Roadblocks To Global Automotive Free Trade

Byline: Louis Rumao

There is a broad consensus among economists that protectionism has negative impact on economic growth and social welfare in the long-run. The magnitude of this impact varies across countries as it depends on local macroeconomic and policy environment. Protectionist tendencies are creeping into the global automotive industry, mainly in the US and China.

The global automotive manufacturing industry is valued at about US$1.5 trillion. Half of that amount (US$ 750 billion) is generated by the auto parts supplier industry.  No wonder, the automotive industry is of strategic importance to every country. Most of the developing and emerging country players are competing in the global OEM and parts markets for business growth. This naturally leads to protectionism, especially in countries with growing deficits and strong trade unions.

Free Trade

Protectionism is the economic policy of restraining trade between countries to ensure fair competition between imports, and domestic goods and services. The methods adopted for this include tariffs on imported goods, restrictive quotas, and other government regulations.

After the World War II, Japan froze out foreign goods while building up world-class automotive, computer, and electronics industries. Korea later followed Japan’s strategy; in recent years, so has China. It is done to protect nascent industries through tariffs, quotas, and other trade barriers. Some countries welcome foreign producers only if they establish high-tech facilities in which local engineers and workers learn the most modern skills.

Protectionism contrasts with free trade, where government barriers to trade are kept to the minimum. The modern theory of free trade argues that countries are ‘endowed’ with certain quantities of labour, capital, and natural resources. A country with lots of labour, but little capital, should specialise in the production of labour-intensive goods, like hand-woven rugs, hand-sewn garments, or hand-picked fruit. By ramping up production of these goods, a developing country can trade on world markets and earn foreign exchange to purchase capital-intensive products like computers and cars. Free trade thus permits poor countries (or, to be more precise, their most well-off citizens) to consume high-tech goods, that they lack the ability to produce, and to obtain higher living standards. ‘Capital-rich’ countries benefit from relatively cheap fruit and garments, freeing up their workforce to focus on high-tech goods. Free trade, according to this story, is a win-win game for everyone.

The flaw in this tale is that being ‘capital-rich’ or ‘capital-poor’ is not a natural phenomenon like having lots of oil. Capital is created with plenty of government assistance and protection.

In the contemporary global economy, however, there are three difficulties in implementing a local development strategy. First, some countries have bargained away their right to protect local firms by entering into free-trade agreements. Second, protectionism means that local consumers are denied the benefits of cheap manufactured goods from abroad, at least in the short-run.

Finally, in many parts of the world the floodgates of foreign-made goods have already been opened. With the middle and upper classes enjoying their computers and cell phones, it may be impossible to build political consensus to close them.

US Protectionism

The American public in general is not concerned about free-trade vs protectionism, as they enjoy the benefits of cheap consumer goods, especially electronics and clothing. But the issue is very much alive for the labour union leaders. For the automotive industry, the `American-Made Index’ (AMI), developed by CARS.com, can be used by union leaders and union-supported politicians to promote protectionism in the US. AMI rates vehicles sold in the US, taking into account the percentage of parts considered domestic under federal regulations. Domestic-parts content stems from the 1992 American Automobile Labeling Act (AALA), which groups the US and Canada under the same `domestic’ umbrella. It is one of the imperfections of the Act.  AALA is the only domestic-parts labelling system car shoppers can find on every new car sold in America.

Today cars with at least 75 percent domestic content are becoming an endangered species in the US.  For the first time in the AMI’s nine-year history, the list has less than 10 cars for the 2015 model year, out of the 101 models assembled here.  Surprisingly, three of these ‘domestic-rated’ models belong to Toyota and Honda! The dichotomy is that cars with 100 percent domestic content do not sell well.  Because of the low volume, their parts cost more, making these cars more expensive.

Most cars built in the US are assembled using parts that come from elsewhere. Still, Detroit has the bulk of cars with high domestic content. GM, Ford and Fiat Chrysler Automobiles build 37 of the 57 US-assembled cars with 60 percent or more domestic content. Foreign-based automakers are selling dozens of imported cars with zero percent domestic content, according to the US National Highway Traffic Safety Administration. However, in today’s global economy, there is no easy way to determine just how American a car is!

The Detroit OEMs are in contract negotiations with the United Auto Workers (UAW) to replace the one expiring in September, 2015. UAW will try to force the OEMs to increase wages as well as domestic content of their models to ensure higher membership. No doubt, the auto parts suppliers from developing countries will have their work cut out for them when it comes to exporting products to America and, especially to China.

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