The protracted debate over the future of UK economic policy and its relationship with EU monetary union has once again surfaced in the context of automotive industry investment. Sterling appreciation against the euro is causing difficulties for companies and plants in the UK that rely on sizeable exports to continental Europe. This time it is Nissan that is making dark noises about future investment in the UK. And this from a company that boasts, in its UK operation, the most productive plant in Europe. What is the background and what are the most likely outcomes?

Haven't we been here before?

In a European context, it is true to say that exchange rate volatility is nothing new. Throughout the second half of the last century exchange rates moved in response to a range of economic and political events that affected the currency markets and the perceived value of one currency versus others. At times, the movements have been large. More recently - the last ten years - technology advances to currency trading have meant that large amounts of hot capital can be moved around the world very quickly, adding to the sense of volatility. Multi-national companies operating in the European (and indeed global) marketplace learnt to either accept the hit on margins or hedge against exchange rate movements. Where appropriate, this policy was readily supplemented by sourcing policy decisions that could also lessen the impact of exchange rate shifts. At the inter-governmental level, efforts to stabilise exchange rates in Europe culminated in the introduction of the exchange rate mechanism (ERM) designed to give a degree of flexibility on the way to eventual economic and monetary union - which has always been a contentious proposition politically.

Whatever the vehicle makers stated publicly ('investment and sourcing decisions are not affected by exchange rate movements') it was fairly obvious that exchange rate considerations were at the centre of business operations. This is most obviously apparent when you look at the development of the European auto industry over several decades. The huge automotive industry investment in Spain reflected good investment conditions in Spain certainly - and that included competitive labour rates, a growing domestic market, improving communications infrastructure, EC accession and so on. But it was also a reflection of a relatively weak currency versus the strong deutschemark. The perception - rightly - was that Spain would be a relatively cheap place to make vehicles for export to the rest of the European continent. The big increase to vehicle manufacturing capacity that occurred during the 1978-1995 period in Spain has to be seen in that broad European context.

The European automotive manufacturing model is changing

The last ten years have seen a steady transformation to what might be termed the 'European automotive manufacturing model'. Vehicle makers' plants across the region are increasingly much more vigorously operated as part of pan-European strategies. When Renault shut down the Vilvorde assembly plant in Belgium in 1997, there was an outcry. Now there is greater acceptance generally in the industry that change is necessary for survival. Platform consolidation is fundamentally affecting plant-product mix and the number of platforms forming the basis for models produced at individual plants. Renault-Nissan for example, is looking to reduce the number of the whole group's platforms globally from the current 42 (27 Nissan, 15 Renault) to just 10 by 2010. Platform sharing will mean that each make's plants will be liable to make the other's models that share common platforms.

For a manufacturer like Ford, it is no longer necessary to have two or three plants making vehicles on a single platform. It is much more sensible to concentrate activity at one or two plants (at most) and make the most of scale economies. This development has occurred in tandem with an accelerating integration of the European economy. As the European economy becomes more integrated, the rationale for having a large number of plants in different countries starts to break down.

Of course, Europe remains very diverse in cost terms. Surveys conducted by the German auto industry trade association - the Verband der Automobilindustrie e.V. (VDA) - consistently show that labour costs in the auto industry vary widely across Europe. Spain's for example, are less than half those prevailing in Germany. Fiscal regimes and social costs are very different. But, and it is a crucial 'but', exchange rate uncertainties have been taken out of the equation for those countries belonging to the single currency - euro - area. For any manufacturer and international trader in high value goods, that is a very significant development.

The nature of the 'UK problem'

The problem for the UK right now is actually not that the UK is outside of the euro. The problem is that the euro - after its 1999 inception - depreciated considerably against sterling. By the early part of this year, the decline was of the order of 20%. The extent of the decline was largely unexpected and it has left UK plants in considerable difficulty. For manufacturers with an especially heavy export proportion of output or a heavy UK component purchasing element, the exchange rate movement versus all major European currencies tied to the euro has been devastating.

In many respects, it is the Japanese auto investors to the UK - who invested in the 1980's when Britain's economy was recovering from a major recession (the early 1980's recession was accompanied by high interest rates to depress inflationary pressures and - again - an overvalued currency) seem particularly aggrieved. Nissan has complained repeatedly about the pound's strength. The managing director of its British manufacturing unit has said that he aims to cut costs by 30 per cent by the end of 2002 in order to offset currency issues. That is pretty ambitious. Toyota and Honda have made it clear that they are to move some parts procurement for their British plants to continental Europe. Honda has said that the UK content of its cars will fall from an average of 70 per cent to 50 per cent or lower over the next two years.

Problems at Ford and Rover have also been severely exacerbated by the level of sterling. Ford of Europe's cost situation has certainly been impaired by its high UK cost base and the decision to stop assembly at Dagenham must surely have been influenced by the position of sterling and Ford's gloomy assessment of UK government policy on the issue. Nick Scheele has called for a level of DM2.5 to DM2.6 as a more sensible sterling exchange rate (the current level is around DM3.11 to the pound).

What about Nissan Sunderland - Europe's most productive plant

Surveys conducted by the Economist Intelligence Unit (see table below; latest available data - vehicles produced per employee) indicate that Sunderland is the most productive vehicle manufacturing plant in Europe - by a considerable margin. The output position in 1999 was not very different to 1998 - 271,000 units produced - and the workforce count was not significantly different.

The plant has benefited from the extensive usage of Nissan's Japanese manufacturing practices and the 'greenfield' nature of the start-up in the 1980s. The EIU's survey reveals that Nissan's achievement at Sunderland reflects an extensive programme of continuous improvement using the assembly techniques employed in Japan. Although automation levels are not higher than average, the plant features extensive use of trolleys in which operators ride parallel to the assembly line. Sunderland operates 80 of these trolleys compared with only 6 in a typical European plant.

The Economist Intelligence Unit reveals that Nissan's Sunderland plant ranks no.10 in the world. Sunderland's productivity of 105 cars per employee compares with the world's best at around 160 and is well ahead of the leading US plants at 87.

Productivity of selected European car plants, 1998

Total Equivalent
Vehicles produced
Productivity: Actual vehicles per employee
Manufacturer Plant Country
workforce
workforceª
in 1998
1997
1998
Nissan Sunderland UK
4,141
2,741
288,838
98
105
Volkswagen Navarra Spain
5,258
4,075
311,136
70
76
GM Eisenach Germany
2,031
2,302
174,807
77
76
Fiat Melfi Italy
5,706
5,217
383,000
70
73
Toyota Burnaston UK
3,224
2,403
172,342
58
72
SEAT Martorell Spain
8,434
7,250
498,463
69
69
Renault Douai France
6,689
5,632
385,118
61
68
GM Zaragoza Spain
9,043
6,687
445,750
67
67
Renault Valladolid Spain
4,965
3,337
213,590
59
64
Honda Swindon UK
2,691
1,763
112,313
62
64
Ford * Dagenham UK
4,534
4,100
250,351
62
61
Fiat Mirafiori Italy
7,829
6,848
416,000
54
61
Ford * Saarlouis Germany
6,665
4,900
290,444
59
59
Renault Flins France
8,068
6,576
387,127
57
59
PSA Mulhouse France
10,874
5,953
345,641
55
58
PSA Aulnay France
5,490
4,528
262,005
51
58
Ford* Valencia Spain
5,841
5,150
296,173
57
58
Renault Maubeuge France
3,922
3,778
212,858
n/a
56
PSA Vigo Spain
8,688
6,491
338,650
35
52
Volvo/Mitsubishi NedCar The Netherlands
6,933
4,872
243,000
36
50
PSA Poissy France
7,344
4,840
218,856
36
45
GM Luton UK
3,533
3,604
154,846
39
43
Volkswagen Wolfsburg Germany
22,483
14,053
589,919
39
42
Renault Sandouville France
6,600
6,003
244,201
36
41
PSA Rennes France
9,357
7,153
289,465
n/a
40
Fiat Cassino Italy
5,509
4,891
193,000
39
39
Volkswagen Emden Germany
10,729
8,885
329,685
28
37
Skoda Mlada Boleslav Czech Republic
18,929
8,145
287,529
33
35
PSA Sochaux France
19,197
7,686
237,002
25
31
Rover Group Longbridge UK
13,000
9,250
281,855
34
30
DaimlerChrysler Rastatt Germany
5,000
5,000
150,000
n/a
30
ªadjusted for comparative purposes; * Derived from EIU estimates.

In contrast to its class-leading productivity, profitability at Nissan's UK manufacturing operations fell 70% in 1998/99 to £23m. Results were hit by the strength of sterling with over two-thirds of the plant's output going overseas. Currency issues could jeopardise a potential £150m expansion of the site. The Sunderland plant which employs 5,000 people and thousands more in the supplier industry faces its biggest threat since opening in 1986. The big decision concerns the next generation small car - which will be on the new B platform and will replace the current Micra. The plant currently produces about 330,000 cars a year and had hoped to lift output to more than 400,000 with the new Micra.

If Sunderland were to lose the Micra project, the likely beneficiaries include Nissan's Barcelona plant or factories operated by Renault in France and Spain.

So what's going to happen?

Number one: the Sunderland plant will remain at the core of Renault-Nissan's European operations. It is not another Dagenham (clapped out and rumoured for closure for years). It is most unlikely that the next generation Micra will not be built there, due to the plant's outstanding productivity record. Existing Micra suppliers will also be looking to supply to the new model in Sunderland and the cost situation would have to be extremely severe to justify the disruption in moving the replacement model elsewhere. Moreover, Renault already has a complicated job sorting out its French and Spanish plants, where the plant-model mix looks in need of further rationalisation.

Sunderland's only significant problem is the level of sterling and M. Ghosn and others are playing a political game. They want sterling tied to the euro at the right exchange rate and they are keeping the pressure on the UK government to achieve that. Whether or not the UK actually signs up to the euro is partly missing the point. No future UK government is going to want to repeat the economic damage caused by the exchange rate events of the last eighteen months (damage that takes time to come through). Greater exchange rate stability is in the interests of all and a commitment to 'shadow' the euro or manage exchange rates so that the sterling-euro differential is kept within a lower and upper bound might be sufficient in the absence of a commitment to actually join the euro. But crucially the rate has to be 'sensible'.