The Impact of Imports on Price Competition in the ...

The Impact of Imports on Price Competition in the Automobile Industry Author(s): Lall B. Ramrattan Source: The American Economist, Vol. 35, No. 2 (Fall, 1991), pp. 60-66 Published by: American Economist Stable URL: http://www.jstor.org/stable/25603892 . Accessed: 02/10/2014 14:16 Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at . http://www.jstor.org/page/info/about/policies/terms.jsp

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THE IMPACT OF IMPORTS ON PRICE COMPETITION IN THE AUTOMOBILE INDUSTRY by Lall B. Ramrattan* Price Competition in the Automobile Industry S. automobile firms fol U. Traditionally, lowed a stable policy in pricing cars. General Motors sets its prices based on a target return on its investments, and other firms imitate its price. Brown (1924), General According toDonaldson Motors estimated sales, cost of unit sold, and added a 15 to 20 percent rate of return to its price. the 1960's, the price differences During and General between Ford Motor Company Motors were only $10 to $20; between Chrysler and Ford Motor Company, only Corporation determine

$40 to $50 (Scherer, 1980, p. 181). In the subcompact

category, General Motors'

Chevette

and Ford's Pinto prices differedby only $11 to $73.

For

the

1957-1971

period,

Boyle

Hogarty (1975) found that the U.S. colluded

in their price

behavior

and

firms

in a hedonic

way.

In the 1970's and 1980's, U. S. auto firms newer in several pricing policies adopted response to high oil prices, inflation, interest to rates, and frequent recessions. According R. L. Polk's data (1988, p. 32), the share of imports climbed from 14.53 percent in 1972, to 32.09 percent in 1987. The increase was steady 1982-1987. and between 1978-1982, smaller firms retaliated by making cars, cutting wages, closing plants, improving to reduce efficiency, and adopting measures and discount Dealer's government regulations. customer's rebate were widespread. Chevrolet,

between Domestic

and American Motors Ford Motor Company a "Two-tier" practiced pricing policy, charging in the western lower prices for subcompacts states where import competition was strongest.

started "interim pricing"?a Motors at the increases than usual price followed the of model year by more beginning also tried Firms later. increases basing frequent

General smaller

* Economist Economics

price increases on "product improvement" only. Chrysler Corporation did not follow the leader's policies frequently. In one instance, it priced in direct retaliation to prices of subcompacts imports. The purpose of this paper is to assess whether the increased foreign competition in the 70's and 80's has affected the price behavior of U. S. automobile firms. We used a hedonic price

model developed by Boyle and Hogarty (1975)

to explain price-collusive behavior among do mestic firms for the period 1972-1987. For was the in which traditional years price policy we not maintained, isolated the cheater, and offered explanations for why the hypothesis may have failed. Finally, as it was argued that the U. S. and Japan may have formed an auto cartel via voluntary import quotas, we hypothesized

that domestic and foreign firms may have colluded in price policies for those years in which the hypothesis has failed.

The Model The statistical model for the determination price uniformity is expressed formally thus: Pi,t

=

f(t) [Xut,.Xi,kt,

of

Ui,J,

where p = price, X = quality characteristics, U = time = ith = an error term, i model, and t period which runs from 1 to k. In that test, the term "quality" refers to size, length, width, engine weight, height, number of doors, power steering and brakes, The and other similar brand characteristics. di index represents horsepower performance vided by curb weight; the comfort index, head and leg room times width. Price refers to list or suggested factory-delivered cludes standard equipment,

retail price. It in federal excise tax,

at theU. S. Department of HUD, San Francisco Regional Office, and Professorial Lecturer of at Golden Gate University, and Adjunct Professor of Economics at JFK University.

60

THE AMERICANECONOMIST


and dealer fee, and excludes taxes and transportation costs.

state and

local

and Hogarty's (1975) best specifica Boyle's tion was the log of price on the log of comfort and a dummy variable for and performance, The power amenities. log variables are weighted car the share of S. model year output. In U. by cases where import brands are used, the close comparable share data is imported new-car sales in the U.

S.

The null hypothesis(Ho) is thatestimatedlist

are nondifferent price-attribute relationships and Ford General Motors, among Corporation, American We excluded Chrysler Corporation. Motors Corporation for lack of adequate data. If the sample data by firms for each year cannot falsify the hypothesis, then we inferred that the in the price firms' pricing behavior expressed rather than attribute relationship was collusive competitive.

The test statistic is F=[[(A-B)/(T-1) where A = resid (K+1)]/[B/(N-T(K+1)]],

ual sum of squares from the combined sample, B = the residual sum of squares for each firm's = number of sample summed over firms, T = K number of independent subsamples, and N = size. Although variables, sample

Boyle and Hogarty [1975] suggested a five percent significant level, we considered a wider band as well. We have drawn the sample to allow compar ison with Boyle's and Hogarty's results. Before from Corporation dropping American Motors the study, we verified that its data yielded singular matrix solutions inmost years. Some of the limitations on the sample size are listed below. are ?Models characteristic data lacking omitted. ?Convertibles

and

station wagons

are not

used.

?If engine

the difference specification,

in a model is due only to then all themodels are not

used.

is available either as (1) a (2) a 4-door sedan, or (3) a hard-top, only the 2-door sedan is used. Another consequence of these limitations is that they did not yield enough observations on foreign firm to test the hypothesis that U. S. firms have colluded with foreign firms for those to Sande years we conducted the test. According ?If 2-door

the model sedan,

Milton (1986), for a t-value of 2, an R2 of 0.9, three independent variables (k), and a minimum addition to r2 of .01 when a new variable is = k + i.e., n added, we need 44 observations,

1+

[t^l-R^/r2]

= 3 +

1+

(4*.1)/.01

=

This represents nearly half the size of all import brands in 1986. For pragmatic reasons therefore, we have created one hypothetical import firm, comprising of all import models. The data come primarily from the "Automo tive News Market Data Book Issue" for each some we In have used "Ward's instances, year. Automotive Year Book", for model especially we offered for share data. The explanations are drawn firms' behavior from generally available sources such as the Business Periodical Index, the New York Times Index, Advertising Age, and Auto Basics. 44.

Results

and Discussions

1 and 2 show, As Tables a explained large percentage

the variables have of variation in list

price.Except for 1984, 1985 and 1987, thelevel

the coefficients appears fairly stable. The dummy variable was highly significant in all years except in 1986, and 1987. The intercept of

TABLE 1

Regression Equations forList Price on Index of Comfort, Performance, and a Dummy Variable for Power Steering and Brakes, 1972-1987 Critical Point at Year

Test Statistics

Distribution

10 5 percent

1972 2.06912 2.046 F(8,84) 1973 2.01411 2.024 F(8,107) 1974 2.49475 2.030 F(8,100) 1975 2.01783 2.024 F(8,108) 1976 2.35469 2.024 F(8,108) 1977 2.42542 2.036 F(8,94) 1978 5.08283 2.038 F(8,92)* 1979 2.27523 2.042 F(8,88) 1980 2.86131 2.048 F(8,82)* 1981 3.86580 2.045 F(8,85)* 1982 0.95454 2.060 F(8,75) 1983 6.17138 2.040 F(8,90)* 1984 2.47562 2.037 F(8,93) 1985 1.91026 2.047 F(8,83) 1986 4.88289 2.047 F(8,83)* 1987 1.59526 2.047 F(8,83) * Indicates reject homogeneity hypothesis.

Vol. 35, No. 2 (Fall 1991) 61


percent 2.736 2.679 2.690 2.677 2.677 2.705 2.71 2.72 2.735 2.728 2.755 2.715 2.707 2.733 2.733 2.733

TABLE 2

Regression Equations Year

forList Price on Index of Comfort, Performance, and a Dummy Variable Steering and Brakes, 1972-1987 Comfort

Intercept

1.1301972

0.730 0.243

0.455

095

(2.548)* 0.260 0.325

(10.963)*

(2.327)*

(9.018)*

(3.109)*

(9.255)*

(3.786)* 3.868 1975

(3.715)* 0.398

(6.629)*

(5.206)* 4.044 1976

(4.056)* 0.406

(3.977)* 0.531 0.241 (5.245)* 0.594 0.182 (4.710)* 0.298 (4.607)* 0.257 (1.547) 0.338 0.428 (1.996)* 0.649 0.306

3.387 1974

(4.441)* 3.961 1977 (4.312)* 1.095 1978 2.197 1979

0.435

(4.170)* 0.250

(4.839)* 3.388 1981

(1.649) 0.550

(2.634)* 3.300 1982

(3.108)* 0.495

(3.297)* 0.611 1983

(3.184)* 0.930 (6.146)* (0.554) 1.081 (10.415)* 1.108

(0.537) -0.564 1985 (0.582)

5.565 1986

(10.608)* 0.363 1987 Significant at 0.05;

** =

the weakest.

0.493 0.258

(3.435)* 0.411 0.582 (3.411)* 0.827 0.204 (1.137) (6.442)* 0.677

(1.815)** 5.232 1980

-0.4111984

term was

R2

(1.576) (7.563)* 0.700

1.388 1973

*

Performance Dummy

(7.467)* (5.128)* (7.316)*

(3.634)* 1.017

(10.007)* (1.488) -0.0640.001

0.94 0.96 0.97

0.94 (6.718)* (5.431)* (5.860)* (3.459)*

(3.857)*

0.96 0.95 0.98 0.97 0.96

(3.765)*

0.699 0.263

0.94

0.93

(8.335)*

(8.431)*

0.96

0.95

(6.319)*

(4.660)* 0.432 0.291 (2.630)* 0.447 0.335 (3.041)* 0.041 0.245 (0.274) -0.0720.379 (0.679) -0.079 0.431 (0.598)

0.256

for Power

0.95 0.93

_(0.214)_(4.337)*_(0.273)_(1.285)_ Significant at 0.1.

It performed

poorly

in

1972, 1978, 1979, 1983, 1985, and 1987. Apparently,itcorrelatedhighlywith thedummy fitting a constant with a near perfect power dummy variable has not been a problem for this model up to 1987. No singular matrix solution resulted, and an attempt to force variable. However,

themodel through the origin resulted in negative index was weak in 1978, R2. The performance 1983, 1984, and 1985, and the comfort index was weak only in 1980. The negative coefficients for the performance

index in 1984, 1985 and 1987 do not falsifythe

hypothesis. The year 1984 marked a comeback firms. Firms of performance for domestic

the stepped up nonprice competition against increased share of imports. In that year, General Motors positioned the firstAmerican mid-engine Pontiac Fiero. sports car, and the wedge-shape as a new perfor Chrysler pitted the Daytona new mance turbo car, and Ford mobilized charged and diesel engines for its Mustang, firm and Lynx. Each Cougar, Capri, Topaz an excess of 200 horsepower. offered engine in At the same time, American cars were becoming lighter with more high-stress and high-strength plastic styling. In 1987, 80 percent of the cars were fitted with four- and six-cylinder. The full effect of performance in those years were only partly captured

in the performance

index. The

62 THE AMERICANECONOMIST


residual that picked up the other part appeared to have dominated the horsepower to weight ratio we have used. The net result was negative coefficients in those years. As no superfluous we in the specification, variables appeared

followed the advise of Rao andMiller (1971,

in keeping the equations. the test statistics with the critical Comparing points of the F-distribution, the results of Table 2 indicate that we should have no doubt in pp. 38-46)

accepting thehypothesis in 1973, 1975, 1982, 1987. At the ten percent significance 1985, we it in eleven of the should accept level, sixteen years. However, we should reject it in

1978, 1980, 1981, 1983, 1986. Why did the hypothesis fail in those five

years? In 1978, the "interim pricing" policies described above were practiced. In 1980, firms to increased prices every quarter in response a manufacturer will inflation rates. "Sometimes toss in an extra hike, as Chrysler did inMarch on Omni and Horizon." (Automotive News,

1980, p. 62) In 1981, Ford Motor Company and Chrysler Corporation hesitated to follow leader's "GM hiked prices a substantial price policy.

$351 effective April 13,bringingits 1981-model

year average to $914 and pushing the average GM car above ten price of the average-equipped on that It become thousand dollars. $10,200 date.

Then came a couple of surprises. Ford, which almost always follows GM in such matters, said itwould not hike prices before the end of April. And Chrysler said it would make no increase 'until absolutely necessary'." (Automotive News.,

1981, p. 50)

In 1983, the U. S. auto makers were looking for newer direction in pricing that year's It was the third year in which models. the was in recession. General Motors' industry

average price increase was somewhat flat, 1.9 percent. Still, the other firms were reluctant to follow. Ford Motor average price Company increase was a modest 0.4 percent. Chrysler went the other way, cutting the base sticker price on its convertibles and other models. In 1986, General Motors reduced its incentive programs as the industry had itsmost profitable second year in 1985. Its average price increase was 2.9 percent or about $350 per unit. Chrysler Corporation again refused to follow, reducing to prices on its Omni and Plymouth Horizon

current base below of $710 prices subcompacts. Table 3 presents additional tests for the years the hypothesis has failed. We attempted to find different grouping of firms that set prices results show that General uniformly. The Motors and Ford Motor Company have colluded in 1986. The leadership role had changed in that year with Ford Motor Company topping General in earning, reversing a historic trend Motors since 1924. Chrysler Corporation behavior in to corroborate Schwartz going alone appears man's words that "Small firm . . .will be more inclined to utilize price cuts in an effort to increase sales" [1970, p. 107]. The subgrouping of firms also indicate that Chrysler Corporation had abandoned the price-cartel in 1986. The voluntary import quotas of the 1980's has raised the issue as to whether the domestic firms accommodated, extinguished or neutralized for about

and Lindsey eign firms' price policy. Dolan an have that international (1988, p. 960), argued automobile cartel was formed between Japan to the price benefits and the U. S. consequent firms have enjoyed. We have tested the price hypothesis with domestic vs. imported models to identify any international price-cartel. Data limited the test to the broad availability U. S. of and U. S. firms vs. all hypothesis

Importsfor 1983, and 1986. Table 4 displays

the results. The results indicate a high probability that the domestic and foreign firms do not price the characteristic of their product similarly for the two years in which the price-collusion hypothe sis failed for the domestic the industry. Given experimental nature of the domestic firms price policies, and the propensity of Chrysler Corpo ration, the smallest firm in the cartel, to cheat,

thedomestic firmsbehavior in 1983 and 1986

as neither openly extinguishing nor appeared but mostly neutral. Only the accommodating, smallest firm exhibited extinguishing tenden cies. General Motors and Ford Motor Company preferred the oligopoly with differentiated prod such as R&D, uct, choosing nonprice weapons advertising, styling, dealership arrangements, over price competition to rival foreign competi tion.

Our findings allow the inference that domestic firms in the automobile industry followed a uniform price policy when foreign competition

Vol. 35, No. 2 (Fall 1991) 63


TABLE 3

Regression Equations

forList Price on Index of Comfort, Performance, and a Dummy Variable Steering and Brakes, Several Years

for Power

Results for Ford and General Motors only Year

Comfort

Intercept

1978

0.736 0.868 (0.707) 1980 4.705

1983 1986

Performance Dummy

(3.309)* 1981 3.229 (1.702)**

(2.234)**

(0.999) (6.527)* 0.335 (2.925)* (6.176)* 0.412 0.299 (1.575) (3.969)*

(2.52)*

(9.958)*

0.866 0.893 (4.379)* 5.748 0.181

(0.580)

0.073 0.296 (0.359) (3.687)* 0.708 0.487

j

1978

1986

096

(6.255)* 0.309 0.563 (1.585) 0.572

(10.155)

Year

R2

0.143 0.298

Distribution

5 percent10

F(4,80)

2.330 3.250

1.64459*

F(4,57)

0.97 0.93

tCritical Points at

6.79265

F(4,66) F(4,66) F(4,70)

0.99

(1.996)

Statistics 1980 4.00582 5.48495 1981 7.79162 1983

0.91

percent

2.508 3.616 2.508 3.616 2.517 4.100

2.462 3.677

Results for Ford and Chrysler only Year

Comfort

Intercept

1978

1983

1986

-0.614 1.103 (-0.410) -0.106 1980

(5.447)* 1.004

(-0.044) 1981 -2.929

(3.005)* 1.425

(-1.682)

(5.850) -2.464 1.389

(-1.773)

(7.193)*

0.247 5.517

(9.746)*

Year

1978 1983

(3.813)*

Statistics

Distribution

6.79265

F(4,80)

4.00582 1980 5.48495 1981

F(4,66) F(4,66)

8.31193

F(4,44)

Performance Dummy

R2

0.079 0.263

0.95

(0.382) -0.014 0.241

(3.744)*

(-0.045) (2.841)* -0.358 0.222 (-1.654) (3.535)* -0.339 0.133 (-1.826) (1.548)

0.720 0.338

(10.864)*

0.93 0.98 0.98

0.97

(1.045)

at TCritical Points 5 percent 10percent

2.330 3.250

2.508 3.616 3.616 2.508

2.594 3.794

1986_6.98958_F(4,37)_2.634_3.887_ Source: Estimate by author. was

weak. foreign Strong caused Chrysler Corporation

has competition to break away

from traditionalpricing policies. While import competition was not significantly disruptive to in eleven of the sixteen domestic price policies

years between

1972 to 1987,

its force was most

visible in 1978, 1980, 1981, 1983, and 1986.

The domestic industry showed its thick skin in those disruptive years when import quotas were to step up in place. Firms had the chance

64

THE AMERICAN ECONOMIST


TABLE 4

Regression Equations

forList Price on Index of Comfort, Performance, and a Dummy Variable Steering and Brakes, 1983, 1986 and ImportModels

Results forDomestic

(3.435)*

0.442 4.252 (2.594)* 0.123 6.528

(9.987)*

(1.442)

1983 1986

Performance Dummy R2

Comfort

Year Intercept

for Power

0.95

0.361 0.542 (3.458)* (3.266) 0.869 0.495

0.93

(2.173)*

(10.384)

Critical Points at t 5 percent10 percent j

Distribution

Statistics Year 8.69026 1983+ 4.36084 1983# 7.91789 1986+ +

3.32 2.37 1.75 2.18 2.37 3.32

F(4,152) F(12,144) F(4,171)

1986#_4.29709_F(12,163)_L75_ Firms vs. Imports: # indicates Domestic

indicates U.S.

nonprice competition, maintaining their differen status quo, while tiated oligopoly avoiding with foreign firms in setting price cooperating policies.

2.18_ vs. Imports.

The Automobile Industry [New Epstein, Ralph C, York: A. W. Shaw Company, 1928]. Ferber,

R.,

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