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The Economist: Europe — we have a problem




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The author of this entry is responsible for this content, which is not edited by the Wilson County News or wilsoncountynews.com.
October 1, 2015 | 2,678 views | 1 comment

I have long thought (and continue to think) that Europe would muddle through its debt crisis and achieve a new, sustainable norm. I must say, however, that a recent development has given me pause, and it comes from, of all places, that company that gave us Beetles, Hippie Vans, and even The Love Bug.

As the scope of the Volkswagen emissions scandal grows ever larger, the level of concern regarding the fallout for Germany’s economy grows apace. As the dominant engine for business growth in Europe, the health of the German economy, in turn, raises fears that Europe could backslide into stagnant growth or recession. Add to that an ongoing crisis in dealing with refugees from war and poverty stricken regions of Syria and elsewhere, stalled growth in China, problems in Greece, and other tensions around the world, and there is clearly reason for concern.

Volkswagen is the largest German car maker and one of the country’s top employers, providing more than 270,000 jobs and supporting a network of suppliers. The company sold close to 600,000 cars in the United States last year and 9.5 million around the world. In case you haven’t been following this story, evidence has come to light that the company installed software on diesel models which essentially allowed them to cheat emissions tests.

The US Environmental Protection Agency has said the company could face penalties of up to $18 billion, more than its entire operating profit for last year. Volkswagen is also faced with repairing 11 million vehicles with the bad software, which is significantly more than the number of vehicles the company sold last year. It is also among the largest recalls by a single car company (though it’s far smaller than the numbers recalled by multiple auto manufacturers to deal with faulty Takata airbags).

Not only will VW have to figure out a way to deal with the necessary refitting of affected cars, but also hope that people continue to buy other models. Furthermore, there are serious questions as to why the software was installed in the first place. Unlike many recalls where a faulty part or design is discovered and must be fixed, in this instance there are additional layers of complexity. Who authorized the software and why? The potential legal ramifications range from deceptive trade to criminal charges. The legal battles will take years and likely billions to resolve. Reputational effects can also dwarf even these issues in terms of the long-term implications for profit and even viability.

There could be valid reasons for the software, such as allowing adjustment to various tests for cars sold in the US versus Europe, for example. Nothing has been proven at this point. If it is ultimately proven that the fraud was deliberate, however, Volkswagen is in deep trouble. The question then becomes how other German car companies will be affected.

The German auto industry is a cornerstone of the economy and exports. In 2014, an estimated 775,000 people worked in the sector (almost 2% of the workforce), and when the supplier networks and related business are considered, a large component of the economy relies on the industry. Automobiles and car parts account for nearly a fifth of Germany’s exports.

As noted, the Volkswagen scandal comes at a particularly bad time. Economic performance in Germany and across the European Union has been sluggish, and the aftereffects of the Great Recession continue to enhance vulnerability. Slower growth in China is also affecting export-oriented firms in Germany and the rest of Europe.

In addition, the refugee crisis is straining social systems across Europe. The German government recently passed measures to help German towns deal with the estimated 800,000 refugees projected to enter Germany this year. Providing for these people fleeing war and poverty would not be easy at the best of times. To do so while a core source of jobs and economic activity, the automotive industry, is under threat could be even more difficult.

Volkswagen has the cash to pay the EPA fine and may be able to find a way to repair affected cars, but the company is going to have to reinvent itself in a hurry in order to survive. Even so, VW has a long history of manufacturing quality cars, and the emissions scandal doesn’t change that. There are not yet signs of mass dumping of used Volkswagens and customers may remain loyal to the brand. The VW division of Volkswagen has been facing structural problems such as high costs and low profits, and maybe some good could come out of the reinvention necessitated by the emissions scandal (though certainly no one would suggest that this is a good way to go about corporate restructuring).

In addition, the idea that the crisis could affect demand for all German-made cars (and even other products) seems farfetched unless evidence comes to light that other firms were also cheating emissions tests. Corporate scandals are a fact of life, and I suspect that the fallout for other German firms will be relatively contained.

Clearly, the timing is bad. Economic growth in Germany and the rest of Europe is already lackluster, and there are threats and challenges from multiple directions. For one of Germany’s largest companies to face such a potentially catastrophic threat could be the proverbial straw on the camel’s back pushing the region back into recession. Much depends on the reaction of customers and whether they shun the VW brand completely (or even worse, German-made products in general). Given what we know now, the most likely outcome appears to a mammoth struggle for Volkswagen, ripple effects through the German economy, and some fallout for Europe, but not a major recession for the region unless the situation worsens. For the debt crisis to be managed, however, Germany must remain fundamentally strong. It is the linchpin of the entire continent. The situation certainly bears watching.


Dr. M. Ray Perryman is President and Chief Executive Officer of The Perryman Group (www.perrymangroup.com). He also serves as Institute Distinguished Professor of Economic Theory and Method at the International Institute for Advanced Studies.
 
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Your Opinions and Comments

 
Gregory Ripps  
San Antonio, TX  
October 1, 2015 3:19pm
 
My wife, my daughter and I each drive a Volkswagen, so we find the revelations very disillusioning. I once thought I would always have an American-made car, but I became sold on VW engineering and fuel economy about 12 years... More ›

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