For years, Americans have had a love affair with their Hondas. Compact and mechanically near-perfect, they occupy a special place in the automotive pantheon. First, nimble Civics revolutionized the way Americans regarded utilitarian, high-mileage cars. Next, agile Accords proved you could cram big-car style and comfort into an affordable compact package. And lately, Honda's Acura line has helped to redefine the notion of luxury cars. In all, Americans have bought 2.4 million U. S.-made Hondas since the production line started rolling in Ohio in 1982, and today its Accord is the best-selling car in America.
More than any other foreign auto maker, Honda has also worked hard to establish itself on North American soil. It operates three auto-assembly facilities and an engine plant. Of the 854,879 cars that Honda sold in the U. S. last year, nearly two-thirds were built in North America. And those cars, Honda says, have a "domestic content" of 75% -- meaning that three-fourths of the price tag is based on American labor, components, and other costs.
But now, some suspicious U. S. officials are questioning whether Honda's U. S. operations are all they seem to be. Government investigators say that Honda has overstated the local content of the cars it builds in Ohio and Ontario. Studies by the U. S. government and private researchers suggest that Honda's cars -- and those of Toyota and Nissan assembled in the U. S. -- are mostly collections of Japanese parts handled by Americans but designed, engineered, and fabricated in Japan. The efforts of Japanese auto companies to use American-owned suppliers are "a sham," charges J. Michael Farren, Commerce Dept. Under Secretary.
The U. S. government is now looking at Honda to see if it unfairly took advantage of the 1989 U. S.-Canadian Free Trade Agreement. If Honda is found to have less than 50% local content in cars shipped duty-free between the two countries under the trade pact, the company could be hit with $20 million in back tariffs for a single year. Worse than the cost, Honda would tarnish its reputation for conscientiously working to become American.
The dispute could exacerbate tensions with the Japanese, since three-quarters of the U. S. trade deficit with Japan is in autos and auto parts (chart, page 109). The issue of Japanese auto keiretsu, or industrial groups, operating on U. S. soil is quickly emerging as one of the hottest in Washington. And as U. S. companies relocate offshore only to be replaced by Japanese transplants, the issue of foreign investment could help decide some congressional races, especially in the Rust Belt states. "The Administration thinks foreign investment is the answer to our trade problem," says House Majority Leader Richard A. Gephardt (D-Mo.). "But America gets a few crumbs off the table, while the Japanese market remains closed."
DUAL CITIZENSHIP. The issue of transplants also reverberates across the Atlantic. Should the Europeans consider Japanese cars made in Ohio or Tennessee as American or Japanese? As the Europeans ponder this, the Bush Administration is giving confusing signals. While one arm of the U. S. government is scrutinizing the content of Canadian Honda Civics, another is trying to convince Europeans that Honda Accords made in Marysville, Ohio, are truly red, white, and blue.
The Administration argues that the U. S.-assembled Hondas should not count against European Community and French quotas on Japanese imports. U. S. Trade Representative Carla A. Hills has been adamant on Honda's behalf, insisting "the nameplate doesn't matter. This is an American car." And Secretary of State James A. Baker III cabled the embassy in Brussels to lend support. The contradiction, says Representative Sander M. Levin (D-Mich.), "is another example of incoherent trade policy -- calling something American that is primarily Japanese."
The complex argument over the national origin of autos is also bogging down U. S.-Canada-Mexico free-trade talks. Congress is pushing the Bush Administration to take a tough bargaining stance with Mexico, fearing that Japan will exploit low wage levels there to flood the North American market with cheaply made, Japanese-designed cars. But the government of Mexican President Carlos Salinas de Gortari insists that rules of origin not be drawn so tightly that they turn away Japanese investors.
This dispute could jeopardize confirmation by Congress of any agreement. Warns Senate Finance Committee Chairman Lloyd Bentsen (D-Tex.), a strong backer of the free-trade deal: "Nothing will do more harm than evidence that Mexican factories are being used as a launching pad, as kind of a trampoline for foreign goods to get into the United States without paying the proper duties." For its part, Canada seeks assurances that its four Asian auto transplants will not be regulated out of the lucrative U. S. market.
METAL DESK. Of all Japanese auto companies, Honda has operated in the U. S. for the longest and claims the highest U. S. content. It is a pioneer, and thus has emerged as a potent symbol of this debate. Honda officials, both in the U. S. and in Japan, are understandably sensitive about allegations that it misrepresents itself as American. "Look at me!" exclaims Scott N. Whitlock, executive vice-president of Honda of America Manufacturing Inc. "Do I look like a transplant or an American citizen?"
That's a tough question to answer. Whitlock, an intense, 48-year-old former real estate lawyer from Columbus, Ohio, is, of course, an American. But as the top-ranking American at Honda's U. S. manufacturing facilities, he wears stark white coveralls and works at a plain metal desk amid a vast force of other Honda workers, just like a Japanese executive might in Tokyo. The U. S. government has also decided that Whitlock isn't just another U. S. auto executive: His salary is counted as an expense of the Tokyo-based parent, Honda Motor Co., not of the American subsidiary. Now, as a result of a preliminary U. S. Customs Service investigation, the results of which were first leaked in June, Whitlock is being called on to defend Honda as an American entity. In the report, Customs alleges that Honda manipulated the rules of U. S.-Canadian free trade to overstate the North American value of its Civics built in Alliston, Ont. It concludes that these Civics lacked the 50% North American content needed to qualify for duty-free export to the U. S..
As they probed, Customs auditors challenged the origin of U. S.-made components, as well. Investigators found only $51.75 worth of U. S. parts and raw materials in the Honda engines made in Anna, Ohio, while more than $700 in engine parts came from suppliers in Japan or transplant parts makers, wholly or partially owned by Honda.
Customs investigators concluded that just 15% of the value of parts in Civic engines was North American. In fact, by Honda's own accounting, the biggest item of local content added at the Anna engine plant was depreciation of the factory's equipment. And most of that machinery had been imported from Japan, Customs charges.
Even more explosive was Customs' charge that Honda's Tokyo headquarters dictated the prices that Honda-related suppliers in the U. S. and Canada charged Honda's North American subsidiaries for parts. The parent company in Tokyo allegedly told suppliers, many of them partially owned by Honda, to sell parts at a loss.
Not only would this practice constitute the "dumping" of Canadian-made Civics onto the U. S. market at less than the cost of production, a trade violation, but it also suggests that Honda engaged in transfer-price manipulation, understating its U. S. profits to minimize its U. S. tax exposure.
PILING ON. Whitlock and Honda of America are livid about such charges and deny any improprieties. Honda points out that the Treasury Dept. has yet to issue regulations on determining just how "American" a particular car model is. Customs, Whitlock charges, has just made up its own criteria. "We are being pilloried in public because the U. S. government didn't do its job," he says. Moreover, he argues that it was necessary to induce Honda's suppliers from back home to come to the U. S. because U. S. auto-parts suppliers initially either couldn't -- or wouldn't -- meet Honda's specifications. Honda also argues that its production system hinges on longtime suppliers that can make crucial just-in-time deliveries.
The flap is not likely to stop there, however. Other units of the Bush Administration are entering the fray. The Internal Revenue Service has beefed up its scrutiny of transfer pricing behavior by Japanese companies. The Justice Dept. is reviewing its guidelines on whether the vertically integrated Japanese auto keiretsu violate U. S. antitrust laws. The Federal Trade Commission and the U. S. International Trade Commission are examining the same issue. "All of a sudden, the issues of cars and transplants and keiretsu are coalescing into one," says a Washington-based representative of one major Japanese trading company.
The broader issue for policymakers is whether the transplants have done what most Americans expected. When the Japanese began large-scale investment in U. S. facilities in the 1980s, many Americans, particularly in the hard-hit Midwest, viewed them as models for a revitalized U. S. auto industry and as voracious new customers for the struggling U. S. auto-parts industry. Transplants were to offer salvation to American auto workers, whose jobs were drying up as imports soared.
Certainly, the transplant factories have boosted economies in the six regions where they have located. Aside from Honda in Marysville, Nissan selected Smyrna, Tenn., and Toyota chose Georgetown, Ky. Others include Mitsubishi Motors in Normal, Ill.; Subaru-Isuzu in Lafayette, Ind.; and Mazda Motors in Flat Rock, Mich. Of all these, Honda's stake is the biggest. Its $2.2 billion central Ohio complex employs 10,000 workers and pumps a payroll of $7.3 million weekly into the local economy. And 39% of the Japanese-nameplate vehicles sold in the U. S. last year were built in North America, up from just 9% in 1986.
But a growing chorus of skeptics charges that there's less than meets the eye in these statistics. Most of the American-made parts the makers buy are supplied by tight webs of related suppliers stretching back to Tokyo. Rather than stimulating the auto-parts industry, the transplants are exerting new competitive pressure on it and on Detroit. And the transplants have not narrowed the U. S. gap in auto-related trade with Japan. Instead, says Commerce's Farren, the keiretsu relationships among Japanese manufacturers and their suppliers in the U. S. "have exacerbated" the gap.
Indeed, the $100 billion auto-parts industry in the U. S. and its 600,000 workers -- the largest single manufacturing sector of the U. S. economy -- may be in a tailspin. Already, the Japanese transplants "record a large and growing overall trade deficit, particularly with their foreign parent firms, mainly due to the extensive use of imported inputs to their manufacturing operations," a recent study by Commerce concludes.
NORTHERN CHILL. Honda isn't the only one unhappy with the transplant debate. Many Canadians also are outraged, since they depend on the jobs provided by Honda's Alliston plant, which assembles Civic hatchbacks. "It is only the latest example of an intimidation process" designed by Washington to divert Japanese investment from Canada back to the U. S., charges Patrick Lavelle, a former president of the Canadian Automotive Parts Manufacturers' Assn. He calls revelations of the Customs Service action "terrorism."
Even General Motors Corp. is concerned, since the North American content of the vehicles it makes in a joint venture with Suzuki Motor Co. in Ontario is also under scrutiny by Washington. A negative ruling could deal a blow to the venture, since the Geo Tracker it makes in Canada would then be subject to a crippling 25% truck duty to enter the U. S.
The transplant debate is also a potential bombshell for relations between the U. S. and Japan. The gap in auto trade is expected to grow, even as transplant operations expand throughout North America. The reason: Japanese manufacturing operations are twice as likely to import parts for assembly in the U. S. than the average foreign company. And they are four times as likely to import parts as the average U. S. company, according to a recent study by Massachusetts Institute of Technology economist Paul R. Krugman. Another study, by the University of Michigan, forecasts that the cars and parts trade gap with Japan will widen further, from $31.1 billion in 1990 to $45.7 billion by 1994.
'STRATEGIC EXERCISE.' Critics of Japan's trade policies, in Congress and within the Administration, are calling transplants the Japanese auto makers' latest weapon to drive competitors out of business. As proof, the trade hawks point to Japan's insistence that products made by American corporations that locate in Japan be counted as American-made. For example, Tokyo counts as American the semiconductors manufactured in Japan by IBM of Japan Ltd. Yet Honda of America is making American cars. One top Administration official goes so far as to insist that the double standard and the Japanese habit of buying parts from Japanese suppliers "is a strategic exercise for Japan to totally dominate the worldwide car market."
The irony is that although Honda is under greatest scrutiny, it is almost certainly ahead of the other Japanese companies in establishing American content and American value added. (A BUSINESS WEEK Cover Story in 1988 examined the "Americanization" of the auto maker.) Honda produces more than 500,000 cars a year in Ohio. Its $670 million factory in Anna produces 1.5-liter engines for the Civic and 2.2-liter engines for the Accord. It also turns out brake and suspension components and automatic transmissions for both cars, as well as Accord drive shafts and engines for Honda motorcycles. For all cars, engine and transmission assemblies account for 18% to 25% of each one's cost.
Toyota in Kentucky and Nissan in Tennessee also have engine plants, but they are newer and less extensive than Honda's. That limits the amount of local content the factories contribute to their parents' car factories and how many engine parts they buy locally. "If we can't pass local-content requirements," says Thomas G. Elliott, executive vice-president of American Honda Motor Co., Honda's marketing arm, "no one else can pass."
Consider Toyota's Kentucky plant. The company says the 1992 Camrys built in Georgetown are 75% American, as measured by one formula. Toyota Motor Manufacturing Senior Vice-President Alex M. Warren Jr. declines to give the Camry's local content as measured by the more stringent free-trade agreement calculations. Says Warren: "We want to accent the positive."
True, Toyota has more to offer American suppliers now than in the past. U. S. purchases have soared from $70 million in 1988 to an anticipated $1.2 billion in 1992, with more than half of that coming from U. S.-owned companies. Still, of the 145 "American" suppliers for the 1991 Camry, 29 were Japanese-American joint ventures, 18 were Japanese-owned concerns, and 13 were either owned by Toyota or distributors of Japanese-made parts. Perhaps because it is a newer arrival, Toyota has not made the same progress that Honda has in "Americanizing" its production.
The problem is that even Honda's progress has been painfully slow, according to a study by the University of Michigan's Office for the Study of Automotive Transportation. The Michigan study found that only 16% of the Civic's content consisted of parts purchased from U. S.-owned suppliers. "It was a shocking number," says J. P. Reilly, president and CEO of Tenneco Automotive and chairman of the Commerce Dept.'s Automotive Parts Advisory Committee, which sponsored the study. Because Honda has been a trendsetter among transplants, he says, it was chosen for scrutiny to see "how this problem will look five years from now. But there was no progress."
The embattled auto-parts industry doesn't have to wait five years to start worrying. In the first nine months of this year, the Japanese transplants produced 25% of all passenger cars built in the U. S. The Michigan study also found that the parts provided by U. S.-owned suppliers were mainly low-margin commodity components. The more lucrative parts still came from Japan or from Japanese suppliers who had set up shop in North America. Notes David J. Andrea, a co-author of the report: "With the transplant suppliers, you're creating stress on the traditional suppliers, who have been beaten down by the Big Three carmakers' loss of market share. This is not a win-win situation."Honda disputes the study. When the research was done in 1989, the Anna engine plant was still being phased in, says Honda. Overall local content is higher than the study found, and the engine's local content in particular now exceeds 50%, not 42% as reported. Honda declines, however, to provide a more detailed breakdown of its own local-content analysis.
Not that it's easy to calculate local content. Nearly three years after the free-trade pact with Canada went into effect, Treasury officials admit, only "interim" regulations covering relatively noncontroversial issues exist. By contrast, Revenue Canada has promulgated a complete set of regulations. Honda claims that Revenue Canada has certified the Marysville-built Hondas to be North American enough to qualify for duty-free import into Canada. But Revenue Canada says it is just beginning its first audit of a U.S.-based Japanese transplant. And it is Mazda that they are looking at, not Honda.
CORN ROW. What should be counted? The 75% figure claimed by Honda and Toyota includes overhead costs that the trade pact doesn't allow. Surely, the wages paid assembly-line workers represent local inputs. But the heart of the argument is how to count parts bought from a Honda-affiliated or other Japanese supplier that has thrown up an assembly plant in a cornfield to merely inspect, test, and paint components shipped from Japan. And in capital-intensive auto manufacturing, to what country do auditors attribute the value added by machinery, especially if the machinery is from Japan?
Honda asserts it couldn't get a straight answer to its questions. Whitlock says that when he recently asked a group of Customs auditors whether Honda should use tax or book depreciation schedules in his calculations, "they just squirmed and laughed and looked at each other." Customs Commissioner Carol B. Hallett refused to discuss details of the audit. "I concede we may not have drafted the Canadian Free Trade Agreement right the first time," says John P. Simpson, deputy assistant secretary for enforcement. "We expect to be able to fix some of these problems in the North American negotiations." Among the flaws that need fixing, says Simpson: a practice called roll-up. Under this accounting method, the local content of a part may be recalculated whenever it undergoes "substantial transformation." Once the North American content exceeds 50%, the component may be counted as 100% American at the next stage of production. This allows vertically integrated companies such as Honda to manipulate the process, Customs auditors say. Simpson allows that "it is possible, with some extraordinary planning, to have a car with less than 50% North American content become 100% North American on paper."
This, say the Customs auditors, is exactly what Honda has done. Outside experts note, however, that there can be honest differences of opinion. "It's a largely subjective rule," says Ralph H. Sheppard, a New York attorney and authority gn rules of origin. "It's hard to describe. You have to know it when you see it."
Throw these complex questions into the pending U.S.-Mexico-Canada pact, and you understand the nightmares of Big Three executives. Detroit wants to get the maximum benefit from free trade for itself and the other auto makers already in Mexico -- Volkswagen and Nissan -- but it doesn't want any newcomers in autos to share that advantage for at least 15 years. And the Big Three also want to protect their U. S. business with high local-content requirements: Chrysler and Ford seek a 70% North American content rule, while General Motors is pushing for a 60% limit. All want to scrap the roll-up process and measure the actual local content.
NEW LAWS? Against this backdrop of a domestic industry in turmoil, Customs' audit of Honda proceeds. No matter how it comes out, the controversy isn't likely to go away. In fact, it could deepen if the economy deteriorates and the Big Three continue to lose market share. As an election year approaches, the Democrat-controlled Congress and the White House are certain to get more combative about the growing trade deficit. Some politicians will single out the Japanese. Already, the Democratic leadership is drafting laws that would restrict Japanese imports and transplants.
Ultimately, responding to Honda and other Japanese auto investments will force Americans to tackle sensitive issues that have long been taboo. The Bush Administration is dead set against greater regulation of foreign investment and against setting rules that pick winners and losers in the marketplace. Yet the political and economic pressure is rising for it to at least clarify the rules that will prevail not only in the U. S. auto industry but in an expanded North American marketplace.
As that happens, Laura D. Tyson, economist at the Berkeley Roundtable on International Economy, predicts Washington will have to "strive for greater quality of investment," not just count jobs. And it will have to be done without choking off investment or trade. That would simply interfere with Americans' love affair with Hondas, while doing nothing to guarantee quality jobs.