A Cold Look at Australian Car Manufacturing

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 Markets and Money

 

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Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:

 


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