The Good News in NAFTA 2.0

Effects Would Have Raised Car Prices

Oct 01, 2018
Logistics

SMITH BRAIN TRUST – Absent from the trade agreement announced late Sunday between the U.S. and Canada are the car tariffs the Trump administration had been threatening to impose. Gary Cohen, at the University of Maryland’s Robert H. Smith School of Business, says that’s a win, not just for the U.S. auto industry, but for consumers, shareholders and the economies of all three countries. 

As recently as last week, President Donald Trump told reporters at a news conference that the administration was looking to impose tariffs on new cars from Canada. “That’s the mother lode. That’s the big one,” he said. “We’re very unhappy with the negotiations and the negotiating style of Canada.”

But slapping tariffs on car imports crossing from Canada into the U.S. was never a good idea, says Cohen, clinical professor of international business, global trade and supply chain management. The effects would have meant higher vehicle prices for Americans, lower share prices for U.S. automakers, and potential job losses across America’s manufacturing sector.

“It is a fact that tariffs raise prices and that ultimately impacts all of us as consumers. Automobiles are the second most expensive purchase for most U.S. consumers, with the first being a home,” he says. 

The proposed new trade agreement, being called the United States-Mexico-Canada Agreement, or USMCA, does include some changes for the auto industry, in particular a stipulation that 75 percent of a vehicle’s value be manufactured in North America, marking an increase from the previous 62.5 percent. 

It would also require that some 40 percent of the vehicle be manufactured by workers making at least $16 an hour. The fine print on that is that white-collar work in North America could account for up to 15 percent of that threshold. That creates an advantage for U.S. automakers, over their German, Japanese and Korean counterparts, because of the amount of research and development done in an automaker’s headquarter countries.

Cohen says significant tariffs would have had a significant impact on the competitive position of U.S. automakers. “I would have predicted a reduction in profits that would certainly threaten share prices and the market caps of American automakers,” he says.

The economies of the three partner countries – Canada, the U.S. and Mexico – likely would have seen at least short-term repercussions as well, particularly if the countries began to engage in retaliatory tariff actions, like the ones being lobbed back and forth between Washington and Beijing. 

There are 37 states that count Canada as their No. 1 trading partner, another 10 states that list it as No. 2 or 3. A trade war would carry large potential downstream effects on the economies of those 47 states.

“There are generally unintended consequences in these situations and the consequences could be worse than the benefits of our actions,” Cohen says.

How NAFTA transformed the industry

The free trade agreement between the United States, Canada and Mexico fundamentally changed the way automobiles are manufactured in North America.

“In post-NAFTA years, American automobile manufacturers capitalized on efficiencies through arbitrage by building automobile assembly plants in Mexico and Canada, knowing that shipment back into the U.S. would be tariff-free,” Cohen recalls. “Investment in these plants was significant.”

In 2017, GM made 400,000 large pickup trucks in Silao, Mexico, a plant that today produces the Chevrolet Silverado, the GMC Sierra and various propulsion systems.

Its plant complex in Oshawa, Canada, meanwhile makes the Chevrolet Equinox, the Cadillac XTS and the Chevrolet Impala. 

Chrysler produces its Pacifica and 300 in Ontario, along with the Dodge Challenger, Charger, and the Grand Caravan. The Dodge Journey, Fiat 500 and Jeep Compass are produced in Mexico. 

And Ford Motor Company assembles its Edge, Flex and Lincoln MKX and MKT in Canada. 

The manufacturing of many vehicle parts and components, meanwhile, are spread across all three countries.

Those supply chains can’t easily be unraveled. Repatriating production of vehicles back to the U.S. from Canada or Mexico would be “a costly and disruptive endeavor,” Cohen says. 

“We’d be looking at a huge Capex (capital expenditure) when setting up assembly plants, and large tariffs would force the abandonment of these plants in Mexico and Canada or risk a non-competitive position and eat away profits,” he says. “Moving the assembly back to the U.S. would require an additional Capex domestically for automakers. Additionally, this repatriation would void the prior benefits of arbitrage and threaten ongoing profits.” 

Automakers couldn’t simply move production from one country to another without major impact on costs of goods sold (COGS), Cohen says. “If it could have, it would have been unlikely that the automakers would have chosen to move production out of the U.S. in the first place,” he says.

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About the Expert(s)

CohenGary

Gary is a Clinical Professor of International Business, Global Trade and Supply Chain Management. He has served as the Associate Dean of Executive Programs and was the founding Academic Director of the Master of Science program in Supply Chain Management. Gary has led Undergraduate, MBA and Executive MBA Consulting Projects in the U.S., Europe, South America and Asia, and has served as an Executive Coach in the Executive MBA program.

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