Oil Shocks, Segment Shifts, and Capacity Utilization in the U.S. Automobile Industry: What has changed in 30 Years?

1. Oil Shocks, Segment Shifts, and Capacity Utilization in the U.S. Automobile Industry: What has changed in 30 Years? By Valerie A. Ramey and Daniel J. Vine

2. Questions Asked • Did gas prices affect the auto industry similarly in the 1970s and 1980s and the 2000s? • Were the mismatches between capacity and demand across vehicle segments similar in each era? • How much of the decline in capacity utilization in the auto industry can be attributed to gas prices? • What margins did the automobile companies use to achieve their production reductions?

3. Overview of Events During the Past 4 Decades

4. Real Price of Gasoline Average of all grades, relative to headline CPI

5. Consumer Anxiety over Gasoline Prices Percentage of respondents to the Reuters/University of Michigan Survey of Consumer Sentiment who cite high gasoline prices or shortages of gasoline as reasons that car‑buying conditions are poor

6. U.S. Light Vehicle Sales

7. Vehicle Market Segments Cars (5) • Subcompact • Compact • Intermediate • Full-size • Luxury Light trucks (6) • Compact pickup • Small vans • Cross-utility vehicles • Full-size pickups • Large vans • Utility vans

8. Domestic Sales Shares Percentage of domestic vehicles sold Full-size trucks, vans, utilities Small cars Standard cars Small cars, CUVs “Domestic” is defined as cars produced in North America

9. Domestic Days’ Supply Small cars Full-size trucks, vans, utilities Small cars, CUVs Standard cars “Domestic” is defined as cars produced in North America

10. Bresnahan-Ramey Measure of Capacity Mismatch A high dispersion in days’ supply across segments indicates that an imbalance exists between the composition of capacity and the composition of demand.

11. Dispersion of Days’ Supply Variance of days’ supply across 11 market segments

12. How do increases in gasoline prices affect the auto industry? • 3 possible effects: • Increase in costs of production • Decrease in overall sales • Shifts in composition of sales • (1) is probably not as important. We will focus on (2) and (3)

13. Stylized Model • Purpose: • To investigate various channels through which gas prices affect the auto industry • To determine conditions under which segment shifts can affect capacity utilization

14. The Importance of the Shape of Marginal Costs for Segment Shift Effects on Capacity Utilization MC MC MR MR Q Q Linear-Quadratic Model Capacity-Constraint Model

15. Stylized Model The monopolist produces cars for 2 segments.

16. Constraints and Demand Inventory identity: Demand:

17. Calibration Monthly discount factor: β = 0.997 Desired days’ supply: φ = 2.5 months of sales Penalty for deviation from days’ supply: α = 0.1 Capacity: K = 40 Steady-state output: Y = 40 Elasticity of demand in S-S: elasticity = -1.5 Autocorrelation of shocks: ρ = 0.75

18. Effect of a Negative Aggregate Shock

19. Effect of a Segment Shift Shock: Segment Variables

20. Effect of a Segment Shift Shock: Aggregate Variables

21. Investigating the Role of Gas Prices Empirically We now study the behavior of capacity utilization in the data and estimate a model that allows us to determine the importance of gas price shocks

22. Capacity Utilization Percent, light vehicle assembly

23. VAR Investigation of Gas Price Role Y consists of : • Consumer sentiment about gas prices • Days-supply of domestic cars (DS) • Variance of days supply • Capacity utilization (CU) A(L) is a matrix of polynomials in the lag operator L. U is a vector of disturbances. Identification: Choleski decomposition with consumer sentiment orderedfirst.

24. Effect of a Shock to Consumer Sentiment about Gas Prices January 1972 to March 2009

25. Sample Stability How has the response changed from the early period to the recent period? To answer this question, we estimated the VAR over two subsamples: 1972 – 1989, 1990 – 2009

26. Effects Estimated Over Different Subsamples 1990-2009 1972-1989

27. Relative Importance of the Aggregate Channel vs. the Segment Shifts Channel • How does the response of capacity utilization to gas prices change if we shut down the particular channel? • To answer this question, we perform the following counter-factual experiment: • To shut down the aggregate channel, we simulate the estimated VAR, not allowing aggregate days’ supply to change. • To shut down the segment shifts channel, we simulate the estimated VAR, not allowing the dispersion of days’ supply to change.

28. Effects of Gasoline Sentiment Shock: Counterfactuals counterfactual counterfactual baseline baseline

29. Importance of Gas Price Shocks to Capacity Utilization How important have gas price shocks been to capacity utilization during particular historical periods? To answer this, we decompose the movements in capacity utilization into those due to gas price shocks versus other shocks.

30. Historical Movements in Utilization and Dispersion

31. How the Detroit 3 Changed their Production We use the plant level data collected by Bresnahan and Ramey (1993) and Ramey and Vine (2004, 2006) to study the margins of adjustment of the Detroit 3.

32. Margins of Adjustment used to Curtail Auto ProductionDetroit 3 Firms; North American Production by Model Year

33. Isolated Margins of Adjustment:Detroit Three Motor Vehicle Output Overtime Hours Temporary Closures

34. Isolated Margins of Adjustment:Detroit Three Motor Vehicle Output Shifts Plant Entry/Exit

35. Conclusion • In many ways, the effect of gas prices on the auto industry during the last 10 years has been similar to the effect during the 1970s and 1980s. • Shifts in demand across segments continues to be an important channel for the effect of gas prices on the auto industry.