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October 5, 2018 Article 6 min read

Following last minute negotiations, we have a proposed NAFTA replacement: The United States, Mexico and Canada Agreement (USMCA). What’s in it for the auto sector? In this article we look at implications for the supply chain, regional content, and labor.

Photo of a United States government building with a flag in front of it.

The Trump Administration announced a new three-way trade agreement with Canada and Mexico this week. The agreement — called The United States, Mexico and Canada Agreement (USMCA) — will, once ratified, replace the North American Free Trade Agreement (NAFTA) as we know it.

As with NAFTA, the USMCA is a broad, encompassing agreement covering manufacturing, agriculture/dairy, financial services, telecommunications, and other sectors. In addition to the trade of physical goods, it addresses intellectual property, labor markets, anti-competitive practices, and the environment. This article focuses on the implications of USMCA to the automotive sector.

Three major takeaways for automotive suppliers

The USMCA has three important provisions of interest to the automotive sector. You can find them in the Appendix to Annex 4-B, “Provisions Related to the Product-specific Rules of Origin for Automotive Goods.”

The Annex 4-B provisions cover the important areas of domestic content, steel and aluminum content requirements, and labor wage provisions. Additionally, they spell out the different handling for passenger cars, light trucks, heavy-duty vehicles, and automotive parts.

We’ve identified three important takeaways for automotive suppliers:

1. Grow-in periods allow OEM and supplier-sourcing strategies to play out.

The USMCA provides for “grow-in” periods to allow time for OEMs and suppliers to review sourcing strategies. Under these provisions, most content percentages and other provisions generally will be effective in 2023. This means that OEMs and suppliers will have five years to adjust the supply chain underneath existing vehicles and new vehicle introductions. However, these more complex reporting requirements will lead to greater company compliance costs.

OEMs will have five years to adjust the supply chain underneath existing vehicles and new vehicle introductions.

These higher regional content values lead to several anticipated adjustments:

  • More detailed tracking of even low-value components to assure all value is captured
  • Accelerated engine, transmission, and advanced battery facilities investment (as these are required for the greatest technology credit in the labor value content calculation
  • Increased localization of second- and third-tier components
  • Increased distribution of R&D and information technology investment in the region  

The following are the basic grow-in periods for each of the key areas:

  • Regional value content requirement (62.5 percent current level)
    • January 1, 2020: 66 percent
    • January 1, 2021: 69 percent
    • January 1, 2022: 72 percent
    • January 1, 2023: 75 percent
  • Labor value content: high wage or $16/hour (no current requirement)
    • January 1, 2020: 30 percent (from a minimum of 15 percent from materials/manufacturing; maximum) of 10 percent from technology; maximum of 5 percent from assembly). Note: Light- and heavy-truck origination is frozen at this calculation.
    • January 1, 2021: 33 percent (from a minimum of 18 percent from materials/manufacturing; maximum) of 10 percent from technology; maximum of 5 percent from assembly
    • January 1, 2022: 36 percent (from a minimum of 21 percent from materials/manufacturing; maximum) of 10 percent from technology; maximum of 5 percent from assembly
    • January 1, 2023: 40 percent (from a minimum of 25 percent from materials/manufacturing; maximum) of 10 percent from technology; maximum of 5 percent from assembly
  • Steel and aluminum (no current requirement):
    • January 1, 2020: Seventy percent of a vehicle producer’s purchases on average during the previous year will originate in North America including direct purchases, purchases through a services center, and purchases contracted through a supplier. The base includes all production, including exported vehicles in the following year.

2. Core, principal, and complementary will become the common vocabulary describing parts.

The Annex 4-B vehicle regional value content requirements have three tables with specific parts codes defining regional value content requirements and grow-in periods to be declared originating in the North American region:

  • Core products: This category includes items such as engines, lithium ion batteries, bodies, gear boxes, axles, and steering and suspension components. These products must have 66 percent regional value content beginning Jan. 1, 2020, (and growing to 75 percent in 2023). These components have the highest value-add, capital intensity, and economic multiplier effect. Thus, the USMCA’s framers wanted to assure these components (and their sub-tier value) are localized to drive economic development.
  • Complementary components: This includes a wide range of items, including catalytic converters, lighting, electric motors, and wiring sets, which have a lower regional value content to claim origination, from 62 percent in 2020 to 65 percent in 2023. This reflects the higher raw material costs sourced outside of the region, but still the USMCA’s authors desire to incentivize local, final assembly. As all forms of electrified vehicles increase in the market, products such as electric motors should grow in demand to justify localizing their manufacturing and counting their value in the USMCA formulas.
  • Principal parts: In between these two bookends are principal parts. Their required regional value content to be counted as an originating part is in between at 62.5 percent in 2020, growing to 70 percent in 2023. This is an interesting list of components that ranges from tires to air/gas pumps and tapered roller bearings to flywheels and clutches. Certainly, on the original equipment side of the business, there’s significant regional production capacity of the final, assembled product. These USMCA requirements may be in place to drive greater, regional material sourcing — such as tire steel cord and other specialty steels required in bearings and clutches.

3. Be cautious regarding potential, future automotive tariffs.

We’re urging caution regarding the potential for future automotive tariffs under Section 232 of the Trade Expansion Act of 1962. In a previous article, we covered the May 23 announcement that the United States was initiating a Section 232 investigation to determine whether automobile and automotive part imports threaten to impair U.S. national security. Now, the proposed USMCA contains language that shields Canada and Mexico from potential automotive vehicle and parts tariffs should the United States conclude that foreign vehicle and part imports are a threat to national security.

We’re urging caution regarding the potential for future automotive tariffs under Section 232 of the Trade Expansion Act of 1962.

The agreement has four side letters that cover the exclusion of Mexico and Canada from automotive Section 232 tariffs and establishes a 60-day negotiation period to work out the details of how vehicles and parts could flow under an established quota system. The fact that the three countries chose to explicitly handle this issue through side letter agreements clearly shows the potential for future automotive Section 232 tariffs. It also has potential implications for the negotiating strategy between the United States, Japan, South Korea, and the European Union.

We also note that the USMCA doesn’t change the steel (25 percent) and aluminum (10 percent) Section 232 tariffs currently in effect.

What next?

Given that the majority of all timelines written into the USMCA begin Jan. 1, 2020, there’s a general perception that the United States, Canada, and Mexico will live under the current NAFTA agreement through 2019.

In the meantime, the U.S. International Trade Commission is required to issue an economic impact analysis, and the U.S. Senate Finance Committee and the U.S. House Ways and Means Committee should hold public hearings and report out on the final text. It’s unlikely these items will go forward before the next session of Congress convenes in 2019.

Since the USMCA is being put forward under the Trade Promotion Act, Congress cannot amend the text that is presented to them. The Senate will vote the agreement up or down with a majority of votes.