The Slow, Subsidized Death of Europe’s Carmakers

The better alternative would be to ditch loss makers and restructure.

BY NEIL WINTON

Europe’s governments have a choice as the automotive industry shudders under the impact of the worst recession since the 1930s. They can insist on reforms to make European carmakers leaner and meaner, and able to face down the looming cut-throat competition from India, China, Korea and Japan. This would mean painful job cuts and plant closures, uncomfortable pressure from unions, and, with German elections coming up in two months, risking to be voted out of office.

Or they can take the easy way out, open taxpayer coffers to bail out companies, “save” jobs in the short term, and put off the day of reckoning. No prizes for guessing what is happening. The U.S. government is not alone in propping up ailing auto manufacturers, even if Europe’s help hasn’t come quite close to the massive aid extended to General Motors and Chrysler.

In Germany, the government is prepared to lend €4.5 billion to save perennial loss-maker Opel-Vauxhall from the knacker’s yard. It has already provided the company with a short-term loan of €1.5 billion. Last year Opel-Vauxhall (and Saab, the old GM Europe) lost together €1.1 billion and is expected to lose another €2.1 billion in 2009. Meanwhile, France has lent Renault and PSA Peugeot-Citroen €3 billion each. PSA had planned to cut costs and move production and jobs from France to lower-cost Eastern Europe. It’s reasonable to assume that this plan won’t be on the agenda for some time.

The trouble is that the European industry has at least 20% overcapacity, according to investment bank Credit Suisse. The big six European mass car makers—VW, Renault, Peugeot-Citroen, Fiat, Opel-Vauxhall and Ford Europe—have all suffered from long periods of meager profits. Flooding the market with cars and offering steep price cuts to get consumers to buy them may have allowed them to make a little money in the good times. But the good times are definitely over. For the European manufacturers, the old business model is broken.

Among the mass carmakers, only Volkswagen, Europe’s market leader, and Fiat are likely to be profitable this year despite government incentives for new car purchases across the continent, including in Germany, Italy, France, Britain and Spain. Once the government subsidies expire next year, Fiat is expected to struggle again.

If Europe’s automakers have few prospects for success and steady profitability now, think how bad the situation will be once India and China join Korea and Japan in producing reliable and attractive cars at prices Europeans can’t match using their current business models.

The threat from South Korean manufacturers is about to ratchet up even higher, pushed by a combination of a new free trade agreement with the European Union and Korea’s depreciating currency. These two factors will give Korean cars a price advantage of about €2,000 per car, according to Credit Suisse. Korean brands like Hyundai and Kia have already been the major winners from the recent government incentive schemes around Europe to encourage consumers to buy new cars. These subsidies have increased the Korean share of the Western European car market to about 4% from 3% within only a few months.

This means that government handouts to national car champions will likely have to increase and become permanent if policymakers want to protect the domestic auto industry from restructuring. Despite the fact that left-wing parties are on the decline across Europe, it seems that populists of all political colors, including conservatives in Germany and France, want to save their car industry.

“We are far from a world where the post-Thatcherite British model represents the future of Europe,” says Karel Williams, who teaches political economy and accounting at Manchester University. “We are in a world where politics beats economics.”

Government help to avoid a short-term crisis may appeal to voters, but it will also impede plans to rationalize and cut overcapacity. When Europe’s car industry is tottering under the next Asian assault and is ill prepared to cope, how many of the current chancellors, presidents and prime ministers will still be in power to apologize?

Europe’s car industry can choose to ditch the hopeless value destroyers and prepare for a successful future facing down the new competition or it can evade the truth, take government handouts, and prepare for a slow, subsidized death.

Mr. Winton writes the European Perspective column for Detroit News Online’s Automotive Insider.