In the early 1950s, for various reasons Detroit developed a cozy three-way oligopoly. The UAW developed a cozy monopoly on supplying labor service to that oligopoly. In some ways, the UAW helped sustain that oligopoly. If you're a big company whose quality suffers, you have problems. But if you have a union making sure that labor quality cannot vary across the industry, you don't need to worry that your competitors will make a better car. Detroit competed on styling and power, not reliability or price.So much for that manufacturing-based middle class: it relied on an absence of competitors elsewhere in the world.
Again, it appears as if the first Chrysler loan guarantee simply deferred the real pain for a quarter century.
Detroit should have reacted, I'm sure, by making smaller cars. But smaller cars were harder to make for Detroit. Buyers thought of them as a non-premium product, which meant they wouldn't pay for the lucrative options packages. And because they used fewer materials, the labor component became a relatively larger part of their cost. Labor was where Detroit was least competitive. According to the automotive analysts I've seen, Detroit still loses money on small cars like the Ford Focus, which are sold at a loss to help make Corporate Average Fuel Efficiency numbers come out.
Detroit needed to do a lot of things in the 1970s. It needed to get better engineering, it needed to get control of its assembly process, and yes, it needed to lower labor costs. But it did none of these things. By the early 1990s, Detroit wasn't even trying very hard to make a profit on cars. Detroit was making profits on light trucks, where the higher sticker price made it easier to hide labor costs (and which foreign companies were not, anyway, very good at making). It's worth noting that Detroit's focus on light trucks was not merely a management decision; it was what the powerful unions wanted, because they knew the math as well as management. Light truck plants were better for the UAW than more Ford Focus capability.
But perhaps more importantly, Detroit turned from making money on cars to making money on financing. Detroit didn't make a big profit by selling you a Ford Taurus. It made money on financing your Ford Taurus; often, the car was sold at a loss in order to get the finance business. The Big Three were banks manufacturing cars as a loss leader.
There's another part of this story that matters: passenger-carrying trucks do not count against the fuel economy standards for cars. The standards effectively banned the station wagon. Perhaps as part of the government-supervised restructuring to come, we might have a performance review of all the regulatory constraints that leave safety-conscious drivers with little alternative to minivans and passenger trucks.