NAFTA’s ‘Uninvited Guest’: Why China’s Path to U.S. manufacturing Runs Through Mexico

Throughout Latin America, imports of Chinese steel are surging. In October 2012 alone, for example, Chinese steelmakers exported US$3.515 billion worth of steel products to Latin America. According to a joint study recently undertaken by the steel associations of Mexico, Brazil, Colombia and Argentina, Chinese steel exports to Latin America “have grown in a significant way, so that they now threaten the value chain of the industry.”

Nowhere has that threat become more an issue than in Mexico. According to Canacero, the Mexican steel manufacturers association, Mexican imports of rolled sheets from China rose 140.6%, year-on-year, between January and November 2012. “A considerable volume of the total of Mexican steel imports comes from countries with which Mexico has no free-trade agreements, and which practice unfair trade practices, such as China, Russia and Ukraine,” according to a statement by Canacero, which has filed anti-dumping charges against Chinese steelmakers on more than one occasion.

Why are Chinese steel exporters so attracted to Mexico? Does their expansion into Mexico portend that Chinese automakers will soon be assembling some of their own vehicles in Mexico, and exporting some of that output to the United States? Or will the Chinese be tempted to build their own automotive assembly plants in the U.S. in order to take advantage of trade preferences offered by the North American Free Trade Agreement (NAFTA)? In what ways are China’s trade and investment relationships with Mexico different from its ties with other emerging Latin American countries, such as Brazil and Colombia?

The Unique Factors in Mexico-China Ties

Opportunities for Chinese steel manufacturers in Mexico have been expanding because of strong demand for steel in the Mexican automotive sector. Companies such as Honda, GM, Nissan and Ford all operate plants in Mexico whose output is largely exported to the United States. Fausto Cuevas Mesa, director of the Mexican automotive industry association (AMIA), predicted recently that the output of the Mexican auto sector will continue to grow over the next five years at an annual pace of 8% to 10%, reaching 3.9 million units by 2016. Mexican automotive output was projected to reach 2.86 million in 2012, according to LMC Automotive, a research firm, because of strong demand for vehicles in the United States.

In September, luxury automaker Audi announced it will build a US$1.3 billion plant in Puebla, its first production facility in the Americas. Most of Mexico’s auto output is exported to its NAFTA partners, the United States and Canada. Only 990,000 to 1 million locally assembled vehicles were sold in Mexico in 2012, said Cuevas Mesa — slightly higher than in 2011. Cuevas Mesa predicted that in coming years at least three more auto assemblers could come to Mexico, not just from Germany.  

Will any of those additional automakers be coming from China? During the administration of former Mexican President Felipe Calderon, Mexico and China announced that they were about to become “strategic partners.” But the meaning of their emerging partnership was only vaguely defined, notes Margaret Myers, director of the China-Latin America program of the Inter-American Dialogue, a non-profit policy research center in Washington, D.C.

For Chinese exporters of steel and other industrial inputs, Mexico has become a natural opportunity because of its proximity to the United States, says Myers, and the fact that Mexico’s transportation networks and industrial supply chains are closely integrated into those of the U.S. and Canada, the other members of NAFTA. “In a way, China is a part of NAFTA because China contributes a lot to the goods that wind up” in the United States and Canada, says Myers.

However, there are some differences between China’s relationship with Mexico, and China’s relationships with the other emerging countries of Latin America, analysts point out. Kevin Gallagher, associate professor of International relations at Boston University, argues, “There are two ways in which the China-Mexico relationship is somewhat unique. Lots of South American countries are exporting raw materials to China and importing cheap goods from China,” which puts pressure on their domestic markets. Thus, in effect, China pays for its imports of Peruvian and Chile copper, Argentine soybeans, Brazilian wheat, Colombian coal and so forth, by exporting low value manufactured goods to those countries. However, notes Gallagher, “Mexico is different in that its primary raw material export — crude oil — goes to the United States, and not much of Mexico’s exports go to China.” The two countries also compete directly in a wider range of products. “Over 90% of Mexico’s exports are under threats from China in markets where China is gaining market share and Mexico is losing it,” adds Gallagher, co-author of the 2010 book, The Dragon in the Room: China and the Future of Latin American Industrialization.

For his part, Enrique Dussel Peters, professor of economics at UNAM, the Mexican National University, highlights unique sources of tension in the China-Mexico relationship. First, he notes, Mexican elites began their integration with NAFTA way back in 1994, when NAFTA was established. That was long before the leading South American countries deregulated their trade regimes. As a result, “Mexican trade is very integrated into specific trade flows with the U.S. and Canada.” Second, Dussel Peters says, “Mexico prefers to settle its trade disputes via multilateral panels at the World Trade Organization, rather than settle disputes bilaterally. This is highly disliked by the Chinese,” who prefer to settle disputes bilaterally. This difference in mindset has fostered “distrust and misunderstanding” between Mexico and China. Third, although China has been Mexico’s second-biggest trading partner (behind only the U.S.) ever since 2003, Mexican policymakers have yet to develop a clear and coherent strategy toward China. Dussel Peters argues that despite China’s rising importance for NAFTA nations, China remains “NAFTA’s uninvited guest. China is of critical importance to the region, but NAFTA has not been able to formalize relationships between the NAFTA countries and China.”

Felipe Monteiro, a senior fellow at Wharton’s Mack Center for Technological Innovation, stresses that China-Mexico ties have been complicated by the fact that “China is a direct competitor of Mexico in the United States.” There was a time, notes Monteiro, when Mexico could afford to relegate its relationship with China to the back burner, but Mexican policy makers “have realized that you need a bilateral strategy with China. China is too big a country [not to do so].” Short term, Mexico’s competitive disadvantage vis-à-vis China has “been tempered in the last year,” notes Gallagher, for two key reasons. On the one hand, the Chinese yuan has risen in value, making Chinese exports a bit more expensive. On the other hand, while Chinese wages have risen versus the peso or the dollar, Mexican wages have been largely stagnant — thus, cutting into China’s wage-rate advantage. For years, Gallagher notes, China benefitted from having both an undervalued yen, and manufacturing wages of about 73 U.S. cents per hour. Since NAFTA, Mexican wages have risen at an annual rate of only 1.5%. While that sounds like something positive for Mexican workers, most Mexican manufacturing takes place in maquiladora enclaves into which 70% to 90% of all inputs are imported from outside Mexico, and then re-exported to the U.S. and Canada “with little impact on the rest of Mexico,” says Gallagher.

A Strategic Decision

Given its low costs and proximity to the U.S., Mexico can provide “a great platform” for a growing number of Chinese companies eager to penetrate the U.S. market, notes Monteiro. However, he adds, some Chinese companies may opt to locate their new plants in the U.S., rather than Mexico, for other strategic reasons. Take, for example, Haier Electronics, the Chinese appliance manufacturer, which opened the first Chinese-owned plant in the U.S. back in 2000. Haier might have manufactured in Mexico at a fraction of the cost. According to Monteiro, “The obvious question is: Why didn’t Haier decide to have a plant in Mexico instead, and then export from there to the United States?” One key reason behind Haier’s decision may have been that the company, which is owned by the Chinese government, decided that “it was necessary to build manufacturing channels inside the United States, in order to reduce animosity against China. This was a strategic decision by the Chinese.” According to Monteiro, the strategic question for other Chinese companies in such a position is to decide: “Does developing strong relationships with our stakeholders inside the United States out-weigh [in importance] the extra costs” of building a plant inside the United States? Monteiro concludes, “The answer is not obvious. Short-term, it may make sense to be in Mexico, but longer term, it may be better to be in the U.S.”

Mexico’s membership in NAFTA enables any goods made by Chinese companies in Mexico to benefit from NAFTA so long as they meet NAFTA’s “rules of origin” for gaining tariff preferences. NAFTA’S rules of origin “don’t talk about the firm of origin,” notes Gallagher. While they specify that a certain percentage of the value of vehicles sold in North America must be added in North America to qualify for those trade preferences, NAFTA rules of origin don’t specify that the “local value” in those vehicles must be added by companies owned by North Americans. Those goods could just as well be manufactured by Chinese-owned firms inside the walls of NAFTA.

If Chinese automakers calculate that they cannot meet NAFTA rules of origin by assembling those vehicles in Mexico, they can opt to build such a plant in the United States. In such a case, more of the steel they use to build those cars could wind up being sourced from the U.S. – or exported to Mexico, and then shipped to U.S. auto assembly plants. “The [Chinese-owned] plants don’t have to be in Mexico,” noted Dussel Peters. Like Honda, Toyota, Hyundai and other Asia automakers, he said, the Chinese could locate those plants in the United States.

Gallagher predicts that the next wave of Chinese exports to Mexico may well include finished vehicles, but he argues that those Chinese-built cars are more likely to be assembled in Mexico than in the U.S. “There will be Chinese automotive manufacturing plants in Mexico before there are any such plants in the U.S. because the costs are lower [in Mexico], and it is harder to operate a plant in the U.S., where there are so many regulations.” Nevertheless, Gallagher worries about whether Mexico’s transportation infrastructure is up to the task of handling huge, additional volumes of goods made within the country’s own borders.  To overcome the significant gaps in Mexico’s industrial and transportation infrastructure, Gallagher suggests that Mexico approach the China Development Bank for loans that would be used to construct and expand Mexican seaports and high-speed highways. That way, Mexico could smoothly accommodate additional volumes of imported Chinese raw materials and components that would flow from the decision by Chinese firms to build automotive plants inside Mexico.

Between 2008 and 2010, China’s First Automobile Works exported a low-cost sedan to Mexico, but its sales figures in Mexico were so weak, FAW’s initial plans to build a factory in Mexico were shelved entirely. However, wage rates in China’s major industrial areas have continued to rise in recent years, while wage rates in Mexico have barely risen, so that “the cost of labor in Mexico is now very similar [in Mexico] to that in the Pearl River Delta [of China],” notes Myers. Moreover, as Chinese auto producers improve their quality control and upgrade their automotive technology, FAW or another Chinese automaker may want to take the plunge into assembling in Mexico.

Although Mexico has enacted wide-ranging free-trade pacts with a few dozenother countries around the world, Mexico and China are unlikely to negotiate their own bilateral trade pact, analysts agree, because the two countries compete in too many product sectors, and there is too much resistance to such a pact in Mexico among low-value-added Mexican manufacturers who have already lost significant market share to Chinese competitors in their home market.

More encouragingly, inaugurated Mexican president EnriquePena Nieto has shown interest in establishing a more cordial partnership with China, notes Myers. “Under [former President] Calderon, the relationship with China went to pieces, because he prioritized Mexico’s relationship with the United States. But the view of Pena Nieto is that it is time to diversify Mexico’s relationships,” given the rising importance of Asia, and China in particular, Myers concludes.

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