In European Union-Japan Trade Deal, Tariff Reduction Unlikely to Be Good for Car Makers in Both Blocs

July 05, 2017

Lower tariff barriers generally benefit consumers in the form of lower prices. If they don’t increase overall unemployment, they will lead to gains for the economy as a whole. However, there will almost always be specific industries that are losers. This is why it is a bit strange to read in a NYT article on a prospective trade deal between the European Union (EU) and Japan:

“Among other things, the pact would eliminate a 10 percent duty that the E.U. imposes on Japanese car imports, while removing obstacles that European automakers face in Japan. That would be particularly significant for luxury carmakers like BMW, Mercedes and Toyota’s Lexus brand, said Ferdinand Dudenhöffer, a professor at the University of Duisburg-Essen in Germany who focuses on the auto industry.

“Those vehicles suffer the most from high import duties. ‘It could be a chance for the high-value, premium vehicles,’ Mr. Dudenhöffer said. American brands like Cadillac or Lincoln ‘won’t have the same advantage and will be in a worse position,’ he said.”

The existing tariffs give the sellers in these markets the opportunity to charge a premium over the tariff-free price. This premium will be lost when the tariffs go away. It is possible that either EU car makers or Japanese car makers will gain enough market share that it will offset the loss of this premium, but it is highly unlikely that both would gain enough market share to offset the loss of the premium. The lower price will undoubtedly lead to some increase in sales and there is the possibility of gaining share at the expense of U.S. car makers and other third country sellers, but these gains would have to be extraordinary to make both sets of manufacturers as winners.

To make the arithmetic simple, suppose a 10 percent tariff is passed on fully to higher prices. Suppose the profit would be 5 percent of the sales price in the absence of the tariff. This means that the tariff makes the profit 15 percent of the sales price. (I’m rounding here.) The loss of tariff protection in this story would then cause the per car profit to fall by two-thirds, meaning that unless sales triple, the company ends up a net loser.

The real world story is more complicated. The tariff is not completely passed on in higher prices and some of the benefits of the higher prices are shared with workers in the form of higher wages. But unless a company in a protected industry has a very large gain in market share, it is unlikely to be a benefit from ending the protection.


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