Today, much of the Western world is holding its collective breath, wondering what comes next as U.S. President Donald Trump threatens to pummel the global auto industry with tariffs on imports. In 2017, the United States imported $350 billion worth of vehicles and parts, most of which came from Canada, Mexico, the European Union, Japan and South Korea — all U.S. allies. But just as he did with steel and aluminum, Trump is threatening to levy tariffs totaling as much as 25 percent on the vehicles and parts of his country's closest allies as part of a Section 232 national security investigation. In doing so, Trump is threatening to upend seven decades of consistent integration in the global automotive industry — something that could have grave ramifications for all.
The United States is threatening to enact tariffs on finished vehicles in its latest trade offensive against the rest of the world. The threats ultimately form part of President Donald Trump's trade negotiations, but as seen during recent steel and aluminum negotiations, a collapse in talks can lead to the implementation of tariffs on all fronts. Because of deep integration in the global auto industry, the imposition of tariffs would reverberate around the world. Given the significance of the issue, Stratfor is embarking upon a series that will cover the implications on both a global and a national level.
Integration Gives Way to Indignation
The U.S. automotive industry grew rapidly starting in the 1950s, thanks to the country's post-war economic boom and the National Interstate and Defense Highways Act of 1956, which established interstate highways. Initially, Detroit's big three automotive manufacturers, Chrysler, Ford and General Motors, dominated the U.S. and Canadian automotive industries to the degree that the latter's auto manufacturers pushed for a complete integration between the two countries' car industries. Since the 1965 Auto Pact (APTA), the two have become so intertwined that Washington does not even bother distinguishing between American and Canadian production for some statistical purposes.
But Canada was just the first country to strive for a slice of the U.S. automotive pie. Because of the 1973 Oil Crisis, Detroit's gas-guzzling cars became a drain on consumers' pocketbooks, offering an average fuel economy of no more than a paltry 11.9 mpg. Across the Pacific, carmakers in Japan — a country dependent on oil imports — had already prioritized small cars with a higher fuel economy, enabling them to enter the U.S. market after the oil crisis. Unsurprisingly, the influx of Japanese cars engendered resentment from U.S. automakers and elicited threats from Washington. In response, Tokyo agreed to limit the number of Japanese vehicle exports to the United States.
To circumvent these constraints, many Japanese carmakers began to invest in new final assembly plants in the United States and Canada, creating a legacy that continues to this day — even as their North American competitors have flown the roost for other shores. Of the 20 best-selling light-duty vehicles in the United States in 2017, just five featured a significant number of components (50 percent or more) that were produced in the United States — and all five models were Japanese.
More change occurred in the 1990s, including the North American Free Trade Agreement (NAFTA) and the emergence of the World Trade Organizations. NAFTA effectively transformed the APTA into an automotive bloc with Canada, Mexico and the United States. And because Mexico — then as now — offers lower wages than its northern counterparts, many labor-intensive aspects of the automotive value chain (such as parts with intricate wiring) have moved there.
From a purely macroeconomic perspective, the globalization of auto value chains has doubtless benefited the United States and many others by keeping prices stable for consumers. From a political perspective, however, the repercussions have been enormous since imports and other factors such as automation have decimated local industries, eliminating jobs. Even if assembled domestically, foreign cars provide a visible representation of the rise of imported cars and — for communities dependent on manufacturing — the related elimination of domestic industries and jobs. And it is, of course, such communities that Trump is now vowing to protect.
The Links Between: The Global Auto Industry Today
The globalization of the auto sector has also aided global automakers, who have necessarily integrated to reduce costs and handle turbulence. Today, just 14 companies produce the vast majority of the planet's top-selling car brands. Given such integration, it is no surprise that none of the United States' big three automakers or organizations lent their backing to Trump's tariffs during public hearings in the country — in stark contrast to the U.S. steel industry's enthusiastic support for tariffs in similar hearings.
Similar to North America, European carmakers have also integrated since World War II. As a result of the European Union's eastward expansion, Western Europe's auto juggernauts like BMW and Volkswagen have constructed deep and complex value chains that penetrate the Continent, taking advantage of a cheap labor supply in Central and Eastern Europe — areas with long-established auto sectors.
Supply chains elsewhere, however, do not rival those in North America and Europe in terms of complexity. For example, just 14.5, 10.2 and 4.3 percent of the inputs for the respective South Korean, Japanese and Chinese auto industries come from overseas, according to estimates from the World Input-Output database. By contrast, the figures for the European Union's largest car producers (France, the United Kingdom and Germany) are each 33 percent or higher. The difference stems from the Asian development model, in which each country erects high trade barriers — either through tariffs or non-tariff barriers — to protect domestic industry, thereby reducing integration with neighbors (who they also view as competitors). Nevertheless, South Korea and Japan are naturally heavily dependent on exports, and many of their companies are integrated into global supply chains.
Today, the United States remains heavily dependent on vehicle imports, as just 52 percent of the cars sold in its market last year were produced domestically. As a result, the United States applies a tariff of just 2.5 percent on light-duty vehicle imports (in contrast to the EU level of 10 percent) — a level that makes sense given its production restrictions. Even if U.S. vehicle assembly lines operated at 100 percent efficiency, the country would still need to import roughly one-third of its vehicles, meaning any large tariff on such imports would represent nothing more than a tax on U.S. consumers.
The United States imported 8.3 million automobiles in 2017 and exported just 2 million, producing a trade deficit in the auto sector of $195.4 billion, or a third of the country's total trade deficit. And given Trump's abhorrence of trade deficits, it should come as no surprise that the president has prioritized an ostensible rectification of the automotive trade imbalance while demanding global auto producers reduce their barriers to match those of the United States.
Trade Barrier Threats as a Tool in Talks
At heart, Trump may be a protectionist who is willing to inflict short-term pain at home on the U.S. economy — especially as it enjoys some of its strongest recent economic growth — in the hope of solving what he views as a long-term problem: a persistent U.S. trade deficit. Trump may accordingly follow through on his threats to enact the Section 232 tariffs, but even if not, the threats alone might be enough to achieve his goals at present during trade negotiations.
Ultimately, however, Washington's goals depend on the trading partner in question.
The NAFTA talks, the United States' biggest current priority, stalled prior to the latest push by Mexico City and Washington to seal a quick deal. In terms of the auto sector, Washington has demanded that workers earning at least $16 per hour produce 40 percent of NAFTA-eligible vehicle content — a factor that could greatly hurt Mexican auto workers, who make less than $5 per hour on average. The U.S. threats, however, have forced Mexico to cave into some U.S. demands: Mexican Economy Secretary Ildefonso Guajardo said last week that his country had begun to negotiate wage requirements that would be included in rules about NAFTA vehicle eligibility.
Canada, however, has been slow to accept some of the United States' demands. The level of confrontation in the pair's auto negotiations has decreased since Washington dropped a demand for a U.S. content requirement, but Ottawa is gearing up for more contentious fights. Canada wants to protect its dairy supply chain management system and softwood lumber industry — two areas the Trump administration has specifically highlighted — and is hoping to protect a NAFTA dispute settlement mechanism, unlike the United States. In the end, Washington is likely to use the threat of vehicle tariffs to push Canada to finalize a NAFTA deal and cave on other issues. After all, auto tariffs could plunge Canada into a recession and put Prime Minister Justin Trudeau in a vulnerable position ahead of 2019 elections.
Ultimately, the degree of integration in NAFTA might make U.S. tariffs against the Mexican and Canadian auto sectors more trouble than they're worth. Indeed, a Center for Automotive Research study released in July reported that if the United States slapped a 25 percent tariff on all vehicles and parts, it would cost the country at least $59.5 billion in gross domestic product and eliminate 715,000 jobs — even before trading partners enacted any retaliation. In contrast, if the United States carved out exemptions for Mexico and Canada, the hit would total just $15.3 billion of GDP and 197,000 jobs before retaliation. The United States could allow NAFTA-eligible cars and vehicles to go unscathed, while still applying higher tariffs to vehicles that do not meet the criteria to qualify for NAFTA conditions but are still imported from NAFTA members. (These are a relatively small percentage of total U.S. auto imports.) But if the United States' immediate neighbors can rest relatively easily, South Korea, Japan and the European Union all face sleepless nights ahead.
In Asia, the United States' demands are vaguer, suggesting the ultimate goal may be more about protecting the U.S. market than anything else. Seoul believed it had finalized a new South Korea-United States Free Trade Agreement (KORUS), but an agreement has proved elusive — and could even be rendered moot if Trump enacts tariffs on Korean cars. To the east, the United States could be using the threat of tariffs against Japan to bring Tokyo to the table for a bilateral deal. The two had hoped to start talks soon after Trump pulled out of the Trans-Pacific Partnership (TPP) last year, but Tokyo has been hesitant due to Washington's onerous demands on other trade matters. If Tokyo can avoid vehicle tariffs during trade talks — talks which, according to U.S. law, would last nearly a year even based on an accelerated timeline — it may behoove it to do so. Still, some of Japan and South Korea's biggest carmakers assemble 40 percent or more of their vehicles in the United States, meaning they could escape some of the wrath that their European counterparts will not.
Though the United States and European Union have played up talks of a trade truce, the sense of disagreement is palpable on both sides of the Atlantic. Brussels has said that ongoing comprehensive trade talks include auto tariffs, but Paris has balked at any inclusion of agriculture, saying that any agreement would only cover industrial goods. Berlin, which stands to lose the most if Washington imposes auto tariffs, has entertained hopes that a small trade deal on industrial goods could appease the United States.
Yet, contrary to Berlin's expectations, the U.S. demands don't appear to center on the auto sector but rather on other barriers, including agricultural ones. Because the carefully worded language of the agreement announced at a recent meeting between European Commission President Jean-Claude Juncker and Trump excluded both agriculture and vehicles, it is likely that the United States is holding back on vehicle tariffs in exchange for agricultural concessions. Such an exchange makes sense from Washington's perspective because it knows that even if the European Union's auto tariffs drop to zero, the United States does not have the spare auto manufacturing capacity to export large volumes to the bloc and will never be competitive in areas dominated by Germany. Its agricultural exports, on the other hand, are more competitive, but a deal might prove difficult due to the unlikelihood that France and others will accept U.S. demands on agricultural imports and standards — meaning the United States could ultimately impose vehicle tariffs.
Who Blinks First
The Trump administration's heavy-handed strategy may produce trade deals, but it also carries many risks. To understand the potential repercussions, one need look no further than the national security investigations on steel and aluminum, in which talks collapsed and the United States imposed tariffs, triggering retaliation. Other nations might not play ball with the United States and some, including Canada and the European Union, have already threatened to respond in kind and/or begin drafting lists of U.S. goods to target in retribution.
The potential for damage will vary from company to company and country to country depending on who — if anyone — receives exemptions. Japanese and Korean carmakers like Toyota, Kia, Nissan, Subaru, Honda and Hyundai are best-placed to ride out the storm thanks to their many final assembly plants in North America, even if their import parts from back home could be hit by tariffs. In contrast, German carmakers — and, accordingly, automakers in Central and Eastern Europe — stand to fair the worst as Volkswagen, BMW and Audi all have little manufacturing presence in the United States.
Naturally, the rest of the world's major auto producers will attempt to mitigate the impact of the tariffs. Already, the United States' turn toward protectionism has facilitated a raft of new trade deals among other countries; Mexico City and Brussels inked a tentative deal in April, followed three months later by a pact between Japan and Brussels. The biggest deal, however, occurred in March, when members of the Trans-Pacific Partnership (TPP) trade agreement that the United States abandoned last year signed a successor agreement, the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP). The deals have reduced multilateral trade barriers on automotives and other trade — as well as U.S. exporters' competitiveness around the world. And while all such CPTPP signatories might feel some short-term pain from U.S. tariffs, the countries, workers and companies affected will be better able to survive Washington's trade measures if they become long-standing.
As U.S. leaders consider their next course of action, the stakes surrounding potential auto tariffs are higher than they were for steel and aluminum. If the United States provides no exemptions when imposing a 25 percent tariff on auto sector imports, it could cost over a million U.S. jobs and even plunge the country into a recession, especially amid China's retaliation against previous U.S. tariffs. Needless to say, such a scenario could devastate chances for Trump and the Republican Party in 2020 elections. And unlike the steel and aluminum industries, the U.S. auto sector opposes the tariffs, while proposals in Congress to restrict the president's authority on Section 232 investigations continue to gain momentum.
The most likely proposal thus far may be one in the Senate by former U.S. Trade Representative during the Bush administration, Rob Portman. His proposal wouldn't require Congressional support to move forward with 232 tariffs like previous ones, but it would make the Pentagon, rather than the Department of Commerce, responsible for the initial determination of whether imports harm national security. It would also allow Congress to pass motions of disapproval on the tariffs that would nullify them if they get a two-thirds majority.
Many moving parts remain in the national security investigation. Given the United States' reliance on imports, the Commerce Department could push back on Trump and recommend more narrow tariffs. A reduced tariff — at around 10 percent, and only targeting non-NAFTA members — would do far less damage to the world, and the United States, than the more extreme scenarios. The Commerce Department could also only back tariffs on finished cars, not parts, so as to not hurt U.S. assembly plants. Still, it's possible that Trump will decide to follow through on his threats anyway, prompting an event with repercussions that would reverberate around the world.