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Neil H. Buchanan

Political Power in the Auto Industry: Why Did Congress Protect Car Dealers?


Thursday, December 17, 2009

Last Thursday, the U.S. House of Representatives passed an omnibus spending bill that included an unusual non-spending provision: If General Motors and Chrysler want to stop doing business with any of their dealers, the dealers may appeal that decision through arbitration. The two auto companies have announced plans to discontinue their business relationships with more than 2,000 dealerships across the country. Thus, this provision (if it becomes law) will potentially be quite important to the way the automobile industry will be structured in the future.

Why does Congress think it is wise to intervene in the automobile industry in this way? The relationships between the automakers and their dealers are, after all, already governed by contract law. If the dealers believe that they have been the victims of breach of contract, then they should be going to court, not to Congress. Yet we now face the specter of Congress imposing rules on business relationships that go beyond existing contractual obligations, and would essentially force G.M. and Chrysler to remain partners with companies with which they have no further interest in doing business.

Generally, when Congress (or any legislative body) acts in a way that imposes obligations on people or businesses, there should be nothing uniquely troubling about such legislation. Because businesses operate within a system where the ability to earn profits is premised on the government's writing of the rules of the game, the possibility of changing those rules is simply part of legitimate governance. That does not, however, make every change equally wise. Indeed, the proper argument is not about whether the government is imposing rules, but about whether changes in those rules would achieve desirable and legitimate ends. And that is surely a question that should be asked in this instance.

In this column, therefore, I will discuss whether Congress's proposed rule is part of a well-reasoned strategy to improve the lives of Americans. I conclude that it is not, both because such a rule advances no legitimate public purpose and -- more fundamentally -- because the underlying business model connecting automakers, dealers, and their customers is badly flawed.

Given these problems with the proposed rule, I then discuss why the House nonetheless passed it. Perhaps the most interesting aspect of this episode is that G.M. and Chrysler seem to have lost a major political battle with one of the most unpopular groups of people in the country -- car salesmen (and, very rarely, car saleswomen). This is like losing a political battle to, say, e-mail spammers or house repossessors, and this defeat provides important insights into the nature of political power and how it is wielded in the United States.

Why Do Car Dealers Exist?

For most Americans, it would seem odd even to ask why we buy our cars from independent car dealers, as the system is deeply entrenched. Yet we could, instead, buy our cars directly from manufacturers, as we often do with computers, televisions, and so on. We also go to wholesalers to buy even the most expensive items that we own.

Why, then, are automobiles sold everywhere through independently-owned dealerships, most of which use the same business model? And, why do car salespeople everywhere have the well-earned reputation of using high-pressure tactics that too often leave their customers feeling confused, manipulated, and cheated?

The answers to these questions could be a matter of simple economic calculation. Auto manufacturers might long ago have decided that they should subcontract the sale of their products to people who specialize in that aspect of the business, and the costs of the subcontracting relationship could be exceeded by the benefits of specialization.

Moreover, as spokespersons for car dealers are quick to point out, the dealerships provide benefits such as, for example, inventory control (absorbing unsold vehicles from the automakers), and one-stop shopping deals for trade-ins and financing as well as purchases (practices that are not without their own abuses, of course).

If the industry's structure were truly an outgrowth of economic efficiency, then consumers might not like how they are forced to buy their cars, but they would have a reason to put up with it: That would merely be how "the market" has decided the business will work. And complaining about the car sales process would be just like complaining about, say, going to the multiplex and finding movies dominated by car chases and overgrown adolescent men discussing bodily functions. The market would have spoken, and it would have catered to the lowest common denominator.

Let the Market Decide!

As frustrating as it might be to feel powerless in the face of market forces, the supposed genius of capitalism is that it allows competitors to challenge the way things are done. Better business methods drive changes in the ways that business is conducted. But is the structure of the car industry really market-driven? The answer is no.

Some corporate decisions are plainly dictated by the market. For instance, IBM lost its dominance in personal computers, ultimately selling what little remained of its PC operations to a Taiwanese company. It decided that it was better off engaging in other businesses, and the consumer is presumably better off.

This, quite simply, is not what has happened in the automobile business. There was never an open competition to see whether people would prefer one method of buying cars over another. Rather, in each state, there are highly-restrictive laws that prevent the automakers from selling cars directly to the public. The dealers, in other words, have been handed the market on a silver platter -- by law, not by market competition.

Interestingly, the current set of rules for selling automobiles is anything but ideal from the standpoint of the automakers. Customers who feel abused by dealers do not distinguish between Chevrolet and the local Chevrolet dealership; the dealership's sins or sharp practices are attributed to Chevrolet. Thus, the manufacturers spend a great deal of effort and money every year responding to angry buyers, essentially being forced to defend practices that they cannot control.

In addition, while the automakers have an interest in building customer loyalty, a salesperson trying to meet a quota is the ultimate short-term thinker. Even the dealerships, which one would think might care about long-term relationships with customers, have shown themselves not only to tolerate high-pressure sales tactics, but to encourage such tactics -- and even to spend money to train their salespeople to hone those tactics. The manufacturers, then, are left picking up the pieces – and facing more ill will from consumers.

Even so, in theory it could still be true that the dealers provide such important benefits to the market that they offer the best way to sell cars, notwithstanding the persistent problems that plague their practices. If so, then maybe they should finally be forced to prove that point. The issue, after all, is not whether independent dealers should be made illegal (a suggestion that no one has ever made, to my knowledge); it is simply whether they can compete with other ways of doing business. If they can, then surely the law should allow them to do so.

Many people, in fact, suspect that the dealers could not win such a competition. Indeed, the dealers themselves, through their behavior, all but admit that they believe that they could not win, because they expend great efforts to make sure that they will never have to compete with another business model. A confident competitor does not need to waste money to exclude rivals from a race that he knows he will win if it is run fair and square.

Letting Contracts Run Their Course

Even in light of the many disadvantages of continuing to support legally-required dealer networks, however, the automakers have not proposed anything so radical as changing the underlying business sales model. Instead, when facing the worst crisis in the industry's history -- a crisis that, we should remember, put the very face of American capitalism, General Motors itself, into bankruptcy protection and virtual federal receivership -- GM and Chrysler decided that they simply needed to reduce the number of dealers with whom they do business.

They proposed to do so by letting dealer agreements expire without renewal, not by breaching their contracts. (Again, in those instances where they might have breached their contracts, they can be taken to court. And if they are in the wrong, they should lose.)

The political response to this has been, in a word, stunning. Dealerships nationwide mobilized to garner public sympathy for their cause. Hearings and news conferences have featured teary-eyed members of families who have been in the dealership business for generations. Arguments implicitly drawing upon the legal concept of "reliance interest" -- in which a party reasonably expects a situation to continue, even if there has been no promise to do so -- became a staple of the public relations barrage. "We have always been a Chevrolet dealership," the public was being told, in essence, "and we have a right to continue to be a Chevrolet dealership for as long as we'd like."

As noted above, this public relations maneuver is especially remarkable because of the underlying "product" that is being sold. The venue in which millions of Americans have had some of their most unpleasant experiences, experiences likened in many minds to having a root canal or going to divorce court, is being sold as a precious piece of Americana. Even more remarkably, Congress has stepped in on the side of the abusers.

Local Politics and National Consequences

Former Speaker of the House Thomas P. "Tip" O'Neill once famously said that "All politics is local." The power of auto dealers is Exhibit A in making O'Neill's case. It is hardly surprising that car dealers have been able to lock down state legislatures across the nation in maintaining anticompetitive laws: After all, some of the richest people in nearly every town across the country are the owners of car dealerships. Although their wealth is not in the category of that of Wall Street executives, the car dealers dominate local business (especially in smaller towns), with economic power that translates directly into political might.

This political might, in turn, is not limited to campaign donations. Once, when I was living in Boston, a local TV station ran a news story in which an intrepid reporter exposed some of the more seamy aspects of local car dealers' practices. I called her at the station the next day to congratulate her and to offer some insights from an economist's perspective on the inefficiencies (indeed, the absurdities) of the business. She thanked me, but she informed me that her station manager had forbidden her from doing any more stories critical of car dealers. Her story had so outraged the dealers that they were threatening to pull their advertising from the station. Her local station, even in a market as large as Boston's, had no choice but to capitulate.

It should not be surprising, therefore, that the House of Representatives would respond to the cries of the car dealers. House members have frequently risen through the ranks of state legislatures, and in any event, they are the products of local politics. The wealth and might of the car dealers must be a very real consideration for any politician.

Notably, even in the most partisan Congress in memory, the House's intervention on behalf of the car dealerships has been embraced across the aisle. Republicans voted against the bill in which this provision appeared, but their votes were determined by the spending items in the bill. They offered no criticism of the dealer protection provisions, and there is every reason to believe that such a provision would pass in a truly bipartisan landslide, if offered on a stand-alone basis.

The Timid Auto Manufacturers: Why Not Fight?

Thus, the surprise here is not the dealers' power: It is longstanding and formidable. Instead, what is surprising is Detroit's capitulation. The political muscle of the automakers is, of course, hardly inconsequential. They succeeded earlier this year in getting Congress to pass bailout measures, even though the public seems to oppose the concept of bailouts for large companies. They are hardly afraid to fight powerful foes: For instance, they aggressively (one might even say gleefully) attacked the autoworkers and their union, twisting evidence to blame their woes on "overpaid workers." Detroit is, in short, never afraid of a political fight.

Why, then, do the automakers exhibit such passivity in the face of the dealers? One argument could be that G.M. and Chrysler are uniquely under the thumb of the federal government, having accepted the terms of the bailouts. This does explain why the legislation applies only to G.M. and Chrysler, because Congress's power over those two companies is at its height. But it does not explain why Ford (which is not receiving direct federal assistance) is not taking on its dealer network more aggressively. Nor does it explain why foreign manufacturers, too, have acquiesced in the U.S. system of selling automobiles. In America, it is the political power of the car dealers that explains the continuation of the flawed approach to selling cars.

In the midst of the most frightening economic crisis that this country has faced in generations, nearly every aspect of our society faced – and continues to face -- the possibility of radical change. Union contracts have been torn up. Financial regulations have been reconsidered. Direct and unprecedented federal government intervention in the economy has been approved (quite correctly, in my view). Yet the one thing that did not face the prospect of even modest change was an indefensible business model for selling cars. Now, the House has gone one step further and would protect that model even in the face of valid contracts and a radically-shrunken domestic auto industry. That is political muscle.

Neil H. Buchanan, J.D. Ph. D. (economics), is a Visiting Scholar at Cornell Law School, an Associate Professor at The George Washington University Law School, and a former economics professor.

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