By Jorn Madslien BBC News business reporter

The chairman of Europe's largest carmaker has reason to be worried.

Pischetsrieder: Europe must chose between competitiveness and over-regulation

"People are buying cheaper and cheaper cars," Volkswagen Group chairman Bernd Pischetsrieder said ahead of an annual motor industry dinner in London.

In fact, the average spent by Europeans on their cars has been sliding since the turn of the century after having risen steadily until the late 1990s, Mr Pischetsrieder said at the Society of Motor Manufacturers and Traders (SMMT) event on Thursday.

"This doesn't really contribute to the profitability of the car industry," he pointed out.

Costly regulation

Making matters worse for car makers, Mr Pischetsrieder insisted, is the ever-increasing mass of red tape the industry is having to cut through before it can bring cars to market.

VW Group operating profits fell 48% in 2003 Profits continued to slide during the first half of 2004 In July, VW Group warned its full year profits would fall short of its previous prediction Volkswagen Group's share price

"When it comes to Brussels, it is not creeping, but explosive legislation," Mr Pischetsrieder declared, singling out EU emission legislation in particular as being too ambitious.

The EU wants cleaner diesel engines which release less harmful particles and nitrogen oxides, or NOx, which have been linked with lung diseases, including cancer.

But although Mr Pischetsrieder is in favour of cleaner diesel engines, he said the EU criteria were too strict.

Reducing emissions from 200 NOx to 150 NOx, as the European Union commands, does not sound much, but the effect would be to make diesel powered cars much more expensive, he argued.

"The difference in the cost [not the price] of a motorcar is going to be in the region of 600 euros," said Mr Pischetsrieder, who is also president of ACEA, the European Automobile Manufacturers Association.

The European Union must chose between excessive regulation of the car industry and its desire to become a globally competitive entity, he insisted.

Falling profits

But solely blaming tight-fisted consumers and Eurocrats in Brussels for the car industry's difficulties would be churlish, and this, say industry observers, is particularly true for Volkswagen.

The company offered job guarantees in return for concessions

The group - which owns Audi, Volkswagen, Seat and Skoda, as well as Bentley, Bugatti and Lamborghini - has seen its profits slide sharply since Mr Pischetsrieder took over at the helm in the spring of 2002.

Last year, the group reported a 48% fall in operating profits for 2003 to 2.5bn euros ($3.3bn; �1.75bn).

Then, after a more than 20% fall in profits during the first half of this year, the group issued a profit warning, slashing expectations for 2004 as a whole from 2.5bn euros to 1.9bn euros.

Fired

Much of Volkswagen's difficulties have been due to the strategy put in place by Mr Pischetsrieder's predecessor Ferdinand Piech.

And Mr Pischetsrieder's movements remain restricted by Mr Piech's continuing presence as chairman of Volkswagen's supervisory board.

It seems openly criticising Mr Piech remains risky, as discovered last week by Audi's US head Axel Mees. He was fired soon after criticising Mr Piech's brainchild, the upmarket Volkswagen Phaeton which competes head-to-head with the group's own Audi A8.

When asked by BBC News, Mr Pischetsrieder insisted that "it is not a taboo to criticise the Phaeton", though even he is now prepared to concede that "expectations which were raised [largely by himself ahead of the Phaeton's launch] were absolute pipedreams".

Recover

Needs must, so Mr Pischetsrieder has begun distancing himself from Mr Piech's strategy and instead pushed through a series of cost cutting exercises which should safeguard the company's fortunes.

Earlier this month, Volkswagen's German workers - who have been earning up to 20% more than car workers elsewhere in the industry - agreed to a 28-month pay freeze in return for a one-off 1,000 euros payment and job security until 2011.

Many challenges remain on Mr Pischetsrieder's horizon, though: he is still battling with German ownership rules which give local government a say in how the business is run, and he has to reform the group's corporate structure.