Saturday, 18 March 2017

Of cars and tariffs, and Brexit fantasies




"The Germans won't want tariffs on their car exports to the UK", said my father the other day.

I have to agree. No-one likes tariffs, especially when they are used to having none. But it was his next comment that made me pause. My father's idea is that the EU will allow the UK to have tariff-free access to the EU's markets after Brexit in order to placate the powerful German car manufacturing lobby. He's not alone in this view: it has been repeatedly stated by Brexit promoters, both during the Leave campaign and since the vote last June.

The obvious rejoinder is that the EU (ex-UK) is 27 countries, not one, and although Germany is powerful it does not call the shots with regard to trade. Although a qualified majority vote is sufficient to allow the UK to leave the EU, a new free trade deal between the UK and the EU post Brexit would require the agreement of all 27 members, and in some cases sub-sovereign agreement too. The recent trade deal between the EU and Canada was nearly derailed by Wallonia, a sub-sovereign of Belgium.

Nor could there be a deal specifically between Germany and the UK regarding car exports. The UK is leaving the EU, but Germany is not. And members of the EU are not allowed to negotiate their own third-country trade deals. If it tried to enter into a separate agreement with the UK, Germany would be breaking EU treaties. However powerful its car manufacturing lobby is, undermining the EU is not in Germany's interests. The car manufacturers know this. To my knowledge, they have never suggested that Germany should negotiate directly with the UK, nor are they ever likely to do so. That is a Brexiteer fantasy.

Of course, Germany does sell a lot of cars to the UK. But the UK certainly isn't the destination for "most of" its car exports, as some Brexiteers have asserted. Full Fact, debunking Louise Mensch, gives us the figures:
Germany sells about 14% of all the passenger cars it makes domestically to the UK, a little over one in seven. (That makes up about 18% of the passenger cars it exports, a little under one in five.)
So - assuming the UK did impose a tariff of some amount on car imports from the EU - 18% of German car exports would suddenly become more expensive (unless German manufacturers absorbed the tariff as a hit to profits). UK consumers might not like this price increase. But just look at German cars sold in the UK. Mercedes, Audi, BMW.....they are luxury cars. Even the Volkswagen Golf is a status symbol. If British people want cheap runarounds, they don't buy German. They buy Japanese or American cars manufactured in the UK. German cars already command higher prices than these: it is hard to see that British purchasers of German cars are suddenly going to exhibit extreme price sensitivity because of an import tariff. Top-of-the-range luxury marques might even benefit from a price rise, since they are Veblen goods. And some German cars are manufactured in the UK - Minis and Rolls Royces, for example: these would not incur the UK's tariff at all if sold in the UK, though they would incur EU tariffs if exported to the EU.

But where do the rest of Germany's car exports go? Well, a lot of them go to the rest of the EU. In general, the rest of the EU is a much bigger destination for German exports than the UK. And the rest are exported to the rest of the world. According to Eurostat, in 2015 exports of new and used cars made up 11% of the EU's total exports. Of those, over half came from Germany.  Interestingly, the UK is the EU's second largest exporter of cars, at 12% of total car exports. This contribution to EU exports will of course be lost post-Brexit. The EU's trade surplus in cars versus the rest of the world (exports exceed imports by a considerable amount) will therefore fall somewhat. But Germany's trade surplus in cars versus the rest of the world will actually increase, since it is a sizeable net exporter to the UK. The chances of its UK car exports collapsing sufficiently to eliminate this effect is vanishingly small.

The largest export market for EU car exports is the USA, which in 2015 took 26% of EU cars. The US imports more German cars than the UK does. The EU has no free trade agreement with the USA, so sales of these cars incur the US's WTO "most favoured nation" tariffs, which are about 2.5%. The second most important export market for EU-manufactured cars is China, which also has no free trade agreement with the EU. Clearly, not having a free trade agreement is not a great obstacle for German car exporters. There is no particular reason to suppose that the UK imposing tariffs on imports of German cars - or Italian, French and Swedish cars, for that matter - would be a major obstacle either. Admittedly, grandfathering EU WTO tariffs, which is how the UK is likely to do tariffs in the short term, will cause some pain, since the EU's tariffs are rather high. But given the relative price inelasticity of German cars in the UK market, the pain is likely to be limited and short-lived. So Germany is not likely to take fright at the prospect of UK import tariffs. German manufacturers may moan, but the response from the German government is likely to be along the lines of "if you can cope with tariffs elsewhere, you can cope with UK tariffs".

Some have suggested that threatening the EU with a trade war - "if you impose tariffs on our Nissan exports we will impose bigger ones on your Volkswagen exports" - might secure tariff-free access. This is foolish in the extreme. The UK has far, far too much to lose.

When it leaves the EU, the UK will face the EU's WTO "most favoured nation" tariff of 10% on its entire car exports to the EU. In 2015, that was 57% of its total car exports. And British car exports, with few exceptions, do not carry the "luxury" premium of many German marques. It is British car manufacturers, not German ones, who have the most to lose from Brexit. It is British car manufacturers who have lobbied most heavily for UK trade with EU to continue to be tariff-free. And in any trade war over car exports, it is the UK that would suffer most. Ratcheting up tariffs on EU car imports could reasonably be seen by the EU as unfair competition and met with retaliatory action. In a trade war, those that have the greatest exposure suffer the most.

Sterling weakness, if it continues, would also raise the UK price of imported German cars. If the combination of depreciation effects with new import tariffs raised the price enough, German exports to the UK would fall. But just as Brexiteers like to assume that the UK can readily substitute cheaper rest-of-world destinations for the expensive EU after Brexit, so too can Germany. Germany's engineering is respected worldwide. If the UK made exports difficult, Germany would simply seek markets elsewhere. It can well afford the short-term hit to its net exports: it has already weathered worse in the Eurozone crisis. In contrast, even with the assistance of a debauched currency, UK exporters to the EU might find it difficult to find new markets. 57% of total car exports is an awful lot to relocate to lower-tariff destinations.

It doesn't take much fact checking and common sense to debunk most Brexiteer fantasies. This is simply the latest in a long line of myths, legends and outright lies that crumble when exposed to the harsh light of reality. Sadly, though, in this age of fake news and the dominance of opinion, facts and sense are massively devalued goods. The Brexiteers will discover in due course the folly of their ideas. But by then, it will be too late.

Related reading:

Game theory in Brexitland

Image from www.car-brand-names.com



24 comments:

  1. I thinks Mr Ridley gets it about right here http://www.rationaloptimist.com/blog/brexit-and-free-trade-agreements/

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    1. I don't. It's typical Brexiteer "trade agreements are easy" nonsense. Australia is nothing like the UK: its primary exports are commodities, not services. Services are much more difficult, requiring harmonisation of laws, regulations and standards. That's why nearly all trade agreements don't cover them.

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    2. But I thought you were talking about German Cars.....

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    3. Viscount Ridley's views on this matter have already been comprehensively de-bunked over here: -

      http://www.eureferendum.com/blogview.aspx?blogno=86407

      Viscount Ridley might want to recall his own recollection of how the 2008 financial crash affected his then Bank, Northern Rock when he said in the Daily Telegraph: -

      "We were all taken by surprise by that. There was almost nobody who saw it coming. Those who did were not in the right place to warn everyone else"

      It looks like he's going to be "taken by surprise" again.

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  2. Luxury cars, at least as far as you have defined them, are not Veblen goods. They are much more price sensitive than you would expect. At the extreme end of the market, Rolls Royce, Ferrari, Lamborghini et al, there may be a slight attraction to exclusivity pricing, but even then, only for the most specialist models.

    The German manufacturers do enjoy higher margins on U.K. sales and I would expect that they would have to (and be willing to) absorb import tariffs rather than lose market share. The auto business is a volume game and the UK volumes and particularly the relatively rich product mix are crucial to overall profitability. The single market has protected European manufacturers from Japanese and Korean imports to a much greater degree than most people realise. The Asian brands are much more efficient manufacturers than their EU competitors.

    It is also wrong to think that lost sales in the U.K. would only affect the apparent home country of Europe's principal brands. OEM manufacturing is pretty widely dispersed and the supplier base is even more widely dispersed. It's not just workers in Germany and France that would lose their jobs with lost U.K. sales, just about every remaining EU country would be heavily affected. Just think of the significant number of Mercedes Benz or Porches that are built in Finland for example.

    And don't be deceived by the hyperbole surrounding the UK investments being made by Nissan and Toyota; they have as much to gain from an equalisation of trade tariffs on imports from Japan as they might lose in exporting their UK production to mainland Europe. In any case, anything that pushes up the cost of imported volume products from the EU only serves to make their UK offer more competitive. Not that anyone will be shouting that from the roof-tops!

    You are also completely wrong to suppose that the German brands could easily replace lost U.K. sales by upping their export game to other markets. If it was that easy, they'd be selling there already. The pressure for volume in auto manufacturing is immense and no stone goes unturned in the pursuit of sales. The major auto markets around the world are just as protective of their domestic manufacturing as the EU has been. At the risk of repeating myself, there are also very few markets in the world that can rival the U.K. for the richness of its product mix.

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    1. You need to read what I say a little more carefully. I said the TOP marques in the luxury car market would be veblen goods, not all of them. I also said that German manufacturers might absorb the tariff in reduced margins.

      I frankly do not believe your assertion that premium priced German cars are as price elastic as cheaper Japanese or American models. This does not fit with the behaviour of UK consumers.

      I did not say anything at all about the distribution of job losses. Please do not read into my post things that are not there. They are absent for a reason.This post is not about jobs.

      Supply chains are of course globally integrated, which means that both tariffs and currency depreciation do not necessarily act as expected. However, in this post I am not concerned with the effect on Japanese-owned businesses of equalising tariffs. I am interested in the effect that leaving the EU will have on UK exports compared to German exports. The fact is that a far higher proportion of the UK's car exports go to the EU than German ones come to the UK.

      I did not explicitly say this in the post, but the fact that the EU is so much bigger and more diverse than the UK also puts the UK at a considerable competitive disadvantage post Brexit, since the UK will have to source far more of its raw materials and components from 3rd countries. Even low WTO tariffs add up if continually imposed along supply chains. Losing free trade with the EU will be therefore be far more costly for the UK than losing free trade with the UK will be for the EU: extended supply chains simply make matters worse.

      Why on earth would German manufacturers already be selling to places where they face higher barriers to trade than they currently do in the UK? Clearly, they will diversify when exporting to the UK becomes less attractive.

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    2. Marque is usually taken to mean the brand of vehicle. Audi, BMW, Bentley, Ferrari are all marques. Q7, 7 series, Mulsanne, 488 Spider would all be models. So perhaps you should edit your original post to read "models" instead of "marques". Even then the number of models (and associated volumes) that would qualify as Veblen goods are irrelevant for any meaningful discussion on the state of the industry.

      I can claim some specialist knowledge on the pricing of Japanese imported cars as well as German and UK manufactured brands as I have managed all three at a senior level.

      If you want a practical example of how elastic car pricing is, observe the sheer complexity of any manufacturer's model range and the sheer number of derivatives that are marketed to ensure that they cover the maximum number of price points.

      It is also wrong to think of price elasticity as an absolute. The pricing power of any brand is relative to the positioning of its competitors. Hence if a Japanese import is priced sufficiently below its German competitor, it will tend to increase its volume at the expense of the competitor. Removal of the current import tariffs on Japanese cars would have a transformative impact on the U.K. Market - particularly the premium market. Admittedly there are other factors at work, but examine the strength of Infinity, Accura and Lexus in the US relative to the European market if you want to study what could happen here.

      Volume and absolute values also do not tell the full story of the relative imports/exports between the UK and the rest of the EU. Margin and profitability are a big part of the equation as well. The manufacturers don't call us "Treasure Island" for nothing.

      The idea that German manufacturers would choose not to compete in certain markets because they face higher barriers to trade than in the UK is ridiculous. All manufacturers work hard to maximise volumes in all markets using the most expedient channel available to them. If a large market like the UK should see a declining sales volume, it may increase the volume pressure on other markets, but inevitably that comes at the cost of price and margin. EU manufacturers can only lose if trade barriers are imposed in this market post Brexit.

      I mentioned jobs because they are also an important consideration in the real politik that will govern the long term decisions on trade barriers in this sector. Every single member state of the EU stands to lose if tariffs are imposed.

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    3. Stuart,

      I think we are slightly at cross purposes. I'm happy to change the wording, of course. But top-of-the-range luxury cars are often used as typical examples of Veblen goods. The Wikipedia link I used even has a picture of a Rolls Royce - which is, of course, now a German car, though manufactured in the UK at the moment. One of the effects I would expect to see from EU tariffs being applied to UK car exports would be production shifting to EU countries. So Rolls Royces might not continue to be manufactured in the UK.

      On elasticity, I think we are at cross purposes. I am talking about price elasticity of demand, not supply. The fact that manufacturers respond to the complexity of the consumer market tells us absolutely nothing about people's willingness to substitute cheaper alternatives when prices rise.

      We are not discussing removal of tariffs on imported Japanese cars. No-one except the Brexit weird fringe has ever suggested that the UK would significantly reduce tariffs on imports of products it produces itself. The likeliest scenario is that the UK will "grandfather" EU tariffs, at least to start with, in which case there will be absolutely no change as far as Japanese car imports are concerned. What we are discussing is the imposition of 10% tariffs on cars manufactured in the UK and exported to the EU. Some of those cars are Japanese. But that doesn't matter.

      My observations were about margin and pricing as much as volume. There is, of course, a trade-off between the two: if manufacturers absorb tariff increases in order to maintain volumes, their margins are squeezed.

      I have not denied that EU manufacturers would lose to some extent. However, UK manufacturers stand to lose far more. After all, if as you say German manufacturers are already at maximum volume in all their product markets, so cannot diversify away from a market that has suddenly become more expensive, that is equally true of UK manufacturers (or rather, American and Japanese manufacturers producing in the UK). If, as I suspect, British manufacturers also face higher price elasticity of demand than their German counterparts, then the effect is even worse.

      However, I don't accept that volumes are always maximised in all markets. If that were true, then the change in the distribution of German exports since the Eurozone crisis would not have been possible. Germany is selling much less to the Eurozone periphery and much more to third countries, including the USA. And it is not caused by falling periphery imports. If it were, Germany's gross exports by volume would not be increasing - but they are, across all products.

      As I said, this piece is not about jobs. But if it were, why do you think that Brexit would mean German politicians suddenly became concerned about jobs in Spain and Finland? They have not been remotely concerned about jobs in other EU countries for the last ten years. Also, note my comment about shifting production. If I were a car manufacturer producing cars in Britain for export to the EU, and I faced 10% tariffs and a weakening currency, I would be considering moving production to an EU country. We are already seeing this with financial services, of course: physical production takes longer to shift, but car manufacturers must surely be considering this already. Taking a hard line with the UK could therefore improve employment prospects in EU countries.

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    4. Just to clarify - a weakening currency doesn't help exporters much if they are integrated into international supply chains, and because of its inflationary effect it is likely to put upwards pressure on wages and on the cost of borrowing. So manufacturers might wish to move production to a place where they don't face tariffs, where they aren't under pressure to raise wages and where external costs are more stable.

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    5. Good input Stuart, nice to see an expert commenting on things for a change!

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  3. I'm afraid you still don't get it - being right about the economics (and I would dispute that you are, but lets assume for the purposes of argument that you are) does not trump democracy. If Brexit is going to be an economic disaster then we will have to find out the hard way, otherwise we can chuck any pretence of democracy in the bin and just tell people 'Look, you can have a vote every few years about whether the bins are collected weekly or fortnightly, but you can never really change anything fundamental about how the nation is run, because we clever people have already decided the best course of action and you're all too stupid to understand we're right, so thats what you're getting, like it or lump it' That at least would be honest.

    For example in 1945 the country voted for (or rather about 47% of the country voted for) socialism. For the Common Ownership of the Means of Production, a massive step change in how the economy of the nation was to be organised. Now I'm sure there were people who opposed this policy with righteous (and ultimately correct) fervour, however that did not give them the right to tell all the people who had voted Labour that they were wrong about socialism, that it would not prove to be the Land of Milk and Honey they were promised, and indeed would eventually prove to be far inferior to free market capitalism at creating wealth for all. Or demand that those votes be ignored because of the manifest stupidity of those who made them. No, we had to find that out the hard way ourselves, because thats what democracy means.

    Its very alluring, the idea that 'I know best what the country needs, so ignore the votes of of the idiot masses and listen to MEEEE!!!' but if you have an ounce of historical perspective you can see where it leads.

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    1. Explaining why the claims of Brexiteers are fantasy is not an attack on democracy. I do not have to agree with how the majority have voted, and I do not have to keep silent about the reasons why I think they are wrong. In the example you gave, those who disagreed with socialism had EVERY right to tell those who had voted Labour that they were wrong. And they did so, at every opportunity. THAT is democracy. You want to deny me my democratic right to speak out about the lies told by Brexiteers and the terrible effects that this disastrous decision will have on people's lives.

      Democracy means having the right to oppose, openly and vociferously, a decision I think is wrong. It means having the right to speak freely, the right to campaign, the right to organise and mobilise, the right to try to change the decision. It is you, not me, who doesn't understand democracy.

      The populist appeal of liars and charlatans like the Brexiteers leads in only one direction. And where trying to silence or discredit those who warn about the consequences of listening to liars and charlatans takes us even faster down the road to totalitarianism. It is you, not me, who needs to learn from history.

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  4. Hi,

    Would the absorption of tarifs by a manufacturer for a specific market even be permitted under EU rules?

    And even if it was, there would be a big "unfair pricing" flag raised in the UK and "measures would be taken"....

    In Asia there is certainly a "status" symbol effect. Even with up to 200% import tax the cars get sold because it shows the owner can afford it, the more expensive the better.

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    1. Tariff effects are absorbed into pricing to a greater or lesser extent all over the world. It would also be very difficult to pinpoint how that had happened in any case as final pricing is a function of brand power, specifications, retail capability and a host of other factors. A manufacturers price position will shift over time purely in response to their own ambitions and the actions of their competitors.

      It's true that some brands are revered for their price position in Asian markets, but that has to be offset by the limited sales volumes that are available. China is a notable exception from a volume perspective but most of the European premium brands are well entrenched there and it is certainly not a market that is capable of absorbing the full potential of lost UK sales.

      The issue of tariffs or not will simply come down to politics. Business on both sides of the channel has everything to lose from punitive tariffs. Businessmen, especially the people that lead the automotive companies are pragmatists. They will be arguing for tariff free trade, but will always work to find ways of minimising the effects if they have to deal with them. In the end long term economic trends and demographics determine market potential, politicians are a marginal influence.

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  5. 'That's what democracy means'

    Sadly democracy requires a properly informed electorate. The UK population are not properly informed as they have been lied to for decades by their newe papers, which have their own agenda. As a result the UK is much better seen as an oligarchy.

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    1. «Sadly democracy requires a properly informed electorate.»

      That's an elitist fantasy: it simply requires that the electorate be accountable, that is that the electorate will suffer the consequences of their choices.
      The purpose of democracy is to ensure that the electorate can only blame themselves for political choices, rather than blaming their elites.

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  6. Sorry typo

    Newspapers

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  7. Yes, yes: yet another piece anticipating serious adverse economic consequences from Brexit. Of course there will be such consequences. Some of those who voted for Brexit were and remain in denial; others ranked sovereignty above cash. But at this point I don't really see it as productive to keep flogging this dead horse. For me the question is not so much how bad are things to get ( it's very hard to know but once the negotiations get going we'll be able to form a better picture) but what can we as individual citizens and voters do about it. We can go on the march, yes; and we can promise ourselves never to vote again for idiots. But is that it?

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    1. Refusing to listen to the charlatans spreading lies about the benefits of Brexit would be a good start. That is the point of this piece.

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    2. «others ranked sovereignty above cash»

      My impression from reading a lot of "Leaver" materials is that tehy ranked unilateralism above cash, because of a rather deep conviction that only unilateral decisions count as being properly "sovereign". Multilateral or even bilateral agreements requiring reciprocal duties and rights are infringements of sovereignty. For example "Leavers" seem to assume that EFTA or EEA membership or choice of the terms of trade with the EU27 are a matter of unilaral decision of the english government, and any condition or restriction requested by other parties are clearly interference with or subjugation of english sovereignty and independence to hostile foreign powers.
      It is not difficult to suspect that such confusion of sovereignty with unilateralism comes from the deep feeling that England as the ruler of the vast and great english empire is a great power and can simply choose unilaterally the terms of treaties with other smaller lesser entities like the EU27 or EFTA, or otherwise retreat in Splendid Isolation and Imperial Preference within that vast and great english empire. That's more or less the "haver our cake and eat it" approach so ably and popularly fantasized by B Johnson. Because "England rules the waves!", because "England waives the rules!" :-).

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  8. Very helpful. And the responses and replies. Thanks.

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  9. Personally, I agree that politics will trump economics. However, cars assembled in the UK can contain up to 75% of imported components, mostly from the EU and Japan. Some UK cars exported to Germany, might in some instances, contain enough German components to qualify as a German product under WTO rules of origin. It seems to me that UK/EU trade disruption would have an effect greater than an analysis that concentrates on the final product.

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  10. "The Brexiteers will discover in due course the folly of their ideas."

    I doubt it. I think rationalization is a more likely response than discovery.

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    1. «I think rationalization is a more likely response than discovery.»

      Your link is to Wikipedia, but there is a popular culture gem about that:

      https://www.youtube.com/watch?v=pqc1_v2Nj70
      Michael: I don't know anyone who could get through the day without two or three juicy rationalizations. They're more important than sex.
      Sam: Ah, come on. Nothing's more important than sex.
      Michael: Oh yeah? Ever gone a week without a rationalization?

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