As can be seen from the industry shake-out in Korea and the cutthroat incentive wars in Europe and North America, the world auto industry can build far more passenger vehicles than consumers can absorb.
On the basis of one eight-hour shift a day, five days a week and 46 weeks a year - the generally accepted definition of straight capacity - the ability to produce light passenger vehicles is 5 million units a year more than demand. That is about equal to the combined output of Fiat and Honda, or BMW/Rover, Mercedes-Benz, Hyundai, Daewoo and Mazda.
To that can be added another 1 million light commercial vehicles.
The passenger-vehicle overcapacity is just over 2 million units in Western Europe, about 1.0 million in North America, 500,000 in Japan and 1.5 million in the rest of the world.
Overcapacity in a free competitive market is a sign of a lack of adjustment by companies and/or governments.
In economic theory, overcapacity should force marginal players to quit the industry, thereby reducing capacity and supply. That increases prices and profits for the survivors. Unfortunately, in the real world, the process is not so neat.
Government and/or corporate subsidization of weak companies ensures that capacity adjustment is slow and sticky. Governments want to maintain employment in their economies, so they keep marginal companies alive through tax subsidies and other means. Corporate groups keep their weaker subsidiaries afloat though subsidies from other operations.
The results are entirely predictable: lower profits and higher marketing costs as companies attempt to keep plants working in order to enjoy maximum benefit from economies of scale.
In Europe until the mid-1980s, an overall decline in demand would cause makers to reduce output. That maintained prices for everyone. But in the face of increasingly stiff competition for market share in Europe, makers no longer feel it is prudent to reduce output in the face of weakening demand.
Thus, they try to maintain sales and share by various expensive means. Huge amounts are spent on brand development, marketing and product proliferation. But the financial returns are constrained by the dead hand of overcapacity, which weakens prices and demands even more marketing expenditures.
The result: pressure on profits and a continuation of the capacity overhang.
In addition, as vehicle quality has improved, it has become more difficult for any carmaker to charge a premium for perceived quality. The value of the premium is eroded by the intensity of the competition. That illustrates that prices increasingly are being determined by the market and not by the maker.
Therefore, the impact of overcapacity on pricing is increasingly powerful, with very few firms able to protect themselves by premium pricing.
Even the makers that operate at - or above - full capacity are affected by overcapacity because of its downward pressure on retail prices. Hence, even companies enjoying strong demand find it difficult to maintain or increase prices in a market weighed down by overcapacity.
In an attempt to maintain profits by reducing costs, automakers also are turning to joint ventures and outsourcing. That is merely tinkering with the impact of overcapacity. The problem cannot be solved without a major restructuring of the global industry.
In short, plants must be closed and companies must be allowed to leave the industry, whether by liquidation or merger.
The U.S. industry has always been more flexible than the European in meeting overcapacity problems. It may be that the future will show that it is more adept than the Japanese as well. The closure of plants in the United States and the substitution of light-truck production for auto production contrasts with the glacial pace of major restructuring in Europe outside Britain.
Indeed, in recent years, Europe has added excess capacity. Companies have built plants to make minivans when the market already was saturated at the current prices. Only if prices are cut to unprofitable levels will the markets be cleared of the extra supply.
There have been attempts to explain away the excess capacity problem on the grounds that there is not an excess of efficient and usable capacity in the world. That is a flawed view.
Capacity is available for use even though it may contain a variety of efficiencies. The vehicle maker will try to utilize all of its capacity in order to spread overheads, so that the capacity contained in the marginal plants is available for use.
Capacity is not a 'net' phenomenon. That is, the shortage of capacity at, say, Honda, cannot be offset against excess capacity at Nissan or General Motors. The firms enjoying excess demand will seek to add capacity to meet it, leaving the volume of excess capacity untouched.
Thus, only when a plant is closed will its impact disappear.
Overcapacity is an issue that must be addressed sooner rather than later if stability is to return to the world automotive sector. If overcapacity remains at the current level, the industry will not be able to generate the funds necessary to compete and to meet government environmental and safety requirements.
Long-term excess capacity is a sign of market failure, and as such it threatens the long-term development of the global motor industry.
The existence of global excess capacity is the consequence of the highly competitive nature of the motor industry. Makers want to increase their volumes and build the plants to do so. If the market turns against them at a later date they are left with that capacity.
All firms do the same thing.
Thus, in a highly competitive industry like automaking, a mismatch of capacity and demand is inevitable. Even so, long-term excess capacity must be eradicated, even if its reappearance is likely. After all, consolidation of existing producers does not mean that new entries will not occur.
The problem must be addressed -and quickly.