February 23, 2018
NAFTA Motor Vehicle Talks Reopen Old Trade Debate
Automotive trade is among the most sensitive issues in
negotiations with Mexico and Canada over revisions to the
North American Free Trade Agreement (NAFTA). The
United States has proposed major changes in the rules of
origin that determine which vehicles and parts qualify for
tariff-free treatment when traded among the three countries.
The proposal has reopened a decades-old debate about
regulating the content of vehicles sold in the United States.
If some variant of the proposed changes is accepted by
Canada and Mexico and then ratified by all three countries,
it would make the fifth time since 1965 that Congress has
sought to encourage greater use of domestic content in cars
and light trucks.
Motor vehicle content rules were originally a response to
rising imports of passenger vehicles, primarily from Japan.
Such rules were included in the Automotive Products Trade
Agreement of 1965, better known as the U.S.-Canada Auto
Pact, which was designed to integrate U.S. and Canadian
vehicle manufacturing. Vehicles covered had to have 50%
U.S. or Canadian content for free entry into the United
States, and separate provisions required Canadian content
for vehicles sold and parts used in Canada. (The Auto Pact
was terminated in 2001 after the World Trade Organization
found that some provisions violated its trade rules.)
In 1975, the Energy Policy and Conservation Act (EPCA;
P.L. 94-163) established the corporate average fuel
economy standards for light vehicles sold in the United
States. To prevent U.S. automakers from importing fuelefficient vehicles to meet fleet-wide efficiency standards,
the law set one standard for domestic vehicles and a stricter
standard for imports. For a vehicle to be considered
domestic, at least 75% of its content had to be
manufactured in the United States or Canada. (After
NAFTA went into effect in 1996, EPCA was amended to
count Mexican content as “domestic.”) EPCA states that
the value added from parts manufacturing and final
assembly is the basis of determining whether a vehicle
meets the 75% domestic value standard. For components
assembled outside the NAFTA region, only the value of
parts produced in a NAFTA country counts as domestic
content. Unlike with other content provisions in later laws,
transportation and insurance costs within the NAFTA area
are included as domestic costs.
A third attempt at mandating vehicle content came during
the Reagan Administration, at a time when recession
reduced U.S. vehicle sales and Japanese automakers were
increasing their U.S. market share. The proposed 1982 Fair
Practices in Automotive Products Act would have
eventually required vehicles sold in the United States to
have 90% U.S. content (including parts and labor). Seen as
targeting imports from Japan, the bill passed the House
twice, but was not voted on in the Senate amid concerns
that it violated international agreements and faced a pledge
by President Reagan to veto it.
Congress revisited the domestic content of vehicles again in
1992, when the American Automobile Labeling Act
(AALA; P.L. 102-388) required a label on all new vehicles
showing domestic and foreign content of parts and the final
assembly location. Parts content does not include final
assembly, distribution, or other non-parts costs.
AALA specifies that only U.S. and Canadian content is
domestic; Mexican content does not qualify. If imported
parts count for no more than 30% of the value of a vehicle
component made in the United States or Canada, 100% of
the value of the component is counted as domestic. For
engines and transmissions, however, a broader category of
assembly and labor costs is also included in the domestic
content calculation. The country that contributes the most
value to the engine or transmission is considered the
country of origin, even if some parts are imported.
Table 1.Top 10 Domestic Content Vehicles in 2007
Pontiac Grand Prix
Source: American Automobile Labeling Act, 2007 Report, by
The overall domestic content of many vehicles sold in the
United States, as measured under AALA, has declined over
the past decade as the vehicle supply chain has globalized.
AALA reports show that many motor vehicle parts
manufactured in 2007 contained well over 75% domestic
content. Table 1 shows the 10 models with the greatest
domestic content in 2007. In contrast, only a few vehicles
NAFTA Motor Vehicle Talks Reopen Old Trade Debate
had as much as 75% domestic content in 2017 (Table 2).
Despite the requirement that dealers post AALA
information for new cars, surveys have shown that few car
buyers use the data in making purchase decisions.
Table 2.Vehicles with At Least 75% Domestic Content
in 2017 AALA Report
Wrangler 4 Door
CR-V All Wheel Drive
Ridgeline Pickup Truck
Source: American Automobile Labeling Act, 2017 Report, by
NAFTA has no provisions concerning U.S. content. It
provides that vehicles and parts produced in Canada,
Mexico, and the United States may move tariff-free in that
zone as long as at least 62.5% of the value of the assembled
motor vehicle is produced in the region. Parts and
components sold separately must have 60% regional
content to qualify for tariff-free status.
The calculation of regional value content (RVC) under
NAFTA is far more complex than the domestic content
determinations under EPCA and AALA. Vehicle and parts
producers are required to use a “net cost” method that
includes calculating six separate costs for each vehicle:
materials, processing, labor, production equipment,
overhead, and general expenses. In addition, the net cost
method requires that intermediate and indirect materials be
traced back to their raw material origins. Tracing was
included in NAFTA to eliminate imported material in a part
or vehicle net cost calculation. For example, engine
components purchased in Asia and assembled into a
finished engine in Mexico must be traced so that the Asian
parts are not counted as NAFTA content. This cumbersome
process is governed by a list of products that must be traced
by automakers back through each stage of production, until
there is a raw material not on the list. Not all products used
in producing vehicles are included on the tracing list,
Evolving Motor Vehicle Supply Chain
Since NAFTA took effect more than two decades ago, the
motor vehicle industry has changed significantly. More
vehicles are being produced in North America by
automakers from Japan, South Korea, and Germany as the
market share of the Detroit Three—General Motors, Ford
and Chrysler (now Fiat Chrysler)—has declined.
Over the same period, three factors have reshaped the
vehicle supply chain. First, vehicle assemblers have sourced
more parts from specialized parts makers. An estimated
70% of the value added in a finished motor vehicle now
originates with the parts makers, compared with about 40%
25 years ago. (Value added is the amount by which the
value of a product is increased at each stage of its
production, minus initial costs.) Second, the parts industry
itself has seen a major consolidation in the past decade and
is now global in its own right, as parts makers have
followed their vehicle assembler customers to new markets.
The auto parts industry now sources components from Asia,
Europe, and Latin America. Third, parts suppliers have
increasingly turned to new production methods in which
they deliver complex modules to auto assemblers that
include parts from many suppliers—and potentially many
countries. With as many as 15,000 parts in typical
passenger motor vehicles, tracing the origin of parts
becomes much more complex than it was at the time current
laws governing domestic content were enacted.
An increase in the required RVC alone would not assure
that more parts and vehicles would be manufactured in the
United States. The Trump Administration has called for an
additional change in NAFTA, requiring that vehicles
imported from Canada or Mexico have 50% U.S. content in
order to benefit from tariff-free access to the U.S. market.
Canada and Mexico have reportedly opposed this change. A
50% U.S. content provision might not lead manufacturers to
assemble cars in the United States rather than in Mexico; it
could instead encourage auto producers in Mexico to import
cheaper parts from Asia or Europe and pay the 2.5% U.S.
tariff on cars shipped to the United States. (This is less
likely with light trucks, on which the U.S. tariff is 25%.)
Revising or eliminating the NAFTA tracing list is also an
issue. Calculating each of the separate costs required to
determine RVC may be costly, especially for small parts
manufacturers. One option would be to eliminate tracing; it
was not included in the proposed Trans-Pacific Partnership
(TPP) trade agreement, which instead would have required
automotive products to undergo “substantial
transformation” in North America to qualify as domestic.
The United States withdrew from that agreement in 2017.
Other options would lead to an expanded use of tracing.
Under current NAFTA rules, not all materials are included
on the tracing list. Some steel, aluminum, electronics, and
electric batteries are excluded from tracing, which means
that even if they are produced in a NAFTA country, their
value does not count towards the 62.5% threshold for tarifffree trade. Another proposal is to include research,
development, and software costs in determining RVC.
Little software was installed in vehicles at the time NAFTA
was signed, but software is now a significant cost factor in
vehicle assembly and will likely become more so as
manufacturers develop increasingly automated vehicles.
Bill Canis, Specialist in Industrial Organization and
NAFTA Motor Vehicle Talks Reopen Old Trade Debate
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