Mexico, the world’s eighth largest automotive producer, has hit new production and export levels for the fourth year running, and is even set to become the number one exporter of cars to the US in 2014, overtaking Japan.
However, many watchers say that the Mexican market still has a long way to go, claiming that it would be wise to learn from the experiences – both good and bad – of the automotive industry in neighbouring South American countries.
What exactly can Mexico’s industry learn from other nearby countries going forward? Four market experts discuss the future of the automotive industry in Mexico.
The panel
Ana Nicholls (AN), Automotive Analyst, Economist Intelligence Unit- Nathan Hayes (NH), Latin America Automotive Analyst, Business Monitor International
- Manmeet Malhi (MM), Senior Analyst, EOS Intelligence
- Brad Brennan (BB), Managing Director, Evolution Time Critical
What should Mexico take on board from the experiences of automotive industries in other South American countries?
AN: One major lesson is the need for a stable macro-economic situation. As several other countries in the region have demonstrated – particularly Venezuela but also Argentina – high inflation can have a major effect on local producers, and attempts to impose price or exchange rate controls only exacerbate the problems. Although sometimes the effect can be a short term boost in demand for cars, nothing scares off long-term investors faster than this kind of instability. Indeed, any short term market boost, whether it’s cheaper loans or scrappage schemes, unusually has a long-term downside, so should be used with caution.
MM: In 2012, Brazil and Mexico accounted for about 85% of the total vehicle production in South America. So, with all due respect to other South American countries, there is only Brazil to learn any lessons from.
For instance, in October 2012, the Brazilian government approved a new programme to encourage vehicle technology innovation, to foster industry competitiveness by encouraging OEMs to produce more efficient, safer, and technology-advanced vehicles while investing in Brazil. The programme, Inovar-Auto, provides these incentives in two ways. It first increases a tax on industrialised products (IPI) by 30% for all light-duty vehicles and light commercial vehicles. Secondly, it imposes a series of requirements for manufacturers to qualify for up to 30% IPI discount. In other words, IPI taxes will remain unchanged for those OEMs that meet the requirements, thus incentivising investments in vehicle efficiency, national production, R&D, and automotive technology. Such an initiative by the Mexican government could propel production of more innovative vehicles in the country.
NH: Ensuring that labour remains competitive is important, both in terms of productivity and wages, relative to rival countries; labour costs in Brazil have risen from previous levels, hampering competiveness.
Developing a domestic supply chain is vital for the manufacturing sector to mature and attract new investment, while also reducing costs and overcoming currency effects. The supply chain in Argentina and Venezuela has really struggled in recent years, hampered by government interference in the industry, and problems with importing materials and components. Accordingly, the supply chain has received very little investment and has not matured to its potential.
BB: Mexico’s neighbours have developed as manufacturing countries for far longer; the importance of a robust supply chain is understood at a greater, more involved and senior level now, just as the benefits of dependable supply are more visible and the consequences of failure well publicised.
Suppliers setting up in Mexico should also now be aware of the level of production agility required. Be it through fluctuating OEM demand, difference of trim or component supply, or the ability to handle alternative materials, they can factor this in during planning and set-up of facilities. Previously, plants could be set up more rigidly with a limited ability to react to diverse demands as the requirements of vehicle manufacturers were easier to predict.
Rather than working on international trade agreements, should Mexico build better relationships with Argentina and Brazil, both of which have capped Mexican imports at US$1.55bn for three years?
AN: Mexico clearly needs to diversify its export markets because, although US exports have been strong in the past year or so, the market is expected to slow. Many OEMs, including the Japanese, are keen to use Mexico as an export base for the wider Latin American region, so improving relations with Argentina and Brazil would make sense, but I wouldn’t expect it to be easy. Both countries have a history of reverting to protectionism whenever their local auto industry feels threatened. In that context, I think Mexico is wise to join in global trade talks, particularly those over the Trans-Pacific Partnerships. Obviously, even if it is agreed, shipping costs are going to be a bigger factor in supplying Asian and other markets involved, but a multilateral trade agreement tends to be more stable long term than bilateral arrangements that can quickly turn sour.
MM: Brazil already produces more vehicles than Mexico and is fairly self-sufficient. So Brazil is unlikely to allow Mexico to build a strong export presence, especially with a focus on the Brazilian market. Moreover, Brazil is also an exporter to neighbouring South American countries and it will see Mexico as a competitor.
With regards to Argentina, as already proven by the limited sanctions, it’s unlikely that Argentina would allow Mexico to increase its cars in the country – unless Mexico is able to offer a form of partnership that is mutually beneficial to both countries – such as offering indigenous Argentinean products incentives to sell in Mexico, as a trade-off to Mexican vehicle import into Argentina – we do not see much change in the capping of Mexican imports in the near future.
Beyond Brazil and Argentina however, the next five biggest markets in Latin America – Chile, Colombia, Ecuador, Peru and Venezuela – present a strong opportunity for the Mexican industry. 2012 saw these five countries recording combined sales of 1,000,000 units, indicating the underlying opportunity.
Mexico produced more than 3,000,000 units in 2012 and since the South American countries can only whet so much of the Mexican manufacturers’ appetite, it’s imperative that Mexico views trade agreements with South American neighbours as complementary to the trade agreements with rest of world.
NH: Total shipments to Latin America accounted for only 13% of Mexico’s autos exports in 2013. Following the trade caps with Argentina and Brazil, shipments to the region declined 16% from 2012 levels. Autos sales in Argentina and Brazil will be fairly weak over the medium term. This, combined with the ongoing trade restrictions, will hamper growth in Mexican autos exports to the region. Therefore, building closer relationships in Latin America is unlikely to boost trade.
On the other hand, shipments to the US constituted some 68% of Mexico’s auto exports, representing a 9.5% increase over 2012 levels. The rest of the world accounted for around 19% of Mexico’s autos exports. We expect to see further gains in many key export markets over the medium term, including the US. This, combined with new FTAs under negotiation, should help drive export growth globally.
BB: It is crucial for Mexico’s long-term establishment as a hub for manufacture that is strikes a balance between relationships with competing countries and the benefits of global trade agreements. A broadening base of strong links is able to provide contingency through a level of alternative business sources should they be required; the nimble production footprint of the automotive industry is unable to provide suppliers with long-term assurances over continued demand, so consideration of the worst-case scenario should be on the agenda for companies worldwide and not just Mexico.
Do you agree with the idea that Mexico has been the biggest ‘winner’ in the first 20 years of NAFTA?
AN: Mexico has clearly been the biggest winner from NAFTA in terms of auto production. The US and Canada now produce fewer vehicles than they did in 1993, whereas Mexico produces more than twice as many, overtaking Canada in the process. That has helped its economy more than double in size too. But Mexico has not been the only winner from NAFTA in economic terms: GDP per head in purchasing power parity has doubled in all three countries – Canada, USA and Mexico – over the past decade. The economic growth has had most impact on living standards in Mexico, because of its lower starting point, but actually Canada and the US have seen a bigger boost in value terms.
MM: The Mexican automotive industry has definitely gained immensely due to NAFTA over the past decade. Since the passage of NAFTA in 1994, the transformation of the automotive industry in Mexico has seen the biggest makeover of any industries in all three of the countries. In 1995, the automotive industry represented 2% of Mexico’s GDP; it is now the main engine of growth of the Mexican economy, accounting for more than 17% of the GDP and 15% of jobs in the manufacturing sector.
Automotive manufacturing in Mexico has reached such a high level of maturity and competitiveness that it’s one of the largest suppliers of vehicles to the USA and, in 2011, bilateral trade in the auto sector reached US$30bn.
American consumers have also benefitted significantly as the relatively low costs of production in Mexico has led to cheaper cars. OEMs have also gained as this has spurred vehicle sales in the USA, and Mexico has gained by emerging as a strong manufacturing hub.
NH: Certainly in terms of manufacturing, yes. A great deal of auto sector investment into Mexico is centered on exporting to the North American market. This has led to huge growth in manufacturing, technological innovation, and job creation for Mexico.
Indeed, there is evidence that OEMs have chosen to produce for the US in Mexico over certain parts of the States. According to a report from the Centre for Automotive Research, of US$43bn invested in North American by auto firms between 2010 and 2012, only 5% went to Canada; southern US states claimed US$4.9bn and Mexico US$7.8bn.
Do you think having so many Free Trade Agreements is a good idea for the domestic automotive industry in the long term?
AN: I do think that FTAs benefit the industry. The lesson from several countries is that it is impossible to sustain a strong automotive industry in the long term if it is not competitive internationally. Unlike some other products, the auto market really is a global one, and on the demand side that has proved to be a benefit over the past few years, with market growth in some emerging countries helping to stave off problems caused by market declines elsewhere.
Moreover, investment in the auto industry always has to be long term. Some forms of trade protection can undoubtedly be helpful in early stages of building up the industry: localisation quotas, for example, can help to build up a supply base, as long as they are not too high, while sometimes restrictions on second-hand imports are necessary both for environmental and economic reasons. But long term, trade barriers are not helpful.
MM: Vehicle penetration in the Mexican automotive market is already very high and it’ll soon get fairly saturated. Once that happens, it won’t remain attractive to import cars in the country due to lack of demand.
Moreover, Mexico doesn’t really have domestic or home-grown automotive OEMs – so there is no one who will be a net loser really. For instance, the decision will be up to GM or Toyota or VW to decide whether they want to import a car to Mexico or whether they want to sell cars produced from their respective plants in Mexico itself.
NH: Mexico is a very competitive manufacturing location and most production is export-orientated, so opening up new markets through FTAs is advantageous to manufacturers. Low labour costs allow Mexico to produce more efficiently than its competitors. Furthermore, companies won’t be too worried about cheap imports flooding the market – as the lion’s share of Mexico’s output is for export and therefore not in competition for domestic market share.
FTAs would facilitate more export-orientated manufacturing in Mexico, as companies seek to take advantage of the low cost production base. This would result in the sector maturing, with investment across the supply chain.
BB: Free trade agreements encourage the increasingly agile production footprints that were witnessed in 2013, which will undoubtedly intensify throughout 2014. What we do not want to see is a situation where agility is replaced by fickle fleet-footedness: however well prepared manufacturers, supply chain managers and suppliers are, a certain level of continuity is required before quality of product is jeopardised and dependability of supply is compromised.
What key issues does Mexico need to address as its automotive industry develops over the next ten years?
AN: The growing number of FTAs and the development of manufacturers in emerging markets, particularly China, are going to make the auto industry increasingly competitive on a global level. Moreover, the global industry has now seen four successive years of record sales, and even the setback in 2008-09 was only a blip. Despite the emergence of new fast-growing markets, particularly in Africa, there is going to come a time when global growth will slow or even go into reverse. When that happens, the overcapacity problems that are already affecting some markets will become global. Mexico needs to make sure that it gets the automotive investment to cope with that, and that as its economy and living standards grow further, it manages to stay competitive as a producer. The key to combining the two is obviously to focus on quality and skills, but that’s a path that plenty of other countries are trying to go down too.
MM: Already boasting a high vehicle penetration rate of 275 vehicles per 1000 inhabitants, Mexico is no China or India or Brazil in terms of potential for domestic demand for vehicles; there is only so much domestic demand that production can cater to. Therefore, it does not come as a surprise that Mexico exported more than 80% of its total vehicle production in 2012, and is likely to continue serving the global automotive industry as a low-cost manufacturing hub.
Mexico is already the fifth largest exporter of automobiles in the world, however, what sets it apart from the top four is that it doesn’t have any indigenous brands. Germany has VW, BMW and Daimler; Japan has Toyota and Honda,;the US has GM and Ford; and South Korea has Hyundai-Kia. These companies have expanded operations across the world and made critical contributions to respective countries’ economies. But Mexico is unique and the emergence of its automotive industry is without precedent since it is not meant to serve the home population or driven by a particular homegrown company. The inherent risk in such a market characteristic is that the government has no real control over the presence of foreign OEMs. If in the future OEMs think it isn’t a feasible base any more, they will move on. Of course it would hurt the OEMs as well since they have invested so much, but they would rather cut their losses and move on rather than keep bleeding.
The most important thing for the government is to have domestic automotive know-how, similar to what China has done by making it mandatory for OEMs to enter the market only through JVs with domestic companies.
NH: A big issue for Mexico will be remaining cost competitive – many countries have seen wages increase on the back of surging manufacturing, thereby reducing their competitive edge.
Ensuring that the country’s supply chain develops is also key: companies are increasingly looking to localise the entire production process, so the presence of globally competitive supply manufacturers is paramount to facilitate investment.
Infrastructure investment will also be of paramount importance: road and rail links to ship parts and cars, and shipping ports and airports will greatly affect the competitiveness of the industry and could influence investment.
BB: It is crucial for Mexico to prepare for the agility required to support the constantly moving footprint of automotive production. Infrastructure needs to be in place, capable of supporting this dynamic industry, and investment in human resources with the requisite skillsets to manage world-class manufacturing. If the overall value of exports drops off, then alternative routes to sustained profitability need to be lined up to avoid, in the worst case scenario, a rapid decline in manufacturing and a sudden drop-off in the country’s economy.
Is it up to OEMs to address the disparaging safety standards on the same car models between Europe and South America? Or should Mexican authorities enforce stricter standards?
AN: Manufacturers have an incentive to improve car safety because of customer demand, particularly if they can do so in a way that harmonises with other markets they may be involved in, thereby reducing production and development costs. But making cars safer does involve substantial investment on their part too, which they might be unwilling to make. It may also involve compromises on other desirable aspects of the vehicle, such as comfort or speed, and different OEMs are inevitably going to make different decisions about those compromises.
For those reasons, even if it involves voluntary agreements as well as legislation, safety has to be led by the government and other authorities, which can have a more single-minded focus. Also, given how desirable it is to make the legislation as compatible as possible with that of other countries, this really needs to be led at a national rather than company level.
NH: Governments must work with OEMs to overcome disparities. Legislation needs to develop alongside industrial growth – although this can be difficult in emerging markets as output is growing at a fast pace.
Safety standards are increasingly becoming normalised globally, and will allow for greater export diversification. Safety legislation in Brazil, for example, has lagged far behind industrial development, and is now a major concern for OEMs, over exporting cars produced in the country.
MM: In 2012, the Mexican government tried to introduce fuel efficiency rules, on the same lines as those that exist in the USA, but Toyota and a few other OEMs arm-twisted the government to back track, and the requirements were eased significantly.
When it comes to safety standards, it is the responsibility of OEMs to deliver vehicles to the Mexican consumers with the same features that are delivered from vehicles – Mexico to the US and Western Europe. However, if the Mexican government observes that OEMs aren’t voluntarily passing on the safety features to its consumers, then it should introduce safety proposals to make it mandatory. Mexico hasn’t introduced any safety proposals other than general safety belt requirements. This is in stark contrast to the US and Europe, where cars must meet stringent safety criteria .
To make the case worse for OEMs, the price of the vehicles fitted with elaborate safety features being exported to the US and Europe are almost the same or only marginally higher than vehicles being sold in Mexico. This clearly indicates that the OEMs are avoiding providing the safety features.
BB: Safety is a standard-bearer for modern vehicle manufacturers who strive for the most positive results in an increasingly competitive market. Investment in R&D is intensifying, and where authorities stipulate differing basic standard requirements for safety this will ensure OEMs strive to hit individual targets and drive up safety levels. Consumers’ awareness of safety issues is heightening and driving a competitive environment for technology development – manufacturers will not simply make do with attaining bare-minimum safety requirements.
