to restore profitability. In both the auto and airline sector, the number of employees has fallen at an annual rate of around 4 percent since 2000, compared with largely unchanged payrolls in the economy as a whole. Firms in both sectors have also negotiated reductions in compensation of employees. As a result, productivity growth has remained robust despite weakness in revenues, and unit labor costs have been cut (Figure 6).

Figure 6.Labor productivity and unit labor costs, 2000-2005

Sources: Haver Analytics; and Fund staff calculations.

C. Intra-Industry Trends

6. Foreign auto companies have increasingly supplanted domestic companies in the U.S. market. Having enjoyed higher profitability in the 1990s, the three major domestic auto companies have struggled to break even in recent years while their four largest Asian competitors remained profitable (Figure 7). The foreign firms appear to have attained higher vehicle quality and a better brand image than domestic firms—illustrated by the fact that average prices are about $2,000 higher per vehicle for a standard model (Moody’s, 2005, McKinsey Global Institute, 2005). Customer satisfaction and resale value of the vehicles of foreign companies have also been consistently higher (Moody’s, 2005, Sloan, 2006).

Figure 7.Auto manufacturers: Net income as a share of operating revenues

Sources: Bloomberg, LP; and Fund staff calculations.

7. Partly as a result, foreign car companies have maintained healthier credit ratings and financial ratios in recent years. The four largest Asian firms, for example, have all improved their credit ratings since 2000, while two of the three major domestic firms have seen their rating fall by eight steps from investment grade to “junk” status. The competitive advantage of foreign firms extends to their U.S.-based operations. While domestic firms have reduced their North America-based production by 2 percent per year since 1997, foreign firms have expanded their North America-based production by 6 percent per year, with their share of total U.S. production rising from 20 percent to 30 percent.

8. There has also been a wide disparity between the performance of legacy airlines and low-cost airlines. The revenues of legacy airlines have fallen almost 7 percent per year since 2000, while revenues of low-cost carriers have grown at a 3½ percent annual rate. Despite success by legacy carriers in cutting costs, the cost gap per passenger mile between legacy and low-cost airlines has remained, and the growing market share of low-cost airlines has allowed them to avoid the massive losses experienced by legacy airlines (Figure 8). Of the seven legacy carriers operating in 2000, five have gone through Chapter 11 bankruptcy restructurings. Between 2000 and 2006, the credit ratings of legacy carriers were lowered five and a half steps on average, while low-cost carriers’ ratings were lowered an average of one step.

Figure 8.Airlines: Net income as a share of operating revenues

Sources: Department of Transportation; and Fund staff calculations.

9. In both industries, less profitable firms have clung to outdated business models and face significant costs related to pension and health benefits:

  • In the auto sector, unionization and firm age have added to the legacy costs facing domestic firms—at about $130 billion (1 percent of GDP), their unfunded liabilities related to pension plans and other benefits are several times higher than their competitors’ (FitchRatings, 2005). In addition, retiree medical costs of domestic auto firms amount to about $10 billion per year, an amount significantly higher than their competitors (Moody’s, 2005). Domestic companies also lagged their competitors in introducing production process improvements, adding new vehicle features, and raising vehicle dependability (McKinsey Global Institute, 2005).

  • Labor costs account for over 40 percent of the unit cost difference between legacy airlines and low-cost airlines. This reflects a more highly-tenured, highly-unionized workforce and greater retiree costs (GAO, 2004). For example, the unfunded pension liabilities of legacy airlines amount to $22 billion (0.2 percent of GDP), not including $9 billion in claims that the PBGC already assumed in 2005 from two firms in Chapter 11 (PBGC, 2005b). Low-cost carriers, by contrast have not offered significant defined-benefit pension plans (Kiefer, 2005). Planes of legacy airlines also spend fewer hours in flight each day, in part because of older fleets with more different types of planes, which raises maintenance and training costs (GAO, 2004).

D. Conclusion

10. The overall macroeconomic effects of further difficulties in the domestic auto and airline sectors would likely be manageable. Airlines are a small proportion of the economy, and the importance of auto manufacturers has already been in decline for some time. Moreover, the presence of healthy firms in each industry means that, from a macroeconomic perspective, difficulties at any firms could be offset to some extent by expanding capacity at others—as is currently occurring—or takeover of weak firms by strong ones. Even the unfunded pension liabilities covered by the PBGC represent a relatively small risk to fiscal outlays, given that losses would likely be spread over several years.

11. However, recent cutbacks of promised pension and health benefits highlight the broader issue of how workers and firms will adapt to a world of global competition. Recently-approved legislation to increase PBGC premiums and index them to inflation will limit risks to the PBGC but impose a further burden on firms with underfunded defined-benefit plans. This could accelerate the trend toward defined-contribution pension plans which, combined with the declining generosity of worker and retiree health benefits, transfers risk from firms to individuals.


Prepared by Andrew Swiston.

Domestic auto parts suppliers have also lost market share. Imported parts as a share of domestic auto output has risen from 16 to 21 percent since the late 1990s, and employment in the parts industry relative to other auto industry employment has fallen 15 percent since 2000.

“Legacy airlines” refers to the six large, national carriers (historical data includes a seventh, which in 2001 was taken over by one of the other six). “Low-cost airlines” refers to seven, mostly smaller, national carriers. “Regional airlines”—smaller carriers that do not maintain a national flight network—are not included in the analysis. See GAO (2004) for a detailed description, as well as a thorough analysis of competition among airlines.

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