Stylised facts and brexit

By Dr Laszlo Czaban, The University of Manchester, UK laszlo.czaban@manchester.ac.uk

Since the triggering of Article 50 (Brexit), a number of international manufacturing companies announced that they would relocate production, component manufacturing or assembly from the UK. Some stated that it has nothing to do with Brexit, some that Brexit affected their decision, and some that it was due to Brexit.

Obviously, tons of evidence could be piled up for any of these narratives – the data are infinite, so there would be some supporting the argument (and if there are contradictory data, we could always resort to probabilities, relative weights, and so on). These pieces of data in combination with the narrative become stylised facts – it is partly a theoretical necessity, partly a practical solution.

Just consider the following: the manufacturing of the components starts in Britain, then makes its way to Northern France, then to Germany, finally back to Britain for assembly the Mini (which is owned by BMW and only really sells in the UK)[1]. Obviously, Brexit would affect this. And Brexit would affect the sandwich company whose many components are transported from the EU, assembled in the UK, and sold in France[2], or those destined to the UK market whose ingredients, apart from the bread derive from a rather long supply chain, and only assembled here[3]. On the other hand, Brexit would not affect the fish caught just off the coast of the UK, transported to China[4] (more recently to Vietnam) where it is filleted, returned to the UK, and sold in chip shops. Yet, there are ups and downs in this trade, and not quite dissimilar to the one Brexit may cause, just triggered by prices, costs and alike.

Let’s leave the fish filleting industry, and sandwich making for the rest of this post, and let’s turn to manufacturing (actually both fish fillets and sandwiches are manufacturing sectors, just we not associate them with the sector). While this Brexit upheaval has been going on supposedly causing the relocation of manufacturers (oddly the Japanese ones didn’t move to Continental Europe, but back to Japan), or the denial of it (blaming on the falling demand for, let’s say, diesel cars), or exploiting short-term government subsidies to produce something or other in Singapore, German car manufacturers simply couldn’t satisfy the domestic demand for their personal vehicles. While this Brexit upheaval has been going on, and German car manufacturers cannot meet the demand mainly because their sluggish response to the new emission standards, and while there is demand for their cars, Audi is considering the cutting out of one shift a day (which will also have a major effect on the supply chain)[5].

So, supply chain. It sounds boring in an academic article, but it is much more interesting seeing it. Just try to visualise it: one of the Audi assembly factories is in Iglostadt, and the engine factory supplying it is in Hungary, so about 650 km away. That’s about 7-8 hours’ drive or 11 hours on the train.  Inputs to the engine factory comes from many places, mainly (but not exclusively) on road. The engines leave the factory mainly (two thirds) by train. That’s 60 wagons a day at normal times[6]. There must be an economic reason behind it.

It was Peter Dicken who summarised the regionalisation of the automotive industry (and manufacturing in general) in the most convincing way that became a paradigm[7]. It was based on evidence, and a clear logic (economies of scale and value/weight ratio in combination with Dunning’s eclectic theory). By the time it gained sufficient attention, it became undermined by the findings of global commodity chain (now GVC) approach – economies of scale (for example, in assembly (Volkswagen), or in cutting (US garment industry) regionalised, production as a whole globalised utilising the relatively low transportation cost (still value/weight ratio), and global efficiencies in low value added parts (that is adjusting the value/weight ratio with accounting for margins)[8]. And there was something else: China[9]

All these, the regionalisation of production, the long supply chains chosen on the grounds of various considerations in combination with lean production, and other kinds of modern in-factory management techniques make completely common sense. There is economies of scale in assembly, in components, in transportation, there is low inventory, the globalisation opened trading routes, companies are able to optimise the location of various aspects of the production (be it via subsidiaries or outsourcing) by production factors or total production factor. And it offers the basis for Industry 4.0.

Yet, these stylised facts cannot explain why German car manufacturing couldn’t comply with the new emission requirements in terms of output, why Japanese car manufacturers (among them the most productive in Europe) withdraw, and seem to choose centralised manufacturing and distribution – the Brexit argument is not a sufficient explanation, the drop in demand for diesel engine cars is not a sufficient explanation because we are supposedly talking about those wonderfully modern, advanced, intelligent, technology focused, whatever companies, so such a simple Fordist, because this is what they are, answer does not seem to match those stylised facts.
Not only that – it seems that we are within a year from the next recession, which will probably be led by manufacturing, and for the first time it may take China to recession[10].
So, what’s going on?

It would be nice if economics could get a kind of working partnership with management studies (and vice versa) at a theoretical level, and then for the practical level we would also need psychology, sociology and so on to give an explanation.

I will try to keep it simple. I will talk about cars, but the points are valid for most manufacturing sectors.

Cars are not produced faster today than towards the end of the 1970s. Workers cannot jump in the skeleton cars quicker to fasten the screws, human biology hasn’t changed to accommodate the higher speed of the conveyor belt. Yet, the HPV (hours per vehicle) has come down[11]. Why?
Well, firstly, there is less waste (quality problem), which obviously reduces the useful hour per vehicle. However, even if all problems are addressed in the free time of the workers, it is now at a level that cannot really be further reduced.

Secondly, workers (teams really) operate at the highest possible speed, so it cannot be further increased. Replacing them with robots means being exposed to capacity utilisation, so there are limits to that too. In financial terms it would expose companies to market changes more.

Third, a lot of back office staff and supervisors have been fired, replaced by teamwork and by versions of artificial intelligence, thus their hours are now taken out of the calculations. Not many more people could be fired[12].

Fourth, the combination of platform and model numbers are at a technological crunch. Every new model increases the HPV, less so on the same platform, but platforms can accommodate only a limited number of models (and the same applies for the shared components), thus new platforms are needed, increasing the HPV. However, the decisions on the models and platforms are not driven by HPV (unlike the poor factory manager’s KPI), but by market segmentation and competition, thus it is largely beyond the control of the modern optimising managers, and it is unlikely to provide more productivity gains.

Now we get to the supply chains. Supply chains don’t only reduce the cost (through location and negotiating position between the assemblers and the component manufacturers, or through shared R&D), but they also increase responsiveness and variety. Indeed, as it is written in the textbooks. This, in combination with lean management techniques, has been the main life support of the current structure of manufacturing.

Automobile companies have been squeezing drips from the five points above, here a percent, there two, and this with the growing and more segmented market provided further impetus to maintain and perfect the existing production system.
To put it simple: the current system has no ability to deal with any larger impediment than a few drops of rain on the road. Fluctuation at any point of the system creates an increasing wave of diversions from the expected norm, and the effects are enduring as the production system has limited capacity to catch up with itself.

A week-long strike somewhere would stop the output for 3 days somewhere else, and then extra resources needed to catch up – all these have to be financed from the limited margins. Now, match this with such a shock as Brexit or new emission criteria. The point is – the unsustainability of the production system. Not only in environmental terms, not only in terms of global politics, not only in terms of international trade rules, but also in terms of management. We know companies where suppliers suddenly gained an upper hand[13]. We know companies where quality checks are a problem[14]. We know companies where the opportunity cost between flexibility and margins tilted, and cannot be balanced[15].

All these are happening when in some sectors (the most observed is automotive) a major technological upheaval is imminent (alternative energy, autonomous cars, etc.) but without much knowledge about the winner – which one would become the dominant technology, the “dominant design”.

So now back to the theory. We have had the valid theoretical argument when Fordism in some sectors and in some parts of the world got into crisis. We have had a valid theoretical argument when regionalised production emerged. We have had a valid theoretical argument when regionalised production with global supply chains emerged. There has always been a problem when applying these models to concrete cases (it’s an epistemological problem that cannot be resolved at the level of the theory or at the level of the concrete case – inductive and deductive inferential reasoning really).

It is too easy to get distracted right now with the turmoil caused by Brexit, regulatory changes, trade wars and so on. The point is: these are triggers and not causes.
What all these suggest, when accounting for the key characteristics of the business models, of international business, of management of processes of the concrete firms: the current model of international manufacturing reached its limits – the cause of its crisis is internal, and the solution is unlikely be anything but managerial.

Thus the theoretical analysis, be it from the firm to the theory of international business or from the theory of international business to the firm, it should treat the consequential point as a frame, and hence recognise the crisis.


[1] https://www.theguardian.com/business/2017/mar/03/brexit-uk-car-industry-mini-britain-eu
[2] https://www.ft.com/content/2097f502-95ad-11e8-b67b-b8205561c3fe
[3] https://www.politico.eu/article/brexit-will-kill-the-sandwich/
[4] https://www.robedwards.com/2009/08/the-madness-of-filleting-scottish-fish-in-china.html
[5]https://www.reuters.com/article/us-volkswagen-audi/vws-audi-mulls-cutting-night-shifts-at-ingolstadt-plant-handelsblatt-idUSKCN1Q818T
[6]https://www.kisalfold.hu/gyori_hirek/tudta_hogy_a_gyorben_keszult_audik_ketharmada_vasuton_hagyja_el_a_gyarat/2538544/
[7] Dicken, P. (1986): Global Shift: Industrial Change in a Turbulent World, Harpercollins College.
It was effectively the first edition of the Global Shift (now in the 7th edition.
[8] Of course, the global commodity chain concept did not come from nothing. There have been articles about outsourcing by Swedish companies or by the US apparel industry as far back as the 1970s.
[9] The Chinese domestic market has been a conceptual problem to both the Global Shift and to GVC. It has become more and more localised (regionalised), but because of the conceptual problem, it was worth leaving it to those who were writing about China rather than those who were writing about international business, thus avoiding uncomfortable questions about the boundaries of these theories (The Chinese domestic economy is international business through and through – just a different kind, and not “just” – it is one of the main components of the outward FDI from China: the outward FDI supports the localisation/regionalisation of manufacturing production and assembly in China).
[10] China has been buying time via soft loans and quasi-quantitative easing. It can maintain it for a long time.
[11] https://www.emeraldinsight.com/doi/abs/10.1108/IJPPM-08-2015-0117
https://www.tandfonline.com/doi/abs/10.1080/00207541003627837
[12] I’m not going into the replacement of professionals with AI. It is happening and it will continue to happen, but the research is quite weak (in terms of evidence).
[13] Sorry for bringing in Porter’s Five Forces.
[14] I chose this example because according to textbooks it wasn’t supposed to happen: https://www.bbc.co.uk/news/business-43298649
[15] The entire retail sector really.