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September 7, 2009

COMMENT: Beware of scrappage-induced mirage

Automotive markets all around the world are getting a lift from government subsidies to car purchase and they come obligingly dressed up in a light green cloak. New for old. There's not necessarily anything wrong with that. If car markets are stimulated and the car parc gets a little less dirty in the process, it looks like most people are happy.

Automotive markets all around the world are getting a lift from government subsidies to car purchase and they come obligingly dressed up in a light green cloak. New for old. There’s not necessarily anything wrong with that. If car markets are stimulated and the car parc gets a little less dirty in the process, it looks like most people are happy.

Even more importantly, scrappage schemes have kept car plants operating and dealers open at a time when collapsed consumer demand and sharply adverse cash-flow threatened to decimate the industry in some places.

Is government-sponsored scrappage expensive? In net terms – all taxes taken into consideration including those such as VAT arising from extra sales – I would guess it stacks up pretty well against the huge cost of bailing out the banks late last year.

Payback worry
There is a worry though. Just how many of the sales that scrappage incentives bring in are non-incremental sales that would have happened anyway at some point in the future – next year, say? You can argue quite legitimately that the sales were needed more desperately in the industry this year and that’s surely a part of the rationale, but there’s still the concern over next year’s sales level. This ‘pull-forward’ number is obviously going to be very substantial and historical evidence suggests that a market decline through ‘payback’ follows such incentives as sure as night follows day.

Policy-makers can choose to extend incentives and that can indeed provide further market support, but there are diminishing returns from lower numbers of successive waves of buyers. The first hit tends to be the big one, when the proposition is at its strongest.

The scrappage incentive works best as a short-term tool to lift the market in extremis – as it was widely used by European governments during the recession of the early 1990s.

The big questions now surround the rate at which the schemes still in operation are running out of funding and also the strength of a post-scrappage market payback that will send car markets down.

Can economic recovery come fast enough?
Ideally, the underlying economic situation is improving fast enough to act as a counterbalance to lost sales in future time periods. In this benign scenario, the economies of the US and Western Europe bounce back from recession in the second half of the year (with unemployment at least stabilising, consumer/business confidence improving, interest rates remaining low, inflationary pressures under control). And therefore, as we get into 2010, there’s increasing support from growing economies for car demand and that helps to compensate for the ‘lost’ sales that happened earlier under scrappage.

At least the news on the economic front hasn’t been too bad lately. The latest OECD assessment sees the US and Western Europe emerging from recession in the third quarter. Some economists are saying that things are improving more rapidly than was expected a few months ago. That’s good to hear.

But there have also been warnings that the root financial causes of this recession are still with us and that governments would be ill-advised to take their collective feet off the fiscal stimulus gas pedal too soon. A ‘double-dip’ remains a real possibility after an initial economic rebound – from an exceptionally low base – triggered by short-term inventory replenishment.

The underlying problems that have caused this recession have not gone away. Credit remains in short supply, with the banks far from ‘fixed’. American and European households are not in the mood for a spending spree despite interest rates on the floor. The cost of government bailouts will weigh on public finances for many years to come. And past experience also suggests that banks are slow to resume lending after banking crises.

Even if things have stopped getting worse and there is some light in the gloom, this economic recovery may well turn out to be a slow and uneven one by historical standards – at least in the West.

US and German car markets set for reverse
What about the big car markets that have seen scrappage boosts this year? The US and Germany stand out. There are real concerns that the US market will weaken over the remainder of the year now that ‘Cash for Clunkers’ has finished. Some analysts are predicting a painful ‘hangover’ with a sharp contraction to sales over the next month. That’s one to watch.

In Europe, all eyes are on Germany, where the scrappage incentive – combined with manufacturer discounting – has provided major market support this year. Industry observers believe that the German car market could slump as low as 2.5m units next year after ballooning to an eye-boggling 3.8m units this year. That would be an uncomfortably large swing.

Car markets could actually start to look quite a bit worse in a number of places in the short-term and into next year  – even if an economic recovery is taking hold. Carlos Ghosn recently said that he is expecting 2010 to be every bit as difficult as 2009. I’m sure many automotive industry executives will agree with him.

Global auto industry centre of gravity changing
Scrappage schemes can play a useful role in supporting car markets and promoting firms’ survival, but the automotive industry – just like others – needs underlying demand to return on the back of a sustainable economic recovery.

Things won’t go back to how they were a few years ago, but a period of economic stability would determine where the new ‘normal’ market levels are – especially for replacement demand in the mature markets. By contrast, developing vehicle markets and industries in places like China and India will continue to expand more quickly than mature ones as motorisation gathers pace. And the global centre of gravity of this industry will likely carry on moving towards Asia as the economic adjustment wrought by this recession continues.

Scrappage incentives can help to buy some time or respite and healthier looking car markets, combined with better economic news lately, are indeed welcome. But there are still tough times ahead for many and the pressures may well intensify in declining car markets suffering from scrappage payback.

Dave Leggett






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