Mini cheers for BMW

At the end of July there was positive news about the UK car industry. Production was 1.7 million vehicles, the highest since 1999, and  newspapers reported favourably on the decision by BMW to assemble the new electric mini at its Cowley plant, near Oxford, rather than in Germany or the Netherlands, when it goes into production in 2019.

Greg Clark, the Business Secretary, called this a “landmark decision” showing confidence in the Government’s intention to make Britain a key player in the production of the next generation of motor vehicles.

However it is worth examining this decision in more detail to see what it suggests about the UK economy. A key concept in the discussion of the gains from international trade is “comparative advantage” which relates to those goods and services in which a country has the greatest relative advantage in production over other countries. (In economic terms we are looking at focussing on the production of goods and services where a country has a lower opportunity cost than its trading partners).

Ideally, the UK would like to be involved in the high value-added aspects of the production process since this is where the most income is likely to be earned and hence workers’ pay, profits and living standards will increase. In car production this is in the development and production of such things as batteries and motors rather than the assembly of component parts into the finished product. The most important parts of the new Mini, the electric motor and battery, containing new technology, will be manufactured and assembled in Germany and then shipped to Oxford to be put in to the vehicles. While the assembly of the vehicles will ensure that jobs will remain in Britain, the greatest value-added is likely to occur in Germany since that is where the highly-skilled parts of the production process will occur.

Fifteen years ago James Dyson moved the manufacture of his vacuum cleaners to Malaysia because of the significantly lower labour costs while emphasising that the high value areas, such as research and development will remain in Britain. Similarly, Apple designs its products in the USA but the manufacture is outsourced to plants in China, Korea, Mongolia and Taiwan.

Is the BMW decision a sign that this is the way the UK economy is going?  Are we going to become a low-skilled assembly hub, trying to keep costs low in order to offset tariffs imposed on us by the EU? (With no deal with the EU, we could be facing tariffs of 10% on vehicles and 4.5% on parts). Alternatively do we look to the success of prestige British manufacturers such as Rolls Royce, Bentley and Jaguar which, although now foreign-owned, successfully manufacture high quality products in the UK?

 

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Nigeria’s dollar crunch adds to fuel crisis — FT.com

 

Refinery woes, currency controls and militant attacks combine to prolong acute shortage

Source: Nigeria’s dollar crunch adds to fuel crisis — FT.com

Inadequate infrastructure means that, despite being Africa’s top oil exporter, Nigeria has to import fuel putting downward pressure on the value of it’s currency, the Naira (see Chart 2 below). Value-added increases when oil is refined to become something more useful, in this case fuel, so the $’s received for each barrel of oil Nigeria exports is worth less than the $’s Nigeria has to pay for the same volume of refined oil, leading to a reduction in foreign exchange reserves (see Chart 1 below).

It is difficult to see how this cycle will end. If the value of the Naira continues to fall, the price of refined oil in Naira terms will continue to rise, further depleting foreign exchange reserves and accelerating the Naira’s depreciation.

There are several solutions, central bank intervention to revalue the Naira, but they need, already dwindling, foreign exchange reserves in order to manipulate the market price for the Naira. Investment in infrastructure, a fiscal supply-side policy, to reduce the reliance on refined oil imports is an alternative, but oil accounts for 90% of Nigeria’s export revenue and, subsequently, a significant proportion of government revenue. The price of oil has collapsed and with it government revenue, a classic example of the dangers of over-reliance on a primary commodity, prone to price volatility. The fall in foreign exchange reserves, the value of the Naira and an increasing budget deficit will make lenders nervous and will lead to an increase in the yield on government borrowing, put simply, the interest rate on government bonds will have to rise to offset the greater risk, increasing government expenditure on debt repayments.

Clearly, these options are not presently viable, but the second should have been enacted when the oil price was high and export earnings plentiful, however, corruption, some $16bn in government oil receipts is unaccounted for in the last year alone, has meant that infrastructure remains undeveloped.

A further consequence of the falling value of the Naira is that despite global oil prices falling, Nigerians have to pay more for petrol at the pump. To combat rising petrol prices the Nigerian government have imposed price controls, however, this has resulted in several-hour long queues and a rise in hidden market activity. Subsequently, Nigerians either face having to pay extortionate prices or waste valuable time queueing. Ultimately, output is lost and Nigeria’s economy suffers.

Nigeria’s relatively new president has a tough task on his hands.

Chart 1

Chart 2