The U.S.-Mexico-Canada Agreement (USMCA) takes effect July 1, replacing and modernizing the 26-year-old North American Free Trade Agreement (NAFTA), with the aim of supporting mutually beneficial trade.
This agreement is expected to impact the future of the automotive industry’s supply chain due to new and elevated requirements.
Under USMCA, the rules of origin for automotive industry producers have been elevated from previous NAFTA standards, with the most significant changes as follows:
Regional Value Content
Ultimately, by 2023, the agreement requires 75% of passenger vehicle and light truck components to be manufactured in a USMCA country without being subjected to tariffs.
The same standard will apply to core parts but will be slightly lower for complementary and principal parts, for which the content requirements will be 65% and 70%, respectively, by 2023. This is an increase from the current NAFTA provision of 62.5% that will remain in effect until USMCA is ratified.
Labor Value Content Rule
Beginning in 2020, 30% of work completed on passenger vehicles must be performed by workers earning at least $16 per hour. This percentage will increase to 40% in 2023.
Steel and Aluminum Purchases
Beginning in 2020, 70% of steel and aluminum purchases must be made in a USMCA country.
Potential Relief with Section 232 Tariff Quota Exemptions
In May 2018, President Donald Trump directed the U.S. Department of Commerce under Section 232 of the Trade Expansion Act of 1962 to review whether imported vehicles posed a threat to national security.
Related to this, Trump proposed imposing 25% tariffs on imported automobiles and automotive parts. Probes were initiated into these potential threats, but findings have not yet been released nor a determination made with regard to additional tariffs beyond those in place for steel and aluminum, for which Mexico and Canada are already exempt.
As part of USMCA, the U.S. signed side letters with Canada and Mexico to establish quotas exempt from potential Section 232 tariffs. Additional side letters were also signed to establish a 60-day process negotiation period, if Section 232 tariffs are implemented.
It is difficult to predict what the exact effect of USMCA will be on the automotive industry. Based on what we know, we can likely expect the following:
Manufacturers may incur additional cost and time to meet content, labor and purchasing reporting requirements.
To meet wage requirements, the labor value requirement will likely lead manufacturers with deeper roots in USMCA countries to shift production jobs from Mexico to the U.S. and Canada.
It is also likely that higher content percentage requirements will raise material costs to manufacturers. Higher material and labor costs will ultimately increase retail prices that may influence consumers in the market for replacement vehicles to consider used vehicles that are less expensive. Financing more expensive vehicles may also become more difficult for less creditworthy consumers.
A potential win for manufacturers complying with USMCA is the quotas exempt from Trump administration tariffs under the 232 side letters.
The need to address such issues in side letters indicates an even greater probability that such tariffs will be implemented in the near future.
If this happens, manufacturers operating under USMCA may experience a competitive advantage, assuming costs of compliance are lower than the potential 25% tariffs. Consumers may be influenced to move to USMCA brands for which new-vehicle prices will likely not increase as considerably.
In light of the coronavirus pandemic that has already caused global plant shutdowns, automakers are evaluating whether the new requirements can be met by the effective date of July 1.
At the same time, the Office of the U.S. Trade Representative has requested petitions from automakers seeking extensions on the new requirements that, if granted, would extend the phase-in period from three to five years. Ultimately, whether automakers seek and are granted such extensions, the race is on to comply with the inevitable changes coming under USMCA.
Ashlie Lopez is senior manager in the audit department at accounting firm MBAF.