Two years into his presidency, U.S. President Donald Trump is on the brink of implementing one of his trade proposals from his 2016 campaign, a tariff on imported auto vehicles. On February 17, 2019, the U.S. Department of Commerce announced that it had submitted a report to President Trump regarding the national security risks posed by imported auto vehicles and auto parts, paving the way for the Trump administration to impose new tariffs on auto vehicle imports. Under Section 232 of the Trade Expansion Act, the President has the authority to impose import restrictions on products following the submission of a report from the Department of Commerce affirming that the importation of those products “threaten[s] to impair national security.” In a recent Fox Business op-ed, U.S. Commerce Secretary Wilbur Ross criticized U.S. trading partners’ “unfair practices,” mentioning, among other things, that the U.S. tariff rate on auto vehicle imports was too low. In light of this op-ed, it seems highly likely that the Department of Commerce’s report will affirm that auto vehicle imports pose a threat to national security.
How are auto tariffs tied to national security?
The connection between national security and auto vehicle imports is tenuous. German Chancellor Angela Merkel, whose country would be amongst the most economically affected by new U.S. auto tariffs, said that any suggestion that European auto vehicles pose a national security risk to the U.S. was a “shock.” However, the Trump administration’s definition of national security is broader than the traditional military and public safety characterizations. When the White House formally requested the Department of Commerce investigation in May, 2018, Commerce Secretary Ross stated that there was a connection between domestic unemployment and national security and that “economic security is military security.” This argument was the basis for the Department of Commerce’s report on Section 232 and steel and aluminum tariffs issued in January, 2018. That report defined “national security” incredibly broadly and included the necessity of steel as an input for several “critical industries” and military logistics. The Department of Commerce will likely rely on these same arguments for its report on auto imports.
Auto tariffs and the “new NAFTA”: a possible workaround?
If imposed, Section 232 tariffs would not be the Trump administration’s first formal trade policy that addresses auto vehicle imports. The United States-Mexico-Canada Agreement (“USMCA”), the successor to the North American Free Trade Agreement, specifically addresses auto vehicle imports. Annex 4-B of the USMCA Rules of Origin section requires that auto vehicles imported from Mexico or Canada meet strict “labor value content” (“LVC”) requirements or else be subjected to the U.S.’s most favored nation (“MFN”) tariffs. To meet the LVC standards, approximately one third of the production cost of imported auto vehicles must be devoted to high-wage labor. In the State of the Union that President Trump delivered on February 5, 2019, he explicitly stated his goal for the U.S. auto industry under USMCA: “[to] ensure that more cars are stamped with … ‘Made in the USA.’”
However, the USMCA automotive provisions also limit the U.S.’s ability to execute further restrictions on auto vehicle imports from Mexico and Canada, its top two auto vehicle trading partners. According to two side letters that pertain to the Section 232 process, the U.S. must wait 60 days after adoption before applying new tariffs to Mexican or Canadian goods. Two other side letters on Section 232 provide that, even after the 60-day waiting period, the U.S. must still exclude 2.6 million passenger auto vehicles imported from Mexico and another 2.6 million imported from Canada, annually, from any new tariffs. Furthermore, imported auto vehicles that do not conform to the USMCA Rules of Origin, including the LVC standards or the regional value content requirements, are, at a maximum, only subject to the 2.5 percent MFN tariff rate that the U.S. had in effect on August 1, 2018, as long as those vehicles are imported from Mexico or Canada and do not exceed either country’s 2.6 million auto vehicle quota. These Rules of Origin include the LVC standards and regional value content standards, which require that a large percentage of each vehicle’s parts be produced in North America in order to qualify for USMCA tariff rates.
The USMCA side letter on auto vehicles, however, may allow foreign automakers to circumvent massive Section 232 tariffs on auto vehicles with minimal changes to their supply chains. Because the side letter includes exemptions for all Rules of Origin, including the regional value content standards, vehicles that are not produced in North America may also qualify for the lower MFN tariff rate as long as they are exported to the U.S. from Mexico or Canada. Because up to 2.6 million auto vehicles can be exported from both Mexico and Canada to the U.S. at the lower tariff rate, foreign automakers could manufacture auto vehicles outside North America, export them to Mexico, and then from Mexico to the U.S. at the aforementioned 2.5 percent MFN tariff rate. The U.S. imports approximately 2.2 million vehicles from Mexico and 1.4 million from Canada, annually, which is far below each country’s 2.6 million auto vehicle cap. This gives foreign automakers an opportunity to export up to 1.6 million non-originating vehicles to the U.S. via Mexico and Canada, annually, at the previous 2.5 percent MFN tariff rate.
Still, there are economic reasons that foreign automakers may elect not to export to the U.S. via Mexico or Canada. First, any auto vehicles exported to the U.S. via Mexico or Canada would be subject to Mexican or Canadian tariffs unless covered by a trade agreement with Mexico or Canada. Depending on the exact figure of Trump’s Section 232 tariffs, automakers may find paying Mexico’s 28.3 percent MFN tariff rate for standard passenger auto vehicles may not be worthwhile, although foreign automakers may find Canada’s 6.1 percent MFN tariff rate more palatable. However, since Mexico has free trade agreements with Japan and the European Union, and Canada has a free trade agreement with the EU, Japanese and European automakers may make use of this workaround to pay little more than the aforementioned 2.5 percent MFN tariff rate. This makes this workaround a very cost-effective option for Japanese and European automakers, which are responsible for the first- and second-most U.S. vehicle imports outside North America. Second, there are transaction costs involving in importing auto vehicles, such as transportation costs, that foreign automakers must consider because it is possible the workaround increases those costs, and in doing so, makes the workaround costlier than paying the Section 232 tariff. Finally, the workaround would fail to cover all three million vehicles that the U.S. imports, annually, from countries other than Canada or Mexico.
Even if the tariff workaround proves successful, U.S. consumers will end up paying a higher price for auto vehicles while the U.S. auto industry sees little benefit. If foreign automakers elect not to utilize the workaround, but instead, elect to source production in North America, they are more likely to site factories in Mexico than the U.S. Therefore, President Trump’s tariffs may have a minimal effect on national security, no matter how broadly “national security” is defined, as they are not likely to cause automakers to site more factories in the U.S.