There's a fatal flaw at the heart of Trump's auto tariff strategy

  • A new Commerce Department investigation into foreign car imports is supposed to set up a win-lose scenario for the US in NAFTA negotiations.
  • The problem is that’s not how trade deals work.
  • Canada and Mexico have already threatened to walk away from negotiations if Trump overplays his hand. This auto tariff could trigger that.

Awesome, now we’re going to play trade war chicken with cars.

This week the Trump administration announced that it will initiate an investigation into whether or not imported cars pose a threat to national security under Section 232 of the Trade Expansion Act.

If this report is anything like other reports written by the Commerce Department, helmed by billionaire Wilbur Ross, it will be loaded with experts saying that auto imports do in fact pose a threat, siding with President Trump’s conviction that there’s been an “abuse” of the law, according to trade experts.

This is bad for all sorts of reasons, not least because our top five sources for car imports are key US allies – Mexico: 24% Canada: 22% EU: 22% Japan: 21% S Korea: 8%. We get just 2% of the rest of our foreign cars from other countries. The US imported $US192 billion worth of passenger vehicles last year.

Analysts are saying that Trump is doing this in order to force Canada and Mexico’s hands in NAFTA negotiations.

“So his logic is that by increasing the auto tariff to 25% – under the national security law – I can bully them into accepting my bad NAFTA deal,” Chad Bown, a trade economist with the Peterson Institute for Economics, told Business Insider via email. “But the weakness of this approach arises with him failing to realise that trade agreements are not one off deals. NAFTA has to make sense for Canada and Mexico economically one year from now. If it doesn’t, then they will want to pull out.”

And then no one wins. Not Canada, not Mexico, not Trump, and certainly not the American consumer.

Forcing the hand or overplaying the hand

What Trump wants to force Canada and Mexico to do is tighten the “rules of origin” for what qualifies as a North American car. That is to say, ensure that more of the parts and labour that go into making a car have to be from the US for it to qualify as “American.” Right now, if an imported car doesn’t have enough American parts, there’s a 2.5% tariff on it.

So, if NAFTA negotiations fall through now, Canada and Mexico would just pay that 2.5% tariff. Not great, but not the end of the world.

Trump wants to hike that tariff to 25%, though, in order to incentivise them to come to the table to talk rules of origin.

“Suppose NAFTA got agreed to while there was a 25% tariff on cars from other places. If you’re a car company in Mexico or Canada you REALLY want to adhere to whatever rules the deal contains. So it gives the US negotiators more leverage while trying to tighten the rule,” tweetedEconomist trade editor Soumaya Keynes (she and Bown host a really useful trade podcast together if you’re into that sort of thing.)

“The BIG QUESTION,” she continued, “if this becomes an explicit part of the NAFTA negotiations, is whether the Canadians/Mexicans feel that this is in effect a gun to their heads and so pull out of talks. They have said they will walk away if Trump triggers a NAFTA withdrawal. Is this so different?”

A NAFTA withdrawal would leave Canada and Mexico with 25% auto tariffs (if they’re even enacted), which is not great. Otherwise, the rest of their dealings with the US would revert to World Trade Organisation rules. Chaotic, but not the end of the world.

And if you’re Canada and Mexico maybe you’re betting that these tariffs are so onerous they will never be enacted. If they are the US would have to face the consequences of higher costs. American consumers would definitely feel that, and based on how Trump folded with China, it’s clear he doesn’t have a high tolerance for pain.

The pain wouldn’t just come from Mexico and Canada either.

“The other [trade war] front that likely opens up here is with Europe,” Bown pointed out.

So, to review: Mexico and Canada can come to the table and talk rules of origin. But bending to Trump’s will on that could end up potentially raising manufacturing costs, killing jobs, and messing up well-oiled supply chains. In Mexico, NAFTA negotiations have become a matter of pride during a national election in which the leading presidential candidate has talked about suspending talks. So there are political consequences too.

In this scenario, the US would win, and Canada and Mexico would lose.

OR: Canada and Mexico could walk away from the deal entirely causing pain on all sides. Meanwhile the US will have opened itself up to retaliation from the EU and possibly Japan. Mexico and Canada have a lot to lose if they walk away from negotiations because of a 25% tariff, but the US has even more.

Everyone would lose.

“Trade agreements need to be voluntary, self-sustaining agreements that are win-win,” Bown told Business Insider. “And President Trump wants a NAFTA that he thinks will be win-lose.”

That’s not how these things work.

Business Insider Emails & Alerts

Site highlights each day to your inbox.

Follow Business Insider Australia on Facebook, Twitter, LinkedIn, and Instagram.