How (not) to make a North American car

Canada’s autoworkers have had a front row seat to the political theatre of Canada-U.S. trade relations in recent years.

While we generally liked what we saw in the strengthened labour protections of the renegotiated NAFTA—now called the Canada–U.S.–Mexico Agreement (CUSMA)—the Biden administration’s proposed electric vehicle credit for U.S.-made cars, and now an official trade dispute over when tariffs should be applied to North American trade in automotive goods, have Canadians bracing for impact.

This article puts the far more troubling electric vehicle credit proposal aside for now to properly contextualize the latter spat, filed jointly by Mexico and Canada, over how CUSMA’s automobile rules-of-origin (ROO) are calculated and applied.

The essence of the dispute is this: under CUSMA, which succeeded and replaced NAFTA in July 2020, automakers face new, arguably stricter criteria, including higher local content quotas, for determining what is (or is not) a North American-made car. The revised trade pact also stipulates that only products that originate in North America (i.e., that meet these criteria) can cross Canadian, U.S., and Mexican borders duty free.

However, the key to determining what counts as North American content is not so simple, taking up hundreds of pages of convoluted text in Chapter 4 of CUSMA and a package of regulations.

CUSMA’s complicated auto rules-of-origin

Unlike in NAFTA, the renegotiated pact establishes multiple tests to determine if a car or car part qualifies for preferential tariff-free treatment. Starting in 2025, finished vehicles, including passenger cars, must contain at least 75% North American content to qualify. But there are also local content rules for the individual parts that go into that completed vehicle, ranging from 65% to 75%.

On top of that, the CUSMA requires that 40-45% of car content must originate in facilities that pay workers an average of US$16 per hour. Further still, automakers must now source at least 70% of the steel and aluminum they use in car manufacturing from North American sources.

The dispute in question, initially launched by Mexico on January 6, then joined by Canada on January 13, focuses on the calculation of so-called “Core Parts.” These are a subcategory of auto parts widely acknowledged to be the most valuable in any car, including engines, transmissions, chassis, steering systems, and advanced batteries. To avoid tariffs, automakers must ensure that at least 75% of the content in each Core Part originates from a North American factory.

If the U.S. wins, the new interpretation significantly tightens up the math in “Made in North America.” In extreme cases, supply chains will need to be rejigged to ensure compliance.

As you might expect, these higher domestic content rules drew the ire of automakers, who complained of increased costs and the complexity of the new reporting requirements. To throw them a bone, trade negotiators loosened the rules with respect to calculating domestic content of Core Parts in two ways.

First, negotiators assured the auto manufacturers they did not have to calculate every bolt, screw, or washer in an engine, for example. Instead, they need only focus on the North American content across a specific set of predefined parts (for engines, this includes blocks, heads, cranks, etc.). Trade nerds colloquially refer to this as the Component Method.

Second, car companies can aggregate the North American content across all seven identified Core Parts to reach the threshold of 75%. In other words, if one of the seven listed parts fails to meet the required content threshold, the total group of parts may still qualify as originating. This approach is dubbed the Super Core Method.

If negotiators agreed on all these Core Parts rules in CUSMA, you’re asking, what’s the problem? It’s in how the U.S., Canada and Mexico want to determine the North Americanness of full cars—and it’s just as complicated.

How North American is that engine?

Mexico says (and Canada agrees) that if an automaker qualifies an engine as North American, using the Component Method or Super Core Method described above, then the value of the engine assigned to the car counts as 100% North American. That would be true, say Canada and Mexico, even if 25% of that engine originated outside the CUSMA region, overseas perhaps.

Mexico and Canada also contend that all parties involved in the negotiation understood this to be the case when they signed the agreement. The U.S. disagrees that it agreed to this. They say automakers must conduct two separate calculations to determine conformity with CUSMA’s rules of origin.

In the U.S. opinion, flexibilities are available to automakers who wish to qualify a Core Part and then export it duty free, but that does not entitle them to roll up the value when quantifying North American content in a car (i.e., to treat it as 100% North American in origin). Instead, the U.S. contends, the automaker must calculate the content again for each Core Part, with no flexibilities allowed.

Both sides in the dispute are at loggerheads. Despite months-long efforts to resolve the impasse, including consultations prescribed under Chapter 31 of CUSMA, fingers have been pointed and no one is budging. This Chapter 31 dispute is the final course of action, leaving the matter to a three-person arbitration panel whose decision is binding.

Implications of the CUSMA dispute

It would be foolish to venture a guess at who will win at this point. Unlike the clear and present danger that a U.S.-only EV tax credit will have on Canada’s auto industry, the consequences of a U.S. win in this dispute is still unclear.

Automakers are naturally concerned. If the U.S. wins, the new interpretation significantly tightens up the math in “Made in North America.” In extreme cases, supply chains will need to be rejigged to ensure compliance. Depending on the costs associated with compliance, that may trigger other indirect effects on the continental industry of concern to Mexico and Canada.

For example, automakers may determine that the cost of complying with CUSMA rules of origin is higher for them than paying the tariff (a mere 2.5% for cars exported into the U.S.). In that case, the entire North American auto trade architecture falls apart.

The window is open for governments to put the policy tools in place to deliver on this massive industrial transformation project—one that might set the template for what a just, sustainable, and worker-centred transition can look like.

Automakers may also decide it is less costly to in-source supply parts work to the U.S.—by a wide margin, the largest of the three auto sales markets on the continent. Building and selling in the U.S. market will help avoid these trade “irritants,” but it would also leave Canada and Mexico in a vulnerable spot.

That said, it is unlikely a dispute over content rules will boil over into a full-scale trade war. For one thing, given the heavy concentration of production in North America, most automakers likely already pass the stricter regional value content tests in CUSMA (as interpreted by the U.S.). For another, more content that is North American means more jobs and investment, a win for workers.

More importantly, this latest trade dispute pales in comparison to other significant headwinds facing the North American industry, including a global semiconductor shortage, production backlogs, a hyper-competitive investment climate and tightening labour markets.

Trade diplomacy and trade enforcement are not sufficient to meet these challenges. For that, Canada has to seize the opportunity to rebuild its auto industry as a global leader, driven by clean technology. The window is open for governments to put the policy tools in place to deliver on this massive industrial transformation project—one that might set the template for what a just, sustainable, and worker-centred transition can look like.