31 August 2018

What Higher U.S. Car Tariffs Could Mean for Europe


As the main producer of cars in Europe and the main exporter to the United States, Germany would be the biggest loser if the White House imposed higher tariffs on automobiles made in the European Union. Complex supply chains in Europe mean that higher American tariffs would affect many other countries, particularly in Central and Eastern Europe. Should the United States pressure the European Union to include agriculture in their trade negotiations, the move would lead to friction between Germany and France and reduce the chances of reaching an agreement.


Trade friction between the United States and the European Union has de-escalated since late July, when they agreed to study ways to eliminate non-auto industrial tariffs and reduce non-tariff barriers. While the agreement defused the immediate danger of higher American tariffs on European cars, it did not eliminate the threat, and business and political leaders in the bloc remain nervous. The precedents don't allow for a lot of optimism either, because most of the trade negotiations that the administration of U.S. President Donald Trump has undertaken have either stalled or failed to produce a deal.

The automobile sector is a crucial part of Europe's manufacturing system and a large source of employment, and the United States is a major market for its cars. In 2017, EU auto exports to America reached $38 billion, against only $6 billion in EU imports of American cars. Because of the large size of its car-making sector and its exposure to the U.S. market, Germany in particular stands to lose big if the United States imposes new tariffs on European cars. However, complex supply chains for auto parts within the European Union mean the effects of those tariffs would be felt across the Continent.

The Big Picture

The U.S. government has threatened to impose higher tariffs on cars imported from the European Union. The negative impact of such a decision would be felt throughout the union, because the bloc's main carmakers rely on complex supply chains. America's trade strategy could also lead to friction among the main EU political and economic players.

A Key Part of the European Economy

The automobile industry is a key part of Europe's economic, political and social fabric. It provides millions of jobs, accounts for large parts of economic output and is a constant source of innovation. According to the European Automobile Manufacturers' Association, the sector represents about 7 percent of the EU gross domestic product and employs 12.6 million people, or 5.7 percent of the bloc's workforce. Moreover, Germany's Volkswagen, Mercedes-Benz and BMW, France's Renault and Peugeot, and Italy's Fiat have become part of the national identity of their countries, and company leaders are often important political and economic players. As a result, the European Union is protective of its automobiles. The bloc's common external tariff for passenger cars is 10 percent, which is twice the average tariff for the European Union, while multiple non-tariff barriers such as standards and regulations make it hard for foreign carmakers to penetrate the European market. The United States, meanwhile, imposes a 2.5 percent tariff on imported passenger cars from the European Union, though the tariff is 25 percent for vehicles like pickup trucks.


Germany produces roughly one in three of all the cars made in Europe. France, the United Kingdom, the Czech Republic, Italy and Slovakia also have large automobile sectors. Germany also accounts for 55 percent of all EU automobile exports. The United States is the main destination of European cars, receiving 29 percent of exports in 2017, followed by China (17 percent) and Japan (6 percent). Higher American tariffs would hurt the European automobile sector, because exports to Europe's main customer would probably decrease. But new tariffs would not affect all European countries equally. While the United States is Germany's main destination in terms of value, Spanish or French exports to the United States are negligible, because these countries sell most of their cars in Europe and other markets.


Thus Germany has been particularly supportive of reaching a trade agreement with the United States, while other EU members have been more skeptical. Germany wants to preserve its access to the U.S. market, but other countries, such as France, are happy with the current level of protection for the European automotive sector. They don't stand to gain as much as Germany from an agreement that preserves European exports of cars to the United States, and they are worried that the White House will push to include agricultural products (a sensitive area in many EU member states) in its trade negotiations with the European Union.

Political friction in Europe would deepen should the Trump administration use the threat of higher car tariffs to pressure the European Union to open its agricultural markets to American exports. Including agriculture in EU trade talks would test the stability of the Franco-German alliance, the most important political and economic partnership in Europe, and reduce the chances of reaching an agreement with the White House.



Complex Supply Chains

While Germany would be the biggest loser if the United States levied higher tariffs on EU cars, it would not be the only one. Many products are not really "made" in a single place anymore, and carmakers rely on parts and services provided by several countries linked by complex supply chains. The European single market contributes to this situation, because auto parts move within the European Union without paying any tariffs.

This factor creates a notable difference between the European automotive industry and those in other regions. While 90 percent of a Japanese car is made with inputs obtained in Japan, and more than 80 percent of a Brazilian car is made with inputs obtained in Brazil, only two-thirds of the parts and services involved in the making of a German, French or British car come from those countries, and the share is below 50 percent for Spain. As a result, lower car sales to the United States would hurt the main European exporters directly and their suppliers indirectly.


Countries in Central and Eastern Europe, including the Czech Republic, Poland, Hungary and Slovakia, form key links in Germany's supply chain. French, Spanish and Italian carmakers rely mostly on Western and Southern European suppliers. Lower German exports to the United States would hit companies in Central and Eastern Europe harder than those in Southern Europe. But because German companies also import parts such as suspension systems from Spain, gearboxes from France and brakes from Italy, some companies in those countries would be hurt even though carmakers in those countries do not stand to lose as much as Germany from higher U.S. tariffs. The effects of lower car sales to the United States would also be felt outside the European Union, since countries such as Turkey and Tunisia provide parts and services to the German car industry.

The White House could also decide to impose higher tariffs on European auto parts. Companies that make cars in America import most of their parts from Mexico, Canada, China and Japan, but they also obtain parts (such as gearboxes, engines and steering wheels) from Europe. Once again, Germany is one of Europe's main providers of such parts to the United States. Higher tariffs in the United States would affect not only the European companies that supply car factories in Europe, but also those that export parts to U.S. factories.


Dollars, Demand and Brexit

Other factors also come into play when assessing the potential impact of higher U.S. tariffs on EU cars. One is price elasticity. While overall sales would decrease, some U.S. demand for European luxury cars probably would remain even if higher tariffs make them more expensive. The evolution of the value of the dollar versus the euro could also play a role, because a stronger dollar could mitigate the effect of the tariffs, especially if the United States decides to introduce only a modest hike in tariffs (for example, a 10 percent tariff, which would put the United States at the same level as the European Union, instead of the 25 percent tariff that Trump recently mentioned).

At the company level, the impact of higher U.S. tariffs would also be varied, because some European carmakers assemble their models in the United States. Audi, Jaguar Land Rover and Porsche do not have assembly plants in America, so all their U.S. sales are imports. In contrast, Mercedes-Benz and BMW operate factories in the United States, where some of their cars are assembled.

Finally, Brexit puts the United Kingdom in an uncertain position in this trade conflict. It is the second-largest exporter of cars to the United States after Germany, and the terms of its exit from the European Union will determine the future of its exports to America. The British government wants to exit the EU single market and customs union and have an independent trade policy. The United States may exclude the United Kingdom from higher tariffs, since it will no longer be a member of the bloc. But if the United States and the European Union reach a trade deal, the United Kingdom would be excluded as well. British officials have expressed interest in reaching a free trade agreement with the United States after Brexit, but such a deal would take years to negotiate, approve and implement.
Looking for New Markets

The trade disputes with the United States validate the EU strategy of seeking new markets for its exports. In recent years, uncertainty about the future of global trade has emboldened the bloc to seek new trade agreements with as many countries as possible. It recently reached agreements with Japan and South Korea, two major automobile producers, showing that the European Union is becoming more open to including this sensitive sector in its trade talks. At the same time, the European Union is pressuring the Common Market of the South (the South American trade bloc better known by its Spanish acronym Mercosur) and Australia to reduce their tariffs on European cars. But tariffs are not the only issue the European Union will have to negotiate with its partners, because non-tariff barriers (such as different production standards) will also be an obstacle.

Trade diversification will also depend upon individual companies. In recent years, many European carmakers have been trying to increase their presence in other markets. For example, exports of European cars to China grew by around 10 percent and exports to Japan grew by 11 percent from 2016 to 2017. Trade disputes with the United States will continue to give European companies additional reasons to look for new places to sell their cars.

The complexity of Europe's automotive sector means that the impact of higher U.S. tariffs on EU cars would be felt not only in the countries that export the most automobiles to America but also along their supply chains. This is an argument Germany will make when debating EU strategy with France and other countries that are skeptical of making concessions to the United States. Countries along Germany's supply chain, most of which are in Central and Eastern Europe, probably will support Berlin's position, while Paris will likely rely on its partners in Southern Europe. The bilateral commission created by the European Union and the United States to explore a trade deal plans to release its report before 2018 ends. This means that dealing with the Trump White House and avoiding an escalation of the trade disputes will be at the heart of the European debate by the end of the year and in early 2019.

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