Chinese Tariffs: Clear Skies Now, Clouds on Horizon

Industry Voices

The Trump Admin.’s imposition of trade tariffs on approximately $50 billion worth of Chinese goods prompted the Chinese government to respond in kind by slapping a 25% tax on U.S.-imported cars. The question many are asking is what impact this conflict between the world’s largest and second-largest car markets is likely to have on the U.S. auto industry.

The answer is for now, not much.

China has long protected its automotive industry behind 25% tariffs. This, in combination with lower production costs, has led foreign auto manufacturers – including Ford, Fiat Chrysler and General Motors – to locate production for the Chinese market in China. At this juncture, most American automakers already have a significant manufacturing footprint in China and are well integrated into the local supplier landscape. Consequently, they export very few cars to China, except for luxury vehicles.

In an odd twist of fate, the decision by German automakers Mercedes and BMW to locate production of certain models in the United States now has dragged them into a U.S.-China trade conflict.

For U.S. buyers, the impact is likely to be minimal. Until now, the U.S. has levied very low (2.5%) tariffs on imported cars (pickup trucks are, however, protected by a 25% tariff barrier based on the argument they qualify as agricultural equipment). But even with a major increase in tariffs, China exports so few cars to the U.S. market – primarily because their vehicles do not conform to U.S. regulatory standards or consumer preferences – that American car buyers won’t feel much of an impact.

For the time being, the effect of bilateral tariffs will be felt in other places; consumers will see price increases in sectors such as consumer electronics, while producers in areas such as agriculture will experience more of the pain.

So far, so good for auto manufacturers, but the industry hardly is out of the woods yet. First and foremost, the Chinese retaliation has only served to up the ante, with the U.S. government threatening tariffs on an additional $100 billion worth of goods. Should these include auto parts, the story will look quite different. Not only do U.S. manufacturers import parts directly from China, but China also has emerged as a large source of imports for the North American Free Trade Agreement (NAFTA) auto supply chain.

And therein lies the other big cloud for U.S. auto producers: NAFTA’s fate currently is uncertain, as renegotiations are under way between the member governments. For one thing, as part of ongoing negotiations, the U.S. is seeking to change the rules of origin, pushing to lower the percentage of Chinese content that would be allowed in cars manufactured in either Canada or Mexico. Vehicles containing above this amount would not qualify for NAFTA treatment and therefore would be subject to import tariffs.

An even bigger setback for automakers, however, would be the outright termination of NAFTA, something the U.S. government has threatened should negotiations not succeed. Given the degree to which automotive supply chains are intertwined across the United States, Canada and Mexico – both for finished vehicles and for parts – costs would be certain to increase dramatically were NAFTA to end and tariffs between countries reinstated.

It is difficult to predict the outcome of all these economic policy shifts. But one thing is certain: While it may seem like the U.S. auto industry has dodged a bullet with the current proposed tariffs, there’s a lot that still can happen. Complacency would be premature.

Johan Gott is a principal with global management consulting firm A.T. Kearney in the Private Equity and Mergers & Acquisitions Practices.