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Saturday, November 17, 2012

Why site assembly in Mexico?

...tariffs are 0% on vehicles shipped from Mexico...
Honda is building a full-sized assembly plant (200K units per year) as is Mazda; Nissan is adding a 3rd plant. Part of that is driven by the strength of the yen, at ¥81.3 per US$ on 17 November; the US is the biggest source of profits for the auto industry, so sourcing vehicles for the US market from a non-yen location is important. [The Euro is also strong, to which anyone who has traveled there on a dollar budget can attest. So while VW has operations in Mexico, here I focus on the Japan angle, because I'm teaching a course on the Japanese economy.]
But why Mexico? Logistics costs are high, because most vehicles will likely be exported and because the local supplier base is not as deep as in the US midwest (hence parts must be imported). So while quality is high and wages are competitive, it's not a priori a natural choice.
The answer lies in free trade agreements: Mexico has been more aggressive on that front than the US (and Japan). As a result not only can vehicles be shipped tariff-free to the US–0% from Mexico versus 2.5% on cars and 25% on trucks shipped from Japan. Ditto Europe–tariffs are 0% from Mexico versus 10% on vehicles shipped from the US or Japan. (I have not researched whether Mexico has similar aggreements in Latin America.)
Now Japan could offset some of this were it to negotiate more free trade agreements. (It has one with Mexico.) But that's an awkward process, and has yet to join the biggest pending agreement (TPP, Trans Pacific Partnership). The reason: farmers, whose political clout is disproportionate to their share of the economy, and whose clout over time has led to subsidies and tariffs that allow rice farmers to remain in business despite costs that are multiples of those in other large producers. So removing protection for rice would drive most farmers out of business. In Japan, it's the "3rd rail" of electoral politics.
While we didn't hear anything about the economies of Canada and Mexico, our two biggest strategic partners, in the recent (and unlamented) US political cycle, this movement clearly benefits NAFTA and thus the US. Do higher wages in Mexico harm us? No! And while we might rather have the jobs in the US, we do pick up additional parts business. If we're going to import vehicles – and economies of scale mean that many will still be built in but a single plant globally – then better Mexico or Canada than Japan or Europe!
...mike smitka...