For decades, the U.S. auto industry ruled America’s economy, shaped the country’s development, and influenced American culture and social mores. Now, buffeted by globalization and other powerful forces, it faces a moment of truth.

The experts say it’s a foregone conclusion. Sometime soon, probably this year, of the millions of cars being churned out in factories all around the world, one of them, unknown and unremarked, will roll off an assembly line and take its place in history. Basking under the hot lights of a showroom, or parked anonymously amid row upon row of its brethren somewhere on a dealer’s back lot, it will nonetheless embody a defining moment in a global race for supremacy. Manufactured by Toyota, this is the car that will propel the Japanese company ahead of General Motors as the world’s largest automaker, a position GM has held for more than seventy years.

Such a turn of events seems inconceivable. For decades, General Motors, Ford, and Chrysler were American icons, Detroit’s fabled Big 3. Responsible for a significant percentage of all American jobs, they lifted countless blue-collar families into the middle class. As much as any single institution, the automobile industry shaped how America lived, worked, and played, helping the country grow into the colossus of the 20th century. But now the U.S. industry, once the bellwether of the nation’s economy, may become just another, ordinary player in a greatly reduced U.S. manufacturing sector.

Although the Big 3 (or maybe the Big 2, after Chrysler’s merger with Daimler) continue to dominate the U.S. market, they are beset by falling sales, staggering financial obligations, and the relentless pressure of globalization and foreign competition. GM, for example, while it still has more than 300,000 employees worldwide, once employed 600,000 Americans alone and estimates it will employ only 86,000 in its U.S. operations by 2008. And in another telling numbers game, highly profitable Toyota has announced it will produce 9.06 million cars worldwide this year, while money-losing GM will cut production (after manufacturing an estimated 9.08 million vehicles in 2005). Increasingly, the glory days seem a thing of the past. How could such a reversal have occurred?

Can it be corrected, and does it matter if it can’t?

Car Trouble

Every novice driver is instructed to beware of “blind spots” in which overtaking cars advance unseen. It’s a lesson American carmakers apparently forgot.

“For the six decades preceding the second oil shock in the 1980s, the United States was a highly protected market,” declares HBS professor Malcolm Salter, who has tracked the auto industry for decades. “That wasn’t because of trade barriers but because gasoline prices were so much lower than in other auto-producing countries. With no serious challenge from abroad, and only relatively benign competition among themselves, the Big 3 and their stakeholders were all happy and doing well.”

That comfortable situation changed abruptly when oil prices soared in the 1980s, and the Japanese gained a toehold exporting attractive, low-cost, fuel-efficient vehicles to America. Responding to that change and the subsequent surge in domestically produced Japanese nameplates “was not just a technological issue for American automakers, but a psychological one,” Salter observes. “It required altering long-established methods, traditions, and ways of thinking. It comes down to this: How do you rewrite all the implicit, explicit, and inefficient contracts and relationships that comprise the U.S. industry? To complete the move from such a protected market into a wide-open, hypercompetitive environment is a very difficult process.”

Today’s headlines confirm that difficulty, as GM and Ford close plants, cut jobs and production, and try to deflect talk of bankruptcy, all the while losing money and U.S. market share. This most recent bout of bad news (coming after the minivan and SUV successes of the 1990s had temporarily eased the woes of the 1980s) has been ascribed to some or all of the following: excessive corporate bureaucracy, arrogance, and insularity; union obstinacy; exorbitant health-care costs and retirement packages; bloated product lines and overcapacity; and, of course, globalization.

For HBS professor Stefan Thomke, who grew up in a Mercedes-Benz company town near Stuttgart, Germany, it comes down to the basics. “Rather than competing on the basis of discounts, U.S. carmakers need to get to the point where people want to buy their cars,” Thomke says. “The companies can’t simply restructure their way out of their difficulties.” Thomke, an authority on the management of technology and product innovation, senses that “the culture within American firms seems different compared with their best European and Japanese competitors. The American carmakers seem less passionate about their product, and relations between the different organizational functions seem more constrained, as does the product-design process.”

Flexible and Nimble

HBS professor Kent Bowen, a technology and operations management expert who has studied Toyota, explains: “The Japanese are very good at two things that are key to success in the auto industry: refreshing their products, and having the flexibility in their factories to do that quickly and economically. These are essential capabilities because the industry’s competition is so intense.”

Detroit, by contrast, has hobbled itself, experts say, in two notable ways: Labor agreements, financially generous but tightly circumscribed regarding worker activity, have hindered innovative uses of the workforce, while in the executive suites, conventional wisdom mistakenly has held that sheer corporate size could ensure industry dominance. Toyota, shunning these approaches, took advantage of this Detroit “blind spot.” While less generous in its compensation packages for workers, Toyota “strives to use its labor force in flexible, creative, and collaborative ways,” Bowen says. And Toyota’s biggest worry, he adds, “is getting too big, too fast, which they feel would make it hard to find enough good managers, thereby jeopardizing the company’s legendary quality.”

For U.S. automakers, adopting the latest high-quality technology in vehicles and factories is often put forth as a solution. But HBS assistant professor Daniel Snow, who studies the application of new technology, offers a caveat. Snow, who has worked with both Honda and Ford, points out that technological advances are a plus only if consumers accept them. As an example, he cites an instance when GM and Ford customers rejected upgrades in the rear suspensions of Camaros and Mustangs because aficionados liked the feel of their “ride” just the way it was. The moral of the story? “It can take generations for a customer base to change,” Snow says, which does not bode well for a U.S. industry feeling pressured to move quickly to improve its products and attract more buyers.

Snow adds that in their factories, the Japanese often prefer to customize existing systems and equipment rather than installing the latest fancy technology. “Their plants are in a state of continual improvement and repurposing, with input from everybody,” Snow notes. “But what’s really gotten the Japanese to where they are is the use of technology not only in the manufacturing process, but also in engineering and designing for ‘buildability.’ ”

Down the Road

While U.S automakers retrench, Toyota is aggressively building American factories and, with other foreign automakers, adding billions of dollars to the U.S. economy while creating hundreds of thousands of jobs. Despite these new plants and jobs, globalization all but assures that the auto industry in the United States will never again offer its employees the standard of living it once did. It’s a portent for all of American industry and its workers.

“The social compact between workers and companies has weakened,” says HBS professor Rosabeth Moss Kanter, an expert on leadership and organizations. “For most of the industrial age, we expected large employers to provide essential benefits, including health care after retirement. That meant we didn’t have to face much public responsibility to do that. The American Dream may have to be reinvented, perhaps with a bit more public responsibility.”

But Kanter says work she did on turnarounds for her recent book Confidence suggests there is hope. “The U.S. companies have great assets: brands; loyal, long-term employees; dealer networks; and design capabilities. What they need is the true leadership, innovative thinking, and flexibility to address problems in new ways. Anything can be turned around, but perhaps in a very different form.”

Notes Mal Salter, “The industry is at a fragile point right now. But there’s evidence that folks in the U.S. firms are now building cars as well as anybody else. Yes, the Japanese have a lead in hybrids, but it’s possible that some other technology will be the better way to go. Things change in this industry. American firms may currently be overburdened by legacy costs, but I think they are undervalued by consumers and by the financial markets.”

HBS professor Richard Tedlow sees a broad fallout should the U.S. auto industry slide into permanent second-class status. “There’s a dilemma when you see the decline of an industry that’s been so central to the country. If it can happen to GM, it can happen to anybody. The Big 3 once seemed untouchable, so their troubles today are like a shot across the bow for other companies. The ripple effect is going to be emotional and intellectual, not just financial. This is a big deal.”

With the auto industry’s problems, globalization’s “creative destruction” is evident as never before to many Americans, as is the fear that the country may no longer be able to sustain an economically secure working class (even with government-funded pensions and health insurance). And Detroit’s troubles magnify — and perhaps exacerbate — the fact that across industries, traditional understandings and loyalties between employers and employees are breaking down. Coupled with a growing race to the bottom in wages and benefits, this workplace erosion of trust could negatively affect America’s business performance generally.

But the U.S. auto industry has a historic opportunity to recast itself, to meet the enormous impending demand for the new type of vehicles that a petroleum-deficient world will require. The dream machine that built America can once again help shape its future. After all, the lure of the open road has always inspired American imagination and innovation to fire on all cylinders — even when the journey’s route, and ultimate destination, have been uncertain.

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