Will the North American Auto Industry Survive Proposed U.S. Electric Vehicle Subsidies?

Several months ago, I asked (and tried to answer) the question, “Will the Mexican auto industry survive the USMCA and AMLO?” This submission posits a related question. Can the North American auto industry survive the proposed U.S. subsidy policies for electric vehicles (EVs) and EV batteries? In the future will this poster child for efficient North American integration, where the U.S imports annually $29.5 billion worth of car parts from Mexico and exports $5.9 billion to Canada, and exports $11.7 billion worth of completed vehicles to Canada and $67.5 billion to Mexico, continue or be radically diminished, if EV and EV battery producers are strongly discouraged from establishing facilities in Canada and Mexico?

The “Build Back Better Act” (BBBA) is a mammoth legislative package worth over $1.8 trillion in its current incomplete form that addresses a wide range of issues ranging from childcare to climate change. (Separate legislation addressing inter alia the rebuilding of America’s roads, bridges, ports and dams, expanding the national network of EV charging stations, improving the reliability of the U.S. electrical grids, and extending the availability of high-speed internet was signed by President Biden into law on Nov. 15, 2021.) My focus here is on the BBBA provisions designed to encourage Americans to purchase more EVs over the next decade.

Caveat: The legislation has been passed by the House but awaits action in the Senate. All provisions are subject to change, including those relating to EV and battery subsidies, and at this writing it remains possible that the entire package will fail because of differences among members of the Democratic Party and growing fears of runaway inflation. Moreover, as discussed below, the “Buy American” and pro-union provisions not surprisingly face broad opposition from multiple sources.

Few would question the desirability of encouraging the substitution of EVs for gasoline powered vehicles by American consumers, even though some wonder whether within the next 8-10 years sufficient clean energy will be available from America’s aging electrical grid, particularly in states such as California and Texas, to assure that the shift to EVs actually results in less carbon dioxide pollution. (In 2020 coal still produced about 20% of US electrical power demand; natural gas, 40%; nuclear, 20%; and renewables, 20%). However, legitimate questions arise as to whether the “Buy American” focused subsidy provisions are consistent with the USMCA, WTO rules and the best interests of American (and North American) auto producers, workers and consumers. Also, the full subsidies that would be provided only for EVs produced in the U.S. with union labor, by reducing consumer choices, seem inconsistent with another Biden administration objective (whether or not realistic) of EV sales of 50% of the U.S. market by 2030.

Under the subsidy scheme as currently specified in the draft legislation, for the first five years EV buyers would receive a $7,500 tax credit regardless of where the vehicle is made. For the ensuing five years, the base credit would apply only to EVs produced in factories located in the U.S. In other words, if the assembly plant is in Canada, Mexico or a third country the credit doesn’t apply and the effective cost to the consumer/purchaser rises by $7,500. An additional $500 tax credit would be applicable only to the sale of any car with a U.S.-made battery, and a further $4,500 (for the entire ten-year period)  only if the car is made in a unionized plant in the United States.

Many of the details are not available and probably won’t be until if and when the legislation is enacted and implementing regulations are issued by U.S. authorities. Canadian government pressure on both the administration and key members of Congress may be effective to some extent, but availability of any major portion of the subsidies for Canadian-built cars exported to the U.S. is in my view problematic. Or not. Canada does have greater leverage than Mexico, given that Canada is a producer of lithium, graphite and cobalt, among the most important minerals for EV battery production (and one of the few stable, friendly nations that produces them). It seems unlikely to me that the Canadians will say to Biden officials, “Fine. We will happily ship these minerals to Tennessee and Kentucky so that your (and only your) battery plants and their workers can turn them into EV batteries.”

The subsidies would not be available for the purchase of vehicles produced in Mexican auto plants that are unionized at wages that are 20% or less of American or Canadian wages. Mexico, other than low-cost labor, has fewer benefits to offer than Canada, in part because energy costs for industry in Mexico are surging and reliability is decreasing, the USMCA rules require that 40% of auto content and 45% of small truck content be produced in facilities where wages are at least $16/hour, and because Mexican President Lopez Obrador’s (AMLO’s) anti-business policies tend to discourage major new investments. However, one of the major benefits of maintaining a robust auto and auto parts sector in Mexico is the jobs it provides for Mexican workers, workers who will be less tempted to cross into the United States if they have gainful employment in Mexico.

The proposed subsidies, as Canada’s trade minister Mary Ng has noted, violate the WTO’s Subsidies and Countervailing Measures Agreement (SCMA) since they are specific to a given industry (EVs and EV batteries). It is uncertain how much this matters in the real world. However, the likelihood of a case being brought at the WTO is slim given that without the domestic subsidies and the Mexican production or co-production option, EV production in the U.S. is likely to be significantly more costly than for competing producers in China, South Korea and Germany among others. Moreover, the WTO dispute settlement system’s Appellate Body has been neutered since December 2019, meaning that any member such as the United States can indefinitely block the adoption of a panel decision against it.

The remedies for Canada and Mexico under the USMCA are much more viable. There is no absolute bar to subsidies under the USMCA,  but the SCMA limits are incorporated by reference. Moreover, a broad prohibition exists in USMCA Article 2.3.1 against the bedrock principle of denial of national treatment.

Under Chapter 31 of the USMCA (state-to-state dispute settlement), unlike the corresponding Chapter 20 of NAFTA, it is very difficult for the responding party (e.g., the U.S.) to block the arbitration proceedings once initiated, by refusing to appoint panelists. Art. 31.1 provides that if “a dispute regarding a matter arises under this Agreement and under another international trade agreement to which the disputing Parties are party, including the WTO Agreement, the complaining Party may select the forum in which to settle the dispute.” In other words, Canada and Mexico could bring a Chapter 31 claim against the United States based on violations of both the USMCA and the SCMA, with trade sanctions as the ultimate remedy if the matter were not resolved through mandatory consultations and ultimately the U.S. were to refuse to comply with the arbitral panel’s adverse decision. Since Canada and Mexico are among the world’s few major auto producing countries that are not likely to be subsidizing EV production, and are major importers of vehicles from and exporters to the U.S., they would have a powerful incentive for filing a USMCA case against the U.S. should all other efforts at reaching a compromise fail.

What ultimately may be more important to the administration than strenuous opposition from Canada and Mexico is opposition from West Virginia Senator Joe Manchin — whose vote for the BBBA is crucial with a 50-50 divided Senate — as Toyota has a major non-unionized auto plant in West Virginia. Toyota and Tesla, along with owners of many other non-unionized auto plants in the U.S. and the Washington ambassadors of nations that export autos to the U.S. have communicated their opposition to administration officials and members of Congress as well. Mr. Manchin has been quoted as noting that the extra credits (for unionized auto production) are “wrong” and “not who we are.” Governors of other non-union auto producing states have also objected. Some critics have charged that Mr. Biden is sacrificing the environment to help his political allies such as the United Auto Workers.

Politically, one downside of the U.S. EV subsidies is that they make it more difficult for the U.S. to take the high road when criticizing China’s own massive (and illegal) subsidies for EV and battery production in China (and for many other items such as AI, robotics and chips), and may effectively give carte blanche to other major producing countries (particularly Germany, Japan and South Korea) to institute their own subsidy programs. This probably doesn’t concern anyone except for the relatively few U.S. trade lawyers and policy makers who believe the U.S. should adhere to international trade rules. One might more logically consider whether from a political/strategic point of view it makes sense for the U.S. to significantly weaken the auto industries (and thus the manufacturing economies) of its nearest neighbors and most significant trading partners, undermining the highly competitive co-production model for autos and auto parts established under NAFTA nearly 30 years ago.

Given the current state of the U.S. legislative proposals, no obvious solution to the problem is evident, although continuing disagreements within the Democratic Party may ultimately cause the legislative package to fail or result in major modifications to the EV subsidies program due to Congressional, business and Canadian/Mexican opposition. Regrettably, the Biden administration, despite the high level “Three Amigos” summit Nov. 18, where AMLO and Trudeau complained strenuously about the discriminatory nature of subsidies, has evidenced little sympathy with the positions of Canada and Mexico. Press secretary Psaki was dismissive: “It’s not the first time that there have been incentives and tax credits for consumers — lower prices for consumers [and] help incentivize a move towards a clean energy industry.” As the Washington Post argued in an editorial Nov. 20, “A level playing field would be more neighborly — and better policy.”

One can only hope that as the legislation moves forward in the Senate a few wiser heads will consider the presumably unintended consequences of the subsidies for Canada, Mexico and the United States, and for the future viability of the USMCA and North American economic cooperation.

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