by Wolf Richter, Wolf Street:
Addicted to cheap labor, Corporate America is not playing along.
President Trump’s threat of imposing 20% tariffs, or earlier 25% tariffs, on foreign produced cars has failed to dull the allure of Mexico’s maquiladorasfor global manufacturers looking to cash in on the country’s cheap labor. Mexican car manufacturers produced a record 1.6 million vehicles in the first five months of 2018, up by 10,000 from the same period of 2017.
Recent data from the Mexican Association of the Automotive Industry (AMIA) show that in May Mexico’s automotive plants produced 3.9% more light vehicles than in the same month last year. Domestic sales were down 8.9% from January to May, but Mexican assemblers continue to work at full capacity thanks to rising demand for exports. In 2017, Mexico produced 3.7 million cars. During the same year the US goods trade deficit with Mexico surged to $71.1 billion, a 10.4% increase ($6.7 billion) over 2016.
And automakers continue to bet on Mexico. On Thursday, GM revealed its new Blazer starting with model year 2019. But this won’t be the rugged truck-based old Blazer that GM killed 14 years ago, but a car-based compact SUV. And it will be made in Mexico.
“GM employs over 15,000 production workers in Mexico, pays the workers less than $3 per hour, and exports over 80 percent of the vehicles to the US to sell here,” UAW vice president Terry Dittes lamented in the statement Thursday night, cited by the Detroit News. “This is all happening while UAW-GM workers here in the US are laid off and unemployed.”
In Mexico, where assembly line workers earn on average around $2.50 per hour compared to $28.70 per hour in the US, fears are rising that Trump may carry through on his threat to impose tariffs on imported cars, SUVs, vans, light trucks and automotive parts. Canada and Mexico are the top two suppliers of vehicles to the US. If these tariffs were to cause a shift in production from plants in those countries to plants in the US, they’d feel the economic pain.
Many analysts expect that the US’ direct neighbors will ultimately be exempt from any new tariffs, as Washington renegotiates the NAFTA trade deal with them. “If we try to read the tea leaves here, there should be a NAFTA deal at some point that will exempt Canada and Mexico from this discussion. But as of now, we just don’t know,” said Jeff Schuster, President, Americas Operation and Global Vehicle Forecasting at LMC Automotive.
President Trump seems intent on undoing some of the key provisions in NAFTA that enabled automakers, both domestic and foreign, to take advantage of a massive pool of cheap Mexican labor. He has proposed changes to NAFTA’s rules of origin for cars, used to determine how much of a vehicle is manufactured at a particular location, but the proposed new standards were rejected by automakers, as well as the governments of Mexico and Canada.
The current Mexican government and global automakers are determined to maintain the cheap manufacturing wages that have underpinned Mexico’s economic model since NAFTA was signed on Jan 1, 1994. But new presidential elections are scheduled for July 1, and the front runner in the race, left-wing nationalist Andres Manuel Lopez Obrador (or AMLO as he’s popularly known), has pledged to bring Mexico’s wages closer in line with those of its NAFTA partners, the US and Canada.
“We need to strengthen the domestic market,” the candidate said at a recent meeting of the American Chamber of Commerce in Mexico. “Trump is proposing to improve the salaries of Mexican workers. In that we agree.”
AMLO described the relationship between Mexico and its northern neighbor as “fundamental” but he argues that it must be based on mutual friendship and cooperation. “With better economic welfare, the migratory pressures and threats to security will subside”.
It makes a lot of sense. Even Mexico’s wealthiest man, Carlos Slim, with whom AMLO has had his share of differences, would seem to agree. “We need to look again at the domestic economy, which for 50 years we prioritized, and it gave us average annual economic growth of 6%. In the last 30 years we have neglected that,” Slim said at a Bloomberg forum in late 2016.
But internal demand on its own will not be enough to insulate Mexico’s economy from the potential fallout of a full-on trade war with its biggest trading partner. Thanks to NAFTA, Mexico has never been so dependent on the US economy, which accounts for over 80% of its exports, around half of its imports and 44% of all its foreign direct investment.
Over 60% of that investment flows into Mexico’s manufacturing industry. Much of it ends up in the automotive sector, Mexico’s biggest export category to the US. In 2017 alone it brought in $84 billion.
Clearly automakers have a lot to lose in the event of an escalating trade war, with Japanese and German automakers expected to be hardest hit since they ship the most cars to the US market in terms of sales value. Volkswagen, the world’s biggest auto manufacturer, might take the biggest hit since 45% of the cars it sells in the US come from international factories.
If Trump decides to impose tariffs on vehicles built in Mexico and Canada, the Canadian government could end up providing direct state aid to affected vehicle manufacturers. After Trump slapped tariffs on Canadian steel and aluminum at the end of May, government ministers promised to support the sectors, and Innovation Minister Navdeep Bains said the same kind of aid could be ready for the auto industry.
“We’re examining all options … our view is that if any such action is taken, we’re going to support our workers,” he said in an interview last week. “The message I would convey to the auto sector workers is — we have your backs.”