Extracted from a paper I wrote for my MBA macroeconomics class.

Countercyclical fiscal policy to combat economic downturns was unheard of before the Great Depression. Even the very idea of monetary policy was nascent in the United States, with the central bank being only 13 years old at the beginnings of the Great Depression. In the pre-Great-Depression era, governments, generally, followed a policy of letting the downturn run its course. Yet, there had never been a recorded case of prolonged slump in peace time that lasted more than 12 months or at worst 24 months. So, what caused the garden variety recession that started in October of 1929 to turn into a persistent economic malaise? The answer to that question could be in the policies pursued by the administrations of Presidents Herbert Hoover, and Franklin D. Roosevelt.

For instance, during the depression of 1920-21, the Government pursued a policy of cutting spending and running budget surpluses. In 1921, the output collapsed more than it did in the first year of the Great Depression yet it was a short recession that lasted barely more than a year, leading the economy into the roaring 20s.

 

 

Year

Revenues

Outlays

Surplus/Deficit

1920

6,649

6,358

291

1921

5,571

5,062

509

1922

4,026

3,289

736

1923

3,853

3,140

713

(Budget of the United States Government: Historical Tables, 2011) – Table 1

For another example of successful budget cutting in the middle of a depression, one has to go back no further than the infamous panic of 1907. Between 1907 and 1908, the real GDP of the US declined by more than ten percentage, and yet in 1909, the GDP grew by more than 7 percent from the bottom and continued to grow at a fast clip in the following years.

Year

Revenues

Outlays

Surplus/Deficit

1907

666

579

87

1908

602

659

-57

1909

604

694

-89


(Budget of the United States Government: Historical Tables, 2011) – Table 2

Hoover – FDR lite

Policies of the Hoover (later FDR) administration in the midst of a garden variety depression (at least until 1930) were a dramatic departure from the past. Historically successful policies of laissez-faire were discarded for continuous meddling into the economy – weak firms were propped up, fall in wages were fought, prices were propped up in several cases. “The Great Engineer” (Hoover) was a worldly man who travelled and lived in many parts of world and had a temperament and mental makeup radically different from his predecessor. Hoover was a problem “solver” who wanted to jump in and intervene.

Hoover’s unfettered enthusiasm for massive public projects was on full display long before he became The President of the United States. As soon as he got back after World War I, as the Commerce Secretary under President Harding, Hoover proposed “Reconstruction Program” which included among other things increased inheritance taxes, public dams, and significant regulation of stock market to prevent “vicious speculation”. His public dam wishes came closer to reality as he got approval for the dam on the Colorado River in 1924 when he was Commerce Secretary under President Coolidge. Originally named Coolidge Dam, project was popularly known by the name Hoover Dam. FDR administration named it Boulder Dam, before grudgingly reverting back to Hoover Dam.

As the Great Depression was slowly setting in (Table 3 – below), government spending grew and grew fast against collapsing revenues. Contrary what one may presume the first Hoover budget was the fiscal 1930 and the first FDR budget was for the fiscal year 1934.

Officially, the depression ended in March of 1933, the very same month that FDR was inaugurated. It is popular amongst many economists that the course of the remarkable economic slump was reversed by a massive spending program started by Roosevelt called New Deal. There are a couple of problems with this myth. As famous New Dealer Rexford Tugwell later acknowledged, “We didn’t admit it at the time, but practically the whole New Deal was extrapolated from programs that Hoover started.” (Gibbons, 2008) Furthermore, Table 3 shows that the increase in spending in the fiscal year (Hoover – 1933) that ended a couple of months after the official end of the economic contraction was lower (however mildly) from the previous year.

Year

Revenues

Outlays

Surplus

1929

3,862

3,127

734

1930

4,058

3,320

738

1931

3,116

3,577

-462

1932

1,924

4,659

-2,735

1933

1,997

4,598

-2,602

1934

2,955

6,541

-3,586

1935

3,609

6,412

-2,803

1936

3,923

8,228

-4,304

1937

5,387

7,580

-2,193

1938

6,751

6,840

-89

1939

6,295

9,141

-2,846

1940

6,548

9,468

-2,920

(Budget of the United States Government: Historical Tables, 2011) – Table 3

Hoover – “Do Nothing” Myth

On November 19th 1929, less than a month after Black Tuesday, President Hoover called a meeting of the railroad presidents in the white house. Railroad was a major industry back then, and was a primary mode of transportation of people and goods. He demanded that railroad industry maintain their construction, and one week after that meeting, the railroad business leaders announced one billion dollars in outlay, a third of the federal budget for 1929.

Two days after meeting the railroad presidents, Hoover setup another meeting in the White House, this time with leaders of major industries. People in attendance included Henry Ford, Julius Rosenwald of Sears, Julius Barnes who was chairman of the U.S Chamber of Commerce, Alfred Sloan Jr. of General Motors, Pierre Du Pont and Walter Teagle of Standard Oil. He(Hoover) demanded that industry keep wages up and share the work among the employees. While noting that “liquidations” was allowed in all previous American recessions, “his very instinct” told him that wages ought to be kept high in this recession. Some of the largest manufacturers, later on, advertised their compliance with Hoover’s wage programs. This specific call, arguably, did more damage to the labor market early on in the Great Depression than any other Hoover intervention. Toward the end of 1931, real hourly wages in manufacturing had increased 10 percent due to a deflation and Hoover wage program, hours worked declined by 40 percent, and average work week declined by 20 percent

President Hoover demanded that governors of states keep the spending up whenever possible. He even received a response from then New York governor, Franklin D. Roosevelt that he is doing his bit to maintain “much-needed construction work”. Hoover and his treasury secretary Mellon, after proposing a federal build program of 400 million dollars, on December 3, 1929, established Department of Public Construction. Hoover went on to provide subsidies for shipping industry. Professor JM Clark of Columbia University in the American Economic Review Journal went on to praise Hoover’s policies as “great experiment in constructive industrial statesmanship.” In January of 1932, Hoover established Reconstruction Finance Corporation (RFC) to make finance available to such projects, and to industry, mortgages etc.

Republican Party platform in 1928 claimed that tariff is a fundamental and essential principle of the economic life of this nation.” Congressman Willis Hawley of Oregon and Senator Reed Smoot of Utah passed a legislation that called for one of the steepest tariffs in U.S history. Tariff separated U.S farmers from their much needed customers abroad at the worst time possible. Smoot-Hawley triggered a global trade-war against the U.S. These retaliatory tariffs affected 125 categories of American products. These tariffs also had secondary effect on the international gold standard – denied many nations opportunity to earn gold that they desperately needed to pay for cross border debt obligations. Global trade collapsed under the burden of this trade war – between the years 1929 and 1934 international trade is estimated to have declined by around 66% (Smoot-Hawley Tariff).

By late December 1929, Hoover also started a verbal warfare on “wave of uncontrolled speculation” in the stock market. Short sellers were picked on as targets for prosecutions, ridicule, and shame. Attack on Wall Street and speculators did not help the stock market one bit.

Hoover laid the foundation for many a “New Deal” interventions, especially in the agricultural sector, including subsidies, protective tariffs etc. Hoover continuously intervened in two ways, first by subsidizing the production of many produce – incentivizing farmers to produce more of something that already had an oversupply, then buying many of these produces and stock piling them under agencies he established – like the Grain Stabilization Corporation and Cotton Stabilization Corporation.

Hoover’s tax policies did everything it could provide disincentive to investment and savings. Highest marginal tax rate was raised from 24% to 25% in 1929, and then again from 25% to 63% in 1932.

In 1932, Hoover signed first of two major banking regulatory bill that goes under the name Glass-Steagall Act.

Hoover lost his bid for the second term to his opponent Franklin D. Roosevelt. Between the November 1932 elections and March 4, 1933 inauguration, the country’s banking situation went from worse to a disaster. Uncertainty of interregnum did not help the cause of the markets. Hoover tried to contact the newly elected President FDR several times. He even wrote a personal letter. There was no response. President Hoover met with Rexford Tugwell (part of FDR’s brain trust) where he (Tugwell) informed President Hoover that the new administration had no interest in co-operating.

Nothing throws more light on Hoover’s policies than the campaign speeches of the two presidential candidates in 1932. Hoover himself summarized his policies in the face of a deep depression in the following words:

Two courses were open to us. We might have done nothing. That would have been utter ruin. Instead we met the situation with proposals to private business and to Congress of the most gigantic program of economic defense and counterattack ever evolved in the history of the Republic. We put that program in action. (Hoover, Address Accepting the Republican Presidential Nomination, 1932)

A couple of months later into his campaign for reelection, Hoover went on to say the following, that he would have nothing to do with any advice that urged him to let economy take it’s natural course.

In the midst of this hurricane the Republican administration kept a cool head, and it rejected every counsel of weakness and cowardice. Some of the reactionary economists urged that we should allow the liquidation to take its course until it had found its own bottom.

We determined that we would not follow the advice of the bitter-end liquidationists and see the whole body of debtors of the United States brought to bankruptcy and the savings of our people brought to destruction. (Hoover, Address at the Coliseum in Des Moines, Iowa, 1932)

Hoover was not just blowing smoke with him claims. His political opponent and, later, the 30th President of the United States, Franklin D. Roosevelt said the following about Hoover during his campaign and acceptance speeches:

I accuse the present Administration of being the greatest spending Administration in peace times in all our history. It is an Administration that has piled bureau on bureau, commission on commission, and has failed to anticipate the dire needs and the reduced earning power of the people. Bureaus and bureaucrats, commissions and commissioners have been retained at the expense of the taxpayer.

And on my part I ask you very simply to assign to me the task of reducing the annual operating expenses of your national government. (Roosevelt, 1932)

Besides the platform of the Democratic Party running against the incumbent republican President Hoover contained the following statement:

The Democratic Party solemnly promises by appropriate action to put into effect the principles, policies and reforms herein advocated, and to eradicate the policies, methods, and practices herein condemned. We advocate an immediate and drastic reduction of governmental expenditures by abolishing useless commissions and offices, consolidating departments and bureaus, and eliminating extravagance, to accomplish a saving of not less than twenty-five per cent in the cost of federal government, and we call upon the Democratic Party in the States to make a zealous effort to achieve a proportionate result.

We favor maintenance of the national credit by a federal budget annually balanced on the basis of accurate executive estimates within revenues, raised by a system of taxation levied on the principle of ability to pay. (Democratic Party Platform 1932, 1932)

As anyone who knows politics and politicians would already know, a political party that has long been out of power would try to differentiate their platform from that of an extremely unpopular incumbent. Implications are clear, far from being a budget cutting liquidationist, as popular myth would have it, Hoover was an interventionist and profligate spender.

FDR and Regime Uncertainty

If Hoover was a profligate spender who took on unprecedented spending programs and interventions, then FDR was Hoover on steroids (Table 3). Coming to power in 1933, FDR quickly forgot his castigation of Hoover administration as “the greatest spending Administration in peace times in all our history”. During his first two presidential terms, Congress enacted under proposals from the administration a plethora of laws severely weakening private property rights. Taking a cue from Roosevelt administration, various state legislatures passed their own “little New Deals”.

The post WWI period also marked severe political disruptions around the world including communist and National Socialist “revolutions” in many parts of the West. “Taken together, the many menacing New Deal measures, especially those from 1935 onward, gave business people and investors good reason to fear that the market economy might not survive anything like its traditional form and that even more drastic developments, perhaps even some kind of collectivist dictatorship could not be ruled out entirely” (Higgs, 2006)

One of the chief ironies of the Roosevelt administration’s policies that “for the most part the New Deal relied on private investment to stimulate recovery yet its rhetoric precluded the private confidence to invest” (Badget, 1989, p. 116)

(Higgs, 2006)

Following are a few selected acts of Congress substantially threatening private property rights.

Year

Legislations

1933

Agricultural Adjustment Act, National Industrial Recovery Act, Emergency Banking Relief Act, Banking Act of 1933, Federal Securities Act, Tennessee Valley Authority Act, Gold Repeal Joint Resolution, Farm Credit Act, Emergency Railroad Transportation Act, Emergency Farm Mortgage Act, Home Owners Loan Corporation Act

1934

Securities Exchange Act, Gold Reserve Act, Communications Act, Railway Labor Act

1935

Bituminous Coal Stabilization Act, Connally (“hot oil”) Act, Revenue Act of 1935, National Labor Relations Act, Social Security Act, Public Utilities Holding Company Act, Banking Act of 1935, Emergency Relief Appropriations Act, Farm Mortgage Moratorium Act

1936

Soil Conservation & Domestic Allotment Act, Federal Anti-Price Discrimination Act, Revenue Ac t of 1936

1937

Bituminous Coal Act, Revenue Act of 1937, National Housing Act, Enabling (Miller-Tydings) Act

1938

Agricultural Adjustment Act, Fair Labor Standard Act, Civil Aeronautics Act, Food, Drug & Cosmetic Act

1939

Administrative Reorganization Act

1940

Investment Company Act, Revenue Act of 1940, Second Revenue Act of 1940.

Table 4 (Higgs, 2006)

This relentless tinkering with the laws, regulations and government policy coupled with political disruptions at home and abroad added to the uncertainty surrounding the investment climate and private property regime. Economist and economic historian Robert Higgs called it “Regime Uncertainty”. As further proof of regime uncertainty and crowding out, we provide the following three charts – Figures 1-1, 1-2 and 1-3 (Higgs, 2006). First, private investment as a share of GDP – did not come anywhere close to full recovery until after WWII when Truman was in Oval Office and government spending collapsed dramatically after WWII. During WWII, “crowding out” was total with government spending replacing private spending/investment. There was no multiplier as the economy functioned essentially under command and control – one that produced a lot of war goods and a few consumer goods. Given the price controls and rationing, CPI and GDP deflators used for this period are questionable at best. The military draft essentially reduced unemployment to zero.

 

 

After his inauguration as President, one of the first few policy moves from President Roosevelt was confiscation of people’s gold – with threat of imprisonment for those who refused to sell their gold to U.S Treasury. He then worked on to remove gold clauses from all sorts of contracts that had been written in to contracts for more than 100 years. It was pitched to the public as a temporary measure, but it remained in place until the breakdown of Brettonwoods in early 1970s.

Ignoring the opposition of the U.S Chamber of Commerce and National Association of Manufacturers, in 1935, Roosevelt administration supported “the Social Security Act, the National Labor Relations Act, the Banking Act, and the Public Utilities Holding Company Act, as well as a host of other laws, including soak-the-rich taxes” (Higgs, 2006)

In 1935, 1936, and 1937, FDR requested legislations intended to punish the wealthy. The administration instituted “Wealth Tax” of 1935 which included a graduated corporate income tax, a tax on corporate dividends, increases of estate and gift taxes, and increase of surtaxes on incomes greater than $50,000 that went all the way up to a top bracket of 79 percent. In 1936, the administration sought to tax retained earnings on top of all other corporate income taxes. The tax act of 1937 closed a variety of “loopholes”. These punishing taxes were levied upon those who made majority of the decisions about private investment. Economic historian Brownlee concluded “the tax reform of 1935-37, more than any other aspect of the New Deal,… stimulated business hostility to Roosevelt…Business opponents of New Deal tax reform charged that Roosevelt’s taxes, particularly the undistributed profits tax, had caused the recession [of 1937-38] by discouraging investment” (Brownlee, 1985)

There were other interventions that stroked the perception that FDR administration was hostile to private property rights. Supreme Court had rightfully struck down many policies of FDR administration as patently unconstitutional. In 1937, the Administration put forth a plan to circumvent the constitutional challenge by packing the Supreme Court. Although he failed to get congressional support, many perceived this move as “a naked bid for dictatorship” (Benjamin Anderson, 1949, 1979 p. 430). This move intimidated justices. They (justices) became weary of public contempt and worried about their constitutional power being stripped away, and they finally capitulated.

The top marginal tax rates were raised further to 94% in multiple increments in 1940, 1942 and 1945. As disastrous as the picture that unemployment statistics paint, it does not come close to describing the real misery that the Great Depression wreaked on the American public. 10 years into the depression, unemployment rate remained stubbornly high at 17.2 percent in 1939. (Margo, Spring 1993).

Folly of spending binges of Hoover and FDR administration was captured in the remarks of FDR’s treasury secretary Henry Morgenthau’s remarks in the House Ways and Means Committee testimony in 1939:

We have tried spending money. We are spending more than we have ever spent before and it does not work.

I want to see this country prosperous. I want to see people get a job. I want to see people get enough to eat. We have never made good on our promises.

I say after eight years of this Administration we have just as much unemployment as when we started. … And an enormous debt to boot! (Morgenthau, 1939)

The Great Depression: An Avoidable Tragedy

It should be reasonably clear from the events that led to the Great Depression and from the policies that perpetuated and lengthened the tragedy, that a better fiscal policy to pursue would have to been to do what was always done prior to the Great Depression – government staying out of it. Drawing from the excellent work of JR Vernon (1994); Ritschl, Sarferaz and Uebele (2008); and Christina Romer (1986) on GDP and historic business cycles, economists George Selgin, Larry White & William Lastrapes concluded that the length, depth and severity of business cycles in post WWII era got slightly worse than the length, depth and severity of the business cycles between Civil War and WWI. This renders questionable at best the perception that fiscal stimulus could solve economic stagnation.

Bibliography

Democratic Party Platform 1932. (1932, June 27). Retrieved from American Presidency Project: http://www.presidency.ucsb.edu/ws/index.php?pid=29595#axzz1Tj5ZvM3p

Budget of the United States Government: Historical Tables. (2011, July 30). Retrieved from GPO Access: http://www.gpoaccess.gov/usbudget/fy09/hist.html

Brownlee, E. (1985). Taxation. In O. G. Wander, Franklin D. Roosevelt, His Life and Times: An Encyclopedic View (p. 417). Boston: G.K. Hall and Co.

Eichengreen, B. (February 2004). Understanding the Great Depression. Canadian Journal of Economics, vol.37, no. 1, 1-27.

Gibbons, P. R. (2008, November 4). Old myths about the New Deal. Retrieved from NPRI: http://www.npri.org/publications/old-myths-about-the-new-deal

Hayek, F. v. (1974, December 11). The Pretence of Knowledge. Retrieved from Nobel Prize: http://nobelprize.org/nobel_prizes/economics/laureates/1974/hayek-lecture.html

Higgs, R. (2006). Regime Uncertainty. In R. Higgs, Depression, War and Cold War: Challenging the Myths of Conflict and Prosperity (p. 13). Oakland: The Independent Institute.

Hoover, H. (1932, August 11). Address Accepting the Republican Presidential Nomination. Retrieved from The American Presidency: http://www.presidency.ucsb.edu/ws/index.php?pid=23198&st=&st1=#axzz1TZPsKZak

Hoover, H. (1932, October 4). Address at the Coliseum in Des Moines, Iowa. Retrieved from The American Presidency: http://www.presidency.ucsb.edu/ws/index.php?pid=23269&st=&st1=#axzz1TZPsKZak

Margo, R. A. (Spring 1993). Employment and Unemployment in the 1930s. Journal of Economic Perspectives, 41-59.

Morgenthau, H. (1939, May 9). Henry Morgenthau Diary. Retrieved from Burton Folsom: Where History, Money and Politics Collide: http://www.burtfolsom.com/wp-content/uploads/2011/Morgenthau.pdf

Roosevelt, F. D. (1932, September 29). Franklin D. Roosevelt Address Sioux City, Iowa. Retrieved from Pepperdine University School of Public Policy: http://publicpolicy.pepperdine.edu/faculty-research/new-deal/roosevelt-speeches/fr092932.htm

Rothbard, M. (2000). Americas Great Depression. In M. Rothbard, Americas Great Depression (p. xiii). Auburn: Ludwig von Mises Institute.

Rothbard, M. (2000). Americas Great Depression. In M. Rothbard, Americas Great Depression (pp. 142-144). Auburn: Ludwig von Mises Institute.

Schwartz, M. F. (1993). A Monetary History of the United States, 1867-1960. Princeton University Press.

Shlaes, A.(2007). The Forgotten Man: A New History of the Great Depression. Harper Collins Publishers.

Smoot-Hawley Tariff. (n.d.). Retrieved from U.S. Department of State: http://future.state.gov/when/timeline/1921_timeline/smoot_tariff.html

Summers, L. (2011, July 26). ‘I think Keynes mistitled his book’. Retrieved from Washington Post: http://www.washingtonpost.com/blogs/ezra-klein/post/larry-summers-i-think-keynes-mistitled-his-book/2011/07/11/gIQAzZd4aI_blog.html

White, E. N. (2009, September). Barnard College. Retrieved from Columbia University: http://www.econ.barnard.columbia.edu/~econhist/papers/White%20_1920s_Real_Estate_September_2009.pdf

 

 

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Following is a paper I submitted on March 18, 2010 to my professor of  Corporate Social Responsibility course @ SCU( I received an A grade for the course) :

“For every complex problem there is an answer that is clear, simple, and wrong.” – H.L Mencken

As an engineer working in the technology industry, my job function and responsibilities are mainly in the area of software product testing. While I am neither an employee of Toyota, nor an employee of any other automobile company, as a Software QA Team Lead, I feel that this topic is very relevant to my day to day work, for the simple reason that Toyota’s recent troubles allegedly stems from some electronic components inside the accelerator/braking system, a defect that was supposedly not caught in their quality tests. This case has a lot of relevance to the kind of decisions that quality personnel have to make on a regular basis.  Furthermore, this is a hotly debated topic in the public policy arena at the moment.

My goal in this paper is to demonstrate the potential repercussions of a populist crusade against genuinely good businesses – a perspective rarely considered by ethicists in their enthusiasm to bring down a corporation because of situations with mere appearance of impropriety.

The Toyota Way

Toyota started in 1933 as a division of Toyoda Automatic Loom Works devoted to the production of automobiles under the direction of the founder’s son, Kiichiro Toyoda. Its first vehicle, passenger cars A1 and G1, rolled out in 1935. The independent Toyota Motor Co. was established in 1937.

In recent years, Toyota had grown into the single largest manufacturer of passenger cars in the world, overtaking GM. Some of Toyota’s sedans like the Camry have outsold most all others in the United States for several years. Over the years, Toyota has earned the reputation as the maker of some of the most reliable, durable, and safe automobiles in the world.

In April 2001 TMC adopted the “Toyota Way 2001”, an expression of values and conduct guidelines that all employees of TMC should follow.  The values and guidelines are summarized as follows: (Human Resources Development, 2003)

  • Continuous Improvement
    • Challenge
    • Kaizen (improvement)
    • Genchi Genbutsu (go and see)
    • Respect for people
      • Respect
      • Teamwork

However, according to outsider observers, there are four components to the Toyota Way (Liker, 2003)[1]

  1. Long-term thinking
  2. A process for problem solving
  3. Adding value to the organization by developing its people
  4. Recognizing that continuously solving root problems drives organizational learning

Toyota takes pride in her insistence on being the highest quality automaker. This was validated by the trust that customers placed in their Toyota and Lexus branded automobiles. Toyota had a reputation for being the car with one of the highest resale value, and longest durability, until the recent brouhaha about the reported “sudden unintended acceleration” problem and subsequent accidents and associated loss of life.

Toyota and the Sudden Unintended Acceleration (SUA)

In November of last year, Toyota initiated a recall of some 3.8 million of its vehicles for a sticky pedal problem. The recall was voluntary, out of fears that loose floor-mats might cause the pedal to stick, increasing the odds of an accident. The recall was the largest in the company’s history.

The recall was followed by an amended recall on Jan 28, 2010, that included 5.2 million vehicles for pedal entrapment/floor-mat problem, and another 2.3 million vehicles for accelerator problem. Around 1.7 million vehicles were subject to both problems. (Toyota Pressroom, 2010)

While working with National Highway Traffic Safety Administration (NHTSA) to send letters to owners of its cars, Toyota planned a 3 pronged strategy for its recall effort:  train their dealer service staff to reshape gas pedals, redesign and ship new gas pedals, and install a brake system that will turn off the engine if both the brake and the accelerator are pressed simultaneously.

Toyota also announced that the cost of the recall will be borne by a $5.6 billion fund that the company had set aside for recalls, and thus there would be no effect on the company’s bottom line. (Toyota Press Release, 2009)

However, history of SUA didn’t start in November of 2009, but going all the way back to the last millennium. Since 1999, at least 2,262 Toyota and Lexus owners have reported to the NHTSA, the media, the courts that their vehicles have experienced SUA under a variety of conditions. These incidents have produced a total of 815 crashes, 341 injuries and, 26 deaths potentially related to SUA. (Kane, 2010)

The critiques of Toyota argue that the company ignored plenty of warning signs, in a callous quest for profit. As stated earlier in this report, there have been over 800 incidents of reported SUA involving a Toyota/Lexus branded vehicle.

Toyota brand has been tarnished by the events of this particular case, the company has been vilified, and has been named defendant in many a class action lawsuit. The biggest impact is to the company’s bottom line. According to JP Morgan’s Kohei Takahashi, the company could take a hit of 5.5 billion USD due to the SUA incident (Hosaka, 2010). So it begs the question – what went wrong for company that could otherwise do no wrong?

Will engineering ever be flawless?

As an engineer responsible for designing quality processes and procedures for complex products, I can tell you that the answer to that question is a resounding never. Even small software products have millions of possible combinations of software code-paths that will be impossible if not impractical to conceive ahead of time, plan it, and test it before a product is released. The job of a smart quality engineer is to design tests such that bulk of the flaws, especially the more serious ones, a customer could encounter be caught and fixed before the product is released.

In the case of an automobile, not only does it contain complex software that controls the fuel injection and breaking system, but also 1000s of electro-mechanical parts that have to work together to create a satisfactory and safe utility for their paying customers. The potential combinations of tests are impossibly huge and, tremendously expensive, as any person with a background in quality engineering can tell you. A product that undergoes this type of “comprehensive” testing will be impossibly expensive, if not impractical to create. So the question really is not, “should Toyota have caught this problem before their vehicles left the factory floor?”, instead, “Should they have taken the early warnings more seriously?” A quick peek into the history of SUA incidents might give us some clues.

History of SUA

The history of SUA did not start with Toyota. It goes all the way back to the late 1980s when SUA was reported with all manner of cars. In the popular case of the late 1980s, the NHTSA eventually ruled that the cause of the accident was “pedal misapplication”, in other words, stepping on the gas when the driver meant to step on the brake. These incidents were correlated with three things: being elderly, being short and parking (or leaving a parking space)

In Sep 2000, I was personally involved in a not-at-fault accident where the other driver crashed into the passenger side of my car, coming from behind at a speed much above the stated speed limit. The location of this accident was right on top of the Dumbarton Bridge that connects eastern shore of the San Francisco Bay to the peninsula. That driver was a gentleman of more than 60 years of age, if not closer to 70 years. He drove a Ford Taurus, and reported to the CHP that he lost control of the car as it accelerated without any intent on his part to do so. Cops who deal with cases like this were pretty sure that it was a case of an old man losing control of the car on top of a bridge with a well known condition of high winds.

One thing that any student of MGMT505 should know about human behavior is that human beings have a tendency to not blame themselves for the circumstances that causes undesirable events or outcomes. It should be easy to see why SUA was construed as one such case, not only by Toyota, but by regulatory agencies such as NHTSA.

As reported earlier in this document, the total reported incidents of SUA, both alleged and real, was “only” 841. That may sound callous, but compared to 1.2 million killed and 50 million injured worldwide in traffic accidents worldwide in year (World Report on Road Traffic Injury Prevention, 2004), the 841 figure really diminishes in significance. Now, here is the real kicker, 34% of those accidents are directly attributable to road design and the road environment, clearly a responsibility of the governments in most part of the world, whose opportunistic agents have gotten a special kick out of demonizing Toyota Motor Corp(TMC) (Santos, 2002).

In addition, if one looks at the demographics of the driver fatalities in these SUA incidents, a striking pattern emerges. In the words of Megan McArdle, “The overwhelming majority are over the age of 55. The elderly are more prone to this sort of neuronal misfiring. This effect would be enhanced by the driver being slightly misaligned in the seat when he first gets in the car. This is not too hard to understand, given that even a basketball player who makes 90% of his free throws sometimes misses the hoop.”

The data from the recent Toyota SUA complaints paints a very similar picture (Williams, 2010):  (McArdle, 2010)

When a car accelerates unexpectedly, the driver often panics, and just presses the brake harder and harder. Drivers typically do not shut off the ignition, shift to neutral or apply the parking brake.

 (McArdle, 2010)

To quote Ms. McArdle again: “in many cases, there were no witnesses, therefore no exact details as to when the car started to run away. In fact, in many cases, the best witnesses to the incident were all killed in the incident, and their families just doing what they can to reconstruct what happened from their prior knowledge of the deceased. In some other cases, the police or doctors have an alternate theory of what happened: one of the victims was bipolar, which puts him at a high risk of suicide; two other young drivers were driving at very high speed, which is something young men tend to do regardless of the stickiness of their accelerator; and few other drivers seem to have had a stroke to which the doctors/police attribute the acceleration” (McArdle, 2010).

In any event, once you digest all of these facts, it becomes clear as to why Toyota did not consider this as overwhelming evidence of a serious problem. That is not to say that it is the drivers who are necessarily at fault. Whatever the defect in Toyota vehicles, it is not smart enough to pick on short and elderly drivers.

None of this is going to help Toyota. Its image has already taken a toll in the eyes of the public, it will continue to face waves of lawsuits, and it might be very difficult to get a fair trial.

Qui Bono?

It should be clear to any student who has completed the MGMT505 course that financial consequences of ethical negligence, purposeful or otherwise, on the part of corporate management, could be devastating to that company. Anyone doing a rational analysis of the situation will find it hard to buy into the narrative that Toyota did not care how many people it killed so long as they made a profit. Not in this day and age. It is too risky, in this age of nosy regulators and angry consumer activists.

Why is Capitol Hill so eager to publicly crucify Toyota executives? One possible answer could be found in the fact that the U.S government can no longer be trusted as a disinterested third party whose sole interest is to protect the U.S citizens they have vowed to represent. Because earlier last year, U.S government chose to become a major shareholder in couple of Toyota’s bigger competitors, in a politically unpopular move, I might add. Sunk-Cost fallacy tells us that those who supported the decision to bailout GM and Chrysler have a vested interest in making sure that their decision turns out to be a positive one. That is not to say that this SUA was born out of a conspiracy on the Capitol Hill, far from it. The congress is, merely, taking advantage of a situation that was thrown into its lap.

When the Transportation Secretary Ray LaHood urged Americans to “stop driving” their Toyotas this January, was he speaking as the head of a federal agency concerned with highway safety or as a sales advocate for a nationalized GM?

Moreover, according to WSJ, lawyers across the U.S are clamoring for lucrative roles in the litigation against TMC, hoping to emerge as leaders from the scrum of those who have filed dozens of lawsuits (Searcey, 2010).

It is clear, that corporations sometimes as large as TMC could be victims of persecution just as much as ordinary citizens.

Conclusion

The Toyota’s voluntary recall case is a clear sign that markets work as they should. A functioning market is one in which the various companies produce products that meet consumer demands – for products that are safe and effective. Companies that don’t meet this demand, intentionally or otherwise, risk losing customers and money, as the Toyota case has demonstrated.

Toyota’s decision to recall 3.8 million vehicles came in the backdrop of its regulator, NHTSA’s reluctance to reopen a closed investigation into potential defects in Toyota branded cars, clearly demonstrating private sector’s incentive to compensate for perceived problems. Errors are part of life, we all make them, and the management of TMC is no exception. Correcting errors when they occur is a necessary part of a well functioning market.

There are trusted private organizations like Consumer Reports, Kelly’s Blue Book, Edmunds.com etc. that have incentive to provide reliable, accurate and timely information on product quality and safety. Customers trust similar organizations when deciding to buy consumer electronics or appliances. So the Toyota SUA experience doesn’t prove the necessity for more regulatory bureaucracy.

The parent organization of consumer reports, Consumer Union, has about the same number of employees as NHTSA – 600 employees. While Consumer Union generates revenues of over 200 million from its willing customers, NHTSA costs tax payers upwards of $850 million (NHTSA FY 2009 Budget Overview, 2009).

If those aren’t enough reasons to distrust more regulations, consider this, among the legislators investigating the Toyota recall are Senator Rockefeller(D-WV) who admits to lobbying Toyota to build a plant in his state, and Representative Darrel Issa (R-CA) who still serves on the board at the auto alarm company he founded, which sells to Toyota. Lawmakers also have an incentive to just chase after catchy headlines.

Politicians in their quest for power and eagerness to boost their own egos have hurt a company with a longstanding reputation for serving its customers, known for producing the highest quality products in its market segment. The hurt that the regulators has inflicted on Toyota has far reaching consequences, in terms of lost jobs at TMC and its dealerships around the world, the loss of trust, and loss of shareholder wealth(therefore retirement funds for many), not to mention the anguish it inflicted on millions of anxious owners of automobiles made by Toyota/Lexus.

To sum up, the incentives to serve the customers’ interest clearly lie with the private sector and not with the government – politicians or bureaucrats. Toyota could be a victim of its own conscientious choice to recall cars. What message are the regulators trying to send to businesses by waging a war against Toyota Motor Corp.?

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[1] http://www.massmac.org/newsline/0806/article01.htm