The black swan is wearing a VW badge

Ben D. Kritz

Ben D. Kritz

FOR an audience of business and economic readers in the Philippines, one of the very few places in the world where Volkswagen does not have a significant presence, the news about the scandal the giant automaker has become mired in may not seem that important.

It is, however, a man-made disaster that could reverberate far beyond the auto industry.

If you are not up to speed on the story, what emerged— “emerged” is used here in the same sense as “exploded like a decomposing whale corpse”—last week was that VW had modified the control software for its 2.0-liter turbo diesel engines, which are installed in the VW Golf, Jetta, and Beetle models built from 2009 to 2015, 2014 and 2015 Passat models, and the 2009 to 2015 Audi A3. The modified software detects when the vehicle is undergoing an emissions test and only then switches on the full emissions control program (settings that regulate fuel and air flow and engine speed to minimize harmful exhaust emissions). The rest of the time, the emissions controls are switched off.

The obvious result of all this is that the harmful emissions from this particular engine are much higher than advertised, and in most countries, particularly the US, at times higher than are actually allowed by law. According to Bloomberg, who broke the story, the US Environmental Protection Agency first detected that “something wasn’t adding up” with emissions testing results from VW cars back in July. VW at the time explained away the discrepancies as a “technical glitch,” but after several weeks passed with no apparent fix, the EPA informed VW that it would not issue its customary pre-approval of the engine for 2016 models, forcing VW to admit that the modification—fraud, to call a spade a spade—was intentional.

As of Tuesday, Volkswagen disclosed that at least 11 million vehicles are affected; a third of the value of the VW group was wiped out in less than two days, and the company has already announced that the 6.7 billion euros ($7.3 billion) it was immediately setting aside to deal with the mess—which may be a drop in the bucket in terms of the costs VW will incur for the scandal—will wipe out its profits for the year; the fine alone that will be levied against it by the EPA, exclusive of any other penalties from other agencies or other countries, will likely be around $18 billion. In addition to investigations being conducted by regulators in the US, South Korea, Canada, Germany, the EU as a whole, and reportedly, China, the US Department of Justice announced on Tuesday it was opening a criminal investigation, which will expose Volkswagen to a sky’s-the-limit risk of follow-on civil actions; a report late yesterday (Wednesday) morning on Bloomberg said a class-action suit in California was already being prepared.

The reason the scandal is not just “a VW problem” is that the Volkswagen group is mind-bogglingly enormous; as of June, it had surpassed Toyota as the world’s largest automaker. In addition to Volkswagen, other passenger car brands controlled by the group include Audi, Porsche, Bentley, Bugatti, Lamborghini, SEAT, and Škoda; it produces MAN, Scania, and Neoplan trucks as well as a line of commercial vehicles with the VW marque; it also owns Ducati motorcycles, has about a 20-percent stake in Suzuki, and is part of the two largest automotive joint ventures in China, FAW-Volkswagen and Shanghai Volkswagen. Volkswagen is the world’s fourth-largest employer with more than 572,000 workers (VW’s headquarters in Wolfsburg, Germany alone employs about 50,000 people), and has one of the highest annual revenue-per-employee ratios, at about $456,000 per worker.

Simply put, if VW goes down it will take a big piece of the global economy with it. The company itself is huge, but it is also just a part of a vast network of businesses—parts and component suppliers, auto dealerships, repair facilities, and the segment that is usually overlooked but may be the linchpin to the sector, financial services. Markets so far have not been particularly discerning in their haste to flee automotive stocks; even though Germany’s other two auto giants, Daimler and BMW, have said their products do not have the same problem (in BMW’s case, at least, this was confirmed by emergency testing by the EPA), they lost 3 percent and 6 percent of their market value while VW’s stock was collapsing. Other rivals Peugeot, Renault, and Chrysler-Fiat suffered losses as well; the presumption of investors is that increased scrutiny by regulators on all vehicles because of VW’s misdeeds is going to turn up other problems of one sort or another elsewhere.

And while there is probably not a “good” time for something like this to happen, it is equally hard to imagine a worse time for it. With the world economy a bit wobbly due to, among other things, a slowdown in China and the increasing pressure of the refugee crisis in Europe, the appearance of a black swan in the form of the VW scandal is most unwelcome, and may cause us more grief than we realize right now.


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