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Markets: State Franchise Laws, Dealer Terminations, and the Auto Crisis

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  • Francine Lafontaine
  • Fiona Scott Morton

Abstract

In fall 2008, General Motors and Chrysler were both on the brink of bankruptcy, and Ford was not far behind. As the government stepped in and restructuring began, GM and Chrysler announced their plan to terminate about 2,200 dealerships. In this paper, we first provide an overview of franchising in car distribution, how it came about, and the legal framework within which it functions. States earn about 20 percent of all state sales taxes from auto dealers. As a result, new car dealerships, and especially local or state car dealership associations, have been able to exert influence over local legislatures. This has led to a set of state laws that almost guarantee dealership profitability and survival -- albeit at the expense of manufacturer profits. Available evidence and theory suggests that as a result of these laws, distribution costs and retail prices are higher than they otherwise would be; and this is particularly true for Detroit's Big Three car manufacturers -- which is likely a factor contributing to their losses in market share vis-�-vis other manufacturers. After discussing the evidence on the effects of the car franchise laws on dealer profit and car prices, we turn to the interaction of the franchise laws and manufacturers' response to the auto crisis. Last, we consider what car distribution might be like if there were no constraints on organization. We conclude that although the state-level franchise laws came about for a reason, the current crisis perhaps provides an opportunity to reconsider the kind of regulatory framework that would best serve consumers, rather than carmakers or car dealers.

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Bibliographic Info

Article provided by American Economic Association in its journal Journal of Economic Perspectives.

Volume (Year): 24 (2010)
Issue (Month): 3 (Summer)
Pages: 233-50

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Handle: RePEc:aea:jecper:v:24:y:2010:i:3:p:233-50

Note: DOI: 10.1257/jep.24.3.233
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References

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  1. Stanworth, John & Curran, James, 1999. "Colas, burgers, shakes, and shirkers: Towards a sociological model of franchising in the market economy," Journal of Business Venturing, Elsevier, vol. 14(4), pages 323-344, July.
  2. Benito Arruñada & Luis Vázquez & Giorgio Zanarone, 2009. "Institutional constraints on organizations: the case of Spanish car dealerships," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 30(1), pages 15-26.
  3. John Kwoka, 2001. "Automobiles: The Old Economy Collides with the New," Review of Industrial Organization, Springer, vol. 19(1), pages 55-69, August.
  4. Blair,Roger D. & Lafontaine,Francine, 2005. "The Economics of Franchising," Cambridge Books, Cambridge University Press, number 9780521772525, Fall.
  5. Smith, Richard L, II, 1982. "Franchise Regulation: An Economic Analysis of State Restrictions on Automobile Distribution," Journal of Law and Economics, University of Chicago Press, vol. 25(1), pages 125-57, April.
  6. Benito Arruñada & Luis Garicano & Luis Vázquez, 1999. "Contractual allocation of decision rights and incentives: The case of automobile distribution," Economics Working Papers 424, Department of Economics and Business, Universitat Pompeu Fabra.
  7. Klein, Benjamin, 1980. "Transaction Cost Determinants of "Unfair" Contractual Arrangements," American Economic Review, American Economic Association, vol. 70(2), pages 356-62, May.
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Cited by:
  1. Annabi, Amira & Breton, Michèle & François, Pascal, 2012. "Resolution of financial distress under Chapter 11," Journal of Economic Dynamics and Control, Elsevier, vol. 36(12), pages 1867-1887.

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