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Aug 20, 2018 | 04:00 GMT

9 mins read

How Trump's Tariffs Would Disrupt the North American Auto Industry

Ford Explorers leave a Chicago assembly plant during October 2017.
(SCOTT OLSON/Getty Images)
Highlights
  • The United States could announce tariffs or quotas on imports of finished vehicles and auto parts in the next six months, which could very well raise the price of vehicles in the United States. 
  • Because of tightly integrated supply chains and extensive reliance on the U.S. market, automakers in Canada and Mexico will suffer as a result of any U.S. trade barriers that are imposed. 
  • The United States will use the threat of auto tariffs to negotiate stricter rules of origin requirements in the NAFTA talks. But even if Washington gets its way, it may still use tariffs to dissuade future automotive investments in Mexico.
  • Tariffs and NAFTA concessions could threaten Canadian Prime Minister Justin Trudeau's 2019 re-election bid and cause Mexico's government to hold off on heavier social spending. 

By using tariffs as a weapon in NAFTA negotiations, U.S. President Donald Trump could end up harming automotive networks that have taken decades to build. As home to one of the largest car-importing nations in the world, North America has attracted numerous companies supplying the U.S. market with Canadian and Mexican finished vehicles and parts. The size and complexity of the U.S. market has led to the sprouting of a network of supply chains across the continent — first to capitalize on Canadian manufacturing capacity and later to take advantage of far cheaper Mexican labor.

Now the Trump administration is weighing tariffs or quotas under Section 232 of the Trade Expansion Act of 1962 to curb the import of automobiles and auto parts as a way to reduce the overall U.S. trade deficit and to protect the jobs of U.S. workers. The administration claims that excessive automotive imports are a threat to national security. The proposed tariffs are largely seen as a negotiating tactic for the North American Free Trade Agreement, so the Trump administration may very well back away from them, choosing instead to target South Korea, Japan or the European Union. But if they were implemented, companies across North America could see slowing sales and higher input costs, and the governments in Canada and Mexico could face problems. Furthermore, those automotive networks could face sustained damage as automakers realigned their long-term business strategies.

The Big Picture

As part of its drive to reduce trade deficits and protect domestic manufacturing, the administration of U.S. President Donald Trump is weighing whether to place tariffs or quotas on automotive imports. Such measures would have a heavy impact on the North American trade in vehicles and their components. The region's extensive supply chains and tightly connected automotive businesses would suffer from the barriers, because it would erode U.S. demand for vehicles and parts.

Growing Integration

Over the second half of the 20th century, North America became deeply intertwined with U.S. automotive manufacturing. The postwar U.S. economic boom drove the demand for more automobiles, which in turn opened export opportunities for Japan, Germany and North America. In 1965, Canada took the first steps toward greater integration of its auto industry with that of its southern neighbor by signing the Automotive Products Agreement. The deal led to the steady decline of tariff barriers for finished vehicles and their components, and it closely linked manufacturing plants in Ontario to U.S. auto manufacturing clusters in the Great Lakes states of Michigan and Ohio. Mexico followed nearly two decades later, removing all limits on foreign investment for automotive manufacturing and leveraging its relatively cheap factory labor years before its government signed NAFTA in 1993. 

North America now has well-developed automotive manufacturing clusters and supply chains. Just under half of the 8.3 million new vehicles imported by the United States in 2017 came from Canada and Mexico. Most major automakers make vehicles in those two countries, and the overwhelming majority of production of components and finished vehicles in both countries is intended for final sale or integration into vehicles manufactured or sold in the U.S. market. Ninety-five percent of Canadian passenger vehicle export revenue is derived from the U.S. market, while Mexico relies on it for 70 percent of vehicle exports. Mexico is the leading supplier of engines, drive axles, suspension systems and steering wheels to the United States, as well as a major supplier of electrical wiring harnesses, gearboxes, brakes, radiators and seat belts. Canada is the leading supplier of clutches and gasoline engines to its southern neighbor, and it's the second largest supplier of suspension systems and drive axles.

A Monkey Wrench in the Works

In May, the White House directed the Department of Commerce to investigate the national security implications of excessive automotive imports. The investigation has until Feb. 17, 2019, to reach a finding, and the president subsequently has 90 days to decide whether to act. In the meantime, Congress has been moving to boost its power and limit the president's authority under Section 232, but the measure may not reach a vote before the Commerce Department's findings are revealed. If the report finds that auto imports harm national security, it will quickly become a major source of uncertainty for businesses across the region and the globe.

The investigation also introduced a new element into already complicated North American trade negotiations. Since early 2017, the White House has wielded the power of the presidency to attempt to remedy what it perceives as disadvantages that the United States faces in global trade. Until May, the main trade concern for North America's automotive sector was the administration's push to renegotiate NAFTA. For more than a year, the Trump administration has pressed Mexico and Canada to accept significantly higher requirements for rules of origin and higher wage requirements in the treaty.

If Ottawa and Mexico City accepted the U.S. demands, then cars produced in these countries would have to contain 75 percent North American content (as opposed to the current level of 62.5 percent) to qualify for tariff-free entry into the United States. About 40 percent of passenger cars and 45 percent of pickup trucks would have to be built in areas with a minimum factory wage of at least $16 an hour. As this requirement is phased in over a period of several years, it would cut the number of vehicles from Mexico that could enter free of U.S. tariffs. The administration's intent is to steadily reduce vehicle imports from Mexico, where it perceives low wages to be an unfair advantage. In a further complication for Mexico, the White House has signaled in NAFTA negotiations that it may exempt production from existing Mexican plants from Section 232 tariffs. Auto plants built after a yet-to-be-decided date could face tariffs.

A chart shows the sources for various auto parts for the U.S. market.

Auto Industry Collision

Depending on the severity of trade barriers or new NAFTA regulations, automakers operating in Canada and Mexico could be dealing with a major blow to their business plans by next year. The price of vehicles in the United States would rise, eroding sales. According to the Center for Automotive Research, the average vehicle price would increase by about $4,000 if a blanket tariff with no exemptions for either Canada or Mexico is applied. However, the Trump administration could choose to exempt auto parts from tariffs and place fees only on finished vehicles, thereby softening any price hike. The White House could also drop the tariff from the originally threatened 25 percent to a much lower level. Or Mexico and Canada could receive tariff exemptions to soften the negative effects on U.S. manufacturers and consumers. But exemptions are uncertain, and vehicles that do not qualify for tariff-free treatment under new NAFTA rules of origin could still get hit by heavier tariffs. 

Other scenarios could also affect Canadian and Mexican exports. For example, if the United States implements a quota system on vehicle components or without country exemptions, the economic impact for Canada and Mexico could be more severe than with hefty tariffs alone. A quota would limit imports at a specific level, whereas a tariff would merely drive up the price of vehicles, but not necessarily erode exports as severely as a quota. Under a blanket quota system that limits imports to a specific level, NAFTA nations would feel a significant economic impact, though the severity would depend on the quota amount.

A chart compares the auto manufacturing wage in Mexico, Canada and the United States.

The Fallout in Mexico and Canada

Slowing or declining vehicle exports will be a fact of life under any scenario in which the United States forbids or limits exemptions for Canadian or Mexican vehicles and their components. But the impact of tariffs or quotas on Ottawa or Mexico City will extend beyond economic losses. In Mexico, the threat of Section 232 action on its auto exports will probably limit the ability of the next president, Andres Manuel Lopez Obrador, to pursue more ambitious social spending. His administration plans to boost youth work programs and pensions to cement its popularity among voters in future elections. But it most likely won't be able to create extensive, permanent social spending mechanisms to address the country's deep poverty without raising taxes. Yet hefty tax hikes that could spook foreign investors or further affect the country's private sector will probably be taken off the table if the Lopez Obrador administration finds itself trying to mitigate the impact of U.S. automotive trade barriers. 

In Canada, the consequences could be electoral as well as economic. Even if the Trump administration is mainly using automotive tariffs as a negotiating tactic to get Canada to cave on NAFTA negotiations, the government of Prime Minister Justin Trudeau may be in a no-win situation. Auto tariffs would be catastrophic for Canada's U.S.-dependent automotive manufacturing clusters. But to avoid tariffs, the Canadian government would likely have to accept the U.S. demands allowing it to opt out of the treaty's dispute-settlement mechanisms and calling for Canada to reduce import controls on agricultural products such as dairy and poultry. Even if Trudeau avoids automotive tariffs, he could pay the price at the polls in the 2019 parliamentary elections if he opens sensitive economic sectors to U.S. competition. 

Section 232 tariffs will be a major part of the NAFTA trade landscape in 2019, but they are only part of the story. The NAFTA concessions that Washington gets from Ottawa and Mexico City, combined with automotive tariffs, could in the long run dissuade some automotive companies from major investments in either partner nation. This effect won't be universal — after all, there will be companies for which importing vehicles and components, despite heavy tariffs, will be an unavoidable part of doing business in North America. But over the next few months, the United States will likely get Canada and Mexico to agree to stricter rules of origin requirements and could leave some Mexican exports exposed to tariffs — even if they would qualify for tariff-free trade under the current system. The Trump administration is trying to shift the rules of North American automotive trade in its favor as much as possible, and in doing so, it may end up drastically altering investment decisions and trade patterns for years to come.

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