Driving to salvation—or disaster

Latin CEO: Executive Strategies for the Americas, Dec, 2001 by Thomas A. O'Keefe, Jerry Haar

The recently released study, The Impact Of Mercosur On the Automobile Industry concludes that the sector has become a pillar of the Southern Cone economy. But reforms will be needed for the industry to thrive in an increasingly competitive global marketplace. The following are excerpts from the study.

A TRANSFORMATION of the automotive industry, particularly the segment involved in production of finished vehicles, has taken place in the Southern Common Market, better known as Mercosur. This is a vitally important development, considering how key the auto industry was in advancing Western economies during the 20th century. The automobile industry also constitutes an important underpinning for the efforts to achieve economic integration in Mercosur.

A Brief History

The automotive industry in South America has its historical roots in a small factory set up in Buenos Aires at the beginning of the century by Argentine entrepreneur Horacio Anasagasti, who began assembling simple vehicles using Bleriot auto parts from France. Ford set up its first South American plant in Argentina, in 1916, followed by plants in Chile, Brazil and Mexico during the 1920s. General Motors and Chrysler followed suit during the 1920s and 1930s. By 1930, Argentina had one of the highest automobile densities in the world--higher than most European countries.

After a slowdown during World War 11, expansion continued during the 1950s and 1960s, as high import duties forced foreign manufacturers to produce locally Restrictive contracts on technology transfers by multinational manufacturers, however, often prohibited export sales. This changed during the 1970s, and by 1980, Brazil--which had the lowest production costs in Latin America--emerged as an important export base both regionally and internationally.

The 1990s marked a decade of dramatic growth, not only for the industry but for the economies of the newly formed Mercosur trade block. In Argentina, the automotive industry experienced a boom through most of the 1990s, with production climbing from slightly less than 100,000 vehicles during 1990 to a peak of nearly 450,000 units during 1998. Much of the growth was driven by an increase in local demand; multinationals attempted to capture this demand with some US$4.5 billion invested in Argentina's automotive industry between 1995 and 1998.

Brazil, too, saw its automotive industry rapidly expand during the 1990s--from under 1 million vehicles produced during 1990 to more than 2 million produced during the peak year of 1997. By the following year, the Brazilian automotive sector was No. 10 in the world, accounting for nearly 12 percent of GDP.

Like Argentina, most of the demand was local, and like Argentina, huge multinational investments took place--US$7.9 billion was spent on new plants between 1997 and 2000. Much of this was forced investment. During 1995, for example, when Brazil doubled import. duties on vehicles produced by companies with no presence in the nation, automobile manufacturers had to set up a Brazilian factory to meet domestic demand.

Automobile assembly plants in Chile and Uraguay also peaked during 1997, with slightly more than 26,000 and 13,000 units, respectively.

Today's Landscape

While automobile manufacturers based in Mercosur became remarkably more productive during the 1990s, the end of the decade witnessed a severe constriction. Production in Argentina, for example, fell during 1999 to its lowest count since 1995--around 300,000 vehicles. In Brazil, production during 1999 fell even more precipitously to the lowest level since 1992--approximately 1,350,000 vehicles. In both cases, 1999 levels were well below installed capacity.

Today the industry is a mix of promise and pitfalls. Although production cuts during 1999 were the result of macroeconomic conditions, the industry itself needs changes if it is to become more competitive.

Despite the expansion during the 1990s, car makers are still unable to reduce manufacturing costs to international levels. Much of the explanation for this lies in a host of national administrative barriers and inordinately high and regressive local taxes. The result is that most Mercosur automakers are currently producing automobiles competitively priced only in their protected regional market.

Overall, the Mercosur region still is recovering from the adverse effects of currency fluctuations, brought on in part by the Asian crisis and the January 1999 devaluation of the Brazilian real. Among other things, the devaluation caused a dislocation of the auto industry with much of Argentina's production moving across the border to Brazil. Currency depreciation also lowered the value of investments in the region, and, along with recessions in the Andean countries and the Southern Cone, this decline has dampened consumer demand.

The fact that certain operating expenses, such as labor and raw materials, are lower in dollar terms has helped cushion the severity of the downturn. Still, Latin American automotive demand fell during 1999, from 1.6 million to 1 million units. All the major car companies suffered losses, and only after second-quarter 2000 did consumer demand begin to rebound. As an example, Brazilian automobile output increased to 168,000 units during April 2001, up 24.1 percent from April 2000.