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Policy certainty seen as key if SA auto sector is to avoid Aussie industry’s fate

30th May 2014

By: Irma Venter

Creamer Media Senior Deputy Editor

  

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Everybody – everybody – wants to participate in manufacturing,” turnaround king Alan Mulally told journalists at last year’s Johannesburg International Motor Show. The company boss who trapezed a now buoyant Ford through the global recession, said the US carmaker has been inundated with requests to establish vehicle assembly sites, as governments worldwide viewed manufacturing as a “source of wealth”.

South Africa’s automotive industry is small in global terms, but active in component production and the export market. It is not merely a hub for assembling vehicles from imported kits.

A number of other African countries, such as Nigeria, are working to establish vehicle assembly facilities of their own, largely from scratch. If successful, they will follow in the footsteps of relative newcomers, such as Thailand, China and India.

How did it then happen that an advanced economy such as Australia will see car manufacturing cease after 2017? And, can it also happen in South Africa?

Australia produces around 230 000 cars a year from three carmakers. By 2017, car production is set to halt, with only truck assembly to continue.

Mitsubishi closed shop in 2008. Ford said in 2013 that it would stop manufacturing in Australia, followed by a similar announcement by General Motors’ Holden operation. This year, Toyota announced that it too would be closing down its plant, citing the strong Australian dollar, the high cost of manufacturing and low economies of scale.

The Australian car, truck and component manufacturing industry employs around 45 000 people, with probably most of these jobs lost after 2017.

There are indeed no economies of scale in the Australian plants, says National Association of Automobile Manufacturers of South Africa director Nico Vermeulen.

The Australian Productivity Commission concluded that each of the three remaining plants required a minimum of 100 000 units a year to be globally competitive, which they could not reach.

“Labour costs are also on par with Japan and Europe, and four times higher than emerging economies such as India and Vietnam,” notes Vermeulen.

Logistics costs for vehicles and components to reach major markets from a distant Australia are high, while import costs are also expensive, compounded by high utility charges, he adds.

“Australia is a high-cost vehicle producer by global standards, with small production volumes.”
Vermeulen says the strong Australian dollar also renders vehicle exports economically unviable, further curbing production scale.

Moreover, low import tariffs allow for a number of imported vehicles to compete with locally manufactured models.
“Import duty went from 15% to 5% in seven or eight years. The tariffs reduced too much too quickly.”

He adds that the roughly A$500-million a year support offered by the Australian government to the automotive industry is also “small compared with what is provided in other competing countries”.

Government support is, “without exception” the norm across the world, emphasises Vermeulen.

Most countries offer a range of support measures to vehicle manufacturers, including subsidies, tariff support and tax concessions.

They do so because of the investment required to set up a plant, the number of jobs an auto- motive industry creates, and the multiplier effect on the broader economy, he states.

For example, new kid on the automotive block, Nigeria, in January raised import tariffs on fully built-up cars from 20% to 70% for those companies which do not participate in its new assembly programme. (South Africa has a 25% import duty on passenger cars.)

Estimates show that the closure of the three car plants in Australia will dent the country’s gross domestic product by around A$25-billion, says Vermeulen.

Australian component manufacturers are also only likely to survive the collapse of the plants they supplied, should they be able to scale up volumes, reduce costs and export to global markets.

A MESSAGE FOR SOUTH AFRICA?
Is it possible for South Africa’s automotive sector to fall prey to the same fate as Australia?

Domestic production of vehicles in South Africa was around 550 000 vehicles in 2013. This is double the size of Australia’s, with seven car assemblers active in the country, compared with three Down Under.

South Africa exported around 276 000 vehicles in 2013. The assembly sector employs roughly 30 000 people, and the component sector between 70 000 and 80 000 people.

“If we want to retain our vehicle manufacturing industry, we need adequate levels of government assistance and protection. The 25% import duty is set to remain in place until 2020,” says Vermeulen.

“The industry also needs certainty and predictability in the automotive support regime, and we have that until 2020 with government’s Automotive Production and Development Programme (APDP). We have reasonably competitive levels of support and incentives in the APDP.”

Despite a seven-week strike in 2013, South Africa’s automotive labour costs remain competitive, compared with Europe and Japan, adds Vermeulen, but “South Africa currently cannot compete with countries such as India and Vietnam. The risk is that we are starting to price ourselves out of the market”.

While the current weak rand helps exporters, it also adds cost pressures that will see inflation catch up with component and vehicle manufacturers.

“In time, a weak exchange rate results in unwelcome inflationary pressures. It also counts against us that many components on vehicles produced here are still imported,” notes Vermeulen.

He warns that it is also necessary for South Africa to get a hold on “excessively high and rising utility and logistics costs”, if what befell Australia is to be avoided.

In the end, says Vermeulen, what happened in Australia should send a strong message to policy- makers in all automotive manufacturing countries about “what not to do”.

National Association of Automotive Component and Allied Manufacturers (Naacam) executive director Robert Houdet concurs with Vermeulen about how the Australian automotive industry met its match.

“The automotive industry in Australia is high-cost and subscale, and global car companies want to locate in cost-competitive locations. Global production capacity is also in excess of local demand, and the high value of the Australian dollar makes being competitive nearly impossible.”

Houdet also agrees with Vermeulen that labour costs in Australia are too high, as is the case with logistics costs. Labour is also inflexible when more or less work is required.

“In South Africa, we need the APDP to offset the high logistics costs between the local industry and our main markets. This position will continue, which means we definitely need an extension of the APDP in some form or the other beyond its end-date of 2020,” he adds.

“We must make sure the APDP makes us one of the most sought after assembly locations in the world. We need the edge the APDP provides to be competitive.”

It is also necessary to incentivise the global vehicle manufacturing industry to remain in South Africa, as it ensures the survival of the local component industry, which employs more people than the assembly sector, and which adds value to locally produced raw material, notes Houdet. But it is not only about survival, he says. Vehicle manufacturers provide “a pull” for component manufacturers to “relentlessly innovate and cut costs”.

Despite this stance, Houdet says Naacam still warns its members to look beyond South African vehicle assembly to ensure their long-term viability.

“It is very difficult for component makers to survive when the vehicle manufacturers go, but it is also very dangerous to rely on one type of client, as the Australian experience shows. We must also develop our export markets.”

Houdet believes one solution to ensure South Africa does not follow in Australia’s footsteps is to increase the percentage of local parts used in South African-made vehicles, as this decreases logistics costs and the impact of currency movements.

Average local content on vehicles made locally is 41%, while this should ideally increase to between 60% and 65%.

Houdet says it is also important for South Africa to fully leverage its position in Africa.

Unlike Australia, a continent on its own, South Africa has many potential markets on its doorstep.

“We must look after our traditional export markets, yes, but we must also increase vehicle sales in Africa, as well as improve logistics costs. Increased vehicle sales will lead to increased component sales.”

PRETORIA STILL INTENDS TO PROVIDE
The closure of the Australian car manufacturing industry can probably also be attributed to doubts as to whether the Australian government wanted to continue support of its automotive manufacturing industry.

An Australian Productivity Commission report out earlier this year recommended that government stopped providing financial assistance to the industry following its Automotive Transfer Scheme, due to end in 2020.

The report noted that justification for continued subsidies to carmakers was weak, with the industry receiving decades of transitional assistance, even though it remained commercially unviable.

South Africa’s support programmes, such as the APDP, have been criticised in the past for not allowing global market forces to play out as they should, leading to increased vehicle prices through import tariffs, and draining the public purse.

Government, however, remains committed to supporting the automotive manufacturing industry, saying the benefits outweigh the costs.

The South African government has supported the local automotive industry since 1961 when Phase I of the Local Content Programme was introduced, says Department of Trade and Industry (DTI) industrial development division deputy director-general Garth Strachan.

Since then the support has been structured in a variety of ways, but has always been based on duties and rebates, with some additional incentives for capital investments.

“Government will continue to support the sector as long as it is evident that this is necessary to sustain the significant benefits the industry brings to the domestic economy,” says Strachan.

South Africa is no different to any other developing country in supporting its automotive sector, he adds. In fact, South Africa’s APDP is modest, compared with other jurisdictions.

“Countries with far larger domestic markets and production provide significant levels of protection and support, mostly in the form of tariffs and large investment incentives, recognising the multiple benefits that vehicle production can bring.

“Countries with smaller markets and existing automotive industries all recognise the necessity to provide either incentive support and/or tariff protection – which can then make some cars more expensive,” he admits.

“And, unlike South Africa, all of the other developing countries are located relatively close to large markets. South Africa has the obvious disadvantage of significant distance to all major export markets.”

A complete lack of support will likely result in the demise of local automotive manufacturing, says Strachan. Multinational vehicle makers (also called original-equipment manufacturers, or OEMs) and the large multinational part manufacturers which supply them, will relocate production to regions producing vehicles in higher volumes.

“Small and medium domestic companies will, as a result, face the prospect of diminished or no demand and will, in turn, face the prospect of closure,” says Strachan.

“Apart from the loss of over 100 000 skilled and semiskilled jobs, there will be significant indirect job losses. Independent studies conducted in other countries demonstrate that indirect jobs constitute at least double the direct employment in the automotive sector.”
Replacing local production with only imported vehicles will have a significant negative impact on the trade balance, adds Strachan.

“Also, the impact on the Eastern Cape economy, which relies heavily on the automotive sector, for example, will be devastating.
“The demise of automotive production will result in billions of rands of foreign direct investment annually being lost. Over the last five years, there has been investment of R18.4-billion, supported by government investment incentives amounting to R6.2-billion.”

Strachan says it is also widely accepted that there are “very significant” spill-over effects from vehicle manufacturing into the broader economy, all helping to drive “increased industrialisation”.

For example, technologies which are introduced by multinational companies provide benefits to the broader manufacturing sector, as well as opportunities for further education and training within OEMs and component suppliers.

MANUFACTURING BY NUMBERS 
In 1994, South Africa exported around R2.2-billion worth of vehicles and components a year.

By 2013, this was more than R103-billion, driven by a consolidation of locally produced vehicle platforms and increased economies of scale, motivated through the APDP and its predecessor, the Motor Industry Development Programme.

All of this also happened during and following a global economic crisis, which saw increasing competitiveness in the automotive industry worldwide, as vehicle makers had little problem finding plants with spare capacity, says Strachan.

“In other words, our industry achieved much higher levels of competitiveness producing a narrower range of vehicles,” he notes. “Also, as tariffs on vehicles and components have come down (from 71% on cars in 1995), so vehicle and component imports have grown very rapidly, to the benefit of consumers in terms of price and range of vehicles.”

Recent reports about the country’s trade deficit have been used to argue that South Africa would have been better off without automotive support programmes, adds Strachan.

But, what would have happened if no such programme had been in place, he asks.

“The sector would have gone the route of the Australian automotive industry, which has effectively collapsed.

“And, would South Africans have imported fewer cars if there were no support programmes? Clearly not.

“Instead of an R136-billion deficit, the trade deficit would have exceeded R200-billion. South Africa would be without a major non- commodity export industry in the face of falling commodity prices,” says Strachan. However, this does not dismiss concern about the size of the automotive sector’s trade deficit, which is one of the critical issues to be addressed in the first review of the APDP, presently under way, he notes.

The South African automotive industry in 2012 posted a trade deficit of around R49-billion.

Strachan says the DTI understands that the Australian industry had alerted the government “over a long period of time that whole-scale tariff reduction and lack of support would have a detrimental effect on future vehicle production”.

The Nissan plant was closed in 1992, following the announcement of a decrease of duty to 15%. It is now 5%.
Australia is a mature economy with a high rate of vehicle ownership. Car production was apparently considered as of secondary importance, as Australia increasingly relied on commodity exports, the services sector and niche manufacturing sectors. Thus, total manufacturing in Australia has declined to below 7% of gross domestic product, says Strachan.

“South Africa’s position is very different. It has a population around 50-million and a low per capita rate of vehicle ownership, which means sales can still grow. Also, the automotive industry remains of critical importance to our industrial prospects.”

Also, the country’s small market constraint can be offset by the prospect of a potentially large and increasingly important regional market in sub-Saharan Africa, unlike Australia, Strachan says, adding his voice to that of Naacam’s Houdet.

“South Africa has to take advantage of this growing market for exports across all sectors, including the automotive sector,” says Strachan.

“Where other African countries such as Nigeria establish automotive production, links with our own production capabilities can be secured, which will allow domestic producers to supply semi-knockdown vehicles and a range components to these OEMs.”

Edited by Creamer Media Reporter

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