Peso Crisis Throws a Wrench into Mexican Auto Industry
The value of U.S. car exports to Mexico decreased 6% from 1992 to 1993, but increased a whopping 685% in 1994 to over $437 million, according to the U.S. Department of Commerce.
Mexican domestic car and light-truck sales were up in October 1994 by 32% compared to those of October 1993. Nissan recorded an increase of 183%; followed by Volkswagen, up 100%; Ford, up 8%; General Motors, up almost 2%; and Chrysler slightly down.
From January 1 to October 5, 1994, Ford Motor Company exported 18,000 cars to Mexico. This represented a huge increase from its 1,700 cars and truck exported there in 1993. Prior to the Mexican Peso crisis, Ford expected its exports from the United States and Canada to Mexico to top 50,000 vehicles in 1996.
Chrysler, Ford, General Motors, Nissan, Mercedes-Benz and Volkswagen currently produce in Mexico. Prior to the Peso crisis, Deloitte & Touche, the international consulting firm, estimated the Mexican auto market to grow by 8% during the next several years. Based on positive economic expectations, many auto producers had planned to expand upon or establish manufacturing facilities in Mexico.
Announced last October, Ford had planned to increase production capacity in Mexico to 108,000 cars annually beginning with the 1996 model year. The additional investment in Mexico would total about $60 million mainly for tools and equipment.
BMW reportedly planned a $600 million investment in car assembly, auto parts and distribution operations scheduled to begin in mid-1995. It chose to locate the assembly plant in Lerma, just west of Mexico City. T&N PLC, a British auto parts manufacturer, began building a plant on the grounds of a Chrysler de Mexico facility in the central Mexican city of Saltillo.
Reported in November 1994, Daewoo of South Korea had planned to invest about $350 million in a joint venture with Mexico's Creaciones Automotrices Nacionales (CANSA) to assemble automobiles in the municipality of Escobedo near Monterrey. Honda Motor Co. Ltd. planned to produce automobiles in Mexico within a two years. The company considered producing a smaller car for sale throughout North and South America.
Since the Mexican crisis, Italy's Fiat Auto S.p.A., which was negotiating a joint venture with Consorcio G. Grupo Dina S.A. (Dina), a Mexican truck and bus manufacturer, pulled out. The joint venture had planned to produce 100,000 cars a year in Mexico. And the Big Three U.S. auto makers have trimmed production plans for the Mexican domestic market. Until the dust settles, future plans of these producers are unknown.
The devalued Peso will boost the price of cars imported into Mexico, drop the value of dollar-based investments in Mexico, and lower the price of Mexican goods shipped to the United States and other countries. According to an industry analyst, prospective Mexican car buyers flocked to showrooms in order to buy before prices increased.
Although confidence in the Mexican economy declined as a result of the crisis, Mexico's solid economic base and entrenched free trade policies will no doubt overcome the adversity.
Protectionism in the Mexico Auto Sector Hurt the Industry
Through a series of regulatory proclamations known as the "Mexican Auto Decrees", the Mexican automobile industry has been essentially state regulated since 1925. The decrees established high tariffs on imports of finished automobiles and effectively encouraged joint ventures between Mexican and foreign firms to construct assembly and parts facilities in Mexico.
The Mexican government's second decree was issued in 1962. It increased the use of Mexican-made components in domestically produced models. The required domestic content of 20% was raised to 60%, and power train production, which is typically a capital-intensive process, was required to be manufactured in Mexico. Additionally, all imports of finished vehicles were prohibited and foreign ownership of parts producers were limited to minority shares.
By 1960, twelve Mexican assembly plants were producing 60,000 finished models annually. By 1970, production reached 188,000 units annually. However, quality was low, and producers continued to import parts despite high tariffs. Consequently, both costs and prices were high, which significantly contributed to a persistent Mexican trade deficit in the automotive sector.
In an attempt to reverse this, new Mexican laws required assemblers to export parts in relative proportion to their production intended for sale within Mexico. Despite rising Mexican exports of engines and power train assemblies, the trade deficit continued to worsen. By the early 1980s, U.S. auto makers began to feel the pressure of low-cost Japanese imports into the American market, and began to view Mexico as a possible site for future low-cost production.
In 1982, the Mexican debt crises resulted in a severe economic decline. Another auto decree was passed that further raised tariffs limiting imports and inhibiting outflows of pesos. Led by Ford, U.S. auto producers built several new and world competitive export-oriented engine and assembly plants. Investment in maquiladora parts production also rose. By the late 1980s, economic activity improved and Mexican sales increased. Mexican production in the 1980s fell from 600,000 units in 1982, to a low of 248,000 units in 1987, and up to 547,000 units in 1990.
The most recent auto decree in 1989 under former President Salinas continued the tradition of high tariffs, restricting ownership, and enforcing local content requirements. The provisions:
- permitted foreign firms 100% ownership of export-oriented plants, but only 40% ownership of suppliers serving the Mexican market;
- raised local content rules to 36% of the vehicles value for models sold in Mexico;
- required foreign assemblers to maintain a positive Mexican trade balance;
- allowed finished cars and light trucks to be imported into Mexico (beginning in 1991) for the first time in nearly thirty years, but limited market share to 20%, and required exports to positively offset imports by a ratio of 1.75 to 1 in 1994;
- set tariffs for finished vehicles and parts and continued to bar imports of used vehicles; and
- allowed Maquiladora plants to sell some of their output domestically.
The effect of these and past trade barriers resulted in a generally non-competitive industry characterized by small outdated plants producing with low productivity and high costs. In addition to this, Mexico's infrastructure is poor making it difficult to produce and transport goods efficiently.
Contrary to popular belief, U.S. assembly plants in Mexico were primarily there to satisfy government requirements and to get around high tariffs -- not to gain access to low-cost labor. According to the Office of Technology Assessment, "Mexico offers limited strategic options for the Big Three: while direct production costs are sometimes lower in Mexico, shipping costs back to the United States can eat up the savings and then some."
Mexican-owned automotive parts suppliers' level of cost-efficiency and quality are well below the levels of their maquiladora counterparts. The previous protection and regulation that governed their competitive environment has prompted little incentive to upgrade labor’s skills or to modernize its plants and equipment.
The maquiladoras are much better equipped and managed, and are able to generate sufficient economies of scale in low value-added activities. In fact, Mexican maquila parts production plants consistently outweigh the additional costs of operating in Mexico.
According to the Office of Technology Assessment, even though such production utilizes very low levels of technology, these plants buy only about 25% of their parts content from Mexican suppliers due to poor quality. In anticipation of greater competition under Nafta, Mexican firms have begun forming strategic alliances with U.S. and European firms in order to gain access to new technologies and more advanced management methods.
The U.S. Auto and Parts Sector Is Restructuring
From W.W.II to the 1970 and 1980, the U.S. auto industry enjoyed a comfortable oligopoly. However, over a period of three decades, U.S.-based auto makers witnessed their domestic market share decline from 95% to 65%. This has forced the industry to restructure, down-sizing and investing in state-of-the-art technology.
In a strategy many believe consistent with dumping, Japanese auto companies introduced attractive, high quality and low-cost vehicles in the U.S. market. While incurring a net loss, they gained a great deal of consumer loyalty and U.S. market share. Upon this success, Japanese companies increased prices by an average of 43% between 1985 and 1991. By the end of the 1980s, the Honda Accord was the best-selling car in America.
In the past, Ford, GM, and Chrysler manufactured most of the major components used in their assembly of automobiles, subcontracting smaller systems components, such as brakes, electronic components, seats, glass, and tires, to independents. In recent years, however, U.S. they have discontinued this and began relying heavily on a independent suppliers.
U.S. suppliers of auto parts are very possibly undergoing a more rigorous restructuring than the auto makers. According to the Office of Technology Assessment, imports of Japanese parts have grown rapidly in the past ten years, from $4 billion in 1984 to $11 billion in 1991. Japanese transplant assembly plants in the U.S. buy from many U.S. suppliers, but mostly low value-added parts, such as gaskets and hoses as opposed to gears and brakes, while continuing to import high value-added parts from suppliers in Japan. Thus, the Big Three models incorporate a U.S. parts content of about 88%, while Japanese transplant models have only a 48% U.S. content.
The U.S. auto industry employs about one million people. Approximately 600,000 work directly for the auto makers and their subsidiaries, while about 400,000 are employed by independent suppliers. From 1978 to 1991, employment of production workers by the Big Three dropped by 37%. Auto industry employment will continue to fall as productivity improves.
From the late 1940s to the late 1970s, real hourly wages rose steadily. By 1982, competitive pressures ended the tradition of annual wage increases. Average hourly wages for assembly workers fell in real terms by 3% from 1985 to 1991.
The Big Three have put intense pressure on their U.S. suppliers to adopt just-in-time delivery requirements characterized by low inventories, lean production and express delivery. In an attempt to meet this demand, many U.S. suppliers see relegating low value-added and labor-intensive production to Mexican maquiladoras as an easy means of cutting costs. Small U.S. suppliers face the toughest struggle and are therefore more likely to relocate production to Mexico. Note: U.S. imports of auto parts from Mexico increased from $1.3 billion in 1984 to $4.7 billion by 1991.
Auto Rules of Origin and Tariff Reductions Under Nafta
In order for a product to receive Nafta status or duty-free treatment, minimum content requirements must be satisfied. Starting from a base of 50% content for most North American products, the rules of origin rise to 62.5% for autos, light trucks, engines, and transmissions, and to 60% for other vehicles and parts.
Concern that Mexico could be used as an export platform by European and Japanese auto makers to secure preferential access to the United States has been well addressed in Nafta. Its stringent rules of origin were devised with the specific intention of retaining the Nafta advantages to Nafta members.
Under Nafta, the Mexican tariff of 20% on autos was reduced to 10% on January 1, 1994. The remainder will be phased out in equal increments over the next eight years. The Mexican duty of 10% on trucks was cut in half immediately upon Nafta's implementation. This will be phased out in equal increments over the following three years. The Mexican Auto Decrees will be phased out by January 1, 2004. Thus, the pre-Nafta requirement that an auto manufacturer's exports be 200% as much as it imports will be phased out as well.
Under Nafta, U.S protection which was not nearly as extreme as Mexican protection, will be phased out with little consequence on U.S. imports. Prior to Nafta's implementation, the United States had a tariff of 2.5% on cars, which was eliminated January 1, 1994; and 25% on trucks, which was reduced to 10% on January 1 and will be completely phased-out over the next 4 years.
Tariffs on most auto parts, in some cases as high as 6%, averaged from 3.1 to 3.7%. Many of these were already eliminated under Nafta while others will be eliminated over the next nine years. Buses and most auto parts imported from Mexico, however, entered the United States duty-free under the U.S. Generalized System of Preferences. Products from maquiladoras entering the United States under the tariff classification 9802.00.80 only had duties levied on the non-U.S. value-added content.
Nafta's Projected Impact on the U.S. and Mexican Auto Sector
According to the Office of Technology Assessment, some U.S. auto companies manufacturing in Mexico may move their plants to the United States -- since they will no longer be required to produce in Mexico in order to sell in Mexico after the year 2004. However, plants which produce primarily for the Mexican market and other Latin markets will likely find Mexico an attractive low-cost producer.
Prior to the Mexican Peso crisis, the Office of Technology Assessment projected that Mexican auto consumption could approach that of Canada's 10 years after Nafta is implemented. Although economic activity will be slowed, the market will again pick up. And with the immediate reduction in tariffs, Mexico's ill-equipped domestic auto industry is now subject to intense U.S. competition. This has and will continue to result in greater U.S. exports to Mexico. Again, the economic decline due to the recent crisis will slow this pace.
Although U.S. plants are becoming more efficient and solid sales of U.S.-built autos will continue long into the future, the number of Americans employed in the industry will decline -- as it has done for the past fifteen years for reasons extraneous to Nafta. Increased sales globally and to Mexico under Nafta is expected to only slow this process.
Many U.S. parts suppliers, however, may relocate more of their low value-added production to the Mexican maquiladoras in an attempt to become more competitive.
In the intermediate to long-term, Mexico's auto industry will likely become more efficient as investment increases and unproductive plants are closed. Although Mexican economic growth may be curtailed over the next few years due to the peso crises, a tremendous long-term potential exists for a rapidly growing Mexican consumer market. As this occurs, U.S. auto makers will be well positioned to gain the greatest market share vis-Ã -vis European and Japanese competitors.
This article appeared in Twin Plant News, January 1995.
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