The rise in delinquencies on auto loans is one sign that America’s auto industry is in trouble — along with the rest of the economy. How hard are the auto makers being hit and what should the Big Three do to stem the damage? Meanwhile, the global auto industry has seen some interesting developments, including the introduction in India of Tata Motors’ Nano and the arrival of five Chinese auto manufacturers at the Detroit auto show earlier this month. Will China and India be big players in the global market for cars? And what is the current state of Europe’s auto industry? Knowledge at Wharton asked Wharton management professors John Paul MacDuffie and Mauro Guillen to steer us through the turmoil.

An edited transcript of the interview follows:

Knowledge at Wharton: The U.S. auto industry is predicting a weak year. How weak is weak, and does this affect all models from economy cars to luxury cars?

MacDuffie: Yes, it’s really a big chunk of bad news for the U.S. industry which has been trying hard to overcome a lot of its problems. I do think that the bad economy does hit all car sales and rising fuel prices hit sales of big cars more. The U.S. companies have been trying to regain market share after years of losses to the Japanese and the Koreans, and this won’t help them. I think the short term looks pretty bad. 

Guillen: The prospects are obviously not good right now. However, there are some foreign markets that are still growing — especially in the emerging economies. And, the U.S. automakers do have a presence there. So, I fully agree with John Paul that the short term outlook for the U.S. looks bleak, especially for certain kinds of models.

The fact that the Fed has lowered interest rates may perhaps help some potential consumers buy automobiles. This is because the rates will go down on automobile loans and it will help some of them avert not bankruptcy but at least from defaulting on their auto loans. I think it’s a mixed picture. We need more information, but it doesn’t look good. It certainly looks no better than last year, that’s for sure.

Knowledge at Wharton: Car companies are concerned about what some of them call “the most affluent” who typically do well in a strong economy, but now are feeling the pinch of a lower stock market, lower bonuses and so on. Is their possible reluctance to purchase new cars a big part of the gloomy outlook?

Guillen: Sure. People have superfluous expenses. If the bonuses are not coming in, you need to postpone buying things you don’t need. You have to pay for your kids’ education [I guess] and you have to pay for the family trip — rather than for the third convertible in the driveway. But the future of the U.S. automakers will not depend so much on that very, very tiny segment at the very top.

It’s going to be much more important to watch the middle of the market and see how consumers there are thinking about or rethinking their purchases of durable goods and looking ahead for the next six months or so. It’s going to be interesting, as the new models come in, to see whether people will feel, “Wow, I cannot postpone buying this really nice car,” or whether they will hold on to their wallets. That [latter option] is going to have a devastating effect because the U.S. automakers have spent a lot of time developing new models this year, right?

MacDuffie: Yes, absolutely. They are trying to regain ground in the passenger car segment, getting away from so much reliance on trucks and SUVs. So they were counting on winning people back. In any economic pinch, people are tempted not to replace or to purchase used cars. There’s a very healthy, huge used car market in the U.S. and better information than ever. People do national searches for used cars, unlike in the past and so: Why not switch to the two- or three-year old more fuel efficient used car instead of the new car sale? That is part of what will hurt in the short term.

Knowledge at Wharton: What are the Big Three doing besides cutting costs? Are they considering increasing incentives to attract more buyers, even though that caused a lot of problems the last time they did that because consumers got so addicted to them?

MacDuffie: They would like to break this addiction to big discounts because it has hurt them in lots of ways. They’ve trained customers to wait for big discounts. They’ve driven down the residual values of leased vehicles, the used car prices, etc. That has been the problem, along with trying to stop the habit of boosting their sales numbers by pushing vehicles out to rental car companies and the like, which again are not really a true test of what consumers want.

But it’s always tough when you have a certain amount of factory capacity that you need to keep occupied. You don’t want those finished goods sitting around. So I suspect we won’t see discounting at a level that we became familiar with, but there will be isolated examples.

Knowledge at Wharton: Are you expecting any shake-ups at the Big Three? And, also, how would you rate Robert Nardelli’s performance at Chrysler so far?

MacDuffie: I don’t know if you mean management shake-ups. The last couple of years have seen a new CEO at Ford and the sale of Chrysler to Cerberus and Nardelli coming in. Then there were these historic new labor agreements this year. There have been a lot of turbulent activities in the last year.

It’s a little bit hard to read the Chrysler situation, now that the company is privately owned. They don’t have to provide as much information, and there certainly have been a lot of management shuffles within the ranks. They’ve recruited a couple of people from Toyota, and there was a lot of publicity around that. It’s a little early to tell, but certainly this has to be bad news for the new owners that they hit this economic slowdown right when they took over. You already hear noises of having to make bigger cutbacks than they said needed to be made at the time of assuming ownership — and that has to have a chilling effect on the morale of the employees.

Ford is probably still in financially the weakest shape of the three. GM seems to be rebuilding; Chrysler is trying to adjust to this new change in ownership structure; and Ford is still really very much on the brink of real financial crisis.

Guillen: A couple of other things are going on. As John Paul mentioned, Ford is trying to make up for its weaknesses by selling some divisions, especially the Rover and the Jaguar. Interestingly, Tata has emerged as the major beneficiary of these actions.

The other thing is that not even very well established players like Toyota have been free from trouble recently. They’ve bumped into serious quality issues, and I don’t know to what extent this will tarnish their reputation because it is a brand that is widely recognized for producing cars of the highest quality.

All the established automakers will need to take this opportunity, during the downturn, to rethink their strategies and ponder what they should be doing over the next 15 or 20 years. This is because as you mentioned at the beginning, we have the Chinese automakers getting in and this is going to affect some automakers more than others. We haven’t even talked about the European automakers, who have their own problems.  

Knowledge at Wharton: Speaking of the Chinese automakers, do you think they will be able to make a dent — no pun intended — in the U.S. market? Five of them were at the U.S. auto show recently.

Guillen: Give them a few years. If experience or history can teach us anything, we know it takes 10 to 15 years for a foreign automaker from a developing country or emerging economy to be a serious contender in a developed market. I think it took that long for Hyundai, right?

MacDuffie: Yes.

Guillen: They stumbled the first couple of times with the Pony [a rear-wheel drive vehicle that was the forerunner to the Hyundai Excel].

MacDuffie: Yes.

Guillen: But then, eventually they got it right. Now China is building up its presence. It’s tough, because neither the Americans, nor the Europeans, and of course the Japanese want to give up market share in a market that potentially is as profitable as the U.S. But they have agreements, they’re learning how to manufacture, they’re buying the technology, and maybe they’ll start developing some of their own technology. I would give them five to 10 years, and I think they might become a serious force to acknowledge. Presumably this is going to benefit the consumers. We shall see what happens.

MacDuffie: The growth that is happening in China and other markets close to them is so huge that any of the Chinese companies will be more than busy with just keeping up with that growth. But to sell into the U.S. market is a big achievement. It’s a source of pride. It’s a major goal.

So far I don’t see any reason to expect the Chinese will follow any different path than the Japanese and the Koreans before them — of wanting to export successfully to the developed countries — understanding that they need a lot more technological expertise. They won’t want that to be through licensing or getting that from joint venture partners. They will eventually want to be in control of the technology themselves, and it will take them a while to meet the standards of U.S. regulations and the very demanding expectations of U.S. consumers in terms of quality, ride and comfort, etc.

They’ll work hard for that, and I’m sure they will get there. Will they get there faster than the Japanese or Koreans? Possibly there may be some features that have speeded the amount of technology transfer coming into those companies now. But, it’s not going to happen in the next couple of years. It’s definitely further down the road. And, the fact that they come to U.S. auto shows doesn’t really mean that they’re necessarily any readier to meet that test just yet.

Knowledge at Wharton: Let’s talk about the Nano. It’s the world’s cheapest car at $2,500. It’s a five-door hatchback, powered by two cylinders, capable of going 75 miles an hour and getting 54 miles to the gallon. Tata hopes to sell 1 million cars a year and expand to other countries. Can they do that? Also, does it increase the pressure on U.S. manufacturers to come up with really cheap cars?

MacDuffie: People have been watching the Tatas’ $2,500 car with interest for a long time. Tata has done a great job of building up a lot of very high expectations. It’s not a new quest to build products at the low cost end of the market and sell into these rapidly growing developing markets. This just seems bolder in its ambition.

The design is clever in a lot of ways, but some major questions still exist about how well the product will hold up over time. Even if the Nano now meets Indian emission and safety standards, will that continue to be true after two or three years of hard use on rough Indian roads? Certainly, these products will not be coming to the U.S. or other developed markets because they are a very long distance from meeting our safety and emission requirements, not to mention acceleration and other kinds of things.

As for immediate pressure on U.S. companies to serve that low cost end of the market, we won’t immediately be seeing those products here. But many auto companies are trying to create products at that end of the market. I might say a word or two about the experience at Renault with the Logan. That’s a product that was designed from scratch to build and sell in Eastern Europe. It’s been very successful and part of the surprise with the Logan is that it’s also selling very well in Western Europe — to people who want inexpensive second cars. It doesn’t sell in its cheapest version; it sells with a lot more of its comfort features which helps Renault because they are making some profit margin on those models. Maybe that is more of the example that is relevant to the U.S. car companies.

Knowledge at Wharton: Ratan Tata, chairman of the Tata group of companies, has said he is happy that other car companies are planning to enter the low cost market. For example, Renault and Nissan have partnered with Bajaj Auto to produce their own version of the $2,500 car. Toyota, Honda, Ford and Fiat are also working on their own models. How will the Nano retain its competitive advantage if the market gets so competitive?

MacDuffie: It’s a very competitive industry, and I don’t think they [the Tatas] have any guaranteed edge. There’s nothing I have seen that suggests that what’s helped them reach that price point can’t be imitated by others. They will have some advantages in selling to the Indian consumer. They are a well known brand name. People are excited about this new product. They’ll want to buy from an Indian company that is doing innovative things, and that will certainly help them.

Another wild card is what happens at the Indian government level in terms of regulations. If emissions and safety standards are toughened up — which a lot of people think they will be — the Nano would have to meet those requirements. This will instantly raise its price a lot and put it into competition with a lot of other products, not just these new ones, but some of these existing products from Maruti and the like. I see a very competitive road ahead for Tata. But it was kind of brilliant of them to make such a splash and have some bit of time to really catch on with Indian consumers before some of these new developments tighten things up.

Guillen: It is important to highlight that there’s a symbolic aspect to all this. Tata has certainly scored a big win with this announcement and attracted a lot of attention. But even in the Indian market, they are going to be challenged, let alone in neighboring markets or other locations around the world, especially in the developed countries where Tata doesn’t even have a distribution network. It’s going to be really hard for them.

What I find fascinating is that exactly 100 years ago, the first Model T Ford rolled off the assembly line in 1908. It’s exactly 100 years ago. Another thing I find fascinating is that Henry Ford priced the Model T Ford at one-third the U.S. per capita income at the time. And the per capita income in India is also about nearly three times [more or less] what the Nano would cost.

I haven’t been able to check the numbers for the Volkswagen when it came into the market; that was the people’s car. That was also intended to give rise to mobility on a grand scale in Germany. Italy has also had its people’s car, Il Topolino [“Little mouse,” the name given to the Fiat Cinqecento or 500]. The same thing was true for Spain. In all the markets around the world, there has always been one car that has been priced right there, so that increasing numbers of people could essentially enter the automobile age.

Tata can be one of the players that may play that role in India; I don’t think they will be the only one. I don’t think this car will make Tata’s reputation in the global auto industry because there is going to be so much competition for that segment with that kind of product. It’s not totally clear to me what advantage they have that some other company doesn’t already possess. The technology cannot be it, unless they were able to find some new revolutionary engine. Branding can’t be it either. Low cost? Well India may have low costs but so do many other locations around the world. So whatever initial advantage Tata obtains from these bold announcements, how on earth will they sustain it over time? I just don’t see it. It’s very clever, I agree, but it will be difficult to keep this just to themselves and to exploit all the profits. 

Knowledge at Wharton: Mauro, you said earlier that European car companies are having their own sets of problems. Can you expand, both of you, on that?

Guillen: Some of them have been facing problems for quite a while — like Fiat of Italy. They are muddling through, trying to hold on to their past glory. Renault actually and surprisingly has been very innovative for the last 10 years with new models, especially for European markets. They have expanded globally in the form of alliances while taking stakes in companies, especially in Asia.

The Germans, I guess, are doing reasonably okay. BMW has put behind a lot of the problems that they bumped into when they acquired Rover in Britain. They essentially transferred those problems to American firms. And then, who else is left? The British are all gone. The Eastern Europeans have essentially been acquired by the Germans, for the most part, or have disappeared altogether.

Another interesting thing is we will see what happens with the Volvo…whether it will revert to Swedish hands or not. What the Europeans have, of course, is distinctive technology and a very valuable brand image. Some of these brands command premium prices around the world, even in this industry, which John Paul has been saying has become commoditized. That is to say that the competition is really, really intense. It’s become difficult to charge premium prices because there is always somebody else who can offer a good product, in the same price range, with very good technology. If it’s not the Europeans, it’s the Japanese. And so, there are always alternatives for buyers, even for very sophisticated buyers. My sense is that Europeans have been struggling again with the same thing.

So far the European automakers have been lucky because European economies have been growing. But there are already signs of trouble ahead. Let’s see how and to what extent the U.S. downturn actually affects the growth of the European economies. Auto sales are already down from regular levels. I think they will confront some serious problems.

MacDuffie: Some of the common themes are slow growth of markets and so the European markets are not the places where these companies can find a lot of growth. The tougher emission standards are advancing much more quickly in Europe than in the U.S., so all the companies are working hard to figure out how they will meet them. These companies are obviously used to dealing with much higher fuel prices than we are. But, of course they’re affected by that trend as well.

For different companies there is a different story with respect to globalization. The most successful globalizing companies have been somewhat shielded from the ups and downs of any particular local market, including their home market. Getting back to what Mauro said at the beginning, GM is very much helped right now by the fact that their international sales are doing great. And their international sales are now a much bigger percentage of their total business. So, again, companies that were earlier into that process and have figured out a way to manage that effectively are doing better. But there are probably a smaller number of examples of successful global alliances than of the ones that have failed or come unstuck.

Guillen: I would like to add one more thing about the European companies and the market over there. By the way, that includes not just the automobile companies that are European owned, but also the Americans who are operating there. In this new era of very, very high gas prices, I wonder when the diesel engine for passenger cars is going to be accepted, in the U.S. market [finally] or beyond.

In Europe, I don’t remember now the exact percentages but it was something in the neighborhood of 70% of all new cars that are equipped with a diesel engine. Some 15 years ago, diesel engines were noisy; they were very big; they didn’t give you the performance, the acceleration and all of that. But, Europeans have innovated in terms of diesel technology so much that now you can barely notice the difference in terms of performance. I mean if you are driving a Porsche, of course you would notice a difference. But for the average auto driver, a diesel engine in a passenger car is actually no less appealing today in Europe than a conventional gasoline engine, and it is much cheaper to operate.

So, I wonder whether there will be some major movement in terms of exporting this European technology — which is owned also by American firms over there — to other parts of the world. This is an interesting future development that may occur. I’m interested in knowing what John Paul thinks about that because it’s one of the most conspicuous differences between the U.S. and European automobile markets these days.  Do you think that the American automobile driver/consumer may be persuaded, with good marketing, maybe to adopt the diesel engine?

MacDuffie: Well, the Europeans are clearly hoping against hope that this will happen and they are betting on that. If we think of this as a time when there will be some transitional technologies between the traditional internal combustion engine and maybe some future advanced technology — whether its fuel cells or something else, or fully electric cars — clean diesel is going to be that transitional technology in Europe.

In the U.S. hybrid gas electric designs have a big head start and have won a big public following.

Guillen: But it’s only 5% of the market or less…

MacDuffie: Well, that’s true…

Guillen: …versus 75% in Europe for diesel.

MacDuffie: That’s true. But, I still think that there are a lot of negatives that diesel has to overcome in the U.S. If clean diesel can come in at a big price advantage over the hybrid, maybe. But the hybrid cost premium will go down as the volumes increase. Toyota is already working on hybrid diesel, diesel electric combinations which they will push in Europe. But I think that they will continue to push the performance envelope in the U.S. with the gas electric combination. I still think that diesel has a long, long way to go. It won’t be easy for the Europeans.