The Mexican automobile industry has been essentially state-run since 1925. A series of auto decrees have been issued periodically in Mexico. These have effectively erected high tariffs on foreign imports of finished automobiles -- requiring foreign auto manufacturers to relocate in Mexico if they wished to sell in Mexico. Under NAFTA, the auto decrees and other trade barriers will be eliminated, positively affecting the U.S. auto industry.

With the goal of increasing the use of Mexican-made components in Mexican domestically produced models, the government issued a second decree in 1962. It increased the domestic content requirement to 60% from its previous level of 20% and mandated that power train production (a typically capital-intensive process) be undertaken only in Mexico for models intended for domestic sale. Additionally, the government prohibited all imports of finished vehicles and limited foreign ownership of parts producers to minority shares. While production more than tripled to 188,000 units annually by 1970, this was still significantly below the capacity of a solitary modern plant. While the decree did encourage the formation of a supplier base, quality was still low, and producers continued to import parts despite high tariffs. Consequently, both costs and prices were high, significantly contributing to a persistent Mexican trade deficit in the automotive sector.

In 1982, Mexican demand plummeted and capital flight ensued as a consequence of the debt crisis. Motivated by this crisis atmosphere, another auto decree was passed that further raised tariffs in order to limit imports and inhibit outflows of pesos. Led by Ford, U.S. auto makers constructed several new export-oriented engine and assembly plants that were competitive on both cost and quality with their U.S. and Canadian counterparts. Investment in maquiladora parts production also rose. By the late 1980s, the worst of the debt crisis was over and Mexican sales began to increase. The roller coaster ride of Mexican production in the 1980s saw production fall from 600,000 units in 1982 to a low of 248,000 units in 1987, but recovering to approximately 547,000 units in 1990.

The most recent auto decree was one of the few protectionist and pro-regulation pieces of legislation passed by the Salinas administration. It continued the tradition of high tariffs, limited foreign ownership, and enforcement of local content requirements. The provisions:

1. Permitted foreign firms 100% ownership of export-oriented plants, but only 40% ownership of suppliers serving the Mexican market;
2. Raised local content rules to 36% of the components’ value for models sold in Mexico;
3. Required foreign assemblers to maintain a positive Mexican balance of trade;
4. 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;
5. Set tariffs for finished vehicles and parts and continued to bar imports of used vehicles; and
6. Allowed Maquiladora plants to sell some of their output domestically.

By the end of 1993, Mexico imposed tariffs of 20% on cars, 10% on dump trucks, 20% on other trucks and buses, and 10 to 15% on auto parts. As a direct result of all Mexican trade barriers, the Mexican auto industry is highly inefficient and non-competitive. Nearly three-quarters of a century’s protection and regulation have produced an industry characterized by small and outdated plants, high costs, and low levels of productivity. In Mexico, only Ford’s Hermosillo plant and a new Nissan factory at Aguascalientes are considered world-class facilities by international industry standards.

Under Nafta, the Mexican tariff of 20% on autos were reduced to 10% upon the Agreement's implementation. This will be phased out in equal increments over the following nine 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 four 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 eliminated as well.

Contrary to popular belief, U.S. assembly plants in Mexico have been primarily there to satisfy government requirements and to get around high tariffs, not to gain access to low-cost labor. Thus, 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. Only for engines and labor-intensive maquila parts production do low labor costs consistently outweigh the additional costs of operating in Mexico." Consequently, investing in Mexican auto operations was the necessary price that GM, Chrysler, Ford, Nissan, and Volkswagen had to pay in order to gain access to the Mexican market -- which could be much better served by exporting from the United States. Historically, existing Mexican plants have only been profitable due to government protection -- which Nafta will remove.

Mexican-owned automotive parts suppliers' level of cost-efficiency and quality are well below the levels of their maquiladora counterparts. The protection and regulation that governs their competitive environment has prompted little incentive to invest in the upgrading of labor’s skills or the modernization of plants and equipment. Not only are they unable to export their products northward, but most of these domestic suppliers would not likely be profitable without protection. The maquiladoras, however, are much better equipped and managed, and are able to generate sufficient economies of scale in low value-added activities. 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 effective long-standing requirement that foreign firms produce in Mexico in order to sell there would be eliminated -- allowing much production to shift back to the United States. Thus, its no wonder that the U.S. automotive industry calls the elimination of these trade-balancing requirements "the single most significant accomplishment of the Nafta automotive negotiations." Under Nafta the terms of trade for automotive products will shift in favor of the United States, in at least the short and intermediate term.

Importantly, the rules of origin established under Nafta were devised to prevent non-Nafta countries from using Mexico as an export platform in order to secure preferential access to the United States. In order for a product to receive Nafta status or duty-free treatment, a 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.

While the United States has erected some measures protecting its auto sector, they are not nearly as extensive or extreme as Mexican ones. Consequently, liberalization of its measures will be much easier than Mexico's. Prior to Nafta, the United States had a prevailing tariff of 2.5% on cars, 25% on trucks, and 3.1% on buses. Tariffs on auto parts can go as high as 6%, but usually average in the range of 3.1 to 3.7%. Buses and most auto parts imported from Mexico, however, enter 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 have duties levied on the non-U.S. value-added content. The United States, however, does have a significant non-tariff barrier in the form of corporate average fuel economy, or CAFE, standards imposed by the Energy Policy and Conservation Act of 1975.

Under Nafta, the U.S. nominal tariff of 2.5% on automobiles was immediately lifted upon the Agreement's implementation. The U.S. tariff of 25% on light-duty trucks was immediately reduced to 10% with a phase-out schedule of 5 years. U.S. tariffs on many automotive parts were eliminated immediately, with others being reduced to zero over a period of five to ten years. Nafta's elimination of all auto trade barriers within ten years will effectively integrate the Mexican auto sector into that of the United States and Canada, creating a truly continental auto industry.

The U.S. auto industry is currently undergoing a massive restructuring for the purpose of becoming more efficient, modern and productive. This is being pursued in order to combat higher levels of global competition, especially from Japanese companies. This restructuring process is unrelated to Nafta and will continue with or without Nafta.

According to the Office of Technology Assessment, under Nafta, in the short run some U.S. auto companies manufacturing in Mexico will likely move their plants to the United States -- since they will no longer be required to produce in Mexico in order to sell in Mexico. General Motors and Chrysler, for example, have already announced plans to close two Mexican plants in Mexico City.

According to the U.S. Trade Representative's office, the Big Three auto makers predict U.S. exports of automobiles to Mexico to increase from 1,000 cars annually to 60,000 in the first year of Nafta. And the Office of Technology Assessment projects that Mexican auto consumption could approach that of Canada's in 10 years. Although sales of U.S.-built autos are anticipated to continue long into the future, however, the number of Americans employed in the auto industry will grow to decline -- as it has done for the past fifteen years for reasons extraneous to Nafta. Thus, Nafta will only slow this process. Many U.S. parts suppliers may relocate more of their low value-added production to the Mexican maquiladoras, which will help them become more competitive.

In the intermediate to long-term, Mexico's auto industry will become more efficient as investment increases and unproductive plants are closed. While imports of automotive products from Mexican-owned firms are of no threat to the U.S., increased productivity could serve as a further incentive for U.S. manufacturers of auto parts to relegate low value-added production to the maquiladoras. By producing fewer automobile models and importing a larger number of models, which Nafta would allow them to do, Mexican producers may finally generate cost-efficient economies of scale.

Finally, a tremendous potential exists for a rapidly growing Mexican consumer market, as continued economic reforms create a middle class with significant purchasing power. As this market develops, U.S. auto makers will be well positioned to gain the greatest market share vis-à-vis European and Japanese competitors.

About The Author John Manzella [Full Bio]

John Manzella, founder of the Manzella Report, is a world-recognized speaker, author of several books, and an international columnist on global business, trade policy, labor, and the latest economic trends. His valuable insight, analysis and strategic direction have been vital to many of the world's largest corporations, associations and universities preparing for the business, economic and political challenges ahead.




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