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Kiel Institute of World EconomicsDuesternbrooker Weg 12024105 Kiel (Germany)Kiel Working Paper No. 1093Globalization of the Automobile IndustryTraditional Locations under Pressure?byJulius SpatzPeter NunnenkampJanuary 2002The responsibility for the contents of the working papers rests with the authors,not the Institute. Since working papers are of a preliminary nature, it may beuseful to contact the authors of a particular working paper about results orcaveats before referring to, or quoting, a paper. Any comments on workingpapers should be sent directly to the authors.

Globalization of the Automobile Industry –Traditional Locations under Pressure? *Abstract: Even though the automobile industry is technologically advanced, theincreasing integration of low-income countries into the global division of labor has putcompetitive pressure on traditional automobile producing countries. New end-producersemerged in Asia, Latin America as well as Southern and Central Europe. In addition, theautomobile industries of Germany, Japan and the United States engaged in outsourcing ofrelatively labor intensive segments of the value chain, especially on a regional level. Ouranalysis of the labor market effects of these developments supports the predictions oftrade models: Low-skilled workers and labor intensive subsectors of the automobileindustry in traditional locations suffered deteriorating wage and employment prospectsin the process of globalization. The adjustment to fiercer competition from belowdiffered considerably between Germany, Japan and the United States. Economicrestructuring was least pronounced in the US automobile industry, largely due to theresistance of trade unions. As a result, the employment record and the world-marketperformance of US automobile producers turned out to be poor compared to theirGerman and Japanese counterparts.Key Words: Competitive pressure, outsourcing, specialization profiles, revealedcomparative advantages, relative wages, employment restructuringJEL classification: F14, L62Julius SpatzKiel Institute of World EconomicsDuesternbrooker Weg 12024105 KielPhone 49 431 8814 212Fax 49 431 8814 500e-mail:*Peter NunnenkampKiel Institute of World EconomicsDuesternbrooker Weg 12024105 KielPhone 49 431 8814 209Fax 49 431 8814 500e-mail: nunnenkamp@ifw.uni-kiel.deThis paper has been produced as part of the research project „Ursachen undImplikationen der Globalisierung am Beispiel der Automobilindustrie“. Funding bythe Fritz Thyssen Foundation is gratefully acknowledged. We are indebted to Rolf J.Langhammer for many helpful comments and suggestions on an earlier draft of thepaper. We would also like to thank Christiane Gebühr and Michaela Rank forexcellent research assistance. The usual disclaimer applies.

Table of ContentsI.INTRODUCTION .1II.COMPETITION FROM BELOW: STYLIZED FACTS.3III. LABOR-MARKET EFFECTS IN TRADITIONALPRODUCTION LOCATIONS.141.Theoretical Models on Distributional Effects of Globalization . 142.Intersectoral Distributional Effects . 163.Intrasectoral Distributional Effects . 19IV. THE ROLE OF STRUCTURAL ADJUSTMENT .311.Specialization Patterns in the German, Japanese and USAutomobile Industry . 312.V.Relative Price Developments in the German Automobile Industry. 38CONCLUSIONS.40LITERATURE .44

List of Tables and FiguresTable 1 —Regional Distribution of FDI Stocks of the German AutomobileIndustry, 1981–1998. 9Table 2 —Wage and Employment Trends in the German, Japanese and USAutomobile Sector . 16Table 3 —Wage Ratio Between the Automobile Assembly and theProduction of Automotive Parts and Components. 18Table 4 —Import Pressure and Labor-market Developments in theAutomobile Industry: Correlation Results. 29Table 5 —Specialization Profiles: Regression Results for the German,Japanese and US Automobile Industry. 36Figure 1 —New Competitors: Share in World Production of Automobiles,1980 and 1998. 7Figure 2 —Major New Competitors: Share in World Exports of Automobiles,1985–1998 . 8Figure 3 —Imported Inputs of the Automobile Industry in TraditionalProducer Countries from Low-income Countries, 1978/79 and1997/98 (percent) . 12Figure 4 —Wages and Employment in the German, Japanese and USAutomobile Sector (1978 100). 20Figure 5 —Wages and Employment in Two Subsectors of the GermanAutomobile Industry (1978 100) . 24Figure 6 —Wages and Employment in Two Subsectors of the US AutomobileIndustry (1978 100). 26Figure 7 —RRCA-Index Values of the German, Japanese and US AutomobileIndustry. 32Figure 8 —Price Ratios Between the Automobile Assembly and theProduction of Automotive Parts and Components in the GermanAutomobile Industry (1980 100) . 38

1I.IntroductionIn contrast to industries producing labor intensive and standardized goods, theautomobile industry in high-income countries should be among the winners ofglobalization. The production of automobiles is relatively human capital intensiveand technologically advanced. Nonetheless, globalization is likely to have animpact on wages and employment in this industry, too. Trade models predict thatthe gains and costs of globalization are unevenly distributed among variousemployment groups and various subsectors of any industry, includingautomobile production. Especially low-skilled workers and labor intensivesegments of the sectoral value chain should suffer deteriorating wage andemployment prospects because of competitive pressure from low-incomecountries.We study the automobile industries of three major traditional producer countries,namely Germany, Japan and the United States, in order to test this hypothesis.The analysis covers the period 1978–1998 and proceeds in three steps. InSection II, we discuss several aspects of globalization in the automobile industry.We focus on new competitors which emerged in countries with relatively lowper-capita income. This is because trade models predict that increasing tradebetween countries at different levels of economic development should haverelatively pronounced effects on the intrasectoral distribution of income and

2employment. In addition to new producers and exporters of finishedautomobiles, we assess the degree of outsourcing of relatively labor intensivesegments of the value chain undertaken by the automobile industry in traditionalproducer countries.Section III portrays trends in wages and employment in the automobile industryof Germany, Japan and the United States since the late 1970s. We stress thatintersectoral wage premia of the automobile industry, relative to totalmanufacturing, must not be confused with the intrasectoral distributional effectsof globalization. The latter are captured by the development of the wage ratio forlow-skilled (production) workers versus high-skilled (non-production) workersand the development of the sectoral human capital intensity (proxied by thenumber of non-production workers per production worker). We then correlatethe intrasectoral wage and employment trends with variables reflecting theintensity of international competition. The predictions of trade models are largelysupported for Germany and Japan, but rejected for the United States.Against this background, Section IV inquires more deeply into globalizationinduced restructuring processes in the three traditional producer countries. Wecalculate a measure of revealed comparative advantage, which suggests that theUS automobile industry was badly prepared to cope with competitive pressurefrom below. Next we run simple OLS regressions to evaluate the stability of

3production patterns in the automobile industry and its degree of specialization.We find that trade unions resisted economic restructuring in the US automobileindustry. In Section V, we conclude that the employment record and the worldmarket performance of the automobile industry in traditional producer countriescritically depends on the intensity and timeliness of economic adjustment tofiercer competition from below.II.Competition from Below: Stylized FactsThe question to which extent automobile production has become globalized maybe assessed by referring to UNCTAD's transnationality index. This index iscalculated as the average of three ratios, namely the share of a company's foreignassets to total assets, its overseas sales to total sales, and its employment abroadto total employment (UNCTAD 1999). It may come as a surprise that, accordingto the transnationality index, the automobile industry of traditional producercountries is less internationalized than various other industries, including foodproduction, chemicals and electronics (ibid.: 83).Nevertheless, the automobile industry is typically considered to be at theforefront of globalization. Evidence supporting this view includes:

4 the intricate network of alliances and cross-shareholdings among automobilecompanies, within nations and regions but also between regions (Vickery1996); intensified M&A (mergers and acquisitions) activities in the 1990s, involvingboth end-producers and automotive input suppliers (PricewaterhouseCoopers2000; World Trade Agenda 2000); the trend towards technologically motivated cooperation agreements, whichwas caused, inter alia, by end-producers entering into new forms ofpartnerships for the design of principal components and subsystems(UNCTAD 1998: 25 f.); and the significant role of intra-firm trade, e.g. of US-based automobilemultinationals (UNCTAD 1999: 443).All these indicators do not reveal, however, whether new competitors fromcountries with relatively low per-capita income have become integrated into theinternational division of labor in the automobile industry. This element ofglobalization is of utmost importance for analyzing the labor market implicationsof globalization in traditional producer countries. Labor market effects should berelatively benign as long as international relations remain restricted to intraindustry trade between countries that are similarly advanced economically and

5characterized by comparable factor endowments. By contrast, competition frombelow, i.e., from considerably less advanced countries with an abundantendowment of less qualified labor is expected to cause significant adjustmentpressure, especially on less qualified automobile workers in high-incomecountries.At first sight, the automobile industry seems badly suited to study theconsequences of fiercer competition from below. The industry as a whole istechnologically advanced and relatively human capital intensive (Heitger et al.1999; Vickery 1996).1 As a consequence, automobile production continues to bedominated by high-income countries, accounting for about 70 percent of worldproduction. However, subsectors of the automobile industry differ considerablyin terms of factor intensities. In Germany, for instance, the ratio of workers tosales was 2.5 times as high in the production of autoparts as in the production ofautomobiles and engines (VDA b, var. issues). Hence, outsourcing, thefragmentation of value chains and the integration of low-income countries into theinternational division of labor are reasonable options in this industry, too. Putdifferently, relatively labor intensive segments of this industry and less qualifiedworkers are likely to be negatively affected by the emergence of new1For instance, R&D expenditure amounted to 12 percent of value added in the Germanautomobile industry in the mid-1990s, twice as much as in total manufacturing (Weiß2000).

6competitors, even though the automobile industry of high-income countries as awhole should be among the winners of globalization.New competitors comprise end-producers and input suppliers from countrieswith relatively low per-capita income; in addition to developing and newlyindustrializing countries, Eastern and Central European transition countries andthe so-called EU-periphery (Greece, Ireland, Portugal and Spain) belong to thisincome category. Considering the most important producers of automobilesamong low-income countries, Figure 1 reveals rising market shares especially forend-producers located in Asia and in Southern and Central Europe. As acorollary, the share of high-income industrial countries declined by almost 10percentage points since 1980.This shift in worldwide production of automobiles towards low-income countriesonly partly reflects increased competitive pressure from below. New supplierssuch as China expanded the production of automobiles for serving protectedlocal markets, while lacking international competitiveness. However, several newsuppliers, including Mexico, South Korea and Spain were quite successful inpenetrating world automobile markets. In the second half of the 1990s, thecountries listed in Figure 2 accounted for almost a quarter of world exports ofautomobiles, thereby nearly doubling their export share within a decade.

7Figure 1 —percent109876543210New Competitors: Share in World Production of Automobiles,1980 and 19988. aAsia b1980Latin America c1998aCzech Rep., Hungary, Poland, Spain. – bPR China (1983 instead of 1980), India, SouthKorea. – c Argentina, Brazil, Mexico.Source: VDA (a, var. issues).Taking recent developments into account, Figure 2 tends to understate thecompetitive pressure from new automobile production locations. Automobileproduction in Brazil was traditionally restricted to serving local (or at bestregional) markets, but its world-market orientation is likely to become stronger.Investment projects initiated since the mid-1990s indicate that automobilemultinationals are changing strategy as a response to liberalized import policies inBrazil (Inter-American Development Bank and Institute for European-LatinAmerican Relations 1996: 41; The Economist 2000: 66). Furthermore, whilecomparable data are lacking for exports from Central European locations, some

8suppliers in this region have clearly emerged as internationally competitiveexporters recently. Notably in the Czech Republic, automobile production hasbecome integrated into the value chains of automobile multinationals, as before inMexico and Spain (Richet and Bourassa 2000).Figure 2 —Major New Competitors: Share in World Exports of 422. 90/94 95/98 85/89 90/94 95/98 85/89 90/94 95/98 85/89 90/94 95/98BrazilMexicoSouth KoreaSpainaPeriod averages; missing values for Mexico: 1985–1991 and 1993; South Korea: 1985.World exports approximated by the sum of exports of relevant exporters as given inVDA.Source: VDA (b, var. issues); American Automobile Manufacturers Association (1998;for Brazil 1985–1992); Auto & Truck International (var. issues; for Mexico).The emergence of new producers and exporters of automobiles was frequentlydue to foreign direct investment (FDI) in low-income countries by multinationalcompanies. For example, low-income countries taken together hosted almost halfof total FDI stocks held by the German automobile industry prior to the

9DaimlerChrysler merger in 1998 (Table 1). In the early 1980s, Latin Americarepresented the by far most important host region for German automobilecompanies. In the process of forming the European Single Market, Spainattracted substantial FDI by the German automobile industry. More recently, thisindustry grasped new investment opportunities in Central and Eastern Europe. Inthe late 1990s, FDI stocks held in this region were of a similar magnitude as FDIstocks held in the EU-periphery.Table 1 —Regional Distribution of FDI Stocks of the German AutomobileIndustry, 1981–1998EUthereof:– EU-peripherybother industrial countriesdeveloping and transitioncountries– total– Africa– America– Asiae– transition countries f1981 198525.8 a 27.4 a199047.5199445.7199740.6199821.910.821.4 c7.637.5 c24.420.014.514.911.321.27.752.752.810.6 d40.4n.a.n.a.35.03.6 g (2.9) ga Excluding Sweden. – b Ireland, Portugal and Spain; 1981–1990: only Spain; 1994and 1997: Portugal and Spain. – c Including Sweden. – d Rep. of South Africa andNigeria. – e Excluding China. – f Including China. – g China in brackets.Source: Deutsche Bundesbank (var. issues).The crucial role of FDI notwithstanding, the automobile industry of newcompetitors developed under strikingly different conditions. In China, whichopened up to FDI in the process of market-related reforms starting in the late

101970s, automobile production continues to be dominated by national companies(VDAa 1999: 68 pp.). Korea set up an indigenous automobile industry(Daewoo/Ssangyong and Hyundai/Kia) which successfully penetrated worldmarkets. In contrast to Mexico and Spain, Korea's exports of automobiles werenot focused on neighboring high-income countries, but regionally diversified.2As a consequence, traditional producers were affected by competitive pressurefrom Korea both in their home markets and in third markets, including in thedeveloping world.On the other hand, the development of an indigenous automobile industryrendered it more difficult for Korea to become integrated into global sourcingnetworks of automobile multinationals. Apart from assembling automobiles,locations such as Mexico, Spain and Central European countries increasinglysupplied traditional producer countries with automotive parts and components.In other words, competition from below goes beyond world-market orientedassembly operations in low-income countries and extends to imports ofautomotive inputs.2In 1998, Europe absorbed 48 percent of Korean exports of automobiles, 31 percentwent to America (two thirds of which were exported to the United States andCanada), and about one fifth were destined to Africa, Asia, Australia and Oceania(VDAa).

11Figure 3 shows that low-income countries have become relevant suppliers ofautomotive inputs for the automobile industries of Germany, Japan and theUnited States. According to detailed country studies, trade in automotive inputswith low-income countries expanded particularly on the regional level (Diehl2001): In the case of the US automobile industry, a rising share of imports ofengines, electrical equipment and other parts and accessories originated fromMexico. For the Japanese automobile industry, other Asian countries represented themost important (low-income) suppliers of automotive inputs. Apart from high-income European neighbors, the EU-periphery was the mostimportant supplier of electrical equipment to the German automobile industry.Since the mid-1990s, this industry imported a steeply rising share of enginesfrom Central European countries.Measured by the share of imports from major low-income trading partners intotal imports of automotive inputs, competitive pressure from below appears tobe similarly advanced in all three traditional producer countries (Figure 3).However, imports from all sources contributed significantly less to domestic

12absorption of the automobile industry in Japan than in Germany and the UnitedStates (Diehl 2001).

13Figure 3 —Imported Inputs of the Automobile Industry in TraditionalProducer Countries from Low-income Countries a, 1978/79 and1997/98b (percent)403020100GermanyJapan1978/79United States1997/98aShare in total imported inputs; inputs considered here comprise parts and accessories(SITC 784), electrical equipment (SITC 778.3) and motors (SITC 713.2). Low-incometrading partners of Germany include the EU-periphery, Turkey, and Central and EasternEurope; low-income trading partners of Japan and the United States include Asia andLatin America. – bAnnual averages.Source: OECD (2000).All in all, the evidence suggests that traditional automobile producing countrieshave been subjected to increasing competitive pressure from new locations inlow-income countries. Countries such as Mexico, Spain and the Czech Republicemerged as competitive suppliers of both finished automobiles and automotiveparts. Other countries, notably Korea, focused on penetrating world markets forfinished automobiles. All three traditional producer countries considered here

14were affected, even though imports of automotive inputs remained less importantfor Japan than for Germany and the United States. Hence, the stylized facts let usexpect adverse labor market implications of fiercer competition from below forlow-skilled workers in all traditional automobile producing countries.III. Labor-Market Effects in Traditional Production Locations1.Theoretical Models on Distributional Effects of GlobalizationThe links between the globalization of the world economy and changes in relativefactor prices have long been discussed in the theoretical literature. With regard tothe intrasectoral dimension of income inequality, i.e., wage differentials betweenworkers of different skill levels in the same sector, there are two basic models. Inthe Heckscher-Ohlin model, the liberalization of international trade in final goodscauses a restructuring towards the relatively human capital intensive sectors inhigh-income countries. High-skilled workers gain relative to low-skilled workers,both in wages and employment (Stolper, Samuelson 1941). This is because morehigh-skilled workers per low-skilled worker are required for the expansion ofhuman capital intensive sectors than are released in the contraction of laborintensive sectors. In the Feenstra-Hanson model, the liberalization of foreigndirect investment and international trade in intermediate goods enables highincome countries to outsource relatively labor intensive segments of the value

15chain to low-income countries (Feenstra, Hanson 2001). Hence, like in theHeckscher-Ohlin model, the labor market situation of low-skilled workers in highincome countries is expected to deteriorate.With regard to the intersectoral dimension of income inequality, i.e., wagedifferentials between workers of the same skill level in different sectors, there arealso two basic models to explain globalization-induced distributional effects. Inrent-sharing models 3, firms and unions bargain over sector-specific rents. Thegreater these rents and the greater the union bargaining power, the higher thesectoral wage level. Opening up to international trade erodes the market power ofincumbent firms and, hence, the sector-specific rents in once protected sectors.Furthermore, the exit-option of capital and know-how in liberalized factormarkets curtails the bargaining power of unions. Therefore, the rent-sharingmodels predict a decline in the sectoral wage levels in the course of globalizationin those sectors where import penetration rises and where firms can easily moveproduction to low-income countries.In efficiency-wage models, firms do not regard wages as exogenous but usethem as a motivation instrument to increase labor productivity. Workers receive asectoral mark-up on their reservation wage. The size of this mark-up is positivelyrelated to the strength of the relationship between wages and labor productivity,3For a comprehensive survey of rent-sharing models see Oswald (1985).

16which in turn depends on the capital and technology intensity (according to theshirking and the labor-turnover approach)4 and on the average profitability ofthe firms in the sector (according to the gift-exchange approach). The higherthese variables, the stronger the wage-productivity relationship. Hence, theefficiency-wage models suggest that high wages can be paid only in those sectorswhich can maintain their international competitiveness by specializing in humancapital intensive segments of the value chain.2.Intersectoral Distributional EffectsThe analysis of the intersectoral dimension of globalization-induced distributionaleffects proceeds in two steps. First, we trace the development of wages andemployment in the German, Japanese and US automobile industry relative to thetotal manufacturing sector of the respective country. Second, we perform thesame analysis for important subsectors of the automobile industry.The automobile industry is characterized by a higher-than-average capital andtechnology intensity. Furthermore, the development and manufacturing ofautomobiles requires increasing R&D and involves significant fixed costs(Vickery 1996). Hence, it is not surprising that the average earnings of automobile4The different approaches to explain the positive wage-productivity relationship arepresented in Akerlof and Yellen (1986).

17workers are significantly higher than those of workers in total manufacturing(Table 2).Table 2 — Wage and Employment Trends in the German, Japanese and USAutomobile IndustryAverage earnings (total manufacturing tes117121124129135133c2. cEmployment (percentage share of a Transport equipment. – b Unweighted average. – c 1994–1996.Source: Bartelsman and Gray (1996), Ministry of Finance (var. issues), StatistischesBundesamt (var. issues).In Germany and Japan, the intersectoral wage differential increased over the last20 years, while it slightly decreased (albeit from a very high level) in the UnitedStates. According to efficiency-wage models, this development may reflect thatthe German and Japanese automobile industries were more successful in adaptingto globalization by outsourcing labor intensive segments of the value chain tolow-income countries.5 At the same time, the employment share of theautomobile industry in total manufacturing increased in Germany and the United5As shown below, the high wage premium in the United States does not mean that thiscountry was best prepared to deal with fiercer competition from below.

18States but remained fairly stable in Japan. In the case of the United States, theostensibly favourable employment trend is, however, mainly due to a seriouslydepressed starting point. The US automobile industry was hit especially hard bythe recession of the late 1970s and early 1980s, during which it shed 27 percentof its production workers and 18 percent of its non-production workers.The overall favorable wage and employment situation in the automobile industriesof Germany, Japan and the United States does not rule out that some of theirsubsectors lost out in the course of globalization. Both Heckscher-Ohlin andFeenstra-Hanson models suggest that labor intensive subsectors should beespecially vulnerable to competitive pressure from low-income countries. Thishypothesis is corroborated by the development of the wage ratio between therelative human capital intensive automobile assembly and the relatively laborintensive production of automotive parts and components (Table 3). 6Table 3 — Wage Ratio between the Automobile Assembly a and the Productionof Automotive Parts and itedStates1. the United States, the production of automotive parts and components requires 3.7times as many workers per revenue unit than the automobile assembly. In Germany,the ratio is 2.5.

19a Germany: automobiles and motors; Japan: automobiles; US: cars and car bodies. – b1999.Source: Bartelsman und Gray (1996), Confederation of Japan Automobile Workers'Unions (JAW) (unpublished data), Statistisches Bundesamt (var. issues).As expected, this wage ratio increased significantly over the last 10 years in Japanand the United States. In the German automobile industry, by contrast, workersin labor intensive subsectors did not incur income losses relative to their peers inhuman capital intensive subsectors. The different experience of Germany isstriking as all three countries were hit by competitive pressure from low-incomecountries.7 The fairly stable wage ratio may be explained in two alternative ways:Either the intersectoral wage structure8 in Germany is less flexible, or Germanproducers of automotive parts and components adapted more successfully toglobalization. This issue is taken up again in Section IV.3.Intrasectoral Distributional EffectsIn order to assess the impact of globalization on the intrasectoral dimension ofincome distribution, we compare recent wage and employment trends of lowskilled and high-skilled automobile workers in Germany, Japan and the United7See Section II.8As mentioned before, the term intersectoral is also used when comparing differentsubsectors within the automobile industry.

20States. Using correlation techniques, we subsequently link the changes in thehuman capital intensity and the relative wage of lo

segments of the value chain undertaken by the automobile industry in traditional producer countries. Section III portrays trends in wages and employment in the automobile industry of Germany, Japan and the United States since the late 1970s. We stress that intersectoral wage premia of the automobile industry, relative to total

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