ESSAYS ON ISSUES THE FEDERAL RESERVE BANK MAY 2013 OF CHICAGO NUMBER 310

Chicag­o Fed Letter

The growing importance of Mexico in North America’s auto production by Thomas H. Klier, senior economist, and James M. Rubenstein, professor, Miami University

Mexico’s share of automotive production has grown relative to those of its neighbors to the north because the country has become more integrated with North America and pursued trade agreements with numerous other countries. Those developments have boosted Mexico’s motor vehicle production by way of raising exports.

Mexico’s share of North America’s light Chicago Fed Letter puts recent develop- vehicle (car and light truck) production ments in Mexico’s automotive industry has steadily increased over the years, into historical perspective. rising from 6% in 1990 to 11% in 2000 and then to 19% in 2012.1 In 2008, Role of trade policy Mexico for the first time surpassed Mexico has a long history of motor vehi- Canada to become cle production. Two Detroit-based auto- 1. Light vehicle production in Mexico, 2012 the second-largest makers, Ford and GM, were assembling producer of light vehicles there by the mid-1930s. Several Share of Share Share of vehicles in North additional producers, such as Chrysler, Plants in all auto exported all auto Company operation production by company exports America, after the VAM (Vehículos Automotores Mexicanos), (------percent ------) United States. Since and Renault, entered the Mexican mar- General then, Mexico’s pro- ket over the years, yet no dominant Motors 3 20 82 20 duction gap with Mexican vehicle producer emerged.3 Ford 2 16 96 18 Canada has increased A key factor shaping the development Chrysler 2 15 92 17 every year. Recent of Mexico’s automobile industry was Volkswagen 1 21 86 22 decisions on new plant the country’s auto-industry-specific openings in Mexico Nissan 2 24 68 20 trade policy. During the first half of are set to widen that Honda 1 2 60 2 the twentieth century, vehicles sold in gap even further.2 Toyota 1 2 99 2 Mexico were either imported as finished Similar to Canada, all Notes: In addition, the following plants have been announced: Mazda in Salamanca (to products or put together from kits (made light vehicle produc- open in 2013); Nissan in Aguascalientes (to open in 2013); Honda in Celaya (to open in up of domestically produced and im- 2014); and Audi (Volkswagen) in San José Chiapa (to open in 2016). Most of them are tion in Mexico is at- currently under construction; see note 14 for more details. The last column does not total ported components) at small-scale assem- to 100% because of rounding. tributable to foreign Source: Authors’ calculations based on data from WardsAuto InfoBank. bly plants. In 1960, a dozen assembly producers, including plants in Mexico produced a total of the Detroit-based auto- about 50,000 vehicles; back then, local makers—Chrysler, Ford, and General content in the vehicles assembled in Motors (GM)—as well as auto manu- Mexico amounted to less than 20%.4 facturers headquartered overseas, such as, in Mexico’s case, Volkswagen (VW) In 1962 the Mexican government started and Nissan (see figure 1). In contrast to implementing a policy that favored do- Canada’s situation, the rapid expansion mestic production over imports. The new in Mexico’s vehicle output is chiefly due policy prohibited imports of finished to growth in its vehicle exports. This vehicles, engines, and many other auto Ford at Hermosillo into Mexico. In addition, in order to qual- 2. Mexico’s light vehicle production and exports, 1985–2012 in 1986. These ify for duty-free exports from Mexico percent millions of units plants also altered after 2004, at least 62.5% of a vehicle’s 90 3.5 the traditional foot- content had to be made somewhere in 10 80 print of Mexico’s North America. 3.0 auto industry. Ear- 70 NAFTA’s passage stimulated another lier plants had all 2.5 round of investment by these five pro- 60 been located near ducers. For example, Nissan opened a 50 2.0 Mexico City, where second assembly plant in Aguascalientes most customers for 40 1.5 during the NAFTA ratification process, new vehicles pro- 30 and within a year of NAFTA’s imple- duced in Mexico 1.0 mentation, Chrysler and GM opened 20 were concentrated. 0.5 plants in Saltillo (in northern Mexico) 10 The two new plants and Silao (in central Mexico), respec- were located much 0 0.0 tively. NAFTA also required that some 1985 ’88 ’91 ’94 ’97 2000 ’03 ’06 ’09’12 farther north, clos- production be located in Mexico in or- er to the United Production (right-hand scale) der to be able to import vehicles there.11 States, where Subsequently, both Honda, in 1995, Export share (left-hand scale) most of their out- and Toyota, in 2002, established small- Source: Authors’ calculations based on data from WardsAuto InfoBank. put was headed scale production plants in Mexico.12 as exports.7 With the implementation of NAFTA, parts, significantly raising trade barriers Integration with North American market Mexico had opened up its market.13 As for Mexico’s auto industry. This policy Mexico’s trade restrictions were loosened, a result, auto manufacturers optimized required that at least 60% of the parts though not completely eliminated, their production operations within in vehicles assembled in Mexico be with the implementation of the North North America. Indeed, vehicle assem- produced in Mexico and that the parts American Free Trade Agreement bly plants in Mexico implemented state- suppliers have at least 60% Mexican (NAFTA) in 1994.8 That agreement of-the-art technology and became, more 5 ownership. Thus, Mexico’s 1962 auto included several key provisions affect- or less, interchangeable with those in decree enticed producers that wanted ing Mexico’s auto industry: the United States and Canada (e.g., to sell in Mexico to set up production note that since the launch of the North • Import duties on light vehicles were operations in the country. For instance, American version of the Ford Fusion cut from 20% to 10% in 1994 and it stimulated the construction of several in model year 2006, it has been exclu- eventually phased out over ten years. vehicle assembly and engine plants by sively produced at Ford’s Hermosillo foreign firms near Mexico City, the • The minimum requirement for plant in Mexico). Since 1994, the coun- country’s largest city, where the majority Mexican content in Mexico’s auto try’s production has on balance steadily of the vehicles were going to be sold. production was reduced from increased, in step with the rising volume Notably, during the mid-1960s both 34%–36% in 1993 to 29% in 1999 of vehicle exports (see figure 2). By Nissan and VW first entered the Mexican and eventually eliminated in 2004. the end of 2012, light vehicle produc- market as vehicle producers by estab- tion had reached an annual level of • The level of the trade compensating lishing plants in Aguascalientes and 2.86 million units, with 2.38 million of ratio for vehicles was reduced from Puebla, respectively; both plants were those representing exports. located fairly close to Mexico City. 1.75 to 0.80 in 1994 and eventually 9 The new policy succeeded in raising to zero in 2004. Recent developments the level of Mexico’s vehicle production In addition to reducing trade barriers Mexico’s vehicle production capacity is to 250,000 units by 1970, yet those ve- within North America, NAFTA intro- soon to be boosted further by a number hicles “were of poorer quality and en- duced barriers to the vast majority of of additional vehicle assembly plants. In tailed higher production costs than competitors that were not already pro- 2011, Mazda and Honda announced the 6 their foreign counterparts.” ducing vehicles in any of the three North construction of their first full-size assem- By 1983, the Mexican government American countries by 1994. The five bly plants in Mexico (Mazda at the same shifted its auto industry policy again, automakers that were operating pro- time ended a production agreement this time focusing on export promo- duction facilities in Mexico prior to the at a former Ford facility in southern tion. Vehicle producers responded by implementation of NAFTA—namely, Michigan). Mazda’s and Honda’s plants opening modern and competitive plants. Chrysler, Ford, GM, Nissan, and VW— are scheduled to begin producing small For example, two assembly plants were received a head start in the free trade cars in 2013 and 2014, respectively. Nissan opened during the 1980s—one by GM era. Until 2004, only those five auto- is currently building its third assembly at Ramos Arizpe in 1981 and another by makers could import vehicles duty-free plant in Mexico, also designated for the production of small cars. Finally, earlier, are slated for the production of that all the new assembly plants are Audi—VW’s luxury marque—last year small vehicles. being located in the interior of Mexico, announced its decision to start building which has easier access to ports than lo- Furthermore, Mexico has become a a small luxury crossover vehicle at a cations farther north. This access enables very attractive location for automakers new plant in Mexico by the middle of exports of finished vehicles to several because of the country’s aggressive pur- the current decade.14 global markets, as opposed to just the suit of free trade agreements. Indeed, United States and Canada.

Summary Producers with overseas headquarters accounted for 45% of Mexico’s auto sector has been growing Mexico’s light vehicle exports in 2012, compared with 16% in 1985. strongly. The country is on track to account for 22% of North American light vehicle production by 2020.21 A What are the reasons behind this re- signing NAFTA was merely one of distinctive feature of Mexico’s rapidly markable expansion in auto produc- Mexico’s first steps in liberalizing its growing auto industry is the importance tion capacity? The primary drivers of trade. As of 2012, the Mexican govern- placed on exporting vehicles rather this growth are low production costs, ment had signed free trade agreements than selling them in Mexico. Exports changing consumer preferences in au- with 44 countries, including those with accounted for 83% of Mexico’s light tomobiles prompted primarily by rising the European Union, Japan, and Israel.18 vehicle production in 2012, represent- gasoline prices, and country-specific So, it is of little surprise that auto man- ing a higher share of auto production export opportunities. ufacturing firms with headquarters over- than in any other major car-making seas (i.e., those not headquartered in country in recent years.22 In terms of Mexico’s auto industry wage rate (start- North America) have played a dispro- volume, Mexico was the fourth-largest ing at $40 per day for assembly line portionate role in the recent growth of exporter of motor vehicles in 2012, workers in 201215) is low relative to its Mexico’s vehicle exports. Between 1985 behind only Germany, Japan, and South neighbors to the north as well as other and 2012, Mexico’s exports of light vehi- Korea.23 In contrast to the other major industrial nations, so it continues to cles grew 40 times—from 60,000 units to car-exporting countries, Mexico has help attract international automakers. 2.4 million units; yet, exports of vehicles no domestically owned automakers to Auto manufacturers choosing to pro- produced in Mexico by auto producers spearhead the export strategy. And so, duce vehicles in Mexico instead of the with headquarters overseas increased Mexico’s role is unique among auto- United States (or Canada) face a trade- over 100 times during the same time motive export hubs. off between somewhat lower labor costs span—from fewer than 10,000 units to and somewhat higher shipping costs 1.1 million units—boosting those pro- for vehicles produced in Mexico and ducers’ share of Mexico’s light vehicle Charles L. Evans, President ; Daniel G. Sullivan, sold north of the border.16 However, Executive Vice President and Director of Research; exports from 16% to around 45% (see for automakers choosing between pro- Spencer Krane, Senior Vice President and Economic the distribution of the nation’s light Advisor ; David Marshall, Senior Vice President, financial ducing in North America and producing markets group ; Daniel Aaronson, Vice President, vehicle exports by company in the last overseas and shipping vehicles from microeconomic policy research; Jonas D. M. Fisher, column of figure 1). Vice President, macroeconomic policy research; Richard there to North America (and some- Heckinger,Vice President, markets team; Anna L. times other markets), Mexico appears As a further sign of Mexico’s emerging Paulson, Vice President, finance team; William A. Testa, Vice President, regional programs, and Economics Editor ; to have a clear advantage over the rest role as an automotive export hub, vehicle Helen O’D. Koshy and Han Y. Choi, Editors ; of the world of late. For example, the exports to destinations outside North Rita Molloy and Julia Baker, Production Editors ; substantial appreciation of the yen America have been experiencing the Sheila A. Mangler, Editorial Assistant. against the U.S. dollar and other cur- fastest growth rates in recent years. For Chicago Fed Letter is published by the Economic Research Department of the Federal Reserve Bank rencies has made Japan a much more example, Chrysler is now exporting some of Chicago. The views expressed are the authors’ expensive place in which to produce of its Fiat 500 vehicles produced in Mexico and do not necessarily reflect the views of the 17 19 Federal Reserve Bank of Chicago or the Federal vehicles than Mexico. all the way to China. During the twen- Reserve System. tieth century, nearly all auto exports from As the mix of vehicle production is © 2013 Federal Reserve Bank of Chicago Mexico were destined for the United Chicago Fed Letter articles may be reproduced in shifting toward small vehicles on account States. In contrast, during 2012 only 63% whole or in part, provided the articles are not of rising gasoline prices and consumers’ reproduced or distributed for commercial gain of the 2.38 million vehicles exported concerns about vehicle fuel efficiency, and provided the source is appropriately credited. from Mexico went to the United States; Prior written permission must be obtained for Mexico has become the location of any other reproduction, distribution, republica- Latin America received 16% and Europe choice for Asian-headquartered auto- tion, or creation of derivative works of Chicago Fed 9%, with the balance evenly split between Letter articles. To request permission, please contact makers to produce vehicles destined Africa and Asia.20 Given this recent dis- Helen Koshy, senior editor, at 312-322-5830 or primarily for the Americas. Notice how email [email protected]. Chicago Fed tribution of destinations for Mexico’s all of their newly announced assembly Letter and other Bank publications are available automotive exports, it is noteworthy at www.chicagofed.org. plants in Mexico, which were mentioned ISSN 0895-0164 1 Unless otherwise noted, the automotive be exported. It had been implemented to 17 Note that Honda is planning to produce its statistics presented in this article are from provide incentives for the auto sector to smallest car—the Fit—at its new plant in authors’ calculations based on data from become competitive internationally (see Mexico. That vehicle is currently being WardsAuto InfoBank. Moreno Brid, 1996). imported to North America from Japan. See www.autoblog.com/2012/03/30/ 2 See, e.g., Nicholas Casey, 2012, “In Mexico, 10 Carrillo (2004, p. 111). honda-announces-fit-production-moving- auto plants hit the gas,” Wall Street Journal, 11 See NAFTA’s Annex 300-A, available at to-mexico/. November 19, available by subscription at www.sice.oas.org/trade/nafta/anx300a1.asp. http://online.wsj.com/article/SB100008 18 Mexico’s free trade policy contrasts with the 72396390444083304578018462369529592. 12 Honda’s plant was located in El Salto (in policies of Brazil and Argentina—both of html. central Mexico), and Toyota’s was located which represent possible alternative pro- in Tijuana (near the Mexico–U.S. border). duction locales for automakers serving the 3 VAM was a Mexican auto producer from Latin American market. These two coun- the mid-1940s to the late 1980s. In 1983 13 For example, the export share of vehicles tries, after running up substantial deficits the Mexican government decided to sell produced in Mexico jumped from 52% in in light vehicle trade with Mexico, last year its 100% stake in VAM to Renault; see Juan 1994 to 84% in 1995 (see figure 2). reached separate agreements to freeze the Carlos Moreno Brid, 1992, “Structural 14 For details on Mazda’s plans in Mexico, see level of Mexico’s vehicle exports to their change in Mexico’s motor vehicle industry http://content.usatoday.com/communities/ shores for the next three years (Casey, 2012). (1977-89),” in Industry on the Move: Causes driveon/post/2011/06/mazda-flat-rock- 19 and Consequences of International Relocation michigan-autoalliance-uaw-united-auto- Adam Thomson, 2012, “Mexico: China’s in the Manufacturing Industry, Gijsbert van workers-ford-mustang/1#.UUjO-jf2KSo. unlikely challenger,” Financial Times, Liemt (ed.), Geneva, Switzerland: Inter- For details on Honda’s plans, see http:// September 19, available by subscription at national Labour Office, pp. 259–278 (in content.usatoday.com/communities/ www.ft.com/intl/cms/s/0/9f789abe-023a- particular, p. 269). driveon/post/2011/08/honda-building- 11e2-b41f-00144feabdc0.html. 4 Moreno Brid (1992, p. 260); and Juan new-800-million-auto-plant-in-mexico/1#. 20 Brendan Case, Alan Ohnsman, and Carlos Moreno Brid, 1996, “Mexico’s auto UUzHNBw4t8E. For details on Nissan’s Craig Trudell, 2012, “Automakers boost industry after NAFTA: A successful experi- plans, see www.thedetroitbureau.com/ investing on vehicle factories in Mexico,” ence in restructuring?,” Helen Kellogg 2012/01/nissan-announces-new-plant-for- Bloomberg, November 13, available at Institute for International Studies, work- mexico/. And for details on VW’s plans, www.bloomberg.com/news/2012-11-14/ ing paper, No. 232, August, available at see http://content.usatoday.com/ automakers-boost-investing-on-vehicle- http://kellogg.nd.edu/publications/ communities/driveon/post/2012/04/ factories-in-mexico.html. workingpapers/WPS/232.pdf. audi-picks-mexico-over-us-for-its-factory/ 1#.UUjPjTf2KSo. 21 R. L. Polk & Co., 2012, “Strategic questions 5 Moreno Brid (1992, pp. 260–261). for automotive business planners,” white 15 Casey (2012). paper, Southfield, MI, December, p. 8, avail- 6 Moreno Brid (1996). 16 able at www.oesa.org/Doc-Vault/Industry- 7 In 1992, the U.S. Department of Commerce Moreno Brid (1996); and Jorge Carrillo, found that the total cost of producing a Information-Analysis/Polk-Automotive- 2004, “NAFTA: The process of regional in- 1992 Ford Escort in Mexico and exporting Business-Planners.pdf. tegration of motor vehicle production,” in it to the United States slightly exceeded the Export shares of auto production are Cars, Carriers of Regionalism?, Jorge Carrillo, 22 cost of assembling the same vehicle at a from authors’ calculations based on data Yannick Lung, and Rob van Tulder (eds.), Michigan assembly plant. Higher labor costs from www.mexicotradeandinvestment. London and New York: Palgrave Macmillan in Michigan (relative to those in Mexico) com/pdf/2012/abril/17/Presentacion% in association with GERPISA, pp. 104–117. were more than offset by lower shipping costs; 20Automotriz%20mizuho.pdf. 8 Unless otherwise noted, NAFTA details see Max Gates, 1993, “Great debate: Pending Casey (2012). are from Moreno Brid (1996). free-trade pact has automakers, UAW argu- 23 ing over ramifications,”Automotive News, 9 The trade compensating ratio specifies Vol. 67, No. 5519, September 27, p. 1. the share of Mexico-produced vehicles to