The It-Will-Be-Here-Sooner-Than-You-Think USMCA: Motor Vehicles and Auto Parts

By Alejandro N. Gomez-Strozzi

Building upon the centuries-old business relationship between Mexico and the United States, NAFTA allowed both countries to benefit from a seamless border that clearly made the pie larger. The 25-year-old agreement 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 individual companies coordinate upstream and downstream operations and recordkeeping).

Mexico ́s economic importance to the U.S. is frequently overlooked. As the 11th largest economy in the world, Mexico has a population of 126 million, roughly 40 percent of the United States’, and is close to three times the size of Texas. Mexico has more free trade agreements (FTAs) than any other country in the world (12 FTAs with 46 countries) and seven more will be added with the renewed Trans-Pacific Partnership (TPP).¹

In 2019, Mexico became the largest U.S. trading partner, and in 2018 it was either the first or second largest export market for more than 50 percent of the states: it was first for six states² and second for another 22 other states.³

Mexico’s middle class has grown accustomed to purchasing American goods and services. The country has proven to be a near-shore, reliable manufacturing partner and will benefit from the dwindling U.S. population and workforce.

The United States-Mexico-Canada Agreement (USMCA),⁴ signed in November of 2018, has already been approved by the Mexican Senate and is making its way through the legislatures in the U.S. and Canada; though subject to political timing, it is expected to be ratified by the three countries during the calendar year 2019.

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 develop common strategies with their up- and down-stream business partners.

In the interim, companies need to be aware of certain desired changes to USMCA from the U.S. House of Representatives, although they would not necessarily mean reopening the negotiations as they could be addressed utilizing U.S. domestic implementing provisions. In the long term, we believe that Mexico’s export orientation and openness will be strengthened by USMCA.

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 rules of origin (ROO)⁵ 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 met, increasing from the current 62.5 percent to 75 percent during a five year transition period; additionally, 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 wages of $16 per hour or above; there are, however, specific rules in USMCA that allow for some flexibility to comply with these requisites.

USMCA will require auto parts to be classified into highly detailed categories that describe different types of products such as “super-core,” “principal” or “complementary” parts. Rules of origin will then vary depending on how those products are used; for ex- ample, to produce passenger vehicles, light or heavy trucks, etc.

Even though the previous rules may look overwhelming, 68 percent of current Mexican motor vehicle exports already comply with them.⁶ For the remaining 32 percent, the appropriate USMCA ROO will need to be adjusted—or dropped altogether—along the chain of production on a model-by-model basis to pay the 2.5 percent import duties for passenger vehicles, 25 percent for light trucks.

We believe that, due to the USMCA requirements, Mexico will ultimately receive greater investment as a result of production relocation out of Japan, China, Korea and other countries.

U.S. President Donald Trump’s 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” status, that is, no preferential commercial treatment, under World Trade Organization (WTO) standards, creating a serious disruption of numerous production chains that extend beyond motor vehicles.

The López-Obrador Administration

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 which would liberate a large sum of financial resources to be redirected to less privileged groups and geographic regions within Mexico.

López-Obrador offered to freeze taxes for at least the first half of his tenure and has already issued a Northern-Border program that, on one hand, reduces value added and income taxes to eight and 20 percent, respectively, and, on the other hand, doubles the minimum wage. Further, a labor reform bill was passed that would, among other things, ensure union votes by secret ballots, allow workers the freedom to join or not join a union, and create a new set of independent labor courts.

In the end, López-Obrador’s administration would not risk losing export-oriented manufacturing positions that provide income for 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 support export promotion programs so that valuable chains of production do not flee Mexico.