How the VW scandal could get as big as the ’08 financial crisis

The problem of manipulating emission tests goes to the heart of a capitalistic system. In a capitalistic system, the general view is that government should ensure a level playing field and participants should play according to the rules.

The case of the VW Group shows that this noble goal has failed dismally. The undesired outcome was not an unforeseen or unfortunate error; it was the result of deliberate deceit.

It seems that the VW Group developed engine management software that detected when the vehicles were subject to emission tests, rather than normal road use, and adjusted exhaust emissions to lower levels.

In short: the exhaust emissions were lower under test conditions than under normal use. Sounds simple, but with major economic implications.

Wide implications

The immediate question is whether other car manufacturers are guilty of the same practice. Given the level of competition among car manufacturers and the quest to be the best, it is not impossible that this scandal runs wider in the industry.

It is not yet clear in which other countries and jurisdictions the VW Group used this equipment. But its use in even just one country is shocking and completely unacceptable. Equipment of this nature to foil government regulation should simply not exist.

Governments generally have three functions. First, they must ensure freedom for the people in their jurisdiction. Different governments have different interpretations of this requirement. One extreme example is of a country where the interpretation of this freedom results in civil war.

Secondly, governments must provide order. This is generally associated with the safety of citizens.

Thirdly, governments must take care of welfare. One example is that governments should take the necessary steps to prevent externalities (negative outcomes from economic activity) in the interest of the country’s population.

An example is the prevention of pollution through regulation, which includes the limitation of exhaust emissions. In many countries, for instance South Africa, buyers of new cars pay an emissions tax, calculated on the exhaust emissions of the particular vehicle.

Remedies for cheated consumers

In countries where such a tax is applied, the respective governments will have every right to recoup the underpayment of these taxes from VW, or any manufacturer guilty of similar practices, who fitted their vehicles with the equipment that distorts emissions readings. The net effect of the equipment’s use would have been an under-reported of taxes due to government. Buyers of the vehicles cannot be held responsible for this misrepresentation.

It also raises the question whether the owners of these vehicles can hold the VW Group legally liable if the second hand value of their vehicles deteriorates as a result of the faulty emissions testing.

Governments have to reassess whether they can trust large companies in future to apply regulation. The world is still battling to recover fully from the consequences of the 2007/08 world financial crisis, when banks did not apply the letter and the spirit of regulation.

The 2007/2008 financial crisis started as the so-called “sub-prime crisis”, when the risk of lending to people with dubious credit records was not fully reflected in lending transactions. As more information became available, it seems that the financial crisis was the result of “sub-crime prices”, rather than a “sub-prime crisis” problem. It is really necessary to assess whether there was conduct bordering on criminal intent in structuring transactions in the quest for short-term financial gain, profits and bonuses.

VW’s current problem has the potential to become as big as the 2007/2008 financial crisis if it can be shown that other vehicle manufacturers followed similar approaches. As was the case with the financial crisis, concerted effort by vehicle manufacturers will shake the capitalist system to its core.

The only difference is that regulators will not be as forgiving as in the case of the banking crisis. Banks raises deposits from the public on the basis of confidence and trust and are therefore treated with particular care. It is not necessary to retain the same level of trust in the manufacturing industry.

But even if the problem is simply contained to the VW Group, it nevertheless raises the question whether self-regulation by companies is indeed possible once the government has framed the necessary regulatory framework.

The end of self-regulation?

The VW Group experience gives governments every right to increase their supervisory role beyond regulation and to involve themselves to a much larger degree in economic activity. If companies cannot behave themselves, governments must ensure they do.

The conduct of the VW Group, following on the financial crisis of 2007/2008, has in it all the elements of ending capitalism as we know it today. Governments will rightfully argue for a much larger role in economic activity.

The bottom ends of the V and W in the name of the VW Group might be the thin edge of the wedge ending the current capitalist economic model based, inter alia, on self-regulation.

Jannie Rossouw is the head of School of Economic & Business Sciences at the University of the Witwatersrand. This article originally appeared on The Conversation.