The pros and cons of car firm subsidies

By Jorn Madslien
Business reporter, BBC News

All governments support their incumbent motor industry

Amidst early signs of a recovery in global car sales, carmakers like to pretend that they have survived the recession through their own efforts.

Indeed, in many cases they were quick to respond to early signs of the sales slump, instantly idling shifts and cutting jobs, slashing production to match plunging demand.

In the UK, plants were shut down over Christmas and output was cut 47.5% in December compared with a year earlier, according to industry body SMMT.

Indeed, across Europe the vehicle manufacturing sector lost more jobs than any other sector, including retailing, during the last three months of 2008, according to official EU data.

Fiction

But the notion that only the fittest have survived is fiction.

The motor industry has been nursed back to health by a series of cash injections administered by well-meaning governments, according to Calum MacRae, automotive analyst with the consultants PricewaterhouseCoopers (PwC).

"While in the main 2009 has been characterised by a deep economic recession in many markets, intervention has been visible in underpinning both markets and industry players," he says.

Governments across the world have been prepared to assist the sector through a broad range of initiatives such as:

• scrappage incentive schemes
• soft loans
• fuel economy regulations
• technology grants
• increased import tariffs
• tax reductions
• surgical bankruptcy

All this begs the question - what is in it for taxpayers?

Major benefits

"The main rationale for direct action," according to Mr MacRae, has been the "industry's role as a significant - some say the most significant - economic multiplier".

The benefits of intervention now will undoubtedly have to be weighed against the future costs Calum MacRae, automotive analyst, PricewaterhouseCoopers Suffering and assistance around the world

In other words, a recovery for the motor industry should be good news for the economy at large.

The idea behind the multiplier theory is that the government gets back more than it puts in.

It expects the national income from an expanded automotive sector to exceed the sums it spent to keep the wheels turning over.

This is true at a basic level, where under the scrappage scheme the government gets more back in VAT than the £1,000 it pays towards the scheme.

But the benefits can be much broader if initial government incentives kick off virtuous cycles.

Direct support for manufacturers, for instance, through subsidies of so-called "green" technology, can deliver direct benefits, such as extra jobs.

But it can also bring about indirect benefits, such as consumption in other areas of the economy, which should then lead to further job creation, and so forth.

Flawed scheme

But is not all smooth sailing for the car industry.

Some of the subsidies are poorly designed and could have negative long-term consequences.

Scrappage schemes benefit some manufacturers more than others

Take the various scrappage schemes introduced by governments, most notably Germany and the UK.

One rather predictable drawback that characterise such schemes is the vacuum left in their wake.

When they come to an end, many of those who had been thinking about buying a car will have already done so a bit earlier than planned.

Others may be put off because cars suddenly seem expensive compared with what they were under the schemes.

"Given this, we expect EU light vehicle sales to fall by around 2% in 2010," observes PwC.

Another drawback relates to how the scrappage schemes have pushed consumers towards small, cheap cars.

At the industry level, such a shift erodes profit margins, since it is easier to make money from large luxury cars.

But at company level - and indeed on the international arena - there are winners and losers from such schemes.

For instance, following the introduction of scrappage schemes, small car specialists such as Fiat, Citroen or Hyundai have seen rising sales of cars that deliver relatively little profits.

This, in turn, has eroded the overall market share held by luxury car manufacturers such as BMW and Mercedes, which produce more profitable cars.

In turn, this is pushing car industry earnings towards Italy and France, or South Korea, with Germany losing out.

Beneficial or detrimental?

Many European carmakers are indignant at how scrappage schemes and other government initiatives have favoured rivals from outside their own country, or outside the EU. The schemes distort competition, they insist.

Industry body Acea, which represents European carmakers, also objects to plans by the EU to remove tariffs on imports from Korea until an effective reciprocal has been made.

Acea insists the plan "effectively opens the door for cheap imports from China and other Asian countries", yet it fails to "sufficiently improve access to the South Korean market".

Similar arguments - which favour self-beneficial subsidies or tariffs and oppose those benefitting rivals - are continuously made by carmakers across the world.

In many ways, though, such a debate about which company benefits the most misses the point about the automotive industry's chronic overcapacity.

Governments around the world, motivated by national pride or fears about job losses, are loath to let domestic carmakers fail, and there is not a single country that does not support its motor industry in some form or another.

Whether that is good or bad is debatable.

"The benefits of intervention now will undoubtedly have to be weighed against the future costs," explains Mr MacRae. "be they to the long-term health of an industry still plagued by excess capacity; to taxpayers paying down budget deficits; or to future market demand levels being damaged by demand pulled forward now."