The Winter Of Car Discontent: Washington’s Interpretation Of USMCA Gets Frosty Reception From Mexico

Washington increasingly seems to want every little part of an automobile to be made in North America. Mexico and Canada say that is not what they agreed to during recent USMCA trade negotiations. The text can come across as vague, so Mexico has requested a USMCA dispute resolution panel, and Canada has joined the complaint. A decision is expected sometime this year. In terms of the economics, though, the US position borders on micromanagement, protectionism and inflationary policy.

USMCA states that at least 75% of the value of a car’s content must come from North America to enter the United States without duties being owed. (The predecessor agreement, NAFTA, required a lower threshold of 62.5%.) A car that falls short of that threshold at our border is subject to a 2.5% tariff.

That might not sound like much, but even with a humble 2022 Chevrolet Equinox starting at $28,095, the tariff would slap an extra $645 onto the sticker price. On pickup trucks — where US carmakers derive the bulk of their profits — the tariff is a whopping 25%. Ford Mavericks, which start at $19,995 as they roll off assembly lines in Mexico, would face an additional $4,999.

But Mexico claims the United States is now taking an “unduly strict approach” in how the 75% pedigree is calculated. Despite being located in North America, Mexico cares what the threshold is because its automakers want to use some inputs from other countries and in their production and assembly process, and then ship to the US market. Mexico contends that USMCA allows manufacturers to count a component as fully originating from North America if it reaches the 75% threshold (a methodology known as “roll-up”). The United States contends that the non-North American portion of every component needs to be traced out and accounted for throughout the supply chain. This is called the tracing methodology.

Paul Vandevert, an international trade lawyer and former in-house trade counsel at both Ford and GM told me that the car industry unsuccessfully pursued tracing in the early days of NAFTA. “Tracing never achieved the original intent (to support US labor), it just increased administrative and regulatory costs.” Once enough people in the industry realized there was no value and no benefit from the overly cumbersome approach of tracing, the new industry standard became roll-up and has been used ever since.

The components in question include engine parts like crankshafts, which are increasingly built in Asia. While Mexico used to be a key North American manufacturer for a lot of these components, today Mexican manufacturers are focused on higher value-add activities like high-tech assembly.

It will be left to a dispute panel to interpret USMCA, which may involve going back and documenting discussions that led to that text. Further complicating matters is that the two top US negotiators for the auto chapter are no longer at the Office of the US Trade Representative.

Canada just last month lost a case to the United States which parallels this one in terms of the text being vague on the point of contention, with Canada attempting to implement a new and very strict interpretation. But long-time precedent won. In the US-Mexico auto case, the US is the one attempting to implement a new and strict interpretation. So, if precedent rules the day, then Washington may be facing an uphill battle because its preferred interpretation differs from precedent.

Aside from the legalities, the economics of the US position do not add up. On one hand, Washington demands 40 to 45% of auto content to be made by workers earning at least $16 per hour, which really only pertains to Mexico, because US and Canadian hourly wages are far higher. On the other hand, they want Mexico to make various components that add less value to the supply chain.

The policymakers pushing the US position may have good intentions but don’t have economic reality on their side.

First, Mexico is ascending the value chain. By all accounts that is a good thing. Micromanaging the supply process from Washington to force lower-end component production from places like Asia back into Mexico is counterproductive. Second, cars are a major component of recent US consumer inflation. The last thing the Biden administration should be seeking is to make new vehicles even more expensive. Third, with labor shortages and an increasingly volatile supply chain plaguing the car industry, giving manufacturers some flexibility will help keep production going, which the industry sorely needs.