MNI Data Analysis: EU-US Brace For Collision Over Auto Tariffs

By Jaspreet Sehmi

     LONDON (MNI)

     * A US Commerce Department investigation has reportedly designated US auto

imports a threat to national security...

* ...paving the way for US President Donald Trump to make good on previous

threats to hike auto import tariffs to 25%

* MNI's analysis looks at the potential economic consequences of such a move for

the EU

* We find that a rise in tariffs to 25% on car exports to the US could knock

0.2pp from annual GDP growth in the EU

* In Germany, the EU's economic motor, the hit to growth could amount to a much

heftier 0.6pp

     --Trump ups the ante

     US President Donald Trump has once again set his sights on the EU car

industry. The results of a Commerce Department investigation reportedly conclude

that auto imports pose a threat to US national security, paving the way for

Trump to follow through on previous threats of car tariffs.

     At present, the US levies a 2.5% tariff on imported cars versus a 10%

tariff imposed by the EU. However, the US imposes a much higher tariff of 25% on

SUVs and pick-up trucks. Trump has previously threatened to hike the tariff on

cars from 2.5% to 25%. He has 90 days from the report's submission (Feb 17) to

decide whether to endorse its findings. If he does, he then formally has another

15 days to decide whether to take action.

     --Measuring The Potential Hit 

     The complexity of the global auto supply chain makes isolating the impacts

of a one-off hike in US tariffs on European cars very difficult.[1]

Nevertheless, our analysis aims to provide some guidance on the potential

magnitude of the hit to the EU economy. Note that this does not take into

account the (potentially offsetting) impacts of any possible retaliatory

measures, or the additional harm that would be caused by an escalating trade

conflict.  

     To assess the impact of car tariffs, the price elasticity of US demand[2]

for EU auto imports is key. MNI's research of the literature found that

estimates vary between -0.8 and -2.0. Taking an average of -1.4, this would

imply that US demand for European cars declines by 1.4% when prices rise by 1%.

A tariff of 25% amounts to a 22.5 percentage point (pp) increase from the

existing 2.5% tariff. Assuming a price elasticity of -1.4 implies that a 22.5pp

rise in European auto prices on the US market would lead to a 32% reduction in

the quantity purchased.[3]

     According to data from Eurostat, the EU exported a total of EUR48bn worth

of autos and auto parts[4] to the US in 2018. This accounted for 24% of total EU

car exports, making the US the main export destination for European autos, well

ahead of China (17%).

     Applying our estimate of a 32% hit to exports suggests that a 25% tariff

could reduce the export of European cars to the US by almost EUR15.1bn. Germany,

which is the largest auto exporter in the EU, exported just under EUR27bn of

autos and auto parts to the US in 2018, accounting for 56% of the EU total.

Tariffs could thus result in a hit of just over EUR8.5bn, or 0.3% of absolute

German GDP (2018, current prices).

     While these figures may seem relatively unalarming, they do not capture the

total losses that would be incurred, as they do not include supply chain

impacts. Nor do they take into account the indirect (or second-round) impacts,

which we discuss below.

     To capture the effects on the whole auto supply chain and thus estimate the

total direct impact of tariffs, we need to look at the domestic value added

generated by the export of cars to the US. The domestic value added of auto

exports to the US is the sum of value added across all steps of the export

production chain that is added domestically. This includes, for example, auto

assembly, vehicle transportation and the energy used to produce and transport

vehicles.

     Conventional measures of international trade do not reflect the flows of

goods and services within the entire production chain. As such, for our

analysis, we incorporate the OECD's Trade in Value-Added (TiVA) indicators,

which measure the value added by each country in the production of goods and

services that are consumed worldwide. Based on these statistics, we calculate

that the domestic value added of motor vehicle exports[5] to the US accounted

for 0.31% of total EU gross value added (GVA, which is equivalent to GDP) in

2015 (most recent data available). For Germany, this share is more than three

times the size (0.96%).

     Using the estimate obtained in our elasticity analysis - i.e. a 32% hit to

the sector resulting from 25% US tariffs - we calculate that the contribution to

total GVA of the domestic value added in auto exports to the US would fall to

0.21% for the EU and 0.66% for Germany. Based on our calculations, this would

shave 0.1pp from annual EU GDP growth and would constitute a more significant

0.3pp hit to annual German GDP growth. With the German economy already in lower

gear amid a number of (mostly) external pressures, the imposition of car tariffs

could be enough to tip it into recession.  

     --The Indirect Effects

     The indirect, or second-round, effects of car tariffs include the hit to

consumption and investment that would result from softer consumer and business

sentiment. These indirect economic consequences are even more difficult to

measure, but are arguably at least as significant.

     Weaker profits as a result of higher tariffs would inevitably cause

European automakers to scale back investment and employment. Lower employment

would in turn hit consumer confidence and spending power. The risk of a further

escalation in the trade dispute would also weigh on both business and consumer

sentiment, further harming consumption and investment. Moreover, financial

market sentiment would likely take a hit too, potentially depressing stock

prices and leading to a tightening of financial conditions.

     As such, the overall impact of tariffs would likely be substantially

greater than the 0.1pp (EU) and 0.3pp (Germany) hits to annual growth we

calculated by measuring only the direct costs. A rule of thumb that is

identified in various studies[6] is that the indirect impacts could very

feasibly double the economic costs. And if a 'tit-for-tat' trade spat were to

materialise, the economy would likely be hurt significantly more.

     --Cutting America's Nose to Spite it's Face?

     The tariffs are, unsurprisingly, strongly opposed by the US car industry.

Indeed, tariffs on autos and auto parts pose a threat to the supply chains of

US-owned auto companies, given that a lot of the parts they use to build their

cars are made in Germany. Moreover, according to the German auto industry

association VDA, German car companies are responsible for an estimated 113,000

American jobs at some 300 US-based factories. And as German Chancellor Angela

Merkel herself recently pointed out, BMW's biggest plant is based outside of

Germany - in South Carolina.

     --Will Trump Pull The Trigger? 

     While it is a tough call given the unpredictability of the Trump

administration's trade policy, our view is that the US and EU will eventually

settle on a compromise and avoid a mutually damaging outright trade conflict.

Trump will probably employ a similar approach to that he has adopted with China

- i.e. using the threat of tariffs as a bargaining chip to obtain concessions in

trade negotiations, while refraining from actually pulling the trigger.

     For the PDF version of the report including charts and tables see: 

     https://emedia.marketnews.com/marketnewsintl/MNI_Car_Tariffs_Analysis.pdf

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     [1] As an example of one of the complications, some German firms own

US-based plants and could avoid tariffs by shifting production to the US.

     [2] The Price Elasticity of Demand is the responsiveness of the quantity

demanded to a change in price.

     [3] Based on the following formula: Price Elasticity of Demand = % change

in quantity / % change in price

     Note that price elasticity of demand will vary depending on various

factors, including the initial price point. 

     [4] SITC category 78: Road Vehicles

     [5] Category D29: Motor vehicles, trailers and semi-trailers

     [6] See for example p.13 of the following Bank of England document:

https://www.bankofengland.co.uk/-/media/boe/files/speech/2018/from-protectionism

-to-prosperity-speech-by-mark-carney

--MNI London Bureau; +44 207-862-7489; email: ukeditorial@marketnews.com

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