The impact of trade liberalisation on the EU automotive industry: trends and prospects

Transcription

1 The impact of trade liberalisation on the EU automotive industry: trends and prospects European Commission DG TRADE 11 July 2014

2 FINAL REPORT This study is produced by Copenhagen Economics on the request of the European Commission, DG Trade, under framework contract (TRADE/07/A2). The opinions expressed are those of the Contractor only and do not represent the Commission s official position Authors: Martin H. Thelle Anders Oskar Kjøller-Hansen Tine Jeppesen Jens Sand Kirk Sigurd Næss-Schmidt Frank Verboven (University Leuven) Jo van Biesebroeck (University Leuven)

3 Table of contents Summary 3 1 The automotive industry in the EU Car makers in Europe are in a difficult situation Production in Europe The outlook: Business as usual will be poor business Employment in vehicle manufacturing in Europe Summary 28 2 How cars are traded Current trade situation Little impact from trade liberalisation to date Cars sold in Europe are mostly made in Europe Local vs imports for EU car makers abroad Summary 66 3 Trade barriers for cars and parts Tariffs on cars, parts and components Processing trade Non-tariff barriers (NTBs) Quantifying NTBs in terms of trade costs 80 4 FTAs and trade liberalisation for cars Data baseline Counterfactual analysis Results 98

4 5 Impact on parts, components and related industries FTAs and trade liberalisation for parts and components Methodology Baseline data Results for parts and components Impact on related industries in the EU 123 Conclusions 127 References 128 Appendix A 131 Appendix B 133 Appendix C 136 Appendix D 146 Appendix E 148 Appendix F 158 Appendix G 167

5 Summary This report, produced at the request of the European Commission (DG Trade), quantifies the individual and cumulative impacts for the automotive industry in the EU of a series of FTAs with EU trade partners. Having performed detailed analyses of 19 FTAs with existing and potential EU FTA partners, we come to the overall conclusion that free trade also is a win-win situation for the automotive industry in Europe and its partners. The automotive industry has a large economic footprint in the EU today, and that footprint is likely to grow even larger, if FTAs with the 19 FTAs partners are fully implemented. Our analysis covers cars, light vehicles and parts and components. In a cumulative scenario with both tariff and non-tariff barriers reduced, we find large positive effects on the EU automotive sector. Completing and fully implementing all 19 possible FTAs would increase in EU car production by 4 per cent, or almost 580,000 more cars, even after taking into account the increased competition in the home market. Both in relative and absolute terms, the changes in EU exports are expected to exceed the change in imports, and free trade is more likely to be an opportunity than a threat to the EU s automotive industry. That being said, Europe s automotive industry is in a difficult situation. Consequently, due care is needed in sequencing and refining the agreements to ensure a successful transition to more open trade. Seen in a broader perspective, the EU automotive industry should find good opportunities from the full menu of FTAs that is on the table, and should not be threatened by fears and lose their appetite for more open trade. The present study is based on assumptions used in previous studies conducted as part of impact assessments of the FTAs. For most negotiations, the assumptions used in the present study are the conservative/central scenarios used in the previous studies which often correspond to the least ambitious (i.e. in case of EU-Japan FTA). The only exception is the EU-Korea FTA, which is the only new generation FTA that is already in force, and for which the assumptions are based on the study of consequences which analysed the outcome of the negotiations. These assumptions are far more ambitious than those used for the other FTAs as in this particular case empirical evidence existed that supported the use of a more ambitious scenario (i.e. the agreement and provisions to remove NTBs are already in place). The current situation: Car makers in Europe are in a difficult situation Europe s car makers are in a difficult situation. In 2007, the European automotive industry recorded profits of 15 billion. By 2012, that profit had become a loss of 1 billion. There are two main reasons. First, Europeans bought fewer new cars. New registrations in 3

6 Europe dropped by more than four million units since 2007 and car sales are at levels not seen in 20 years. Second, Europe s well-developed automotive industry has not fully captured the growth in car ownership outside Europe, and the EU industry suffers from overcapacity and fierce competition, keeping prices and profits down. As a result, EU sales of passenger cars relative to global sales have decreased from 34 per cent before the crisis to 20 per cent today. The outlook: Business as usual will be poor business Towards 2020, both production and sales of European and foreign car makers in the EU is expected to increase, and so is net export. But the expected improvements are unlikely to be sufficient to return the industry to healthy levels of capacity utilisation, and consequently, the outlook is poor. In a business-as-usual development (i.e. a no policy scenario), Europe s role as an automotive production hub will decline. While the European share of total world production is expected to decrease from 19 per cent in 2012 to 17 per cent in 2020, the share of total production taking place in China is expected to increase from 22 per cent in 2012 to 28 per cent in Employment in vehicle manufacturing in Europe is at the same level as before the crisis, but it can be expected to decrease given the current outlook. We estimate that returning capacity utilisation to a healthy level will require increased production of approximately 2.5m vehicles. The Opportunity: Growth in demand outside Europe The rather bleak outlook for EU s automotive production and employment will be somewhat counter-balanced by the opportunities presented by the global increase in demand for new cars, especially in emerging markets. But for that opportunity to generate jobs in Europe, exports of cars manufactured in Europe would need to increase. With weak demand at home, and with current market shares for European car makers in foreign markets being relatively low, growth in markets outside Europe is needed to reinstate the profitability of European car manufacturing. To assess these possibilities, we have assessed the increasingly complex value chains of the modern car industry and looked at whether FTAs with main partners will present an opportunity or a threat to the European automotive industry. A solid and growing trade surplus The starting point is not so bad. The EU has a solid trade surplus in automobile trade with the rest of the world, and this surplus has been growing in recent years. This is true for both cars and parts and components. And the EU has a trade surplus with most partners, both in cars and in parts with the exception of Japan and South Korea. The EU has a surplus with Japan when measuring the value of cars, but because of a significant importation of car parts and components, which in part result from the large production of Japanese car manufacturers in Europe, the EU has a trade deficit with Japan when looking at the combined trade in cars and parts and components. While overall EU exports have 4

7 increased, home market demand has decreased even more, leaving the European auto industry in dire straits. Car makers in Europe sell in Europe Manufacturers in the EU, whether of a European or foreign origin, are very dependent on the European market for selling their vehicles. Around 10 million of the 16 million EUproduced vehicles in 2012 were destined for the home market, corresponding to 65 per cent of production. Cars sold in Europe are mostly made in Europe A similar picture appears when looking at the EU market from a sales perspective. For the past ten years ( ) around 86 per cent of the cars sold in the EU were produced within the EU and only 14 per cent of the units sold were imported. Little impact from trade liberalisation to date Did past trade liberalisation cause the problems we are facing? No, this is unlikely. Besides the free trade agreement with South Korea, no trade agreements between the EU and a main car producing country has been implemented. The Korea FTAs has given rise to many concerns, but it is still too early to assess the actual impact of the agreement. Taking a preliminary look at trade with Korea between the last full year without the agreement (2010) and the first full year with the agreement (2012), we find that imports of Hyundai s and Kia s from South Korea have increased by 65,000 units. At the same time, imports from India to Europe of the same two brands have dropped by 40,000 units. Deliveries to the EU market from the Korean manufacturer s plants in Turkey increased by around 30,000 units. But still, a much bigger increase was seen in output from the two plants located within the EU, which supplied 100,000 more Hyundai s and Kia s to the European market in 2012 than in 2010 (up from 300,000 to 400,000 units). It has also to be borne in mind that the comparison year 2010 was a year of lower vehicle exports to Korea. So in absolute terms it is difficult to see that the free trade agreement with Korea is having dramatic negative effects in Europe as of Three years after the provisional application of the agreement, it is also important to acknowledge that the market share of EU cars in the Korean market has also increased reaching 10 per cent in With a high dependency on the home market and with only around 14 per cent of sales being imported, it seems clear that the root causes of the bleak financial situation for European car makers are to be found in the domestic market rather than abroad. More trade liberalisation a threat or an opportunity? The EU automotive industry has many strengths in areas such as skills, leadership, technology and brands. The industry has also had some success in gaining market shares in both mature and emerging markets outside the EU, and many European car makers have 5

8 invested substantially in overseas markets. EU manufactures have benefitted from these opportunities and the growing and positive trade surplus in passenger cars is demonstrating these achievements. Trade barriers (tariffs and non-tariff barriers) are depressing these opportunities for the EU automotive industry and making it more difficult to take part in the growth in foreign markets. Similarly, the EU s own tariffs and non-tariff barriers make it more expensive for foreign competitors to sell cars produced outside the EU on the European market. Given the current challenges with slack domestic demand, the EU automotive industry has voiced concerns about the potential negative impacts of some of the new bilateral free trade agreements (FTAs) that the EU is signing or is the process of negotiating. Assessing the impact of 18 FTAs beyond Korea In addition to assessing the likely impacts of the agreement with Korea, this study provides a detailed analysis of the most likely impacts on the EU automotive industry from the assumed full implementation of the potential FTAs with Canada, the US, Central America, Colombia/Peru, MERCOSUR, Ukraine, India, Singapore, Thailand, Malaysia, Indonesia, Vietnam, Japan and the eventual re-negotiations of the existing FTAs with Morocco, Tunisia, Egypt, Jordan and Mexico. An investment agreement with China is also discussed. The potential FTA partners represent 58 per cent of total EU export of cars in 2012 and 75 per cent of total car import measured in value. Building on the method developed in Van Biesebroeck, Gao and Verboven (2012), we have performed comprehensive econometric analyses using detailed data the individual car model-level (e.g. Fiat Punto, Ford Fiesta or Toyota Yaris) to quantify the most likely consumer and producer responses when prices of imported cars drop as a result of the FTAs. The analysis takes the actual location of the production of individual models into account in the most recent available year (but assumes no changes), and thereby our analysis captures the fact that for example Korean car makers produce certain models within Europe, others at home in South Korea and others models again at locations in India and Turkey and supply the European market from there. The model takes a number of other relevant aspects of choice of new cars into account (besides the price), and thereby we capture the observed substitutability between the various models available to consumers not only on the European market, but also in the markets of the FTA partners. The scenarios analysed comprise both tariff elimination and the reduction of so-called non-tariff barriers. The degree of trade protection and the potential for reducing the impact of trade barriers in the automotive sector varies from country to country, but is consistently higher for final cars than for parts and components. The scenarios analysed comprise reductions in landed marginal costs of final cars of up to 12 per cent in the EU, and reductions ranging between 5 per cent and up to 35 per cent in the partner countries. 6

9 Main results: Many opportunities, few threats We analyse the impacts of the FTAs both individually and the cumulative effects of various combinations of FTAs, including the full set of 19 FTAs. We assess two scenarios. One where only tariffs are removed, and another where both tariffs and non-tariff barriers are reduced. In the tariff only scenario for Korea, production in the EU will increase or remain almost unchanged. EU import is predicted to increase by around 25,000 vehicles, when taking into account that increased exports from South Korea will be partly offset by decreasing exports from other countries. EU export to Korea will increase by slightly more (27,000 units), and overall demand will increase, resulting in a small positive impact on car production in the EU. In the tariff + NTB scenario for Korea alone, the impacts are more pronounced with respect to EU export while identical to the results in the tariff only scenario with respect to imports from Korea. The result is an increase in EU exports of 97,000 units compared to the situation without the Korea FTA (or 70,000 more than in the tariff only scenario). As a result, EU car production increases by more than 80,000 units, when taking into account the increase in import and the overall demand effect. In the tariff only scenario for the cumulative effects of all other FTAs in addition to the Korea agreement we see bigger impacts. More trade is set free and implementing several FTAs simultaneously will cause firms that benefit from an FTA to respond more aggressively to price reductions by their competitors from other FTA countries. EU exports will increase by up to units if tariffs with all partners are removed, while imports from all non-eu countries will increase by units. Taking the increase in demand and displacement of imports from non-fta partners into account, we estimate an increase in EU car production of units. A large share of the positive impact stems from agreements with Mercosur and other Asian countries, which are significant export markets, but insignificant sources of imports into the EU. In the tariff + NTB scenario for the cumulative effects of all other FTAs in addition to the Korea agreement, impacts are naturally even more pronounced. The expected cumulative impact of all possible FTAs, is an increase in EU production of almost 570,000 cars or 4 per cent of current levels. As in the case of each individual FTA, both relative and absolute changes in EU exports are expected to exceed the change in imports. More detailed results are presented in Chapter 4 and results are compared with previous studies. Positive impact on parts, components and related industries Finally, we have assessed the impact of the FTAs, not only for car manufacturing, but also for the EU production of parts and components and the industries related to the automotive sector. 7

10 We find that the agreement with Korea in the tariff + NTB scenario will lead to an increase in production of parts and components in the EU of around 0.4 per cent. Looking at the cumulative impact of all the other FTAs (assuming the EU-Korea FTA is already fully implemented) we estimate an increase of EU production of parts and components of 2.9 per cent compared to baseline. This result is from the comprehensive scenario of tariffs + NTBs and adding the effects of all 18 FTAs to the effect of Korea agreement. In the tariff only scenario, the cumulative impact of all the FTAs is naturally smaller than in the case where NTBs are also reduced. According to our simulations, we estimate an impact on the production of parts and components of around 1.8 per cent. Large economic footprint today - and more FTAs will leave an even bigger footprint Looking at the current economic footprint, we find that the production of cars, parts, components and related industries contributes to the EU economy with a production value of 772 billion. Compared to the contribution of total EU manufacturing, the automotive industry make up no less than 12 per cent. We find that the full implementation of all FTAs analysed in this will increase the production value in the automotive industry by more than 20 billion (on top of the impact from the Korea FTA) that the cumulative impact of all the FTAs, assuming the agreement with Korea is already fully implemented, will correspond to over 100,000 jobs in the automotive industry and related industries. Of this impact, the tariff reduction alone is estimate to yield an increase in production of more than 15 billion, and corresponding to around 75,000 jobs. Structure of the report The report is structured as follows. In the following pages, we provide a short introduction. In Chapter 1 we assess the current situation for the EU automotive industry and present an outlook for 2020 on key parameters such as sales and production. In Chapter 2 we present the current situation when it comes to trade and the location of production of passenger cars and its supply chain. In Chapter 3, we present the current trade barriers in terms of both tariffs and non-tariff barriers and presents the expectations of the degree of reduction of these barriers resulting from the FTAs once they are fully implemented and phased-in. In Chapter 4, we present our simulations from the econometric model of the impacts using detailed data at the car model level, and present our assessments of the possible impacts of the scenarios presented in Chapter 3. Finally, Chapter 5 is devoted to the analysis of the supplier industries in Europe. 8

11 Introduction Background The automotive industry represents a significant share of output and employment in the European Union. The continued process of global economic integration implies growing incomes in emerging markets both nearby Europe and further afield, and at the same time new car manufactures have entered the stage and compete in the global markets. In addition, the supply chains have become even more integrated and growing global in scale. Recently, domestic demand in Europe for new cars and other motor vehicles has dropped as a result of the global financial and economic crisis starting from 2008/2009, and trade volumes have dropped in response to the drop in demand. At the same time, demand for new cars has been less affected in emerging markets during the crisis, and consumption and trade patterns are shifting towards fast growing markets outside Europe, and consequently access to these overseas markets is becoming ever more important both for trade flows of final goods and for the organisation of the supply chain. This presents the European automotive industry with new opportunities and new challenges in the home market as well as abroad. While the EU automotive industry has many strengths in areas such as skills, leadership, technology and brands, there is also an overcapacity compared to domestic consumption and current export levels, and the industry is struggling to maintain production levels in the face of the declining sales in Europe resulting from the economic downturn. At the same time, the EU automotive industry has also been successful in gaining market shares in both mature and emerging markets outside the EU, and many European car makers have invested substantially in overseas markets. EU manufactures have benefitted from these opportunities and the growing and positive trade surplus in passenger cars is demonstrating these achievements. Trade barriers (tariffs and non-tariff barriers) are depressing these opportunities for the EU automotive industry and making it more difficult to access and take part in the growth in foreign markets. Similarly, the EU s own tariffs and non-tariff barriers are discouraging foreign competitors from further success in the European market. Given the current challenges with slack domestic demand, the EU automotive industry has voiced concerns about the potential negative impacts of the new bilateral free trade agreements (FTAs) that the EU is signing or is the process of negotiating. Objective and scope of the study The objective of the study is to quantify individual and cumulative impacts for the automotive industry in the EU of a series of FTAs with EU trade partners. 9

12 The study covers manufacturing of passenger cars and light commercial vehicles, its parts and components suppliers as well as the related industries. The study analyses the implications for the automotive industry in the EU from the assumed full implementation of the FTAs listed below. EU-South Korea EU-Central America EU-Colombia/Peru EU-Singapore EU-Canada EU-Ukraine EU-India EU-Japan EU-MERCOSUR EU-Morocco EU-Malaysia EU-Vietnam EU-US EU-Thailand EU-Indonesia EU-Tunisia EU-Jordan EU-Egypt EU-Mexico The study covers both domestic and foreign car manufacturers established in the EU as well as the opportunities for the EU manufacturers in the partner countries. Methodology used in the study The study provides an assessment of the current situation, the trends and outlooks for the industry and provides a detailed analysis of the possible impacts on the automotive industry of the above FTAs. The study has two main analytical parts. First we perform a comprehensive econometric analysis of the most likely consumer and producer responses when prices of imported cars drop as a result of the FTAs. This provides our assessment of the most likely changes in demand side substitution for new cars resulting from the FTAs. Second we perform a follow-on analysis looking at the implications in other parts of the value chain taking into account the impacts on supplier industries including suppliers of parts and components, but also the derived demand for steel, aluminium, machinery and engineering as well as other relevant suppliers. The two analyses are linked together such that the results from the first analysis feed into the second analysis. In the first analysis we use detailed data at the individual car model-level (e.g. Fiat Punto, Ford Fiesta or Toyota Yaris) to analyse the most likely consumer and producer responses when prices of imported cars drop as a result of the FTAs. We analyse both the individual FTAs one-by-one and the cumulative impact of the above FTAs and subsets hereof. This analysis is central as it predicts the most likely responses on the trade and EU production in new cars, and we perform analyses of two scenarios - one with only tariffs being reduced and another where both tariffs and non-tariff barriers are reduced. The analysis takes the actual location of the production of individual models into account in the most recent available year, and thereby our analysis captures the fact that for example Korean car makers produce certain models within Europe, others at home in South Korea and others models again at locations in India and Turkey and supply the European market from there. The model takes a number of relevant aspects of choice of new cars into account besides the price, and thereby we aim at capturing the substitutability between the various models available to consumers not only on the European market, but also in the markets of the FTA partners. 10

13 Box 1 Demand side model for cars The econometric model of the demand side is used to assess the impact of FTAs on domestic sales, domestic production, imports and exports for manufacturers of passenger cars. Both the separate and the cumulative (and sequential) impact of such FTAs are calculated. In this part of the study we will follow the methodology used by Van Biesebroeck, Gao and Verboven (2012) in their study on the impact of FTAs on the Canadian auto industry. The methodology includes the following steps: 1. Estimating an aggregate demand system, using a nested logit model, which is a variant of the random coefficients model as done by Berry, Levisohn and Pakes (1995), in order to obtain own and cross price elasticities for each model of car sold in the EU. 2. Inferring the marginal costs of each car model using the estimated price elasticities from step Conducting a counterfactual analysis of the impact of a given FTA by calculating the reduction in the marginal costs of the car models that are directly affected by the tariff or NTB cuts. 4. Hereafter, the new equilibrium price vector in the market is obtained by taking into account that producers of competing brands will also adjust their prices. 5. Finally the new market share of each car model is calculated. As such, it is possible to calculate the overall impact of a given FTA on consumer surplus and average prices, as well as on total sales, imports, exports and production. These steps allow us to estimate the most likely impact of a given FTA on total import volumes by aggregating the calculated sales quantities for all models by their import status. We further examine the resulting consumer responses within the EU, resulting from a given FTA building on estimates from our econometric model of how closely different models compete. Note: The above is a summary of the approach. For more details, we refer to Chapter 4 and the technical annex. Source: Copenhagen Economics based on Van Biesebroeck, Gao and Verboven (2012) In the second analysis we conduct a quantitative analysis of the impact of trade liberalisation on EU demand, production, imports and exports of car parts and components and associated/dependent industries. In this part we analyse the down-stream linkages of the related industries i.e. the suppliers to the automotive manufacturers based on detailed input-output modelling. This includes the suppliers of car parts and components, but also the derived demand for steel, aluminium, machinery and engineering as well as other relevant suppliers. The analysis covers the impact of trade liberalisation on EU demand, production, imports and exports for the same FTAs as above. Both the individual and cumulative impacts are assessed, and again we apply the same two scenarios of tariff only and tariffs + NTBs. For this part, we rely on a modelling framework based on detailed input-output modeling and industry specific data. This provides a more suitable analytical tool than traditional CGE-models. In our view this will better capture the nature of the value chains, and we will be able to assess impacts through the value chain for example through lower input prices (e.g. components) as a result of trade liberalisation. 11

14 Together the two analyses provide a comprehensive and detailed analysis, yet still a partial equilibrium analysis of the automotive industry and related industries. The approach differs from the traditional general equilibrium studies done previously to assess the impact of FTAs. The advantage of the approach chosen in this study is that we can capture the details of the automotive industry much better than in a general equilibrium model, since we have detailed data on individual car models and the location of their production. The downside from choosing a partial equilibrium approach instead of a general equilibrium approach is mainly that we do not assess the interaction with other sectors. The omission of general equilibrium effects means that we do not assess impacts for other goods and services outside the automotive sector and related industries. Naturally FTAs will also cover other industries and services and the changes for other sectors are not analysed here. FTAs will have impacts on production in other sectors which in turn will lead to changes in the demand for inputs such as labour, capital, energy and materials. The resulting changes for input costs are well captured in the general equilibrium models, but not included in the partial analysis. In addition, FTAs will generally increase real income, which is also captured in a general equilibrium model, but omitted in partial analyses. Finally, we have not quantified the eventual long-term impact in terms of the changes in location of production of cars as a result of FTAs. The reason is clearly, that we have no basis for forecasting the eventual changes in the location of production for global automotive producers. Furthermore, our approach requires detailed market data on prices and sales at the individual car model level as well as detailed trade flow data. These are not projected to a future years, and consequently it is not possible to predict such changes with a sufficient degree of accuracy. This needs to be borne in mind when interpreting the results, and the eventual changes in location of production needs to be considered separately. 12

15 Chapter 1 The automotive industry in the EU In this chapter we assess the current situation for the European car industry, the structure of car production in Europe and the outlook for car manufacturing in Europe. We distinguish between car manufacturing in Europe and European car manufacturers. The former denotes the production of cars in Europe regardless of ownership and origin of the car maker, while the latter refers to car makers of a European origin. 1.1 Car makers in Europe are in a difficult situation Europe s car makers are in a difficult situation. In 2007, the European automotive industry recorded profits of 15 billion. By 2012, that profit had become a loss of 1 billion according to a recent study by McKinsey. 1 The study points at two main reasons for the decline. First, fewer people bought new cars. Across the region, the number of new registrations declined by more than four million units over this period, and car sales today are at levels last seen in the early 1990s. Second, Europe s well-developed automotive industry suffers from overcapacity; fierce competition is keeping prices and profits down. Before the financial crisis, in 2007, total sales of passenger cars and light commercial vehicles were 17.8 million per year in the EU, while by 2012 this figure had dropped to 13.5 million vehicles. 2 A further drop in 2013 is foreseen to around 13.1 million units, cf. Figure 1.1. In the same period, EU sales of passenger cars relative to global sales have also decreased from 34 per cent of global sales before the crisis to 20 per cent today. This is driven both by declining sales in Europe, but also by sales growth in emerging markets. The development in Europe is in stark contrast with the global development. Globally, the automotive industry has recovered from the economic crisis. The industry has seen profits increase from 2007 ( 41 billion) to 2012 ( 54 billion) according to McKinsey analysis, which also predicts further growth global profits by another 25 billion reaching 79 billion in But as shown in this chapter, growth and future profits will not be distributed equally across all geographies or all types of cars. Most of the future growth will take place outside Europe, and European car makers will therefore be increasingly dependent on access to these growing markets to pursue future growth and profits McKinsey (2013), The road to 2020 and beyond: What s driving the global automotive industry?, August This corresponds well with the new registrations of 13.5 million in 2012 reported by ACEA. McKinsey (2013). 13

16 Figure 1.1 The EU market has been decreasing, and so has the EU sales relative to global sales Note: Columns shows sale of passenger cars and light commercial vehicles. The curve and the corresponding right-hand axis shows the EU market sales as share of global sales, but for passenger cars only. Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. Although car sales in the EU have been declining, sales numbers are not likely to have hit rock bottom yet. Declining sales are expected for 2013 although the rate of decline is expected to be less dramatic than in recent years and growth will slowly return in 2014 although the pre-crisis level above 17 million is not foreseen to be reached by 2020, cf. Figure 1.2. The base forecast 4 for passenger cars and light commercial vehicles sales shows a positive mid-term outlook which is supported by recovery of the global economy, growing replacement needs and a comparably broad range of planned new model introductions. 4 The forecasts presented here are from the so-called base forecast. The forecast covers the next 7 years and can be seen as a no policy change scenario not taking new FTAs into account. The forecasts are built on examination of the automotive industry from a demand perspective using a disciplined forecasting methodology combining analyst knowledge, macro econometrics, and statistical analysis with segment trends, brand strategies, model lifecycle stages, future model plans, consumer behaviour and production capacity constraints. The forecasts present in this report are from IHS Automotive Light Vehicle Sales Forecast released for Q as supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. 14

17 Figure 1.2 From a car sales perspective the negative impact of the economic crisis is still looming (cars + LCVs) Note: Includes passenger cars and light commercial vehicles. Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. 1.2 Production in Europe In 2012, approximately two thirds of the vehicles sold in Europe were produced by manufacturers of European origin (see Box 1.1 for definition). One third of the vehicles sold were produced by foreign original equipment manufacturers (OEMs). Most of the production for the European market of both European (domestic) and foreign car makers takes place in Europe. Box 1.1 European and foreign car makers We distinguish between European and foreign car makers. European car makers are those of a European origin while foreign car makers are denoting OEMs of a non- European origin. The distinction is based on the origin of each group. European car makers include among others Volkswagen (Germany), BMW (Germany), Fiat (Italy), PSA (France) and Daimler (Germany). Foreign car makers include among others Ford (US), General Motors (US), Honda (Japan), Hyundai (Korea), Toyota (Japan) and Tata (India). See appendix Table A.1 for a complete list. Both European and foreign car makers have production facilities in Europe and both generate benefits for the European economy. Likewise European car makers also have production facilities outside of Europe. Source: Copenhagen Economics 15

18 Production in the EU has also yet to recover from the effect of the crisis, cf. Figure 1.3. While production grew in 2010 and 2011 it saw a decline of 7 per cent in In the base forecast (assuming no FTAs), the decline is expected to continue in 2013 where after production will increase from 2014 towards 2020, cf. Figure 1.3. This is driven both by an expected rising demand in Europe, cf. Figure 1.2, but also by expected export growth even in the absence of new FTAs. Figure 1.3 Production in the EU is picking up after 2013 Note: Includes cars and light commercial vehicles. Covers production of domestic OEMs in the EU as well as foreign OEMs in the EU. Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. Relative to world production in 2012, 23 per cent of global passenger cars were produced in the EU. A slightly bigger share of cars was produced in China (25 per cent of all passenger cars) NAFTA and Japan produced 11 per cent and 13 per cent of the total respectively. 16

19 Figure 1.4 Share of world passenger car production 2012 (%) Asia Others 6% India 5% Brazil 4% Others 2% Russia 3% Europe Others 1% EU27 23% South Korea 7% NAFTA 11% China 25% Japan 13% Note: Asia Other: Australia, Indonesia, Malaysia, Taiwan, Thailand; Europe Other: Ukraine, Serbia, Turkey; Others: Argentina, Egypt, Iran, South Africa, Uzbekistan. Source: Authors calculation based on data from OICA. Of the top 20 largest car producing countries in the world in 2012, seven were European. Germany is by far the largest producer in Europe producing 5.4m passenger cars in The second and third largest EU producing countries are France and Spain, cf. Figure 1.5. Figure 1.5 Top 20 car producing countries, 2012 Mio. units CHINA EU27 JAPAN GERMANY SOUTH KOREA USA INDIA BRAZIL RUSSIA MEXICO FRANCE SPAIN UNITED KINGDOM CZECH REPUBLIC CANADA THAILAND SLOVAKIA IRAN INDONESIA TURKEY POLAND 4,2 4,1 3,3 2,6 2,0 1,8 1,7 1,5 1,5 1,2 1,0 0,9 0,9 0,9 0,7 0,6 0,5 5,4 8,6 15,5 14,6 Note: Passenger cars in EU countries are marked with light pink. Source: Authors calculation based on data from OICA 17

20 While China is the largest producer of cars in the world, most of the production is in the lower value entry-level segment. The EU is characterised by producing higher value vehicles compared to other markets. In the EU, 32 per cent of cars produced are in the premium segment compared to 8 per cent in the US and 5 per cent in China. This is largely driven by production in Germany were 54 per cent of produced cars are in the premium segment, cf. Figure 1.6. Figure 1.6 Share of production in each country by segment % 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 6% 13% 5% 13% 8% 16% 32% 25% 43% 54% 22% 99% 94% 87% 79% 62% 30% 49% 46% 16% India Brazil South Korea China Japan USA EU27 Germany Note: Premium Mid Entry Segments are based on global production price class (see box) Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. The segments used (entry, mid and premium) are based on price segments, cf. Box 2. Box 2 The segments entry, mid and premium The analysis divides the industry into three major vehicle segments according to the brand and the market positioning of vehicles in different regions. The premium segment (representing highest prices and margins) comprises 10 percent of the market. The value segment is the mid-price range; this comprises the vast majority of vehicles sold in all markets (70 percent). The entry segment refers to the least expensive vehicles in the different vehicle classes, making up the other 20 percent. We have chosen to use segments based on price classes rather than segments based on size (such as production segments A, B, C, or sales segments such as mini, compact, mid-size, ). The price class segments provides a categorisation of different models based on where the specific model places itself on price relative to other models of similar size. Consequently, a premium priced smaller car (e.g. Audi A3) is categorised as premium although from a size perspective it is in the C-segment. Similarly the Peugeot 308 is in the mid-price class, while it is also a placed in the C-segment when it comes to size. Source: Based on data supplied by IHS Global SA; Copyright IHS Global SA, 2013 and McKinsey (2013). 18

21 Examining world production by manufacturer, Toyota comes out as the largest producer with 9.8m vehicles produced in Second is Volkswagen with 9.1m vehicles, while General Motors was the third largest producing 7.7m vehicles, cf. Figure 1.7 (OEMs of European Origin are marked with light pink). Figure 1.7 Top 20 largest manufacturers by OEM, 2012 Note: Production numbers are based on manufacturer group in production data provided by the European Commission. Includes passenger cars and light commercial vehicles. Manufacturers of European origin are marked with light pink. Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. The production by European OEMs in Europe is both for the European market and for exports. In 2005, net exports by European OEMs were 1.7m cars. Likewise foreign OEMs produce cars in Europe, but they also import cars to Europe in order to match supply with demand, cf. Figure

22 Figure 1.8 Net exports and net imports of domestic and foreign OEMs in EU, 2005 Note: Net export is calculated as production less sales. Net import is sales less production. Unsold vehicles are not accounted for. Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. By 2012, net exports of European OEMs had risen to 3.4m vehicles, while net imports of foreign OEMs vehicles had decreased by 0.1m to 1m vehicles, cf. Figure 1.9. The drop in sales occurred for US and Japanese OEMs, who saw a decrease of approximately 1m vehicles each. Meanwhile the Korean OEMs saw an increase in sales. The pattern for production was slightly different with most of the decline being for US OEMs, who saw a decline of approximately 1.5m vehicles. Japanese OEMS experienced a decline of approximately 300,000, while Korean OEMs increased production from zero to approximately 500,000 vehicles. Figure 1.9 Net exports and net imports of domestic and foreign OEMs in EU, 2012 Note: Net export is calculated as production less sales. Net import is sales less production. Unsold vehicles are not accounted for. Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. 20

23 1.3 The outlook: Business as usual will be poor business Towards 2020, both production and sales of European and foreign OEMS in the EU is expected to increase, and net export is expected to increase as well, cf. Figure Figure 1.10 Net exports and net imports of domestic and foreign OEMs in EU, 2020 Note: Net export is calculated as production less sales. Net import is sales less production. Unsold vehicles are not accounted for. Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. Seen in the bigger picture, the global importance of Europe as an automotive production hub is declining. While the European share of total world production is expected to decrease from 19 per cent in 2012 to 17 per cent in 2020, the share of total production taking place in China is expected to increase from 22 per cent in 2012 to 28 per cent in 2020, cf. Figure The production in the EU is expected to continue to be dominated by German car makers. The share of total production by German car makers has been on the rise since 2005 and is expected to stay at the 2012 level of 44 per cent towards Likewise the share of production by US and Asian car makers in the EU is expected to be relatively constant towards Examining the development of production by size segment we find that since 2005 a larger proportion of vehicle production has been in the A- and C-segments, while the proportion of cars in the D-segment has declined. Cars in the A-segment are models such as the Ford Ka and Suzuki Alto. The C-segment covers cars such as the Volkswagen Golf and the Mazda 3. The D-segment, which has seen a decline in production, includes the Hyundai Sonata and the Peugeot 407. Since 2005 the production structure in the EU has shifted towards a higher share of production of cars in the premium price segment. In 2005, 24 per cent of the cars produced in Europe were in the premium price segment while in 2012 the share was 32 per cent. 21

24 Towards 2020 the share of vehicle production in the premium price segment is expected to remain at 32 per cent. Figure 1.11 Development of European vehicle production structure Note: Premium segment includes: BMW, Mercedes, Audi, Lexus, Infinity, DS. Mid-range segment includes: PSA, Renault-Nissan, Toyota, Suzuki, Fiat, Opel, VW. Entry segment includes: Dacia, Chery, Hyundai, Chevrolet Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. The critical situation in Europe is intensified by low capacity utilisation at the car manufacturing plants in Europe. Low utilisation has an impact on profitability, particularly for manufacturers dependent on entry and mid segment vehicles for revenue, and most manufacturers producing in this segment reported losses on their European operations in recent years. Theoretical maximum capacity in Europe has continued to increase since 2000 and throughout the crisis, although production has declined. Consequently, European car makers are facing growing overcapacity, quite contrary to the situation in the US, where significant restructuring of production capacity took place, cf. Figure According to ACEA, the current average overcapacity across Europe is in the range of 25-30%. This overcapacity is not evenly spread across Europe; some manufacturers are operating at 50-60% of their capacity, whereas others are at 80-90% or even higher. According to ACEA, a number of European manufacturers have already announced that they have no alternative but to implement significant restructuring plans

25 Figure 1.12 Consolidation in the US - Overcapacity in Europe Note: 1) Based on maximum production capacity; theoretically 24 hours, 7 days per week; usually constrained by paint line capacity Source: McKinsey (2013) This picture is confirmed by our analyses showing a capacity utilisation of 68 per cent on average between 2010 and 2013, which is below profitable levels, cf. Figure Consequently, OEMs in Europe are facing a major challenge in dealing with the restructuring that is clearly required. Figure 1.13 Excess capacity of car plants in Europe Note: Overall utilisation rate of the European automotive industry. Precise data on overcapacity are subject to discussion, as it depends on the number of shifts used in a given factory amongst other things. Some spare capacity is needed for business flexibility. Source: LMC Automotive (2011) p. 20, ACEA (2013). 23

26 Low utilisation is not an issue in all companies and countries. The companies and plants which are struggling with a decline in market share are under particularly pressure. This is especially true for non-german manufacturers. Generally the German manufacturers have higher capacity utilisation than other European and foreign manufacturers in Europe, cf. Figure Figure 1.14 Capacity utilisation by manufacturer, 2013 Note: Estimated utilisation rates are based on straight time utilisation for European production facilities Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. Contrary to the United States, only limited restructuring has taken place in Europe following the crisis, and some new plants have been opened, mainly in Central and Eastern Europe. Overcapacity introduces a continued situation of price war (especially in the midand entry range segments), negative profitability on new vehicle activity and further weakening of the weakest players. Mid-range manufacturers are the most affected, and a return to sustainable plant utilisation rates of around per cent in this segment would imply closure of up to ten plants for the most affected manufacturers 6 : five plants in the short term and potentially five additional if the market trend continues, cf. Figure Several mid-range OEMs have already announced plans to close production facilities within the next 2-4 years: Ford s plant in Genk will be shut down at the end of 2014 PSA s plant in Aulnay is expected to be shut down at the end of According to Roland Berger (2013), it is estimated that there are currently 43 mid-range manufacturing plants in Europe. Total plant count is 123. The average production capacity per plant for all mid-range OEMs in Europe is estimated at approximately 200,000 vehicles. Taking into consideration that in case of plant closures production capacities may be partially shifted to other plants in Europe (e.g. Ford plans to shift a part of its production from Genk to its facility in Valencia) the total figure of capacity reductions per plant should be lower. Based on industry knowledge, it is estimated that capacity declines by 30,000 to 70,000 per plant closure. 24

27 The GM/Opel plant in Bochum will be shut down at the end of 2016 In total, European OEMs have announced capacity reductions of 750,000 vehicles by 2015 according to McKinsey analysis. 7 A reduction by 750,000 units would require closure of around 10 plants of average size, but given how the market is likely to develop, that may not be enough. If OEMs in Europe do not revise their production capacity beyond the announced adjustments, the McKinsey study estimates it could be five years before the industry gets back to its pre-crisis utilization rate and related profitability levels. Figure 1.15 Mid-range manufacturers plant closures from returning to sustainable capacity utilisation #plants 5 43 Very likely 5 Depending on economic context 33 Utilisation 62 75% 80% Note: Figures are from Source: Roland Berger analysis. Closure of 10 average size manufacturing plants will also affect automotive employment. The impact is estimated to be a loss in the range of 40,000 jobs (five plants) and 80,000 jobs (10 plants), including outsourcing. 1.4 Employment in vehicle manufacturing in Europe Employment in vehicle manufacturing in Europe is at the same level as before the crisis, but it can be expected to decrease given the current outlook. Lifting capacity utilisation back to sustainable levels will also require more demand for cars produced within the EU. As presented in Figure 1.2, demand is expected to rise in the coming years which, along with plant closures, which will contribute to higher utilisation rates. We estimate that raising average capacity utilisation from 68 per cent to 80 per cent will correspond to increased production of approximately 2.5m vehicles. 7 See McKinsey (2013). 25

28 Figure 1.16 Employment in vehicle manufacturing is at the same level as before the crisis Mio. 3,5 3 2,7 2,7 2,8 2,9 3,2 2,9 2,8 3,0 2,5 2,4 2,4 2,4 2 1,5 1 0, Note: Industry classification changed from NACE 1.1 to NACE 2.0 in Figures are based on employment within manufacturing of motor vehicles, trailers and semi-trailers (NACE rev.1.1/2.0: 34/29) for the working-age population (age 15-64) within EU27 countries. Source: Copenhagen Economics based on Eurostat data. The automobile sector remains important to the EU economy in terms of employment with employment in vehicle manufacturing being 3.0m in As the production of passenger cars in Europe would need to adapt, a pressure to reduce employment in vehicle manufacturing is also likely to follow in the mid-term. This will also have negative repercussions on jobs in the supplier industries. According to estimates by Roland Berger Strategy Consultants, approximately 10 per cent of a total 750,000 automotive supplier jobs could be at risk in Western Europe alone, cf. Roland Berger (2013). This is based on an estimate that 5-7 percent of the jobs in supplier firms in sales, general and administration (SG&A) are at risk of being reduced and a similar percentage for research and development (R&D) jobs. The actual manufacturing jobs in operations are likely to suffer the most and a drop of percent is foreseen, cf. Figure All in all, this shows that at least 75,000 supplier jobs are at risk in the businessas-usual scenario in Western Europe alone. 8 Please refer to Chapter 5 for more analysis of the employment and economic footprint of the EU automotive industry. 26

29 Figure 1.17 Employment at automotive suppliers are also at risk Source: Roland Berger (2013) The rather bleak outlook for automotive production and employment will be somewhat counter-balanced by the opportunity presented by the global increase in demand for new cars, especially in emerging markets. But for that opportunity to generate jobs in Europe, exports of cars manufactured in Europe would need to increase. But while growing exports to emerging markets certainly will benefit the European car makers, it may not happen to quite the extend one could hope for. The reason is that European car makers generally tend to serve emerging markets from production locations outside Europe, in which case European automotive employment will not necessarily benefit from this growth. To analyse this aspect in more detail, we have looked closer at eight main markets outside Europe: BRIC (Brazil, Russia, India and China) NAFTA Japan ASEAN South Korea Again following the base forecast (without the impact of FTAs) production and sales of European OEMs is expected to increase in all eight main markets, cf. Figure But in the eight markets, combined sales are going to increase only slightly more than production, making little room for increased exports from Europe (and from EU producers plants elsewhere) to these markets, cf. Figure

30 Figure 1.18 Production and sales of European car manufacturers in main markets is going to increase Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. Figure 1.19 All of the growth in sales of EU OEMs in key markets is going to be served by local production Note: Total for main markets consisting of Brazil, Russia, India, China, NAFTA, Japan, ASEAN and South Korea Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. 1.5 Summary To summarise, the current state of play for European car makers and car making in Europe is one with weakened profitability and production below sustainable capacity utilisation levels. Furthermore, even though the outlook is more positive, adjustments in production capacity, notably in the mid-segment, can be foreseen if the current and mediumterm market outlook materialises. 28

31 We note that the current situation for European car makers is primarily a result of domestic demand factors and a lack of adjustment to the new and weaker home market demand. Changes in net imports from non-european countries have only been very small in comparison, and in our assessment, imports cannot be seen as a substantial cause for the weak situation for car manufacturing in Europe. With weak demand at home, and with current market shares for European car makers in foreign markets being relatively low, growth in emerging markets is needed to reinstate the profitability of European car manufacturing. Increasing the market share for European car manufacturers in foreign markets seems to be a likely key driver for reinstating a healthier situation for car manufacturing in Europe. To assess these possibilities, we shall turn to the analysis of how cars are traded. 29

32 Chapter 2 How cars are traded In this chapter we analyse how cars are traded, and in particular we map the trade flows in and out of Europe, and find that there is little impact from trade liberalisation to date. We find that most of the cars being sold in Europe, regardless of the origin of the car maker, are also made in Europe, i.e. a large part of the sales by foreign OEMs in Europe are made or assembled in Europe. We also look at how European car makers are entering and selling in foreign markets, and we find that modes of entry differ from market to market and from car maker to car maker. 2.1 Current trade situation The EU has a trade surplus in automobile products with the rest of the world, and this surplus has been increasing in recent years, cf. Figure 2.1. This is true for both cars (left side) and parts (right side). Figure 2.1 Continued and growing surplus in automotive trade Note: Car product categories include all or some sub-categories within: HS8703 and HS8704. Parts include 19 product codes listed in appendix C. Source: Copenhagen Economics based on data from Eurostat. While exports have increased, home market demand has decreased, as presented in Chapter 1, leaving the European auto industry in dire straits. Exports have increased since 2005 and the EU also has a trade surplus with most of the main trading partners individually, both in cars and in parts, except Japan and South Korea, cf. Figure 2.2. The EU has a surplus in cars with Japan, but a deficit in parts and components. Combining them shows a deficit in trade with Japan because of the large import values in parts and components, which in part relates to the significant production by Japanese car manufacturers in the EU. 30

33 Figure 2.2 Trade detailed for the EU s main FTA partners 2012 billions United States China Japan Rep. South Korea Parts Mexico MERCOSUR Canada India Cars Note: Same coverage as figure 2.1. Data for Cars imports from China were around 300 mio. Imports of cars from Mercosur were around 200 mio. and exports of cars to India were around 200 mio. Source: Copenhagen Economics based on data from Eurostat. The United States is the EU s largest trading partner for both complete vehicles and parts, China is the second largest trading partner followed by Japan and South Korea. For the US, China and Japan exports are dominated by trade in complete cars. For the US and China exports of complete cars is twice as large as exports of parts and components, while for Japan exports are three times the size. For South Korea, though, export of complete cars has roughly the same values as exports of parts and components. Imports from the United States are also dominated by complete cars with twice the value of imports of parts and components. Imports from China are largely dominated by trade in parts and components. In 2012 imports of parts and components from China were 3.3 billion, while imports of complete cars were only 0.3 billion. From Japan the EU imported around 5.7 billion worth of complete cars and 4.9 billion worth of parts and components while imports of complete cars from South Korea were 3.9 billion and imports of parts and components were 2.6 billion in

34 Table 2.1 EU27 selected trading partners Million Cars Parts and components Imports from Exports to Imports from Exports to United States China Japan South Korea Mexico MERCOSUR Canada India Thailand Morocco Ukraine Singapore Malaysia Tunisia Indonesia Egypt Colombia Central America 5,529 25,096 1,795 10, ,292 3,346 8,167 5,736 6,312 4,917 1,597 3,920 2,498 2,561 1,002 2,341 1, , , , , , , , , < < Vietnam < Peru <1 123 <1 32 Jordan < Note: Same definition as in figure 2.1. Data for Source: Copenhagen Economics based on Eurostat data. 32

35 Millions The impact of trade liberalisation on the EU 2.2 Little impact from trade liberalisation to date Manufacturers producing cars in Europe are very dependent on the European market for selling their final product. Around 10 million of the 15.8 million EU-produced vehicles in 2012 were destined for the home market, corresponding to 65 per cent of production. A similar picture appears when looking at the EU market from a sales perspective. For the past ten years ( ) around 86 per cent of the cars sold in the EU were produced within the region and only 14 per cent of the units sold were imported. 9 Figure 2.3 Development in cars sold in Europe by origin Total sales Produced in EU Imported Note: Produced in EU means the number of vehicles sold in the EU in each year also being produced or assembled at a plant in the EU (no data for Malta and Cyprus). Imported means the number of cars sold being imported for outside the EU27. Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. Besides the free trade agreement with South Korea, there have been no trade agreements between the EU and other main car producing countries. Some concerns have been raised with respect to the free trade agreement with South Korea that went into force in July The agreement has a phasing-in period over three and five years depending on the car model and it will be fully implemented by 1 July 2014 and 1 July 2016 respectively. It therefore too early to evaluate the impact of the agreement based on actual sales and import numbers. However, based on the existing data so far the impact on the car sector has been more positive than anticipated (i.e. there was a significant increase in export of European cars to South Korea). Chapter 4 provide a model based analysis comparing the situation without an agreement with Korea with a counter factual scenario of a fully implemented agreement Based on EU-25 numbers for the entire period. No data for Malta and Cyprus. ACEA, the European Automobile Manufacturers Association, has openly criticised the agreement. See for example European Parliament, Policy Briefing, September 2009, EXPO/B/POLDEP/2009/173, accessed at: 33

36 As a background for the assessment of the impact of free trade agreements with other car producing countries such as Korea, it is instructive to take a closer look at the development in the sales by the main Korean car producers, Hyundai and Kia (now partly owned by the Hyundai group). Until 2007, there was limited production of Hyundai and Kia cars within the EU, and almost all cars sold in the EU were imported. However, in recent years the Korean manufactures have invested substantially in Europe, and the production in 2012 amounted to more than 500,000 units, at the two European plants: In 2005, Kia opened its European plant at the initial cost of 1 billion, in Žilina, Slovakia, about 200 kilometres north-east of Bratislava. The capacity of the plant is 300,000 units per year. 11 In 2008, Hyundai opened its European plant in Nošovice, Czech Republic, following an investment of over 1 billion and over two years of construction. The plant has an annual capacity of 300,000 cars. The Hyundai plant is 90 kilometres north of Kia Motors' Žilina Plant in Slovakia. 12 This development means that Korean cars of a regional European origin now exceeds the number of imported cars, and while imports of Kia s and Hyundai s have increased from , so has sales of these cars from the two European plants, cf. Figure Currently Zilina builds the Cee d family (five-door hatchback, five-door wagon) and Pro-Cee d (three-door coupe) and Sportage SUV models. The intention is to supply 40 per cent of European demand for Kia products with European-made vehicles. Company website and wikipedia. The plant mainly manufactures the i30, ix20, ix35 for the European market. Company website and wikipedia. 34

37 Thousands The impact of trade liberalisation on the EU Figure 2.4 Development in Korean brands* sold in the EU Total sales in EU market Produced in EU Imported Note: *) Diagram includes Hyundai and Kia cars. Produced in EU means the number of vehicles sold in EU25 in each year also being produced/assembled at a plant in the EU (no data for Malta and Cyprus). Imported means the number of cars sold being imported from outside the EU27. Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. Furthermore, it should be noted that the imported cars of the main Korean car brands, Hyundai and Kia are not all sourced from South Korea when sold in Europe. The Hyundai group had production in 12 different countries in Besides South Korea and the two plants in the EU, Hyundai s and Kia s are also produced in India, Turkey, Russia, Egypt, Iran, China, Brazil, Vietnam and the U.S. The Hyundai group is supplying Europe from its plants in South Korea, India and increasingly from Turkey. In 2010, for example, the EU imported as many cars from the Hyundai group from India as from South Korea (approximately 125,000 units from each). Since 2010, imports of vehicles from the Hyundai group from India to Europe have dropped by 40,000 units while the group s imports from South Korea increased by 65,000 units over the same period. Imports by the Hyundai group from Turkey also increased between 2010 and 2012 by around 30,000 units. But a much bigger increase was seen in output from the EU located plants, which supplied 100,000 units more to the European market in 2012 than in 2010 (up from 300,000 to 400,000 units). So in absolute terms it is difficult to see that the free trade agreement with Korea is having dramatic effect as of 2012, but a number of caveats apply because a) it is still too early to expect the full effect of the FTA, b) the Hyundai/Kia models being produced in Europe are not necessarily close substitutes with the models being produced in South Korea, and c) the imported Hyundai/Kia cars may be in closer competition with other imported cars or with other models being produced within the EU. All these features are being taken care of in our detailed simulations in Chapter 4. 35

38 Trade with the potential partners In this report, we analyse the potential impact of FTAs with 19 main trade partners. The partners represent 58 per cent of total EU export of cars in 2012 (including China). Looking at the import side, we find that the partners cover 75 per cent of total car import. We furthermore see that the trade balance is positive overall when looking at values of trade and is also positive for the 20 partners in combination. Looking further at the trade volumes with the main FTA partners for Europe, it is shown that 14 per cent of total imports of complete cars (measured in value) are from South Korea. The 20 partners have a combined share of 75 per cent of total EU imports of complete cars, and four large car producers (S. Korea, US, Japan and Mexico) account for over 60 per cent of total imports in On the export side, the picture is naturally more diversified. The 20 partners account for 58 per cent of total EU exports of complete cars in The four main partners with respect to EU export (US, China, Japan and Canada) account for 48 per cent of the total EU exports. 36

39 Table 2.2 Trade in complete cars with main partners 2012 FTA Partner EU export (bn. euro) EU export (pct. of total extra EU) EU import (bn. euro) EU import (pct. of total extra EU) South Korea % % Central America % % Columbia-Peru (Columbia) % % Columbia-Peru (Peru) % % Singapore % % Canada % % India % % Japan % % Ukraine % % MERCOSUR % % Malaysia % % Vietnam % % Morocco % % United States % % China (FDI) % % Mexico % % Thailand % % Tunisia % % Indonesia % % Egypt % % Jordan % % Sum of 20 partners % % Total extra-eu % % Note: ASEAN include: Indonesia, Malaysia, the Philippines, Singapore, Thailand, Brunei, Burma (Myanmar), Cambodia, Laos and Vietnam. Amounts in billions of euros. Complete cars include: HS and HS Source: Copenhagen Economics based on Eurostat. 2.3 Cars sold in Europe are mostly made in Europe Most of the cars that are sold in Europe are also produced in Europe and all the main OEMs of non-european origin have production plants in Europe, cf. Figure

40 Figure 2.5 Automobile Assembly Plants in Europe by OEM and manufacturer origin Renault/Nissan 14 PSA 9 Sevel (PSA/Fiat)- 2 BMW Group 6 Daimler 11 Volkswagen 28 FORD 11 General Motors 14 FIAT 10 Geely 3 SAIC 1 Toyota 3 Honda 1 Mitsubushi 1 Tata 3 Hyundai 2 Other manufacturers 15 Total number of plants 123 Note: Automobile assembly plants within EU27, based on source plant ownership based on manufacturer. Numerical value indicates total number of plants located in EU27 countries Source: Copenhagen Economics based on Eurostat data. Imports account for 14 per cent of sales in the EU and local production accounts for the remaining 86 per cent of sales, cf. Figure 2.6. This includes production and sales from both EU and non-eu OEMs. The share of imports is generally lower in the main Asian markets, while the share of imports in sales is higher in NAFTA countries, Russia and Brazil, cf. Figure 2.6. Figure 2.6 Share of imports in total sales by market, % 80% 78% 70% 60% 50% 49% 43% 40% 30% 20% 10% 0% Canada Mexico United States 32% 23% 19% 14% 9% Russia NAFTA Brazil EU27 South Korea 6% 6% 6% 0% ASEAN Japan China India Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. 38

41 Millions The impact of trade liberalisation on the EU As the global competition for production locations is becoming more intense, the share of imported vehicles in total EU sales is increasing for both foreign and domestic OEMs. Additionally, OEMs are aligning their global production capabilities to regional differences in demand and to existing trade patterns (e.g. BMW is producing most of its X- series SUVs in its Spartanburg plant in the US). The decisions on production location certainly depend on a range of factors including labour costs, tax incentives and R&D and supply chain clustering. According to detailed data based on known plans about production locations and expected volume of production at each plant for ten EU car makers globally, we have analysed the expected development between 2012 and This shows that while production in Europe is expected to increase between 2012 and 2020, the growth is expected to be even stronger outside Europe. In 2012, 53 per cent of the light vehicles (passenger cars + LCV) produced by EU car makers where produced in Europe. Although the production volume in Europe is expected to grow by 14 per cent between 2012 and 2020 according to known plans, the growth will be significantly higher at the plants outside the EU by the same ten EU manufacturers. Production outside the EU is expected to grow by more than 50 per cent. Consequently, the picture will change by 2020, and more cars will be produced by the ten EU originating car makers outside the EU (55 per cent) than within the EU (45 per cent), cf. Figure 2.7. Figure 2.7 Location of production for 10 main EU car makers % 15 47% % 45% NonEU EU Note: This analysis covers 1o main EU manufactures (VW, BMW, Audi, Mercedes, Skoda, Seat, Peugeot, Citroën, Renault, and Fiat). Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. The base forecast contains the predicted sale in each market and by combining this data with the production forecast a split between local production and import can be obtained model by model. This can allow us to look at share of vehicles sold in the EU market by 13 Based on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. 39

42 origin of the car maker (domestic or foreign) and whether the units are imported or produced within the EU. Looking at imports by origin of the car maker we see that imports account for a larger share of foreign car makers in Europe is gradually expected to increase from the current 26 per cent towards percent between 2016 and The share imports for EU car makers is lower from the outset, 8 per cent in 2013, but expected to increase to 13 per cent for their sales in the EU by Figure 2.8 Share of imported vehicles in total EU sales (%) 50% Base Forecast 40% 30% 31% 28% 26% 26% 32% 35% 33% 34% 21% 20% 21% 20% 15% 15% 14% 14% 17% 10% 0% 13% 13% 13% 6% 7% 8% 9% 5% Foreign Domestic All Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. The above development is based on information about known plans for production locations and volume of production at each plant. The forecast used is the so-called base forecast, which is a no policy forecast. It follows that there is a degree of uncertainty as to whether all plans will materialise as foreseen. Another analysis along the same lines is based on the historic development. This shows that the drop in sales in the EU since 2007 have been more severe (measured in percentage-terms) for foreign (non-eu) car makers than for EU car makers. Sales in the EU of foreign brand cars made in the EU dropped 32 per cent between 2007 and 2013 and sale of foreign brand cars being imported to the EU dropped by even more (36 per cent). In comparison, sales of EU brands made in the EU dropped by 26 per cent. 40

43 Millions The impact of trade liberalisation on the EU Figure 2.9 Development in cars sold in Europe by car maker origin and production location ,4-26% 8 Domestic EU brands 7, ,8-32% Domestic non-eu brands 3, ,0 0,6-36% Imported non-eu brands Imported EU brands ,3 0,8 Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. From the analysis above, we also note a development going against the overall drop. Contrary to the general decline in sales, we see an increase throughout the crisis of the imports of cars produced by EU brands outside Europe. This indicates an underlying trend of relocation of EU production to locations outside Europe for the purpose of exporting to the EU market. Sales by European car manufacturers in Europe Based on sales data for the EU27, we found that in 2012, 64 per cent of the vehicles sold were from European car manufactures. The analyses in this section covers cars and light vehicles as the previous sections. Further analysis of vehicle model data for the European market includes details on the origin of production for vehicles sold in the European market. This shows that, on aggregate, 92 per cent of the vehicles sold by European car manufactures in Europe are produced in Europe itself. 41

44 Figure 2.10 Sales by main European Groups in EU27 by origin of production, 2012 Thousand units <-- Foreign <-- EU 92% of vehicles sold by European car makers in Europe are produced at plants in Europe Note: The analysis covers sales in the EU27 for all light vehicles. Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. For some European brands, all their models sold in Europe were also produced in Europe (e.g. Audi, Skoda, Seat and Mini), and the least European brands from this perspective were BMW, with 87 per cent of the vehicles sold in Europe being produced in Europe and Renault with 86 per cent share in Europe. Thirteen per cent of the BMWs sold in Europe in 2012 were imported, mostly from the US, where its two large luxury SUV/4x4 models, X5 and X6, are produced. Similarly, Mercedes also imported their large luxury 4x4 (Mclass and GL-class) from their US plant. The Italian car maker Fiat also imported 3.5 per cent of the cars sold in Europe from outside Europe in This is mainly because of imports of the mid-size model Stilo from Brazil. Although the sales numbers are small, less than 10,000 units in 2012, cars such as the Citroën C-Crosser (and the equivalent Peugeot 4007) are examples of the increasingly integrated value chain and comprehensive global cooperation between car makers, cf. Box

45 Box 2.1 A Citroën from Japan The Citroën C-Crosser is a compact crossover SUV that went on sale in the summer of 2007, designed for the French manufacturer Citroën and produced by Mitsubishi Motors on the basis of the new Outlander. The equivalent Peugeot-badge-engineered version is the Together the 4007 and C-Crosser are the first Japanese-produced cars sold under any French brand. Since 2009 they have been assembled for Europe, in the factory that was built in the 1960s to assemble DAFs now Mitsubishi's plant in Born, Netherlands. Since 2011 they ve also been produced at the Russian PSA Peugeot Citroën/Mitsubishi joint venture factory in Kaluga. Source: Manufacturer website and Wikipedia Sales by American car manufacturers in Europe Sales data show that in 2012, 16 per cent of the cars sold in the EU were from American car manufacturers (GM, Ford and Chrysler). The analysis shows that, for American cars sold in Europe, 85 per cent are also produced in Europe. This is mainly because of the European production of Ford (with the models Ka, Fiesta, Focus, Mondeo and Kuga), and GM/Opel/Vauxhall (five models). Again, the global nature of the car business is illustrated by the fact that the largest non- European location for production of US car brands sold in Europe is in fact South Korea, and not the US. In 2012, approximately 180,000 units from GM s plants in South Korea were exported to the EU (the models Matiz, Lacetti, Epica, Cruze and Captiva were produced at the Daewoo plants acquired in 2001). A smaller number of cars of US origin were exported from the US to the EU in 2012, namely around 30,000 cars from Ford, GM and Chrysler. 43

46 Figure 2.11 Sales by main US firms (Groups) in EU27 by origin of production Thousand units <-- Foreign <-- EU 85% made in the EU Ford General Motors Chrysler Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. In 2012 the EU imported approximately 160,000 cars from the United States, 95,000 of which were BMW vehicles and another 36,000 were Mercedes vehicles. Accordingly, imports from the US to the EU were dominated by cars in the premium price segment. The remaining 30,000 units were Chrysler and General Motors vehicles in the entry and midlevel price segment. Towards 2020 the number of imported vehicles from the US to the EU is expected to increase only slightly, but the distribution is expected to shift from the premium level segment towards the entry level segment, cf. Figure Figure 2.12 Imports from the US dominated by premium segment '000 units Entry Mid Premium Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. 44

47 Export from the EU to the US is also dominated by the cars in the premium price segment. In 2012, 91 per cent of vehicles that were exported to the US were in the premium price segment. The number of vehicles exported to the US (740,000) was more than four times the number of vehicles imported from the US (160,000). Towards 2020 exports are expected to grow to 1.1 million units. While the share of cars in the entry and mid-level segments is expected to increase relatively, exports are largely still to be dominated by cars in the premium segment in Figure 2.13 Exports from the EU to the US are also dominated by premium segment '000 units Entry Mid Premium Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. Sales by Japanese car manufacturers in Europe Japanese firms (Toyota, Nissan, Mazda, Mitsubishi, Subaru, Suzuki and Honda) accounted for 11 per cent of the cars sold in the EU in On average, 63 per cent of these vehicles were also produced at a location in Europe. Some of the best-selling Japanese brands in Europe are producing a large share in Europe. Toyota for example is producing 67 per cent of the vehicles sold in the EU in Europe (the most popular models are Yaris, Aygo, Avensis and Auris). Likewise for Nissan and Honda, which produce more than 80 per cent of the vehicles sold in Europe at locations in Europe. Suzuki is producing 63 per cent of the vehicles sold in Europe at European locations. The smaller car makers Mazda, Daihatsu (part of Toyota group) and Subaru are importing from Japan. Nissan is a special case as it produces more cars in Europe than it sells in Europe, as part of the European production is exported to the neighbouring regions. 45

48 Figure 2.14 Sales by main Japanese Groups in EU27 by origin of production Thousand units <-- Foreign <-- EU 63% of vehicles sold by Japanese car makers in Europe are produced at plants in Europe Toyota Nissan Suzuki Honda Mazda Mitsubishi Subaru Lexus Daihatsu Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. In 2012 the EU imported 330,000 vehicles from Japan. This represents a large drop from 650,000 vehicles in 2005 caused preliminary by an increased local production in the EU of Japanese branded cars and to a lesser extent by a drop in demand in the EU. Towards 2020 the number of imported vehicles from Japan is expected to increase again to 520,000, a level that is still lower than in 2005, cf. Figure Most of the vehicles imported from Japan were in the entry and mid-level segment. This distribution of vehicles between price segments is expected to be relatively constant going forward. 46

49 Figure 2.15 Imports from Japan dominated by entry and mid segment vehicles '000 units Entry Mid Premium Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. The level of exports from the EU to Japan is at a much lower level. In 2012, approximately 170,000 cars were exported from Europe to Japan. As a baseline, the number of exported cars to Japan is expected to increase in the coming years then fall back by Contrary to imports from Japan, exports are dominated by cars in the premium price segment, which account for roughly 70 per cent, cf. Figure Towards 2020 the premium price segment vehicles are expected to dominate European car exports to Japan. Figure 2.16 Premium price segment dominates European exports to Japan '000 units Entry Mid Premium Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. Again, an example of the international and integration of car manufacturing is the Nissan Qashqai, which despite its Japanese ownership, is a very European car, cf. Box

50 Box 2.2 A Nissan from Europe The Nissan Qashqai is a compact CUV (Crossover Utility Vehicle J-segment in Europe) produced by the Japanese car manufacturer Nissan since The Qashqai has been built at Nissan Motor Manufacturing in Sunderland (UK) since late It is the first model to be styled by Nissan Design Europe in London, with engineering development led by Nissan Technical Centre Europe (NTCE) in the UK. The Qashqai is exported to the Middle East and additional overseas markets. To free up assembling capabilities in Nissan s UK plant, production of the new generation Qashqai is set to move to Nissan s Russian plant in Saint Petersburg in Source: Manufacturer website and Wikipedia. Sales by Korean car manufacturers in Europe In 2012 Korean firms (Hyundai and Kia, both part of the Hyundai group) accounted for five per cent of total sales in the EU. Looking behind the aggregate numbers, we find that 54 per cent of vehicles sold in Europe by Korean car makers are made in Europe, which is a lower share than the average for US and Japanese car manufacturers. In 2012, the Hyundai group sold approximately 740,000 cars in total in the EU, split between 410,000 of the Hyundai brand and 330,000 of the Kia brand. The share of sales produced in the EU was slightly larger for the Kia brand at 56 per cent than it was for the Hyundai brand at 53 per cent, cf. Figure

51 Figure 2.17 Sales by main Korean firms in EU27 by origin of production 2012 Thousand units <-- Foreign 54% made in Europe <-- EU 0 Hyundai Kia Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. In 2012, the EU imported 390,000 vehicles from South Korea of which 190,000 units were Hyundai s and Kia s and 180,000 from General Motors in Korea (formerly Daewoo). As mentioned earlier, cars from Korean car makers (e.g. the Hyundai group) is also being imported from other countries than South Korea, e.g. India and Turkey. While we have demonstrated this integrated nature of the supply chain for the Hyundai Group, this is by no means a feature solely applicable to the Korean car maker. On the contrary, most car manufacturers have a globalised production footprint, and are supplying vehicles from multiple locations. Towards 2020, the base forecast (not including the impact of the FTA) predicted an increase of imports from South Korea to 500,000 units based on currently known plans. Since 2005 imports have been dominated by cars in the entry level segment with some imported cars in the mid-level segment. The base forecast predicted imports to increase from 2016 and entry level vehicles will continue to dominate imports from South Korea, cf. Figure

52 Figure 2.18 EU imports from South Korea by segment '000 units Entry Mid Premium Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. The number of vehicles exported from the EU to South Korea is lower than the number of imported vehicles. In 2012, EU exports to Korea were approximately 83,000, with 85 per cent of these in the premium segment. Exports to South Korea have increased by 65,000 vehicles since 2005 (approximately 18,000), and there has been a higher growth rate in exports than in imports measured in units. Towards 2020, the base forecast (not taking the impact of the EU-Korea FTA into account), predicted European exports to South Korea to slowly moving past the 80,000 vehicles mark by 2020, cf. Figure The FTA with South Korea, which entered into force in July 2011, is the most ambitious trade deal ever concluded by the EU to date. The FTA is expected to change the outlook for European exports to Korea as it is gradually being implemented. Although it cannot be taken as a measure of the isolated effect of the FTA, an increase in EU exports to South Korea was observed between 2011 and 2012 with EU exports up from around 70,000 vehicles in 2011 to approximately 83,000 units in 2012 (18 per cent increase), cf. Figure Measured in value of exports, EU exports increased from 2.0 billion in 2011 to 2.5 billion in 2012 (28 per cent increase) according to Eurostat numbers. Imports from Korea has increased by more than 100,000 vehicles between 2010 and 2013, cf. Figure

53 Figure 2.19 Premium price segment dominates European exports to South Korea '000 units Entry Mid Premium Note: Data from 2013 and onwards are based on the so-called base forecast and does not include the expected increase resulting from the EU-Korea FTA. See Chapter 4 for our predicted impact. Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. European premium cars are selling well in Korea (BMW, Mercedes, Porsche, etc.). In April 2012, the French automaker Citroen resumed sales on the Korean market after a decade-long time away from the Korean market. Recently, Fiat also returned to Korea for the first time since Local vs imports for EU car makers abroad Car makers can generally choose to serve a market in two different ways, by a) producing the cars locally or b) importing cars from plants outside the market. This choice of serving the market through local production or imports depends on a range of factors including business strategy, market size, trade costs associated with transportation and tariffs as well as non-tariff barriers such as local content requirements, and market specific technical requirements. Existing production locations and production costs in the given market also play a role. Economic fundamentals of production costs and market size are important determinants for car manufacturers in choosing the mode of supplying a specific market. Another important factor determining the location of production is the availability of local supply chains. Since production costs and supply security depends on the local supply chain, 14 See EU Commission website, DG TRADE, EU-Korea FTA sees strong rise in EU exports, July

54 manufacturers of parts and components are most often seen to co-locate with car manufacturers assembly plants. 15 The mode of entry in each market is different and even for the same market, the mode of entry differs from car maker to car maker. While local production makes up almost 100 per cent of European OEM sales in some markets (Brazil), imports cover a larger share of sales in others (Japan and Russia). Most car manufacturers do not produce all the models that they sell in a market in that market. Often some models produced by a certain manufacturer in a country are exported while some of the car models sold by that same manufacturer are imported, even though the number of cars produced and sold is roughly the same. This is an important point to keep in mind when examining the net import figures for key markets on the following pages. Brazil Based on strong growth in recent years, Brazil has developed to become one of the larger automotive markets globally reaching sales of 3.6 million light vehicles in 2012 (passenger cars and light commercial vehicles). In 2012 European car makers produced and sold two million cars in Brazil and less than 100,000 cars of an EU originating brand were imported to Brazil, making local production almost equal to sales. EU brands have a combined market share of approximately 56 per cent of the Brazilian market, cf. figure 2.9. Figure 2.20 High market share and local production in Brazil Note: Data are for Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. Local production is the dominating way of serving the Brazilian market, not only for European car makers, but also for US car makers. Around 95 per cent of the cars of a Euro- 15 Klier and Rubinstein (2011). 52

55 pean brand sold in Brazil were produced in the region and 5 per cent were imported to Brazil. The EU car makers had eight production plants in Brazil in 2012, all for completely build up cars (CBU) assembly 16, and the largest being the Fiat plant in Betim, Brazil producing more than 800,000 vehicles in EU car makers also have four manufacturing plants in Argentina, and Fiat has a small completely knocked-down cars (CKD) 17 assembly facility in Venezuela. On average for the EU producers, 80 per cent of the production in Brazil is destined for the Brazilian market. The remaining 20 per cent is exported out of Brazil, hereof half to Argentina (10 per cent of total production by EU car makers in Brazil). There is also trade in the other direction as there is export of cars from EU manufactures from locations in Argentina for sale in Brazil (approximately 130,000 units in 2012, including for example 20,000 units of the VW Amarok from the Pacheco outside Buenos Aires). US brands sold in Brazil had a market share of 27 per cent in 2012, of which 92 percent were produced in the region and the rest imported. Japanese brands captured a combined 12 per cent of the market and this was served 71 per cent by regional production and 29 per cent import, whereas South Korean brands, with a combined market share of 4 per cent was more based on imports (62 percent) than regional production (38 per cent), cf. Table 2.3. Brands with high market shares are much relying on production in the region, and notably in Brazil, while those brands with small market shares tend to rely on imports. On average, 88 per cent is produced within the region. Table 2.3 Sales of passenger cars and LCV in Brazil 2012 Brand origin Regional origin Imported Regional + import Market share of sales EU 95% 5% 100% 56% Japan 71% 29% 100% 12% South Korea 38% 62% 100% 4% US 92% 8% 100% 27% Other 20% 80% 100% 1% Total 88% 12% 100% 100% Note: Brands grouped by origin of the car maker. Other covers predominantly Chinese car makers. Regional origin is South America. Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. The choice of serving the Brazilian market by local production versus importing varies between the main European OEMs. While this comes partly from the fact that Brazil is an Of the foreign car makers in Brazil only Hyundai uses the completely knock down (CKD) assembly in Brazil. Fully disassembled item that is required to be assembled at the local assembly plant. Goods are shipped in CKD form to reduce freight and/or tariffs charged. 53

56 important future market, one of the reasons is also certainly the application of a localisation scheme (Inovar Auto), which aims at granting sales tax reliefs for manufacturers establishing operations in Brazil. The three German OEMs, Audi, BMW and Mercedes, had no production in Brazil in 2012 and rely on imports to serve the market. These three car makers sell relatively few cars in Brazil with sales of 5,000-10,000 each. But while they had no production in 2012 both Audi, BMW, and Mercedes have made announcements that they will start production in Brazil, BMW in 2014, Audi in 2015 and Mercedes in This indicates that Brazil is an important future market for European car makers. The car makers Fiat, Renault, Citroën and Volkswagen each produce approximately the same number of cars as they sell in Brazil, while the number of cars produced by Peugeot in Brazil accounts for 60 per cent of sales. The five European car makers with local production in Brazil (Fiat, Renault, Volkswagen, Peugeot and Citroën) all sold significant volumes in Brazil in Fiat and Volkswagen are by far the largest European car makers in Brazil with production and sales of 840,000 and 770,000 vehicles respectively while the other three sold and produced smaller volumes in Brazil, cf. Figure All production in Brazil by European car makers is socalled completely build up cars (CBU). Figure 2.21 Local production as share of sales of European car makers in Brazil Local production as share of sales 120% Citroen 75,000 Peugeot 72, % 80% 60% 40% Fiat 840,000 Renault 240,000 Volkswagen 770,000 20% 0% Share of total European OEM sales Note: Data for Numerical value in figure denotes total sales of the car maker. Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. In the coming years the sales of European OEMs are expected to grow by 3 per cent per year, reaching 2.5 million in 2020, but production is expected to increase even more 18 Company websites. 54

57 growing by 4.5 per cent per year to 2.7 million in This growth is expected to see a continued presence of the five European car makers who already have a strong presence in Brazil, and they are likely to be joined by Audi and BMW who announced plans to locate production in Brazil. This implies that the dominating mode of serving the Brazilian market will continue to be local production, but increasingly using Brazil as an export base for other markets e.g. other markets in the Americas, but also to Europe, which is the case for the Fiat Stilo. India The Indian market for passenger cars and light commercial vehicles was around 3.3 million units in 2012 against a domestic production of slightly more units, namely 3.8 million units, so there is a small overall net export from India (measured in number of vehicles). The Indian market is dominated by Indian and Japanese car makers. The single largest car maker in India is Maruti-Suzuki, with a market share of 34 per cent in The company was a started as a joint venture between the Indian government and the Japanese automotive group Suzuki. Indian car makers have a combined market share of 33 per cent (excl. Maruti-Suzuki) and South Korean car makers have a combined market share of 12 per cent in EU car makers have a small market share in India of only 6 per cent, or 200,000 vehicles in 2012, only slightly higher than the share for US brands, cf. Table 2.4. The dominating mode of supply for all brands is local production in India. Only the European car makers have notable import of cars, but only 3 per cent of the EU brand cars sold in India in 2012 where imported, which is around 6,000 vehicles (predominantly highend Audi models such as the Q3 and Q7). Table 2.4 Sales of passenger cars and LCV in India 2012 Brand origin Regional origin Imported Regional + import Market share of sales EU 97% 3% 100% 6% Japan* 100% 0% 100% 43% South Korea 100% 0% 100% 12% US 100% 0% 100% 5% India 100% 0% 100% 33% Total 100% 0% 100% 100% Note: Brands grouped by origin of the car maker. *) Japan is incl. Maruti-Suzuki. Regional origin is India + Pakistan Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. The Indian light vehicle market has grown substantially and consistently during the last few years. The light vehicle market is expected to grow to 6.8 million units in 2020 compared with 3.3m units in

58 The share of EU producers regarding sales and production is quite low. Towards 2020 sales of European car makers are expected to increase from 0.2 million to 1 million units, implying a growth in market share from 6 per cent today to 15 per cent in Figure 2.22 Low market share as well as low level of production of European cars in India Note: Data for 2012 Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. In India, European car makers, like all others, choose to serve the market by local production. For European car makers combined, local production accounts for 97 per cent of sales. In 2012 the Volkswagen group produced as many Volkswagen and Skoda vehicles as they sold in India. BMW, Fiat and Renault produced above 95 per cent of the cars they sold, while local production covered 80 per cent of the sales of more premium segment cars like Audi and Mercedes vehicles, cf. Figure

59 Figure 2.23 Local production as share of sales of European car makers in India Local production as share of sales 120% 100% Audi 9,000 BMW 9,000 Mercedes 7,000 Fiat 11,000 80% 60% Renault 50,000 Volkswagen 67,000 Skoda 35,000 40% 20% 0% Share of total European OEM sales Note: Data for Numerical value in figure denotes total sales of the car maker. Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. The European car makers furthermore differ in the way they structure their assembly in India. The majority of vehicles produced by EU car makers in India are so-called completely build up (CBU) implying that the vehicles are sourced locally and assembled locally (over 80 per cent in 2012). Some manufactures do however import so-called completely knocked-down cars (CKD) for assembly in India. This is the case for all BMW s sold in India and the predominant mode of assembly for other premium brands such as Audi and Mercedes. Other brands, such as the Volkswagen Group do also use this mode, but mostly for the higher-end models such as the Passat. 19 Towards 2020 the production of cars by European car makers is expected to increase to 1 million units implying that local production will continue to be the dominating way of serving the Indian market in the future as well. NAFTA The NAFTA area is a very large market with 17.2 million passenger cars and light commercial vehicles sold in The US market is by far the biggest of the three with 15.5 million units sold in 2012 (of which 22 per cent were imported) followed by Canada with 1.7 million vehicles sold (26 per cent imported) and finally Mexico with 1.0 million cars and light commercial vehicles in 2012 (30 per cent imported). EU car makers had a combined market share of 10 per cent across the NAFTA area of which 61 per cent were imported 20 and 39 per cent produced within the region (i.e. in US, Canada or Mexico). US car makers dominates the market with a market share of 45 per cent, and with little im CKD kits are typically sourced from a plant in Europe (e.g. the Passat is sourced from the Mosel plant in Germany), but this is not always the case. Some models for CKD assembly in India are for example sourced from a non-eu location (e.g. the CKD Volkswagen Jetta s sold in India are sourced from Puebla in Mexico and assembled at the VW plant in Aurangabad, India). Including from other NAFTA partners. 57

60 port followed by Japanese car makers having a market share of 37 per cent predominantly served by local production (71 per cent). South Korean car makers had a market share of 9 per cent in NAFTA with a close to fifty-fifty split between regional origin and import, cf. Table 2.5. Table 2.5 Sales of passenger cars and LCV in NAFTA 2012 Brand origin Regional origin Imported Regional + import Market share of sales EU 39% 61% 100% 10% JP 71% 29% 100% 37% SK 48% 52% 100% 9% US 98% 2% 100% 45% Other 27% 73% 100% ~0% Total 77% 23% 100% 100% Note: Brands grouped by origin of the car maker. Other covers predominantly Chinese car makers. Regional origin is NAFTA (US, Canada and Mexico). Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. Car production in NAFTA amounted to 15.4 million units in 2012 (passenger cars and LCVs combined), implying that the region is a net importer when comparing with total sales in the region of 17.2 million. European car makers produced 9 per cent of the cars produced in NAFTA, while Japanese car makers produced 33 per cent of the produced units in the region (5 million vehicles). In 2012, European car makers produced 1.4 million cars in the NAFTA region while they sold 1.7 million units. Net imports of European cars to the NAFTA region were about 0.3 million units in Almost all production in NAFTA by EU car makers is so-called completely build up (CBU) assembly Only one model from Mercedes was CKD assembly. 58

61 Figure 2.24 In NAFTA local production covers more than 80 per cent of the total market Note: Data for 2012 Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. In 2012, EU car makers had the following production plants in the NAFTA region: BMW plant in Spartanburg, North Carolina, US (producing the premium SUVs X3, X5 and X6) Fiat plant in Toluca, Mexico (producing Fiat 500 and the Fiat/Chrysler Freemont) Mercedes plants in Vance, Alabama (producing the premium SUVs/4x4 ML, GL) Mercedes plant in Ladson, South Carolina, US (producing the Sprinter van, CKD) Opel plant in Detroit, Michigan US (producing the mid-class Ampera) VW plant in Chattanooga, Tennessee US (producing the Passat) VW plant in Puebla, Mexico (producing the Jetta and the new Beetle) VW also had production in Windsor, Ontario in Canada, but the production ceased during In NAFTA, Volkswagen and Fiat produce more cars than they sell. In 2012 Fiat produced twice as many cars as they sold, while Volkswagen produced 20 per cent more. BMW sold around 0.4 million cars in the NAFTA region and produced just over 0.3 million units. The share of Mercedes vehicles produced relatively to those sold was 57 per cent in Audi, Renault and Peugeot did not produce cars in the NAFTA region in

62 Figure 2.25 In the NAFTA region more Fiats and Volkswagens are produced than sold Local production as share of sales 250% 200% Audi 170,000 Peugeot 5,000 Fiat 62,000 Renault 25, % 100% 50% 0% BMW 400,000 Mercedes 340,000 Volkswagen 630, Share of total European OEM sales Note: Data for Numerical value in figure denotes total sales of the car maker. Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. Towards 2020, moderate and constant growth is expected with regard to total sales and production volumes. The sales volume is expected to reach 19.4 million units in 2020 and the production volume is expected to reach 17.5 million units in In the same period the sales of cars from European car makers are expected to grow to 2.2 million and production to 1.7 million units. Japan In 2012, total sales of European cars in Japan were only 218,000 out of a total market of 5.2 million vehicles and all European cars sold in Japan are imported. The Japanese market is dominated by Japanese car manufacturers representing over 95 per cent of the cars sold in European producers are responsible for only 4 per cent of the cars sold in Japan. Other car makers represent less half a percent of the market, cf. Table

63 Table 2.6 Sales of passenger cars and LCV in Japan 2012 Regional origin Imported Regional+ import Market share Japanese brands 98,5% 1,5% 100,0% 95,5% European brands 0,1% 99,9% 100,0% 4,2% US and other brands 11,3% 88,7% 100,0% 0,2% Total 94,1% 5,9% 100,0% 100,0% Note: Brands grouped by origin of the car maker. Regional origin is Japan + South Korea. Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. The German cars Audi, BMW, Mercedes and Volkswagen were the most popular European brands in Japan in 2012 with sales of 23,000, 41,000, 40,000 and 56,000 vehicles respectively. Fiat, Citroën, Renault and Peugeot each sold between 3,000 and 6,000 vehicles in There was a production of 9.4 million passenger cars and light commercial vehicles in Japan in 2012, of which more than 99 per cent is by Japanese car makers. Production in Japan exceeded the domestic sales by 4.2 million units in 2012, which points to a very high export dependency. There is very little production by European car makers in Japan. European car makers produced 40,000 units in Japan in 2012 and sold 218,000 units. All units sold in Japan were imported and all units produced in Japan were exported resulting in a net import of 178,000 units of European car brands, cf. Figure Of the European car makers, only Citroën and Peugeot are producing in Japan in cooperation with Mitsubishi. Each were producing around 20,000 units in Japan 22 with Citroën producing six times as many cars in Japan as they sell in Japan and Peugeot producing three times as many cars as they sell (based on 2012 numbers). All the Citroën s and Peugeot s sold in Japan are imported, and all the Citroën s and Peugeot s produced in Japan are exported, so there is no local production for the Japanese market by European manufacturers. It is also important to keep in mind that 2012 was a particular year in terms of imports to and export from Japan due to the 2011 Tsunami. Since the present study was launched in 2013, the latest data available dated back to The majority of both the Citroën and Peugeot vehicles produced in Japan are the models based on the Mitsubishi RVR and are produced at the Mitsubishi plant in Okazaki. Citroën also produces the C-Crosser and the C-Zero in Japan while Peugeot, besides the RVR-based models, produces the 4007 and the ion. All are exported out of Japan. 23 The US production in Korea includes for example the Alpheon, which is a localized version of the US model of Buick LaCrosse for the South Korean market. The Alpheon is a standalone brand from GM Korea. Production began in 2010 at GM Daewoo's factory in S. Korea. 61

64 Figure 2.26 Low market share and high import share in sales of European OEMs in Japan Note: Data for 2012; the EU local production in Japan as it is in fact conducted by a Japanese company: Mitsubishi Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. South Korea The South Korea market is smaller than the other main markets described in this chapter with sales in 2012 of 1.5 million cars in 2012 (passenger cars and light commercial vehicles combined). The market share of European brands in Korea is 10 per cent of the cars sold in The market is dominated by the domestic group Hyundai/Kia having a combined market share of more than 75 per cent The US car maker General Motors acquired the Korean manufacturer Daewoo Motors in 2001 which is the main explanation for the 10 per cent market share of US car makers in Korea. Likewise, the Korean car manufacturer Ssangyong was acquired by the Indian group Mahindra & Mahindra in The market share of original Korean brands would be 88 per cent if GM Korea 23 and SsangYong are counted as domestic. Japanese car makers obtained a market share of 2 per cent in Korea in 2012, cf. Table The US production in Korea includes for example the Alpheon, which is a localized version of the US model of Buick LaCrosse for the South Korean market. The Alpheon is a standalone brand from GM Korea. Production began in 2010 at GM Daewoo's factory in S. Korea. 62

65 Table 2.7 Sales of passenger cars and LCV in S. Korea 2012 Brand origin Regional origin Imported Regional + import Market share of sales EU 39% 61% 100% 10% Japan 48% 52% 100% 2% S. Korea 100% 0% 100% 75% US* 94% 6% 100% 10% Other** 90% 10% 100% 3% Total 92% 8% 100% 100% Note: Brands grouped by origin of the car maker. *) US domestic production in S. Korea consists of GM Korea (formerly Daewoo). **) Other consist SsangYong, now owned by Indian Mahindra & Mahindra (formerly Korean owned). Regional origin is South Korea + Japan. Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. The majority of cars sold in Korea by European car makers are imported (61 per cent). The remaining part (39 per cent) of the cars sold in Korea is produced in South Korea. This is the production by Renault through its subsidiary, Renault Samsung, which is the only European manufacturer with production facilities in Korea. At its plant in Pusan, Renault produced around 54,000 units of the Samsung QM5 and SM5, which are sold as the Renault Koleos and Latitude respectively in Europe. Japanese car makers are partly serving the Korean market from Japan (48 per cent) and from outside the Japan-Korea region (52 per cent). No Japanese car makers are producing in Korea. Looking at total production in Korea, it is clear that Korea is a net exporter of cars. Total production in 2012 amounted to 4.5 million units (against domestic sales of 1.5 mio. units). Looking at European car makers in Korea, there is only the Renault-Samsung plant in Pusan. This plant produced 154,000 units of the Koleos/Latitude/QM5/SM5 in 2012, of which 54,000 were sold locally and around 100,000 units exported. Total sales by European car makers in South Korea were approximately 153,000 in 2012 including the 54,000 units of the Renault Samsung brand. Thus the remaining 99,000 units were imported, cf. Figure

66 Figure 2.27 Low market share and high import share in sales of European OEMs in South Korea Note: Data for 2012 Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. ASEAN The ASEAN market saw sales numbers of 3.2 million cars in 2012 (passenger cars and LCV). The market is predominantly served from within the region as 3.0 million of the cars sold were produced within the region, and 0.2 million of the units sold were imported to the region. The market share of European car manufacturers is low in the ASEAN market. Only 3 per cent of the cars sold are from European car makers, amounting to approximately 0.1 million units in Towards 2020 the market share is not expected to increase with sales of European cars expected to grow by only 20,000 vehicles. 24 The ASEAN market is largely dominated by Japanese producers with a market share of 77 per cent, of which the vast majority is produced within the region (98 per cent). There are two car producers from Malaysia (Proton and Perodua) each producing 150, ,000 units in 2012 and with a combined market share in ASEAN of 11 per cent. Proton is a regional player with sales on many of the ASEAN countries while the Malaysian number two (Perodua) is selling in the local market in Malaysia and Singapore. The US manufacturers have a small market share of 3 per cent, and predominantly served from locations within the region (97 per cent), while Korean manufactures uses a mix of channels with an almost fifty-fifty split in their sales by regional origin and imports. 24 Based on the base forecast by IHS Global SA; Copyright IHS Global SA, All rights reserved. 64

67 Table 2.8 Sales of passenger cars and LCV in ASEAN 2012 Brand origin Regional origin Imported Regional + import Market share of sales EU 54% 46% 100% 3% Japan 98% 2% 100% 77% South Korea 53% 47% 100% 3% US 97% 3% 100% 5% Malaysia 100% 0% 100% 11% Other 72% 28% 100% 1% Total 95% 5% 100% 100% Note: Brands grouped by origin of the car maker. Other brands are mainly Indian and Chinese manufactures. Regional origin is Indonesia, Malaysia, Philippines, Singapore, Thailand and Vietnam. Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. In 2012 Audi, BMW, Mercedes, Volkswagen and Peugeot all produced vehicles in the ASEAN region with a combined production of 46,000 vehicles. The production by European car makers in ASEAN in 2012 was split across 11 production locations with five plants in Indonesia, three in Malaysia, two in Thailand and one in Vietnam. European manufactures uses both CBU and CKD assembly in ASEAN, with a dominance of CKD (around 30,000 units out of the 46,000 produced). Figure 2.28 Low market share and high import share in sales of European OEMs in the ASEAN region Note: Data for 2012 Source: Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. 65

68 Figure 2.29 Relatively low level of production of European cars in ASEAN region Local production as share of sales 70% 60% Audi 5,000 50% 40% 30% 20% BMW 20,000 Mercedes 30,000 Peugeot 7,000 Volkswagen 19,000 Others 7,000 10% 0% Share of total European OEM sales Note: Figures are for Numerical value in figure denotes total sales of the car maker. Source: IHS, Copenhagen Economics 2.5 Summary In summary, the mode of entry for European OEMs differs from market to market and from car maker to car maker (as presented in the above figures). In most markets local production accounts for most of the total sales, but in Japan and Korea, imports play an important role in meeting local demand for European vehicles. The share of local production in sales varies from car maker to car maker with the producer s sales in the given market seeming to be an important factor in the choice of serving the market by local production or by imports. In summary, the European Union is a net exporter of cars and light commercial vehicles, and the trade surplus is increasing over time. Still, car makers in Europe are relatively dependant on domestic demand since around 65 per cent of production is destined for the home market. Only 14 per cent of the car sales in Europe are imported, and it seems clear that the root cause of the bleak situation for European car makers is to be found in the domestic market rather than abroad, and on this basis we do not find that trade liberalisation is to blame for the difficulties at home. We also found, based on detailed car model data for the European market, that 92 per cent of the cars sold by European car manufactures in Europe are also produced within Europe. 16 per cent of the cars sold in the EU were from American car manufactures (GM, Ford and Chrysler), and 85 per cent of those were also produced within Europe. 66

69 Japanese firms (Toyota, Nissan, Mazda, Mitsubishi, Subaru, Suzuki and Honda) accounted for 11 per cent of the cars sold in the EU in 2012, and on average 63 per cent of these vehicles were produced in Europe. The Korean Hyundai Group (producing Hyundai and Kia vehicles) had a five per cent market share in Europe in 2012 and 54 cent of the cars they sold in Europe were produced in Europe. For the European car makers in main markets outside of Europe we found that local production was the predominant way of serving the market, especially in larger markets such as NAFTA and Brazil. Local production also seems to be the predominant way of serving local demand in the future. For those markets where sales of European cars are expected to increase the most (India, NAFTA) local production is expected to follow. 67

70 Chapter 3 Trade barriers for cars and parts This chapter provides an overview of the barriers to trade in the automotive sector. We cover both tariff and non-tariff barriers (NTBs) and assess the magnitude of each for the selected FTA partners as well as for the EU. The first part of the chapter focuses on tariffs and provides an overview of their magnitude across each of the countries of interest for cars as well as for parts and components. The latter part of the chapter focuses on NTBs. As NTBs cover a wide range of measures, ranging from customs procedures to regulatory policy measures, it is methodologically challenging to quantify them in terms of trade costs. A multitude of methodologies have so far been applied in the literature, but as of yet, no consensus regarding the preferred methodology has been reached. For this reason, we take a conservative approach and use the lower end numbers across the range of estimates from both existing and own estimates. 3.1 Tariffs on cars, parts and components Below we focus on tariffs for the main markets (EU, US, Japan, Korea, Canada, India and Brazil). Appendix B provides the full set of tariffs for all potential FTA partners. For each market, tariffs are given for both passenger cars and commercial vehicles. While the interest of this report is mainly passenger cars, the latter category is included as some vehicles used for passenger purposes (such as the BMW X5 or the Audi Q7) are in fact considered commercial vehicles and frequently have a different tariff applied to them. This distinction is especially important in the US, where passenger cars are subject to a 2.5 per cent tariff, while the average tariff for all commercial vehicles is close to 20 per cent. For so-called light trucks, such as those listed above, the US applies a tariff of 25 per cent. 25 Comparing the level of tariffs applied across the seven main markets, Japan is the most open country, with zero tariffs on both passenger cars and commercial vehicles, while India is, by far, the most closed market, with tariff rates of 100 per cent on passenger cars. Canada imposes relatively low tariffs, with an identical rate of 6.1 per cent applying to both passenger and commercial vehicles. 26 Korea and Brazil impose tariffs on passenger cars of 8 per cent and 35 per cent respectively. Brazil also imposes 35 per cent on most commercial vehicles, including light trucks, while Korea applies a rate of 10 per cent to all commercial vehicles except dumpers. In the case of Korea, the EU-Korea FTA will gradu Light trucks fall into the 6-digit HS codes (Motor vehicles for the transport of goods (excl. of ), with C-I internal combustion piston engine (diesel/semi-diesel), g.v.w. not >5tonnes) and (Motor vehicles for the transport of goods (excl. of ), with spark-ignition internal combustion piston engine, g.v.w. not >5tonnes). The reason that the average duty applied is slightly less than 6.1 per cent in the case of both passenger and commercial vehicles, is that tariffs applied to the six-digit HS-codes (cars for travelling on snow, golf cars and similar vehicles) and (dumpers designed for off-highway use) is lower than for other passenger cars and commercial vehicles. 68

71 ally remove tariffs on automobiles. Since cars are considered a sensitive product, the EU s tariffs on cars vis-a-vis Korea are reduced over a five-year period. 27 The level of tariffs imposed by the European Union is currently 10 per cent for all passenger cars, not including specially designed snow cars, golf cars etc. For commercial vehicles tariffs up to 22 per cent are applied, with an average duty of 13.5 per cent for light trucks. Table 3.1 Import tariffs for selected FTA partners country Tariff line Average of AV Duties Min. AV Duty Max. AV Duty Duty Free TL (%) European Union Passenger cars European Union Commercial veh Brazil Passenger cars Brazil Commercial veh Canada Passenger cars Canada Commercial veh Japan Passenger cars Japan Commercial veh Korea Passenger cars Korea Commercial veh India Passenger cars India Commercial veh USA Passenger cars USA Commercial veh Note: The tariffs presented are applied MFN rates and are downloaded for the most recent year available. For the EU this is 2013, while it is 2012 for the remaining countries. Passenger cars cover all products within the 4-digit HS-code 8703 while commercial vehicles cover products within HS code Source: WTO, Tariff Download facility Tariffs on parts and components are shown in Table 3.2. Aside from Korea, the duties applied on parts and components are substantially lower than the duties on final vehicles. In the case of the EU, an average tariff of 3.8 per cent is applied. This is slightly more than the average Canadian duties applied (3.4 per cent) and substantially larger than the US average duties of 1.3 per cent. India and Brazil impose the highest rates on parts and components with average duties of 10 per cent in India and 15.4 per cent in Brazil. The last column of Table 3.2 contains the percentage of tariff lines, within the 4-digit product group, that enter duty free. In Canada and the US this is close to 50 per cent of 27 For small cars, the tariff went down on 1 July 2011 to 8.3 per cent, and again on 1 July 2012 to 6.6 per cent. The tariff is scheduled to be eliminated on 1 July For medium and large cars, the tariffs went down by 3 per cent on 1 July 2011 to 7 per cent, and by an additional 3 per cent on 1 July 2012 to 4 per cent. The tariff is scheduled to be eliminated on 1 July See also European Commission (2011), The EU-Korea Free Trade Agreement in practice. 69

72 the tariff lines, while it is zero in Korea, India and the EU. As in the case of final vehicles, Japan applies no tariffs on parts and components, while Brazil admits only 6.5 per cent of tariff lines duty free. Table 3.2 Import tariffs for the main FTA partners (parts and components) Country/Region Tariff line Average of AV Duties Minimum AV Duty Maximum AV Duty Duty Free TL (%) European Union Parts and components (8708) USA Parts and components (8708) Canada Parts and components (8708) Japan Parts and components (8708) Korea Parts and components (8708) India Parts and components (8708) Brazil Parts and components (8708) Note: The tariffs presented are applied MFN rates and are downloaded for the most recent year available. For the EU this is 2013, while it is 2012 for the remaining countries. HS-code 8708 covers the following products: bumpers, safety belts, bodies, brakes, gear boxes, axles, wheels, suspension systems, radiators, silencers, clutches, steering wheels, safety airbags and other parts and accessories for motor vehicles. Source: WTO, Tariff Download facility. 3.2 Processing trade The special trading regime known as processing trade is widely used in the automotive sector. In order to get a comprehensive picture of the level of protection applied to such products on the European market, it is therefore necessary to take this into consideration. Processing trade can take the form of either outward- or inward-processing. Under outward-processing, intermediate goods may be temporarily exported outside of the EU for further processing and hereafter re-imported into the EU, allowing the processed product a full or partial exemption from customs duties. Under inward-processing trade, intermediates imported from non-eu countries may be imported duty-free into the EU in order to be further processed and subsequently exported to a non-eu country 28 The trade regimes for processing trade are naturally applicable to trade in parts and components, and consequently the details of these regimes are further analysed in Chapter 5 regarding the parts and components industries. 28 The formal definition of inward processing trade is as follows: The inward processing procedure makes it possible to import goods temporarily so that they can be processed (assembled or transformed) and then to export the resulting compensating products, while benefiting from an exemption from duties, levies or checks which would be carried out under the trade policy normally applicable to imported goods, cf. European Commission (2006) Statistics on the trading of goods - user guide, page

73 3.3 Non-tariff barriers (NTBs) In this section we examine the size of non-tariff barriers in potential partner countries and in the EU. We begin by introducing the concept of NTBs using a classification scheme proposed by UNCTAD and collaborators, and discuss the channels through which various NTBs may affect trade. Following on from this, we discuss specific NTBs that affect EU exporters of automobile products in the most important FTA markets. Finally we discuss how to quantify these in terms of trade costs and present estimates of so-called tariff equivalents of NTBs in the automotive industry for a sub-group of the potential FTA members. What are non-tariff barriers? In cooperation with a number of other international organisations, UNCTAD has developed a classification scheme of so-called non-tariff measures, which is helpful in understanding the various guises that non-tariff barriers may take and the channels through which such barriers may affect international trade. 29 However, it is important to note that while non-tariff measures (NTMs) comprise all non-tariff barriers (NTBs), the former refers to a larger set of measures and contains both policies and regulations that restrict and facilitate trade, while the latter refers only to policies or regulations that contain a discriminatory element against foreign produced products (see Box 3.1 for definitions of NTMs and NTBs provided in the literature). Box 3.1 NTMs and NTBs Non-Tariff Measures Non-tariff measures (NTMs) are policy measures, other than ordinary customs tariffs, that can potentially have an economic effect on international trade in goods, changing quantities traded, or prices or both. (UNCTAD, 2012) Non-Tariff Barriers Any governmental device or practice other than a tariff which directly impedes the entry of imports into a country and which discriminates against imports, but does not apply with equal force on domestic production or distribution. (Hillman, 1991 cited in Beghin and Bureau, 2001) Source: As listed above UNCTAD s classification of NTMs is presented in Table 3.3 and includes both technical and non-technical measures. The latter includes measures applied at the border of entry in the same way as tariffs, such as anti-dumping and safeguard measures (chapter D), quota and licensing restrictions (chapter E), para-tariff measures including taxes, levies or customs surcharges (chapter F) and so-called behind-the border measures, including for instance the regulation of access to and the cost of foreign exchange (chapter G), anti- 29 Other international organisations involved in the project include the Food and Agricultural Organization of the United Nations, the Internal Monetary Fund, the International Trade Centre, the Organization for Economic Cooperation and Development, the United Nations Industrial Development Organization, the World Bank and the World Trade Organization. 71

74 Imports The impact of trade liberalisation on the EU competitive practices such as the granting of exclusive rights to control imports (chapter H) or infringements of intellectual property rights (chapter N). (UNCTAD, 2012) Table 3.3 Non-tariff measure classification by chapter Technical measures A SANITARY AND PHYTOSANITARY MEASURES B TECHNICAL BARRIERS TO TRADE C PRE-SHIPMENT INSPECTION AND OTHER FORMALITIES D CONTINGENT TRADE PROTECTIVE MEASURES E NON-AUTOMATIC LICENSING, QUOTAS, PROHIBITIONS AND QUALITY CONTROL MEASURES OTHER THAN FOR SPS OR TBT REASONS F PRICE-CONTROL MEASURES, INCLUDING ADDITIONAL TAXES AND CHARGES G FINANCE MEASURES H MEASURES AFFECTING COMPETITION Non technical measures I TRADE-RELATED INVESTMENT MEASURES J DISTRIBUTION RESTRICTIONS K RESTRICTIONS ON POST-SALES SERVICES L SUBSIDIES (EXCLUDING EXPORT SUBSIDIES UNDER P7) M GOVERNMENT PROCUREMENT RETSRICTIONS N INTELLECTUAL PROPERTY O RULES OF ORIGIN Exports P EXPORT-RELATED MEASURES Source: UNCTAD (2012). Classification of non-tariff measures. UNCTAD/DITC/TAB/2012/2. United Nations Publication. In what UNCTAD defines as technical measures, the most relevant chapter for the autoindustry is chapter B ( technical barriers to trade ), which covers measures such as technical regulations and standards (i.e. requirements regarding product characteristics and/or production processes e.g. environmental or safety requirements) as well as requirements in terms of conformity assessments (procedures to ascertain fulfilment of technical regulations, e.g. testing of automobiles against specified safety requirements) (UNCTAD, 2012). It should be noted that while standards and regulations may be defined as non-tariff measures, they are not necessarily erected as barriers to trade per se, but may serve legitimate purposes. Policies such as health and safety standards, for instance, protect consumers from a range of risks that they would otherwise be exposed to (CE, 2009). However, these may come to act as barriers to trade if they differ across countries. Idiosyncratic national standards, which require the producer to substantially modify existing products, limit the producer s ability to take advantage of economies of scale, and impose an additional fixed cost on the producer. While the same standards and regulations apply to both domestic and foreign producers, they can provide the former with a relative advantage, as domestic producers generally have a much larger sales base on the domestic 72

75 market than foreign producers. Domestic producers can therefore spread the additional fixed costs over a larger quantity of production than foreign producers (USITC, 2007). For the latter, it may prove unprofitable to implement the required modifications to production or undertake other required activities in order to enter or remain in the market. 30 For the same reasons that nationally diverging standards may act to deter trade, internationally shared standards may act to facilitate trade. Adopting shared regulations across borders allows producers to take advantage of economies of scale and promotes specialisation (Swann, 1996) 31. In the empirical literature, international standards have also been shown to increase intra-industry trade (i.e. trade in the same type of goods, e.g. cars, across borders) and intra-company trade 32. With respect to the auto-industry, the need for international standards in order to facilitate trade has long been recognised. Already in 1958, an international agreement known as the 1958 agreement (see Box 3.2), was implemented under the auspices of UNECE (United Nations Economic Commission for Europe) and signed by a handful of European countries (Schweppe, 2008) It should be mentioned that there is some evidence to suggest that even idiosyncratic standards can be trade promoting as they codify local knowledge and thereby make it less costly for a potential exporter to that market, to gain local product-specific knowledge (Swann, et al. 1996). However, this should be weighed against the cost of implementing the given standards. Swann (1996) also notes the possibility that international standards could lead to a reduction in intra-industry trade due to a reduction in the variety of goods. However, in the case of compulsory health and safety or environmental regulations frequently found in the auto-industry, it is not obvious that replacing national standards with internationally shared standards should have such an effect. See Swann, 2010 for a review of studies. Schweppe, R. (2008). History of the 1958 Agreement. Speech given at the 50 th Anniversary of the 1958 Agreement in June 2008 in Geneva. 73

76 Box 3.2 The UNECE 1958 Agreement In 1952, the United Nations Economic Commission for Europe (UNECE) established the ECE-Working Party on the construction of vehicles (WP.29), within its Inland Transport Committee. The first meeting of this group and its member states was held in 1953 with the specific purpose of discussing whether vehicles should have one or two red lights installed at their rear (Schweppe, 2008). The efforts of this group and its member states (all European) led to the so-called 1958 Agreement, also known as the Agreement concerning the Adoption of Uniform Technical Prescriptions for Vehicles. This is still today the main international framework for the adoption of technical regulations for vehicles and their components and for the reciprocal recognition of vehicle approvals granted on the basis of these recognitions (Cars, 21 p.30). Initially, the focus of the WP.29 was on accident prevention and safety concerns, but the scope of the working group has since extended to issues such as environmental protection, air quality and noise reductions all under the framework of the 1958 Agreement (Schweppe, 2008). While the 1958 Agreement was initially limited to European countries, revisions have been undertaken with the 1998 Agreement, calling for a further global harmonisation. Non-European countries to accede to the 1958 Agreement include Japan (1998), Australia (2000), South Africa (2001), New Zealand (2002) and South Korea (2002). Today the agreement has 48 contracting parties and has annexed 127 regulations, the first of which was the harmonised requirement for two headlamps emitting an asymmetrical passing beam (Schweppe, 2008). Source: As indicated above Examples of specific NTBs for selected partner countries In a recent report by the European Commission on the competitiveness and growth of the EU automotive industry, NTBs on foreign markets are flagged as a major trade problem for the EU auto industry (EC, Cars 21, 2012) 34. Specific examples of NTBs mentioned in the report include: [ ]..national automotive standards and technical regulations, national and local administrative procedures and restrictions, technical procedures (e.g. factory audits or product testing), marking, customs valuation and related border disruption, IPR violation, import licensing and quotas, restrictions on investments and public procurement, discriminatory taxes, lack of transparency, restrictions to raw materials, divergences from international standards, etc. (EC, Cars 21, 2012, p ). 34 European Commission (2012), Cars 21: High Level Group on the Competitiveness and Sustainable Growth of the Automotive Industry in the European Union, Final Report. 74

77 In this report we will provide some examples of NTBs for the most important markets for EU exports of automobiles. These are, as shown in Chapter 2 Table 2.2, the US, China, Japan, and South Korea. 35 However, as a potential agreement with China would be limited to the area of Foreign Direct Investment (FDI) and would therefore not target NTBs faced by EU exporters, we do not discuss China here. NTBs on the US market for automobiles Ecorys (2009) have plotted the most important NTMs faced by EU exporters of vehicles to the US. Among the highest ranked are diverging standards, discriminatory taxes and the promotion of vehicles produced in or using North American intermediate inputs, through the American Automobile Labelling Act (see Box 3.3 for a short review of each of these items). Box 3.3 Examples of NTBs on the US auto market Technical barriers to trade Products sold in the US must conform to the Federal Motor Vehicle Safety Standards (FMVSS), which differ from the international standards set by UNECE, cf. Ecorys (2009) Different cetane levels in diesel fuel in the EU and US, requiring manufacturers to tune their engines accordingly, cf. Ecorys (2009) According to the American Automobile Labelling Act (AALA), from 1992, passenger cars and other vehicles must be labelled with both the proportion of US and Canadian made parts as well as the location of the final assembly point, cf. Ecorys (2009) Additional taxes and charges In the US, a penalty payment entitled the Corporate Average Fuel Economy (CAFE) payment is levied on importers or manufacturers for which the sales-weighted average fuel efficiency, across their range of models, is below a certain level, which is currently around 10.3 litres per 100 km, cf. the EC Market Access database In the US, the Gas Guzzler Tax is an additional tax (per car) levied on manufacturers of cars that do not meet minimum fuel economy level, cf. Ecorys (2009) Source: as indicated. The highest ranked obstacle found on the US market is the divergence in standards and regulations between the EU and the US, cf. Ecorys (2009). While the EU is moving towards replacing its rules on vehicle regulations with those of UNECE 36, the US is not a signing partner to the 1958 Agreement and the Federal Motor Vehicle Safety Standards (FMVSS) apply. According to Ecorys (2009), the FMVSS entail 42 different standards, to which manufacturers of vehicles and motor equipment must certify compliance According to table 2.1, the US alone accounts for 22% of total EU exports of passenger cars to non-eu countries, followed by China (17%), Japan (6%), Canada (3%) and South Korea (2%). All remaining FTA partners (Central America, Colombia and Peru, Singapore, India, Ukraine, MERCOSUR, Malaysia, Vietnam, ASEAN and the Mediterranean) account for a combined share of only 7%. UNECE th Anniversary of the Agreement on Uniform Technical Prescriptions for Vehicles. 75

78 The so-called CAFE payment and Gas Guzzler Tax are ranked as the second and third most important non-tariff measures by Ecorys (2009). The former is also flagged in the European Commission s Market Access Database. As explained in Box 3.3, the CAFE payment is a penalty payment levied on importers or manufacturers on the basis of the sales-weighted average fuel efficiency of their models. According to the European Commission s Market Access Database 37, CAFE favours large integrated automakers or producers of small cars rather than those who concentrate on the top end of the car market, such as importers of European cars. 38 The Gas Guzzler Tax, introduced in 1978 and expanded in the Energy Tax Act of 2007, also contains discriminatory elements and does not, for example, apply to mini-vans, SUVs and pick-up trucks, which are mainly produced by US manufacturers, cf. Ecorys (2009). Another type of NTM flagged in the report by Ecorys (2009) is the American Auto Labelling Act, requiring the labelling of vehicles with the proportion of US and Canadian-made parts in addition to the location of assembly. As noted by Ecorys (2007), such legislation may influence consumers to buy domestically produced cars. 39 In term of inputs from the industry itself, the European Automobile Manufacturers Association focuses their proposal on the elimination of NTBs on regulatory convergence between the EU and the US and mutual recognition in terms of conformity, compliance and technical harmonisation (Accessed August, 2013). Ibid The AALA also requires the origin of engines and gearboxes to be indicated, which may affect imports of such parts from the EU negatively (Ecorys, 2009). 76

79 NTBs on the Korean market for automobiles The Korean market for automobiles is dominated by the domestic industry (USITC, 2007) 41,42 and characterised by a relatively low import penetration rate (Decreux, 2010). Box 3.4 Example of NTBs on the Korean auto market before the FTA took effect Technical barriers to trade EU standards for On-Board Diagnostics (OBD) systems are not recognised in Korea. Average fuel efficiency regulation. A lower mileage limit applies to cars with engine displacements below 1500ccm than to those with engines above 1500ccm, which is the category that the majority of imported vehicles lie in. (CEPS, 2008) Korea Ultra-Low Emission Vehicle (KULEV) regulations. Compulsory reductions of CO 2 emissions, which exceed the EURO 4 standards and therefore require EU producers to undertake product modifications. (Decreux et al. 2010) Special Act on Capital Region Air Quality Improvement. Importers who in the past three years have sold an average of 3000 units in the capital area (Seoul, Incheon, Gyeonggi) have to market a given number of low-emission vehicles. (CEPS, 2008) Note: See Decreux et al. (2010) for a more in-depth explanation of each of the above NTBs. Source: CEPS (2008) and Decreux et al. (2010) As in the US, the main NTB on the Korean market appears to be diverging standards and regulations. In a report by the United States International Trade Commission (USITC) from 2007, Mr. Stephen Biegun, vice president, International Government Affairs of Ford Motor Co. is cited as describing the Korean safety and environmental regulations as nontransparent and out of sync with international standards (USITC, 2007 page 3-85). In terms of the cost that such standards impose and the volume of production required to undertake these, he is further noted as having explained that in order to build a vehicle according to Korean emission standards, sales in the tens of thousands would be required to make sense from a business perspective (USITC, 2007 p. 3-86). The most important standards in the Korean market for automobiles, according to Decreux et al. (2010), are noted in Box 3.5 and include both safety and environmental standards. The EU-Korea FTA addresses technical barriers to trade in the Korean auto market in an ambitious manner. According to the agreement, Korea will accept the equivalent of UNECE (and in most cases EU) standards for its most significant technical regulations. This means that an EU producer will be able to sell cars in Korea which are produced in accordance with EU regulations without having to adapt the technical specifications. This United States International Trade Commission (USITC) U.S:-Korea Free Trade Agreement: Potential Economy-wide and Selected Sectoral Effects. Investigation No. TA , USITC Publication According to calculations conducted by USITC, based on Korean auto registration data, domestically built passenger cars had a market share of 95.8% in 2006, while foreign producers accounted for only 4.2% of the market in the same year (USITC, 2007 page 3-75). 77

80 means that among others, the equivalent of the EU standards on OBD are accepted (the Euro-6 standard) from 1 January 2014 for those producers which can meet those by that time and derogations for EU cars will be given from Korean emission requirements. 43 As pointed out by the European automotive sector (ACEA) their members are concerned that the South Korean authorities are unwilling to accept the full scope of UN ECE regulations, and have among others expressed concerns about the E-mark and Conformity of Production standards not being accepted by the Korean Ministry of Land, Infrastructure and Transport (MOLIT), and that the conformity of UNECE type approval certificates are not fully recognised by South Korean authorities, requiring excess technical data. Furthermore, ACEA is concerned about new certification & post-market surveillance policies being implemented without consultation with the European Commission and that new fuel consumption rate certification procedures are or might be implemented by South Korean authorities resulting in duplicated certifications. 44 NTBs on the Japanese market for automobiles Both technical barriers to trade and the Japanese taxation system are among the NTBs identified in the literature or by industry sources (see Box 3.5). In terms of technical barriers to trade, Japan has its own safety and environmental standards, driving up the cost of product approval for foreign auto producers (Automotive News Europe, 2013) 45. The obstacles caused by diverging standards and assessment procedures is also touched upon in a survey conducted amongst managers of European motor vehicle firms in Japan, by Copenhagen Economics (2009). As a means to lowering barriers in the Japanese auto market, the majority of respondents called for an increase in the use of international standards. Specific recommendations from the report include the Japanese adoption of UN-ECE standards with regards to emissions, noise and safety in addition to a simplified certification procedure (CE, 2009) European Commission EU-South Korea Free Trade Agreement: 10 Key Benefits for the European Union. June, See presentation by ACEA to the INTA Committee, July 2013, Brussels. Accessed at: Automotive News Europe. Europe s automakers worried by Japan free-trade agreement, Knauer, Michael., April 6,

81 Box 3.5 Examples of NTBs on the Japanese auto market Technical barriers to trade Safety and environmental standards (Automotive News Europe, 2013) Technical guidelines concerning advanced safety features (EC, MAD) 46 Additional taxes and charges Tax advantages provided to so-called Kei cars, accounting for a third of sales in Japan (Automotive News Europe, 2013). Source: See above In addition to technical barriers to trade, industry sources also note that tax advantages are given to so-called Kei cars, with engines below 0.66 litres, which is smaller than the engine size of European models, rendering them unable to enjoy the same tax benefits (Automotive News Europe, 2013). According to the European automotive sector (ACEA), Japan should adopt existing UN ECE Regulations unless such regulations are already under review by WP29 and the EU should not agree to modify existing UN ECE Regulations in order solely to meet Japanese domestic regulations. The ACEA list also included: The generic exemption from the import inspection requirements of the High Pressure Gas Act of airbags using compressed hydrogen, the approval of high pressure gas tanks which conform to EU/ISO standards, the relaxation of the zoning regulations for automobile service shops. 47 How do different NTBs affect trade? As seen from the examples provided above, diverging regulations and standards are listed as NTBs in all three markets. As firms may have to undertake additional investments or make changes to their production process in order to comply with such measures, this type of NTB may increase the fixed cost that firms have to undertake in order to access the given market (World Trade Report, 2012). NTBs like these may therefore impact on the so-called extensive margin of trade, i.e. the number of exporters that are active in a specific market or the number of models each car maker sells in a market. In contrast, more traditional measures of trade barriers applied at the border, such as tariffs or indeed other types of NTB, will impact on the intensive margin of trade, i.e. the volume of each product sold, by increasing the cost of each unit of export. Provided that such measures are not prohibitive, i.e. large enough to wipe out demand for the exported good entirely, they will not affect the ability of a firm to enter a given export market but will instead affect the quantity that the firm is able to sell in that market See presentation by ACEA to the INTA Committee, July 2013, Brussels. 79

82 3.4 Quantifying NTBs in terms of trade costs NTB estimates translate the qualitative information on NTB s into a quantitative measure of the restrictiveness of NTBs. The most common way to do so is to quantify the impact that NTBs have on trade flows. This allows for NTBs to be expressed in terms of so-called ad-valorem equivalents (AVE), meaning the ad-valorem tariff that would restrict trade to the same level as the NTBs in place. Quantifying NTBs in terms of trade costs thereby allows for a comparison of the restrictiveness of NTBs across both countries and sectors, in the same way as tariffs. Furthermore, following this approach one would assess the joint impact of several NTBs in place, e.g. discriminatory taxation policies and idiosyncratic technical regulations. While the trade costs equivalents of NTBs is required in order to include NTBs in our later simulations, estimating these is by no means simple and, as of yet, no consensus has been reached in the empirical literature regarding the preferred choice of methodology. 48 For the purposes of this report, we have chosen to follow a range of methods including the approach used by Kee et al. (2009), which aims to obtain AVEs of NTBs at the product (6 digit) and country level. However, given the uncertainties that still surrounds the estimation of NTBs, we review the existing estimates from the literature, obtained using a variety of methods and supplement these estimates with our own econometric estimates. Doing so allows us to assess the range of AVEs for the EU as for the main FTA partners, and by relying on the lower end estimates of the available estimates provides us with NTB estimates that are more robust than relying on one single methodology. Comparison of available estimates We have identified NTB estimates for cars and/or the automotive industry in four existing studies. Three of these are summarised in Box 3.6. The method developed by Kee et al (2009) also builds on Leamer (1990) and the methodology is further explained below in relation to the supplementary estimates we have performed using this methodology. 48 Several review papers and reports discussing proposed methodologies are available. Among these are the WTO s World Trade Report 2012, Carrére and Melo (2011) and Beghin et al (2001). 80

83 Box 3.6 Existing studies of NTBs for the automotive sector Copenhagen Economics (2009) In this study the interest lies in estimating the cost equivalents of NTBs in multiple 2-digit sectors (including automotive) on the Japanese market using a variety of models. Among the models used, is a so-called gravity model from which the impact of NTBs on the quantity of imports can be obtained for a number of countries. 49 Using import demand elasticities, the impact on prices can hereafter be obtained. In Copenhagen Economics (2009), NTBs are accounted for through importer fixed effects, capturing the effect of all country-specific trade barriers, which do not vary over the time period used in the study ( ). Ecorys (2009) The focus in this study is on non-tariff measures and identifying the cost imposed on EU exporters by NTMs on the US market and vice versa. As in the former study, a gravity analysis is conducted followed by a derivation of the price-effect. However, the measure of NTMs used in the model is based on an index relating to their perceived restrictiveness, obtained from survey answers from firms in the industry. Decreux et al. (2012) The objective in this study is to quantify the expected effects of the Korea-EU FTA across sectors, accounting for NTBs. For the auto sector, the authors employ a bilateral version of Kee et al. (2009). The dependent variable is the import of passenger cars in Korea from a list of countries including the EU. NTBs on passenger cars into Korea are measured using a binary variable as in Kee et al. (2009). In order to get at the impact of NTBs on specifically EU exporters, the authors interact the NTB measure with a dummy for the EU. Note: Source: See box A more in-depth explanation of the methodology used in Copenhagen Economics (2009) is contained in appendix D, where an overview of the coefficient estimates used to derive the AVEs, is also available. The reader is referred to each individual study for further details. The results from the four existing studies are summarised in Table 3.4 for the EU and the trade partners for who we have been able to find estimates from at least one other study than Kee et al. (2009). 49 The name gravity comes from the models analogy to Newton s law of gravitation, as it predicts that trade between any two countries will be positively related to the product of their economic size and inversely related to geographic distance between them. Linguistic and historical factors such as a common language or a shared colonial history are also most commonly included. See the appendix for a more detailed outline of this methodology and an overview of the coefficients estimates used to derive the AVEs. 81

84 Table 3.4 AVEs of NTBs for automotive/cars on selected markets CE (2009) Decreux et al. (2012) Ecorys (2009) Kee et al. (2009) Lowest estimate (1) (2) (3) (4) (5) Minimum of (1) to (4) Korea 41% - 87% 27% - 59% 27% Japan 48% - 92% 48% US 37% - 83% 27% 59% 27% Canada 32% - 77% 29% 29% Brazil 40% - 86% 32% 32% EU 16%* - 81% 26% 16% Note: The lowest estimate for each market in columns (1)-(4) is marked in bold. The estimates shown in bold in column (5) are those where the supplementary estimates did not produce a lower estimate. *) estimate based on survey, see Copenhagen Economics (2009). Estimates in column (1) are based on an elasticity of -1 and -2 respectively to allow for comparison with Decreux et al (2012). Source: Indicated above each column The estimates from Copenhagen Economics (2009) will theoretically give an upper bound estimate, which is confirmed by our comparison with other studies. 50 Since there is a large degree of uncertainty surrounding these estimates, and no single method is yet agreed upon, we follow a conservative approach and use the lowest estimate for each market in order to obtain the most robust lower bound estimates of the effects of FTAs. Hence, for Korea we have identified the Decreux et al. (2012) lower bound estimate of a 27 per cent trade cost equivalent of NTBs on the import of cars. However, as will be shown below, our supplementary estimates found a somewhat lower estimate of 22 percent, which after rounding resulted in a lower bound estimate of the NTB impact in South Korea of 20 per cent. For Japan, there are no other existing comparable estimates available than the lower bound estimate from Copenhagen Economics (2009) of 48 per cent. 51 Our supplementary estimates, as presented below confirmed this high level of NTBs, since it provided estimates in excess of the lower bound found in Copenhagen Economics (2009). Consequently, after rounding, a 50 per cent estimate is used for imports of cars to Japan. This high level of NTBs in Japan seems in line with the industry perception that the Japanese market is very inaccessible, which is also what is justified by the econometric estimates. In the case of the US, the lower bound NTB estimate is found to be 27 per cent following Ecorys (2009), while other estimates point to a somewhat higher level of NTB impacts on This is because NTBs are implicitly accounted for via so-called importer fixed effects, which will also pick up other time-invariant factors such as consumer preferences and institutional/cultural issues, which cannot be addressed by trade policy. The NTB estimates from Copenhagen Economics (2009) as for other estimates, e.g. Decreux et al (2012) are dependent on the import demand elasticity used. In the EU impact assessment estimates based on a survey of EU firms selling in Japan have been used. These values were lower but could not be used in this study because there are no comparable surveys for all the other FTAs covered in the present study. See Appendix D for more detail. Using the demand elasticity of 3.8 as estimated in Chapter 4 82

85 imports of cars to the US. The potentially higher level of NTB impact in the US was confirmed by our supplementary estimates 52, which provided estimates in excess of the lower bound estimate in Ecorys (2009). 53 In terms of the simulations in this report, we shall remain consistent with our robust and conservative approach and consequently the lower bound estimate from Ecorys (2009) is used, and reflecting the predominance of higher estimates in most other approach we have rounded the estimate upwards resulting in a NTB estimate of 30 per cent for the import of cars to the US. The results obtained for Canada indicate a lower range of estimates obtained by Kee et al. (2009) for each 6-digit product code of passenger cars of 29 percent. Based on somewhat newer data and a more comprehensive coverage of NTB incidence, we found a slightly higher estimate of 36 per cent using the same approach in our supplementary estimations. Following our conservative approach we rely on the lower of the two which after rounding result in a lower bound estimate of the NTB impact on Canada s import of cars of 30 per cent. The lower bound estimates for Brazil are found in Kee et al. (2009) with an NTB estimate of 32 per cent. Similarly to the estimates for Canada above, our supplementary estimates obtained from using newer data and a more comprehensive NTB coverage showed a somewhat higher estimate, and again we use the lower of the two, which after rounding again resulted in a NTB estimate on the import of cars to Brazil of 30 per cent. Finally, the estimates for the EU also vary within broad range reflecting the uncertainty of the estimates. Ecorys (2009) finds an AVE of 26 per cent for the EU, which is the lowest estimate amongst the available estimates. Our supplementary estimates did not yield any lower estimates, but the study Copenhagen Economics (2009) included a survey based estimate of 16 percent, which after rounding result in a 15 per cent estimate being used as the lower end estimate of impact of NTBs on the import of cars to the EU. It seems appropriate that the EU should have an estimate towards the lower end of the range compared with the countries described above since the EU is perceived by industry as relatively open, and since the EU s use of UN ECE standards for cars is becoming the international standard in the industry. Supplementary estimates As mentioned, we have performed supplementary estimates using the methodology developed by Kee et al. (2009). The Kee methodology differs from other methods by being applied at the detailed product level (in this case 6 digit HS-codes). This gives the advantage of a detailed mapping of the specific products of interest (e.g. passenger cars) and a mapping of whether a specific measure identified as an NTB is applicable to the specific product in a given country. The disadvantage of this approach is that the estimates be One reason for the higher estimates in the US is likely to be related to the differences in vehicle standards between the EU and US as described above, and this difference may be attributed to either of the two partners. The various econometric models will allocate the effect on trade of differences in standards between two the partners in different proportions. The Commission s impact assessment of the impact of the EU-US agreement, CEPR (2013) also rely on the Ecorys (2009) estimate for motor vehicles of 27 per cent and assumes the elimination of 25 per cent of existing NTBs. 83

86 come rather sensitive to the definition of the product categories (e.g. threating cars with engine size below 1500 ccm as one product, and cars with engine size above 1500 ccm as another). Estimating NTBs product by product runs the risk of misinterpreting the substitution between products, which is of some relevance here, since cars at the 6-digit level consists of seven products covering three engine size groups for petrol cars and four engine size groups for diesel cars, between which there is some degree of substituability. We apply the approach to different product groups covering final cars (as reported here and used in Chapter 4) and parts and components (as reported in Chapter 5). According to the approach, we first estimate the impact of NTBs on the imports of a given product in a given country (in values) using detailed product-level trade data combined with information on the presence of NTBs at the product-level, and a number of control variables. 54 Secondly, in order to obtain the estimated effect in terms of tariff equivalents, the quantity impact is hereafter converted into a price-effect using information on the price sensitivity of the products (price elasticities). It should be noted that this methodology does not involve estimating the impact of NTBs on imports from a specific country (e.g. on US imports of EU cars) but estimates instead the average impact of NTBs on total imports to a country, making the AVEs obtained comparable in nature to MFN tariffs. To undertake the first step, an econometric model is employed which extends the factor endowment approach introduced by Leamer (1990). The basic idea of this approach is to predict imports of a given product, on the basis of a country s stock of labour, capital and other control variables in order to observe the deviations from this prediction caused by the presence of NTBs. Following this approach, the estimated effect is allowed to vary across both products and countries according to the latter s factor endowments. 55 Similar to Kee et al. (2009) we model total import flows of a given product (at the 6-digit HS-level) in a given country as a function of a country s stock of capital and labour relative to GDP, the country s economic size, its trade-weighted distance to the world and protective trade measures, including both tariffs and NTBs, where the former is measured as the average applied MFN rate at the 6-digit level. In order to smooth any time-specific effects that may influence the results, we make use of the average values of all variables over the period In total, we have data from 79 countries including 26 possible FTA partners and 25 EU countries, which we include separately See also appendix C. WTO and United Nations Conference on Trade and Development (2012) A Practical Guide to Trade Policy Analysis. Excluding intra-eu trade. Appendix C contains a more detailed explanation of the estimation method, a list of all data sources and the list of countries and products included. 84

87 Information on NTBs enters the model as a binary variable, which indicates whether an NTB is in place on a given market for the 6-digit product in question 57. Measuring NTBs in this way has the advantage of being less data intensive as all we need to know is whether or not there is an NTB in place on a given market. The downside is that the approach does not distinguish between different types of NTB s in place on a given market or indeed the number of NTBs in place. In order to determine whether or not a given product is indeed covered by an NTB, we use a variety of sources. For 15 of the countries in our data, including the EU, relatively new data is available via the TRAINS database, which contains detailed information on all NTBs covering a given product, classified according to the UNCTAD classification presented in Table For the remaining countries we rely on Kee et al. (2009). Unfortunately, this data is by now rather old and we have therefore updated this using data from the European Commission s Market Access Database and further information received from the Commission s Directorate General for Trade. To give the reader an idea of how the data looks, Figure 3.1 plots the share of all products in each category where NTB are identified across all 79 countries. As evident from the figure, final vehicles is the product group with the highest incidence of NTBs, followed by tyres, parts and engines. Figure 3.1 Incidence of NTBs across all countries 30% 41% 52% 35% 70% 59% 48% 65% Vehicles Parts Engines Tyres NTB No NTB Note: The figure shows the share of products within each group, where an NTB has been identified. The diagram uses data from all available countries in the data. Vehicles include HS codes and Parts include all 6-digit product codes within the 4-digit code 8708, Engines cover the 6-digit product codes: , , , Tyres include and Source: Copenhagen Economics using data from TRAINS, Kee et al. (2009), The European Commission s Market Access database and further information from the European Commission s Directorate General for Trade This variable is equal is one if there is at least one NTB in place for a given product in a given market and zero otherwise. The data covers Bolivia, Brazil, China, Costa Rica, Egypt, EU, India, Japan, Madagascar, Mauritius, Morocco, Namibia, Senegal, Tanzania, and Tunisia. The data for all countries has been collected over the years

88 In Table 3.5, we report two sets of results from these estimations Column 1, contains the trade weighted average AVEs for passenger cars, using only those product codes, for which the results indicated a statistical significance of NTBs on the quantity imported. Column 2 contains the trade weighted average AVE across all 6-digit product codes covering passenger cars including both significant and insignificant estimates. Table 3.5 AVEs of NTBs for passenger cars on selected markets Supplementary Estimates Method 1 Method 2 Korea 22% 50% Japan 79% 107% US 96% 100% Canada 60% 36% Brazil 40% 40% EU 25% 28% Note: The lowest estimate of the two methods for which there no lower estimates from existing studies is marked in bold. Source: Authors own estimates. See technical appendix for more detail. In the case of Korea, our estimates indicate an AVE of 22 per cent, which is close to the estimate of 27 per cent by Decreux et al. (2012) and the high end results for Japan are confirmed by these estimates. Potential FTA partners not shown in the table above has insufficient information about the existing NTBs and consequently no estimates of the NTBs are possible. Using the estimated coefficients on all factor endowments in combination with information on NTB coverage, the impact of NTBs on the quantity of imports can be computed for each market. However, to make this effect comparable with tariffs, we must use information on the import demand elasticity, i.e. the percentage change in the quantity of imports of a given 6-digit product in response to a one per cent increase in price (see Appendix C for a formal description of how this is done). The value of the import demand elasticities naturally matters for the size of the computed AVE. If the quantity of any given goods imported responds very little to an increase in its price (i.e. the absolute import demand elasticity is small) the estimated quantity impact will translate into a larger price-effect. Likewise, when the quantity of imports responds strongly to a price change, the price-effect will be small. This means that even if the estimated quantity impact of NTBs is similar for two goods, there can still be a significant difference between their computed AVE, depending on differences in the import elasticities (Decreux et al. 2010). NTB estimates used as basis for simulations Due to the uncertainties related to the quantification of the NTBs, we choose to rely on the lower bound estimates from both our own estimates and those estimated elsewhere 86

89 using different methodologies and elasticity values, in order to obtain as robust a range of estimates as possible. 59 Table 3.6 AVEs of NTBs for passenger cars Level of NTBs before FTAs (lower bound AVE estimate) Source of estimate Korea 20% Own estimates (method 1) Japan 50% Copenhagen Economics (2009) US 30% Ecorys (2009) Canada 30% Kee (2009) Brazil 30% Kee (2009) EU 15% Copenhagen Economics (2009) Note: For other partners we assume an NTB estimate of 25 per cent corresponding to the average of above. Source: Existing estimates and authors own estimates. See description above. Reduction scenarios of NTBs Perhaps more important than assessing the order of magnitude of the NTBs is the assessment of how much the NTBs can be reduced as a result of the FTA negotiations. This potential reduction has been assessed partner by partner by the European Commission and the reductions are typically between 5-20 per cent with the exception of Korea, Singapore and the Ukraine where reductions of per cent are assumed, cf. Table 3.7 (see also appendix G). 59 The computed AVEs will depend on the choice of methodology, the way in which NTBs are measured and accounted for in the model and the magnitude of the elasticities, which are themselves estimated and therefore also subject to a degree of uncertainty). 87

90 Table 3.7 Assumed reductions in NTBs FTA Partner EU Partner(s) South Korea 0% 80% Central America 0% 0% Colombia-Peru 0% 9% Singapore 0% 80% Canada 5% 5% India 1% 1% Japan 20% 20% Ukraine 35% 100% MERCOSUR 15% 15% Morocco 20% 20% Malaysia 20% 20% Vietnam 20% 20% US 25% 25% Thailand 20% 20% Indonesia 10% 10% Tunisia 20% 20% Jordan 5% 5% Egypt 10% 10% Mexico 20% 20% Note: Table shows the reductions of NTBs as assumed by European Commission for each FTA. Source: Assumptions provided by the European Commission Using these reduction potentials allows for the calculation of the resulting percentagepoints reductions in the AVEs for each market. The resulting AVE reductions for passenger cars are presented in Table 3.8 for the trading partners for which NTB estimates could be obtained. These reductions are applied in the tariff + NTB scenario deployed in the following chapter. The results show for example that is assumed that EU exports to Korea will face a 16 percentage-points reduction of NTBs on top of the tariff reductions, and similarly for the other partners as shown below. Table 3.8 NTB reductions for passenger cars Partner Partner NTB reduction (percentage points) Korea -16% Japan -10% US -8% Canada -2% Brazil -5% Note: The reduction for the European Union is assumed to vary between the FTAs depending on the partner, and consequently the EU reduction is not shown above. Source: Copenhagen Economics analysis of NTB estimates from sources named above and assessments by European Commission staff of the reduction potential in each market 88

91 The countries not shown above have smaller import volumes from the EU and there is insufficient information about the existing NTBs. We therefore use the average of the AVEs of the countries shown above to generate an estimate of AVEs for other FTA partners. 89

92 Chapter 4 FTAs and trade liberalisation for cars In this chapter we estimate the impact of possible FTAs on the European market for passenger cars. Based on sales data from 2011, we conduct a counterfactual analysis in which we simulate the impact of all the possible FTAs on the quantity of local sales and production of passenger cars in the EU, in addition to the impact on the quantity of cars imported or exported into or from the EU. The analysis provides a picture of what the market equilibrium would have been in 2011, had a given FTA regime been in place. The only factor assumed to change under an FTA is the reduction in trade costs resulting from a reduction in trade barriers including tariffs and NTBs. This will directly affect the cost of cars imported under an FTA and provide the beneficiary firm with a relative advantage on the EU market. Likewise, EU car makers will achieve lower-cost access to the partner country s market. It should be noted that the analysis does not include any dynamic effects that may arise from an FTA, such as possible relocations of production facilities, or indeed other factors, including changes to consumer preferences or a firm s portfolio of models. These are all factors that are assumed constant in the analysis and changes may impact the results to varying degrees. We also note that our estimates are based on actual trade flows in 2011, which for countries with a particular high level of protection such as for example India, our estimates might underestimate the impact because we only model the impact of an increase in existing models already being sold in each market, and thereby not capturing the eventual impact of new models being put on the market in a particular country, e.g. India. The results presented here should therefore be interpreted as valid in a short to medium term, as it is based only on current market and economic parameters. The method used is outlined in section 4.2 and the results are presented and discussed in section 4.4. Section 4.1 contains a brief overview of the data used and a short description of the EU auto market in 2011, as this is the baseline used. 4.1 Data In order to simulate the impact of a given FTA regime, we use detailed sales data from The data contains sales quantities and list prices for all vehicles sold in a given market in that year. While information on prices is available for each specific variant of the models sold, sales quantities are only recorded at the model level, which means that the analysis must be conducted at this level. In the case where several variants of the same model exist, the price of the cheapest variant is used. Keeping in mind that the point of the analysis is to simulate what happens to the volume of EU local sales, production, imports and exports when trade barriers currently imposed 90

93 on cars in the EU and the partner country are reduced, it is vital that we can identify exactly which models are imported from where. We therefore augment the sales data with information on the origin of each model, identified as the current assembly location. In terms of geographical coverage, we have data for nine EU countries and for most of the partner countries. 60 The sales data for the EU market allows us to simulate the predicted changes to local sales and import flows, arising from a given FTA. Supplementing this with the data for the partner countries further allows us to predict changes to EU export flows and thereby to total EU production. The latter is defined as changes in local sales on the EU market (i.e. cars sold and produced in the EU) in addition to changes in the volume of cars exported from the EU. Box 4.1 Data and parameters used for econometric model The demand estimates and price elasticities are taken from Grigolon and Verboven (2013), who estimate a model-level demand model using sales and price data from JATO Dynamics. The simulations are based on 2011 sales, where trade flows for the estimates are harmonized from three sources: UN Comtrade, JATO Dynamics, and ACEA. Finally, the production locations come from data supplied by IHS Global SA. The nine EU countries for which we have data are the following: Germany, UK, France, Italy, Spain, Belgium, Netherlands, Greece and Portugal. In terms of sales volumes, these countries account for the majority of new car sales in the EU27. In 2011, these markets alone accounted for 86 per cent of EU27 local sales 61 (i.e. cars produced and sold in the EU27) and 81 per cent of the sales of imported new cars. 62 As 2011 is the baseline used and all predicted changes will be relative to this year, we provide a short overview of the 2011 EU27 market for new vehicles below baseline Table 4.1, contains the quantities of local sales, imports, exports and production of new vehicles in the nine EU countries for which we have data, and the equivalent values scaled up to EU27-level. Import quantities refer to the total imports of new vehicles from non- EU countries, while exports refer to EU exports of new cars to all potential FTA partners Sales data is available for the US, Japan, Canada, Korea, India, Brazil and Mexico. For the remaining possible FTA countries, data from UN Comtrade is used to identify the volume of EU27 exports to each market. The latter covers the all 6-digit HS product codes in the 4-digit code 8703, except (golf cars etc.) and (other vehicles not mentioned elsewhere in 8703). Authors calculation on data supplied by IHS Global SA; Copyright IHS Global SA, All rights reserved. However, as the export flows (obtained from sales data in the partner countries) cover the whole of the EU27, we use the above ratios to scale up the predicted changes in both local sales and import flows to EU27 level. All results, presented in this chapter, are therefore to be interpreted as the predicted changes in sales and production volumes across the whole of the EU27. It is implicitly assumed in the analysis, that any given FTA will only affect exports to the partner country in question. 91

94 Table 4.1 Number of vehicles, 2011 Local sales EU Imports (from world) EU Exports (to all potential FTA partners) EU Production EU EU Note: The baseline for EU27 local sales and imports is obtained by scaling up the equivalent figures for EU9, using data on sales volumes from IHS data. Local sales are defined as the sales of EU produced vehicles. Production quantities are the sum of local sales and exports. Source: Author s own calculations based on industry data To give an indication of the relative importance of all potential partners in terms of trade flows in 2011, the quantity of EU imports and exports are broken down by origin and destination in Figure 4.1 and Figure Figure 4.1 Share of vehicles (no.) imported by origin, 2011 Korea 30,93% US 12,67% India 8,38% Turkey 5,32% Other 2,43% Brazil 1,80% Mexico 0,32% Russia 0,19% China 0,08% Canada 0,02% Japan 40,27% Malaysia 0,02% Note: The figure shows the origin of vehicles imported into Germany, UK, France, Italy, Spain, Belgium, Netherlands, Greece and Portugal in 2011 (intra-eu imports are not included) Source: Authors own calculations based on industry data. In terms of imports (Figure 4.1) the most important partners are: Japan, Korea, the US and India, which in total accounted for 92 per cent of the number of cars imported into the EU in Vehicles imported from Japan include, among the most important, those produced by Mazda, Toyota and Suzuki. From Korea, notable car producers exporting to the EU include GM and Renault, while BMW, Mercedes and Chrysler all export from the US. Finally, cars imported from India are produced mainly by Hyundai. Countries such as Malaysia, Canada and Mexico, on the other hand, are minor players in terms of EU-imports of passenger cars. The likely impact of a potential FTA with one of these countries on the domestic EU market is therefore very small. 64 As the data on local sales and import quantities only covers the aforementioned 9 EU countries, the share of imports from each partner country in Figure 4.1, is computed for those 9 countries. 92

95 The picture in terms of exports is somewhat different. The single most important market is the US, solely accounting for 44 per cent of the number of vehicles exported from the EU to the potential FTA partner countries. In addition, several of the countries which accounted only for a minor share of EU imports, such as Canada and Mexico, are relatively important export markets. A possible FTA with Canada and a potential revision of the FTA with Mexico, in terms of NTBs, will therefore be significant for the EU. Figure 4.2 Share of vehicles (no.) exported by destination, 2011 Euromed 7,49% Central America + Colombia + Peru + Singapore + Ukraine 7,45% Japan 15,09% Mercosur 4,77% Korea 4,76% Other 25,84% Canada 5,68% Mexico 3,61% US 44,12% Other Asia 6,70% India 0,32% Note: The figure shows the destination of vehicles exported from the EU27 in 2011 (Intra EU exports are not included). Other Asia includes Malaysia, Vietnam, Thailand and Indonesia. Euromed countries include Morocco, Tunisia, Egypt and Jordan. Mercosur refer to Brazil. Source: Authors own calculations based on industry data. 4.3 Counterfactual analysis In this section we explain the methodology used to quantify the impact of FTAs on the EU auto industry. The method applied is the same as used in Van Biesebroeck, Gao and Verboven (2012) to study the impact of FTAs on the Canadian auto industry. Simulating a new market equilibrium under a given FTA regime requires us to take into account both the direct and indirect effects that an FTA will have on the prices of all cars in the market. The direct effects arise from the removal or reduction in tariffs and NTBs on each market, which will reduce the cost of each country s exports in the partner country. An FTA between the EU and a given partner country will therefore directly reduce the cost of each car imported from the partner country into the EU and vice versa. Under, for example, 93