Mexico's Automotive Industry Post Covid-19

Leo Guzman-Anaya¹
University of Guadalajara, Mexico
Member of PECC Mexico

Background

Mexico’s automotive industry experienced a wave of rapid growth after the 2008 financial crisis. It now ranks as the fourth major exporter and the seventh global producer of automobiles and fifth producer of auto parts. This position was achieved primarily because the industry has been characterized by global production networks with fragmentation of their production processes, where companies have searched for locations that favor cost optimization and manufacturing quality. In this sense, Mexico provided a developed and functional productive infrastructure, human capital endowment, and a growing internal market which stimulated the arrival of automotive Original Equipment Manufacturers (OEM) from north America, Europe, and Asia. Also, the favorable geographical location that provide entry to the north American market and a network of 13 Free Trade Agreements (FTA) with preferential access to 50 economies position Mexico as a preferred location for investment projects as reflected in an inflow of Foreign Direct Investment (FDI) in the automotive industry². Between 2008 and 2019, FDI flows to the industry experienced an annual average growth rate of 11.6% in real terms³.

The Covid-19 Pandemic and the Mexican Automotive Industry

The dynamism and growth in the industry was brought to a halt last March 2020 as widespread of the Covid-19 in north America demanded the shutdown of non-essential economic activities including automotive manufacturing. According to data from the Mexican Association of Automotive Distributors (AMIA in Spanish), from April 2019 to April 2020, automotive production and exports fell by 98.8% and 90% respectively. Internal automotive sales were also hit hard, with only 34,903 units sold in April 2020 compared with 98,346 in April 2019, representing a drop of 64.5% or 63,443 less units.

The pandemic has been devastating to the Mexican automotive industry; however, the Covid-19 pandemic will also incentivize companies to relocate and diversify parts of their production chains⁴. This is augmented by current trade frictions and may become an opportunity for Mexican endogenous suppliers to successfully enter regional automotive production chains. However, local suppliers must improve their quality and productive capacity, where training and development will be crucial via collaboration between firms in the production chain, the public sector and academia. For example, the Japanese Cooperation Agency (JICA) has implemented development projects with state governments and federal agencies for the bolstering of endogenous suppliers and human capital. A specific project for local supplier development was carried out between 2012 and 2015 in the states of Guanajuato, Queretaro, and Nuevo Leon. Overall, the project was able to impact local participating firms improving their quality and productivity indicators. This in turn allowed them to obtain certifications, increase their customers and diversify into new markets. A previous research study found that the project created positive knowledge externalities, where local firms were able to acquire new knowledge, internalize it and diffuse it throughout the firm, and in some cases these externalities spilled-over to other production lines and other companies⁵. The project also highlighted the need for the industry to strengthen the Tier-1 and Tier-2 levels of procurement. For Mexican endogenous firms, there are growing opportunities to enter regional production chains in the Tier-1 and Tier-2 levels, since more than half of these inputs are currently imported, and the industry has steadily been demanding higher levels of local content pre-Covid-19 and will do so even more after the pandemic.

The USMCA and Post Covid-19 Challenges for the Industry

Some of the short-term challenges facing the automotive manufacturing process include how to keep up with quality and productivity under a new normal. The current situation has accelerated the digitalization of processes and the transition to the 4.0 industry that will transform manufacturing. The pandemic has changed the way we do business and interact with each other. Firms must protect their workers not only during the time they spend at the plant, but from the moment they leave their homes, throughout the production process and until they safely return home. Automotive plants are implementing protocols considering the Chinese experience to allow operations to continue. Workers are now equipped with gloves, masks and firms are changing the plant layouts to comply with social distancing. The industry must adapt to remote working in activities that allow for it, the pandemic has shown that remote working is being effective especially in administrative tasks.

In terms of the domestic market, there will be new logistic challenges where firms need to innovate to reach customers in a new way. This becomes evident in terms of product delivery to the final consumer. However, opportunities for the industry emerge, there are expectations for larger volumes of vehicle sales as customers would want to avoid public transportation, this might show true even in millennials whom were avoiding purchasing cars, however the current situation might change their minds. Also, there is a trend for e-commerce increase, where vehicles will be essential for the movement of merchandise. In this sense, online car sales may also emerge as a new business opportunity; however, for economies like Mexico, car sales still require physical contact (paperwork, permits and signatures) so the system must prepare for a new way of doing business.

The external market poses another defiance. The pandemic has disrupted the demand and supply chains, so the industry must learn from this experience and prepare back-up plans for future scenarios. Mexico has achieved the position as the fourth overall exporter by using its capital and human resources efficiently. However, there needs to be a clear agenda for the path and goal in the short, medium, and long-term. There must be a clear vision on where the industry wishes to be in the next 10 years and this agenda needs to be drawn up between the public, private and education sectors in preparation for the upcoming years The industry will not survive solely based on low labor costs and geographical proximity to the U.S.

Another challenge is the recent implementation of the United States-Mexico-Canada Agreement (USMCA) where firms must adapt to the new rules under the treaty. The new rules for the industry, specifically the local content requirements of $16 USD per hour will be a challenge and firms will have to adapt on how this local content will be measured and how often. The labor market provisions indicate that 40 to 45 percent of automobile parts must be made by workers earning at least $16 USD per hour by 2023. Days after the implementation of the USMCA provisions, Japanese multinational automakers expressed their willingness to keep operations in Mexico and pay the wage increase in the short term instead of relocating to the U.S. or Canada. The main reason according to the Nikkei Asian Review⁶ is the cost of moving production, especially in firms that had recently located production in Mexico and had not yet recovered their investment. For firms that may not be able to meet the 16 USD an hour requirement, it seems that they would still prefer staying in Mexico even if this means paying the imposed tariffs. In the end, the higher production costs will increase prices for the final consumer and reduce automotive sales and competitiveness in the region.

Furthermore, the labor provisions included in Annex 23a of the USMCA agreement specify worker representation in collective bargaining in Mexico. The provisions include a bolstering of Mexican worker rights to unionize and to have more control over their contracts trying to avoid wage stagnation. However, the agreement also establishes a “Rapid Response Mechanism (RRM)” where an independent panel investigation will attend possible labor right violations at “covered facilities” instead of government inspections. The RRM applies an unequal treatment for Mexican and U.S. firms since the legal resource may be only used for U.S. firms that have previously been convicted of breaking U.S. labor laws while for Mexican firms the claims may be set forward for firms that have not previously violated Mexican labor as established under the USMCA. The RRM mechanism will be applied to priority industries such as automobiles and auto parts, aerospace components, cosmetics, steel and aluminum, among others. Possible infractions may lead to a suspension of preferential tariffs or sanctions to products and services offered by the covered facility.

Nonetheless, the USMCA will also consolidate economic and social advances over the upcoming years. Following the results achieved from the North American Free Trade Agreement (NAFTA), active and efficient dialogue between the industry, government and academia will be crucial for the implementation of the new USMCA rules to maintain competitiveness. It is important to point out that the Covid-19 pandemic has highlighted the importance of Mexican suppliers in various industries and the post-Covid-19 scenario will pose major opportunities for further integration in the region where Mexico will play a key role in the strengthening of the north American supply chain.

Conclusions

The pandemic has affected us all in some way. For the automotive industry, the challenges have been major, but opportunities lie ahead. The industry must work closely with firms along the production chain, government, academia, private and public sectors. In the short-term there is a need for the industry to share protocols and implement best practices under the “new normal”. There is an urgency for the strengthening of the Tier-2 and Tier-3 levels of procurement, and the development of endogenous suppliers to satisfy the regional content requirements under the USMCA. Also, the industry demands the training of workers and technicians; labor shortage has become an issue for many automotive firms. In this sense, the local, state, and federal government must set a clear agenda for the industry, prepare for the upcoming years and set targets and regulations accordingly, where the rule of law must be clear and apply to all stakeholders; Japanese firms, for example, criticize the complex and confusing legal requirements at the federal, state and local levels, becoming an obstacle to enhance their presence in Mexico.

In the medium and long-term, Mexico’s automotive industry must transition from a manufacturing hub that thrives on low labor costs to higher value-added activities related with design engineering and tooling manufacturing. Academia is crucial for this achievement and needs to stay one step ahead, updating human capital formation to new realities in terms of soft skills (critical thinking, creativity, communication, cooperation) and hard skills (programming, embedded software and use of advanced technologies). There is a need for improving the human capital formation of technicians and engineers but also there needs to be clear opportunities to retain them and avoid brain drain to other economies. The adaptation to a new reality will particularly pressure the supplier base as the industry not only transitions from internal combustion cars to new technologies but also needs to adapt to new business requirements post Covid-19.

Mexico has achieved a strong and growing automotive industry during the last three decades, and this has been more evident during the last ten years. The industry is now an important motor of the economy. The current uncertainty under the Covid-19 pandemic and the implementation of the USMCA has brought disruption in the industry; however, opportunities lie ahead. It is critical for all firms throughout the production chain to work closely together and cooperate with other stakeholders, government and academia to face these challenges, not doing so will bring the growing dynamism of the industry to a halt and set back the achievements attained. The new working conditions must be dealt with head on to bring the industry to a new phase of supplier development, comply with the current and upcoming local content requirements and transition to new technologies and higher value-added activities.

1. Leo Guzman-Anaya is a research professor at the Center of Economic and Managerial Sciences, University of Guadalajara, Mexico. He is currently a member of PECC Mexico, collaborating in research activities related to Foreign Direct Investment in the automotive industry and Japanese multinational companies in Mexico.

2. For further reading and a comprehensive analysis on this topic please refer to: Falck Reyes, M. & Guzmán-Anaya, L. (2018). Japanese Direct Investment in Mexico’s Transport Equipment Sector. Macro Impact and Local Responses. Singapore: Springer

3. Calculations with data from Mexico’s Secretariat of Economy.
https://datos.gob.mx/busca/dataset/informacion-estadistica-de-la-inversion-extranjera-directa

4. Currently, over 80% of the world automotive supply chain is connected to China. (LMC Automotive Limited, Presentation: 20200312_Coronavirus_Impact Assessment_for Amcham_vF.pdf, Page 16, 1 Point)

5. Guzmán-Anaya, L. (2019). Knowledge Transfer in the Automotive Industry: The Case of JICA´s Project for Automotive Supply Chain Development in Mexico. México y la Cuenca del Pacífico, 8(23) 93-122.

6. https://asia.nikkei.com/Business/Automobiles/Japan-auto-companies-triple-Mexican-pay-rather-than-move-to-US