'Q:)dg hair-F .. 1” LIBRARY Michigan State u. - THESIS This is to certify that the thesis entitled TECHNOLOGICAL SUBOPTIMI ZATION AND THE U.S . AUTOMOBILE INDUSTRY presented by Louis Silvia, Jr. has been accepted towards fulfillment of the requirements for Ph . D. degree in Economics {(29% wow; Major professor Date July 10, 1980 0-7639 TECHNOLOGICAL SUBOPTIMIZATION AND THE U.S. AUTOMOBILE INDUSTRY BY Louis Silvia, Jr. A DISSERTATION Submitted to Michigan State University in partial fulfillment of the requirements for the degree of DOCTOR OF PHILOSOPHY Department of Economics ABSTRACT TECHNOLOGICAL SUBOPTIMIZATION AND THE U.S. AUTOMOBILE INDUSTRY BY Louis Silvia, Jr. The purpose of this dissertation is to contribute to the understanding of technological change. The study dif- fers from the bulk of the investigations in this area in three ways. First, an industry study approach is used instead of a cross-sectional analysis. Second, the method- ology is institutional rather than econometric. Third, the study is oriented towards market performance instead of conduct. In the first part of the dissertation a theory of social optimality in the production and use of technology is deve10ped. Three conditions must be met for a social Optimum: technology production must be efficient; the rate of technology production must be such that net social bene- fits are maximized; and the existing stock of technology must be used in a way such that no other selection of currently available technology results in a greater sum of producer and consumer surpluses. Failure to meet these criteria is referred to, respectively, as Type I, Type II, and Type III suboptimization. The possibilities of tech- nological suboptimization by the auto industry are then discussed. In the last part of the thesis attention is focused on suboptimization in powerplant technology. The technology of alternative powerplants (Otto, stratified charge, Diesel, rotary, Rankine, gas turbine, Stirling, and electric) is examined with the use of corporate, government, and other reports. The industry's efforts to promote powerplant technology is also reviewed. The evidence was of little help in evaluating the extent of Type I suboptimization. The data strongly suggest, however, that Type II subOptimi- zation was present. That is, given the technological Opportunities in the powerplant field, it appears that the industry's efforts fell short of the socially desirable level. Finally, the evidence is ambiguous on Type III sub- optimization; it is unclear that the industry's continued commitment to the conventional internal combustion engine during the mid-1970's conflicted with the social interest. @Copyright by LOUIS SILVIA, JR. 1980 ii TO MY PARENTS iii ACKNOWLEDGMENTS I wish to thank Professor Walter Adams for suggesting this topic and for his brilliant insights in directing the grand strategy of this work. I am greatly indebted to Professor Bruce Allen whose guidance and diligence were invaluable to completion of this thesis. I also appreciate the suggestions and comments of Professor Warren Samuels and Professor Kenneth Boyer. Finally, I thank Professor Elizabeth Crowell for her kind help and encouragement. iv TABLE OF CONTENTS INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . 1 Chapter I SUBOPTIMIZATION IN THE PRODUCTION AND USE OF TECHNOLOGY. . . . . . . . . . . . . . . . . . . . 5 1. Invention and Innovation. . . . . . . . . . . S 2. Optimization in the Production and Use of Technology. . . . . . . . . . . . . . . . . . 6 3. Three Kinds of Suboptimization in the Production and Use of Technology. . . . . . . 9 4. Technological Suboptimization in a Market System. . . . . . . . . . . . . . . . . . . .10 II THE MARKET FOR AUTOMOTIVE TECHNOLOGY. . . . . . .16 1. Introduction. . . . . . . . . . . . . . . . .16 2. The Institutional Setting . . . . . . . . . .17 a. The Process of Invention in the Auto- motive Field. . . . . . . . . . . . . . .17 b. Producers of Automotive Technology. . . .20 c. Patents and Property Rights . . . . . . .29 3. The Supply of New Automotive Technology . . .32 4. Demand for New Technology in General. . . . .40 a. The Firm's Decision Situation . . . . . .40 b. The Role of Capital Markets . . . . . . .45 c. Consumer Factors. . . . . . . . . . . . .46 d. Rivalry in New Product Space. . . . . . .46 e. Pre-Innovation Market Position. . . . . .50 v —n III 5. 6. 7. f. Market Demand for New Technology. Demand for New Automotive Technology. a. Preferences of the Firm . b. The Role of Capital Markets c. Consumer Factors. d. The Presence of Rivals in New Product Space 8. The Firm's Position in Pre-Innovation Product Space Equilibrium Output of New Automotive Tech- nology. Possibilities for Technological Subopti- mization. . a. Type I Suboptimization. b. Type II Suboptimization c. Type III Suboptimization. THE STATE OF POWERPLANT TECHNOLOGY DURING THE MID-1970's. 1. Introduction. 2. Technical Descriptions of Alternative Auto- motive Powerplants. a. The Conventional Otto b. Stratified Charge Otto c. Diesel. d. Rotary. e. Gas Turbine f. Rankine g. Stirling. h. Electric Powerplants. 3. The Characteristics of a Powerplant a. Unit Cost of Manufacture. vi 52 52 52 52 52 53 62 68 76 76 79 86 96 96 96 97 97 98 98 98 99 99 99 .100 .101 h. i. Driveability. Fuel Efficiency Maintenance Durability. Weight of Powerplant. Size of Powerplant. Noise Control of Emissions. The Test for Type III Suboptimization Dominance of the Conventional Otto. Sources of Technological Information. Stratified Charge Engine. a. General Motors. b. Ford. c. Chrysler. d. Eaton . e. JPL-197S. f. JPL-1978. Diesel. a. General Motors. b. Ford. c. Chrysler. d. Eaton e. JPL-1975. f. MIT g. JPL-1978. Rotary Engine 3. General Motors. vii 102 102 103 103 103 104 104 104 107 108 112 113 113 115 116 117 118 120 122 122 125 126 127 127 128 130 131 131 10. 11. 12. b. Ford. c. Chrysler. d. Eaton e. JPL-1975. f. JPL-1978. Rankine a. General Motors. b. Ford. c. Chrysler. d. Eaton e. JPL-1975. f. JPL-1978. Electric Vehicles General Motors. Ford. Chrysler. Eaton JPL-1975. MIT . JPL-1978. Turbine General Motors. Ford. Chrysler. Eaton JPL-1975. JPL-1978. viii 131 132 132 134 134 135 135 136 136 137 137 139 139 139 147 149 151 151 153 154 156 156 157 158 158 159 160 13. 14. Stirling Engine 3. General Motors. b. Ford. c. Chrysler. d. Eaton . e. JPL-1975. f. MIT . g. JPL-1978. Conclusions on Type III Suboptimization IV THE RATE OF DEVELOPMENT OF ALTERNATIVE AUTO- MOTIVE POWERPLANTS DURING THE MID-1970'S 1. 2. Introduction. The Efforts of Automotive Technology Pro- ducers in the Development of Alternative Powerplants a. The Automakers. b. Other Technology Producers. c. The Observed Rate of Powerplant Tech- nology Production . . . . . . Government Policy and Its Impact on the Rate of Development of Alternative Power- plants During the 1970's The Test for Type II Suboptimization. The Causes of Type II Suboptimization in Powerplant Technology . . . a. Inability to Practice Perfect Price Discrimination. b. Externalities c. Differences in the Private and Social Time Rates of Discount. d. Uncertainty e. Collusion to Reduce Uncertainty ix 161 161 163 163 164 164 165 166 167 179 179 180 181 184 184 187 190 194 197 198 200 204 f. Monopsony in the Purchase of New Technology. . . . . . . . . . . . . . . 217 g. Final Remarks on Type II SubOp- timization. . . . . . . . . . . 218 5. Type I Suboptimization in Powerplant Technology. . . . . . . . . . . . . . . . . 219 V CONCLUSIONS . . . . . . . . . . . . . . . . . . 225 1. Auto Industry Progressiveness . . . . . . . 225 2. Market Structure and Progressiveness. . . . 227 a. Firm Size . . . . . . . . . . . . . . . 227 b. Market Concentration. . . . . . . . . . 229 3. Implications for Public Policy. . . . . . . 231 a. Energy Prices . . . . . . . . . . . . . 231 b. Government-Induced Demand . . . . . . . 231 c. Government Entry into Automobile Production. . . . . . . . . . . . . . . 232 d. Current Public Policy . . . . . . . . . 232 4. Recommendations for Further Research. . . . 234 a. Automobile Industry . . . . . . . . . . 234 b. Application of This Thesis' Method- ology to Other Industries . . . . . . . 234 LIST OF REFERENCES . . . . . . . . . . . . . . . . . . 238 Table 10 11 12 13 14 LIST OF TABLES Corporate RGD Expenditures, 1967-1978. EPA Evaluation of Automotive RGD Directed Toward Emission Control, 1970-1975 RED Expenditures as a Percent of Sales, 1967-1978. RGD Expenditures as a Percent of Value Added, 1967-1978 Ownership Cost Differential for Mature Otto- Engine Equivalent Cars Fuel Economy Projections for 1985 Full-Sized Cars Using Various Engines . . . . . . Fuel Economy Projections for 1985 Small Cars Using Various Engines. Fuel Economy of Rankine Prototypes and Selected Otto Production Cars Comparison of Characteristics of Three Lead- Acid Electric Cars and an Otto-Powered Chevrolet Vega Energy Consumption Ratios: Electric Car Relative to Otto-Powered Car. Car Battery Characteristics. Life Cycle Costs (1974 cents per mile), Elec- tric Cars versus Otto-Powered Subcompact Comparison of Per Mile Cost, Electric Cars and Otto-Powered Subcompact. Annual Cost of Ownership, 5 Year Period, 10,000 Miles per Year. xi 28 30 64 . 65 .121 .123 .124 .138 .141 .143 .145 .146 .148 .150 15 16 17 18 19 20 21 22 23 Characteristics of Electric Cars Built During 1960's and Early 1970's Estimated Costs for Electric Vehicles G.M. Estimates of Stirling Engine Fuel Economy in Small, Compact, and Large Cars G.M., Ford, and Chrysler RED Expenditures on Alternative Unconventional Powerplants. Data on Chrysler Powerplant RGD Expenditures. Reported RGD Expenditures in the U.S. on Powerplant Technology, 1973-1975. Reported RGD Expenditures in the U.S. on Power- plant Technology, 1976-1978 . . . . . . EPA Funding for Alternative Automotive Fuels and Power Systems, Fiscal Years 1969-1974 ERDA/DOE Expenditures on Alternative Unconven- tional Powerplants, Fiscal Years 1975-1978. xii 152 155 162 181 183 186 186 188 189 Figure 4a,b LIST OF FIGURES Relation Between Cost and Time for Completion of an R&D Project Average and Marginal Cost of Technology Pro- duction . . . . . . . . . Utility Maximization for a Monopolistic Innovator Derivation of a Firm's Technology Demand Curve. Firm Equilibria under Monopoly, Collusion, and Competition . . . . . . . . . . Output Depressing Effect of Monopsony Output Increasing Effect of Monopsony Socially Optimal Rate of Technology Production. xiii 37 38 43 44 48 71 72 82 INTRODUCTION In December 1978, the U.S. Secretary of Transportation, Brock Adams, addressed the Detroit Economic Club. Mr. Adams challenged the American automobile industry to re- invent the automobile. Refinement was not enough: nothing less than a "quantum jump" in engine technology was necessary to save the automobile's role in American life. Adams' challenge implied that the current state of domes- tic automotive research and deve10pment was not in line with the national interest. Shortly after the speech, the largest and most profit- able automaker, General Motors, stated that "the record of technological progress in the automobile industry is un- paralleled, and American manufacturers remain preeminent in automotive technology;"1 GM's defense of the industry was echoed by its fellow automakers. 2 Nevertheless, at a meeting with President Carter the following spring, the automakers agreed to join the federal government in sponsoring the development of a totally new car.2 Given Congressional approval, much of the work will be done on university campuses. These events raise a number of interesting questions: (1) Has technological progress in the U.S. auto industry been inadequate? (2) If so, what have been the causes? (3) If so, what are the public policy remedies? This dissertation attempts to answer these questions. Since the controversy over the industry's progressiveness is largely centered on the car's powerplant, the study focuses on that area of automotive technology. Before looking at the evidence on powerplant develop- ment, it is necessary to develop criteria of optimality in the production and use of technology and to identify fac- tors which may prevent the satisfaction of these criteria. These are the goals of Chapter I. In Chapter II, the structural and behavioral features of the market for automotive technology are ana- lyzed. The likelihood of technological suboptimization in the automotive field is discussed. The level of powerplant technology during the mid- 19705 is examined in Chapter III. The merits of alterna- tive powerplants are reviewed to determine whether the standard internal combustion engine has remained the best choice. 3 The rate of development of alternative powerplants is discussed in Chapter IV. Here, the crucial question is whether the observed rate of development approximates the socially optimal one. In Chapter V, conclusions and their implications for public policy are presented. The contribution of the thesis to the understanding of technological change in general is then discussed. Finally, suggestions for fur- ther research are offered. It is unlikely that this thesis will resolve the controversy over auto industry performance. The issues are complex, the data imperfect. Yet, if future discus- sions of this important industry are at least enlightened as a result of this study, it will have achieved its goal. 1. 2. NOTES The Detroit News, December 6, 1978. Ibid., May 19, 1979. CHAPTER I SUBOPTIMIZATION IN THE PRODUCTION AND USE OF TECHNOLOGY 1. Invention and Innovation Professor Schumpeter defined invention as the creation of "new possibilities."1 One possibility is the reduction of a good's cost of production. Another is the making of better goods. An increase in society's stock of technology is required for these possibilities to come about. In- vention, therefore, can be viewed as the production of technology. This is a broad use of the term, for it in- cludes everything from the explorations of basic research to the last steps of development. Invention is a process of experimentation and observa- tion. Like other production processes, invention consumes labor services, capital, and natural resources. However, the production function for invention is difficult to formulate.2 It is hard to quantify the output in a 6 practical way; equally troublesome is the measurement of that peculiar input called creative insight. But even if the measurement problems could be solved, another difficulty remains. Simply not enough is known about the production of creative insight itself. Unlike the other inputs to the production of technology, creative insight seems to materialize out of thin air. More im- portant, its occurrence cannot be regulated by the inventor. Thus the production function for invention is a probabilistic relation. Unlike the usual concept of the production function, which asserts a fixed relation between inputs and output, invention is a process where, for any given sacrifice of tangible inputs, a range of output levels is possible. The extent of creative insight determines the actual outcome. The use of new technology is called innovation. Pro- fessor Schumpeter defined it as "'doing things differently' in the realm of economic life."3 Process innovation refers to an advance in production techniques, while product in- novation is the making available of new goods. 2. Optimization in the Production and Use of Technology The optimal conditions for the production and use of 4 The analysis is new technology are now set forth. restricted to the invention and innovation of new goods. Assume a prodigiously enlightened society. This society can measure, with certainty, the benefits and costs of invention and innovation throughout time. Further 7 assume that technology is quantifiable in units called "techtils." New products are distinguished by the em- bodiment of some number of formerly non-existent, or unutilized, techtils: to simplify further, assume that this number always equals one. At t=0 society determines the optimal rate of tech- nology production. This calculation requires a weighing of the benefits and costs of the production and use of each unit of new technology. First consider the cost of producing a new unit of technology. The development time for a new techtil may be varied according to the commitment of resources per unit time to invention. Let C(T) denote the monetary value at time t=0 of the cost stream required to produce a techtil by time T. Furthermore assume that (l) C(T) > 0, C'(T) < O, C"(T) > 0 for all T > 0. Crash programs are assumed to be more expensive than leisurely ones. Conversely, if the unit is not produced (T + 00), C(T) is equal to zero. The monetary flow of the social cost of producing the innovation is given by Ktt,q), where q is the rate of pro- duction of the new product at time t. Assume _ 3K 32K 3K < (2) K(t’O)-Ofi>O,W>0’-a_t—;O. The cost of innovation is zero if there is no production. The marginal cost of production is positive and increases with output. A product's cost of production may change 8 over time due to changes in input prices. Invention itself is assumed to provide no benefits. Instead, social benefits are derived solely from the consumption of goods. Thus the benefits of new technology are realized only after innovation. The monetary flow of social benefits at time t of a new product is given by B(t,q), where q is the rate of consumption (and production) of the new product at time t. Assume that 3B 32B 3B 5 (3) B(t,0) = 0, Sq > 0, 337 < O, 5? > 0. The marginal social benefits of a new product decline with increases in consumption. Changes in preferences or subsequent innovations may cause the flow of benefits to fluctuate over time. Now let V denote the present net monetary value of a new product at time t=0 where (4) v = I; B(t,q)e'rt_m=9ax: e_a._a o.a59=oz pizza—E O>_m:a.x= odauoecz e~.~_; 9.3.9532 o>.m:9.x: caaaoccz o>_m:O.x: o>_w=a.x: :>_m=o.x: o>_m:o.x: Ouzuoeoz O>_m:o.x= 0.355362 ;>_m:a.n= O>_w=O.x: azoz 2: o_u._a ouahoacz 0_u._g 0—.._; o~==3oee=. o>_m=uux: Ouuboec: vacuoaoz o>_m:a.x: vuaaoacz 0:30—52 ouahoaoz aquama 0—.am; 90550162 0.55653: cassava: 0—.u_; o>_m:o.x= o>mm=o.x: 0::2 ‘53..— u 1....‘01 y n..i o.u~_4 o_aa¢; Ouuhosaz O_.a_a a~e::o=< nuances: bananas: o>.m:a.x= 0.3.0192 9.5.036: oaahoso: ausaaeoz 33.3.52 euahoscz 330.5: nuances: occz educate: o—uuu; a.=hoeox O—.u_a uo_mxass .:o.u .ww< La< flea—u 9;. he =O_~aa:oaa_.l_ .mxccz u_.::a :: oeu._lzou .OLacom .wmobuzou .m.= .a.a~a .a; :— ca _=a=O§:CC_>:: :c bo.amlicu;:m 0;. cache; mu=mheaz 0—..m; 0—yea4 c_.~_; ouauma o.~ua; 9—H._; 0:02 0:92 o_.a,; unauma 393—5: cassava: ozcz o:oz 9:02 bananas: 0:02 0:02 azoz o_~._a o=ez “__‘,‘ I « .OI, .. in. t (11:041.- c. .I .II msa—-=na_ neuuzcm .,l IIIIIII. mo~=:.m m_aez.:xm maaamxm o_um:o> ._~ =c_.s~_s_.=c aeo=\m_mm=;; .=~ ans—awn; .aza ao..oa .a. Ioumxm Loauaaz um>_=.59-50auao= .m— mo=_u== O>au==ao.—< .h. .=o§o>:»:a_ “ma-sun: cowunamxc .c. no.1zam =Oaqum:_ h_< .m. heaven: .alhosb =aa4 .9— .Odoaoz .alhozh su_z .m- u=_1.au_=az Oxa.:— eo>aa:a_ .~_ mOm—u:um Oma-uz :O_.n.r..O.:-IOC 7:5 hOa—EflsU =0_~W=£IOU .—— m.:oso>Oa:I_ Iodmxm =O_._=u_ .:— _:u~:cu u: ea>=.:l_ .a .eolao—O>O= sum eouss>z< .m x:_ao.oz .93; eo>aazn_ .n OL:.x_= h_<\_o=a 1:3 .0:; .c .m».a.au Roz.” .m .m>.s.ac .aaoz ems: .. um>.e.=u .aaoz e_==z .m mc_1:.w =Oaumzaacu .~ ~=a§sc.e>e: .mx—a.=u o>mu=hazoeu .- 5.33:...— _Oa.:ou :O.mm_i: church aouOO—.: =w: o>muoaa.:< be =c_.a:_a>: <;: N mfi_n 0; in addition to the fact that more techtils cost more, ceteris paribus, it is possible that the firm's own purchase may drive up the price per techtil. As far as w(T) is con- cerned, it seems safe to assume that after some point there are constant or decreasing returns to innovation. That is, after some point n”(T) s 0 with n'(T) s K. Assume, therefore, that the IPC is concave to the horizontal axis. Figure 3 illustrates. The innovation-possibilities curve is a probabilistic function: the present value of any rate of innovation is uncertain. The degree of uncertainty varies monotonically with the rate of innovation. Consider the difference be- tween a refinement-type innovation and a radical one. A refinement-type innovation is a good that is only slightly 42 PV(T) Indifference Curve IPC r--— -0.-- Techtils/t, Uncertainty FIGURE 3 Utility Maximization for a MonOpolistic Innovator 43 different from existing goods and, as a result, its demand is apt to be similar to existing goods; furthermore, the uncertainty of refinement-type innovations is fairly low. In contrast, the demand for a radical innovation cannot be as easily inferred from demands for existing goods. More- over, uncertainty about the cost of technology acquisition is apt to increase with the rate of innovation. Let the uncertainty of innovation be measured by the variance of the present value of PV(T). Assuming that un- certainty increases with the rate of innovation, the horizontal axis of Figure 3 can serve double duty by indicating both the rate of innovation and the uncertainty associated with that rate. Now assume that the firm's decisions on innovation are based on a utility function whose arguments are ex- pected present value and uncertainty. Risk aversion is the most likely characterization of the firm's attitude towards uncertainty; assume, therefore, that the firm's indiffer- ence curves, when plotted in present value-uncertainty space, are positively SIOped, and reflect the usual prOper- ty of diminishing marginal utility. For a given set of preferences and innovation- possibilities, there exists a utility-maximizing level of innovation for the firm. Point A in Figure 4-a repre- sents one such equilibrium. This point implies a certain level of innovative effort by the firm. This level, in turn, implies a certain demand for new technology by the 44 PV(T) New IPC Old IPC I I I I I l I P A T1 T2 Techtils/t, Uncertainty Old Supply Price New Supply Firm's Demand T1 T2 Techtils/t FIGURES 4-A AND 4-B Derivation of a Firm's Technology Demand Curve 4s firm--or more precisely-~a 2912: on the firm's new tech- nology demand curve. Moreover, assuming for the moment that the firm is the only buyer of new technology (but ignoring any possible monopsony effects), this equilibrium level of quantity demanded equals the quantity supplied. This being so, the entire technology demand curve can be determined by imagining alternative technology supply curves. Thus a second point on the firm's new technology demand curve could be identified if the supply of new technology in- creased. The IPC would be pushed up, although it would remain anchored at the origin. As Figures 4-a and 4—b show, a risk-averse firm would likely increase its inno- vative effort from T to T l 2' b. The Role of Capital Markets A firm's innovation-possibilities are more at- tractive if interest rates are low. Firms that finance the purchase of new technology from returned earnings are en- couraged to innovate since the Opportunity cost of tech- nology investment is low. Similarly, firms that borrow to purchase new technology are encouraged by small interest charges. High interest rates, on the other hand, make the firm's innovation-possibilities less attractive. As a result, an increase in interest rates would reduce the firm's demand for new technology, ceteris paribus. 46 c. Consumer Factors These factors include the tastes and incomes of consumers, the prices of substitutes and complements of innovations, and the size of the population. These factors determine the profitability of new products. For example, an increase in consumer income is likely to make innovation more profitable; such an increase would shift the IPC up- wards, and would tend to increase the firm's demand for new technology. d. Rivalry in New Product Space In the context of innovation, rivalry has two forms. The first is imitative. Firm A, for instance, brings out an innovation which embodies T1 units of new technology. Imitation occurs when Firms B, C, etc., merely copy A's new product without compensating A; imitation is prevented, however, if Firm A has secure patent rights. But even with patents, a second form of rivalry is possible. Here Firm A brings out an innovation while rivals introduce innovations outside Firm A's patent coverage, which nevertheless are reasonably close substi- tutes for Firm A's innovation. Call this form of rivalry "counter-innovation." If the firm has imitating or counter-innovating rivals in new product space, it cannot expect to capture as much profit as a monOpolist; for any T, n(T) is less than that under monopoly. This effect, ceteris paribus, reduces the 47 incentive to innovate and, as a result, tends to reduce the firm's demand for new technology. However, the presence of rivals increases uncertainty for the firm. Under the monopoly case, the firm suffers no uncertainty if it chooses not to innovate: the present value of no innovation equals zero. This is not true if innovating rivals are present. Here, the non-innovating firm may suffer losses if rivals innovate successfully, since it may find its products becoming obsolete. In other words, the value of n(T) at T=0 is apt to be negative and not known with certainty. Therefore, under rivalry, the firm's IPC shifts down and to the right. The extreme left point of the curve, which still implies zero innovation by the firm, is no longer anchored at the origin but lies somewhere to the southeast. Figure 5 illustrates. It is indeterminate whether the individual firm will innovate more under monopoly or under competition. To some extent, the firm will be discouraged from innovation since imitation and counter-innovation reduce the expected present value. But, on the other hand, the firm will be encouraged to innovate by the fear that rivals will make its existing products obsolete. Theory does not tell us whether the carrot is stronger than the stick. The effect of competition on the individual firm's demand curve for new technology is similarly ambiguous. To the extent that the present value of innovative effort is reduced by competition, the firm's demand for new 48 PV(T) //, Techtils/t, Uncertainty FIGURE 5 Firm Equilibria under Monopoly, Collusion, and Competition 49 technology will be lessened; to the extent that the firm is fearful that rivals may score an innovative ggpp_dg giggg, the firm's demand will tend to be greater. Note that with competition, the firm Operates at a lower level of utility, denoted by indifference curve 12: hence, a motivation for collusion. If firms cooperate, "ruinous" competitive innovation could be reduced or eliminated entirely; collusion would drive surprise out of the industry and, as a result, lessen uncertainty. A rate of innovation could be set which had the effect of increasing the present value of innovation and is consis- tent with the firms' preferences on uncertainty. The collusion case is also illustrated in Figure 5. Since uncertainty over rivals' strategies has been re- duced, the firm's IPC moves to the left and upward. If uncertainty about rivals is eliminated entirely, the curve, as in the case of monopoly, begins at the origin. In Figure Five, the firm is in equilibrium at point C. In terms of utility, this point is superior to point B where competition is unconstrained, but not to point A, the monopoly case, since the firm must share the rewards of innovative efforts with its fellows. The effect of such collusion is to reduce the firm's demand for new technolo- 8Y- The factors that encourage collusion of this sort are the same which encourage the traditional kind of collusion on price. These factors include fewness in the number of 50 firms, a mechanism for coordinating change such as domin- ant firm leadership, free flow of information between firms, and similarity in preferences and goals. e. Pre-Innovation Market Position There are two effects of sales and profit- ability on the firm's willingness and ability to innovate. The first is the possibility that a large market share in old product space may help the firm capture the profits accruing to an innovation; in other words, the value of n(T) is enhanced due to a favorable market position in the sale of old products. The well-established firm may enjoy the advantages of efficient channels of distribution or a well-known name. As a result, the firm may be able to achieve a high rate of sales of its innovations in a short time, or be better able to keep ahead of imitators and counter-innovators. Consequently, good pre-innovation market position may tend to increase the firm's demand for new technology. The second effect Of sales and profitability has to do with the cost of new technology. Entry into new product space by innovation is like entry into markets of already existing goods; in the latter, a certain minimum amount of capital is required to start up operation. However, new firms which must appeal to capital markets may find entry impossible: lenders tend to view new firms as risky and are apt to charge relatively high interest rates; indeed, if the capital requirements are very large, 51 new firms may not be able to secure the necessary loans at any interest rate. Profitable and well-established firms, on the other hand, are apt to have an easier time in deal- ing with the capital requirements for entry. Entry may be financed through retained earnings: in effect, the firm borrows from its stockholders, implicitly promising a greater return in the future. And if the firm does appeal to the capital markets, it is apt to secure loans on terms more favorable than those offered to the new firm. Similarly, entry into new product space requires the financing of a certain amount of new technology; the more radical the innovation, the greater the likely requirement. Small firms may have trouble overcoming the technology- requirement barrier to new product space; or they may be limited to relatively minor innovations. To be sure, the unpredictability of the technology-production function may offer fairly radical innovations whose cost is within the reach of firms with limited financial resources; in other words, the height of the technology-requirements barrier, due to the erratic nature of technology produc- tion, is variable. Nevertheless, there may be a tendency that high levels of sales and profitability encourage in- novation. As a result, the new technology demand curve of the prosperous, well-established firm may be greater than that of a lesser firm, ceteris paribus. 52 f. Market Demand for New Technology The market demand for new technology, in a given direction, is simply the sum of individual firm demands. 5. Demand for New Automotive Technology a. Preferences of the Firm It may be safely assumed the managements of the automobile companies are risk-averse. However, the degree of risk-aversion may vary from one management team to another. The presidency of Edward Cole at G.M. during the late 1960's and 1970's, for example, has been cited as being responsible for that firm's relatively progressive conduct with respect to the catalytic converter and the 21 rotary engine. In short, an auto firm's demand for new technology is affected by who is running the company. b. The Role of Capital Markets The discussion of the role of capital markets, which was presented in section four, needs no elaboration. c. Consumer Factors Most car buyers cannot readily judge the techni- cal merits of alternative design configurations. As a result, consumers tend to focus on styling and those en- gineering features which they easily perceive as adding to performance, convenience, or comfort. In other aspects of design, the incentive for the manufacturer is to select technology that minimizes the cost of production, subject to quality constraints. 53 Automotive innovation is sensitive to consumer in- come. To a great extent, real income determines the premium that consumers are willing to pay for an innovation. Premiums are necessary not only to reward the investment in new technology, but to cover the increase in production cost which usually accompanies quality-improving innova- tions. Clearly, quality and novelty are more important to wealthy buyers. It is not surprising, therefore, that most innovations have been introduced on the higher-priced car lines first. The record of firms such as Packard, Duesenberg, Stutz and Mercedes-Benz support this impres- sion. A large number of G.M.‘s innovations have been brought out on that firm's highest-price line, Cadillac. Moreover, a general rise in consumer income encourages innovation. The upgrading of cars during the 1920's and the decade or so following World War II, was no doubt en- couraged by the growing prosperity of most Americans. A decline, or perhaps merely a stabilization, of incomes makes innovation less attractive to firms. The bad economic conditions of the early 1930's, for instance, led G.M. to postpone the introduction of the automatic transmission to the end of that decade.22 The last consumer factors to be considered are the prices of other goods. General equilibrium analysis teaches that the prices of all substitutes and complements affect the profitability of innovation. 54 However, in anticipation of the following chapters on alternative automotive engines, it is worthwhile to re- strict attention to just three prices. The most important substitutes for an innovation are the goods or design con- figurations which it seeks to displace; in the case of alternative engines, this is the price associated with the :unv dominant design configuration, the Otto cycle, inter- nal combustion engine. The most important complements of automotive engines are fuel and maintenance services. It is noteworthy that historically low fuel prices in the United States have influenced American engine design. As early as World War I, differences in American and Euro- pean practice were apparent. After noting the higher price of gasoline in Europe, one prominent automotive engineer in 1921 remarked: American cars have sold and are still selling in EurOpe in large numbers, because they have a great reputation for reliability, and they can always be bought from stock, but they do not show to such a great advantage in EurOpe as in America. The reason for this is that their engines are, from the Euro- pean point of view, too big for the performance obtained from the car. In other words, they consume too much gas. Other articles of similar content may be found in later editions of automotive trade journals. It was not surprising, therefore, that the most fuel-efficient car sold in the U.S. during the 1970's was designed in West Germany instead of Detroit.24 55 d. The Presence of Rivals in New Product Space Although their position has been threatened in recent years by foreign auto-makers, the Big Three have dominated the U.S. automobile market throughout the post- war era. Collusion is not unlikely in such a tight oligopoly; indeed, tacit collusion on pricing appears well- established, with G.M. in the role of price leader. It is now argued that product competition has also been restrained by tacit collusion. The lessening of un- certainty and the easing of the downward pressures on profits due to competition are the goals of such collusion. Its effect is to reduce the industry-wide demand for new technology. A review of the industry's history is enlightening. The industry's history can be divided into three parts. During the first, which may be called the formative era, the industry was made up of many firms; barriers to entry were low and no firm dominated the industry. (This period came to an end by the First World War. The formative era was followed by the early oligOpoly; during this period the industry came to be dominated by three firms; in addi- tion, however, there remained a fringe of smaller firms; entry by this time had become difficult, if not impossible. The early oligopoly was followed by the mature oligopoly. The boundary between these periods is not distinct; the years between the mid-thirties and early fifties are ones of transition. The structural evolution of the industry 56 is not especially noteworthy in itself: its significance is the resulting impact on industry conduct. The striking features of the formative era were the great uncertainty of doing business and the individual firm's powerlessness in coping with it. Product innovation was fast-paced. Frequent and extensive redesign meant relatively large expenditures for new dies, jigs, templets, and machinery. Success in picking the right design seemed to depend as much on luck as insight, and the firm could not rely for long on consumer loyalty.25 No doubt many producers would have preferred an easier life. But collective restraint was made impossible by the ease of entry and the large number of firms. To make mat- ters worse, some firms seemed nearly indifferent to risk, as Benjamin Briscoe, an important automotive pioneer, once recalled: In the spring of 1908, the conditions that confronted the automobile industry were thought by some of us to be somewhat ominous, especially for such concerns as had large fixed investments in plants, machinery, tools, etc. Not a few of the concerns of the day were run by what might have been called "manufactur- ing gamblers." In many cases, the management had adopted methods that were described as "plunging." In fact we all plunged, and conditions came about which were thought by some of us to predicate disaster. The influence of several companies was always exciting and sometimes disturbing. The business of even the sanest among the manufacturers was influenced by them, for they had to submit into business risks which they would not have entered had they not been fearful that some other concern would gain a few points on them.2 57 Uncertainty, the powerlessness of firms, and the in- tense competition between them, combined to make market shares highly unstable; of the top ten sales leaders in 1903, for example, only one (Ford) remained a leader in 1924.27 That firm conduct contributed to the instability of market positions is a fact that cannot go unstressed. Firms made product decisions independently of each other and, as a result, there was a great diversity in product policies. Such diversity, with the usual fickleness of consumer preferences, made instability inevitable. Now consider competition during the early oligopoly. By World War I the industry had become highly concentrated; the interdependence of market shares became keenly felt. Moreover, smaller firms were falling by the wayside, and high barriers to entry prevented a replenishment of the ranks. However, the evolution of conduct lagged behind that 28 of structure. There appeared to be little or no col- lective behavior to constrain competition. Moreover, each major firm asserted a distinct brand of product policy. Ford was dedicated to the production of low-price cars. Styling and change for change's sake had little place in the firm's product policy. Henry Ford himself: We cannot conceive how to serve the customer unless we make him something that, as far as we can provide, will last forever. It does not please us to have the buyer's car wear out or become obsolete. We want the man who buys one of our products never to have to buy another. We never make an iggrovement that renders any previous model obsolete. 58 At Chrysler, excellence in engineering was emphasized. During the twenties the firm was prominent in the deve10p- ment of more powerful engines and the use of design configurations formerly seen only on more expensive makes. Chrysler was responsible for a number of innovations such as the use of rubber in the mounting of components and for insulation, rust-proofing, and advances in transmission design. The aerodynamic body and the scientifically de- signed suspension system of the 1954 Chrysler Airflow were the classic examples of the firm's zeal for engineering.30 That car, because of its radical nature, was singled out by G.M.‘s Sloan as not the way to build mass-produced automo- biles. Chrysler's RED laboratories were praised in the 31 To be sure, Chrysler press on a number of occasions. did not ignore styling as an element in the selling of automobiles, but it was clearly subordinated to engineer- ing. General Motors' product policy, on the other hand, stressed "the very great importance of styling in selling."32 This was by no means a novel or revolutionary idea when it became part of G.M.‘s product policy during the early twenties. G.M.‘s contribution was a refinement and un- precedented mass-market application of this approach. Styl- ing changes were relied upon to ”create a certain amount of 33 dissatisfaction" among the owners of older cars. G.M. certainly did not ignore engineering improvements in car 59 design, but in this area the corporation's policy was con- servative. Alfred P. Sloan wrote: The policy we said was valid if our cars were at least equal in design to the best of our competitors in a grade, so that it was not necessagy to lead in design or run the risk of untried experiments.34 When such differences in product policies exist, the stage is set for a reallocation of market shares. In 1907 Ford was the maverick by bringing out a low-price car. That decision enabled Ford to capture over 50 percent of the market by 1920. But by the mid-twenties, the demand for new, cheap cars had been largely exploited; by then a large stock of used cars offered a good alternative to the purchase of a new car, even a Model T. The selling of new cars increasingly became something more than providing "basic transportation." The product policies of General Motors and Chrysler were more in line with the market's demand for something new and, consequently, both firms surpassed Ford in sales. Conduct in the mature oligopoly has been of a differ- ent sort. Here the product policies of the major firms are remarkable for their similarities. This had become apparent by the late fifties. In 1958 George Romney, president of American Motors, noted that there was a "con- centration of the three largest companies on the same product philosophy," yig., that of General Motors; Romney added: Ford's adoption of General Motors' product policy was gradual but became complete in the period of Ford internal reorganization following World War II. 60 Chrysler, under its present management recently adop- ted it, and gave it full expression with the forward look and fins . . . . Now that wasn't conspiracy. It wasn't the result of anything other than the other two doing what the champ had done, and the result is that there has been a concentration in that area.35 In contrast to the formative era, decision-making on product design is highly interdependent. Imitation, with a conservative degree of differentiation, has been the rule. Recent statements by the Big Three's tOp stylists are enlightening. Asked by Automotive News in 1978, "Do you try to be different from General Motors?", Gene Bordinat, top stylist at Ford responded: As a matter of fact, we have enough G-Z, as they do, to know what they're doing, frequently not early enough for us to do anything about it. We strive not to an In stylist be like them and not to be too far from them. It's interesting balance. They do the same thing.36 another interview, Automotive News asked the head at Chrysler, Richard G. Macadam, "Whom do you rate among your chief competition?" A. I don't worry a lot. I certainly maintain a very careful and complete awareness of General Motors. You just can't ignore them with 55, 56, 57 percent of the market. If they introduce something that deviates from the norm at all, they're going to saturate the market with it in one year flat, and it's going to have a significant effect and influence on people's perception and values and taste in automotive products. So we've got to be extremely aware of what they're doing. When Bill Mitchell makes statements about his leadership, it's not just big leadership, it's the corporation's leadership. It's their ability to saturate. Will Dick Macadam and Chrysler Design Spring any surprises on the industry in the next few years? Do you have anything up your sleeve? 61 A. Oh, I guess I do. I wouldn't want to disappoint the public. We'll keep everybody alert. G.M. needs an occasional challenge and we'll do what we can. It is noteworthy that Bill Mitchell, in charge of G.M.‘s styling between 1958 and 1977, placed considerably less weight on the designs of his competitors. "I would never c0py an American car," he once said. "I would be em- barrassed."38 Nor was the self-confident Mitchell any more enthusiastic about consumer surveys as a guide to new styl- ing: ”I have contempt for surveys. I've told everybody from Donner (G.M. president during the late fifties) on down, 'Why ask people what they like when they don't know what the hell they want?'"39 As these statements imply, G.M. has been the industry's product leader during the post-war period; its leadership in the product area, moreover, appears as consistent as in the setting of prices. G.M. has initiated most of the major changes in car design over the last thirty years. These changes include the introduction of high-compression V-8 engines, stylistic features such as tail-fins and wraparounc Windshields, the introduction Of compact and intermediate-sized cars, changes in the pace of styling modifications, the catalytic converter, the "downsizing” of cars in the 1970's, and the introduction of diesel engines. More often than not, the lesser firms have followed G.M. or have been careful not to differ very much from the leader's policies. As a result, a pattern of parallel product de- velpment has emerged. 62 This parallelism goes beyond that of an unconcentrated industry where firms react in a similar way to change in market conditions. In the mature oligopoly, parallel be- havior has the added dimension of avoiding the lower profits and greater uncertainty of unrestrained competition. That parallelism has lessened uncertainty in the industry is shown by the fact that since the adoption of a common prod- uct policy in the 1950's, there has been no significant shift in the relative market shares of the Big Three. As a result, product parallelism reduces the demand for new technology. Imitation calls for the restraint of counter-innovation; experimentation with the unorthodox is discouraged. Moreover, collective uncertainty-avoidance urges a modest pace of technological change for the in- dustry in general. e. The Firm's Position in Pre-innovation Product Space This factor refers to the relevance of the firm's sales and profits before innovation. Does G.M., for in- stance, have a greater incentive to innovate, and does it tend to demand more new technology than its lesser rivals because of its superior revenues and profitability? Obviously, G.M. spends more on RED than its rivals, and this may be a result of high revenues and profits. However, some exenditures are due to the larger number of car lines that G.M. carries; to some extent, each line requires separate development. Therefore, it is neces- sary to look at G.M.‘s RED on a relative basis. Table 3 63 presents RED figures as a percent of sales for the domestic automakers between 1967 and 1978. Expenditures relative to sales for G.M. and Ford are nearly identical, while those of Chrysler and American Motors are much less. A correction must be made for differences in vertical integration. That is, the amount of new technology that goes into the cars of the smaller, and less integrated, firms tends to be understated by RED as a percent of sales: the smaller firms tend to rely more on vendors for compon- ents, materials, and hence for new technology; their larger rivals do more of their own component development. This being so, RED figures as a percent of value added are re- quired; these data are presented in Table 4.40 Table Four defies easy interpretation. If size and profitability encourage innovation, it would be expected that RED as a percent of value added (RED/VA) would be greatest for G.M., somewhat smaller for Ford, and smaller still for Chrysler and A.M.C. This pattern is not ob- served: over the period, RED/VA for Ford averaged higher than that of G.M.‘s; and in recent years, Chrysler's RED/VA has exceeded G.M.‘s. Moreover, it is unfortunate that except for one year, 1974, the figures for A.M.C. are not strictly comparable with those of the larger firms. In short, the data do little to encourage the hypothesis that Sales and profitability tend to increase the firm's demand for new technology and its inclination to innovate. 64 TABLE 3 RED Expenditures as a Percent of Sales Year G.M. Ford Chrysler A.M.C. 1967 3 3 3.1 l 2 -- 1968 3 l 2.5 l l -- 1969 3 2 2.8 l 3 -- 1970 4 3 3.0 l 2 -- 1971 3 2 3.1 l l -- 1972 3 l 3.1 l -- 1973 3.0 3.6 1.3 -- 1974 3 4 3.6 l 4 l 9 1975 3 l 3.1 1 7 l 6 1976 2 4 3 2 1.8 l 7 1977 2 6 3.1 l 7 l 9 1978 2 6 3.4 2 5 l 9 AVERAGE 3 l 3.1 1 5 l 8 Sources: Chrysler Corporation, "Request for Suspension of the 1977 HC and CO Emission Standards," January 1975; Ford Motor Company, "Application for Sus- pension of 1977 Motor Vehicle Exhaust Emission Standards," January 1975; General Motors Corpora- tion, "General Motors Request for Suspension of 1977 Federal Emission Standards," January 1975; Annual Stockholders Reports, 1976-1978. 65 TABLE 4 RED Expenditures as a Percent of Value Added Year G.M. Ford Chrysler A.M.C 1967 6.3 7.8 3.0 -- 1968 6.0 5.9 2.6 -- 1969 6.4 6.8 3.4 -- 1970 8.6 7.0 3.1 -- 1971 6.1 7.1 3.7 -- 1972 5.9 7.2 4.0 -- 1973 5.4 8.3 3.1 -- 1974 7.2 9.5 3.8 5.6 1975 6.6 8.4 6.4 6.1* 1976 5.4 8.0 6.3 6.2* 1977 5.3 6.6 5.0 6.6* 1978 5.3 8.8 7.6 6.4* AVERAGE 6.2 7.7 4.4 6.3* *Not strictly comparable with other figures Source: Same as Table 3 66 However, it is clear that high cash flows give dis- cretion to managers. Ultimately, the decision to spend an extra dollar on RED or to give it to stockholders depends on the preferences of stockholders on dividends today versus dividends tomorrow; these preferences are largely influ- enced by rates of return on alternative investments. It is possible stockholders exhibit diminishing marginal utility on dividends today in the sense that after more and more dividends are paid out, it becomes easier for management to hold back a sum that can be devoted to RED. As a result of higher profits, G.M., and to a lesser extent Ford, have been less constrained than Chrysler and A.M.C. in setting RED expenditures. It is not surprising that Richard Terrell, vice-chairman of General Motors, denied that there is any fixed percent of revenues which is automatically assigned to RED. Instead, Mr. Terrell insists that the amount of money that goes into RED "evolves from the effort we HERE to put forth."41 In contrast are the following testimonies of the president and chief engineer of Chrysler; note the emphasis on economy and necessity: Mr. Riccardo: I want to clarify an issue of money here today because our figures will not be very dramatic when compared to General Motors. But, Senator, this has been our life all along. We have never spent the money in engineering and research that either Ford or General Motors has done. We don't believe that money alone solves problems. I think the Federal Government can prove that. 67 It is our position that we have more innovations in the field of emission controls and we have as many or more than our share of innovations in any engineering part of the automobile than our competitors. We have done that, Senator, with very restricted bud- gets compared to them. We don't make anywhere near their profits. Obviously we cannot afford to apply the same resources, but a comparison of dollars in the cold light of day does not tell the story. We have to be emphatic about that point. We get a lot for our money . . . . Senator, I would like my top engineer who runs my engineering department to speak on the adequacy of what he thinks his budget is. Mr. Loofbourrow: It has always been my experience with the operation at Chrysler Engineering that the corporation has been very liberal in supplying funds for what we feel is necessary to get the technical work that we need to do. As Mr. Riccardo has indicated, because of the differ- ences in profits and size we have had to, over the years, use a different engineering approach. You don't have to be real good technically to build samples of every idea that comes along and try it and find it won't work. This takes a better engineering technical skill to do this. It takes a lot of self-confidence as well. This is our lifeblood. It is how we stay competitive. We have done this over the years. We have looked at every alternative or modified engine that anyone has suggested. These suggestions that come in literally are hundreds. We have looked at every one. We make math models of some of them to find out how they run, run them through the computer. This is an economical way of doing it.42 Were it not for indivisibilities in the introduction of new technology (i.e., progress comes in the form of "chunks" of techtils called innovations), profits and revenues would be of little consequence. If indivisi- bilities were absent, even tiny firms, with limited financial resources, could afford the cost of entry (the 68 price of one techtil) into new product space. While this is not the case, it is a mistake to jump to the comple- mentary conclusion that firms with large revenues and profits are "an almost perfect instrument for inducing technical change."43 While the ability to overcome in- divisibilities plays a role in determining the firm's demand for new technology, the willingness of the firm to accept uncertainty is as critical. 6. Equilibrium Output of New Automotive Technology In any market, equilibrium price and output are deter- mined by the interaction of demand and supply. So too in the case of new automotive technology. The extension of supply and demand analysis to new technology involves a higher degree of abstraction in comparison to the analysis of well-defined markets such as wheat or gasoline. The unit to measure technology is imaginary, the "price" for new technology is apt to be invisible, and the nature of supply is probabilistic. Nevertheless, the extension of supply and demand analysis to new technology is helpful since the factors that affect the output of new technology can be clearly indicated. Activity in the market for new automotive technology does not have the impersonalness of perfect competition. In any given direction of new automotive technology, there are too few sellers and certainly too few buyers to satisfy the conditions of perfect competition. Therefore, 69 modifications of the model are required to take market power into account. While there may be occasions of bilateral market power, the bulk of the bargaining power is on the side of the technology-buyers, i.e., the automakers. This power is based on the high concentration in automobile production and high barriers to entry. Since a unit of new automotive technology has no value until embodied in the final product, firms that produce the technology must turn to the auto- makers. With respect to vendors, the automakers can threaten to stOp or reduce purchases of existing components and raw materials if new technology is not supplied on favorable terms. It is noteworthy that a Ford vice-president in charge of purchasing once stated that "Ford suppliers re- ceive constant encouragement from the company's purchasing activity to step up their RED programs . . . . Suppliers who maintain progressive RED activities and who contribute to the improvement of Ford products are the suppliers most frequently asked to bid on the company's requirements."44 The threat to withdraw sales is serious, since a vendor may not be able to offset the loss quickly by sales to another automaker. Moreover, since the Big Three are integrated backwards into the production of not a few com- ponents and materials, the potential substitution of in-house production further enhances the automakers' lever- age; this backward integration also extends to technology 70 production itself. To be sure, the automakers may have more bargaining power with some vendors than others and, over time, the relationships may change. However, in general, this is a case of monopsony--or more precisely, oligopsony--where the buyer(s) can sway the terms of trade to their own liking. As Figure 6 illustrates, theory predicts a restric- tion of output with monOpsony as compared to the competitive case; the monopsonist increases his profits at the expense of sellers by forcing a lower price than would occur under competitive conditions. As a result, sellers reduce output. It is suspected that there is a second effect of monop- sony power in this particular case. By tying the purchase of current inputs to the production of new technology, the automakers may be able to force the vendors' supply of new technology to the right. Vendors are often eager to conduct RED to keep good relations with the automakers; they are apt to view technology production as a form of non-price competition instead of a line of business in it- self. This is not to say the effect of a restricted quan- tity supplied due to a monopsony price is absent: it and the supply-increasing effect may both be present. Figure 7 illustrates. 5' represents the new technol- ogy supply curve for vendors under the assumption that supply-increasing effect is present. While in Figure 7 the equilibrium output is less than that predicted for competitive conditions, this may not be true: 71 "Price" Marginal Expense of Technology Svendors I l I p ...... _J-_-_ c I l I l I l I P __._ _ ‘ __‘._ - I m I I I I I I I I I I I 1 . D . I I I Techt'l t qm qc 1 5/ FIGURE 6 Output-Depressing Effect of Monopsony ”Price" 72 MET MET' S S! D Techtils/t FIGURE 7 Output-Increasing Effect of MonOpsony 73 conceivably, 8' could be much more to the right than pictured. Also note that if the automakers use their bar- gaining power to drive down the price of new technology, this, by itself, continues to restrict the quantity supplied. Figures 6 and 7 represent the pure monopsony case. To the extent that the market power is weakened by there being several instead of one buyer, or due to coun- tervailing power on the sellers' side, the equilibrium output of new technology from vendors is apt to be closer to competitive level. If the automakers' market power shifts the technology supply curves of vendors to the right, the total supply of new automotive technology increases by the same amount. However, it is also possible the automakers, to at least some extent, merely substitute the RED work of vendors for that of their own RED departments. A strong incentive to do so is the shifting of the uncertainty of technology pro- duction to the vendors; this would be consistent with the automakers' aversion to risk. This substitution may be so extensive that any increase in the technology supply of vendors is completely offset by a lessening of effort by the automakers. Whether the automakers have a similarly decisive power in dealing with inventor-firms is not clear. On the one hand, inventor-firms, unlike vendors, are not threat- ened by the loss of current sales. On the other, barring entry into the product market, the inventor-firm must sell 74 its technology if a profit is to be made. If an inventor- firm has an economic monopoly on a new concept and secure prOperty rights, it is conceivable that even if the firm faced a small number of buyers, it could secure the monopo- 1y price. Still, concentration on the buyers' side could force a lower price, especially if there was collusion. Is there collusion among automakers to keep the price of outside inventions down? Unfortunately, evidence on this matter is scanty. One case of overt collusion to control competition in the acquisition of pollution-control patents and licenses occurred during the 1950's and 1960's. A document of the Automobile Manufacturers Association, dated May 10, 1954, stated: Heinen [of Chrysler] asked whether a company coming across a satisfactory device either submitted by an inventor, deve10ped during the course of normal company research, or during the course of (VCP) Subcommittee studies should make the device and its details known to the other companies participating in the Subcommittee work. The alternative, of course, would be for the company to say nothing and then "scoop" the other manufacturers with an anti-smog device. In view of the common importance of the smog problem to all of the companies and in view of the satisfactory COOperative nature of the work thus far, the individual company approach was not generally favorable. However, it was recognized that very serious legal problems might be involved in the co- operative acceptance and review of devices.45 The threat of antitrust prosecution did not deter the automakers from adopting a cross-licensing agreement in April, 1955. This agreement required royalty-free cross- licensing of six categories of devices; in addition the firms agreed to share the cost of obtaining patents from outsiders; a "favored nation" clause was also included, in 75 which outsiders were forced to license all members to the agreements at the same royalty rate. These provisions eliminated competition in the purchase of inventions. This anticompetitive arrangement remained in effect until chal- lenged by the Justice Department in 1969. This episode no doubt is an exceptional case. But an exception from what? Perhaps it was an overt expression of normally tacit collusion; or possibly the norm is fairly vigorous competition. Ralph Nader, to whom many small-time inventors have turned, believes the auto companies are not eager for the ideas of outsiders: As far as the consideration of outside technology is concerned, the domestic manufacturers will not review the disclosure of unpatented technology unless the inventor signs a submission agreement which negates any potential obligation of the manufacturer. Many inventors are completely frustrated by this artifi- cial barrier to technological consideration and inno- vation, and refuse to cooperate further with auto manufacturers. Copies of inventor correspondence showing this fact are submitted for the hearing record along with a staff memorandum analyzing this correspondence. Obviously most of these inventors are warded off with being told that this has to clear the offices of legal counsel first. The road to technological feasibility is not through the doors of legal counsel. Even when legal counsel is involved, inventors who have pro- gressed this far are frequently given such short shrift that the principles of the invention are not even un- derstood by the representatives of the auto industry evaluating the invention.4 Nader also points to a General Motors pamphlet that states G.M. "does not solicit ideas" or "does not in any way 35k people to make submission."47 76 G.M. maintains that this language is required for legal reasons, and is not designed to choke off the contri- bution of outside inventors: It is essential to protect the public and General Motors, that the legal rights and obligation asso- ciated with technological suggestions be defined accurately at all stages of the procedure. Some legal decisions have suggested that solicitation of suggestions by a business concern creates some obli- gation to make payment therefore. It is impossible for General Motors to know the worth of any sugges- tion in advance of its submission and it cannot incur such obligations. Therefore, to avoid any possible contention that General Motors is soliciting tech- nological suggestions, the formal papers associated with submission of such suggestions affirmatively state that General Motors does not solicit ideas or ask people to make suggestions.48 It is not clear whether submission agreements are anticompetitive devices or are merely an unfortunate drawback of our legal system. The author is inclined to support the latter view. 7. Possibilities for Technological Suboptimization Now consider suboptimization in automotive technology. a. Type I Suboptimization Type I suboptimization occurs when more than a necessary minimum of resources are sacrificed to produce a given amount of new technology. The major cause of Type I suboptimization is insufficient competitive pressure. As far as the automotive vendors are concerned, Type I suboptimization seems unlikely. Competition among vendors for sales to the automakers is strong; the production of new technology by vendors is used to maintain current sales 77 and to promote future ones. Moreover, the market power of the automakers probably enforces the vendors' efficiency in the production of new technology. Type I suboptimization by inventor-firms also seems unlikely or trivial. Inventor-firms must be quick to pro- duce patentable new technology if a profit is to be made; the number of inventor-firms and the relative ease of entry in the production of unrefined new technology would seem to discourage inefficiency. Furthermore, the market power of the automakers may also force inventor-firms to be effi- cient. The RED departments of the automakers, however, are subject to less pressure than either vendors or inventor- firms and this makes Type I suboptimization more likely. After all, they represent "captive plants" of their firms' car-producing divisions, and may have less incentive to sell their ideas to these divisions than outsiders. Unfortunately, it is difficult to reach a firm con- clusion about Type I subOptimization at the auto companies. It is interesting to note, for instance, that during re- cessions the automakers tend to cut their RED budgets: this may indicate a tightening of cost-controls in RED programs. On the other hand, the cutbacks may not mean an increase in efficiency but a reduction of marginally important research projects. Another factor is the internal competition in the firms' RED departments: this may be strong enough to enforce efficiency. In short, more information is needed. 78 Finally there is the matter of "defensive” research and develOpment. Defensive RED is defined as technology- production whose purpose is to protect the firm's future market position from potential entrants or to put the firm in a more favorable bargaining position in the purchase of new technology. To the extent that defensive RED merely duplicates the units of technology already produced by others, it is, from the social point of view, wasteful, and is a form of Type I suboptimization. Nevertheless, RED work whose supposed object is merely defensive may fortu- itously result in socially useful technology. And the defensive RED of a firm puts pressure on challengers and, as a result, forces them to invent efficiently. Defensive RED is not uncommon in the auto industry. For example, some of the automakers' efforts to develop the catalytic converter appeared to be defensive. One official of Universal Oil Products, an early leader in the develOpment of catalytic devices, complained in 1971 that the automakers were largely duplicating the work already done by his firm. "This is traditional with Detroit," he said. "They want to have their own in-house solutions to problems if they can. They don't like to have one source of supply for anything. Detroit is stalling to see if they can do in a couple years what took us a decade to do."49 In short, if Type I subOptimization exists in the automotive technology market, it is most likely associated with the automakers since their RED departments appear less 79 subject to competitive pressure than other technology pro- ducers. Also, Type I suboptimization may be more prevalent at the more profitable firms because there is more room for organizational slack; admittedly, this may be putting the cart before the horse in the sense that higher profits may be the result of better cost control. Finally, Type I suboptimization may be present due to purely defensive RED activity. b. Type II Subgptimization Type II subOptimization is zero when the vector of technology production and use is such that no other vector results in a greater increase in social net benefits. Assume (1) that time is divided into two periods, "present" and "future"; (2) that the costs of producing new technology and setting up for its use are incurred in the present; (3) that the benefits of innovation are not re- alized until the future; (4) that the vector of technology production and use is one-dimensional, i.e., technology is homogeneous; (5) that externalities are absent; and (6) certainty prevails. The addition to social net benefits due to innovation is equal to the change in consumer surplus plus the change in producer surplus. Depending on the underlying social welfare function, the division of the new social net bene- fits may be important. Assume, however, that society is indifferent to how the division is made; that is, social 80 welfare remains unchanged if a dollar of consumer surplus is transformed into a dollar of producer surplus. In such a world, the rate of technology production and use, T, is Optimal if the present value associated with that rate, given by fC(T) + fP(T) (1 + 1‘) (1) PV = ' C(T), is a maximum. Here fc(T) and fp(T) represent the change in consumer and producer surpluses due to the introduction of new technology; C(T) is the total cost of technology pro- duction and set-up; r is a time rate Of discount. 'Moreover, C'(T) is greater than zero with C'(T) + w as T + m. It also is reasonable to assume that after some point the change in surpluses becomes subject to diminish- ing returns, i.e., f'c(T) and f'p(T) become small, and perhaps, even negative. As Figure 8 illustrates, these conditions imply a socially Optimal rate of technology production and use, denoted by T*. Whereas the social calculation must include both pro- ducer and consumer surpluses versus cost, the private calculation includes only the producer surplus. The firm seeks a rate of technology production and use which maxi- mizes the value of f .(T.) (2) PV. = _P.L_L - C.(T.). 1 1 1 (1 + r) 81 Here fpi and Ci(T) are the producer surplus and new tech- nology cost functions for the individual firm; Ti is the new technology introduced by the firm. The socially optimal rate of technology production and use requires that .ngi = T*, where n is the number of in- novating firms. 1- It is clear that if a firm enjoys a monOpoly in the use of new technology (n = l), the rate of technology pro— duction and use is less than T*. Unless the monopolist is able to impose a costless form of perfect price discrimina- tion, some part of the social net benefits will escape and emerge as consumer surplus. As a result, the equilibrium rate of technology production and use, when the end-use is controlled by a monopolist, is less than the socially de- sirable rate T*; denote this monopoly rate as Tm' Compare this outcome with that associated with com- petition, i.e., n 2 2 and with no collusion. While a monOpolist must take into account the impact of an inno- vation on the profitability of his other ones, the competitor does not care if an innovation has the effect of reducing the profitability of rivals. Innovations that are substitutes are apt to be offered by the various firms; competition of'a familiar nature takes place with the result that producer surpluses fall while consumer surplus- es rise. Unlike the technology-monopolist, firms in competition are unable to profit from a contrived scarcity of technological alternatives; the rate of return on the 82 C'(T) cfc'+f'p) (1+r) f! (1+r) '-------- Tm T* Techtils/t FIGURE 8 Socially Optimal Rate of Technology Production 83 investment in new technology for each firm will tend to be smaller than that of technology monopolist. While the con- tribution of the individual firm may be smaller as a result of this lower rate of return, the total contribution of firms under competition, Tc’ will be greater than Tm. But will TC equal Ti*, the socially Optimal rate? Or, in other words, if competition cuts the rate of return to some minimum, is that rate a satisfactory incentive for the introduction of T* units of new technology per unit of time? The answer is no. The private calculation on innovation, even under competition, is still based on only part of the new net social benefits of innovation, yi§., the producer surplus which the firms are able to capture. The firm will find it worthwhile to innovate as long as this competitive rate of return is not less than the Opportunity cost of in- vesting in new technology which is equal to the present rate of return in the capital market. This being so, the market system, even under the most ideal conditions, will under-allocate resources to technology production and use.50 The situation becomes more complex when the assumption on certainty is relaxed. Professor Arrow has concluded that while "the economic system has devices for shifting risks" . . . "they are limited and imperfect; hence, one would expect an underinvestment in risky activities." Professor Arrow adds that "risky business activities, in- cluding invention . . . should be undertaken if the 84 expected return exceeds the market rate of return, no matter what the variance is." . . . "Hence any unwilling- ness or inability to bear risks will give rise to a non- optimal allocation of resources, in that there will be discrimination against risky enterprises as compared with the optimum."51 In short, uncertainty creates a tendency for the market system to underallocate resources to risky ventures. The rate of new technology production and use is apt to be less than the socially Optimal rate. Furthermore, if uncertainty- avoidance is an argument in managerial utility functions, and if collusion among firms is feasible, the degree of suboptimization is increased. Another factor deserves attention: the socially Op- timal time-rate of discount. Firms make a comparison between the rate of return on innovation and the present market rate of return. Although suboptimization may already be present due to uncertainty, it may be worsened if the market rate of return is not the same as the social rate of discount. There is no reason to assume that the market rate of return is identical to the social rate of dis- count.52 The determination of the social rate of discount re- quires a political judgment. If the social rate of discount is lower than the present market interest rate, the implication is that the production and use of new technology is lower than socially optimal. Technological 85 opportunities with net social benefits would exist, but with returns too low to justify private exploitation. Finally, Type II suboptimization will result if ex- ternalities are present. There may be spillover benefits which the firm cannot appropriate: this is a "free rider" problem. There may be negative externalities due to tech- nology production and use. If spillover benefits are present, there will be a tendency for too little technology production and use; if negative externalities are present, the Opposite is true. What are the possibilities for Type II suboptimization by the automobile industry? Obviously, what can be said about any industry applies here. Externalities in the production and use of automotive technology will not be taken into account by firms; a discrepancy between the rate of returns used by firms and the social discount rate causes a further distortion. The inability to capture all of the new net social benefits due to innovation results in further suboptimization. In the market for automotive technology, moreover, Type II suboptimization may be present due to the market power of the buyers. It is possible that a monOpsony effect is at work which results in a less than socially optimal rate of technology production; the monopsony effect, how- ever, may be offset by a supply-increasing effect. Uncertainty-avoidance product collusion by the auto- makers may be an important cause of Type II suboptimization. 86 The lesser firms tend to follow the product leader, G.M.; in the interest of stabilizing market shares, tacit imita- tion rather than truly differentiated product policies is the rule. As a result, the production and use of new automotive technology falls short of the socially optimal rate. c. Type III Suboptimization Type III subOptimization is the neglect of already produced technology which could increase social welfare. Type III subOptimization occurs when the profit incentive fails to perform its socially desirable role in promoting innovation. Four causes of such a failure can be identified. First, information about invention may fail to reach poten- tial innovators. Second, a commitment to older technology may encourage a firm to block the entry of new technology into the mar- ketplace. Consider this hypothetical example. A firm sells good X. Its research department comes up with a new good that in some respects is a superior substitute for X. The firm's econometrician reports that, although there would be a de- mand for the new good, introduction of it would reduce the demand for the firm's Old product: consequently, no in- crease in profit can be expected. Upon hearing the report, the firm's managers decide that innovation is not worth the trouble, at least at the moment. 87 The decision results in Type III subOptimization. Al- though the firm would be no better off, the welfare of at least some buyers would have risen with the offering of the new product. Note that the firm would have had the incen- tive to innovate were it not for the commitment to the older technology. A third possible cause of Type III subOptimization is collusion. A firm may hold back on innovation out of fear of retaliation by rivals; collusive agreements may replace independent decision-making in determining the timing of innovation. A fourth possible cause of Type III suboptimization has to do with the organization of the firm: this may be called the bureaucratic inertia hypothesis. A large and complex corporate structure may make it difficult for a firm to be an innovator. While the extreme division of labor and democratization of decision-making may be ad- mirable qualities in dealing with the status quo, they may very well discourage change. Bureaucratic inertia may pre- vent the firm from quickly exploiting the possibilities Opened up by invention: in other words, the organization of the firm may preclude long-term profit maximization. The available evidence suggests that collusion and bureaucratic inertia deserve special attention. A blatant example of Type III subOptimization due to collusion oc- curred with the develOpment of pollution control devices during the 1960's. As early as 1960, Chrysler had 88 perfected a system, the Cleaner Air Package, which could meet the demands of California state law. In a memo dated October 5, 1961, a Dupont executive asked a high-ranking Chrysler engineer why his firm did not seek certification of the Cleaner Air Package in California: While admitting that favorable publicity would result, he was very forceful in telling me that if this was done Chrysler would be severely chastised by the rest of the industry. He reminded me that the AMA agree- ment says no one company will gain any advantage because of smog, and that Chrysler was a relatively small cog in the industry. He indicated Ford and GM were calling the shots and implied that Chayne [GM vice president] was the industry mastermind." Although Chrysler nearly struck out on its own in 1964, the firm eventually bowed to industry pressure and joined G.M. and Ford in asking California to delay mandatory in- stallation of pollution control systems until the 1966 model year. Ironically, G.M. and Ford eventually adopted the concepts pioneered in the Cleaner Air Package.54 There is stront testimony to support the bureaucratic inertia hypothesis. One early student of the industry con- cluded that the small auto firms of the 1920's were not always at a disadvantage in competing with their larger rivals: While it is true that the large firm can maintain more elaborate experimental laboratories than the small, it does not follow that the capacity for profitable de- cision as to what changes to make in the product, and the time to inaugurate them, are in any way the pecul- iar property of the large corporation. The very fact that the enterprise 13 large may sometimes hamper the initiation ofgthese alterations in product and policy. In other words, "progressiveness," or what passes for it, in such an industry is not necessarily a function of size. 89 It is noteworthy that Alfred P. Sloan, of G.M., ex- pressed a similar Opinion: In practically all our activities we seem to suffer from the inertia resulting from our great size. It seems too hard for us to get action when it comes to a matter of putting our ideas across. There are so many peOple involved and it requires such a tremendous effort to put something new into effect that a new idea is likely to be considered insignificant in com- parison with the effort it takes to put it across. I can't help but feel that General Motors has missed a lot by reason of this inertia. You have no idea how many things come up for consideration in the technical committee and elsewhere that are agreed upon as to principal well in advance, but too frequently we fail to put the ideas into effect until the competition forces us to do so. Sometimes I am almost forced to the conclusion that General Motors is so large and its inertia so great that it is impossible for us to real- ly be leaders. Perhaps it would be safest for us to let the other fellow take the initiative and then be satisfied to follow him as best we can. It seems a pity, however, that with our resources and ability we can't be a little more aggressive. Despite modern managerial techniques, the problems which Mr. Sloan worried about in 1925 may still bedevil G.M. in the 1970's. Such is the view of John 2. DeLorean, who in 1972 unexpectedly resigned his position of executive vice-president at G.M. Like Sloan, DeLorean complained of the unresponsiveness and unwieldiness of G.M.‘s vast cor- porate structure: "You were getting all your input from lower-level specialists," he says. "They provided information in such a way that they would get the answer they wanted. I know, I used to be down below and do it. The feel- ing I started to get, being suddenly put on the four- teenth floor, was that now I was being presented with information that had limited alternatives. This is totally inconsistent with any thoughtful and creative originality. You never could reflect on and modify a proposal. You couldn't be a planner. You were too 90 harassed by committee meetings and paperwork--you just had tons of it. You were cut off from the outside world. You saw only the men on the fourteenth floor. The corporate hierarchy was just reacting to the de- mands of the organization and responding to some degree to the government and the public. It was like standing in the boiler room and tending a machine and you were just watching it instead of running it."5 The implications of bureaucratic inertia at General Motors are especially significant in view of that firm's role as industry product leader. 10. 91 NOTES National Science Foundation, Federal Funds for Research, Development, and Other Scientific ACtivities—(Washing- ton: U.S. Governmeqt Printing Office, 1966), p. 9. Ibid., p. 14. Ibid., p. 19. Jet Propulsion Laboratory, Should We Have a New Engine?, 2 vols. (Pasadena: Californ1a Instifute of_Technology), 2: 15-2. P. M. Heldt, Torque Converters or Transmissions (Phila- delphia: Chilton Co., 1955), p._18. The electric starter was invented by Charles Kettering's Dayton Engineering Company in 1911; an important im- provement in the electric starter, the Bendix drive (1913), was the first of many automotive innovations coming from the company of the same name. The Budd Co. of Philadelphia developed the first all-steel body in 1914. The first cheap colored lacquer, Duco, was largely developed by Dupont (1923). Gleason Works was responsible for the introduction of hypoid gears (1926). Automatic overdrive was developed by Borg-Warner (1934) while the vacuum-powered clutch was introduced by Ben- dix (1932). The Budd Company perfected the unitary body construction which was first used by Nash in 1940. For other early automotive inventions by vendors, see Ralph C. Epstein, The Automobile Industry (New York: A. W. Shaw Co., 1928), p. 17. U.S. Congress, Senate, Committee on the Judiciary, Sub- committee on Antitrust and Monopoly, Hearin 5 pp Administered Prices, Automobiles, 85t ongress, 2nd Sess., 1958, p. 2878. U.S. Environmental Protection Agency, Automobile Emis- sions Control (Washington, U.S. Government Printing Office, 19751, pp. 7-34. J. H. Hunt, "Opportunities in Design and Research in Automobile Engineering," Journal of the Society pf Automotive Engineers 22 (May I927TT 592. Lawrence J. White, The Automobile Industry Since 1945 (Cambridge, MA: Harvard University Press, 1971), p. 212. 11. 12. 13. 14; 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 92 An exception is the oil companies whose officials keep in close contact with counterparts in the auto industry. Because of the close relation between fuels and en- gines, the oil companies have long been active in the develOpment of better automobile engines. Detroit Free Press, May S, 1978, p. 43. Business Week, June 28, 1976, p. 67. Alfred P. Sloan, My Years with General Motors (Garden City, NY: Doubleday and Co., Anchor Books ed}, 1972), p. 289. Ibid., p. 297. Interview with officials of the General Motors Corpora- tion, August 28, 1975. Ford Motor Company, ”Application for Suspension of 1977 Motor Vehicle Exhaust Emission Standards," Janu- ary 1975, section XI, p. 14. Chrysler Corporation, "Request for Suspension of the 1977 HC and CO Emission Standards," January 1975, section II-A, pp. 36, 38. Jet Propulsion Laboratory, pp, cit., 2: 15-2, 15-3. U.S. Congress, Senate, Committee on Public Works, Hearin s on the Decision of the Administrator of the EPA Regardin the SuspensiOn pf the 1975 Auto EEiEEiOn Standards, 9 rdTCOng., lst sess., May 1973, pp. 1330-1; also see U.S. Congress, House, Subcommittee on Space Science and Applications of the Committee on Science and Astronautics, Hearin s on Research on Ground Pro- pulsion Systems, 93rd Cong.T—2nd sess.,—UUne 19747—— p. 445. Gregg Condaeracci, "Edward Cole May Be Last of Dying Breed in Automotive World," Wall Street Journal, Feb. 5, 1974, p. l. Sloan, pp. cit., pp. 269-270. Maurice Olley, "Comparison of EurOpean and American Automobile Practice," Journal of the Society pg Auto- motive Engineers 16 (August I921): 111. The car was the Volkswagen Rabbit equipped with diesel engine. See U.S. Environmental Protection Agency, 1979 Gas Mileage Guide. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38. 39. 93 For a more complete account of this period see Ralph C. Epstein, "The Rise and Fall of Firms in the Auto- mobile Industry," Harvard Business Review 5 (January 1927): 157-174. L. H. Seltzer, A Financial History of the American Automobile Industry (Boston: HoughtOfi Mifflin Co., 19231, PP- On the instability of market shares during the forma- tive era see Ralph C. Epstein, "Leadership in the Automobile Industry," Harvard Business Review 5 (April 1927): 281-292. It is interesting to speculate whether this is a gen- eral tendency in industry. If so, it may account for the apparently weak relation between structural and conduct variables in some industries. Henry Ford, M Life and Work (Garden City, NY: Garden City Publishing Co., 1922), p. 149. For details on this remarkable car see Howard S. Irwin, ”History of the Airflow Car," Scientific AmeriCan 236 (August 1927): 98-106. See A. F. Denham, "New DeSoto Reflects Chrysler Engin- eering Practice," Automotive Industries 59 (August 4, 1928): 149-152; idem., "New Chrysler Laboratories Fitted with Ingenlous Test Devices," 59 (July 21, 1928): 82-84; and "Chrysler Corporation Opens Two New Laboratories," AutomOtive Industries 83 (July 1, 1940): 8. Sloan, pp. cit., p. 310. Ibid. Ibid. Emphasis in the original. U.S. Congress, Senate, Committee on the Judiciary, Subcommittee on Antitrust and MonOpoly, Hearings pp Administered Prices, pp. cit., p. 2973. Automotive News, April 4, 1978, p. 49. Ibid., October 17, 1977, pp. 15, 20. Detroit Free Press, October 31, 1976, p. 10. Automotive News, June 27, 1977, p. 18. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 94 Value added for the Big Three and, for 1974 only, for AMC is based on percent of sales revenue to suppliers. After 1975, AMC did not present such a breakdown in its reports; for 1975-1978, value added for AMC was taken as being equal to the sum of net income before taxes, employee compensation, interest, and depreciation. The author believes that this alternative calculation re- sults in a higher VA/S figure than the other method somewhere on the order of one—half of a percent. Business Week, June 28, 1976, p. 56. Emphasis added. U.S. Congress, Senate, Committee on Public Works, Hearin s on the Decision of the Administrator of the EPA Regarding_the SuspensiOn of the 1975 Auto EEiEEiOn Standards, pp. p13,, pp. 158677. John Kenneth Galbraith, American Capitalism (Boston: Houghton Mifflin, 1952), p. 91. Ben D. Mills, "Ford Purchasing," Automotive Industries 140 (August 1, 1969): 23. COngressional Record-House, May 18, 1971, p. 15628. U.S. Congress, Senate, Commiteee on Commerce, Hearings pp Automotive Research and DevelOpment and Fuel Econ- omy, 93rd COng., lst sess., 1973, p. 94. General Motors Corporation, "Submitting Ideas and Sug- gestions to General Motors," Detroit, 1971. Letter from E. S. Starkman of G.M. to Mr. George Allen, Office of General Enforcement, Environmental Protec- tion Agency, March 16, 1973. "75 Catalyst Developed," Automotive Industries 144 (February 15, 1971): 19-20. This is true under the assumption that both consumers and producers' utilities are arguments of the social welfare function. Considering the new net benefits to consumers, ceteris paribus, it is seen that this is maximized under competition. Hence, Professor Shep- herd's assertion that innovation and invention are "optimized by competition." See The Economics pf Industrial Organization (Englewood_C11ffs, NJ: Prentice-Hall, Inc.,T1979), pp. 394-395. T* is opti- mal under our assumptions in the sense that if the consumers were required to pay a lump sum equal to the new surplus they would otherwise enjoy from innovation, they would be just as well of as before innovation; innovating firms, and their owners, would be better off. 51. 52. 53. 54. 55. 56. 57. 95 Kenneth J. Arrow, "Economic Welfare and the Allocation of Resources for Invention," in The Rate and Direction pg Inventive Activity, National Bureau of Economic Research (Princeton: Princeton University Press, 1962): 611, 612, 614. See Stephen A. Marglin, "The Social Rate of Discount and the Optimal Rate of Investment," Quarterly Journal p: Economics 77 (February 1963): 95-111. Congressional RecOrd, House, May 18, 1971, p. 15632. U.S. Congress, Senate, Committee on Public Works, Hearings on the Decision of the Administrator pf the EPA Regarding the SuspensiOn of the 1975 Auto EmiEEIOn Standards, pp. pip., pp. l632T3. Ralph C. Epstein, "Profits and the Size of Firms in the Automobile Industry," American Economic Review 21 (December 1931): 684. U.S. Federal Trade Commission, Report on the Motor Vehicle Industr (Washington: U. . Govgfnment Printing Office, , p. 84. Rush Loving, Jr., "The Automobile Industry Has Lost Its Masculinity," Fortune 88 (September 1973): 266-268. CHAPTER III THE STATE OF POWERPLANT TECHNOLOGY DURING THE MID-1970'S 1. Introduction The purpose of the next two chapters is to test for technological subOptimization in the selection and develop- ment of automotive powerplants. Type III suboptimization is considered in this chap- ter. The state of powerplant technology during the mid- 1970's is reviewed to see if some alternative is better than the engine produced. The next chapter studies the rate of development of al- ternative powerplants. The extent of Type II subOptimization is discussed and then explained in the context of the model developed in Chapter Three. A discussion of the extent of Type I suboptimization is also offered in the next chapter. 2. Technical Descriptions of Alternative Automotive Power- Plants In this section, descriptions of the various power- plants are presented. 96 97 a. The Conventional Otto This is the standard automotive engine that has been mass-produced for over seventy years. It is an in- ternal combustion engine, which means that kinetic energy is obtained by the expansion of a chemical explosion that directly pushes a piston. In the conventional Otto, the explosive charge is a uniform mixture of air and gasoline, usually provided to the engine's combustion chambers by a carburetor; ignition is achieved by exposing the mixture to an electrical spark. In recent years, exhaust treatment devices, the most important being the catalytic converter, have been added to these engines to reduce air pollution. b. Stratified Chagge Otto Except for a non-uniform air-fuel mixture, the stratified charge engine is basically the same as the con- ventional Otto. There are two major types of stratified charge engines. The first is a carbureted type, which achieves stratifica- tion of the charge through a division of the combustion chamber into two parts. One such divided chamber engine, the Compound Vortex Controlled Combustion engine (CVCC), was introduced on production cars by Honda in 1973. The second type uses fuel injection to achieve stra— tification in an undivided or "Open" combustion chamber. As of 1979, no such engine had appeared in cars sold to the public. 98 c. Diesel The Diesel engine is also an internal combustion engine. However, the air-fuel charge is exploded by com- pression instead of electrical ignition. Diesel fuel is heavier and less refined than gasoline. An automotive diesel was first introduced in 1952 by Mercedes-Benz. At the end of 1977, G.M. began to sell the first diesel cars produced in the United States. d. Rotary The rotary or Wankel engine is a spark-ignited internal combustion engine. Unlike the Diesel and Otto, the rotary's moving member (the rotor) has a circular rather than reciprocating motion. There are uniform and strati- fied charge versions of the rotary engine. Since the 1960's, uniform-charge rotary engines have appeared on cars built by NSU and Toyo Kogyo. e. Gas Turbine The turbine is also an internal combustion engine. Unlike the Otto, Diesel, and rotary, however, combustion is not intermittent, but instead is continuous. Motion is created by directing a constant flow of hot gases against a pinwheel-like moving member. There are two basic types of gas turbine engines. The free turbine type uses two moving members and a conventional transmission; the single shaft type has only one moving member and requires a continuously variable transmission. Gas turbines have never been 99 offered on production automobiles. The turbine is sometimes called the Brayton engine. f. Rankine The Rankine engine is an external combustion en- gine. In this type, a working fluid is vaporized by an ex- ternal heat source and, as a result, expands against the engine's moving member to produce power; the fluid is con- densed to repeat the cycle. Steam engines are Rankine engines that use water as the working fluid. Steam engines enjoyed some popularity as an automotive powerplant around the turn of the century but had disappeared from the scene by the 1920's. g. Stirling The Stirling engine is also an external combus- tion engine; in it a small quantity of a gas is alternate- ly expanded and contracted to produce power. In addition to using a non-condensible working fluid, the Stirling works on a different thermodynamic cycle than the Rankine. Like the gas turbine, the Stirling has never been used in production automobiles. h. Electric Powerplants Electric powerplants use electro-magnetic forces to produce motion. Energy is stored in a battery (in ef- fect, the system's fuel tank) and is transferred to a motor that converts the electricity into kinetic energy. Electric vehicles were not uncommon in this country during 100 the early 1900's, but, like steam cars, were eventually displaced by Otto-powered cars. Today, on-the-road electric vehicles are used in fairly great numbers in the United Kingdom. In 1975 the electric vehicle pOpulation in the UK was "estimated to exceed 130,000 vehicles; 70,000 to 75,000 of these are industrial trucks . . . and the other 55,000 to 60,000 are registered road vehicles.”1 3. The Characteristics of a Powerplant This section offers a framework for the comparison of alternative powerplants. A particular design configuration of a type of powerplant can be described by a n-dimensional vector of characteristics (2x1, zx2""zxn)’ where le is, for instance, the unit manufacturing cost of the configura- tion x, and 2x2 is fuel efficiency, and so forth. For a given powerplant, and at some fixed level of technology, there are apt to be many possible design con- figurations, each exhibiting a different vector of charac- teristics. The set of possible design configurations for a given powerplant may be collectively expressed by a func- tion (1) F(zl, 22,...zn) = 0. The various characteristics are apt to be interdepen- dent. Tradeoffs may exist between characteristics 1 and j, that is, (2) Ozi/sz < 0. 101 Or, powerplant characteristics may vary directly with each other, that is, (3) azi/azj > 0. The most important characteristics of automotive power- plants are now considered. a. Unit Cost of Manufacture A major Operation in the production of a car is the building of the powerplant. Consequently, its cost bulks large in the total cost of the product. The costs of powerplant manufacture can be broken down into fixed and variable components. Fixed costs include factory and machinery depreciation, amortization of special tools, prOperty taxes, and administrative expenses. Variable costs include expenses for labor, components, and other semi-finished and raw materials. Along with the demand for the firm's cars, the levels of variable and fixed cost of powerplant manufacture determine the profit-maximizing rate of output and level of profitability at that rate. Powerplants can differ in either variable or fixed costs. Variable costs are sensitive to differences in structural materials or labor requirements; fixed costs vary from powerplant to powerplant if there are differences in the capital intensities of their production. If a powerplant has a lower unit cost than another, ceteris paribus, the former is superior. Substitution of the cheaper for the dearer would increase the profits of 102 the firm; if the innovation leads to a lower price for the car, consumer surplus would increase as well. b. Driveability Driveability is an industry term that refers to a car's performance in running. One aspect of driveability (and sometimes synonymous with it) is flexibility. This has to do with a powerplant's ability to accelerate the vehicle. In lay terms, a powerplant with great flexibility is "full of pep," while the response of a less flexible engine seems "sluggish." Ease of starting can also be in- cluded under the heading of driveability. Another item that can be included is smoothness; this refers to the level of vibration. It is reasonable to assume that consumers prefer a powerplant with superior driveability, ceteris paribus. It is assumed that this preference is expressed by a will- ingness to pay a premium for such a powerplant. c. Fuel Efficiency The largest operating cost of an automobile is fuel. Although many things affect a car's fuel economy,2 an important factor is the efficiency of the powerplant in converting the energy stored in fuel to motion. It is reasonable to assume that consumers prefer power- plants with greater fuel efficiency, ceteris paribus. The preference for high fuel efficiency is apt to increase with the price of fuel. Moreover, the price of re-fueling is 103 not its monetary cost alone, but its time cost: recent experience with government allocation schemes suggests that the time costs of obtaining fuel are not always trivial. d. Maintenance Another operating cost is maintenance. The cost of maintenance should also be thought of as the sum of monetary and time costs. Aside from "buffs" who enjoy working on their cars, most consumers prefer less mainten- ance, ceteris paribus. e. Durability Durability is a virtue since long life tends to be translated into high economic value. Consumers, it is assumed, prefer more durable powerplants and signal this preference by a willingness to pay a premium for a long- lasting motor; even though the consumer may not keep his car until the powerplant is worn out, the premium can be recouped upon resale. f. Weight of Powerplant The weight of a powerplant affects the design of a car's other components and its fuel economy. The heavier the powerplant, the heavier the required support components in the chassis and suspension; this also increases the car's cost of production. Added weight also means higher fuel consumption. It can be concluded, therefore, that both producers and consumers prefer lighter powerplants, ceteris paribus. 104 g. Size of Powerplant The size of a powerplant also affects the design of other automotive components. Given a set of external dimensions, the more room devoted to the powerplant, the less available for passengers and cargo. It is assumed, therefore, that small powerplants are superior, ceteris paribus. h. Noise Except for some individuals who need an audible display of conspicuous consumption, it is assumed that con- sumers prefer less noisy powerplants, ceteris paribus. Noise also generates negative externalities, but this so- cial effect is not taken into account by presumably ego- centric buyers. 1. Control of Emissions Federal law sets maximum allowable levels for three pollutants: hydrocarbons (HC), carbon monoxide (CO), and oxides of nitrogen (NOx). The final levels of federal emission standards have yet to be settled. Rules on other kinds of pollutants may be established in the future. Since automotive emissions are an externality, the individual consumer is indifferent to his own car's contribution to air pollution. Consequently, automakers have the incentive to select a powerplant configuration which just satisfies the law. So much for the most important powerplant characteristics. 105 It is easy to see some of the tradeoffs (e.g., weight- fuel economy) or the complementarities (e.g., cost- durability) that exist. Other relationships, such as the tradeoff between control of emissions and fuel economy, are not as obvious to the lay mind. The production of new technology changes the relation— ships between powerplant characteristics. More precisely, technological progress reduces the constraints which these relationships impose. An enlightening example involves recent changes in the conventional Otto. Beginning in 1968, national automotive emission standards were established by the federal govern- ment. For the 1970 model year, the standards allowed maximum emissions of 4.1 grams per mile (gpm) of HC and 34 gpm of CO; in comparison, emissions from a typical un- controlled auto were roughly 10.5 gpm of HC and 84 gpm of CO. Stricter standards for HC and CO were put into effect in 1972 and again in 1975. Moreover, beginning in 1973 federal standards were established for NOx at a level of 3.1 gpm; this compares to a level of 4.1 gpm of NOx for a typical uncontrolled car.3 As a result of the standards, automotive engineers had to reduce the level of engine emissions; these efforts had impacts on other powerplant characteristics. I Consider the period between 1968 and 1973. To meet the standards, the firms made changes in the carburetion, ignition and valve timing, compression ratios, and, to 106 control NOx, added exhaust gas recirculation. These changes increased cost around $100 per car.4 Another powerplant characteristic affected by the reduction in allowable emissions was driveability. The Dupont Company estimated that "for representative full size cars produced from 1968 to 1973," changes to control emis- sions increased acceleration time (from 0 to 60 miles per hour) by 10 percent.5 For the same cars, moreover, Dupont estimated that the changes made for emissions increased fuel consumption about 17 percent.6 Eventually, however, technological progress eased the constraints faced by automotive engineers: the major breakthrough was the introduction of the catalytic con- verter at the end of 1974. Tighter federal emission standards were scheduled for 1975. Although they could have been met without the use of the catalytic converter, fuel economy would have dropped five percent relative to 1974 levels. Moreover, driveability would have worsened, perhaps to the point of jeopardizing car sales. With the catalytic converter, however, the job of re- ducing the level of pollutants is accomplished by treating the exhaust gases after they have left the engine: The addition of the catalytic control system in 1975 models resulted in reductions in tailpipe HC and CO levels but allowed 35E_§Hd_75% increases in the "raw" emissions of HC and CO respectively. The catalyst system gave manufacturers the flexibility to re- Optimize the basic engine for fuel economy by shift- ing some of the emission control burden to an after- treatment device 107 The combined effect of using catalysts and lead-free fuel has resulted in a level of fuel economy for many cars which is equal to or higher than the fuel econo- my achieved by pre-1968 models which were not emission controlled.7 The use of the catalytic converter also improved driveabili- ty and reduced maintenance costs in comparison to 1974 levels.8 To be sure, these benefits did not come free: the catalytic converter added about $100 to the sticker price of automobiles.9 The introduction of the catalytic converter is but one instance of how production of new technology changes the function of powerplant characteristics. Although it is convenient to consider a short run when the relations be- tween powerplant characteristics are fixed, the function's evolution is continuous, the speed of which depends on the rate of technology production. 4. The Test for Type III SubOptimization For a sufficiently short period, the level of tech- nology is essentially fixed. Assume such was the case between and including 1973 and 1977; also assume the ex- istence of stable functions, which describe the character- istics of the various powerplants. During this period, American automakers (with the ex- ception of G.M. at the end of 1977) continued to rely solely on the conventional Otto. Assume that of all the possible design configurations of the conventional Otto, the automakers selected that configuration, or range of 108 configurations, that maximized the sum of producer and consumer surpluses. The conventional Otto, as revealed in practice during the mid-1970's, serves, therefore, as the benchmark to determine the worth of alternative powerplants. If it can be shown that some alternative is superior to the conven- tional Otto (in that it would increase the surpluses of either producers or consumers) in one characteristic, while at least equal to the conventional Otto in the re- maining ones, Type III suboptimization is indicated. If, however, an alternative is superior to the Otto in some characteristics but inferior in others, the test for Type III suboptimization is ambiguous; a verdict may be sugges- ted, however, by a preponderance of evidence. 5. Dominance of the Conventional Otto Before comparing the various powerplants, it is worth- while to discuss the present dominance of the conventional Otto; this requires a review of some early automotive his- tory. At the turn of the century, steam, electric and Otto powerplants were used in cars. For a few years, none of the three seemed destined for dominance. Each had a camp of dedicated followers which proclaimed the virtues of their favorite, and there was much confusion about which powerplant was best. Yet, by 1905, the Otto was in ascendancy. By 1910, the market shares of steam and electric cars had become insigni- ficant. 109 That steam and electric powerplants were able to hold their own against the Otto for a while was due to their superiority in some characteristics. Steam cars were su- perior in acceleration and speed; due to the high torque generated at low engine speeds, gear shifting in steam cars was not necessary. To be sure, there were offsetting factors in the driveability of early steam cars;they needed several minutes to warm up; frequent stOps were needed to refill the engine's water supply, and in winter freezing was a problem. The electric car also had advantages over the Otto. Starting was instantaneous and gear changing was no problem. The electric vehicle was more durable and required less maintenance than steam or Otto-powered cars, since the motor was not subject to the stresses of heat and pressure. But the time cost of re-fueling was high: the typical electric vehicle of 1900 could go no farther than twenty miles without a recharge that took from eight to twelve hours; a top speed of only twenty miles per hour was another drawback.10 In contrast to electric and steam cars, the drive- ability of early Otto cars was very poor. Early Ottos were not very powerful. As a result, drivers were forced to change gears frequently; with the unrefined transmissions of the day, it took considerable skill to shift smoothly. Furthermore, starting required that the crankshaft be put in motion by some external force. Before the introduction 110 of the electric starter in 1911, this meant muscle power. The operation of the handcrank was not only cumbersome but dangerous, since the crank had a tendency to kick back once the engine had started. Other liabilities of the early Otto were vibration, noise, and emissions of noxious fumes: steam and electric powerplants were easily superior to the Otto in these characteristics. Why, then, did the industry adopt the Otto? One crucial factor was the Otto's low weight to power ratio. Less structural material in the powerplant was needed for a given output of power than in either electric or steam powerplants. A lighter engine also meant that supports in the rest of the car could be lighter. All of this meant lower production costs for Otto-powered cars. It is noteworthy that the weight to power factor was largely responsible for the abandonment of steam in favor 11 of the Otto by automobile pioneers such as R.E. Olds and 12 Comte de Dion. Henry Ford also experimented with steam before turning to internal combustion; he later wrote of the steam carriage that he had built in 1879: It had a kerosene-heated boiler and it developed plenty of power and a neat control--which is so easy with a steam throttle. But the boiler was dangerous. To get the requisite power without too big and too heavy a powerplant required that the engine work under high pressure; sitting on a high pressure boiler is not altogether pleasant. To make it even reasonably safe required an excess of weight that nullified the economy of high pressure. For two years I kept experimenting with various sorts of boilers--the engine and control problems were simple enough. I definitely abandoned the whole idea of running a road vehicle by steam. 111 . . [this work] served to confirm the opinion I had 13 formed that steam was not suitable for light vehicles. The Otto enjoyed an even greater cost advantage over electric powerplants. Since the cells of the electric vehicle's battery were poor reservoirs of energy, a large number were needed for acceptable acceleration and range. But a large number of cells made the battery bulky and ex- pensive. The differences in cost between the two powerplants was reflected in the prices of their respective vehicles. Elec- tric vehicles never penetrated the lower price ranges where Otto-powered cars had success. For instance, the Columbia Electric car of 1900, which was produced at a volume of about 1500 units, sold for $3000.14 In contrast, the Otto- powered curved-dash Oldsmobile of 1901, produced at a volume of around 425 units, sold for only $650.15 Even during the peak years of electric vehicle sales, 1910-1915, prices remained high; although two models were offered for under $2,000, the average electric vehicle carried a price of around $2,800.16 By this time many Otto-powered cars were available for under $1,000. The second reason for the dominance of the Otto is that technological progress favored it. Progress eliminated or markedly reduced the major faults of the Otto: the in- troduction of more powerful versions of the engine reduced its disadvantage vis—a-vis steam in speed and acceleration and increased its advantage over electric powerplants in these respects; greater power, plus improvements in 112 transmissions made gear changing less difficult; and ad- vances in lubrication, metallurgy, and vibration control increased the durability and smoothness of the Otto-powered automobile. This is not to say no progress was made in steam and electric powerplants. Steam car producers were able to shorten warm-up time and to reduce water consumption. Elec- tric vehicle producers were eventually able to offer cars with somewhat improved range and speed. However, whatever improvements were made in steam and electric powerplants, they were simply not enough to turn back the onslaught of the low-cost Otto. It is important to point out that if a test for Type III suboptimization were to be conducted on the basis of, say, the level of technology in 1920, the result would be ambiguous. Even at that date, when all but a tiny fraction of cars were equipped with Ottos, there were some character- istics in which steam and electric powerplants were superior. Ultimately, therefore, a decision on Type III suboptimiza- tion in an ambiguous case must be based on response of a workably competitive market. 6. Sources of Technological Information Two groups of sources are used to evaluate the state- of-the-art of powerplant technology during the mid 1970's. One group is made up of the Big Three's testimony before Congressional committees, their submissions of data to the 113 Environmental Protection Agency, and other corporate reports and publications. The second group is made up of a number of important "outside" studies of the automotive powerplants. One study is a 1973 analysis by the Eaton Corporation, an important 17 automotive supplier. A second is a 1975 report by the Jet Propulsion Laboratory, which is especially noteworthy for 18 The its exhaustive treatment of the powerplant question. third study was done in 1976 by the Energy Laboratory of the Massachusetts Institute of TechnologY; this report covers only the diesel, electric, and Stirling powerplants.19 A final study in this group is another report of the Jet Propulsion Laboratory that was prepared for the Department of Energy in 1978.20 While the sources are not always in agreement, and while it is sometimes difficult to compare their data, they give a good idea of the merits of the various powerplants and opportunities in this area of technology. 7. Stratified Charge Engine a. General Motors G.M.'s version of the carbureted stratified charge engine is called the Dilute Combustion Jet Ignition Engine. In 1975 the firm reported that the engine: . has been under study at the G.M. Research Labor- atories and throughout the world for many years as an approach to better fuel economy, and has more recently been recognized as being of some assistance in auto- motive emission control. In particular, emissions of CO and NOx were found to be low. 114 Moreover, G.M. stated that "in both cost and fuel econo- my, these engines appear now to offer promise of equalling the performance of our 1975 model conventional engines with catalytic converters."22 By 1977 further work showed that at the lower levels of exhaust emissions that the firm had to meet by 1981, "23 It seemed the en- "fuel economy was unacceptably poor. gine's good fuel economy at low levels of emissions control disappears as the level of control is increased. To be sure, fuel economy could be improved by retuning the engine and letting the exhaust be treated by a catalytic device. This, however, would make the engine at least as costly as the conventional Otto. G.M. concluded that a "NOx standard of 2.0 gpm or more appears necessary to keep the stratified charge engine as a viable alternative across the full range of today's U.S. vehicle lines."24 An additional problem with the engines, according to G.M., "has been their tendency toward unreliable initiation and unstable burning. These lead to driveability problems and the inability to Operate over a wide range of operating "25 Another disadvantage is a "slight" loss of 26 conditions. power relative to the conventional Otto. Work on the fuel-injected, open chamber type of engine does not appear to have begun at G.M. until after 1975. For this reason, G.M.'s remarks are not very informative on this type of engine. According to the firm, high fuel economy 115 and low levels of CO and NOx emissions were the engine's main attraction.27 b. Ford Ford's test of a large divided chamber stratified charge engine indicated "the capability to combine low "28 Ford emissions of HC and CO with good fuel economy. found the driveability of the test cars to be satisfactory. However, Ford found control of NOx was "borderline" for 2.0 gpm standard and emissions levels were "very sensitive to the proper operation of all fuel and spark control devices."29 Like G.M., Ford was concerned about the engine's ability to meet stricter standards for NOx without loss of fuel economy and without use of additional exhaust treatment devices. It was stated that the prechamber engines under investigation were relatively expensive and complex.30 Ford's fuel-injected, open chamber stratified charge engine is called the Programmed Combustion (Proco) engine. This engine, according to Ford, "shows promise of signifi- cantly improving gas mileage while also controlling auto- 31 Driveability of the Proco was cited 32 motive pollution.” as ”good" even "with low emission type adjustments." Ford warned, however, that ”there continue to be un- certainties with respect to this engine's durability, reliability of complex controls, catalyst efficiency at lower exhaust temperatures, complex new pump design, and compatibility with other product changes."33 116 c. Chrysler Chrysler sources are not very helpful on the divided chamber configuration. In 1975 Chrysler's engineer- ing vice president spoke about the engine before a Senate committee: Senator, the prechamber engine, which is the Honda CVCC engine, is not new to the industry. It has been around for, I guess, 30 or 35 years. It first made its appearance in the industry to improve fuel economy. At that time it was competing with the old "L" head combustion chamber design, which was pretty inefficient. And nobody could produce as good fuel economy with the prechamber as they could with the "L” head. Since then the industry has gone to overhead valves, much higher efficiency engines, and the prechamber still has a fuel economy problem . Again, the engine they have in the Civic gets a fuel economy that is somewhat less than one of the other Japanese engines where the car weighs 400 or 500 pounds more and the heavier car is getting better fuel economy than the Honda.34 Chrysler was more optimistic about the Open chamber type of stratified charge engine. The particular configura- tion that Chrysler was experimenting with during the mid- 1970's was originally developed by Texaco; it has been referred to as the Texaco Controlled Combustion System (TCCS). Chrysler predicted: . that widespread use of engines of this type could provide up to 35 percent more vehicle miles for the same amount of crude Oil processed by the refineries. This results largely from the improved engine efficien- cy, and from the multi-fuel capability of the engine which permits significantly greater yield from each barrel of crude oil. Moreover, emissions levels appeared "attractive." 117 On the other hand, "current cost forecasts indicate somewhat higher penalties for the TCCS than for a convention- a1 engine modified for comparable emissions." Chrysler went on to add that "other factors such as driveability, noise, and durability, also require further development."36 chm Unfortunately, the Eaton study did not separately evaluate the divided chamber and open chamber types. For the group as a whole, Eaton found that stratified charge engines have "shown potential for low emissions," and that a "slight" advantage in fuel economy over the conventional 37 It also noted that noise, smoothness, Otto was likely. and durability should be similar to conventional engines. Whether the stratified charge engine had an advantage in manufacturing cost depended on the required level of emissions control. In comparison to conventional engines without catalysts, some increase in cost was found likely. However, it was possible that stratified charge engines could be cheaper than conventional engines if the latter were used with a sophisticated catalytic system; Eaton did not indicate the level of emissions control at which the cost advantage swung to the stratified charge. Similarly, Eaton concluded that "stratified charge en- gines should require slightly more maintenance than uncon- trolled engines," but "somewhat less maintenance than engines with dual catalysts."38 Finally, stratified charge 118 engines were considered to be probably at some disadvantage in driveability, weight, and size. e. JPL-1975 The main object of this study was the identifica- tion of the powerplants whose future evolution appeared likely to produce an alternative superior to an also evolv- ing conventional Otto. A powerplant's state of development was divided into three periods: present, mature, and advanced. The present configuration was the powerplant as it existed in 1975, manifested in either prototype or production versions. The mature configuration was defined as a near-term improved version of the present configuration "as limited by current 39 Finally, the advanced configuration was technology." "defined as a longer-term future version of an engine which embodies advantages afforded by extensions of existing technology"; such configurations, the JPL assumed, would probably not be ready for production before 1990.40 It is the set of mature configurations which is of interest with respect to Type III suboptimization. That is, given the state of technology in the mid-1970's and the probable marginal advances which can be foreseen, could a firm have justified action which would have as its eventual result the replacement of the conventional Otto? The comparison, or "baseline" engine, was the mature version of the conventional Otto. With the exception of electronic carburetion and the use of a three-way catalytic 119 system, the mature version of the conventional Otto was assumed to be essentially identical to the engines in 1975 model year cars. The mature version of the conventional Otto was assumed capable of meeting federal emission standards of 0.41 gpm HC, 3.4 gpm CO, and 0.4 gpm of NOx. Not only were the mature versions of the various al- ternative powerplants assumed to meet these standards, but it was further assumed that they had "Otto-equivalent" driveability, safety, durability, noise, accessories (power steering, air conditioning, etc.), range, and passenger and cargo accommodations. Thus the comparison of the power- plants comes down to differences in manufacturing and operating costs. The divided chamber type of stratified charge engine was not projected in evolution to either a mature or ad- vanced configuration. According to the JPL, "of the various SC Otto implementations, the direct-injected . open chamber type was found to offer the greatest potential in vehicle fuel economy with simultaneously low HC and NOx. . . ."41 As a result, the open chamber configuration was selected for evaluation. The unit manufacturing cost of the mature stratified charge engine was estimated to be around 34 dollars greater than that of a mature conventional Otto of equal power. Fuel economy was projected to be about 12 percent better in the city and 3 percent in highway driving; maintenance cost for the stratified charge and the conventional Otto appeared to be about the same. 120 Based on these estimates, it was concluded that the 42 tended to show some advan- incremental cost of ownership tage for the stratified charge engine (see Table One). But according to the JPL, "the differentialszfixrthe SC Otto are very small, however, and within the uncertainty of the cal- culations probably represent parity."43 Furthermore, JPL's calculations on ownership cost are sensitive to the assumed prices of fuel, the discount rate, and profit margins for the manufacturers and dealers. f. JPL-1978 The concept of an Otto-engine equivalent (OEE) is used in this study also. Fuel economy estimates for full- sized and small OEE vehicles were made; these estimates were made under the assumption of emission standards of 0.4 gpm HC, 3.4 gpm CO, and 1.0 gpm NOx. Comparisons between the various engines were made for both 1978 production ve- hicles (where applicable) and for projection for 1985. For 1978 production vehicles, JPL estimated virtually no difference in fuel economy with respect to a full-sized car; an average fuel economy of 18 mpg was estimated for both the stratified charge and the conventional Otto. Since the Honda CVCC was the only stratified charge engine in pro- duction as of 1978, the comparison necessarily involved the divided chamber type. For the small car, the stratified charge engine was estimated to have poorer fuel economy than a comparable conventional engine; it was estimated that the average fuel economy for the stratified charge engine was 1221 v- ‘I. I. 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Ioumxm sexes me=5ucu m=O.5u> a=.m= mace __¢Im mca— no. mcc..uemO»s alceeu: .O=u 5 méc .m5mH :.m:OHpuOmpmm mam mmpmum zmoaocnupe o>5uoEOuz .m555 .5ocemem 2oz 5 m>mm oz pazocm .xuoumuonmq :O5masmoum ppm "mmuusom 55 .5 ooom 52¢. «50> eo505>mnu m5m. -- 5.5. om55 520. amm> um.oa>o:u 55¢. -- m.5. om55 fleece. .Lemu 5esueoz 5555 memo cowuozwoum capo wouuoaom -- m.m ooom .ou emxuom e52c53-5m5oeo< -- m.m ooom .muou mEOumxm nozom Emppm 5.5. 0.5. om55 memeeeeoecm wmeemu zmznmflz .coafimo H505 mmafiz memo 5550 .coHHao eon m0552 H .e. .5gm.oz a.uwo:H m.u.:m> m mqm<9 OmxuouOHQ OaHMGHm :owuustHQ Oppo downwaom can moaxuouowm Ocfixcmm «O kaocoom Hosm 139 Unit manufacturing cost for the mature Rankine was estimated to be much higher than that of the mature conven- tional Otto; a figure of $965 (1974 dollars) was projected for the Rankine compared to $660 for the conventional Otto.91 As for life-time ownership costs, the JPL concluded that "Rankine-engined cars do not 'pay back' in fuel savings their initial price differential, even at equal maintenance cost, and the situation worsens with increasing fuel price."92 As Table 5 indicates, the increment of the discounted life- time ownership cost for the Rankine over the conventional Otto was estimated to be between $350 (small car) to $550 (full size).93 Very low emissions were cited by the JPL as the major bright spot for the Rankine. f. JPL-1978 The Rankine engine was not evaluated in the second JPL study, presumably due to its unattractive fuel economy. 11. Electric Vehicles a. General Motors G.M. reported that as of 1975 its experiences with electric cars "were frustrating and disappointing." Accord- ing to G.M., "existing batteries, including the most ener- getic batteries commercially available, couldn't begin to do an effective job in moving people in comparison with gaso- line."94 140 The low energy density of batteries, plus the inability to recharge batteries in a reasonably short time, were iden- tified as the major obstacles which blocked commercialization: To place it in proper perspective, for the same work done at the wheels as by 20 gallons of gasoline (58 kilograms) in an internal combustion engine, one would require about 5,000 kilograms of lead acid batteries or 600-700 kilograms of the best projected batteries. It becomes obvious why electric vehicles will continue to be much heavier than their internal combustion en- gine counterparts designed for the same mission. Because of this battery limitation, electric vehicles are unable to match the performance and range of gaso- line powered vehicles. They suffer from greater weight, both the battery weight and necessary added vehicle structure, and this weight penalty demands more propulsion energy. In addition, the original cost is high, and when amortization is considered, the operating cost also is high.95 G.M. explained that a three-way tradeoff exists between acceleration, range, and battery life. As of the mid-1970's it appeared impossible to design an electric car good enough to make it competitive with Otto-powered cars. Electric vehicles themselves do not produce fumes. The powerplants which supply the vehicles' energy needs do emit NOx and sulfur oxides, however. As a result, "the electric car would result in from 2.3 to 12 times as much pollution in the air from powerplants as from the exhaust of the gasoline-powered car."96 G.M. compared the energy consumption of electric and conventionally powered cars. Three electric vehicles, a two-passenger "shOpper," a two-passenger "commuter," and a four-passenger sedan were built. Some of the characteris- tics of these vehicles are presented in Table 9; data on a 141 TABLE 9 Comparison of Characteristics of Three Lead Acid Electric Cars and an Otto Powered Chevrolet Vega Criteria Shopper Commuter Sedan Vega Maximum car speed, km/h 25% grade, 24 km/h headwind -- 72 72 -- 0% grade, 0 km/h headwind 72 >97 >97 >125 Distance in 4 seconds, m 15 -- -- 23 Distance in 10 seconds, m -- 91 91 122 0-48 km/h time, sec 20 -- -- 6 0-72 km/h time, sec -- 30 30 12 5% grade speed, km/h 24 24 24 -- 20% grade speed, km/h >0 >0 >0 -- Electric vehicle range, km 40 80 120 -- Source: General Motors Corporation, "Energy Utilization Comparison of Gasoline and Battery-Electric Powered Urban Vehicle," GMR - 1978, November 1974, p. 142 conventionally powered Chevrolet Vega are shown for com- parison. Note the poor acceleration and limited ranges of the electric vehicles. It was concluded that the energy consumption of electric vehicles (with lead acid batteries) relative to that of "gasoline powered cars with the same cargo capacity and per- formance" depended, in part, on whether the electricity and gasoline were derived from coal or crude oil. If crude oil were the original energy source, conventional cars would consume less energy per mile in all three size categories. If coal were the original energy source, electric vehicles appeared superior only in the smallest size class. The difference in energy consumption between petroleum and coal sources was attributed to the differences in efficiencies in generating electricity from oil and synthesizing petrole- um from coal. The comparison was repeated with the more advanced nickel-zinc battery. Here the electric vehicles did better, especially if coal served as the original source of energy (see Table 10), In short, for only the smallest vehicle did electric power show an unambiguous adVantage in energy consumption over Otto-powered cars: "Increases in desired range, per- formance, or vehicle size beyond that of the shopper increase the electric vehicle energy consumption with respect to the gasoline powered version."98 As further evidence G.M. referred to a study by the General Research Corporation.99 In addition to evaluating 143 TABLE 10 Energy Consumption Ratios: Electric Cars Relative to Otto-Powered Car Lead-Acid Battery Petroleum Coal Shopper 1.88 - 1.42 .97 - .73 Commuter 2.44 - 1.72 1.26 - .89 Sedan 3.41 - 2.22 1.76 - 1.14 Nickel-Zinc Battery Shopper 1.65 - 1.28 .85 — .66 Commuter 1.79 - 1.36 .92 - .70 Sedan 2.00 - 1.48 1.03 - .76 Source: General Motors Corporation, "Energy Utilization Comparison of Gasoline and Battery-Electric Powered Urban Vehicles," GMR-1978, November 1974, p. 7. 144 the performance of cars powered by improved versions of currently available lead—acid batteries, projections were made for vehicles powered by more advanced, yet still ex- perimental batteries, vi£., nicke1-zinc, zinc-chloride, and lithium-sulfur. The characteristics of the various batter- ies are shown in Table 11. It was warned, however, that the ”cost and life characteristics for zinc-chloride and lithium-sulfur batteries are relatively uncertain and the figures . . . are quite optimistic."100 It was assumed that the electric cars were four‘ passenger subcompacts with speed and acceleration just below that of current low performance conventional sub- compacts.101 The urban ranges for cars with lead-acid, nickel-zinc, zinc-chloride, and lithium-sulfur batteries were assumed to be 54, 144, 145 and 138 miles respectively; at a constant speed of 30 mph and on level roads, vehicle ranges would be roughly doubled.102 Life cycle costs (1974 cents per mile) were estimated for the various electric cars and for a car powered by a conventional Otto. The results are presented in Table 12. Although the electric vehicles had an advantage in maintenance, they tended to have higher life-cycle cost than a gasoline-powered subcompact. The cost of the battery was identified as the prohibi- tive factor. As a result, the report concluded that electric cars "are unlikely to approach the conventional subcompact 145 TABLE 11 Car Battery Characteristics Lead- Nickel- Zinc- Lithium- Type Acid Zinc Chloride Sulfur Weight, lbs 1500 1080 570 300 Available Energy, kwh/lb 13 44 70 140 Energy Efficiency, Percent 46 66 70 62 Life, Years 1.3-3.4 5.8 7.3 3-5 Cost, 1973 Dollars 1200 4380 600 600 Source: General Research Corporation, "Impacts of Electric Car Use in St. Louis, Philadelphia and Los Angeles," May 1975, p. 3. 146 TABLE 12 Life-Cycle Costs (1974 cents per mile), Electric Cars versus Otto-Powered Subcompact Otto Sub- Zinc- Lithium Chlorine Sulfur Depreciation Vehicle Battery Upkeep Fuela Pollution Control Financing Taxes, etc. TOTAL Lead- Nickel- Acid Zinc 2.7 2.7 4.0-10.3 5.6 1.5 1.2 2.8 1.8 0 2.9 4.1 4.5 4.5 18-25 20 0.9 1.3-2.2 1.2 l 2 1.5 1.6 0 0 2.4 2.4 4 5 4.5 13 14-15 aFuel costs assumed to be $.40 per gallon gasoline, $0.036 per kilowatt electricity. Source: General Research Corporation, "Impacts of Electric Car Use in St. Louis, Philadelphia, and Los Angeles," May 1975, p. 147 in overall economy until battery develOpment drastically re- duces battery depreciation costs."103 The GRC report implied that a rise in the price of gasoline relative to electricity would favor electric cars. However, it appears that the increase would have to be very large, something on the order of 500%, before electric cars with lead acid or nickel-zinc batteries could be competitive with Otto-powered subcompacts; assuming the successful de- velopment of zinc-chloride and lithium-sulfur batteries, a much smaller increase in the relative price would be needed. b. Ford According to engineers at Ford's Electric Systems Department, . . electric vehicles cannot achieve the performance characteristics of the American IC engine-prOpelled cars of the intermediate and larger classifications without severe limitations in vehicle driving range. However, reasonable driving range is feasible for vehicles of the lower performance hue in the American passenger car spectrum and for delivery vehicles.104 Estimates of lifetime costs per mile were made for electric cars powered by lead—acid batteries and ones driven by the much more advanced, but still experimental, sodium sulfur batteries; these figures, and ones for comparably sized Otto-powered cars are presented in Table 13. The high initial cost of electric vehicles, due primar- ily to the expense of the batteries, resulted in higher lifetime costs for the electric vehicles despite the lower fuel cost. 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