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Trump’s next move? The economic impact of the looming tariffs on cars

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  • Driven by animosity vis-à-vis German cars and a sense of non-reciprocity by the EU on lower car tariffs, US President Trump is expected in the next few weeks to decide on whether the US will impose trade tariffs on cars
  • In order to make a fair comparison between the level of protectionism on both sides of the Atlantic, one should assess average applied tariff levels, rather than individual product groups, such as cars. The United States applies an average tariff rate of 2.9 percent while the EU applies an average 2.5 percent rate
  • On defence and NATO, the president is on more solid ground. Most European NATO-members are still far away from the 2% of GDP defence spending target and few have yet credibly committed to achieving that target by 2024
  • Contrary to what the president seems to think, we argue that the effects of tariffs on the US economy will be ambiguous at best. In the short-term it may protect the domestic car industry and employment, but in the longer term it is likely to confirm the relative decline of the US car industry in terms of productivity. Retaliation by the EU (and Japan) could harm the US economy directly by about 0,2% of GDP
  • In the EU, Germany would be the hardest hit country. There, the direct effect could reach up to about 0.3% of GDP. On the EU as a whole the effect is more modest
  • For the Netherlands, the impact will be very small: direct exposure to the US car market, even through other countries, is limited to about 3 billion USD in production
  • The indirect consequences for the US (and EU) economy may be larger. The escalating tensions could lead to a full-blown trade war and, in the run-up, dent consumer and producer confidence. A more intrinsic point is that the consequences are partly uncertain: as a response to previous tariff hikes we now see companies announcing to shift (part of) their operations to other countries

Pending US car tariffs

Trump’s anger about seeing a lot of German cars parked in Fifth Avenue and not seeing any Fords, Chevvies or (Fiat!) Chryslers in Germany may kick off a new round of tariffs on the import of foreign cars. With US foreign car imports amounting to USD 295bn annually, tariffs on car and car parts would open up a new and significant chapter in the current trade war saga. The Trump administration has started an investigation under Section 232 of the Trade Expansion Act, to determine the effects of foreign car imports on the national security of the United States. This includes cars, SUV’s, vans, light trucks (pickup trucks) and automotive parts. A positive conclusion to this investigation would allow the President to restrict imports that threaten “to impair the national security”. How Trump would exactly want to restrict imports is not yet known, but several tariff rates have passed by in communications with the media. During his campaign, Trump already talked about a 35 percent tariff on German cars. In May, when the Section 232 investigation started, officials mentioned a 25 percent tariff. And following Trump on Twitter, his most recent plan is to impose 20 percent tariffs.

Does Trump have a point?

One key question is whether Trump has a case in point to start targeting car imports with tariffs. This is questionable in our view. First of all it is  highly debatable whether national security is at stake due to the import of foreign passenger cars and the like. Vehicles and vehicle parts used for defence and in the military are already produced in the US, specifically aimed at safeguarding national security.

Unfair trade practices

Secondly, Trump has also repeatedly tweeted that Europe’s trade policy is unfair, as the EU has a 10 percent tariff on cars from the US, while the US only imposes a 2.5 percent tariff on European-made cars. These figures however overlook the fact that the US puts a 25 percent tariff on, e.g., light trucks, while the EU again imposes a tariff of 10 percent on this product group. This example shows that it is relatively easy to find tariff disparities by focusing on specific product groups. In order to make a fair comparison between the level of protectionism on both sides of the Atlantic, one should assess average applied tariff levels. The Worldbank estimates that the United States applies an unweighted average tariff rate of 2.9 percent while the EU applies an average 2.5 percent rate. So in fact, the US applies higher rates than the EU on average, although the difference is rather small.[1]

To a large extent, the observed differences in individual tariffs can be traced back to the Uruguay Round of trade talks, 25 years ago, as a part of the General Agreement on Tariffs and Trade (GATT, which formed the foundation for the World Trade Organisation (WTO)). The trade negotiations followed a crude approach to approximate Pareto efficiency. Two parties could negotiate tariffs settings for individual products, but ultimately the benefits over the entire package would have to be equal for both parties. Trade tariffs should therefore be seen in a broader context of the complete trade package (as that is how they were negotiated), rather than only comparing individual products. In addition, US congress decided to specifically protect the American pick-up truck producers.

Moreover, besides tariffs, countries also have non-tariff barriers in place, such as quotas, licenses and quality standards. It is rather difficult to calculate and compare the distortionary trade effect of these non-tariff barriers (NTB). But in order to make a valid assessment of the ‘fairness’ of the trade regime between countries, one should include NTB’s as well. For a comparison of both tariffs and non-tariffs barriers between the NAFTA partners, see also: The economic impact of a (partial) NAFTA breakdown.

Defence spending

Trump’s motive to target EU cars also relates to his desire for European countries to step up their defence spending to (at least) 2 percent of GDP as agreed within NATO (The defence spending gap in the EU). During the last NATO summit in Brussels he continuously lambasted his European counterparts about not spending enough and being too far away from the NATO-mandated target of spending 2% of GDP on defence.[2] At first sight, he seems to have a point (Figure 1). However, all of these countries have pledged to spend 2% by 2024 and overall there has been an increase in spending since they made this promise in 2014. Moreover, most countries have raised the growth rate in defence spending since Trump was elected.

Trump continues to single out Germany specifically on this front and has linked this to his threat about tariffs on (German) cars. On defence, Chancellor Merkel has responded that increasing defence expenditure is up to Germany’s parliament. Here she is facing resistance from her centre-left SPD coalition partner who oppose a rise in spending on the German army from the currently committed 1.5% of GDP. From Trump’s perspective it could be hard to see, though, why a country with a persistent government budget surplus (on top of its trade surplus) would be unable to increase defence spending.

Figure 1: European NATO-members are moving towards 2%-target, but are still way off
Figure 1: European NATO-members are moving towards 2%-target, but are still way offSource: NATO, Rabobank
Note: 2018 are expected figures. * denotes countries that have laws or political agreements to spend at least 2% of GDP on defence.

At least part of the battle over spending seems to be about semantics: all NATO-members have promised to increase their spending on defence to 2% of GDP by 2024, but only a few (see Figure 1) have committed to doing this via laws or parliamentary consensus. This explains why there was some confusion after the summit where Trump claimed that NATO-allies will spend more whereas those same allies said nothing has changed, at least until they have informed and discussed with their parliaments. The future will tell whether European countries will (credibly) commit to the 2%-target. The pressure is clearly on Europe (and Germany), as they really need commitment of the US to NATO. On the other hand, the US security sector is expected to benefit at least partly from any increase in defence spending via the procurement of US equipment.

The global car trade: what does it look like?

Figure 2: Global US car imports are USD 250bn
Figure 2: Global US car imports are USD 250bnSource: Trademap (ITC)

Looking at the numbers of the trade relationships between the US and the rest of the world in the car industry, the countries appear to be highly intertwined. Depending on the precise category the US is going to target[3], the maximum total value of imported goods related to the car industry amounts to USD 247bn (figure 2). The EU, Canada, Japan and Mexico each export around USD 50bn to the US. Germany is the biggest exporter of cars in the EU with a value of USD 25.5bn, almost 50% of total EU exports to the US (figure 3). The US itself exports only USD 98.5bn worth of cars to the rest of the world (figure 4). The largest share of that falls on Canada (33%) and Mexico (19%). The EU imports USD 13bn worth of cars from the US, a relatively small amount compared to the USD 51.6bn exported.

Figure 3: European car exports to the US
Figure 3: European car exports to the USSource: Trademap (ITC)
Figure 4: US car exports to the rest of the world
Figure 4: US car exports to the rest of the worldSource: Trademap (ITC)

Would car tariffs result in economic gains for the US?

By imposing tariffs on foreign cars and car parts, the Trump administration aims to protect the domestic automotive sector, which could boost of the sector’s domestic market shares and should result in job creation for US citizens. The standard textbook line of reasoning here is that tariffs directly drive a wedge between the level of competitiveness of US versus foreign car manufacturers. Foreign manufacturers can choose to either translate (part of) the tariffs into higher retail prices, which will negatively affect their market share and sales. Hence, US consumers partly pay the price of the higher tariffs. The economic losses for US consumers will be higher the larger the price-inelasticity of demand for foreign cars. In case of a high inelasticity, US citizens will continue to buy foreign cars, despite rising price levels, as they do not regard US cars as a suitable alternative. This might, for example, be the case with German cars: the purchase of a Mercedes or BMW is not solely determined by price, but also by other tangible and intangible factors, such as comfort, innovative features and status.

Foreign manufacturers can also choose to (partly) internalise the tariff by lowering their sales price at the expense of their own profits and financial buffers. This way, the retail price for US consumers will remain equal (i.e. lower sales price + tariff = equal consumer price). Foreign car exporters will choose this strategy when they expect the imposed tariffs to be temporary. Moreover, tariffs yields government revenue gains. The problem with standard textbook logic, is that reality is often far more complex.

Integrated supply chains

The gains for domestic US car manufacturers might be much smaller than what Trump has in mind. First of all, the supply chain of US manufacturers are dispersed across the globe to a substantial degree. In an earlier report, we have shown that 18% of final exports of the Mexican car industry to the US consists of American value added. Raising tariffs on cars labelled ‘Made in Mexico’ will directly affect US suppliers (see Figure 5).

Figure 5: US value added in Mexican cars exports is 18%
Figure 5: US value added in Mexican cars exports is 18% Source: Rabobank
Figure 6: US cars contain 36% foreign intermediates
Figure 6: US cars contain 36% foreign intermediatesSource: Rabobank based on TiVA database

If the tariffs also apply to car parts, the problems for US car manufacturers become even larger as their final products will also face price increases due to more expensive intermediate goods. Foreign value added in US manufactured cars constitutes a stunning 36%, with Japan being the most important supplier (Figure 6).

Of course, one could argue US firms can look for other suppliers and substitute their foreign inputs with US inputs. However, these adjustments are time consuming and involve transaction costs, as other suppliers often do not instantly meet proper requirements and know-how. Moreover, the substitutes could be of lesser quality and/or more expensive, as otherwise they would have been the preferred option already.

Productivity

Although US car manufacturers could be benefitting from the car tariffs in the short term, the long-term perspective of protectionism on domestic firms is generally not that favourable. The literature shows that trade and foreign direct investment are a conduit for foreign knowledge spillovers. Furthermore, openness to foreign trade fosters market competition, which stimulates firms to reduce their X-inefficiencies and increase efforts to innovate. Edwards (1998), Alcalá and Ciccone (2004) and Erken et al. (2018) find that international trade has a robust positive effect on productivity. The bottom-line here is that sheltering firms from foreign competition tends to make firms lazy. This does not bode well for an industry that has been losing on the productivity front compared to its peers (see Box 1). In the long run, protectionism could permanently hurt potential growth of an economy.

Box 1: Productivity in the US car sector has been losing ground

Since 2011, US productivity levels have been stagnant, whereas Germany and the EU as a whole were able to increase their productivity per hour (figure 7). Notably, stagnant US productivity was especially caused by the destruction of human capital: highly-skilled and highly-educated baby boomers were retiring from the sector at an increasing pace, and were replaced by less skilled and lower educated young(er) people. Moreover, there has been major disinvestment in ICT capital as well, which has dampened productivity performance (figure 8). In Europe and Germany, we have not witnessed these negative developments, which explains why annual productivity growth in Germany (2.6 percent) between 2010-2015 outpaced that of the US by a factor ten (0.26 percent).

Figure 7: The US car sector has been losing ground after the crisis
Figure 7: The US car sector has been losing ground after the crisisSource: EUKLEMS, Rabobank
Figure 8: Productivity losses in the US car sector due to disinvestment and destruction of human capital
Figure 8: Productivity losses in the US car sector due to disinvestment and destruction of human capitalEUKLEMS, Rabobank

Retaliation

The US auto industry itself remains staunchly opposed to the introduction of these tariffs, fearing that retaliatory tariffs would hit their industry as well. Given the European Commission’s recent statement on the 232-investigation by the US, it is not straightforward what the response of the EU will be in case of US car tariffs. The EU argues that trade restrictions imposed on passenger cars cannot be justified on national security grounds, and as such the EU has warned the US of possible retaliation by trading partners. However, the statement does not mention whether the EU itself would retaliate, nor what kind of products they would target. Whereas the French economy minister Bruno le Maire has explicitly stated that the EU’s reaction to tariff hikes should be united and strong, Germany has so far responded in a rather mild manner to the tariff threat. German car manufacturers are supporting efforts to end all car tariffs between Europe and the US. They would rather face competition from US car makers than risk higher tariffs both when exporting to US and importing car parts into the US, and from a competitiveness point of perspective they seem to have the upper hand anyway (box 1). German Chancellor Merkel has said she would back lowering EU tariffs on US car imports. But, obviously, Germany cannot decide on its own about the tariffs as EU Member States pursue a common trade policy. 

Economic impact of retaliatory measures

While especially the EU seems likely to try to prevent a trade war with the US, the question is what would be the economic impact in case trading partners would reciprocate the US tariffs. If tariffs on all products concerned by the investigation are targeted, the EU would face tariffs on USD 51.6bn worth of automotive goods. If the reaction to the steel and aluminium tariffs serves as a blueprint, the EU will retaliate with targeting the same value of goods. If we assume a direct retaliation from the EU against 20% tariffs, these measures could shave off approximately 0.2ppts of US GDP. If the US is going to target global car imports of USD 250bn and its trading partners will strike back accordingly, losses could be as high as 0.9ppts of GDP. And keep in mind that these effects do not include the retaliation packages that are already in place against the US steel and aluminium tariffs or the Chinese retaliation of the USD 34bn worth of American exports. Moreover, these effects only encompass the direct trade effects and disregard the adverse impact on disrupted supply chains, productivity (see above) and/or second-round effects on business confidence and investment activity.

The economic impact of car tariffs on the EU

A tariff of 20 percent on automotive exports from the EU to the US amounts to a 17.5 percentage point increase, on top of the existing 2.5 percent tariff. This increase could lead to a reduction in car exports of about 25%. This is estimated by using a simple price-elasticity of 1.5: the higher prices caused by the tariffs will lead to reduced demand from the US for the European cars. The direct economic impact will be significantly bigger than the earlier imposed tariffs on steel and aluminum. Especially Germany is at risk, as they exported around USD 25.5bn worth of cars in 2017. Using the elasticity, the tariffs could reduce the export of cars to the US from Germany by USD 6.5bn. In total for Europe the loss could amount to USD 13.5bn.

Figure 9: German car sector most exposed to further sanctions in Europe
Figure 9: German car sector most exposed to further sanctions in EuropeSource: OECD TiVa (2011), Rabobank
Note: The domestic value added of car export to the US is the sum of total value added in the chain of production to export that is added domestically. Included is for example the assembly of cars, transportation of cars and the energy used in the process of transporting and producing the car.

These estimates are based on a simple price-elasticity and do not take into account any second-order effects. All companies in the supply chain of cars will likely be hurt, for example energy and transport sectors. A different way of estimating the impact of the tariffs, is to look at the value added related to the export of cars to the US. These numbers are also corrected for re-exports, but value added in the whole supply chain is taken into account as well, such as the transport of the cars. In Germany the value added in export of cars to the US is equal to 0.45ppts of total value added (equivalent of GDP). In Europe this is 0.15%. A rise in tariffs to 20% could reduce this to around 0.3ppts and 0.1ppts, respectively. This is data from 2011, though, since then, exports of cars to the US from Europe have increased. The outcome of a 20%-tariff on cars could therefore be larger than these figures predict.

In the longer term economic losses could increase further as investments in the car industry are hit and employment will be reduced when the demand for European cars drops and profit margins erode because of the tariffs. More importantly, for the economy as a whole, new tariffs will increase the risk of further escalation. This could reduce consumer and producer confidence, which could further harm consumption and investment.

Possible impact on the Dutch economy is minor

Figure 10: The Dutch transportation sector is not really exposed to the car tariffs
Figure 10: The Dutch transportation sector is not really exposed to the car tariffsSource: Comtrade (2016), Rabobank

The gross exports of products from the Dutch vehicle manufacturing sector to the US is just 2.5 percent of the total production. However, nearly all products flowing to the US are passenger vehicles or vehicle parts. This means that almost the entire flow will be affected by the new tariffs proposed by Trump. Furthermore, roughly 34 percent of total transport production flows to the German and UK market, who in turn export a large amount of their vehicles to the US. Nearly 40 percent of this export is made up by passenger vehicles and parts. Under the assumption of proportionality in exports, this means that an additional 13 percent of total production might be affected indirectly by these new tariffs. This constitutes about 3 billion USD of total Dutch production.

Overall, though, the impact on the Dutch economy will be limited. Total production in the vehicle manufacturing sector equals 20 billion USD. The potentially affected total production of passenger vehicles and parts is 7.5 billion USD (figure 10), which equals 1.7 percent of the total commodities produced in the Netherlands. Compared to the Dutch GDP of 800 billion USD, this sector is quite small.

The possible impact on the Japanese economy

Figure 11: Japan exports many cars and parts to the US
Figure 11: Japan exports many cars and parts to the USSource: Trademap (ITC)

Japan also has a trade surplus with the US and therefore is another possible target country for US import tariffs. In 2017, Japanese total exports amounted to almost USD 700bn USD. Vehicles make up the largest share of Japan’s exports, equaling almost USD 150bn. The majority of these go to Asian countries (55%), followed by the US. Almost 20% of total Japanese exports are destined for the US and cars and vehicle parts exports do make up a large share of that (figure 11). More than one third of total Japanese exports to the US are cars and vehicle parts. As such, any US import tariff on these categories could seriously hit the Japanese economy.

Aside from the direct US-Japan trade relation, any further escalation in US-China trade relations could lead to more damage, as both countries are the most important trading partners for the country. One important note here is that although the US is pressing for a Japan-US trade deal, after Japan concludes the so called Comprehensive and Progressive Agreement for Trans-Pacific Partnership (TPP-11, excluding the US), they are less willing to set up such a bilateral trade deal, at least in the short run.

Summary and conclusion

In the next few weeks President Trump is expected to decide on whether to impose trade tariffs on cars. We argue that the effects on the US economy will be ambiguous. It could protect the domestic car industry in the short-run, and thereby employment. But, in the longer term it will not help the American car industry, whose productivity is already stagnant for years, in terms of growth.

There is an increasing perception that Trump might link car tariffs levied on the EU to progress of its NATO-allies to achieve the 2% of GDP defence expenditure-target. He is unlikely to be satisfied with recent commitments on this front, raising the risk of the tariffs being applied and a tit-for-tat European response.

That said, the direct impact of the floated 20%-tariff will likely only lob off a few tenths of GDP-growth in the EU, even in Germany, which would the hardest-hit country. In Japan, the impact may be significantly larger as its exports of cars to the US is even more significant.

The indirect consequences for the economy may be larger. The escalating tensions could lead to a full-blown trade war and, in the run-up to this, dent consumer and producer confidence. A more intrinsic point is that the consequences are partly uncertain: as an effect of previous tariffs we now see companies announcing to shift (part of) their operations to other countries, something that could accelerate as more tariffs are declared. Most economic models and estimations cannot take these second-order effects into account.

One thing seems certain though: Trump’s antics on trade make for a hot summer.

Footnotes

[1] The Worldbank also calculates a weighted average of applied tariffs, which takes into account the traded volume of each product and its tariff. That average is 1.7 percent for the US and 1.9 percent for the EU. This implies that US exporters spend relatively more on tariffs into the EU than vice versa. The issue with looking at this weighted average, is that trade in high tariff products is likely hampered more than in low tariff products, leading to more US imports of low tariff European products than of high tariff products. As such, the weighted average figure could falsely suggest that trade into the US is less hampered than into the EU.

[2] There is another NATO guideline that states that 20% of all annual defence expenditures should be on (new) equipment. Just over half of the NATO-members reach this amount, with the bottom half being almost exclusively small countries (for which this guideline is harder to reach) and Germany.

[3] Traded products are classified according to the Harmonized System(HS). We identified HS87 as the relevant category. This category also includes some non-car related trade and therefore we excluded some subcategories. We chose HS8702, HS8703 for passenger cars, SUVs and minivans. Parts for cars, trucks are based on HS8708.

Literature

Alcalá, F. and A. Ciccone (2004). Trade and productivity. The Quarterly journal of economics, 119 (2), 613-646.

Edwards, S. (1998). Openness, productivity and growth: what do we really know? The Economic Journal, 108 (447), pp. 383-398.

European Commission (2018). Comments by the European Union to the bureau of industry and security, office of technology evaluation, US department of commerce.

Erken et al (2018). The economic impact of a (partial) NAFTA breakdown, Rabobank.

H.P.G. Erken, M. Wijffelaars and P. Marey (2017). Why Trump’s protectionist trade agenda fails, Rabobank.

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