David A. Gantz, J.D., J.S.M.
Will Clayton Fellow in Trade and International Economics
Bloomberg News reported August 24 that Mexican officials believe that U.S. interpretation of certain new rules of origin under the USMCA could cause a reduction in Mexican car production and investment. They are right to be worried. However, President Lopez-Obrador’s (AMLO’s) anti-business, anti-private-investment policies have become a more significant threat to the future of the Mexican auto industry (and to investment in Mexico in general, down 24% from 2015-19). AMLO should be seriously concerned, given the broader negative impact of his policies on Mexican investment, job creation and exports.
Auto and auto parts manufacturers are not likely to pull out of Mexico in the foreseeable future regardless of the interpretation of rules of origin or the negative investment climate. Their investments over more than 30 years, generally successful operations, and Mexico’s lower labor costs argue strongly against it. What does seem probable is that new auto-related investment, coming at a time of a gradual shift from gasoline-powered engines to electric cars and their batteries — and to more North American-sourced steel — may take place in the U.S. instead.
This is, of course, what the Trump administration hoped would happen when it insisted in the USMCA negotiations that the regional value content for autos and light trucks be increased from 62.5% to 75% after three years, and when it imposed a $16 per hour requirement for the manufacture of 40% of the content of autos and 45% of light trucks in order to qualify for USMCA duty-free trade. (Other new rules include a requirement that after seven years, 70% of the steel used in auto production be “melted and poured” in North America.) The new USMCA rules of origin have been interpreted by both the Trump and Biden administrations in a manner that is much less favorable to Mexico (and Canada) than many believe was intended during the USMCA negotiations, a disagreement that may soon be subject to binding state-to-state dispute settlement under the USMCA.
The Biden administration and most Democrats in Congress with their heavy union backing are in lockstep with the Trump administration, as they were during the latter part of the USMCA negotiations, when it comes to seeking to create new American jobs and investment in the auto industry rather than in Mexico (or anywhere else). Also, one does not sense that the Biden administration has any significant commitment to the USMCA that would encourage it (despite congressional and union opposition) to accept the Mexican interpretation. While the administration will probably avoid violating most other USMCA provisions, such “benign neglect” of the USMCA’s trade rules does not bode well for Mexico (or for the U.S. if the U.S. approach raises the cost of vehicles sold in the U.S. and indirectly encourages undocumented immigration).
Beyond the differences over rules of origin, existing and new enterprises in the auto, steel and many other industries will not be as likely to make major new investments in Mexico when the investment climate overall is perceived as negative. A spillover effect is likely even though AMLO’s principal targets to date have been existing and new private investment in hydrocarbons and electricity, given his obsession with supporting the government monopolies Pemex and the Corporation Federal de Electricidad (CFE). Still, other evidence of the anti-business climate, beginning with the termination of the mostly completed Mexico City airport project, has been widely reported.
Mexico’s competitive position in North America is further weakened by the massive U.S. subsidies to be offered to producers of chips (including those used in the auto industry) and batteries and battery components for electric car production. Such U.S. industrial policies may further skew investment decisions as the auto industry slowly shifts from gasoline powered to electric cars. When U.S. investors balance the benefits and costs of investment in Mexico, where investment in the U.S. means more costly up-front purchases of robots and other automation, the subsidies as well as the investment climate cannot but have some impact on many companies’ decision-making. The advantages of doing business in Mexico are many, including a quality, relatively low-priced labor force, proximity to the U.S. interstate highway system and a rules-based system under the USMCA, but these may no longer be sufficient.
It also seems likely that the AMLO policies favoring Pemex and CFE to the exclusion of private developers and energy importers will lead to increases in the costs of petroleum and electricity for auto (and other) energy intensive producers in Mexico. And the lack of clean energy — even for factories that produce their own power, which will probably be forced to use dirty Pemex fuel oil — will make it more difficult for multinationals, including those providing financial and other cloud services, to meet their commitments to future carbon neutrality.
The Mexican government and the auto industry enterprises have good reason to be worried about the future. It will take time to resolve the dispute over auto rules of origin, and countering U.S. subsidies is very difficult, but AMLO could immediately take steps to repair the damage caused to Mexico’s investment climate during his first three years in office. Reversing the decline in foreign investment should be a top priority for the Lopez-Obrador administration.