Sunday, November 09, 2008

Detroit Auto Industry Problems & Austrian Business Cycle Theory

Continuing on the subject of the problems of Detroit auto makers, it should perhaps be discussed where this fits into Austrian business cycle theory. As most of my readers presumably know, Austrian business cycle theory predicts that the downturn will primarily be in the investment goods sector. Yet business investments have in this downturn not been particularly weak so far. However, residential investments have plunged more than in any other previous slump, falling from a peak of 6.3% of GDP in the second half of 2005 and 4.4% in Q3 2007 to 3.3% in Q3 2008. As a result, the investment sector as a whole has suffered more than consumer spending.

Even so, the auto industry has also declined sharply. Can this be explained with Austrian theory? Perhaps not with the classic formulations of it, but it can be explained with it through an updated version that applies the logic inherent in the theory on other areas. The distinction between capital goods and consumer goods is in fact not as sharp as many people think. There are some goods which can clearly be classified as consumer goods, such as say fresh fruits which must be more or less immediately consumed, and others which are clearly capital goods such as industrial robots. But for other goods, it is not as obvious whether they should be classified as capital goods or consumer goods. If you for example build a new store, then this will enable consumption of the goods sold in it as soon as it is ready, yet it is considered a investment good. Similarly, houses are considered investment goods even though the purpose of them is to enable people to enjoy housing services. What about the products of GM and Ford, cars, then? They are considered consumer goods even though most of the value in them won't be consumed during the first month, quarter or even year after they're bought. Most cars last for decades, and so they are arguably to some extent capital goods. This is even more evident if you consider that cars are often used for job-related purposes.

And so since cars can be considered as a form of capital goods, the logic inherent in the Austrian business cycle theory that capital goods should be especially cyclical can be applied to the auto industry. As car buyers suffer interest costs (either direct interest costs if they borrow the money, or the opportunity cost if they buy it with their own money), an artificial lowering of interest rates should result in an artificial boom in the auto industry, which will then turn into a bust. And so, the problems of the Detroit auto makers are in fact very much consistent with what the Austrian business cycle theory would predict. Note that this doesn't just apply to cars, it applies to all durable consumer goods.

If you look at the historical data
, you can indeed see that durable consumer goods have in fact fallen as a percentage of GDP during recessions and risen during booms. For example between 1972 and 1975, durable consumer goods fell as a percentage of GDP from 8.9% to 8.1%. Between 1979 and 1982, durable consumer goods fell from 8.4% to 7.4%. Between 1989 and 1991 it fell from 8.6% to 7.6%. The 2001 recession saw a very modest decline from 8.8% in 1999 to just 8.7% in 2001, but in the current recession we have seen it decline from 7.8% in Q3 2007 to 7.1% in Q3 2008. A further decline in the fourth quarter seems almost certain.

So to summarize, despite the fact that cars are considered consumer goods, the problems of the car industry are very consistent with Austrian business cycle theory. Another conclusion that can be drawn is that the cyclical fluctuation in savings is even greater than the usual measures of national savings. Since consumers during booms buy durable goods which are consumed during recessions too, the fluctuation in consumption is even smaller than official statistics suggest. But since this has no implication for the value of production, a smaller cyclical fluctuation in consumption implies a greater cyclical fluctuation in savings.


Anonymous John Petrie said...

I hope you continue to write about this and the auto industry's imminent bailout, so that your criticisms of Bush/Obama policies and your predictions of their eventual failure will be on record as correct. Similar to your predictions about the housing boom and bust.

I guess I pay a little more attention to the American auto industry's complete failure and its numerous bailouts not exactly because I live in Michigan now, near the Motor City, but because everyone around here seems to think it's obvious that other people's money should sunk into GM and Ford because the alternative would be worse. I like reading analyses of whether it actually would be worse, because I fail to see how bailing out failing companies can be good in any way.

12:41 AM  
Blogger dennis said...

Besides the Federal goverment looking into possibly bailing out the auto industry.. Why dont the big three oil companies ExxonMobil, Chevron and ConocoPhilips look into way of helping out?? They once again posted record profits and oil and cars work hand in hand..The big three can loan the auto industries a couple of billions of dolloars which is pocket chanage to them and help them to get back on to speed up the process of making more fuel efficient autos in which in the long run will allow the big 3 oil companies to yet increase their profits as well as allowing them to exits even longer on account of all the talk of oil soon running out!!! Does anyone agree??

10:41 PM  

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