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Journal of Economic Perspectives: Vol. 24 No. 3 (Summer 2010)

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

Article Citation

Lafontaine, Francine, and Fiona Scott Morton. 2010. "Markets: State Franchise Laws, Dealer Terminations, and the Auto Crisis." Journal of Economic Perspectives, 24(3): 233-50.

DOI: 10.1257/jep.24.3.233

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-á-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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Authors

Lafontaine, Francine (U MI)
Scott Morton, Fiona (Yale U)

JEL Classifications

K22: Corporation and Securities Law
L14: Transactional Relationships; Contracts and Reputation; Networks
L62: Automobiles; Other Transportation Equipment
L81: Retail and Wholesale Trade; e-Commerce

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