WHITE CLARKE AUTOMOTIVE SOLUTIONS IN ASSOCIATION WITH THE CENTRE FOR AUTOMOTIVE MANAGEMENT UNIVERSITY OF BUCKINGHAM

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The Global Economy: A Game of Four Halves?

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Professor Peter N C Cooke Professor of Automotive Management University of Buckingham Phone; 01235 539115 Email; peter.cooke@buckingham.ac.uk January 2013

THE GLOBAL ECONOMY: A GAME OF FOUR HALVES?

The Centre for Automotive Management University of Buckingham

The Centre for Automotive Management (CAM) at The University of Buckingham Business School prepares an independent Quarterly Review of Global, European and UK automotive industries set against the prevailing economic and political environment reflecting current status and expectations. The review forms the basis for discussion groups, management presentations and forums and is updated regularly following these events. Given the speed of change in the economic and political environment, the points of view may, at times, be overtaken by global and national change. The views expressed are those of the Buckingham Automotive Team and are not necessarily shared by the sponsors or the wider automotive community. These notes are offered for discussion and debate rather than as the basis for any specific action.

Contents
Introduction Asia Pacific United States The Eurozone United Kingdom Some Good News Some Conclusions 4 5 6 7 12 20 21

THE GLOBAL ECONOMY: A GAME OF FOUR HALVES?

Introduction
December 2012 was good for some, bad for others, it had five Saturdays, five Sundays and five Mondays how did you rate it? The global economy is currently difficult to read; hence the claim, for our purposes, of four halves, Asia Pacific, North America, Eurozone and the United Kingdom. Asia Pacific, China and India appear to be ploughing one furrow. Now that Obama has won a second term, North America should be less difficult to read. Despite the apparently insoluble ideological differences between Republicans and Democrats, the year-end cliffhanger has been survived. Although, the problem has been kicked two months down the line and still has to be solved. Europe, well the Eurozone, is in a mess as the motor industry demonstrates; GDP output has plunged into a double-dip recession in the third quarter of 2012. Although the United Kingdom is showing some signs of an agonising recovery, it is still facing the possibility of negative growth in the fourth quarter. In a sentence, the fragmented global economy is showing a scattering of development despite being closely interlinked. A game of four halves? The following notes seek to review these differences, consider some of the economic inconsistencies and relate them to the automotive industries.

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THE GLOBAL ECONOMY: A GAME OF FOUR HALVES?

Asia Pacific
While many gurus issue economic caveats, Chinese growth continues at a spanking rate by mature economy standards. However, threats of inflation and a declining domestic market are creating some concern. There is increasing emphasis on exports to underwrite and stimulate growth with the motor industry in the forefront of the economy. Vehicle exports are growing at doubledigit rates, up 27.4% year to date, with car exports up 42.9% for the first 10 months of 2012. Realistically, such growth rates are not sustainable but may continue until OEMs reach a global equilibrium. While China is focusing on building exports, Chery is building a plant in Brazil to go live in 2013. It will be the first Chinese manufacturer to offer a full production facility abroad. The choice of location is an interesting pointer to future developing markets. Chery, Geely and Lifan are focusing on exports as domestic competition becomes tougher from both domestic players and overseas companies with Chinese manufacturing. Geely has networks in some 49 markets outside China and plans to assemble in India and Iran in addition to Brazil. Tata has announced it will be opening a manufacturing facility for Jaguar in China. While China is a major Jaguar/Land Rover market, it will be interesting to see the impact of local manufacture on a heritage brand. Surely, Jaguar is a car of the West Midlands in the United Kingdom? In other fashion sectors, we have seen a deliberate retrenchment to the original heritage region for production otherwise, what is special about the product? JLR is also considering manufacturing in Saudi Arabia in the light of growing aluminium production there. JLR says overseas production would not lead to job losses in the UK as it would be in addition to UK output.
Centre for Automotive Management, The University of Buckingham

Talking of the rise of the Indian owned automotive industry, it is interesting to note the share of UK industry owned by Indian multinationals. Optare, the UK bus manufacturer, although traded on AIM, is under the control of the Hinduja brothers and Mahindra & Mahindra have just missed out on acquiring a significant holding in Aston Martin.

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THE GLOBAL ECONOMY: A GAME OF FOUR HALVES?

United States
Barack Obama has been re-elected president. As a second-term president, he will not stand for re-election so he should be able to push through radical global foreign policy and domestic legislation expected during his first term. One problem. He lacks a majority in the House of Representatives. Result. Total impasse some would claim hatred between the two parties. The expected 31 December crisis was avoided on New Years Day. However, the scene has been set for two months of internecine nastiness with perhaps another unsatisfactory longterm outcome. An issue we return to regularly is the relationship between the political classes and reality as seen by those they govern and who create the wealth that politicians seek to dispense. Nothing could illustrate the case better than the current US impasse. Since the President was re-elected and his partys strength increased in both houses, the Republicans have become more adamant about their unbending principles. The consequence is that the American credit rating risks being compromised as a result of this ideological clash with the defeated party promoting its own austerity programme. The fiscal firebrands are largely from safe seats where their only personal threat is a more radical candidate in two years time. The can has been kicked down the road to March and there remain some crucial issues to be resolved. Consider these principal points: The US Treasury hit its legal borrowing limit on 31 December 2012 and will soon run out of skilful accounting tricks to let it continue to borrow $40 for every $100 it spends. The parties are at odds as to how this might be resolved
Centre for Automotive Management, The University of Buckingham

The fiscal cliffs two-month postponement of $110bn in automatic cuts in spending over nine years expires in March The funding for government agencies lapses unless there is some agreement for ongoing funding which could shut down large tranches of federal government The battle lines are in place for what could become the biggest ideological struggle of the decade. Whether a resolution can be found within two months, given such intransigence, is something we will not attempt to second-guess.

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THE GLOBAL ECONOMY: A GAME OF FOUR HALVES?

The Eurozone
Whether the Eurozone has settled down for the long haul to recovery is open to discussion but there will be more problems to be identified and resolved. Post banking and euro crisis, GDP within the Eurozone has fluctuated like a teenagers hormones. Figure 1 shows how GDP has fluctuated over the past decade and has started to head south again. Figure 1; Eurozone GDP Growth 2000-2012

Source; Eurostat

In fact, the Eurozone dropped into double-dip recession in the third quarter of 2012, which is borne out further by forecasts of growth, or otherwise, within the region over the next few years. Figure 2 shows GDP forecasts for the Eurozone for some of its principal members and two comparators through to 2014. Figure 2; Major Countries GDP Growth; 2012-2014

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Source; Capital Economics

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THE GLOBAL ECONOMY: A GAME OF FOUR HALVES?

The Eurozone (continued)

Overall, these figures suggest the UK is pulling out of recession while the Eurozone follows it into recession. While some nations are holding their heads above water, others are falling into recession. Italy and Spain, two of the major players, are showing significant decline while France, too, seems to be slipping into significant recession. The message is a simple one: we are all part of a global economy and the rest of the world does not owe us a living. Maybe the Euro was a bad idea economically and been poorly executed but, without it, the individual states would have had to put their respective houses in order sooner, rather than relying on artificially low interest rates created by Germanys membership and the ability this generated for unlimited borrowing. Given the growing awareness of the magnitude of the Eurozone crisis and the emerging institutional shortcomings, one cannot realistically look for sustainable economic recovery for at least five years. At the time of writing, the major Spanish banks have just been given a massive bailout against a strategy of reduced lending, cutting the number of branches significantly and putting many thousands of employees out of work. One implication that will emerge from this exercise, as the banks restructure their balance sheets, is their capacity to lend will be reduced considerably with the implications this may have for the Spanish economy. This cut in banks capacity to lend appears to be a common theme across the Eurozone and further afield. UK banks are facing a similar dilemma as they will need to strengthen their balance sheets to be able to withstand any future upsets. The woes of the Eurozone are graphically illustrated in Figure 3 which shows unemployment levels across the region. The two nations with extreme levels of unemployment are Spain and Greece, each with a quarter of its potential workforce out of work. However, there are another 12 states with double-digit unemployment, while one finds Austria, Luxembourg, Germany and Netherlands at the bottom of the scale.

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THE GLOBAL ECONOMY: A GAME OF FOUR HALVES?

The Eurozone (continued)

Figure 3; European Unemployment Rates; October 2012

Source; Eurostat

A factor of six times between the highest and the lowest unemployment rates almost inevitably leads to a degree of civil discontent which has manifested itself across much of 2012. In some countries, civil discontent embraces the whole demography. Elsewhere, it is principally young people who protest. Politicians have a serious range of issues to resolve balancing budgets, institutional restructuring and re-engagement with the electorate. Three issues that can no longer be ignored. The only European politician who seems to take a close interest in younger voters is Silvio Berlusconi who appears to have taken another 27 year old companion to assist his bid for another term as prime minister.
Centre for Automotive Management, The University of Buckingham

Nowhere is the changing economic picture in Europe more starkly presented than in sales of new cars. Figure 4 shows how new car sales have slipped in all of the major markets in the past few years. Even Germany has a strategic slippage post 2000. The kick-up in Germany in 2009 was caused by a hugely expensive Scrappage programme, the aftermath of which is now starting to impact on the used car market.

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THE GLOBAL ECONOMY: A GAME OF FOUR HALVES?

The Eurozone (continued)

Figure 4; Major EU New Car Markets; 2000-2012

Source ACEA

The double-sided impact of this slippage is perhaps better represented by the relative changes in the volumes of cars in the under five year car parcs across Europe. Figure 5 shows how the parcs of younger cars have changed across Europe by market. Figure 5; New Car Registrations; 2007/2011 versus 2003/2007 (0-5 year car parcs)

Source; ACEA/Buckingham

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THE GLOBAL ECONOMY: A GAME OF FOUR HALVES?

The Eurozone (continued)

The implications are of strategic concern to OEMs in terms of planning future dealership representation, service and parts policies across countries. While the chart provides an illustration by country there have been equally dramatic moves among the individual brands. One further issue to add to the evolutionary equation is the recent European Councils decision to give the green light to the European Commission to open free trade negotiations with Japan. ACEA has argued for some time that any such deal would be a one-way track for the benefit of Japanese automotive manufacturers, in the same way that the free trade agreement with South Korea has worked against the European auto industry. An independent study on behalf of ACEA suggests that any such agreement would result in some 7,800 incremental sales from Europe to Japan by 2020, but additional exports from Japan to the EU would be closer to 443,000. In employment terms, such an action would, it is calculated, lead to the loss of between 35,000 and 73,000 European jobs. There is an old business adage of Never waste a good economic crisis maybe the time has come for the automotive industry in Europe to tackle its fundamental issues of manufacturing capacity, distribution strategy and profitability as well as the support issues of an ageing vehicle population. Ford has recently announced the closure of its Genk facility and its Transit plant in Southampton, while PSA is also going through a reorganisation. Volvo is cutting production at its Torslanda plant from 57 vehicles per hour to 45 and will make 5,500 fewer cars in December. GM has announced the first closure of a German car plant since the second world war.
Centre for Automotive Management, The University of Buckingham

The new car market is unlikely to recover any time quickly, procrastination is not a sustainable strategy and the appetite is there not to waste a good economic crisis.

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THE GLOBAL ECONOMY: A GAME OF FOUR HALVES?

United Kingdom
The foregoing paragraphs might suggest Europe and the Eurozone, in particular, are having problems. The most recent economic data suggests the Eurozone has entered a mild recession overall, which is worse among its southern members. For once, the United Kingdom might seem to be moving ahead of the curve and to be on the cusp of economic recovery if one listens to the politicians or, at the start of a long, slow and painful economic recovery if one follows bankers or the Bank of England and industry economists. The truth is that nobody can forecast with absolute certainty. Its a matter of my crystal ball, seaweed behind the door or dice rolling is better than yours. Some even resort to using a ginger tom and tarot cards. However, there are deeper institutional and economic issues that may need to be considered when looking ahead. To start in the Westminster playpen. The government, the Coalition, is busy squabbling over issues of philosophical concern rather than seeking to resolve the economic crisis maybe its just too big? Political or legislative control of the press aka the Leveson Enquiry has created the extraordinary sight of the prime minister and deputy prime minister on different sides. The prime minister has announced a parliamentary bill will be prepared to show how difficult it is to legislate and the bill will be rejected while the opposition provide their own bill which will work. Regulation of the printed press is of little relevance to those beyond politics and the media. But has the enquiry completely missed the point, as it has but a single page regarding the internet and other forms of electronic media which are currently uncontrolled? Further Westminster issues are emerging but, maybe, as one cynic commented, this is beneficial as they may stop politicians interfering in issues they do not understand like economic recovery.
Centre for Automotive Management, The University of Buckingham

Elsewhere, financial scandals continue to emerge. PPI miss-selling is running towards 12 billion in settlements but hopefully much of this money will be spent quickly as windfall gains and provide a form of liquidity. A developing banking scandal is associated with Libor rate fixing; if a case is proven this could lead to eye-watering damages for the banks. No wonder there are calls for increases in bank capitalisation. UBS is reportedly close to settling claims that its staff were involved in alleged attempts to manipulate Libor, and could face fines of more than $1bn (620m).

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THE GLOBAL ECONOMY: A GAME OF FOUR HALVES?

United Kingdom (continued)

One fears the City mantra of My word is My Bond has been devalued to whatever I can get and I have a good lawyer if Im found out. The ethos would appear to be migrating from trust to transparency. The United Kingdom, home of global banking and financial services, has appointed a Canadian as the new Governor of the Bank of England. Would the Americans or French do such a thing? But, we do the same for our Premier League football teams and, by their metrics, the new Governor is a positive snip at the price. The new Archbishop of Canterbury has more years business experience than the leaders of the three principal political parties combined. Maybe there is a deep sea change in the offing? Government has attracted a lot of opprobrium with regard to reducing the deficit by planned rationalisation of personal benefits. Claims of homeless already living on the streets as a result of the cuts are perhaps a little premature as changes are not due to be introduced for several months. Analysis of the complainants suggests they are principally the major charities, many of which are run by former Labour Party officials and apparatchiks. Too many charities no longer appear to be about focusing on afflictions or ills, but as stepping stones into national politics. One disabled person of my acquaintance put it succinctly charities are no longer about helping people or wiping bottoms, but are now about telling other people to pay.

UK Economic Situation
At a macroeconomic level the UK continues on a roller coaster path as illustrated by the changes in GDP in Figure 6. The third quarter has shown some recovery but overall the rate of growth is still between zero and not very much. Forecasters are not seeing significant improvements short term and indeed the final quarter of 2012 could dip into negative territory once more.

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THE GLOBAL ECONOMY: A GAME OF FOUR HALVES?

United Kingdom (continued)

Figure 6; UK GDP Quarterly Growth vs Previous Quarter and Previous Year; 2008-2012

Source; ONS

The rate of recovery post recession in 2011-12 has been relatively sluggish compared with recovery from earlier recessions. Figure 7 compares the rate of recovery with previous recessions. It will be noted just how sluggish the current recovery has been slower than any previous recession for which reliable data exists; slower even than recovery from the Great Depression of the 1930s. Figure 7; UK GDP Growth Over Past Recessions

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Source; ONS

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THE GLOBAL ECONOMY: A GAME OF FOUR HALVES?

United Kingdom (continued)

Analysts have offered a number of possible reasons for such tardy growth such as no release of credit; no escalation in house prices to create phantom wealth; individuals paying down previously incurred consumer credit; reliance on the EU for 50% of UK exports. If the latter is correct, then the country could have seen genuine export-led growth in the past. It would be interesting to know what would be the impact on GDP if the majority of UK trade was still with the old Empire where growth has been largely immune to economic crisis in many cases. A further analysis that will impact on market demand is the rate of recovery in household incomes after recession. Figure 8 traces movements in household income following the last recession and recovery from the current period. Figure 8; Household Income Recovery, Past Two Recessions

The second pair of indices we repeat are RPI and CPI shown in Figure 9. The chart shows RPI and CPI and their stubborn refusal to reach the Bank of Englands 2% year-over-year rate for CPI.

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Source; ONS

GDP is a complex measure and is not universally regarded as the most effective guide. Its rather like driving forward using rear view mirrors to judge where one is going.

THE GLOBAL ECONOMY: A GAME OF FOUR HALVES?

United Kingdom (continued)

Figure 9; UK RPI and CPI

Source; ONS

The two indices are expected to rise over the next few months with increases in energy prices see Figure 10. UK consumers also have to brace themselves for an incremental 100 per household in energy costs to pay for the policy of green energy. The anticipated advent of fracgas is unlikely to reduce the price of gas as it will be charged in line with European market rates. Food prices, too, are anticipated to rise in the near future due to the reported drop of up to 20% in world grain production, mandatory use of grain for bioethanol in North America and massive flooding of agricultural land. Equally important are the changing eating habits of large parts of the world. Figure 10; Escalating Energy Prices; 2000-2012

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Source; ONS

All of these issues can have an unnerving influence on personal propensity to spend and consume and ultimately GDP. The economy is indeed a complex and inter-related animal.

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United Kingdom (continued)

UK Automotive Industry
Poor economic performance of the overall UK economy is not always reflected in new car sales. UK performance during 2012 has shown signs of improvement as shown in Figure 11. Figure 11; Monthly 2012 UK New Car Registrations versus 2011

Volumes remain some 15% or more below pre-recession annual markets of 2.4 million units and above. However, there is considerable concern in the industry that a significantly larger than normal volume of self-registrations are included in the registration figures. Concern with pre-registrations is that the numbers create a false picture of the new car volumes and, as such, can cause problems for used car prices and the quantities of used cars coming to market. This, in turn, may impact on prices if there is a false supply and demand equation and any misfit with volume and value can knock through to business car replacement cycles and create losses.
Centre for Automotive Management, The University of Buckingham

Reasons for significant pre-registrations may be many but, as noted previously, European new car sales are falling fast and, to keep plants running, manufacturers may switch to right-hand drive models, ship to the United Kingdom and then set prices at delivery mileage only at a hefty discount. The Buckingham Automotive Team monitor websites of a number of dealership groups to observe used car stocks and the nature of these stocks. During November a surge in what can only be described as pre-registration units from late October appeared for sale across several franchises. This pattern continued in December.

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THE GLOBAL ECONOMY: A GAME OF FOUR HALVES?

United Kingdom (continued)

Although such actions will continue, they need to be moderated for the good order of the industry. While this is seen as a problem in the United Kingdom, it has been seen as a greater problem elsewhere in the Eurozone, particularly in Germany. One of the consequences of prolonged, low new car sales is the average age of cars in the UK parc creeps up. Figure 12 plots average age of the parc since 2002. In 2011 the average age of the parc is the highest it has been for over quarter of a century and our analysis suggests this will continue to rise and, barring a substantial turnround in the market, could reach a record high of eight years. Figure 12; UK Car Parc, Average Age of Cars; 2002-2015

Equally, parc ageing may mean dealers change focus and put more effort into service and repairs for the older car parc. There are further issues in that owners of older cars are less likely to be willing to pay the high retail service rates charged by franchised dealers. This may mean a need for multi-tier service pricing which, in turn, may impact on profitability and new approaches to service.
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Source; SMMT/Buckingham

While many would see an ageing car parc as being a vote of confidence in the quality of the product, there are a number of issues to be resolved. From an OEM and dealership viewpoint it means fewer sales and profit opportunity from new cars. To the dealership, it may indicate a need to change business focus and put more effort into used car sales, assuming the dealership is able to source sufficient units at an acceptable price and quality.

THE GLOBAL ECONOMY: A GAME OF FOUR HALVES?

United Kingdom (continued)

At the end of the line, one may have to ask if there are too many franchised dealers to support the business available. From a national economic viewpoint, there may be two further concerns older vehicles tend to be less fuel efficient so the CO2 levels may rise but, at the same time, the revenues gathered from fuel taxes may increase.

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THE GLOBAL ECONOMY: A GAME OF FOUR HALVES?

Some Good News

The economic review may have been more negative than positive to date; however, one cannot end on bad news. The SMMT, the UK vehicle manufacturers trade association, are forecasting that vehicle production in the United Kingdom is set to continue rising in the foreseeable future as is indicated by its projections in Figure 13. Figure 13; UK Vehicle Manufacturing: 1970-2015

Source SMMT

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The principal concern with this positive chart is that many of the components used in that growing car and assembly operation are imported from mainland Europe, Brazil and Asia Pacific. Similarly, many of the components used in the engine assembly operations are imported as semi-finished parts which are machined and used in the finished engines. What is there to stop global players rationalising production and taking engine assembly closer to the end-user?

THE GLOBAL ECONOMY: A GAME OF FOUR HALVES?

Some Conclusions
This review has been called A Game of Four Halves the Asia Pacific players, or rather assemblers in Asia Pacific are doing well with growing affluence and expanding markets. North America appears to be recovering and now the presidential election is over the economy may begin a long recovery. The Eurozone however has real problems and is likely to take some time, realistically several years, before markets achieve sustainable growth. The United Kingdom is severely influenced by the EU and its recovery is likely to be relatively slow. Professor Peter N C Cooke Centre for Automotive Management University of Buckingham January 2013 Sponsored by: Pamela Halliday White Clarke Automotive Solutions 07740 935808

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DRIVING FORWARD TOGETHER

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