By Liam Sigaud
April 6, 2018 at 5:00 am ET
A blatant example of corporate welfare is driving up automobile prices around the country, helping car dealerships maximize profits at the expense of consumers.
A little history is helpful to understand how we got here, and why reforms are desperately needed. Once automobiles reached the mass market in the early 20th century, it didn’t take long for car manufacturers to settle on dealership franchises as the best distribution model. The contractual arrangements between dealerships and manufacturers were mutually beneficial, since each party depended on the success of the other to ensure its own profitability.
Over the ensuing decades, however, some regulators became concerned that manufacturers had accumulated so much market power that they could exert substantial leverage over small dealerships. In response, states began to enact laws to protect dealerships from allegedly unfair practices by manufacturers. What started as a voluntary agreement between manufacturers and dealerships gave rise to a series of state regulations that today serve only to disadvantage manufacturers and consumers.
While state laws favoring dealerships have proliferated throughout the country, the automobile industry has changed enormously since those early years, and the arguments that were once used to enact these regulations are no longer credible. There is no evidence that a market failure exists that would warrant government intervention in car dealerships. The interdependence between manufacturers and dealerships means that the former have no incentive to exploit the latter, since this would cause dealerships to exit the market and reduce car sales.
Market concentration among automobile manufacturers was once used to justify these regulations, since dominant manufacturers could theoretically exercise unfair leverage over dealerships. But today’s vehicle manufacturing market is no longer concentrated; in fact, it’s highly competitive. The top two manufacturers have seen their combined market share fall from nearly 80 percent in the early 1960s to just 30 percent today.
Collectively, these state regulations increase costs for car manufacturers, which are ultimately passed on to consumers in the form of higher prices. Territorial exclusivity laws, for example, stifle competition and drive up prices by establishing monopoly market areas that reduce intra-brand rivalry. A study conducted in 2015 found that the price of a Honda Accord increased by $220 when dealers were 10 miles apart and by $500 when the distance between dealers grew to 30 miles.
Other state laws constrain dealership termination, hamstringing manufacturers’ ability to negotiate profitable contracts. Many states do not consider gross inefficiency or financial conditions acceptable grounds for termination. Even when good cause for termination is present, dealerships are typically given time to address shortfalls, making termination a difficult, drawn-out, and costly process. Termination also frequently requires manufacturers to buy back unsold cars, parts, accessories, tools, and equipment, which further raises costs for automobile makers. Because of these laws, market forces are not able to operate freely to set the optimal number of competitors in a given market or determine the most efficient size of dealership operations.
Based on a study by the Federal Trade Commission, the American Consumer Institute estimates that removing these state regulations would lower automobile prices by an average of 7.6 percent and bring 2 million additional vehicles to the market. Overall, consumer benefits would increase by roughly $47.5 billion per year if these state regulations were eliminated. These figures likely understate by a significant margin the negative impact these regulations have on consumers, since the study did not explore the costs of other state laws that favor dealers over manufacturers and consumers.
These protectionist state regulations are nothing less than corporate welfare, and Americans should demand that they be repealed.
Liam Sigaud writes for the American Consumer Institute, an educational and research organization.
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