Why a Car Priced at under 10.000 EUR is a Bad Deal for the European Economy

I have recently read about the launch of Ford’s new car for the emerging markets – the Figo. The car is expected to be priced at between 5.000 and 6.000 EUR and will be sold initially in India. There have been in the past news about even cheaper vehicles launched in the emerging markets – Tata’s Nano being the best-known example. The Nano was a resounding approach because it was extremely low-cost, at around 2.000 EUR.  And, these types of products usually do have success in the countries for which they are designed.

At the same time I could not help thinking what impact such a low-cost vehicle would have on Europe’s economies, provided it could be sold at these prices. First of all, it’s necessary to bring into the discussion the obvious barriers that exist for such products. There are first of all the safety norms and also the environmental norms and regulations. These barriers limit a manufacturer’s capacity to sell cheap cars on Europe’s markets but, there’s more to it.

Besides the typical aforementioned arguments, a fleet of low-priced vehicles would be a bad deal for the downstream industries as well. Consider the amount of premiums the insurers would receive for a motor hull policy on a 2.000 EUR car. Or, the interest a leasing company and/or a bank would collect from a loan of such a value (indeed, if the buyer would even need a loan). Even worse, what commission could a car dealer charge or what profit would a repair service make based on such a product?

Europe’s economies are highly dependent on the transport sector. An important segment of businesses is involved in selling, financing, insuring, repairing and servicing the cars we use. The current economic recession has shown what happens if the demand plummets. The fall in car sales was one of the biggest problems the governments have tried to control. Germany and other states have introduced special schemes to support the selling of new cars (the government would pay an allowance (voucher) in exchange for the scrapping of an old, used car and the voucher could be used only for the acquisition of a new vehicle). Putting a large amount of cheap products on the markets would have the same impact as a reduced demand (ceteris paribus).

There are examples of low-cost cars on sale in Europe as well but, the prices are way above those in Asia. The Logan is a familiar example and Dacia’s new model, the Duster, an SUV priced at around 10.000 EUR. These vehicles are very benefic for the Eastern markets. With a relative low purchasing power and a low level of motorization in the region, these products fit the needs. In the West however, a major influx of such products could destabilize the connected industries.

Strictly from an economic point of view I am not arguing about the need to maintain the current status quo. However, the regulations do just that. And, as long as technical innovation brings new safety and environmental technologies, the regulators will incorporate them into the list of mandatory requirements. As long as they will, the downstream industries will use their current business models.

Generally speaking, it’s a political choice for high quality and the price rises accordingly. Collaterally however, this type of policy stimulates a disproportionate allocation of resources to the connected businesses.