ITC Told Compliance With Labor Value Content in USMCA Auto Rules Impossible

In order to qualify for tariff benefits, autos and light trucks must meet many standards -- the sourcing of core parts, super core parts, steel and aluminum, the sourcing for the vehicle as a whole -- and one of these is that either 40% or 45% of the labor that went into the vehicle had to be at a certain wage grade.

The labor value content (LVC) also has complex rules (see 2006300080) about which workers count in the calculation, how to average their wages, and so on -- but that's not the main barrier to compliance.

Instead, automakers say, it's that suppliers just don't answer the questions, so the companies cannot accurately add up how much labor with at least a $16 hourly average went into making the car.

Asociacion Mexicana de la Industria Automotriz, or AMIA, was one of the parties testifying at a day-long hearing at the ITC Nov. 3. Mateo Diego-Fernandez, an adviser to the group's executive president, said that companies that assemble vehicles in Mexico have asked their auto parts suppliers about wages, and have asked them to ask their suppliers, all down the chain. "We believe there are many aspects of LVC which will be frankly near to impossible to acquire because of the needs of having affidavits many levels down the value chain," he said, and so AMIA is proposing that any product assembled in the U.S. should be deemed as complying with the wage requirement.

Most Mexican assembly jobs are not paid highly enough to qualify, but Mexican research and development and engineering jobs do count toward the average.

Jose Zozaya, AMIA executive president, said simply, "Most U.S. suppliers are not willing to answer our request for LVC documentation."

It's not just sending the request from Mexico that creates the hurdle.

Anna Schneider, senior vice president of industry and government relations for Volkswagen Group of America, told the ITC commissioners, "We have to do an annual audit under the agreement, and when we’re calculating LVC, we assume all suppliers in the United States are making the $16 an hour minimum, and yet we’re required to verify or certify that. When we ask our suppliers, we don’t always get a response."

She agreed with AMIA, that the Labor Department should stipulate that U.S. suppliers pay the wage. "It would make our audits much easier," she said.

Many of the questions the ITC is seeking to answer cannot be answered yet, the witnesses said, because the rules of origin thresholds are still being phased in, or because it remains to be seen whether the U.S. denial of roll-up -- a methodology that makes it easier to reach regional value content at the vehicle level -- will stand. Both Mexico and Canada have challenged this interpretation of the ROO, and a USMCA panel is deciding who's right. The witnesses said they recently learned it will take the panel longer than expected to complete its report, and that the decision probably won't be public until January.

Many of the questions focused on how the new ROO could contribute to the rising price of new vehicles -- the average price of a new car in the consumer price index is up more than 18% since the pandemic began. The witnesses agreed it's the shortage of semiconductors, and the slowdown in production that has caused, that's the primary culprit.

American Automotive Policy Council President Matt Blunt, whose members are the Detroit Big 3, said that in 2021, the shortages caused enough furloughs that "it was basically the equivalent of shutting down six automotive plants in the United States for one year, in terms of lost output."

Bill Frymoyer, vice president for public policy at the Motor & Equipment Manufacturers Association, said the problem continues, even as ports and shipping snafus are being resolved.

Zozaya said Mexican production is down 20% compared with 2019, and the auto industry in his country is not expected to fully recover until 2024 or 2025.

Blunt said his organization recommends that the Office of the U.S. Trade Representative make moderate extensions to alternative staging regimes and lengthen some USMCA transitions to mitigate these hits to the auto industry.

He also said that with regard to the battery content requirements passed in the Inflation Reduction Act, the government needs to recognize that North America's battery industry is not yet mature enough to supply the number of electric vehicles that will be built in the next few years, and that it needs to consult with industry and labor to understand what is feasible.

The USMCA is more flexible on batteries -- allowing a tariff shift standard rather than a regional value standard -- but the IRA is quite proscriptive, for both battery components and the critical minerals used in them.

Volkswagen's Schnieder agreed. She said, "As we strive to meet the targets set out in our alternative staging regimes, I think it would be helpful if the ITC and USTR took into account we are not producing at the rate we would like to produce. We have tens of thousands of reservations for our electric vehicle that we can’t meet because our battery supplier is struggling to meet demand, because they have disruptions [in supply]."

Rory Heslington, vice president of government affairs for Autos Drive America, the trade group for foreign automakers (aside from Chrysler's parent company) with manufacturing in the U.S., said his member companies are making every effort to localize production of EVs and EV batteries. He said that while the USMCA allows a transition period of five years for advanced batteries, more may be needed.

The witnesses agreed that the way the negotiators structured rules of origin -- requiring that super core parts originate in the region, not just that the vehicle as a whole meets the standard -- is supporting more jobs in the U.S. and Mexico.

AMIA said there are Asian companies moving parts production to Mexico to help carmakers retain duty-free eligibility.

Schneider gave concrete examples -- such as sourcing axles from North Carolina instead of from Asia. Volkswagen used to send engines from Germany for the VW Atlas. Now all engines for cars and SUVs built in North America are coming from Mexico.

Heslington said he's heard that transmissions, axles and engines are being made here in the NAFTA region that used to be sourced in Asia or Europe from many of the companies in the trade group.

The rules of origin are also driving more demand for steel in the U.S., the ITC heard.

Schneider said sourcing specialty steel in the U.S. in the relatively small quantities they needed for assembly in Mexico was incredibly challenging. She said Volkswagen will meet the 70% standard in three years, "but it came at a price. In order to do that, just the cost of transport is hundreds of millions of dollars."

Because Volkswagen exports a high volume of vehicles from the U.S. to Mexico and Canada, she said it was worth it to change supply chains to meet the new rules. But for some companies, the cost of compliance is higher than paying the tariffs. The U.S. only charges a 2.5% tariff for passenger cars coming from Mexico that don't meet the ROO. "You have to weigh the business case," she said.

Even under the less stringent NAFTA rules, some Mexican vehicles were not covered by the agreement.

Schneider said the U.S. approach on roll-up would impact the ability of automakers to get the tariff benefit. "It is critical that all three parties fully and faithfully implement the panel’s decision," she said, not just for certainty, but also for the competitiveness of the North American auto industry, and to provide credibility to the dispute settlement function of USMCA.

The commissioners had questions about whether the higher costs for USMCA compliance would make U.S. cars less competitive in Canada and Mexico compared with Asian or European exports. According to the International Trade Administration, in Mexico before the pandemic, Mexicans bought 1.3 million new cars annually; only 126,000 were imported from the U.S. According to the ITA, about three-quarters of Canadian new car sales are from imports, and about two -thirds of those imports are from the U.S. In 2019, that was 46,844 vehicles.

In comparison, U.S. consumers bought 17 million new cars in 2019.

The 2022 Harmonized Tariff Schedule update also complicated compliance, according to MEMA's Frymore. Heslington said he also heard that from his members. ITC Chairman David Johanson asked them what caused the problem, and both men said they'd have to talk to members and get back to him with more details.

"That’s something we should know about, since we in this building deal with [HTS updates] all the time," Johanson said.

The report from the ITC is expected in June 2023.