It is interesting to note that calls for scrappage schemes are getting louder in Europe in the face of the severity of the downturn to Western Europe’s car market. Yesterday, we published the latest sales numbers from LMC Automotive and they do look grim.  

After this year’s forecast 8% drop to the car market (now over 20% off 2007’s level), a drop of 3% is now forecast for 2013. There’s no relief in sight to the discounting ‘bloodbath’ (Sergio Marchionne’s apposite term) and more uncomfortable decisions lie ahead for the OEMs on overcapacity.

So, what about fixing the market? After all, coordinated government scrappage incentives in 2009 worked a treat in lifting demand across the region to counteract a sudden and brutal downturn that threatened to decimate the sector, OEMs and suppliers. Yes, they worked then, but that sudden downturn came off a historically high market to bring a severe and sudden stock problem. Some plants stopped working for six months while stocks were run down. It really was a desperate economic situation that justified special measures. Things aren’t great now, clearly, but the stock adjustment now for the industry is not as severe as that faced then. The drift into this crisis has not been a drive over a cliff, as was the case in late 2008, early 2009. It’s been more of a gradual descent into a protracted downturn, manufacturers well aware of the need to trim stock over the last few years (though the demand situation has worsened markedly this year).

What we have now is the realisation that there is a problem for many OEMs of structural overcapacity, given where car demand in Europe is now ‘settling’. It is looking like a long haul in terms of where Europe’s economy is going and the problems of keeping a single currency intact. A  framework for a solution that delivers the right level of economic and political integration (and restores stability) has yet to be formulated and agreed by eurozone states. We’re still muddling along with ad hoc bailouts of one form or another and national austerity packages of varying degrees of severity being imposed across the region. It’s a low-growth economic environment and will remain so for a while yet. 

Against that background, scrappage incentives to encourage car sales are certain to be discussed by policy-makers. To politicians, they can sound very seductive. In a national market where they are introduced, they tend to benefit those with the biggest market shares (usually ‘domestic’ makes and those with manufacturing plants in the country). And because they are not specific to an automaker, they don’t risk a breach of EU state aid rules. You can also couch them in a nice green hue as you describe them as replacing older dirtier cars with newer clean ones and therefore eminently environmentally responsible (although there is the counter argument that cars in perfectly good working order are being needlessly replaced with new cars that come with all the energy utilised in their manufacture).   

But there are problems with scrappage schemes that can make them less effective in practice. They are subject to diminishing returns. The schemes of 2009 took quite a few old cars out of circulation. There’s a big one-off element. The low-hanging fruit – the oldest and most suitable cars for trading in under scrappage schemes – went in that wave. Schemes now would be operating in a less favourable situation simply in terms of the vehicles out there in the parc that are old enough to qualify (at least in terms of typical qualification terms for such schemes).

Also, there’s the issue of ‘payback’. A car purchase brought forward today is a car that won’t be purchased tomorrow. After the boost comes the hangover when there’s a corresponding dip in sales (as we saw in Germany in 2010). If the economic cycle is back on track by payback time, great. Scrappage has smoothed sales and prevented all the damaging liquidity and immediate adjustment issues that come with a sudden off-a-cliff total industry volume crash. But, other things equal, the market will drop when the scrappage scheme ends. And end it must, because that’s the nature of the beast – to beat the deadline and therefore qualify for the incentive (‘I was going to replace the car next couple of years anyway, but brought it forward to get the deal while it was there.’). Of course, there will be be clamours to extend schemes (a peculiar game of poker between government, manufacturers and consumers – usually a ‘last-minute’ extension, thinking back to Italy and France in years gone by). It’s analagous to the drug addict wanting to avoid cold turkey and stay high. But diminishing returns become greater, the scheme in danger of becoming a de facto permanent subsidy from government for car purchases. The ‘boost’ diminishes to negligible as the scheme is extended one deadline after another. The fear of withdrawal of the scheme in industry and subsequent lower sales is heightened after a temporary scheme has become ‘institutionalised’ in this manner. And it’s not exactly an ideal outcome for governments struggling to balance their fiscal books.

To summarise, scrappage incentives now, in Europe, will be of limited benefit. They may well come under greater consideration and they could lift sales a little (let’s see what happens in Spain, a severly decimated car market, where a scrappage scheme is imminent), but the scale of the economic problems in Europe and the real level of the market are at the heart of the industrial adjustment taking place. It’s an adjustment that is arguably long overdue. Policy-makers in Brussels and in capitals across the continent need to get on top of the economic crisis in a way that can restore economic growth and stability. That’s where the pressing need is. The automotive market, like others, will benefit when that happens. And the US experience perhaps illustrates that the turnaround does not need to be especially sharp (indeed, given the depth of the problems and timelines for austerity budgets to work, it won’t be). A sense that things are not getting worse in the European economy should, coupled with natural (and, increasingly, pent-up) replacement demand, be sufficient to lift car demand again from the middle part of this decade. 

Ad hoc plasters, such as bailouts for deeply indebted governments struggling to service their ballooning debt or temporary measures for industrial sectors, such as car scrappage schemes, are just that: ad hoc plastering over the cracks to avoid things getting even worse. A sustainable economic recovery is required in the medium-term, built on a stable European economy with a level of economic integration that also works with voters. Right now, we are still some way off from that, but it will come – through eventual real consensus (the effective presentation of ‘least worst’ options that voters understand) or de facto, via a partial disintegration of the single currency leaving a club of nations with broadly similar economic profiles and attributes who find working together easier.

And car companies operating in Europe need to develop the right manufacturing capacity footprints to respond, competitively, to where the real level of demand is going to be over the next five to ten years. Scrappage schemes have their uses, but they are a temporary tool that needs to be applied with a deft touch. In Europe in early 2009, they made sense. In 2012, they are much less relevant to the wider problems – impacting the auto industry and others – that need addressing so that market growth returns.