U.S. Gives Japan and the E.U. Ultimatum to Negotiate a Deal to “Limit or Restrict” Auto Imports Within 180 Days

U.S. Gives Japan and the E.U. Ultimatum to Negotiate a Deal to “Limit or Restrict” Auto Imports Within 180 Days

Executive Summary

  • Amid expectations that U.S. President Trump would decide on whether to impose tariffs on imported cars and auto parts by May 18, it now seems likely that he will sign an executive order this week that will give Japan and the European Union 180 days to negotiate a deal to restrict imported cars and auto parts.
  • Auto restrictions would mainly target countries with an export-oriented automotive industry such as Japan and Germany, while Canada, Mexico and South Korea would be exempted. Car manufacturers and suppliers with operations in the U.S. and those exporting vehicles and car parts to the U.S. would be affected by the restrictions.
  • In the long term, auto makers may shift to increase production in plants in Canada, Mexico or the U.S. to avoid quotas and reduce their dependence on imported goods. Export-oriented production may also be relocated outside of the U.S. to avoid limited domestic supply. 

According to media reports, U.S. President Donald Trump will sign an executive order on May 17 that will give Japan and the European Union 180 days to negotiate a deal to “limit or restrict” imported cars and auto parts. The executive order reportedly cites that American innovation capacity is at “serious risk” because auto and parts imports have displaced U.S.-owned production. It has also been suggested that the U.S. government will refrain from imposing tariffs for up to six months while trade negotiations continue with the E.U. and Japan. 

The announcement comes after reports on May 15 that President Trump would delay his decision by six months on whether to impose tariffs on imported cars and auto parts on national security grounds following findings and recommendations submitted by the U.S. Commerce Department on February 17. The investigation was originally initiated on May 23, 2018 to determine whether automobile imports – including auto parts, light trucks, vans, and SUVs – threaten national security as defined under Section 232 of the Trade Expansion Act of 1962. 

Despite not having been released to the public, the Section 232 report was rumored to have offered three recommendations: (1) increase blanket tariffs on autos and auto parts ranging from 20 to 25 percent; (2) impose targeted tariffs on automated, connected, electric, and shared (ACES) vehicle technologies; or (3) choose a middle ground between the two options. 

Potential Impact on Global Auto Markets

European Union and Japan affected; South Korea, Canada, and Mexico exempted

If enacted, the Section 232 auto restrictions would mainly target countries with an export-oriented automotive industry such as Japan and Germany, for which the U.S. constitutes a major market. Other E.U. countries which would be significantly impacted by the restrictions are Austria, Italy, and the UK. Both Canada and Mexico, the top car exporters to the U.S., would be exempted from future restrictions as the U.S.-Mexico-Canada Agreement (USMCA), the successor to the NAFTA agreement, already includes quota arrangements. South Korea has also been exempted from the import quota via the U.S.-Korea Free Trade Agreement. And car parts imports from China are already partially subject to 25 percent tariffs since May 10. 

COUNTRYAUTO PARTS IMPORTS INTO U.S. U.S. IMPORTS OF NEW PASSENGER VEHICLES AND LIGHT TRUCKS U.S. IMPORTS OF MEDIUM AND HEAVY-DUTY TRUCKS STATUS
Canada17.538.42.6Exempted via USMCA
China20.11.30.2Subject to 25 percent tariffs
Germany9.618.20.4Must “limit or restrict” imports within six months
Italy0.84.50.4Must “limit or restrict” imports within six months
Japan16.140.30.7Must “limit or restrict” imports within six months
Mexico59.452.612.1Exempted via USMCA
South Korea8.913.8N/AExempted
United Kingdom2.09.50.5Must “limit or restrict” imports within six months
TABLE 1: U.S. VEHICLE AND AUTO PARTS IMPORTS (USD, BILLIONS). Source: International Trade Administration (2018)

Domestic and foreign OEMs equally affected

Two groups of car makers or Original Equipment Manufacturers (OEMs) are likely to experience the brunt of import restrictions on auto parts and cars. First, large OEMs with a strong manufacturing footprint in the US, including the likes of mainly GM, Ford, Fiat Chrysler, Nissan, Honda and Toyota, will face a more limited supply from foreign suppliers, with local suppliers likely to raise prices due to stifled competition from abroad. Since U.S. tariffs on steel and aluminum came into effect in March 2018, U.S.-based manufacturers have already been forced to deal with higher costs for intermediate products, which would either reduce profitability if absorbed by car makers or reduce market share if passed on to customers. Second, auto restrictions would also affect major OEMs, like Toyota, GM, and Fiat Chrysler, which produce cars outside of the U.S. before shipping and importing them into the U.S. as finished vehicles.

Figure 1: Foreign-built vehicle imports to the U.S; Source: Financial Times 

Sub-tier suppliers may face increased financial difficulties

Import restrictions on car components could also pose a substantial credit risk for both U.S. based suppliers relying on parts imports and foreign suppliers relying on exports to the U.S. Unless they find alternative markets elsewhere, restrictions could exacerbate financial difficulties, most notably for companies with an already poor liquidity situation. Rising costs for steel and aluminum since 2018 have already negatively impacted many suppliers’ profitability and cash flow, such as Tier-1 supplier Aisin Seiki, which faced additional material costs in the U.S. of USD 9.1 million (EUR 8.1 million). Switching to a local sub-tier supplier for key components may require a lengthy certification process while suppliers may be faced with limited, and thus costlier, supply in the meantime.

Potential shifts in supply chains: from global to local?

As it takes years for a company to expand or reduce its manufacturing footprint in a particular country to avoid the impact of import quotas, car makers and suppliers are faced with limited options to modify supply chains in the short term. In the long term, OEMs could shift to or increase production in existing plants in Canada, Mexico, or the US to avoid quotas on cars and reduce their dependence on imported goods. However, it could take a number of years for OEMs to replace overseas suppliers with domestic ones amid fierce competition, and there may sometimes be no local alternative to key components from specialized foreign suppliers. OEMs could also shift production out of the US for export-oriented plants which heavily rely on car parts imports. BMW, for instance, has started building more SUVs in China as US tariffs on steel and aluminum significantly cut into the company’s earnings. Restrictions on car parts imports may further accelerate such trends.

Outlook

The reported auto import quota and pending Section 232 decision comes amid ongoing U.S. trade negotiations with the E.U. and Japan which remain in its early stages. Although reports suggest that the U.S. government will not raise tariffs amid trade negotiations over the next six months, President Trump has repeatedly threatened that the U.S. could impose tariffs on vehicles and auto parts to win concessions from Japan and the E.U. in the past.

The E.U. is aiming to conclude a deal before the end of 2019, but has vowed to retaliate against EUR 20 billion (USD 22.4 billion) worth of U.S. exports if Washington were to escalate matters. Against U.S. concerns about the trade deficit with Japan, Japanese Prime Minister Shinzo Abe reportedly pledged to invest USD 40 billion (EUR 35.7 billion) in new car factories in the United States following a first round of negotiations in April 2019. 

To avoid import restrictions on cars and auto parts, several key roadblocks would have to be lifted in U.S. trade negotiations with the E.U. and Japan. First, the U.S. insists that any trade deal with the E.U. would have to involve agriculture to win approval by the U.S. Congress, a no-go area to the E.U. as this may include topics such as biotechnology and genetically engineered ingredients. Second, Japan insisted that any new trade deal would need to provide Japanese goods better access to the U.S. market, and would not be negotiated under a more wide-ranging framework that includes investments and services. 

No schedule for the next round of negotiations has been released yet. 

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