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Sticker shock: Trump’s new trade deal could bring higher car prices

Sticker shock: Trump’s new trade deal could bring higher car prices

By MEGAN CASSELLA and ADAM BEHSUDI

October 9, 2018

President Donald Trump’s new North American trade deal could lead to some increased investment in the U.S., as he promised — but it will come at a price to consumers.

The newly struck three-way agreement includes numerous strict new rules requiring auto manufacturers to source a significant portion of their cars from within North America if they want to be able to sell to consumers in the region without paying tariffs. It also leaves open the possibility that Trump could blow up the status quo by increasing auto tariffs beyond their current level.

The result is that automakers are left with a choice: They can either build cars in the three countries to avoid the penalties, or keep their facilities elsewhere and face a risk of paying tariffs that Trump could ratchet up at any time.

By design, the United States-Canada-Mexico Agreement has taken the flexibility out of investment decisions being made based on market conditions rather than dictates in a trade pact. It also runs counter to manufacturing trends because the auto industry has grown to rely on increasingly complex international supply chains.

Forcing companies to comply with costly regulations and move their operations or find new suppliers will also push up the costs of cars. That could backfire by reducing consumer demand and consequently leading to a loss — rather than an increase — of jobs, economists and analysts warn.

“This is crazy,” said Jeffrey Schott, a senior fellow at the Peterson Institute for International Economics. “Essentially what this means is they are mismanaging trade.”

The result, Schott continued, is that the new rules may “screw things up so badly that people throw their hands up in disgust, that people say, ‘Oh, heck with it … I’m just going to do my business in the United States.'”

One industry source said auto companies now feel as if their hands are tied. The source said a lot of companies would probably pay the current 2.5 percent tariff for autos and parts that don’t comply with new rules rather than change their supply chains. But the deal creates uncertainty over whether that tariff might increase at some point.

“Given that it’s unclear what the tariff will be, they obviously can’t determine what they can do,” he added.

Countries outside of North America are also facing the threat of new U.S. tariffs on imports of autos and auto parts as part of a national security investigation that the president ordered. Mexico and Canada agreed to export caps in order to avoid those tariffs. The law has already been used to levy tariffs on imports of steel and aluminum.

“If I wanted to be absolutely sure that I could access 17 million annual U.S. car buyers, Canada is a safe bet, Mexico is now a safe bet,” said Flavio Volpe, president of the Canadian Automotive Parts Manufacturers’ Association. “But the only guarantee is the U.S.”

For U.S. Trade Representative Robert Lighthizer, however, forcing the auto industry to relocate operations to higher-cost places was what was intended, even if it means less profits for automakers.

“Some businesses and some Wall Street guys will have to figure out another way to make a fortune,” he said last week on the “Laura Ingraham Show.”

He also dismissed the the view that vehicle costs could increase significantly. “All the major auto companies — General Motors, Ford, FCA, which used to be Chrysler, Honda and Toyota — have all said this is fine, they can work with this,” Lighthizer said.

Changing NAFTA’s rules on auto production as a way to bring jobs and productions back to the U.S. was a major goal for Trump and Lighthizer from the outset. In the new agreement, strict rules mandate that three-fourths of an overall car — and three-fourths of core parts like engines and transmissions — must be made up of materials and parts sourced from within North America, up from 62.5 percent in the original agreement.

They also require 40 percent of a vehicle be built by workers earning at least $16 an hour and that at least 70 percent of the steel and aluminum used in a car comes from North America. Those new rules will be phased in over a period of three to five years.

Reaction from auto companies has been mixed. Ford and GM praised the deal. However, the Global Automakers group, which represents Honda, Toyota and other foreign automakers who build some of their cars in the U.S., said the cost and complexity of complying with the pact’s “new auto rules will pose serious challenges for U.S. automakers.”

The new agreement’s language is not straightforward on how much in tariffs auto companies would have to pay if they don’t comply with the production rules.

Embedded in the text is a provision that leaves open the possibility of the U.S. raising its baseline 2.5 percent tariff on cars and parts. Under that language, if the U.S. decides to raise its tariff, companies will still have to meet the original NAFTA’s 62.5 percent content threshold if they want to continue to be subject to the 2.5 percent baseline rate. That basically locks a company into the new rule or the old rule without being able to be exempt completely.

“The mindset is you can always fall back on the [2.5 percent] rate,” said Ann Wilson, senior vice president at the Motor and Equipment Manufacturers Association, the primary trade association representing auto suppliers and parts manufacturers. “Ambassador Lighthizer and President Trump have been very aware that’s been at the back of people’s minds. That may not be a successful strategy for folks.”

The final deal also set up quotas for both Canada and Mexico, limiting the number of vehicles they can export to the U.S. Both countries agreed to the limits to avoid being hit with potential tariffs on autos that Trump has insisted are necessary to protect national security.

The industry hasn’t raised the alarm over the caps since they offer room for a huge amount of growth, which is unlikely to happen as auto sales are expected to plateau in the coming months. But in general, the industry has raised concerns about any sort of constraints.

“It’s an insurance policy of sorts, but this industry does well in its free flow of goods,” said Wilson of MEMA. “Caps and quotas run counter to how we best produce jobs and manufacture in the U.S.”

The investment that might flow into the U.S. — primarily from international companies who may need to localize production of expensive core parts — would likely be “all on the margin,” said Kristin Dziczek, vice president of industry, labor and economics at the Center for Automotive Research.

“I don’t know that the market is robust enough to support a tremendous amount of new investments in North America,” she said.

Japanese companies have already announced a record-setting amount of new investments in the U.S. in 2017, including a $1.6 billion joint venture from Toyota and Mazda to produce vehicles in Alabama. Because of consumer demand, it’s unlikely the market could bear any more significant expansion in production capacity.

“To make considerable new investment plans and commitments at this point may just not make business sense regardless of what the tariff structure is,” said one industry source.

Although Lighthizer rejected the idea that the new rules could raise costs, other White House advisers were more circumspect. White House economic adviser Larry Kudlow, for one, acknowledged last week there had been “some grousing around the cost issues.”

“Let’s look at it. I’ll say maybe,” Kudlow said at an event in Washington. But he made it clear that the new trade deal never would have come about without some sort of strict revamp of auto rules.

“That was a must,” he said. “We didn’t want to lose any more jobs.”

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