Automobiles are vital to the everyday life of American citizens. Now, this already pricey product is in danger of becoming even more expensive. Under the North American Free Trade Agreement (NAFTA), automobile manufacturers can meet certain rules of origin standards that allow for duty free import into other NAFTA countries. The opening of renegotiation of NAFTA under the Trump Administration has raised concerns in this regard from automobile manufacturers, as well as the Canadian and Mexican trade representatives. This also should raise concern for American consumers. A stricter rules of origin content requirement can lead to higher production costs, thus leading to higher costs for consumers.
NAFTA Rules of Origin
The current North American Free Trade Agreement (NAFTA) establishes rules of origin, which separate the necessary qualifications into autos and other light weight vehicles plus as other heavy-duty trucks. For products to benefit from the agreement via duty-free access, the two categories face a value-added content requirement of 62.5% and 60% respectively. NAFTA has allowed for enormous growth in the automotive industries among NAFTA members, especially exports to the United States. In 1995, one year after the agreement took effect, car exports to the United States from Canada was $24.9 billion and $5.9 billion from Mexico. By 2015, these numbers climbed to $43.5 billion from Canada and $25 billion from Mexico. From 2002 to 2016 alone, U.S. exports of motor cars and vehicles (HS 8703) increased by more than 50 percent (Figure 1).Source: Trade Stats Express
Response to Proposed Changes
With the recent comments of disapproval from the US Chamber of Commerce, it is prudent to take a step back and understand what the changes being pushed by the Trump Administration would mean for the automotive industry. The key provision to look out for is the aforementioned rules of origin. An alternation of this clause could potentially lead to higher cost for car manufacturers, in turn leading to higher costs for consumers.
In the 23 years since NAFTA’s inception, the auto industry has constructed complex yet efficient supply chains that allow for production, especially in Mexico to be cheaper than if it were produced in the United States. U.S. manufacturers contest that, in its current form, NAFTA has allowed Mexico to become “an essential location for low-cost automotive parts and vehicle production.” Kristin Dziczek, director of the Industry, Labor & Economics Group at the Center for Automotive Research, argues that a potential raise to even 70% could push manufacturers to find new suppliers at likely higher costs. These higher costs for manufacturers could manifest as higher product costs for consumers. Furthermore, “if this were to be raised to, say, 75-80%, one would expect fewer inputs from Asia and higher component and finished vehicle costs. This would place pressure on the profit margins of both OEMs [Original Equipment Manufacturers] and suppliers.”
In addition to the concerns being raised about a hike in the regional content requirement for NAFTA, the Trump Administration is pushing for a US content requirement as well. Adding a US content requirement in combination with an increase in the regional content requirement would only exacerbate auto industry production cost concerns.
During the fourth round of NAFTA negotiations, which are scheduled for October 11-17th and have been labeled as contentious, concerns about the end of the agreement have emerged. Should the United States end the trade deal and place tariffs ranging from 10 to 35%, it is estimated that the price of a car would increase from $5,000 to $15,000.
NAFTA, like it or not, has allowed for massive expansion of inter-country trading for the US, Canada, and Mexico. One of the industries who has benefited from the agreement is the automotive industry. They have established large complex supply chains that allow for cheaper production in Mexico, which, in turn, lowers the cost for consumers. However, the Trump Administration’s push for an increase in the Rules of Origin content requirement regionally and the establishment of a US content requirement threatens these long-established supply chains. Forcing manufactures to find new suppliers that will raise their cost of production not only causes concern for the industry, but should raise concerns for the everyday consumer as well. A ratification of a new NAFTA agreement with these increases can damage the bottom line of car manufactures. However, the ones who will most likely feel the brunt of the rise in production costs are those who purchase the final product.
Jordan Victor is currently a research intern with the Global Research Institute of International Trade. To learn more about Mr. Victor, click here.
The views expressed in this piece are solely those of the author and do not necessarily reflect the opinions of the Global Research Institute of International Trade (GRIIT).
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Update: Figure 1 added on October 24, 2017 at 9:15 p.m. PST