Disruption, above and beyond

In a guest article, Dr. Wilfried G. Aulbur, Senior Partner and member of Roland Berger's Supervisory Board, argues that for the rapid development of the automotive industry to succeed manufacturers should allow look beyond their own horizons to better adapt their strategies to global changes.

Much has been written – and much more will be written – about disruption within the automotive industry but it is not just within this world that the sands are shifting. Broader, more macro and societal changes are impacting across most aspects of our lives and, notwithstanding the immense pace of change in terms of automotive technologies, it is now instructive – and, I would argue – more necessary than ever to examine these broader shifts occurring within our world.

The history and development of trade mirrors the history and development of our species. Much of the development of national power through the 19th and 20th centuries was predicated upon the development of trade between different countries and, while it is not a theory without its critics, much of what we see today has a direct lineage tracing back to the work of David Ricardo in 1817.

But the sands are shifting and Free Trade Agreements (FTAs) seems to be falling out of favor. Opponents span both sides of the aisle and focus on potential job losses, downward pressure on wages, declining competitiveness of key sectors and large trade deficits. The potential advantages of FTAs, namely increased competitiveness of companies in global markets, larger scale effects due to access of additional markets, lower cost of living due to reduced product prices, increased trade, and potentially increased living and environmental standards seem to weigh less in today's discussions. Rebecca Harding’s assertion that we are living through an unbalancing of politics and economics and that trade has become weaponized seems – in today’s environment – one that is difficult to counter.

Discussing the effects of FTAs and global trade while focusing on a simple number such as the goods trade balance, is limiting. Looking at goods overall, the US has a significant negative trade balance with Mexico. But taking oil out of the equation leads to a far less negative picture. Services are a vital part of trade that are sometimes forgotten in simplified discussions of trade between nations. The US services trade balance with many countries tends to be much more favorable then the goods trade balance. Net trade balances – those that focus on the value add of countries - are probably a more adequate picture of goods exchanged and jobs lost than overall gross numbers. For example, more than 40 percent of vehicle content imported into the US from either Mexico or Canada originated in the US. The comparable number for China is estimated to be dramatically lower at about four percent.  We have to understand that not all exports are created equal. 

Exports by foreign multinational companies can create positive effects in their home countries – via, for example, increased employment in Engineering and R&D. In the case of China, about 42 percent of the goods exported in the first six months of 2018 were produced by foreign-owned multinational corporations rather than by Chinese companies. And, most fundamentally, FTAs and their corresponding trade balances reflect the industrial policy of individual countries. Each FTA is a tradeoff between nations, so if a country chooses to push its agricultural sector more than its automotive sector, it is likely to see the results of that decision reflected to some degree in the import/export balances.

Even if this fact is not universally recognised, and as the example of US content in imported cars mentioned above demonstrates, most trade is either local or regional. The US imports from China are less than three percent of the US GDP and the negative trade balance in goods with China is less than two percent. US imports from China are about 1.6 times the size of its imports from Canada even though the populations of Canada and China differ by a factor of 38.5. While many people think that 38 percent of all global Gross Capital Formation is due to Foreign Direct Investment (FDI), the real number is only a moderate seven percent. While many people believe that 30 percent of the global population lives outside their country of birth, the real number - according to a recent DHL study - is just three percent. In other words, we are less globalised than we think and there is little if any evidence that trade wars are worth the trouble.

There is also little evidence that protectionist policies drive tangible positive benefits in the short term. Rather than strengthening the national economy, we have so far seen a decrease or stagnation in international trade with corresponding risks to employment. Overall, the US market, in particular, has seen increases in consumer prices – notably for white goods - and a decrease in overall consumer choice. Increased prices of intermediaries may also reduce the overall competitiveness of the US economy, an effect that is exacerbated by the continuing strength of the US dollar.

If the current trends continue through the mid- to long-term, a rearrangement of supply chains is likely to happen. This could lead to a reduction of the USD 100+ bn US FDI stock in China. Such a reduction comes with associated risks. While China may not be able to counter US tariffs on a dollar for dollar basis, the country can severely impact the operations of American companies in the country. Similar steps were taken in the past, for example, against Japanese car companies.

This is not to say that a confrontation with China on issues such an IP violation isn’t justified. Just as with Germany in the late 1800s/early 1900s, China must make a transition to fair competition and abandon unfair trade practices. An effective way to ensure that this transition happens in a timely manner has, so far, proven elusive. Such an approach is likely to include international collaboration and, in particular, a coordinated, decisive approach from the EU.

It is also important to remember that China's ascendancy is not due to unfair practices alone. The country has made significant progress in productivity gains and is today a formidable competitor. Some of the ecosystems that China has built, are very difficult to replicate globally. Its technology push will continue and like Germany, Japan and Korea, China will take her rightful place in a global manufacturing environment. This development is legitimate and requires increased focus on productivity improvements and innovation, e.g., around Industry 4.0, for companies in the US, Europe, Japan and Korea.

Is there a way to find out whether trade and economic integration are good or bad for an economy? As the UK inches ever closer to a no-deal Brexit it promises to be the real-world experiment that economists have been waiting for. According to a recent study, in the event of a hard Brexit, UK exports to the EU would fall by 35%, EU exports to Britain by 39%, UK employment would drop by 2.5% (vs. 0.2% in Germany, for example), and the UK economic output over 15 years would be lowered by 9.3%. 

Likely side effects would be a loss of relevance as a financial power center, loss of manufacturing jobs, further GDP reductions in case of a massive exodus of EU immigrants and even a potential disintegration of the country with Scotland seceding from the Union. Part of these effects may be countered by a significant weakness of the British pound but against this we have to stack the deleterious impact of much increased input cost inflation. 
What does the future hold? If we look at the number of "My country first" politicians that are currently in power in countries such as the US, Russia, China, India, Brazil, the UK, Turkey, the Philippines and Hungary, it is fair to assume that the international business environment will not get any easier in the short term. With economies in China, India, Turkey and the US slowing, in some cases dramatically, pressure on nationalists politicians will increase and may lead to further destabilization and insecurity.

An additional area of concern is the fact that we have started to weaponize interdependence. Global common goods, mostly built by the US and Europe, like trade, SWIFT, the Internet and the US dollar exchange rate mechanism are used to pressurize members of the global community by limiting access. This approach will lead to strains among allies, an intensive search for alternatives (currently underway in Europe, Russia, India, China, Iran, …) and a loss of nodal power. While the effects of these changes will not be visible overnight, they are likely to permanently reshape the way countries work together by driving a "balkanization" of standards.

Zygmunt Bauman, a Polish philosopher, sums up our current situation quite succinctly: "For the first time we are in a situation where we have to commit the next step on the road to integration without separation… But as I said already I am pessimistic in the short term. We are at the beginning of a long, long road. But in the long term, on the whole …. I am optimistic." 

The extent to which this optimism is justified remains to be seen but, for anyone for whom mapping the future strategy of the automotive industry is a core task, that which confronts us at present may yet set us on a path that is both very different and ultimately very challenging. With uncertainty not limited any longer to emerging countries, leaders need to focus on flexible and nimble strategies, supply chains, etc. that enable rapid reactions to the quicksand of the current geopolitical environment.