Carmakers face 25% tariffs

Washington has imposed 25 per cent tariffs on imported cars and on key car parts and sub-assemblies, the outcome carmakers had dreaded most. The executive order attacks a manufacturing model that the industry spent fifty years building around integrated continental supply chains, and it puts carmakers' balance sheets and operating margins directly at risk.

The timetable is short. The duty on finished vehicles takes effect in early April, and the levy on engines, transmissions, powertrain parts and electrical components follows about a month later. Vehicles that qualify under the United States-Mexico-Canada Agreement (USMCA) get partial relief: the tariff applies only to their non-American content, once officials have worked out how to measure it. Until then, qualifying parts are spared, which buys the industry weeks rather than years.

How the continent was wired

The supply chain the order targets was built deliberately. The North American Free Trade Agreement of 1994 let carmakers treat Canada, Mexico and the United States as one production zone, and they did. Engines might be cast in one country, machined in a second and bolted into a car in a third, and some parts cross the borders several times before a vehicle is finished. Mexico became a major exporter of cars and components to America, while Canada's industry, centred on Ontario, is closely integrated with plants in Michigan and Ohio. The USMCA, which replaced NAFTA in 2020, tightened the rules of origin but kept the integrated model intact.

Imports from further afield add another layer. Japan, South Korea and Germany ship large numbers of finished cars to America, including many of the premium models that carry the highest margins. Even the Detroit carmakers import vehicles, from their own plants in Mexico, Canada and South Korea, to fill out cheaper parts of their line-ups.

Thirty thousand parts, many passports

A modern passenger car contains about thirty thousand parts sourced from dozens of countries. A 25 per cent duty based on where each part comes from is a logistical mess for the original equipment manufacturers (OEMs). Cars assembled in North America with foreign transmissions, sensors or battery cells now face levies large enough to wipe out the thin operating margins of four to six per cent that are normal for mass-market carmakers.

The arithmetic is brutal. On a car that sells for a mid-range price, a margin of four to six per cent amounts to a profit of a couple of thousand dollars at most. A tariff of 25 per cent on even a modest share of imported content can exceed that. Suppliers, which are smaller and even thinner-margined than the carmakers, face the same bills with less capacity to absorb them, and many of them depend on a few large customers for most of their revenue.

What the chicken tax taught

The industry has lived with a 25 per cent American tariff before. In 1964 Washington imposed one on imported light trucks in retaliation for European duties on American chicken. The tax never went away. It sheltered Detroit's pickup business from foreign competition for six decades, and the profits it protected became the core of the American carmakers' earnings. The lesson is that protection works, in the narrow sense of preserving margins for favoured products, while leaving buyers with fewer choices and higher prices.

A second precedent points to how carmakers adjust. In 1981 Japan agreed to limit its car exports to America under pressure from Washington. Japanese manufacturers responded by moving upmarket, where each exported car earned more, and by building assembly plants in the American South and Midwest. That shift took the better part of a decade. It suggests that the tariffs may eventually bring some production home, but on a timescale of years, and at the cost of higher prices in the meantime.

Buyers cannot take the increase

Car companies do not have enough cash to absorb a 25 per cent tariff. Nor can they simply pass on an estimated $4,000 to $7,000 per vehicle to buyers who are already stretched and financing cars with six-year loans at eight per cent. The likely response is slower production lines, cancelled models and postponed spending on electric vehicles.

The squeeze falls hardest on cheaper models. Many of America's most affordable new cars are built in Mexico or South Korea, precisely because margins on them are too thin to justify costly American labour. Those are the vehicles most exposed to the tariff and the least able to carry a higher price. Carmakers may simply stop importing some of them, which removes the bottom of the market and pushes buyers towards used cars, whose prices are likely to rise in turn. Insurance and repair bills should also climb, since replacement parts face the same duties.

Where the damage lands

The winners are relatively few. Manufacturers that build most of what they sell in America from largely American parts are best placed, and dealers holding inventory imported before the deadline will enjoy higher margins for a time. The losers include carmakers with big Mexican and Canadian operations, European and Asian exporters without American plants large enough to replace imports, and parts suppliers across all three USMCA countries. Canada and Mexico, whose car industries are built around exports to America, face a direct hit to output and jobs, and Ottawa has already promised a response.

The strongest counterargument is that the tariffs are a negotiating opening rather than a permanent settlement. Exemptions have come and gone repeatedly this year, and carmakers are lobbying hard for relief on USMCA content. If the parts tariffs are softened or delayed, the damage would be smaller than the headline rate suggests. Watch the rules for measuring American content, retaliation from Ottawa and Mexico City, first-quarter earnings guidance, and any announcements of new American plant investment.

The tariffs will not bring complex supply chains home in a hurry. Over the next year they are more likely to raise showroom prices, weaken demand for cars and lead to furloughs at plants across the industrial Midwest. Expect carmakers to cut guidance with their first-quarter results this spring, and expect buyers of entry-level cars, rather than the owners of foreign factories, to pay most of the bill.