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Tuesday, August 13, 2013

The Tariff Advantage of Mexico

Adapted from a post by Griffin Cook on the Econ 244 blog, May 18, 2013

Audi's decision to place the plant that will build the new Q5 crossover in Mexico resulted from more than cheaper labor and government incentives. After all, assembly is likely 10% or less of manufacturing costs, and direct labor only one piece of that. Inventives are even less a factor – what big greenfield plant wouldn't likewise enjoy incentives if located in the US? (See an August 13th Bloomberg story on efforts to recruit car-related factories in the US.) So other considerations likely dominate.

According to CEO Rupert Stadler, Europe's growing interest in SUVs and and crossovers played a key role. The European Union slaps a 10 percent tariff on U.S.-built vehicles, which would have cost Audi more than $3,000 per vehicle – and only 25% of the plant's cars will likely be sold inside NAFTA. A majority will instead be headed for the European Union.

This is part of a growing trend in which cars are produced in a foreign country and then exported to the home country, in part due to cheaper labor costs and flexibility in trade laws, but also access to a supply base and to hedge foreign exchange risk. This presents a problem for the European Union, with production in its periphery, outside the Euro zone.

So watch for what happens in the newly launched trade talks between the US and the EU, the Transatlantic Trade and Investment Partnership. Lowered tariffs would help the US. And another component is homologation, which might lessen the divergence in safety and testing standards that mean that Audi and BMW (whose South Carolina plant exports 70% of its output) must produce slightly different products for different markets – variations in headlight standards, how emissions are measured, and on and on.