This article originally appeared on Manufacturing.net and is republished here with permission.
Building upon the centuries-old business relationship between Mexico and the United States, NAFTA allowed both countries to benefit from a seamless workshop that clearly made the pie larger. The 25-year-old contract needed to be revised, though, with motor vehicles and auto parts taking the lion's share of the modifications (for better or worse depending on how well your company coordinates upstream and downstream operations and recordkeeping).
Mexico´s economic relevance to the United States is frequently overlooked. The 11th largest economy in the world, Mexico has a population (126 million) roughly 40 percent that of the U.S. and is close to three times the size of Texas. The country has a network of 12 Free Trade Agreements (FTAs) with 46 countries, and seven additional ones will be added with the renewed Trans-Pacific Partnership (an agreement now known as CPTT, Comprehensive and Progressive Agreement for Trans-Pacific Partnership, TPP 11 in short), from which the U.S. withdrew under the Trump Administration.
Mexico was, in 2018, either the first or second largest export market for more than 50 percent of states in the Union. (It was first for six states –Arizona, California, Kansas, Nebraska, New Mexico and Texas, and second for 22 States–Colorado, Georgia, Illinois, Indiana, Iowa, Louisiana, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, New Hampshire, New Jersey, New York, North Carolina, North Dakota, Ohio, Oklahoma, Pennsylvania, South Dakota, Tennessee, and Wisconsin.) It is also the third-largest source of imports in the U.S.; has an expanding middle class that has grown accustomed to purchasing American goods and services; has demonstrated to be a near-shore, reliable manufacturing partner; as well as will benefit from a demographic bonus during the next several years that will help neutralize the dwindling U.S. population (and necessarily its workforce).
The USMCA, signed on November 2018, is making its way through the legislative process in Mexico, the U.S. and Canada. It is expected to be ratified by the three countries during the calendar year 2019, as 2020 is seen in full as an election year in the U.S. with the office of President, all seats in the House, and one third of the Senate up for grabs.
Regardless of where companies are located in the automotive industry´s production chain, in the short term (read this as “right now”), all players need to evaluate how the USMCA´s provisions will impact their current activities, possibly as early as January 2020, and design a common strategy with their up- and downstream- business partners. In the medium term, companies need to keep an eye out the for Democrat-controlled House of Representatives´ announcement that would seek certain changes in USMCA, though that would not necessarily mean reopening the negotiations as they may be addressed utilizing U.S. domestic implementing provisions. In the long term, we believe that Mexico’s export orientation and openness will remain unmodified.
Regarding motor vehicles and auto parts manufacturing and sales in North America, the USMCA represents a transformation from a straightforward compliance-or-not of the relevant Rule of Origin (ROO) at the Original Equipment Manufacturer (OEM) level, into a complex tracing process through the full chain of production.
For motor vehicles, a more stringent Rule of Origin will have to be fulfilled (from the current 62.5 percent to 75 percent in a five-year transition period), but also, 70 percent of steel and aluminum should be sourced within the NAFTA region, and 40 percent of its manufacturing will have to be made with labor of US $16 per hour or above (there are specific rules in USMCA that allow for some flexibility to comply with the previous requisites).
For auto parts, when USMCA goes into effect, they will have to be carefully classified into highly-detailed lists ranging from “super core”, to “principal”, to “complementary” parts. Rules of Origin will then vary depending on what the parts would be used for, this is, to produce passenger vehicles, light or heavy trucks, etc.).
Even though the previous rules may look overwhelming, as per former Minister of Economy Ildefonso Guajardo, 68 percent of current Mexican motor vehicle exports already comply with them. For the remaining 32 percent, a decision process will likely be initiated in which, on a model-per-model basis, the appropriate USMCA Rule of Origin would be pursued with the necessary adjustments to be made along the chain of production, or dropped altogether to pay the 2.5 percent import duties for passenger vehicles (25 percent for light trucks, though). We believe that, due to the USMCA requirements, Mexico will ultimately receive greater investments as a result of production relocation out of China, Korea, Japan, and other countries.
The Trump administration has threatened to start the six-month NAFTA withdrawal process to pressure Congress to vote on the USMCA as is, or risk having no treaty at all. If the withdrawal actually occurs, trade within North America would go back to “ordinary” (this is, no preferential commercial treatment) status under World Trade Organization (WTO) standards, creating a serious disruption of numerous production chains way beyond motor vehicles.
A left-leaning nationalist, former Mexico City Mayor Andrés Manuel López-Obrador began his six-year term as president of Mexico in December 2018. He ran on a simple message platform: fighting corruption and impunity, which would then liberate a large sum of financial resources to be redirected to less privileged groups and geographical regions within Mexico.
López-Obrador has offered not to increase taxes during his tenure, and has already issued a Northern-Border program that, on one hand, reduces Value Added and Income taxes (to 8 and 20 percent, respectively) and, on the other, doubles the minimum wage. The latter brought the unintended consequence of triggering the appetite of labor unions and lawyers that are now requesting increments for workers that make more than the minimum; this situation is ongoing and currently mostly reduced to the town of Matamoros (across from Brownsville, Texas), but should be closely monitored.
López-Obrador´s team participated in the USMCA negotiations before taking office, so we believe he will be supportive of its approval by the Mexican Senate. Also, the incoming administration would not be willing to risk export-oriented manufacturing positions that support a significant number of middle-class families across Mexico; thus, even in the unlikely NAFTA-less scenario, we anticipate that the Mexican president would do as needed to nurture the maquiladora-type (duty-free and tariff-free) export promotion programs so that valuable chains of production do not flee Mexico.