New NAFTA, the North American Auto Sector, and Arizona: What Is and What Might Be

The recently signed, but not yet ratified, North America’s new free trade agreement that each partner country calls in its own words – USMCA in the Unites States, CUSMA in Canada, and T-MEC in Mexico – includes changes that particularly affect the automotive industry. According to a recent publication produced jointly by the Wilson Center’s Canada Institute and Mexico Institute, the new North American free trade agreement “will have a substantial impact on vehicle manufacturers, the parts suppliers and their customers. The impact on vehicle companies will vary depending in part on where such key components as engines and transmissions are sourced for their North American assembly plants.” ¹ Of particular interest are three provisions with potential impact on Arizona’s exports of automotive parts to Mexico: regional value content, labor-value content, and local content. ² As presented in one of our previous articles, Arizona is geographically outside the major concentration of the North American automotive industry known as “Auto Alley” . ³ However, Arizona’s exports of automotive parts to Mexico had been on the rise in recent years, suggesting a growing integration into the North American automotive supply chain . ⁴ A brief review of current trade relationships between Arizona and Mexico in the automotive sector will provide a glimpse into what might be at stake for Arizona’s economy under the new provisions.

Regional value content

NAFTA rules of origin specified a 62.5 percent value of North American content in vehicles for duty-free access within the three countries. In USMCA, this content requirement is raised to 75 percent. ⁵ While nobody knows yet with any certainty how this will evolve, it is clear that the underlying motive of the U.S. administration was to encourage manufacturing of automotive components and parts within the United States. Yet, the “regional” designation implies that content can be produced anywhere in the Unites States, Canada, or Mexico.

In a simplified scenario this may, at least in the short term, primarily impact European and Asian auto assembly plants in Mexico to the extent that they use their homegrown supplies. ⁶ In order to comply with the new regional content, these companies will need to substitute a portion of their current levels of imported European/Asian components with those produced in North America. ⁷ This, in turn, may positively impact manufacturing of automotive component and parts in the United States. But at the same time, this may not preclude more production of automotive components and parts moving from the Unites States to Mexico to capitalize on lower labor costs for the purpose of keeping the overall auto prices competitive. Asian and European companies may also move more components and parts production to Mexico to increase the “regional,” i.e., made-in-Mexico content.

Labor-value content

The requirement concerning the labor-value content specifies the percentage of the labor content that must come from regions where wages are a minimum of $16 an hour. For passenger vehicles, 40 percent of the labor content must come from such regions; 30 percent for light trucks. These requirements apply to car assembly, as well as to the spending on research and development, and information technology. According to Wilson Center’s scholars, these requirements are aimed primarily toward new-generation vehicles such as hybrids, battery electric vehicles, and autonomous cars and trucks. However, given the current disproportions in wages -- $20 in the U.S. and Canadian assembly and parts manufacturing versus Mexican wages of $7.34 in assembly and $3.41 in parts manufacturing ⁸ – it is possible that production and assembly in Mexico will be more profoundly affected. While this requirement may benefit Mexican workers by raising their hourly wages, it will undercut some of Mexico’s current cost advantages leading to higher supply inputs from the U.S. and Canada. Consequently, this may reduce current levels of manufacturing production of automotive parts in Mexico and/or discourage further expansion. Obviously, in a simple scenario, increased demand for U.S. and Canadian automotive component supplies with more high-wage content will benefit Arizona’s exporters; however, if it leads to stagnation or reduction in Mexico’s automotive industry, the effect will be the opposite if the demand for U.S. made parts decreases.

Local content

As a totally new requirement, the local content clause specifies that vehicle producers must purchase 70 percent of their steel and aluminum in North America. ⁹ As this happened simultaneously with new tariffs imposed by the U.S. administration on imports of steel and aluminum, an exemption from tariffs on steel and aluminum was granted to Mexico and Canada. ¹⁰ This exemption is expected to have positive impact on Mexican homegrown steel and aluminum manufacturers that cater to the automotive industry, but may restrict Mexico’s imports of less expensive steel from South Korea and Japan. Again, it depends on how this provision will affect the overall automotive production in Mexico.

Growing importance of Arizona's automotive parts exports to Mexico

Arizona-based companies exported to Mexico close to $250 million worth of automotive parts in 2018, as shown in Table 1 . Even with a decline in last three years, the exported value in 2018 was about 170 percent above the 2008 level. This was faster growth than the entire transportation sector (an increase of 141.5 percent), as well as exports of all Arizona commodities to Mexico (29.4 percent) in the same period. Thanks to this more dynamic growth, the share of automotive parts increased in both the transportation products and exports of all commodities categories. Automotive parts accounted for more than 40 percent of all transportation products Arizona exported to Mexico, and although up from 2008, accounted for just above three percent of Arizona’s total exports. Thus, while on one side this relatively small share might protect Arizona’s economy from larger tremors in case of any disturbances in the supply chain system due to any of the aforementioned changes, it might be unfortunate because it may affect one of Arizona’s most dynamic export industries.

Table 1. Arizona's Exports of Automotive Parts (NAICS 3363) to Mexico (dollars in millions)

*Transportation sector consisting of: motor vehicles (3361), motor vehicle bodies & trailers (3362), motor vehicle parts (3363), aerospace products & parts (3364), and transportation equipment not elsewhere classified (3369).

Arizona's two-way trade in the automotive supply chain

According to a prevailing but simplified scenario, automotive parts travel south to Mexico and assembled cars north to the United States and Canada, but the reality is more complicated. Trade statistics indicate that automotive components including engines, transmission, suspension, axels, chases, steering systems and batteries, travel in both directions from the U.S. and Canada south to Mexico, but also from Mexico north to the U.S. and Canada. The same parts and components often cross the border several times in a decentralized but highly integrated automotive manufacturing production. Figure 1 proves the point; Arizona is both exporter and importer of automotive parts.

Note: All charts in this article are interactive – scroll over the trend lines for more detailed information.

Figure 1. Arizona's Trade with Mexico in Automotive Parts

Arizona's exports of automotive parts to Mexico grew faster than imports

Although it is evident from Figure 1 that the dollar value of imported automotive parts exceeds the value of exports in the same NAICS category, ¹¹ this does not necessarily mean that Arizona’s negative trade balance in this category has an overall “negative” effect on the economy. Imports can positively influence the state economy when they are part of a supply chain in production of products that Arizona exports further to other U.S. states or to other countries. ¹² Importantly, exports of automotive parts have grown substantially faster than imports in the last several years, as shown in Figure 2 .

Figure 2. Arizona's Trade with Mexico in Automotive Parts (2008=100)

Other components of the automotive industry supply chain

While the exports of automotive parts to Mexico appear to be relatively small in the overall dollar value of Arizona’s exports to Mexico (3.2 percent in 2018), a multitude of other manufacturing products are used in the automotive industry, most notably computer and electronic products (NAICS 334). Other products that are used in the automotive industry include electrical equipment (NAICS 335), plastics and rubber products (NAICS 326), machinery (NAICS 333), fabricated metal products (NAICS 332), and transportation equipment (NAICS 336, excluding already listed motor vehicle parts). Thus, a much larger portion of Arizona’s economy is associated with the automotive industry than the more narrowly classified “automotive parts and components.”

As shown in Figure 3 , the six major industry sectors that participate in the automotive industry supply chain together contributed to more than 60 percent of Arizona’s total exports to Mexico in 2018.

Note: This chart is interactive – scroll over the pie slices for more detailed information.

Figure 3. Arizona's exports to Mexico: automotive parts and other automotive industry-related manufacturing products (% of total exports)

Conclusions

The main changes in the proposed USMCA present a mix bag of implications for Arizona’s economy as they may impact both exports and imports of automotive parts and other manufacturing products used in the North American automotive industry. On one side, there may be some relief that the automotive exports comprise a relatively small portion of Arizona’s exports to Mexico, but on the other side, it will affect exactly one of the more promising export sectors. It is also possible that the impacts might be felt throughout a larger portion of the economy outside the narrowly defined automotive parts manufacturing. With more certainty it is expected that if the agreement is ratified and in place by 2020, the new requirements will be phased in between 2020 and 2023. ¹³ Thus, most likely, trade statistics in the next few years may not show any major disruptions in the North American automotive supply chain as a direct result of USMCA. Yet, we need to keep in mind that it is not states or countries that do trading; it is the companies that do exporting and importing across international borders. And it is the companies that, in order to avoid tariffs and other government-imposed conditions, can shift production to new locations to find new sources, lower production cost, or find more lucrative export markets.

Notes

1. Greg Keenan, North America’s New Free Trade Agreement: Impacts on the North American Auto Sector, Wilson Institute, January 2019. https://www.wilsoncenter.org/event/the-usmca-and-the-future-mexicos-trade-policy-under-amlo?utm_content=buffer14868&utm_medium=social&utm_source=twitter.com&utm_campaign=buffer
2. For detailed content of the Rules of Origin see Chapter 4 of USMCA: https://usmca.com
3. Vera Pavlakovich-Kochi, Arizona and North America's 'Auto Alley' , Arizona-Mexico Economic Indicators, February 2017. https://azmex.eller.arizona.edu/news-article/27feb2017/arizona-and-north-americas-auto-alley
4. Vera Pavlakovich-Kochi, Arizona’s Trade with Mexico in Automotive Products: How Does Arizona Differ from the Nation , Arizona-Mexico Economic Indicators, March 2017. https://azmex.eller.arizona.edu/news/07mar2017/arizonas-trade-mexico-automotive-products-how-does-arizona-differ-nation
5. Rules of Origin –USMCA Chapter 4. https://usmca.com
6. The following major car companies have presence in Mexico: Honda, Mazda, Nissan, Toyota, Kia, Fiat, Volkswagen, BMW, and Audi.
7. According to Automotive News of October 12, 2018, Kia’s Forte model made in Mexico contains 47 percent Mexican content, 51 percent Korean and only 2 percent from the U.S. and Canada. Honda’s HR-V has between 30 and 35 percent Mexican content, between 25 and 30 percent from Japan, and 20 percent from the U.S. and Canada. https://www.autonews.com/article/2018008/GLOBAL/181009774/usmca -a-delicate.balance
8. Greg Keenan, North America’s New … (see footnote #1)
9. Greg Keenan, North America’s New … (see footnote #1)
10. Steel coming into the U.S. will be taxed 25 percent; aluminum at 10 percent rate. Source: U.S. Department of Commerce. https://www.commerce.gov
11. NAICS = North American Industry Classification System that is applied jointly in the United States, Canada, and Mexico for classification of economic activities. For the purpose of this analysis, trade statistics presented by NAICS classification is preferred to the alternative, HS (Harmonized System). The NAICS classification of exports allows for comparison with employment data presented in NAICS mode.
12. George Hammond, “An overview of Arizona’s trade with Mexico,” pp. 25-28 in Arizona & Mexico , Arizona Town Hall Report, 2016. aztownhall.org/Town-Hall-Reports
13. Greg Keenan, North America’s New … (see footnote #1)