The Trump administration’s unapologetic disparagement of the North American Free Trade Agreement (NAFTA) has resulted in a replacement agreement, announced October 1, with the governments of Canada and Mexico.
Now that NAFTA is called the United States-Mexico-Canada Agreement (USMCA), how has it changed besides in name?
The USMCA will implement four measures affecting automakers, (which we address in more detail in our white paper “U.S. & China: Tariff Impact Report”).
1. While NAFTA originally required automakers to use 62.5% of North American-made parts in their cars to be imported duty free, the new agreement gradually raises the bar to 75% by 2023, which will incentivize automakers to increase the amount of North American parts they use in their cars and light trucks.
2. The USMCA also mandates that automakers manufacture 40% of their motor vehicles in facilities where assembly workers are earning at least US$16 an hour. While average wages are even higher than that for auto assembly workers in Canada and the U.S., they are not in Mexico, where a number of U.S. automakers have shifted production in recent years to take advantage of the lower costs.
3. Furthermore, Mexican government authorities are required to allow workers to form collective bargaining units, supporting a more union-friendly regulatory environment.
4. Finally, the agreement includes side letters from the U.S. to the Mexican and Canadian governments promising exemptions from potential future tariffs imposed by the U.S. on some motor vehicles and auto parts, specifically 2.6 million Mexican-made passenger vehicles, all Mexican light trucks, and US$108 billion and US$32.4 billion dollars worth of auto parts from Mexico and Canada, respectively.
USMCA Likely to Raise Production Costs
The aforementioned provisions of the new trade deal are expected to ultimately raise production costs for North American automakers.
First, as Mexican factories typically pay workers much lower wages than workers in the U.S.—and workers in Mexico have less power to negotiate pay—the cost of manufacturing auto parts in Mexico will rise as worker wages and unionization increase to remain in compliance with the agreement.
Secondly, as the agreement incentivizes automakers to manufacture more car parts in North America, reliance on inexpensive parts sourced from overseas will decrease, which will also drive up production costs. The deal may even support a shift in auto-part production from Mexico and Canada to the U.S., as the majority of auto manufacturing plants are located in the U.S., and companies prefer to keep parts sources near assembly plants to minimize supply chain delays.
Car Industry Signals Approval – Will Optimism Endure?
Despite uncertainties regarding the long-term impact of the new trade deal—particularly for companies that rely on lower-cost operations in Mexico to supply the U.S. market—USMCA has gained the favor of at least one U.S.-based automaker, Ford. In a press release, the company applauded the agreement, stating that Ford was “very encouraged” and expected USMCA to “support an integrated, globally competitive automotive business in North America.”
So, why would Ford support the deal, even if it’s going to make Mexican manufacturing more expensive, thereby increasing prices on Ford vehicles?
First, the Trump administration’s threatened tariffs on automobiles from Canada and Mexico had the potential to greatly disrupt automakers’ supply chains. The new USMCA removes that tool from Trump’s trade arsenal – to the great relief of the auto industry. The burden of higher production costs may be offset by the reassurance that these tariffs are now off the table.
The second reason is more company-specific. Ford pledged in 2017 to construct new facilities in Michigan and renovate old ones. A trade agreement that encourages North American and U.S. manufacturing will increase the value of those investments.
While Ford and other automakers may find their supply chains running more smoothly as a result of USMCA, consumer demand may stall if motor vehicle prices rise too much. The new trade deal will force manufacturers to choose whether to:
· Absorb the higher costs as lost margin
· Renegotiate part supply deals to pass costs to suppliers
· Raise finished good prices to pass costs to consumers
· Change product mix to make offerings less expensive
Most likely, automakers will implement some combination of the above.
Nevertheless, if prices increases do occur, more consumers will delay new automobile purchases or buy used cars, reducing new car demand. Given that the U.S. is already preparing to shoulder the costs of $200 billion in new tariffs on Chinese products, a break for consumers isn’t likely anytime soon.
Owen Stuart is a Market Research Analyst with Freedonia Focus Reports. He conducts research and writes a variety of Focus Reports, and his experience as an analyst covers multiple industries.
This article was originally published in the Freedonia Group blog.