The Thoughts of Car Factory Managers on Trump’s Talk of Tariffs

Cars comprise two-thirds of Slovakia’s total exports to the U.S. They mostly represent the luxury end of the market, which is why Slovak politicians are not yet panicking.

When Donald Trump told French President Emmanuel Macron how much he resents seeing European Mercedes being driven around New York, it made headline news. Top managers pricked up their ears all over the world, including in Slovakia.

This is particularly relevant for the Slovak subsidiary of Volkswagen in Devínska Nová Ves near Bratislava. Every fifth car that rolls off its conveyor belt per year ends up in the U.S. And we are not talking about any old cars – U.S. customers prefer high-end models such as VW Touareg, Porsche Cayenne or Audi Q8, which are produced solely in Bratislava and nowhere else in the world. Their high-end status explains why car exports to the U.S. comprise 1.7 per cent of Slovakia’s GDP. To put this into context, the country’s total annual GDP amounts to some 80 billion euros. According to figures from the Financial Policy Institute of the Ministry of Finance, cars make up two-thirds of all Slovakia’s exports to the U.S.

The conventional wisdom in the industry has been that each job in a car making factory generates four additional jobs for subcontractors.

In terms of car exports to the U.S. as a share of GDP, Slovakia is ahead of Germany with 0.6% and Hungary with 0.4%. Apart from VW, no other carmaker in Slovakia supplies the U.S. market: most of the customers of Kia, based in Žilina, are in Great Britain, Russia and Spain, and the French PSA Peugeot Citroën supplies primarily markets in Italy, Germany and France. That explains the panic around Volkswagen, the largest private employer in Slovakia.

Is there a ‘plan B’?

VW employs more permanent staff than Kia in Žilina and Peugeot in Trnava put together. With 14,000 employees it can make a dent in national statistics simply by stopping production for two weeks in the summer and sending its staff on holidays.

In addition, the conventional wisdom in the industry has been that each job in a car-making factory generates four additional jobs for subcontractors. The prospect of VW losing a large quantity of purchase orders could have serious repercussions given that three of the company’s largest customers are at the center of a trade war. In 2017 the only country to which the Bratislava subsidiary exported more cars than to the U.S. was Germany (28 %). China, the third major participant in the escalating trade war, was in third place (13 %).

This is why the question on everyone’s mind is whether the German managers have a plan B in case Trump does impose the import surcharges he has promised. The German managers have been tight-lipped on the issue, insisting that it is mere “speculation” and claiming to be more concerned about precisely the opposite problem: their investment appetite has greatly outgrown the limits of local human resources, which have become increasingly expensive.

The question on everyone’s mind is whether the German managers have a plan B in case Trump does impose the import surcharges he has promised. The German managers have been tight-lipped on the issue.

This is the reason why VW began to import staff from Ukraine and Serbia, and Prime Minister Peter Pellegrini paid the company a personal visit earlier this summer, promising exemptions on these imports.

Trump’s threats might be beneficial

In fact, Trump’s tariffs might not prove to be a huge problem for VW. The company has actually benefited up until now as Trump’s tariffs on European steel made it a surplus commodity in Europe, pushing down the cost of this key element of car manufacturing.

VW’s top managers have also gained time to reflect, as Trump’s policies may have spurred potential U.S. buyers to invest early, if it looks as if the new tariffs could make their dream car more expensive. In fact, it is quite likely that VW’s top managers have prepared a plan B or various scenarios of this kind in case Trump makes good on his threats. The meticulous German managers are used to thinking ahead.

For example, ever since 2017, when the Bratislava subsidiary faced the largest strikes in Slovakia’s modern-day history, speculation has been rife about whether and how VW has been preparing to create parallel capacities for producing of luxury vehicles. This would have been quite a logical thing to do, given that what had attracted VW to Bratislava in the first place was its relatively cheap labor costs, and then, when gross salaries topped 1,800 euros (including bonuses, and excluding top managers’ pay), the unions went on strike.

Now the German managers are facing a slightly different question: what to do if the surcharges on U.S. imports go up from the current 2.5%? to 10% or even 20% (up to a maximum of 25%)? It is worth pointing out that at this stage, however, that it is far from clear what tariffs are currently applied to U.S. imports of large SUVs of the type manufactured in Bratislava. The company has not disclosed this information although some sources claim that for this kind of vehicle 25% has already been a reality for some time.

Look for customers elsewhere?

Whether it is SUVs or smaller cars produced by the Bratislava subsidiary, an opportunity that VW might pursue would be stepping up sales to other markets. On several occasions in the past, Slovak car makers have demonstrated they could deal with a crisis in this way. When Kia faced declining demand, for example, in their key market, Russia, which was being affected by sanctions, the company’s management spotted a gap in the Israeli market. And it worked.

Six per cent of cars produced by the Žilina plant thus went to Israel. Meanwhile, Britain replaced Russia as the company’s major customer despite looming Brexit. As a result, the carmaker was able to keep production at the same level, and even record a minute increase (from 338,000 to 339,000 cars).

The trade war saw the imposition of tariffs worth billions of dollars. No one knows how this dispute will pan out and how it will affect domestic spending.

VW could follow their example and also explore other markets. Historically, China has been identified as a potential market with a demand for top-end products. The problem is that no one knows how China will be affected by the trade war, which is more pronounced between the U.S. and China than between China and the EU.

The trade war saw the imposition of tariffs worth billions of dollars. No one knows how this dispute will pan out and how it will affect domestic spending. That is why U.S. importers will also initially seek to reduce their margins. “Surcharges on imports may not necessarily bring about the end of sales but would, of course, increase the cost of individual brands, which would have to determine how much of the brunt of lowering profits they will bear themselves and how much of it they will pass on to the customer bear via higher prices, which would take the edge off their competitiveness,” suggests Martin Jesný, an analyst with the technical journal Revue priemyslu [Industry Review] On the other hand, people who buy top-end cars might not be oversensitive about price.

Move production elsewhere?

Another option would be relocating production, which is currently based exclusively in Slovakia, to other markets, in other words, adapting production lines in other factories, and moving some of the car production to the U.S., keeping the part aimed at the European market in the EU and basing production for the Chinese market in China. How much such a hypothetical change of portfolio would cost and how long it might take depends on the amount of thought the German managers have previously given to this scenario.

Another option would be relocating production, which is currently based exclusively in Slovakia, to other markets, in other words, adapting production lines in other factories, and moving some of the car production to the U.S.

The insurer Euler Hermes also believes that carmakers vulnerable to U.S. tariffs might establish manufacturing bases in the U.S. and produce cars aimed at that market locally. “We can expect domestic manufacturers to reduce the volume of U.S. exports of certain models,” Martin Bak, Risk Director for Euler Hermes in Slovakia, told us. We should not forget that these models are produced exclusively in Bratislava – wherever the people who order them may be, they can get them only in Slovakia.

The other two carmakers in Slovakia are not immune from Trump’s threat either. Although both the Korean-owned Kia and the French-owned Peugeot Citroën claim in unison that they do not export to the U.S., it does not mean that they will not be affected by the problem, although it may happen to them later and to a lesser, or different, degree. In the worst-case scenario, should manufacturers of car components grow wary of spending their money on German companies and households, VW would immediately have a problem on their hands, but Kia and Peugeot would also have to anticipate how and when Trump’s tariffs would affect consumers’ willingness to spend money, and which of their business partners will be most hit.

Kia relies quite heavily on exports to Germany, Slovakia’s largest export partner. Peugeot Citroën claims that 91 per cent of the cars produced in their Trnava factory goes to EU countries. If European business partners run into problems with U.S. sales, their economy will slow down and that will also dampen consumer spending. If Trump imposes the tariffs he has announced, this might pose a threat.

If European business partners run into problems with U.S. sales, their economy will slow down and that will also dampen consumer spending.

The escalation of a trade war between the U.S. and China would be fatal for Germany, says Holger Bingmann, Chairman of the German Wholesalers Association, BGA. “For Germany as an export-oriented country, the consequences could be fatal and impossible to express in euros,“ said Bingmann in an interview with the newspaper Rheinische Post. By comparison, the figures provided by the Institute for Financial Policy (FSP) show that U.S. tariffs would cost the Slovak economy about 0.03 per cent of GDP. This esti- mate would apply if the Americans imposed a 10 per cent import surcharge on cars. At 25 per cent the cost would go up to 0.11 per cent of GDP, which translates into about 100 million euros.

IFP analysts also looked at the impact import duties would have on Jaguar Land Rover. As the construction of that company’s factory near Nitra has just been completed, the management is at least as concerned about Trump’s threats as the VW managers in Bratislava. “An estimated 20 per cent of the new production capacities of both VW and Jaguar Land Rover were aimed at U.S. exports,” according to IFP’s overall economy forecast published in summer 2018. In other words, 20 per cent of Jaguar Discovery’s annual production, due to start later that year, are destined for the U.S. market.

IFP analysts have further estimated that the potential impact of U.S. tariffs on Slovakia’s economy could amount to approximately 100 million euros. This is because Slovakia ranks third among countries most exposed to the risk of new tariffs. The Reuters ranking reflects the share of individual countries’ participation in global supplier relations, based on the value of exports.

It is worth noting that Slovakia produces 189 cars per thousand inhabitants, which is a global record. Local carmakers broke records for three consecutive years (2015-2017), producing more than a million vehicles annually.

Is he bluffing or not?

World-class managers still have sufficient reasons to believe that Trump’s threats are just bluster and that he will not dare impose import tariffs. There has recently been a debate about zero tariffs on both sides and about a deal on supplies of soy from the U.S. to the E.U.

Europe has one significant advantage in this debate. It is where many U.S. technology companies are based. European countries can thus put pressure on Trump by threatening to raise taxes on iconic companies such as Google or Facebook, who benefit from European tax havens. This may be the reason why Trump said that all he has done so far is commission a study on the impact of tariffs on European cars, which he expects will be ready by 2019. The study is likely to suggest that Europe would retaliate against a massive attack.

It is worth noting that Slovakia produces 189 cars per thousand inhabitants, which is a global record. Local carmakers broke records for three consecutive years (2015-2017).

And that, in turn, would cause problems for the U.S. economy. “We will not sit idly by while our industry is hit with unfair measures that put thousands of European jobs at risk,” is the message President of the European Commission, Jean-Claude Juncker sent to Washington in the summer of 2018.

BMW has a U.S. subsidiary, for example, that also produces for the European market, including top-end models. The same company has recently announced its plan to build a new plant in Hungary in order to “maintain a worldwide balance of production between Asia, America and our home continent,” said Harald Krüger, chairman of the BMW AG Board of Management. BMW is not the only firm, of course, that could turn U.S. tariffs against Trump. VW and Daimler also produce cars in the U.S. for export. “Protectionist measures can have a negative impact on car manufacturing in the U.S. because production aimed at the rest of the world could begin to move somewhere else,” says Jesný.

The tariff issue can prove useful to Donald Trump, however, in mobilizing his own voter base. DVW management in Bratislava, as well as their bosses in Wolfsburg, must bear this in mind when they hear Trump speaking of tariffs.

And one more thing: they have a few tried and tested tricks up their sleeve from the years of crisis. Volkswagen at that time let go a large number of agency workers while additionally introducing flexi accounts for permanent staff. As a result, even those employees who were temporarily laid off did receive their wages, they just had to earn them later.

And since the crisis hit primarily the demand for expensive cars, it came in handy that the production of new urban vehicles had been channelled to Bratislava. Since then this plant has also begun producing the Škoda Citigo, the Seat Mii, the VW Up and its electric version.

Europe has one significant advantage in this debate. It is where many U.S. technology companies are based. European countries can thus put pressure on Trump.

Cars as destiny

Government analysts, caught up in this debate, know that what helped considerably to compensate for the shock of the 2009 crisis was the fact that each car manufacturer was producing several models with a different life cycle, not all of which were equally affected by any particular crisis. This is why government planners are concerned less about the risk of an insufficiently diversified economy and more about focusing on new investment in research and development.

Finance Minister Peter Kažimír reassured the public in the summer of 2017 that a trade war could not possibly have a great impact on Slovakia’s economy, estimating its effect on the country’s economic growth at 0.05 to 0.12 per cent of GDP, which he regarded as a relatively negligible figure. The coming months will show whether his optimism was justified.