What will the EU do when cars become commodities?

Volkswagen has defused the labour crisis sparked by its announcement of impending plant closures with a deal that agrees to keep these factories open and reduce overall worker headcount through natural attrition. Retiring workers will not be replaced, and current workers agreed to forgo pay rises.  While this deal will save VW a fair amount of money, it does little to reduce the company’s underutilised manufacturing capacity.  Money spent keeping zombie factories ticking over represents capital unavailable for the investment needed to compete with the flood of cheap Chinese EVs entering the European market. 

VW and other carmakers face a product cycle that once worked to their advantage but has now grown hostile. Their technological advantage in the mass manufacture of cars has vanished, hurried along by their fateful decision decades ago to buy sales in China with the transfer of critical technologies. Now that China has mastered large-scale car production, it is invading Europe’s home markets with cheap and competitive models.  For the average consumer, the differences in performance and reliability between Chinese-made and domestic models are negligible. Meaning, cars have become a global commodity: profitability depends on a low cost of production. Europe may still charge a premium for its high status models, but will struggle to compete in the middle and low end of the market, which is precisely where Volkswagen, Fiat and Renault make their money.

The history of commodification offers dire warnings for Europe. The invention of the power loom gave Britain the lead in the first Industrial Revolution until the technology migrated overseas (thanks to American espionage). A residual textile industry survived in Europe and North America only thanks to the Multi Fibre Arrangement which limited textile imports by assigning quotas to low cost producers.  After the agreement finally expired in 2005, so too did the textile industry in wealthy countries. However, Europe cannot allow its car industry to go the way of textiles: the employment and tax revenues generated by car making are simply too important.  

A first step would be to abandon the otherworldly requirements of the EU’s Green New Deal.  Outlawing the sale of internal combustion engine (ICE) vehicles in ten years time compounds the dire impact of the product cycle on the European car industry. The core competencies of EU car makers are concentrated in the manufacture of these engines and their drivetrains. The enforced abandonment of these skills compels EU firms to compete in new technologies where they lag well behind. Everything in a modern electric vehicle is a low-profit commodity except for the battery, operating system and connectivity software. In none of these technologies does Europe have a lead or even a credible competitor to Chinese and American makers. 

As it appears that European Commission President Ursula von der Leyen remains committed to her Green New Deal, she may wish to consider another lesson from the history of commodification. IBM invented the PC and regarded the manufacture of its hardware as its core competency. And so it handed over the creation of the PC’s operating system to a small firm called Microsoft.  PCs quickly became a commodity item and IBM abandoned the sector decades ago. Today IBM’s market cap is around $203 billion (€196 billion). Microsoft’s is over $3 trillion (€2.89 trillion). The mandated shift to EVs threatens an equally dramatic shift in the core competencies of European car makers, outside the control of the legacy firms themselves. The skilled labour needed to craft internal combustion engines becomes redundant when car makers replace them with cheap electric motors. Future profits will accrue to the subcontractors providing slick software, seamless connectivity and extended battery range. VW will not survive paying German wages for the modest skills needed to bolt EVs together. 

Assuming the EU remains committed to its phaseout of ICE vehicles, how can it help industry adapt to the looming commodification of cars?  While Brussels poses as the last defender of the WTO, it will likely embrace protection when faced with the collapse of its domestic car industry. Recent tariffs on Chinese EV imports offer a useful precedent, but threaten retaliation and thus the prospects of Europe’s vital car exports.  Import quotas along the lines of the Multi Fibre Arrangement would invite similar retaliation from China. 

A more productive approach would be the adoption of strict trade reciprocity with China. China built its own automobile industry by requiring joint ventures and technology transfers from its European partners. Now that the EU is struggling to catch up with China’s lead in EVs, it should impose identical requirements on China. The EU should require Chinese EV makers strike 50:50 joint ventures with European firms and produce their vehicles in Europe. Transfer of key battery and software technologies should reflect the terms China negotiated (and constantly renegotiated) with European firms in exchange for access to its domestic market.  The timing of this approach is actually very favourable. President Xi has fired up his export machine in a desperate attempt to restore China’s economic fortunes. The EU controls access to 450 million affluent consumers and can offer profits to Chinese car makers but only if they commit to the employment of European autoworkers and the dissemination of the critical technologies driving the EV revolution. 

Von der Leyen faces the impending demise of the global free trade regime as the world fractures into regional trading blocs. If she wishes the EU to prosper, she must negotiate trade deals with Presidents Xi and Trump, both of whom are more committed to their domestic industries than to the preservation of the World Trade Organization. She can trade access to the Single Market for commitments to build factories in Europe, in much the way that President Reagan induced Japanese car companies to build plants in the US. Today some of the most efficient car factories in the world are these subsidiaries of Japanese carmakers, who collectively employ over 90,000 Americans. Americans learned just in time manufacturing and zero defect practices from Japanese firms, which spurred the subsequent revival of American car companies. If Europe is to compete in the next cycle of the automobile industry, it must accept that its car companies need to learn from their former pupils, who will teach them only if Brussels requires them to.  Your move, Queen Ursula.