With its landmark labor agreement, the downsizing of Ford, and a massive influx of private equity, 2007 was the most momentous year for U.S. automakers in decades—and one of the most critical ever. Now they must prove that they have what it really takes to compete globally and at home.

General Motors, Ford Motor, and Chrysler—once known reverently as "the Big Three," now downsized to merely "the Detroit Three"—finally got many of the work-rule, wage, and health-care concessions they had long sought from the U.A.W.

The automakers had laid the blame for much of their shrinking market share and swelling losses on their labor agreements. By some counts, health care costs for union workers—and, especially, retirees—added $1,500 to the cost of every car they manufactured.

No more. Having shifted their obligations to retirees to the union and gained new flexibility on wages, hiring, and plant closures, the Detroit Three are now free to show they can once again make cars that Americans want to buy and can innovate with the best of their foreign competitors.

George Magliano of the economic forecasting firm Global Insight said, "2007 wasn't just a pivotal year for the auto industry, it was transformational for the U.S. manufacturing industry."

Unfortunately, it appears that 2008 will test the industry far quicker than anyone anticipated. The coming year is expected to be the worst in a decade. Global Insight forecasts that sales in the U.S. will drop to 15.5 million light vehicles—cars, crossovers, sport utility vehicles, and pickup trucks—in 2008. That is a level not seen since 1998, and down from an expected 16.1 million for 2007.

Notably, that is a 1.5 million drop from 2006, when the industry was selling upward of 17 million cars and trucks, Global Insight says.

Automakers are shy of making any hard-number predictions for 2008, at least until they meet with analysts in January during the North American International Auto Show in Detroit.

Privately, industry executives are telling one another the same thing they did last year, says George Pipas, U.S. sales analysis manager at Ford. That is: "We are looking at a weak first half and then expect a stronger second half."

But, Pipas adds, "look what happened last year in the second half." Sales tumbled as the housing market faltered and credit tightened, and far fewer buyers were interested in the high-profit, low-mileage sport utility vehicles and pickup trucks that had kept Detroit afloat for years.

"Right now we simply don't have a consensus on the severity of the current economic conditions to make a prediction," Pipas says.

Those economic conditions—in no order of severity since no one knows which one will have the greatest effect on the industry—include oil that fluctuates between $80 and $100 a barrel, tight credit markets that are beginning to affect even auto loans, weaker home prices that dampen consumer spending, and the very real possibility of a very sluggish economy as the country faces true G.D.P. growth of about 1.5 percent.

"It's very muddy right now. There are so many volatile factors at play," says David Cole, chairman of the Center for Automotive Research, an automotive think tank in Ann Arbor, Michigan.

"There's a question of whether we've seen the bottom of the subprime crisis or are we near the bottom," Cole says. "New-car sales generally aren't to those people who would be in subprime. But it's a damper on the economy. The issue is whether people feel as wealthy as they did a year ago."

The problem of car buyers feeling strapped just as carmakers are feeling flush is not lost on Detroit. Automobile company executives have tried for years to dismantle many of the labor-contract provisions that they said had kept them from competing effectively with Toyota and other Asian automakers.

The new agreements—which vary from company to company and even from plant to plant within each company—share several key elements.

All rely on the creation of a Voluntary Employee Beneficiary Association, or VEBA, a union-run trust that will assume responsibility for retiree health care. The automakers will jointly pay as much as $120 billion into the trust in 2010.

"We make one lump sum and that has a fixed end date so we will be able to clearly see the difference," says Diana Tremblay, G.M.'s vice president of labor relations and a lead negotiator in the agreement. "We are under no obligation to put in any more money after that."

Possibly even more important to the industry's future are changes in the way automakers will pay their workers and run their plants.

The agreement creates a two-tier wage and benefit rate that applies to new hires and noncore employees, which are defined as people who don't work on the main assembly lines.

It brings the Detroit Three's labor costs down closer to what Toyota and other Asian carmakers pay in their American factories. Cole contends that U.S. automakers had been at a $30-an-hour disadvantage.

While the new agreement reduces what people will make in the industry, the positive for the union is that those employees remain part of the union workforce—and dues-paying members—instead of watching the companies close unionized plants and move jobs to nonunion factories overseas. Companies also agreed to not shutter plants in the U.S., though the union expects some job cuts.

Other changes include allowing workers to do their own minor maintenance instead of needing to call in a skilled-trades employee. That was costing the automakers time and money as assembly line workers waited for their machines to be fixed. "We used to have 84 job classifications, while the Japanese have two or three," Tremblay says.

According to Tremblay, what you consider to be the most important part of the agreement depends on where you sit in the industry.

"The first one—the VEBA—is about our financial viability," she says. "The second, though—the transfer over the long term of workers to different wage scales and to more flexibility in the plants—is what will transform this industry."

The labor agreement, however, wasn't the only profound change in the industry this year.

  Private equity had been flowing into Detroit for several years as firms such as Carlyle Group and W.L. Ross & Co. snapped up automotive suppliers. But it wasn't until Cerberus Group's purchase of Chrysler in May that it became clear how much privatization was going to affect the industry.

While some of that effect will be in cutting costs—private equity's forte—Cerberus has shown at least some sign that it has more radical ideas in mind. The company, for example, hired a number of respected auto executives from competitors—most notably Jim Press from Toyota.

"Chrysler's new parents do have a shorter time horizon and a heavy hand on cost," Magliano says. "But they also have brought in talent, and that shows that they have something else coming."

They'd better. Industry watchers say the Detroit Three need to show that their business models are focused on profitability and making vehicles that appeal to market segments such as small-car buyers and consumers interested in versatile vehicles with higher fuel mileage.

Industry watchers like Cole and Magliano see G.M. as the best placed of the U.S. automakers to make the most out of the gains made in 2007, no matter what the economy brings.

"G.M. has gone aggressive on revamping their S.U.V.'s and trucks and now they have a competitive advantage," Magliano says. "You have the big crossovers like the Buick Enclave and G.M.C. Acadia that get better gas mileage than the vehicles they replace, but with the same functionality.

Ford is next as it continues to cut costs, but the concern with the No. 2 U.S. automaker is a lack of new product that fits Americans' slowly changing desire for more-fuel-efficient vehicles. Still, Ford has been able to shift its mix of vehicles from 70 percent trucks and S.U.V.'s in 2004 to almost a 50-50 split between cars and trucks in 2007.

Chrysler is still an unknown quantity on products as the industry watches to see what Cerberus and its handpicked chief executive, former Home Depot C.E.O. Robert Nardelli, do beyond slashing costs.

A clear sign of success will be if U.S. automakers can remain profitable and sell more cars in 2008—something their Asian competitors have been able to do despite difficult economic times.

As Mark McReady, vice president of market planning and pricing for CarsDirect.com, says succinctly: "They've got no more excuses."