What happened between the U.S. and China?
China and the U.S. are the two largest automotive manufacturers in the world. The top revenue generating automotive companies in the U.S. are General Motors, Fiat Chrysler, and Ford. Apart from these companies, the U.S. has a huge customer base for companies such as Volkswagen Group, Toyota Corp., Hyundai, and BMW. However, even with the large customer base, the U.S. does not possess ample automotive manufacturing plants, and thus, relies on importing cars from the neighboring countries such as Canada, Mexico, and countries in the European Union. Unlike the U.S., China has very less domestic automotive manufacturing companies. With the strong customer demand for foreign cars, it heavily relies on imports from other countries such as the U.S., Hong Kong, and Japan. Automotive manufacturers around the world are finding themselves sandwiched between the U.S. and China due to the ongoing trade war. The U.S. has imposed a 10% tariff on Chinese automotive parts and vehicle imports, and threatens to increase this to 25%. In return, China has levied a 40% tariff on cars imported from the U.S. Following a 90-day truce between the U.S. and China recently, China is planning to waive off the 40% tariff to 0%. President Donald Trump has also agreed to hold off on his threat to slap the 25% tariff. In this article, the trade war between the U.S. and China is discussed in detail with focus on certain points such as its impact on the automotive value chain.
According to the Bloomberg Innovation Index, China lacks research personnel. However, according to a WIPO analysis, the country ranked second in the total patents filed in 2017. . So, it can be assumed that the Chinese companies are making use of reverse engineering tactics and other illicit methods to gain intellectual property rights. This reverse engineering strategy by China is expected to be implemented in the automotive industry if the tariffs go out of hand. Chinese automakers might copy the design of the U.S. and European cars and manufacture similar cars in their own country. This will have an impact on the cars imported by China from the U.S. and European nations. G
Global Car Import, By Country, 2017, $ Billion
Global Car Export, By Country, 2017, $ Billion
Automakers may think of shifting back to steel instead
In the automotive value chain, steel is one of the main components used in many important body parts such as chassis, door beams, and so on. A typical car comprises more than 50% steel, which is generally a mixture of standard, alloy, and specialty steels. In 2017, 36 million metric tons of steel was imported to the U.S., and only 10.1 million metric tons of steel was produced by the country. Overall, the automotive industry accounts for almost 15% of steel consumption in the U.S. Therefore, the automotive manufacturers in the U.S. rely more on the steel imported from the other countries such as Canada and Brazil, rather than the steel produced inside the country. With Trump’s announcement of 25% tariff on steel imports, the automotive manufacturers in the U.S. are most likely to suffer as this move increases the raw material costs. According to estimates by the Wall Street Journal, this move will result in an average price increase of $300 for the new vehicles bought in the U.S.
A trend which is now being followed in the automotive industry is the use of aluminum and carbon fiber reinforced polymer (CFRP) to lower the carbon emission by cars. The use of aluminum reduces the weight of the car significantly, thereby increasing the fuel efficiency and reducing carbon emission. Since aluminum has a lower density and is less corrosive than steel, it is used as a replacement for steel in the manufacture of body parts. However, as aluminum is more expensive than steel, the final manufactured car with aluminum is more expensive than the one manufactured with steel. China is globally the largest producer and one of the largest exporters of aluminum. Its largest export market is the U.S. with aluminum imports in 2017 from China alone amounting to $3.5 billion. The implementation of 10% tariff on aluminum by the U.S. may hamper the trend in the automotive industry as it will increase the aluminum price further, thereby increasing the production costs. The increased production costs will further affect the already increased final product prices. This move is expected to make the manufacturers stick to steel instead of aluminum to save their manufacturing costs.
Cars will become costlier in both the countries
The U.S. is the top importer of cars in the world. With heavy demand for cars in the U.S., many companies import cars to the U.S. from their production plants in Mexico, Canada, and European nations. The U.S. has levied tariffs of 10% on many items including cars and automotive accessories imported from China in September 2018.Trump is also planning to apply a 20% tariff on all cars coming into the U.S. from the European Union. These tariffs will impact the U.S.-based automotive companies such as General Motors, Ford, and Fiat Chrysler, as they import automotive parts for their cars from different parts of the world. Foreign companies such as Toyota, Volkswagen, BMW, and others who have their manufacturing plants in the U.S., will also be majorly affected.
Volkswagen, one of the largest auto manufacturers in the world, is expected to take the biggest hit since 45% of the cars it sells in the U.S. come from its international manufacturing plants worldwide. Toyota, Japan’s biggest auto manufacturer, is also expected to suffer as 30% decline in car sales in the U.S.. If the automobile companies do not want to encounter these tariffs at the U.S. border, the only option is to start their manufacturing plant in the U.S. or expand the existing plants. However, the setting up or expanding of a production plant requires huge investment and land. As the automotive supply chain consists of tier 1, tier 2 and tier 3 suppliers, it is nearly impossible to obtain all the parts required for assembling a car inside the U.S. This will ultimately affect the trade of automotives in the U.S., and thereby reduce the economic growth of the country.
This tariff on U.S. car imports to China will impact one main segment in the automotive industry in the U.S., — electric cars — as China is one of the largest importers of electric cars in the world. According to the WTEx data, in 2017, China had imported $1.5 billion worth of electric cars, which is 19.1% of the total electric car imports in the world. Tesla, a major electric car manufacturer in the U.S. and an exporter to China, will be majorly affected due to this tariff. Tesla has a huge market for its electric cars in China and with the aforementioned tariffs, the company’s cars will cost 55–60% more than the regional competitors. The share prices of Tesla were down to 2.1% after the announcement of the tariff. This made Tesla sign up a deal with China’s officials for opening a manufacturing plant in Shanghai, China. This new plant, which will require huge investment costs and many approvals, will meet the requirement for the increased demand for electric vehicles in China without any extra tariff. Nevertheless, China is projected to be an emerging market for electric cars sales and manufacturing in the upcoming years.
Another option for the companies to avoid these tariffs is to shift their manufacturing base away from the U.S. Some companies have already started to work in this direction. For example, the German car maker BMW notified the U.S. federal officials that it will substantially move its production plant away from the U.S. to China if these tariffs are announced officially. Harley-Davidson, a U.S. motorcycle manufacturer, is also planning to move some of its production offshore to avoid tariffs from the European Union. This will hamper the production of cars inside the U.S., and result in the increase of the trade deficit of the U.S.
With the recently announced 90-day truce between the two countries, the U.S. claimed that China is going to reduce the tariff on U.S. car imports from 40% to zero. If this move becomes official, it would greatly reduce the price of U.S. vehicles coming into China, making them more affordable for the customers in the country. Moreover, this move could benefit the other automotive companies from foreign countries coming into China, more than the US. According to the World Trade Organization (WTO), countries should not discriminate between their trading partners. This means, if China lowers the U.S. tariff rate on cars to zero, it must also do that for all the other countries. Countries like Japan, South Korea and Germany are expected to be the prime beneficiaries from this tariff, rather than the U.S. manufacturers themselves. Car exports to China from Germany is expected to shoot up, as the tariff on German cars will reduce from 15% to zero at the Chinese border. This trade deal will benefit the automotive customers in China as the prices of new vehicles will decrease drastically.
Impact on the Automotive Supply Chain
The global automotive industry is dependent on a global value chain with fair trade practices and a healthy competition. The imposition of the tariffs on trade threatens to disrupt this chain, as these tariffs become a snag for manufacturers and suppliers in the U.S. and Chinese markets. Major effects of the trade war are anticipated to be seen in the value chain operations of various companies as they struggle to cope up with the increased tariff for products, resulting in the reduced demand for the exported goods.
The raw materials in the automotive value chain includes steel, aluminum, and so on. Tier 3 supplier materials include rubber, plastic, and so on; tier 2 supplier materials include batteries, semiconductors, and so on; tier 1 supplier refers to warehouse management, stock monitoring; tier 0.5 suppliers refer to contract manufacturing companies such as Magna International, Valmet International; and OEMs are companies such as Volkswagen and GM, which manufacture original equipment. With the additional tariffs on all the stages in the automotive value chain, from raw materials to tier 2 suppliers, the manufacturing cost will increase exponentially with each stage before reaching the OEMs or tier 0.5 suppliers. This will in turn increase the overall manufacturing cost for a vehicle, resulting in higher end product prices. This higher prices might disrupt the value chain as manufacturers might tend to shift from foreign suppliers to local suppliers from the U.S. to reduce their overall costs.
China is one of the major suppliers of automotive parts and equipment to the U.S. China imported around $17 billion worth of automotive parts into the U.S. in 2017. As manufacturers grapple to quell the cost increase in manufacturing and exporting, the abrupt disruption in the supply and value chains caused by the trade war tariffs on these businesses may effectively shift the supply and value chain for many products out of the hands of Chinese suppliers. Other Asian countries such as Japan and Korea provide abundant opportunities for this increasing demand for shifting the value chain. However, this process will be slow because of the huge market size of China and the connections and relationships established with China.
How are other industries impacted due to these tariffs?
Electric cars will be affected due to the tariffs on batteries
The U.S. has levied 25% tariff on Chinese imports of primary and secondary batteries including Lithium-ion batteries, the most important component of electric vehicles. China is the leading importer of Li-ion batteries into the U.S., accounting for approximately 24.6% of all the U.S. imports of Li-ion batteries used in the electric cars. This tariff will provide a boost to the U.S. battery manufacturing industries. Since the tariffs solely target China, the U.S. could also hope to source more battery imports from other Asian countries such as Indonesia, Taiwan, and Singapore, which manufacture low-cost batteries. It is unlikely that these countries will have the capacity to supply batteries as much as China, but the U.S. could increase imports from these nations to source more affordable batteries, the costs of which won’t be affected by the tariffs. This will make Tesla’s electric cars more profitable than the traditional cars in the Chinese market. Battery costs will come down as Tesla recently launched its battery Gigafactory in Nevada, the U.S. Regardless, the 25% duty will cause average battery prices to increase in the U.S. Most batteries have a low per unit cost and organizations will not be able to retain the additional expense of the levy, which will cause the final price to rise.
The U.S. people can enjoy cheaper commuting
Another key impact of the trade war is on the oil costs in the U.S. China is a noteworthy importer of U.S. crude oil. With a 25% levy on all U.S. imported crudes, China is shifting its crude trade from the U.S. to the Organization of Petroleum Exporting Countries (OPEC). The decline in crude petroleum demand from China will result in a surplus of oil and its products inside the U.S. This could possibly diminish the prices of crude oil petroleum products. This reduction in prices is expected to boost the transportation and logistics industry, which uses road as a means of transport. Vehicle owners will also profit in this process as this will result in cheaper commuting and traveling. On the other hand, the crude oil prices in China are expected to rise slightly even though it has shifted its trade to the OPEC nations. The increase in oil prices could boost the Chinese automotive industry’s transformation from ICE based vehicles to electric vehicles. However, this situation is likely to occur only if the OPEC nations decide to increase the supply of crude petroleum owing to a shift in Chinese demand for crude oil from the U.S.
In the trade war between the U.S. and China, both the countries had caused minor impacts on the supply chain of the automotive and other markets. If the tariffs are not taken care of, there could be significant negative impacts in the long run.
In the U.S., there is a possibility of the shifting of the automotive value chain to other countries, which will result in fewer exports of automotive parts from the U.S. Increased tariffs on raw materials such as steel and aluminum will increase the manufacturing price of automotive vehicles and push the final increased prices on to the customers. Increased tariffs on other industries such as battery and oil, which the automotive industry relies on, will give an extra boost to the car manufacturing costs in the U.S. With the rise in 0.5 suppliers in the automotive value chain, there is a high chance of automotive companies in the U.S. outsourcing their production to other companies in China and other European Countries without importing to the U.S., thereby reducing the manufacturing costs. If these tariffs on European cars are announced officially, we can expect new manufacturing plants of European car makers in the U.S., as it will reduce the tariffs. The construction of new plants requires heavy funding, but with the increased demand for European cars in the U.S., the European car makers can cross the breakeven point in a few years.
In China, the trend towards electric cars is on the rise. Even though there might be an increase in the electric car prices initially, with the new manufacturing plants to be constructed by Tesla and other Chinese manufacturers, the effect will not be felt much on electric car prices in the upcoming years. With the increase in the crude oil tariffs, the trend of shifting to electric cars will get a boost. The Li-ion batteries exports to the U.S. will be affected more due to these tariffs, however in the long run, the U.S. might consider lowering the tariffs on Li-ion batteries as China is expected to dominate the production of electric cars.
Overall, the imbalance in the trades between the U.S. and China will affect the economy and GDP of the countries in the long run. According to the IMF estimates, these tariffs could lead to a reduction in the GDP of the U.S. by 0.25% and GDP of China by 0.2% by 2019. Hopefully, after scrutinizing all the impacts of these tariffs on various industries during the 90-day truce, there will be a formal trade deal, which benefits both the U.S. and China, which will prevent the detrimental effects on both the countries’ economies.