What are the risks facing the global automotive sector in 2019? This question is obviously worrying all players in the sector and indeed beyond, as the industry has a material multiplier effect on other sectors and particularly on its upstream industries such as steel and aluminium, chemicals and plastics, as well as on downstream sectors like ICT and retail.
There are four main risks to watch for in 2019, namely the possible imposition of 25% tariffs on US car imports (related to the Section 232 investigation), the impact of Brexit, Sino-US trade tensions and a drop in Chinese demand for cars. The trade war between China and the USA which, on 6 July 2018, led to the imposition of 25% tariffs on each other’s vehicle imports, is already hurting car producers. However, the truce announced in early December should lead China to lower its tariffs on imports of US cars and components from 40% to 15%, the level in force before the tensions arose. In total, exports to China of German cars assembled in the United States fell by one third in the first 10 months of this year, according to the German Association of the Automotive Industry (VDA). Falling sales of new vehicles in China probably accounts for part of this development.
In this analysis, we will focus exclusively on the direct risk posed by the possible introduction of a 25% tariff on US imports of cars and components following the national-security-related Section 232 investigation. The analysis will focus on the scope of the Section 232 investigation, i.e. finished vehicles and their components. We will use the term ‘cars and parts’ to refer to these areas in the analysis below.
Section 232 as part of the America First policy
In late May 2018, the US Department of Commerce launched a Section 232 investigation in order to determine whether imports of vehicles and car parts posed a threat to US national security. If so, this could lead to the imposition of tariffs on all car imports regardless of origin. At the end of February 2019, we should find out whether national security is threatened and therefore if tariffs will be proposed. The President will then have 90 days to decide whether to impose any tariffs, followed by a 30-day implementation period. We may therefore see the formalisation of tariffs at the end of June 2019. However, when he imposed the tariffs on steel and aluminium previously introduced in connection with the same Section 232 investigation, Mr Trump acted faster than the timescale outlined above. In addition, the announcement by General Motors in late November 2018 that it would be closing four factories in the USA, one in Canada and two more outside North America (in addition to one in South Korea, as previously announced) could also push Mr Trump to impose tariffs faster.
What would be the direct impact on the US national car and parts market?
The impact of the tariffs will be different for each company and each model of vehicle affected. Indeed, the proportion of components imported from outside the United States-Mexico-Canada Agreement (USMCA) area varies significantly from model to model. Similarly, each company assembles some models in the USA while importing others from abroad. As a result, the tariffs will hit each model and firm differently depending on their business structure. The impact will also depend on the elasticity of demand for new vehicles, but it is likely that a significant increase in the price of any one model may divert demand to other models. A model made in the USA with a high level of imported parts will see its price increase more significantly than those using fewer imported parts. Demand for vehicles with few locally produced parts is therefore likely to fall significantly.
According to a study by the Centre for Automotive Research (CAR)1, a scenario in which the USA imposed a 25% tariff on all car and accessory imports, applicable to all trading partners outside the USMCA region, would see the cost of the average vehicle sold in the USA rise by $2,450 on average, with the price of a vehicle assembled in the USA rising by $1,135 and the price of an imported vehicle increasing by $3,980. Since the price increase for imported vehicles would be higher than for vehicles assembled in the region, the latter would gain in competitiveness and market share in comparison to foreign-made vehicles. A fundamental assumption of this study is that a change in the average price of a car following the implementation of the US tariff will be offset by a proportionate change in total sales volumes, such that the sector’s overall turnover will not be affected. However, since costs are increasing, the average margin for manufacturers and dealers would be revised downwards and the imposition of tariffs or quotas would therefore be detrimental to the US industry.
The CAR report suggests that those impacts may be underestimated for different reasons. Firstly, the cost of repairing and maintaining vehicles could rise as a result of increased component costs, resulting in losses for downstream businesses within the automotive industry. In addition, as the market price of new cars is strongly correlated with that of used cars, an increase in the former would lead to an increase in the latter.
Finally, the study does not take into account the fact that components sometimes cross the border several times before finally being sold in the USA. This could result in an exponential increase in the prices of components and ultimately of finished vehicles. In addition, the study does not take potential retaliatory measures into consideration, which would further reduce the profits of US manufacturers and factories.
Which countries are being targeted by the America First policy?
To answer this question, we need to understand the objectives behind Mr Trump’s tariff dance. Firstly, he wants to reduce the trade deficit with partner countries, whether they are allies or not. Second, he wants to ‘bring back’ jobs to the USA. Finally, he is an advocate of fair trade, by which he means that customs duties should be the same for foreign products entering the USA as for the American goods imported by foreign countries. The car industry is one of the first sectors to be targeted (after steel and aluminium) because the United States has a significant trade deficit in that sector, foreign firms are relocating outside the USA, and the US import tariffs currently in force are lower than those levied on equivalent US products in partner countries.
The US trade balance with the 10 largest suppliers of cars and parts to the United States is shown in Graph 1. It should be noted that these 10 countries together account for 94% of US car imports. The largest trade deficit is with Japan, which accounts for one third of the US deficit in the sector. Next come Mexico, Canada, Germany and South Korea.
However, even if tariffs are imposed on all car imports into the United States, Canada and Mexico should be protected by a very generous import quota under the USMCA, suggesting that the projected measures would not hamper their local industries. They could almost double their exports to the USA without reaching the threshold beyond which the tariffs would apply. Germany is another serious rival for the US industry, according to President Trump. He is eager to reduce the US deficit with Germany and would be prepared to impose 25% tariffs on imports of European cars unless the EU lowers its tariff on imported cars from the USA from 10% to 2.5% (equivalent to the American level). The United States is targeting Germany because the European automotive supply chain is highly integrated and ultimately depends on German exports.
In July, the European Commission held discussions with the US administration about tariffs. Tensions appear to have reduced, and the threat of tariffs may have receded. However, GM’s recent announcement, along with the sluggishness of the European decision-making process, could make the implementation of tariffs on cars imported from Europe more likely. Japan is also likely to be targeted.
Which countries would be most directly affected?
To assess the impact that higher US tariffs would have on exporting countries, we need to combine two ratios, namely the share of cars and parts exports (including re-exports) to the USA as a proportion of total car and parts exports for each country concerned, and the ratio of cars and parts exports (including re-exports) relative to domestic production in each country.
Regarding the first ratio, it is worth highlighting those countries which have a ratio of over 15%, meaning that a large share of their car and parts exports goes to the USA. This is particularly true of countries in Latin America and the Caribbean as well as in South East Asia and Oceania (including China, Japan, South Korea and Australia). Within the Middle East, Israel is the only country which sends more than 15% of its car and parts exports to the USA. In Africa, Egypt, Ethiopia, Ghana, Madagascar, Nigeria, South Africa and some other smaller economies all fall into this group. Within Advanced Europe, Finland, Italy, Sweden and the United Kingdom all export more than 15% of their total exports to the United States, while the figure for Germany is just 12%2. Finally, no country of Central and Eastern Europe and CIS sends a high proportion of its total car exports to the USA; the proportion is highest for Turkey, at 7%.
As regards the second ratio, 51 countries out of the 74 out of the IHS Markit database have exports (including re-exports) totalling more than 20% of their domestic production. In Africa, this applies to Cameroon, Morocco, Senegal, South Africa and Tunisia. In Central and Eastern Europe and CIS3, only Turkey falls into this category. In Central and South America & the Caribbean, Argentina, Chile, Colombia and Uruguay are the biggest exporters, all with a share above 20%. In South-eastern Asia and Oceania4 the list includes Australia, Indonesia, Japan, Singapore, South Korea, Taiwan and Thailand. Finally, all countries of Advanced Europe5 export over 30% of their car and parts production, which shows the tight integration of the European automotive supply chain and highlights that their domestic car and parts production is heavily reliant on exports. As for China, the equivalent of just 4% of its car and parts production is sold abroad, which shows that production is mainly for the domestic market.
The combination of the two ratios mentioned above – which we can call the overall dependence on US imports by region – is summarised in the chart below. It shows the countries with a significant domestic automotive industry as well as the countries for which both ratios are above 10%, meaning that their industry is heavily dependent on US demand. Canada and Mexico are excluded from the chart since they are likely to be exempted from any tariffs imposed. Two groups of countries can be distinguished – European countries (Germany, Italy, Sweden, the United Kingdom and Slovakia) and Asian countries (above all South Korea, Japan and Taiwan). The first group exports a large proportion of its production but only a small share of those exports goes to the USA. The second group exports a lower, but still significant, share of its production and is more reliant on the US market. Therefore, their domestic industry would likely be particularly badly affected by the introduction of new US tariffs on the automotive sector. China is already subject to a US tariff of 27.5%; it should be noted that whereas the USA accounts for 31% of Chinese car exports (including re-exports), domestic production is not reliant on external markets, meaning that domestic demand for cars and the way that demand develops is much more likely to affect the sector than US trade policy. It is also worth highlighting that Asian countries account for more than one third of car and parts imports from the USA, while the share for European countries is lower (about one fifth). In summary, it would seem that Africa and the Middle East region would be less directly affected by the measures as their automotive industries are only dependent on US demand to a very limited extent. However, they could still suffer from indirect effects.
The America First policy represents a dark cloud hanging over the automotive industry, which relies heavily on a seamless international supply chain. 2019 will be a challenging year for the car sector if 25% tariffs are imposed on imports into the USA, with Asian and, and to a lesser extent, European countries particularly badly affected; exporters in the Middle East and Africa would likely suffer less. In the USA, the measure would result in declining sales and imports but an increase in domestic production. However, since the US car industry as a whole is highly reliant on imported parts, the domestic sector would not benefit significantly from the imposition of tariffs. Moreover, the tariffs on steel and aluminium imports imposed last March have already increased manufacturing costs for vehicle factories in the USA, depressing their margins and leading to a reshaping of the supply chain.
Other sources of concern stemming from Chinese demand for cars and Brexit could also darken the 2019 outlook. Even if we have entered something of a truce, uncertainty over how the Sino-US trade war will develop represents an additional risk. That said, since trade wars tends to redirect trade flows rather than destroy them, we might expect the reshaping of the global supply chain ultimately to create some losers (for example suppliers to international groups with low levels of client diversification) but to create some winners at the same time.
Analyst: Matthieu Depreter – email@example.com
2 Although the percentage of German car exports and parts sent to the USA is lower than that for the UK and Italy, in absolute terms Germany exports five times more to the USA than Italy and three times more than the United Kingdom, as can be seen in Graph 1. The lower percentage is due to better diversification of export markets, which makes Germany less reliant on the United States.
3 Central and ‘Eastern Europe & the CIS’ includes the CIS countries, Turkey, Albania, Bosnia and Herzegovina, Kosovo, Macedonia, Montenegro and Serbia.
4 ‘South-eastern Asia and Oceania’ includes Pakistan, Afghanistan, China, Mongolia, North and South Korea, Japan and all countries to the south-east, including the Pacific islands.
5 Advanced ‘Europe’ includes all EU countries, Iceland, Norway and Switzerland.