(FORTUNE Magazine) – SORTING OUT imported cars from the domestic variety used to be simple. The domestics were made-in-Michigan monsters, the imports were those funny-looking little things that arrived on the boat from Europe or Japan. But nowadays a big American-style sedan can turn out to be imported, while some Japanese compacts are on the cusp of qualifying as domestic. So what, you say? Well, more rides on these classifications than you might think. The U.S. law that regulates auto fuel economy says that a manufacturer's passenger cars must average 27.5 miles per gallon of gasoline. (The average is of all the cars a company makes in a model year, or its entire ''fleet.'' Some cars in the fleet will get more miles per gallon, others less.) If an automaker's ''corporate average fuel economy'' (CAFE) comes in under 27.5 mpg, the company is fined $5 per car for every tenth of a mile per gallon it falls short. To discourage producers from importing hordes of high-mileage small cars to increase their overall fuel economy, the law divides manufacturers' fleets into domestic and imported cars, and requires that each fleet meet the CAFE standard. A car with 75% or more U.S. or Canadian content is considered domestic, a car with less than that is foreign. But the law now does the opposite of what Congress intended. Instead of promoting the use of American-made components for cars, it has had the perverse effect of restricting their utilization -- thus adding to unemployment in the U.S. auto industry. Ford, for example, has just converted the Crown Victoria and its sister car, the Mercury Grand Marquis, into imports to escape penalties for selling too many cars that get low gas mileage. To move the two cars into the imported fleet, Ford reduced their domestic content from 94% to 73%. The company reasoned that the redesigned 1992 models would sell better than the outdated sedans they replaced, so it wanted to offset their low fuel economy (average mpg: 24) against its tiny 45-mpg Festiva, which it builds in Korea and imports. Ford accomplished this sleight of hand by buying eight high-value components outside the U.S. The 1992 cars get controllers for their antilock brakes from Germany, engine computers from Spain, shock absorbers from Japan, and key axle parts from England. Windshields, instrument panels, seats, and fuel tanks are made in Mexico. Says David L. Kulp, Ford's manager of fuel economy planning and compliance: ''We tried to find new suppliers for parts with low job content so there would be a minimum of disruption. The alternative was to restrict sales or to eliminate the cars.'' The games automakers play with CAFE standards seem endless. The Mercury Tracer, built in Hermosillo, Mexico, gets about 34 mpg. By shipping huge quantities of U.S.-made parts to Hermosillo, Ford maintains the Tracer's domestic content at 80% and keeps it in the domestic fleet to balance against thirstier U.S.-made models. (If Mexico joins the U.S. and Canada in a North American free-trade zone and CAFE laws are changed accordingly, Ford might not have to go to all that trouble. Mexican parts would then be classified as domestic, just as parts made in Canada are now.) General Motors takes pains to keep its Cadillac Allante roadster classified as an import. Though it is assembled in Michigan, the $60,000 car counts as an import because its body is fabricated in Italy and its content is only 55% domestic. Owing partly to the high cost of flying parts back and forth across the Atlantic in a specially equipped 747, the slow-selling Allante is a big money loser. But if Cadillac tried to cut costs by making the Allante entirely in the U.S., it would add another low-mileage car (20.5 mpg) to GM's domestic fleet, which came in at 27.1 mpg for 1990. All of the U.S. Big Three appear to have fallen below the CAFE minimum of 27.5 mpg for 1990; final computations haven't been made yet. They will avoid fines only by using mileage credits from 1989, when they exceeded the CAFE standard. Makers of European luxury cars have not been so fortunate. Mercedes- Benz, the biggest offender, paid $20,415,045 in fines for 1989. Japanese automakers have mixed emotions about domestic content. On one hand, they want their cars to appear American so they won't be blamed for costing U.S. workers jobs. Toyota has raised the domestic content, as the law defines it, of its Kentucky-built Camry from 60% in 1988 to nearly 75% for 1992. The 1992 Civic that Honda will start building in Ohio this fall will have a domestic content of 75%, vs. 72% for 1991. (For more on the Japanization of America, see The Society). ON THE OTHER HAND, the Japanese have the same incentive American manufacturers do to limit domestic content so they can keep gas-thirsty cars in the import fleet. Some Honda Accord models, for example, get around 26 mpg, well below the 27.5 minimum. But Honda imports enough Accords from Japan so that the overall U.S. content of Accords as a class slips well below 75%. The way the law is written, that makes all Accords part of Honda's imported fleet -- so the Accord's mileage can be averaged in with that of such models as the made-in-Japan CRX, which gets as much as 59 mpg. Result: a fleet average of 30.8 mpg, and no fines for Honda. Toyota has similar problems with some of its U.S.-built cars. Says James R. Olson, Toyota Motor Sales' vice president of external affairs: ''It is a terrible thing to say, but if we ended up with severe enough CAFE problems, we would have to reassess our drive toward 75% local content for the cars we make in the U.S.'' LIKE ALL government attempts at micromanagement, the domestic content rules invite weird outcomes. The law defines domestic content as the value added when the car is put together on the assembly line, expressed as a percentage of the wholesale price. That value added includes all the expenses of running the assembly plant: labor, overhead, distribution, and manufacturer's profit. The actual parts are just one piece of the total reported as domestic content. So it's entirely possible, as with the four-cylinder power plant in Toyota's Kentucky-built Camry, for an engine to be reckoned all-American if it was assembled in the U.S. even though 75% of the parts were manufactured in Japan. The law doesn't look at where the pieces are made as long as they have been ''substantially transformed'' in the U.S. That provision irritates U.S. auto parts makers, who harbor longstanding suspicions that Japanese manufacturers aren't sincere in seeking them out as suppliers. Says Lee Kadrich, an executive of the Automotive Parts & Accessories Association: ''The Japanese can bring in $9 worth of parts and put them together in a $1 box and the whole thing could count as domestic.'' Nor does the law distinguish between parts manufactured by American suppliers and those made by the nearly 300 Japanese parts makers that have set up shop on U.S. soil. The Japanese suppliers may use American materials and workers, but their U.S. competitors are quick to point out that their profits fly home to Japan. So when Honda declares that the made-in-Ohio Accord has a domestic content of around 75%, it takes some distilling of the numbers to find what was actually made by American suppliers. The Office for the Study of Automotive Transportation at the University of Michigan analyzed the 1989 Accord and Civic. Eliminating most overhead and profit leaves 62% of the wholesale price attributable to domestic parts. Three-fourths of that comes from labor and parts at Honda's own Ohio plant (chassis stampings, sheet-metal panels, engines, and so forth) or from U.S.-based affiliates of Japanese suppliers. Only the remaining one-quarter of the ''domestic'' parts comes from traditional U.S. producers. That's still light-years ahead of the 140,000 Japanese-built Accords that are sold here annually. Their domestic content is a measly 4%. The few U.S.-made parts that find their way onto Honda's Sayama assembly line include catalysts, speakers, carpeting, spark plugs, seat fabric, window glass, door- lock switches, and tires. The U.S. suppliers: TRW, Allied Signal, United Technologies, General Electric, Goodyear, and Champion. Questions about where auto parts are made take on more urgency because Japan is winning an ever larger share of U.S. auto sales -- 29.1% so far this year, vs. 27.1% in 1990. The flow of parts to supply Japanese assembly plants is increasing. Last year, in fact, parts accounted for 34% of the $31 billion U.S. automotive trade deficit with Japan. The University of Michigan study estimates that the value of Japanese parts imports will double by 1994 to $22 billion. By then they will make up 48% of an automotive trade deficit that will have reached $45.7 billion. ORIGINAL EQUIPMENT parts are just the beginning. Says Kadrich: ''The real prize the Japanese are aiming at is to control replacement parts sales in the U.S. That's the bonanza.'' By 1994, 37 million Japanese cars will be on U.S. roads, up from 22.9 million in 1989 -- a huge potential market for replacement shock absorbers, exhaust systems, and the like. U.S. parts makers complain that the Japanese control the flow of replacement parts through affiliated suppliers. The Federal Trade Commission has been investigating the charges for a year. Mindful of possible political fallout, Japanese automakers are increasing their purchases of U.S.-made parts. But they say American parts makers still cannot produce the high level of design, engineering, and quality that they demand. Honda has a special program to encourage suppliers to get involved earlier in parts development. Toyota has signed up 175 American suppliers for the 1992 Camry, more than double the number it started with in 1988. Despite several years of preparation, however, some of them won't be ready for the beginning of production in September. Says Alex Warren, head of Toyota's Georgetown, Kentucky, plant: ''It is a long-term process.'' The laws on domestic content have few friends -- even in government. Says Jerry Ralph Curry, the combative head of the National Highway Traffic Safety Administration: ''CAFE is a dumb, ill-conceived law. It forces everyone to play games, and it ought to be killed outright.'' Don't count on it. Congress is likely to approve some increase in fuel-economy standards. That will only raise the stakes for automakers and make their games ever more inventive -- bad news for U.S. workers and consumers alike.