The coming crash

“THIS is one of the most advanced and sustainable car factories in the world.” So declares Karsten Engel, chief executive of BMW China, as he greets visitors to his firm’s newish manufacturing facility in the grim north-eastern city of Shenyang. The plant, run by a joint venture with a local firm called Brilliance, is indeed spotless and efficient, with robots and humans together producing nearly 40 cars each hour. China is the largest market in the world for the firm’s big 5 Series and 7 Series models, and source of perhaps half of its global profits in recent years. Unsurprising, then, that the firm is hoping to double the number of models built locally.

The bosses of many big foreign car firms were in China this week for the Shanghai Auto Show, and they too offered a pretty rosy view of the Middle Kingdom. China has overtaken America as the world’s largest car market, and it has contributed between a third and a half of the global profits of many big automobile manufacturers in recent years. Like BMW, other foreign firms are also betting heavily that the good times will continue by expanding production capacity in the joint ventures that the Chinese government requires them to form with domestic firms. Jochen Siebert of JSC Automotive, a consulting firm, estimates that the joint ventures will open $12 billion-worth of new factories in China this year and next.

And yet the hard truth is that these firms may now be headed for a car crash, shattering their dreams of never-ending profits. The first reason for this is that sales growth is slowing. The days of double-digit annual increases are over. In the first quarter of this year sales of new vehicles slowed to single-digit annual growth. Paul Gao of McKinsey, another Western consulting outfit, forecasts that growth rates will remain in the “mid-to-high single digits” for the next decade.

That is a higher rate of increase than many other countries can look forward to. However, given the new plants being opened, it looks like being insufficient to correct a worrying excess of capacity that is building up. Enough new plants to make another 5.3m light vehicles a year are due to come online in 2015 and 2016, compared with sales last year of 22.8m.

A rough rule of thumb in carmaking is that assembly plants need to be working above about 75% capacity, assuming two eight-hour shifts each normal working day, to be profitable. America’s closures of car factories, followed by a sharp recovery in sales, mean that its plants are now working at above 100% of that capacity. In contrast the average for Chinese assembly plants has now slipped to below 70% (see chart).