Mario Hernández
Leading Partner of the IMMEX Segment at KPMG Mexico
KPMG Mexico
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View from the Top

Taxes, Rules of Origin and Elections: the Ordeals of Mexico’s Auto Industry

Sat, 09/01/2018 - 12:47

Q: What main challenges should Mexico’s economic development strategy address to be successful?
A: Most challenges can be linked to three areas: the US tax reform, rules of origin in NAFTA and the 2018 federal elections in Mexico. The US tax reform was approved with the sole purpose of attracting FDI to the US thus creating more jobs. The US reduced corporate tax rates to 21 percent while in Mexico they are at 30 percent, which could be troublesome. On the NAFTA side, changing rules of origin could heavily impact international supply chains and economic integration in the region. If regional content is increased without proper analysis and a period of adjustment, efficiency of manufacturing operations could be disrupted negatively in all three countries. Changes must not take place overnight but over a transition period that lasts between five and 10 years so companies can find ways to comply with new regulations and countries can create programs to support their local industries. Any disruption to the Mexican economy will bear an impact on the automotive industry and that also includes the 2018 presidential elections. Exports may not suffer much as long as we have good trade conditions with our commercial partners but the domestic market could suffer from reduced consumer confidence.
Q: If regional content were to increase, how could Mexico make the most of this new trade scenario?
A: Mexico is the ideal country to produce more regional content if it were necessary. A more stringent rule of origin would be a big opportunity for Mexico to develop its local supply chain and incorporate more local Tier 1 and Tier 2 companies. OEMs have no issue with investing in Mexico but they will not put their investments at risk if suppliers cannot meet their demands. Mexico has the necessary infrastructure and competitive labor to produce more regional content but both the industry and the government must be involved in developing the local supply chain.  
Q: How feasible do you consider the US’ proposal to include the wage factor in the NAFTA 2.0 negotiation?
A: Salaries cannot be regulated by decree, so establishing a formula whereby only salaries above a certain amount can be considered to meet regional content regulations would force Mexico to focus only on raw material supply. Mexico has focused too much on intensive labor activities and little on better-paying automotive operations such as design or technology development. The US argues that Mexico has kept its salaries low to remain competitive but this was the result of market evolution. The US needs a competitive Mexican automotive industry so its own industry can flourish. If rules of origin were not met through regionally-sourced raw materials and salaries were punished, companies would face tariffs levied on their products. Final consumers in the US would be the most affected due to the price increases resulting from these tariffs.
Q: How can Mexico improve labor conditions without compromising its competitiveness?
A: Almost 24 years have passed since NAFTA was enforced and the wage gap between Mexico and its northern neighbors has only increased. The automotive industry is highly competitive and usually offers better salaries than other manufacturing industries but there is still a large margin for growth. A key concern regarding elevated salaries is the inflation that usually ensues and the impact on people’s purchasing power. Salaries should grow naturally, according to prices so purchasing power is not damaged in a vicious cycle.
Q: How can Mexico boost its trade relationships with key automotive markets such as China?
A: The possibility of a trade war between China and the US offers opportunities for Mexico to diversify its trade partners, become more competitive and attract FDI from more diverse origins. Chinese automakers aiming to manufacture vehicles in Mexico for the Mexican, US and Canadian markets could bring more investments. It is time for Mexico to truly exploit its FTAs with Europe, Japan and the CPTPP, increase trade volumes with other countries and reduce its dependence on the US.