Down and under

Australia's auto demise foreshadows demand slump

Australia's carmaking industry is being hollowed out. Toyota has followed General Motors and Ford in announcing it will stop manufacturing in the country. The decision is a delayed response to a decade-long erosion in manufacturing competitiveness. But the real risk to the economy is not Australians making fewer widgets: it's that they will be able to buy fewer things.

Toyota's decision to close its plant by 2017 has been years in the making. Adjusted for labour cost differences, the average Australian exchange rate against its trading partners rose by 79 per cent between 2001 and 2012. That made imported cars more attractive. Even last year's four per cent drop in the real value of the Aussie dollar was hardly enough to persuade carmakers, whose production has halved since 2004, to stick around.

Shrinking domestic demand is another consideration. It's unlikely that Australians, who have bought more than 1 million vehicles in six of the past seven years, will maintain that pace. Though the falling Aussie dollar will help competitiveness, reining in the country's inflated cost base will also require wage restraint. Salaries are among the highest of OECD members, despite productivity growth not keeping up. Job cuts in manufacturing - thousands of positions are at risk in the auto industry - will start straining wages. That will knock domestic demand, which is already feeling the pinch from fading mining investment.

Australia has few other options to boost demand. Public spending could compensate for thinning private consumption, but Prime Minister Tony Abbott is already under pressure to rein in budget deficits stretching to 2024. Alternatively, Australians could spend some of the wealth stored in house prices, which are currently rising at their fastest pace since 2010. But tapping that asset, which was largely untouched by the 2008 global financial crisis, will be difficult if prices begin to crack. Affordability is low, while the ratio of housing debt-to-assets is higher than in 2007.

The demise of Australia's car industry is a powerful symbol of the country's unfavourable cost structure. The long-term worry, however, is its waning potential as a market.