EU Braces For Collision With US Over Auto Tariffs

EU Braces For Collision With US Over Auto Tariffs

• 1. EU Braces For Collision With US Over Auto Tariffs - 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. Figure 1: The EU’s top auto export markets 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. To assess the impact of car tariffs, the price elasticity of US demand2 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 parts4 to the US in 2018. This accounted for 24% of total EU car exports (see Figure 1), 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 (see Figure 2), 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. Figure 2: Share of Extra-EU Auto Exports by Member State 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 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

• 3. (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 exports5 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 studies6 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. Figure 3: The Economic Costs of A Hike In US Auto Import Tariffs To 25% 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. 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

• 4. 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 more information, please contact: sales@marketnews.com www.marketnews.com ________________________________________ Unauthorized disclosure, publication, redistribution or further dissemination of this information may result in criminal prosecution or other severe penalties. Any such authorization requires the prior written consent of Market News International. Redistribution of this information, even at the instruction of your employer, may result in personal liability or criminal action unless such redistribution is expressly authorized in writing by Market News International. Violators will be prosecuted. This information has been obtained or derived from sources believed to be reliable, but we make no representation or warranty as to its accuracy or completeness. This is not an offer or solicitation of an offer to buy/sell. Copyright © 2019 Market News International, Inc. All rights reserved