A Cold Look at Australian Car Manufacturing

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Another one bites the dust!

Yesterday afternoon, car manufacturer Toyota announced that it’s leaving Australia in 2017, hot on the heels of Ford and Holden’s exits in 2016. Within a few years’ time, Australia will have no car manufacturing capability.

‘Road to recession’, says the front page headline from The Age. They’re not far wrong. Dan Denning predicted this last year. You can see his critical forecasts for 2014 here.  

The closures themselves won’t send the economy into recession, but we’re certainly heading in the right direction. While the direct job losses from the closures aren’t huge, when combined with the loss of the jobs in the supply chain, up to 50,000 positions could disappear over the next few years. The state of Victoria will be hardest hit. Today’s Age says that a recent study ‘found local car makers spend $2.25 billion on parts sourced from Victoria.

That’s $2.25 billion per annum that will no longer flow through the economy of greater Melbourne. While we can hope that the value being created by the city’s real estate agents will make up for that loss somewhat, it’s going to be a big blow for the affected communities.

Let’s look at this coldly though…

Does Australia need a car manufacturing capacity? The answer from most economic rationalists is ‘no!’ We’re a high cost, ‘knowledge-based’ economy now, and it makes no sense to produce cars for export on a sub-scale basis. It’s far better off to shift capital to Asia where manufacturing capacity is much larger and better suited to the economies of scale needed to manufacture profitably.

The argument then goes that it will free up capital in Australia for more productive investment…and you’ll see more import competition that will lower the price of cars…and less subsidies from the government to prop the industry up…so we’ll all be better off. (Except the workers directly affected, of course.)

That argument makes sense on the surface. After all, not every rich nation has a car manufacturing capacity. It isn’t crucial to an economy’s wellbeing. And to be honest, it’s a tough gig for Australia. The tyranny of distance means that we would have to manufacture on a huge scale to be competitive globally. Making things even tougher, we’re right next to Asia, with the world’s lowest labour costs.

But where the argument becomes a little flimsy is when the loss of a major manufacturing industry is justified by claims of Australia being a knowledge based economy. No, we’re not. We’re a high cost, commodity-based economy. Our competitive advantage lies in our vast natural resources, which provides the scale to ‘manufacture’ certain metals and ores cheaply.

The recently released December trade data showed that Australia exported $4.6 billion in ‘services’ for the month…a very rough proxy for the demand for our ‘knowledge’. In contrast, Australia exported nearly $24 billion in ‘goods’, which was mostly commodities.

Our biggest money earner is – you guessed it – iron ore, with $7.3 billion exported in December, representing a record 28.4% of total merchandise exports. And of course it nearly all goes to China, which is now taking in a record 37% of Australia’s exports.

A knowledge-based economy? Hardly.

That brings us back to the question of does Australia need a car manufacturing capability? The honest answer is, no…not really. But perhaps the better question to ask is, should we still have it?

We’re going to argue that we should…and that the demise of our car manufacturing capacity is emblematic of a huge misallocation of resources in this country, resulting from low interest rates both in Australia and globally.

Australia is a high cost economy not because we’re super productive. It’s because we’ve had a series of ‘inflations’ flow through the economy over the past few decades – the result of both low interest rates domestically and globally. (Low rates globally led to China’s boom via the fixed exchange rate with the US dollar).

The main beneficiary of these ‘inflations’ was (and still is) house prices. This put pressure on wages to rise ahead of productivity gains. But this didn’t translate into higher consumer price inflation because at the same time we got the China windfall – a boost to national incomes that pushed our dollar to record highs and kept a lid on imported inflation. Because of this, the Reserve Bank of Australia could keep real interest rates low.

Meanwhile, successive governments were happy to sit back and let easy money bring ‘prosperity’ to the nation, avoiding any hint of structural reforms that would make the economic structure less inflation prone and more productive. (Productivity is what produces true, long term wealth creation.)

Over the long term this combination of events simply turned Australia into a high-cost economy, slowly driving manufacturers into Asia to remain competitive. This vast loss of competitiveness on a global scale isn’t readily apparent because we’re still reaping the benefits of the China boom.

If we did improve our productivity and competed in the knowledge economy on a larger scale then all this wouldn’t be such a big deal.

But when China slows and adjusts its growth path, our dollar will continue to fall and we’ll become only a slightly lower cost economy – but the distortions and misallocated capital from the prior inflation will remain. Now, many people argue that a return to a lower dollar is a good thing. On the contrary, we would argue that a lower dollar won’t be as beneficial as it was in the past. That’s because many of the beneficiaries of a lower dollar have already shut up shop and moved offshore.

Think about it. If heavily subsidised car makers are finally biting the bullet and getting out of the country, you can bet that the smaller, non-subsidised industries are long gone. Many of the household goods that you think are Australian are mostly manufactured overseas.

There’s nothing inherently wrong with that. That’s what globalisation is about. But it means the lower dollar won’t be the saviour everyone thinks it will. A lower dollar will result in either higher imported inflation (as the lower dollar pushes up the price of imports) or weaker profit margins from local companies with offshore manufacturing operations.

Yes it will push commodity prices up in Australian dollar terms, but the iron ore price will be the big loser in the coming China shift.

The bottom line is that Australia’s economy has been highly inflationary for years. It’s pushed our cost structure to uncompetitive levels, and you’re now seeing the effects of that with large, subsidised manufacturers shutting up shop.

The main beneficiaries of the inflation are the banks, and you’ll see firm evidence of that tomorrow when the Commonwealth Bank announces yet another record profit. But the benefits of inflation are always short-lived. It needs constant replenishment.

With the RBA now on hold and China slowly but surely adjusting its economic growth pattern, the Aussie economy might be all out of inflationary impulses. This may just be the last hurrah for the banks. More on that tomorrow…

Regards,

Greg Canavan+
for The Daily Reckoning Australia

Join The Daily Reckoning on Google+

Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.
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5 Comments on "A Cold Look at Australian Car Manufacturing"

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Ross
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Could we now source parts and build a Boomerang equivalent fast enough? http://www.militaryfactory.com/aircraft/detail.asp?aircraft_id=609 Or a Wirraway, a Wacket, a Woomera? They are saying no. It is only when self reliance is foisted upon you when things don’t go so well for your big mates that you would say otherwise, apparently? And learn from great power history? “No, you don’t you worry about that!” We currently sit so far down the road of “engagement” that we play the either/or game of two US strategic policies that lead a declining hegemon to fate? You know the game plans? Well if not, there’s… Read more »
DerekD
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The story was more a macro overview, communist paranoia is just counter productive. Remember that China is wise (though corrupt), unlike North Korea, diplomacy will win eventually on dokdo island issue. China will shift to a limited democracy and take what it has worked so hard for – status.

slewie the pi-rat
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great melt-up call!

Jason
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Australia is acting like a subservient vassal state licking China’s boots and for what? A minority of miners make money and the incomes from the mining sales are used as an excuse for house price inflationary bubbles. This is classic Dutch Disease. Bowing and scraping at China’s feet is a waste of time becuase the one thing that will play a major role in comming years will be the Asian “Rapid Demographic Transition”, just looking at the latest fertility statistics for the region points to a clear picture. China’s growth will slow and in the end it will follow the… Read more »
nhockevi0108
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Bowing and scraping at China’s feet is a waste of time becuase the one thing that will play a major role in comming years will be the Asian “Rapid Demographic Transition”, just looking at the latest fertility statistics for the region points to a clear picture. China’s growth will slow and in the end it will follow the same pattern as Japan becuase the demographic transitions are the same. Even the ‘Economist’ ran an article called “Asia: From Baby Boom to Baby Bust” where they quote demographic research that asserts that (Continental) Asia’s fertility rate was now 2.1 and falling… Read more »
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