Should the US – or the EU – subsidise the motor industry?

The US motor industry faces three problems. Demand for all vehicles from all producers has fallen sharply owing to the Credit Crunch and the weakness of the banks, limiting the number of new car, van and truck loans available. It pays its employees and pension claimants more than global competitors pay theirs. It makes too many fuel hungry vehicles which are no longer so popular.

Two of these are structural problems which require radical changes to the business model. The Credit Crunch is cyclical, requiring short term loans whilst the companies adjust to lower volumes for the duration of the downturn.

On the other side of the world are car makers whose total unit labour costs are lower, and who make more types of smaller and therefore more fuel efficient vehicle. There is over capacity worldwide.

The US motor industry is just a small part of a much wider problem. The West has continued in the belief that we can pay ourselves much more than people are paid in the East, borrowing the money from the East through our banks and governments to sustain our higher living standards. We have decided in some cases that we can work less efficiently and for fewer hours than our Asian competitors. We have sometimes used the borrowed money to buy products made by dearer labour in the west, and sometimes have used the borrowed money to buy cheaper products from the East. Now the Western authorities through higher interest rates and tougher banking regulation have called time on the private sector borrowing which sustained this. So now there has to be a very painful adjustment.

Some of the adjustment will take place by devaluing Western currencies against Eastern ones. Stronger Japanese and Chinese currencies will correct some of the price and cost differentials in favour of the western product. Some of the adjustment will take place through the West adopting smarter ways of making things that requires less labour, and in buying materials and parts better. Fortunately in the case of cars assembly labour is not a large proportion of total cost – materials and bought in components matter much more.

That still leaves the US motor industry needing to help itself more. It will need to reduce capacity – there is simply too much capacity worldwide, and US vehicle demand is not going to magically pick up by enough in the new year. It will need to attack its costs yet again, as it has been doing year after year over the last decade. It will need to speed the design of new more fuel efficient vehicles, to give it the competitive product range it needs.

Should the US taxpayer stand treat? It is difficult to see why the taxpayer should become an equity investor in car companies. That might put off the necessary adjustments. The good news is that GM and the other majors are smaller than the banks the US government is seeking to refinance. GM has assets of just $110 billion, meaning it is smaller than Northern Rock, and an accumulated shareholder deficit of $60 billion. Royal Bank of Scotland’s balance sheet is 28 times bigger than GM’s. The US car makers together are talking of needing say $25 billion, small sums compared with the massive sums the banks have been negotiating.

Of course the US government should talk to the majors and see how they can help, as the bankruptcy of a car aseembler at the moment would not be a good idea. As the car companies themselves have said, they have lots of options for raising the cash they need for 2009. They can borrow in private markets. They can cut costs further. They can run down stocks and improve working capital control. They can sell assets. The government could examine if there are sensible ways it could help with the transitional costs from the present model ranges to more fuel efficient vehicles, given the stated intention of the incoming President to promote greater fuel efficiency and spend taxpayer dollars of new technologies for that purpose. If the banks cannot lend sufficient for short term adjustment, the state could see if it could take proper security for such a loan.

It would be a foolish course to embark on owning car companies, just as nationalising banks poses al sorts of undesirable problems for governments.

The European industry has not yet quantified its problem. Whilst it has produced more small and fuel efficient vehicles than the US as a proportion of its ranges, it too will face a very uncomfortable few months ahead. It also produces a lot of executive and luxury cars which are going to be in much less demand as the financial sector is hit. It too pays people far more than the Eastern low wage competitors, and has factories which in some cases are not up the most efficient standards the world now demands. It also has too much capacity. It would be quite wrong of the EU or the individual national governments in Europe to suspend normal competition laws and to subsidise the industry, just as it is wrong for European governments to buy bank shares. Both courses of action simply delay taking the necessary steps to get costs , services and products into line with global market realities. If governments try to subsidise too many industries, or big banks, governments themselves will run out of money.