Large Inventory, Small Wallet

The New York Times recently took a look at the European recession and its potential effects on the auto industry (see Europe’s Auto Industry Has Reached Day of Reckoning).

In light of the economic situation in the Eurozone, it’s no surprise that the auto industry has taken a hit. Without consumers to purchase automobiles and fuel factories, many auto companies are faced with two less-than-desirable options: slim down or close down.

Analysts say the unprofitable automakers have no choice but to start closing production lines and cutting payrolls…Huge overcapacity…has spawned a crisis similar to the one the U.S. industry barely survived just a few years ago…Underused plants are ruinous for car companies, which must continue to pay upkeep costs and make payroll even as revenue plunges. By some estimates, the European industry as a whole is operating at only about 60 percent to 65 percent of capacity. As a general rule, plants must operate at about 75 percent or 80 percent to be profitable…

The current auto industry crisis in Europe follows the ongoing sovereign crisis and recession. In many ways, Europe’s auto industry crisis parallels the broader Euro crisis, with weakness concentrated in the periphery.

…the pain falls disproportionately on Southern Europe, while Germany seems immune. Car sales actually rose slightly in Germany during the first six months of the year. They plunged more than 14 percent in France and almost 20 percent in Italy…In Portugal and Greece…car sales fell more than 40 percent through June…

The auto industry crisis in Europe is similar to patterns we observed during the 2008-2009 financial crisis, where the effects spill over to companies outside the financial industry. As the Times rightly points out, it is difficult for countries such as Greece, Spain, and Portugal to respond.

When the financial crisis caused a recession in 2009, France and other European countries spent billions of euros to bail out their car companies. But instead of using that money to ease painful downsizing of plants and payrolls, governments provided financial incentives for people to trade in older models for new ones, or subsidized worker salaries to dissuade companies from cutting jobs…But now…European governments are financially ill-equipped to respond.

And even European carmakers that are willing to take desperate measures and reduce capacity are facing pressure from their governments to not engage in such cutbacks. For example, Peugeot has been attempting to close a plant in Aulnay; however, the union and France’s new government are exerting tremendous amounts of pressure to keep the plant open. This could eventually result in Peugeot’s demise.

I’ve written about the auto industry crisis extensively (see Overcapacity Still Plagues the Auto Industry and Auto Industry’s Big Little Problem). I have emphasized the importance of meaningfully reducing capacity from the industry, especially since it largely didn’t happen during the financial crisis. Instead, governments looking to preserve jobs propped up auto-makers in both the U.S. and Europe. I also noted in my previous entries that auto companies cannot rely on demand from emerging markets, like China, to fix the overcapacity problem.

As a result, we’re stuck in the same situation yet again -there is still overcapacity and the weakest of the automobile firms still need to contract. Something’s gotta give…

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