FTG0013 - Evidence on Brexit: future trade between the UK and the EU in goods

Professor Peter Wells – Written Evidence (FTG0013)

HOUSE OF LORDS: FUTURE TRADE EVIDENCE, AUTOMOTIVE SECTOR

1. Importance of EU trade to the automotive sector.

1a. Measured by Gross Value Added the UK automotive industry contributed £12bn to the UK economy (2014) or 8% total manufacturing GVA (ONS, 2015). The trading relationship is not evenly balanced. Direct exports to the EU peaked in 2015 at 57.5% of the total cars produced in the UK, but have typically been around 50% of UK production. Direct imports from the EU constitute 85% of all sales in the UK. Broadly speaking, this means that annually the EU accounts for around 800,000 sales of UK produced new cars, while the EU accounts for around 1.8 million new cars sold in the UK. Ameliorating this volume imbalance, in 2013 the average value per UK car export was £20,600 compared with the average value per new car import of £13,000 (SMMT/KPMG, 2014). According to the ONS (2015) the EU has accounted for over 85% of total UK motor vehicle imports each year since 1998 while the value of imports from the EU have grown from £14.3 billion to £31.3 billion between 1998 and 2014, whereas imports from non-EU countries have grown from £2.2 billion to £4.0 billion over the same period.

Equally, exports to non-EU countries have grown from £2.9 billion to £17.9 billion from 1998 to 2014, whereas exports to EU countries have only grown from £8.0 billion to £11.9 billion over the same period. Therefore, the UK has a substantial and growing automotive trade deficit with the EU. There is further an ongoing trade deficit in automotive components, mostly attributable to the EU, of the order of £12bn per annum. The notable increase in UK automotive exports in recent years is therefore attributable to successes in markets outside the EU. Despite this, it is clear from both collective and individual corporate statements on the issue that the vast majority of the UK automotive industry was of the view that it was better to remain in the EU. A survey by the UK industry body (the SMMT, which notably represents both manufacturing and retail elements of the industry, reported in 2014 that 92% of businesses surveyed preferred to remain (SMMT/KPMG, 2014). In the same survey, 70% responded that if the UK left the EU it would have a negative or very negative impact on business, and 75% responded that it would have a negative or very negative impact on the scale and diversity of investment.

1b. At least 50% of jobs in UK automotive manufacturing, retail and service depend upon trade with the EU. There are 141,500 manufacturing jobs (2013) (ONS, 2015), though the SMMT claims for 2016 some 169,000 directly employed in manufacturing, of which 78,000 are employed in the supply chain (SMMT, 2016). There are 350,000 aftermarket jobs (2015) (SMMT/F&S 2015). Car sales (i.e. retailing) and post-sale support (the aftermarket) constituted £12bn GVA (2015) (SMMT/F&S 2015). Hence, there are many more jobs in automotive retailing, service, maintenance and support than there are in manufacturing. It is notable, however, that as a result of the exit decision some manufacturing operations may fall below a critical threshold output volume or capacity utilisation that would lead to plant closure and the relocation of production elsewhere. Usually such decisions are made at key moments in the product cycle, typically when an old model is about to cease to be in production. Similarly, new investment decisions are also episodic. For example, BMW has reportedly stated that key decisions regarding the Oxford Mini plant are not due for two years, and it at that point that the decision on reinvestment or not will be made (Taylor, 2016). Job losses are therefore likely to be intermittent, localised, and of course of considerable political significance.

2. Important elements of the current UK-EU relationship. The key elements of the current relationship are tariff-free movements of materials, components and finished vehicles across the EU allowing the spatial integration of multi-stage, multi-locational manufacturing processes. In addition, regulatory standardisation and Type Approval procedures have the effect of reducing compliance cost and allowing economies of scale (i.e. the Single Market). The free movement of key, skilled staff (the UK is claimed to lack 5,000 automotive engineers) has been cited as important for future development. The best case would be to reverse the decision. Worst case is WTO rules regime. A form of customs union would be a suitable compromise if it involved no tariffs and no rules of origin to be applied. However, a key problem is the level of uncertainty as to eventual outcomes, which is likely to influence investment decisions. Therefore a protracted process is itself problematic. It is worth noting that ‘hidden’ arrangements of the sort apparently agreed by the Government with Nissan are not helpful, simply acting to fuel the fire of debate.

3. Importance of tariff barriers. Tariff barriers are significant in the global automotive industry. The EU has a standard barrier of 10% (6.5% for developing countries). Barriers would apply to components also; potentially making all aspects of UK automotive production more expensive. UK import tariffs could reduce the long-term trade deficit in finished vehicles and components. Tariffs on exports from the UK to the EU would reduce sales of finished vehicles and components (especially engines in which the UK has a structural surplus). In addition, the UK has benefitted from EU membership though the ability of the EU, as a very large single market, to achieve trade agreements with other nations outside the EU (e.g. Japan; South Korea) that lower tariff and non-tariff barriers to the advantage of the UK automotive industry (DG EXPO, 2012).

4. Non-tariff barriers. NTBs are significant in the global automotive industry (see DG EXPO, 2012). They could apply to both finished vehicles and certain components. NTBs can include technical regulations and approvals. It is probably important for the UK to retain the EU Type Approval criteria and procedures. Globally rules of origin are important in some cases for determining rates of taxation applied to imported vehicles. The EU has rules of origin for EEA and certain other countries based on maximum imported content of ex-works price. The UK has been active in increasing the UK value content of cars assembled in the UK from an approximate 40% in 2015, with a target of 50% by about 2020 (SMMT/Ian Henry, 2015). This would be contrary to EU rules of origin if the UK was outside the EU and was denied entry on a customs union basis, as the EU requires at least 60% of the ex-works value of the car to be of local (i.e. EU) origin.

5. Impact on supply chains. Supply chains could face significant disruption due to the complex flows and multi-stage processes (often requiring cross-border movement) involved. The UK has a trade deficit in automotive components. Long-term investment decisions are likely to be effected. The UK has a structural surplus in engine production with e.g. Ford plants at Bridgend and Dagenham. Overall, the UK produces around 2.6 million engines per annum, with new car production at around 1.6 million units. Ford has said that the exit decision will cost US$500m per annum (though was not specific as to where the additional cost would arise), and that the uncertainty over outcomes is particularly damaging. It is estimated that in 2012 the UK automotive industry spent £33bn on supply chains, of which £112.2bn (37%) was spent in the UK. As of 2015, UK employment in the automotive supply chain was thought to be about 93,000 people; with a target of growth to 121,000 by the early 2020s if the UK supplier content of UK manufactured vehicles could be expanded (SMMT/Ian Henry, 2015; note the variance with figures reported above). There was an expectation before the EU exit decision that UK vehicle assembly could reach 2 million units by 2020. Alongside this volume growth, a shift in the UK share of value added in components by ‘reshoring’ sourcing was anticipated to offer up to £4bn additional spending within the UK tier 1 supply base (Davies et al. /Automotive Council, 2015). In addition, the production profile of UK vehicle assembly has slowly been shifting into higher-value segments, while more cost-sensitive models have been lost. This trend also has potential to increase the value of UK-sourced components. All of the above issues could be disrupted by the decision to leave the EU. It should be noted that vehicle assemblers often use purchases of components and materials to assist in currency risk hedging. In so far as the UK remains a substantial market for the EU automotive industry there will remain some value therefore in UK-sourced components in currency risk management terms.

6. Significance of EU standards. EU standards are highly important in the automotive sector. There is an on-going process of standards unification at UN level but this is not complete. EU Type Approval is a pre-requisite to sell new cars in the EU. In addition, other standards are important, notably the (non-statutory) EuroNCAP safety testing programme and the CO2 emissions (fuel efficiency) regulations. The UK automotive sector has a bias towards larger, more expensive but also higher CO2-emitting vehicles, so the ability to influence the future character of EU CO2 regulation may be important. Thus far, the UK has benefitted from provisions that allow small and medium-sized vehicle producers latitude with the ways in which CO2 regulations are applied. Such latitude may not be forthcoming in the future as a result of exit from the EU decision-making processes. I would recommend that the UK automotive industry continue to comply with EU standards.

7. Differential impact on SMEs. The UK has a thriving specialist car and motorsport sector, as well as niche expertise in e.g. earth-moving vehicles. These more specialist sectors tend to be less price sensitive, and less reliant on the EU as a market – although staff recruitment from the EU is important. In the components sector UK SMEs are also likely to be less affected by changes in the trading relationship with the EU as they are likely to have more of a UK market orientation in serving the large (and non-UK owned) tier one automotive suppliers in the UK. Larger companies have more scope to shift production in the short and long term. A possible concern is the loss of special treatment under Type Approval rules.

8. Anti-dumping and countervailing duties regime. Of late, the main concerns in this area have been with the dumping of low-price steel on EU markets by e.g. Chinese sources. In the context of exit from the EU, the UK government may need to have regard to EU rules on state subsidy and unfair competition, particularly if manufacturers are to be offered some form of ‘compensation’ for the anticipated increased costs of exit, as appears to be the case with regard to Nissan’s operations in Sunderland.

9. Challenges and opportunities with respect to Intellectual Property law. No comment.

10. Which relationship with the EU would have the best / worst impact on foreign investment in the UK automotive sector? The most important relationship may be the one that is resolved quickly and clearly. A protracted process generates uncertainty and deters investment. For the industry in the UK the best agreement is likely to be retained membership of the internal market, but this may be difficult to reconcile with anticipated changes to free movement. The worst outcome is to be treated like any external state under basic WTO rules.

11. EU Rules of origin and the UK automotive sector. It must be recalled that the UK is a tiny fraction of global production and markets. Global production in 2015 of all vehicles was 90.7 million (OICA, 2016) of which the UK accounted for 1.68 million. Ultimately, the fate of the UK automotive industry is largely in the hands of major multinational groups both for finished cars and components, and these groups may restructure their operations to shut down UK manufacturing. The UK automotive industry competitive advantage is not reducible to EU membership alone; a flexible and skilled workforce has been a significant factor in competitiveness, as has the ability to shift output into higher unit value products. Exchange rate movements may mitigate some of the potential exit costs. However, if EU rules of origin prevail and the UK is no longer in the EU, then efforts to ‘onshore’ value-added component production to the UK (SMMT/Ian Henry, 2015) will at best need to be reversed in order to achieve the 60% EU content threshold of local content measured on an ex-works basis. In this respect, a Customs Union which does not require the rules of origin to be applied and which would entail no tariffs would be a viable solution for the automotive industry in the UK. The tariff regime currently applied by the EU varies according to the type of vehicle under consideration (see Stewart-Brown and Bungay, 2012). That is, for cars it is 10%; motorcycles 6-8%; commercial vehicles 3.5-22%). The basis of calculation is ex-works price, which is taken to mean: The value of all supplied materials used in a products’ manufacture; all costs (material costs as well as other costs) effectively incurred by the manufacturer; and any profit. The tariff basis applies to vehicles other than railway or tramway rolling stock, and parts and accessories thereof (i.e. it includes cars, buses, trucks, other types of vehicle and other parts and accessories thereof). Some form of virtual bonded warehouse will be needed to prevent components incurring multiple tariffs if those components or parts thereof cross EU borders more than once.

12. The UK as a trading environment.

12a. For UK manufacturing is to remain competitive in the EU automotive sector it would help that trade policy ensures no tariffs on cars, components or materials either as imports or exports. Additionally, it would help if trade policy ensured rapidity of transit across borders. However, competitiveness also derives from technological innovation, productivity, quality, brand reputation, and new model introductions. It is notable that the most successful automotive industry in the EU is that in Germany, despite having comparatively high labour and social costs.

12b. The UK is currently the second-largest market for new cars in the EU, and is very important as an export destination for EU-manufactured cars notably those from Germany. The UK market further provides a solid foundation of demand for production within the UK, even though for major manufacturers like Nissan a high proportion of total output are exports from the UK (typically about 80%). Equally, Honda and Toyota typically export 75-80% of production to the EU. The UK market is not substantial enough alone to support the UK car plants. The imposition of 10% tariffs may render the plants uncompetitive or unprofitable. Some vehicle manufacturers like Jaguar Land Rover have a more diverse market portfolio: retail sales in YTD April 2016 were 20% UK, 24% Europe for example (JLR, 2016).

12c. It is difficult to envisage any assurances that could be offered by the Government to eliminate the perceived Brexit risk. The most useful action would be to offer clarity on the outcome, but such clarity is impossible given the negotiated character of the exit process.

12d. If any substantive assurances have been offered to Nissan then it would appear reasonable to apply such assurances to the whole automotive sector, and probably to other sectors, if they are relevant. While Nissan generates significant direct and indirect employment, it would be inequitable to deny others similar treatment, even if the other cases lack the scale of Nissan. The Government may be unable to deliver on a customs union pledge, but it is likely that the EU automotive industry would also favour such an outcome. It is notable that Bergin (2016) has argued that for most vehicle manufacturers in the UK wage bills averaged 7.5% of total operating costs, and 7.7% of turnover. In turn, Bergin argues, the cost of tariffs on vehicles exported from the UK to the EU if levied at 10% percent of turnover, would exceed the wages paid to British workers to build those vehicles. In practice the tariffs are arrived at on ex-works price but the general point remains. Moreover, it is likely that any attempt at direct wages compensation would contravene EU anti-dumping and unfair competition rules.

13. EU membership for skilled and unskilled labour. The UK automotive industry does not have a significant requirement for unskilled labour, and it is likely that any such requirement can already be met locally. Automation levels in vehicle assembly, already high, are likely to increase. In 2014 it was reported that the UK had the highest average GVA per job in the EU, at over £75,000, having grown from around £40,000 in the late-1990s (SMMT/KPMG, 2014). Where the UK does have a problem is with skilled engineering and design staff. Given the high-value, high-performance bias of the industry in the UK, shortages of skilled labour could be a critical impediment to progress in the future. The industry is facing a quantum shift in product design, markets and business models around the introduction of zero emissions powertrains, and connected and autonomous vehicles (SMMT/Ian Henry, 2015). The market potential of such a shift is expected to be considerable, albeit difficult to estimate currently and will require considerable new recruitment of software and hardware engineers, materials scientists, and others from sectors that were previously distinct from the automotive industry – including for example in information and communications technologies. It is worth noting that in 2013, according to the ONS, total UK expenditure on R&D for motor vehicles and parts amounted to £2.1bn, of which 91% was attributable to foreign-owned businesses. There has been a significant growth in automotive R&D spending in the UK. In 2005, automotive R&D was £744m or 5% of the UK total R&D spending; by 2013 it was £2,020m or 11.2% of the UK total. This spending is the basis for the expansion of demand for skilled workers. Hence, if exit from the EU triggers a reduction in R&D spending so the demand for skilled workers may be less than anticipated.

14. The impact of significant depreciation of the GBP on the UK automotive sector. It is not unusual for the global automotive industry to be effected by short-term volatility in currencies. Attempts are made to manage the exposure risk by financial hedging, but also by purchasing decisions as noted above. If the depreciation of the GBP is enduring then more structural responses will start to emerge. Imported new cars are likely to become more expensive, but so too are the imported materials and components used to manufacture cars in the UK. Exported new cars are likely to become cheaper, notwithstanding the added import costs associated with components and materials – though UK car manufacturers may prefer to take higher profits rather than expand volumes. Much depends of course upon the relative position of Stirling compared with other currencies such as the Euro or US Dollar. UK-produced cars are likely to obtain a larger market share in the UK, but the overall UK market may decline in size. The expansion of UK market share for UK-produced cars is unlikely in and of itself to be sufficient to offset likely market share losses in the context of import duties for the EU market. Changes in exchange rates may not be entirely passed on to final consumers, just as changes in import tariffs may not be.

Sources

Birgin, T. (2016) Britain's Brexit subsidies for carmakers could top wage bills, http://uk.reuters.com/article/uk-britain-eu-nissan-subsidies-analysis-idUKKBN12X0K7

Davies et al. /Automotive Council (2015) Growing the automotive supply chain: the opportunity ahead, Copy obtained from the Society of Motor Manufacturers and Traders.

DG EXPO (2012) The EU automotive sector in a globalised market, Policy Briefing obtained from the EU Directorate General for External Policies, DG EXPO/B/PolDep/Note/2012_349.

JLR (2016) Annual Report 2015-16. Copy obtained from Jaguar Land Rover.

ONS (2015) The economic performance of the UK’s motor vehicle manufacturing industry, Copy obtained from the Office of National Statistics.

SMMT/KPMG (2014) The UK Automotive Industry and the EU, Copy obtained from the Society of Motor Manufacturers and Traders.

SMMT/Ian Henry (2015) The future of UK automotive manufacturing in 2025 and beyond, Copy obtained from the Society of Motor Manufacturers and Traders.

SMMT/F&S (2015) The importance of the UK aftermarket to the UK economy, Copy obtained from the Society of Motor Manufacturers and Traders.

SMMT (2016) Motor industry facts, 2016, Copy obtained from the Society of Motor Manufacturers and Traders.

Stewart-Brown, R. and Bungay, F. (2012) Rules of Origin in EU Free Trade Agreements, Copy obtained from Trade Policy Research Centre www.tprc.org.uk

Taylor, E. (2016) BMW to await Brexit outcome before taking UK investment decisions on Mini, http://europe.autonews.com/article/20161104/ANE/161109919/bmw-to-await-brexit-outcome-before-making-uk-investment-decisions-on?cciid=email-ane-daily.

11 November 2016