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The Car Industry Doth Protest Too Much.

The Car Industry Doth Protest Too Much

Despite the message put out by some industry lobbyists, Brexit, far from being damaging, could help the motor industry to face its global problems, but only if the UK does not agree to the type of harmonised regulations and competition policy that the EU is insisting upon. For motor manufacturing, no deal is certainly much better than a bad deal.

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The UK car manufacturing lobby group, the Society of Manufacturers and Traders (SMMT) have long been outspoken opponents of Brexit, and particularly the ‘no deal’ variant, which would involve trading between the UK and the EU taking place according to World Trade Organisation (WTO) rules.

Their lobbying has been fairly consistent, and quite prolific, over the past few years, and they have found a receptive audience amongst certain sections of the UK media.

In January 2019, for example, the SMMT claimed that trading on WTO terms risks “permanent devastation” which may result in “destroying” the car industry.[1] In November 2019, they argued that a ‘no deal’ Brexit would cost the UK car industry £40bn, as a result of 1.5m fewer cars being built in the UK by 2025.[2] In September 2020, they had joined forces with their European counterparts, the European Association of Automotive Suppliers (CLEPA), to warn that the European industry as a whole (including the UK) would experience £100bn losses in a trade agreement could not be secured.[3] In October, the SMMT claimed that the failure to reach a trade agreement would result in an increase of around £1,900 on each electric vehicle imported from the continent, thereby undermining the government’s strategy to encourage the shift to lower emissions vehicles.[4] Two days ago, the SMMT predicted that the UK sector might lose up to £55bn over five years, with fewer than 1 million cars being produced, compared to 1.3m in 2019.[5]

Their analysis is based upon concerns over a possible imposition of tariffs on cars and components, together with disruption to trans-national supply chains.[6]  There is some truth to this narrative but, as with most of their interventions, the SMMT tend to ‘over-egg the pudding’, by providing a simplistic narrative that fails to consider the full picture.

Tariffs and Trade

The SMMT is correct is in their assumption that, should the UK and EU fail to reach an agreement on a Free Trade Agreement (FTA), trade would revert to how most trade is conducted in the global economy, namely according to rules set out by the World Trade Organisation (WTO). At its most basic, this means that, unless superseded by a Preferential Trade Agreement (PTA) – such as the Free Trade Agreement (FTA) the UK is currently seeking to negotiate with the EU – trade has to take place under ‘most favoured nation’ rules. In other words, if one country offers another certain trade terms, it has to offer the same to all other nations. It can’t pick and choose.

Trading under WTO rules would mean the introduction of tariffs on many (but not all) goods (not services. In the case of vehicles, the tariff rate would be around 10% for new cars, 22% for goods vehicles (i.e. lorries and vans), and an average of 4.5% for components. [7]

Tariffs would have two likely consequences for the UK vehicle manufacturing industry.

Firstly, if nothing else changes (ceteris paribus), trading under WTO rules would increase the costs for the sector, as imported components will be slightly more expensive to purchase, and the cost of new imported finished vehicles would be higher. This would be expected to reduce demand for certain types of vehicle – more likely the cheaper, more demand-sensitive segment of the market, whereas the luxury market, with more inelastic demand, would be less affected.

The first impact would be to make UK-manufactured vehicles more competitive for sales in the domestic market, assuming of course, that the UK mirrors the EU’s tariff rate on cars imported from the continent. Even after taking account of the tariff impact on that proportion of components which are currently sourced from within the EU, this would give UK produced cars around a 7.5% competitive boost when sold in the UK, and goods vehicles double this amount. If those same manufacturers redesigned their supply chains, to source more components from within the UK, this would both boost the UK economy and provide UK produced vehicles with an even larger competitive boost.

There would also be a degree of import-substitution, as consumers react to the more competitive UK car industry and switch purchases. This would boost indigenous sales and reduce imports. Again, this would be a net gain for the industry and the country. Since imported cars accounted for 87.9% of all new car registrations in the UK in 2019, and van imports an even higher 94.3%, this could be a lucrative new market for UK producers to target additional sales.[8]

The difficulty would be for exports of UK produced vehicles destined for the EU. The SMMT report that approximately 81.5% of cars and 59.3% of vans made in the UK are exported[9], with around 55% sold within the EU single market. So, basic maths suggests that this affects around 44.8% of UK car and 32.6% of van production. The export share for engine components is 62.8%, and, since the EU export share is not given by the SMMT, a reasonable assumption may be that EU exports may account for around a third of total engine output.[10] A 10% increase in costs for this segment of the market, might be expected to lead to a smaller rise in prices, as producers absorb part of the difference, but if no compensatory actions were taken (ceteris paribus), then an increase in the price of UK produced vehicles in the EU market might be expected to reduce export sales.

Although, it is worth noting that, since the value of UK vehicle imports is 28.4% higher than exports[11], any net closing of this gap would likely provide a boost to the UK economy.

The second effect deriving from the introduction of tariffs concerns the introduction of administrative processes and monitoring to ensure that tariffs are correctly applied. These processes naturally take time to complete and can therefore be considered to be examples of NTBs. However, they are likely to be far less intrusive than other potential checks relating to compliance with the safety standards or other regulatory requirements that the exporter is required to meet in order to sell into that overseas jurisdiction. These will apply to exporters irrespective of whether trade between the UK and EU takes place under WTO rules or via a FTA. Consequently, in practical terms, this second tariff effect will matter less than cost-price effects.

What Happens if Ceteris Paribus Ceases to Apply?

The SMMT critique, then, raises a number of important issues for the industry and policy makers to consider. That, after all, is the role of an industry lobby organisation.

What is does not do, however, is make a definitive case that a ‘no deal’ Brexit will lead to its stated conclusions. The real world is dynamic. Economic textbook assumptions of ceteris paribus do not usually apply.

So what happens when we allow things to change? What is the likely end result if we allow the possibility that the UK vehicle manufacturing industry will not simply sit back and passively accept a shift in market conditions without seeking to compensate in some way? Or, if we allow for the probability that policy makers will intervene to reduce potential costs and magnify benefits?

Starting with the industry themselves, there are numerous ways in which any tariff-related increase in costs might be prevented from being passed on to price increases in export markets. The most obvious is for manufacturers to accept lower profit margins on exported vehicles or squeeze their supply and distribution chains. This need not result in overall financial damage to the companies themselves, however, as the increased cost of imported vehicles, produced by their competitors, will likely result in higher domestic sales and hence profitability for UK producers within the domestic market. This could be utilised to cross subsidise export activities, either through transferring part of their cost base back on shore, or covering part of the training or R&D budgets that might have been accounted for by overseas operations, and therein enabling part or all of the tariff-related increase in costs to be negated. In addition, product or process innovation can shift demand and/or increase efficiency, thereby negating tariff-related cost pressures somewhat.

The UK government could similarly utilise some of the increased freedoms it would enjoy post-Brexit to develop a more active form of industrial strategy which facilitated the on-shoring of a greater proportion of the UK car industry supply chain, thereby creating a boost to the national economy and simultaneously reducing the impact of EU tariffs upon UK production. This was mooted with Nissan in the immediate aftermath of the 2016 referendum, and it would make sense for the UK to engage in this type of strategic planning with such a strategically significant industry.

Finally, it should be noted that the value of sterling has fallen by around 15% since the 2016 referendum, which made all UK exports more competitive. The UK car industry has therefore benefitted from a boost to their competitiveness greater than the likely tariff impact caused by any reversion to trading according to WTO rules.

Supply Chain Disruption or Reconfiguration?

A second element in the SMMT critique of a ‘no deal’ Brexit relates to the impact that it would have upon supply chains.

This is not wholly due to any tariff-related costs, but rather stems from the unusual degree of integration between different component manufacturers and vehicle assemblers, both across the EU single market and through accessing the global marketplace. A single vehicle is comprised of hundreds of individual components, and many of these will be manufactured in different countries. Indeed, the way that the current European supply chains is set up, a single complex component may be refined in multiple sites, thereby crossing three of four national boundaries.[12]

Vehicle assembly additionally utilises ‘just in time’ processes, whereby cost savings are sought by reducing the storage of items prior to vehicle assembly. When this system works, it is efficient. When it does not, the absence of critical components arriving at the factory ‘just in time’ can halt the production line.

Brexit challenges this existing model in a number of ways.

For example, irrespective of whether a trade agreement is reached between the UK and the EU, some degree of friction will be introduced. Additional paperwork will need to be completed, and there will be a degree of additional monitoring to ensure that quality is in line with the standards pertaining in the home market – whether for UK produced cars and components being exported to the EU, or vice versa. This has the potential for delaying shipments and hence disrupting ‘just in time’ production processes.

The important point to recognise, here, is that these Non-Tariff Barriers (NTBs) will occur irrespective of whether the UK trades with the EU according to FTA or WTO rules, and certain checks would still occur even if the UK decided to acquiesce to EU negotiating demands that we adopted EU regulations for all of our firms. This so-called ‘level playing field’ may save some paperwork, but would negate the whole purpose of Brexit, namely for the UK to be able to do things differently to the EU, and it would constrain economic policy changes which would flow from this different approach. Perhaps the difficulty in explaining this point explains why the SMMT omits this from their analysis.

There is, of course, a simple solution – reconfigure and shorten supply chains, using existing component suppliers or working with the government to facilitate the establishment of UK component manufacturers. This would enhance the resilience of the supply chain, reduce any deleterious impact of tariffs upon component costs, and simultaneously provide a boost to the UK economy. The shortening of supply chains would additionally create environmental benefits, as components are not repeatedly trucked back and forth across the European continent, in search of small efficiencies whilst downplaying any resulting environmental damage.

It should also perhaps be noted that a FTA, whilst preferable in many respects, would trade-off the avoidance of tariff costs for acceptance of ‘rule of origin’ designation, to avoid third parties tariff-jumping. Hence, UK exporters will have to prove that a certain proportion (typically 55% of final vehicle value) derives from the UK and not a third country. Current figures for the UK car industry are around 44%, albeit this figure fails to account for the fact that almost half the value of these UK components use parts sources from elsewhere in the world. If adopted, ‘cumulation of origin’ would allow products or components originating in any of the parties to the agreement (i.e. the UK or the EU) to count towards this total, which would make reaching this target much easier.[13] However, any on-shoring and shortening of supply chains to operate closer to UK producers would likewise make it easier to reach this target.

Broader Challenges for the Car Industry

The SMMT reaction against the possibility of a ‘no deal’ Brexit is, therefore, somewhat exaggerated. It depends on static assumptions, and ignores the possibility that greater freedom created by Brexit might actually assist the industry to reconfigure itself to face new market realities.

Indeed, when Brexit is placed into context alongside the other challenges that the industry faces, it can hardly be considered to be the main, or even perhaps a significant, contributory factor behind the vehicle industry’s current difficulties.

Many of these challenges were dealt with in more detail in an earlier article, Driving Off A Cliff Edge – Brexit and the Car Industry. To recap, these include: (i) the global dislocation in trade arising from the trade conflict originating between the USA and China, which has impacted upon the car industry more generally; (ii) the FTA struck between the EU and Japan, which reduces the incentive for Japanese manufacturers to locate within European markets and, given substantial excess capacity amongst many of these producers, has encouraged greater focusing of activity on a smaller number of sites; and, (iii) environmental drivers causing a decline in demand for diesel engines and a gradual shift towards low- or zero-emissions vehicles, requiring greater investment in R&D and the reconfiguring of existing production systems.

Added to these challenges is the shock to the global economy caused by the COVID-19 pandemic. This has already had a sizeable impact upon the vehicle sector – indeed, the SMMT president is quoted as acknowledging that the cost of the pandemic is likely to be 28 times the costs the industry has already experienced due to the uncertainty generated by the way the Brexit process has been dragged out.[14] Moreover, the scarring resulting from the pandemic, upon jobs and capacity across a number of different sectors, is likely to persist into the medium term.

Brexit as The Problem, Or Conceivably, Part of The Solution?

Considering the difficulties faced by the UK vehicle industry into this wider context, whilst a ‘no deal’ Brexit could have a number of potential challenges and cost implications for UK car makers, these are of secondary importance when seeking to understand the reasons for the current global restructuring of the industry and considering the scarring likely to be left by COVID-19.

Moreover, what the SMMT critique fails to consider, however, is whether Brexit – either in the form of a FTA with the EU or through trading according to WTO rules – could be part of the solution.

The tariff-related costs can be ameliorated or offset by innovation within industry supported by with judicious industrial policy measures introduced to promote innovation within the industry. This would be much easier after Brexit, as long as the UK does not agree to the type of harmonised regulations and competition policy that the EU seems intent on insisting upon in any FTA. Unless there is some softening on their negotiating stance, therefore, it would be much easier for government to assist the UK vehicle industry acclimatise and thrive under a ‘no deal’ scenario, than being unable to do so under an agreement constrained by acceptance of the so-called ‘level playing field’. No deal, with this in mind, is preferable to a bad deal.

That is the paradox of the SMMT position – seeking to rule out a ‘no deal’ option and arguing for as close a trading relationship as possible, which would have the effect of preventing the type of support that the industry needs to adapt to the changing future marketplace.

 

Philip B. Whyman is Professor of Economics and Director of the Lancashire Institute for Economic and Business Research (LIEBR) at the University of Central Lancashire.

 

[1] http://fortune.com/2019/01/31/brexit-uk-auto-industry-damage/; https://www.independent.co.uk/news/business/news/brexit-no-deal-latest-risks-destroy-uk-car-industry-effect-house-of-commons-vote-a8728661.html

[2] https://www.theguardian.com/business/2019/nov/26/no-deal-brexit-would-cost-uk-car-industry-40bn-by-2024

[3] https://www.bbc.co.uk/news/business-54145987

[4] https://www.theguardian.com/business/2020/oct/22/car-buyers-face-10-additional-cost-in-case-of-no-deal-brexit

[5] https://www.smmt.co.uk/industry-topics/europe-and-international-trade/key-exports-data/; https://www.theguardian.com/business/2020/nov/24/no-deal-brexit-uk-car-industry-tariffs-smmt

[6] https://www.theguardian.com/politics/2020/sep/14/motor-manufacturers-warn-of-100bn-losses-if-no-brexit-deal-struck

[7] https://madb.europa.eu/madb/euTariffs.htm?productCode=87032410&country=KR; https://publications.parliament.uk/pa/cm201719/cmselect/cmexeu/2560/256006.htm

[8] https://www.smmt.co.uk/wp-content/uploads/sites/2/2019-UK-AUTOMOTIVE-TRADE-REPORT.pdf, 5.

[9] https://www.smmt.co.uk/wp-content/uploads/sites/2/2019-UK-AUTOMOTIVE-TRADE-REPORT.pdf, 5.

[10] https://www.smmt.co.uk/industry-topics/europe-and-international-trade/key-exports-data/

[11] https://www.smmt.co.uk/wp-content/uploads/sites/2/2019-UK-AUTOMOTIVE-TRADE-REPORT.pdf

[12] https://www.theguardian.com/business/2017/mar/03/brexit-uk-car-industry-mini-britain-eu

[13] https://www.international.gc.ca/trade-commerce/trade-agreements-accords-commerciaux/agr-acc/ceta-aecg/text-texte/P1.aspx?lang=eng; https://publications.parliament.uk/pa/ld201919/ldselect/ldeucom/6/604.htm.

[14] https://www.theguardian.com/business/2020/nov/24/no-deal-brexit-uk-car-industry-tariffs-smmt

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About the author

Professor Philip B. Whyman

Philip B. Whyman is Professor of Economics and Director of the Lancashire Institute for Economic and Business Research (LIEBR) at the University of Central Lancashire.