The Car of The Future and The Future of Mexico

Arnulfo Arteaga García, Álvaro Bracamonte Sierra, Fernando Camacho Sandoval, Jorge Carrillo, Gerardo González Herrera and Jordy Micheli.  Members of the ROMA- Analysis Team. 

The Car of The Future and The Future of Mexico

In November 2018, General Motors (GM) grabbed the business headlines by announcing the closure of seven plants where it produced the Cruze, an emblematic car that has sold more than 3.8 million units since its debut in 2008.[1] According to the announcement, the plants affected will be in Detroit-Hamtramck (Michigan), Warren (Ohio), Oshawa (Ontario), those that manufacture powertrain and transmission systems in Baltimore (Maryland) and Warren (Michigan), and one in Unsan, South Korea.[2]

With this massive closure, GM hopes to generate savings of around 6 billion dollars over the next two years, reassign these resources to R&D and production of electric and autonomous vehicles, and remain competitive in the market against TESLA and other manufacturers.[3] 

The announcement is relevant because it is the first massive technical adjustment of the transition to the electric car era (today only 2% of passenger vehicles worldwide run on this type of energy). Of course, the reasons for this decision are some of the most common in the industry, such as cutting costs (recently affected by tariffs on steel and aluminum, among other inputs) and addressing downward sales trends in the United States, Europe and China. But what also stands out is the emergence of a new technological criterion which, following the Schumpeterian principle of creative destruction, suggests the replacement of the current business model with one that allows the company to fully enter the race for the car of the future.

 

MEXICO AND THE RACE FOR THE CAR OF THE FUTURE

The growth of the automotive industry in our country has been steady since 1995, except during the global crisis of 2008-2009. Following that, the production of automobiles and auto parts increased at an annual rate of 12.3% on average (2010-2017), a figure that practically quadruples the annual growth rate of manufacturing, which was 3.4%, and of the economy as a whole, at 3.0%. The automotive industry already represents 3.7% of domestic GDP (2017) and, with a total of 824 thousand employees, contributes 22.2% of manufacturing jobs. In the export segment, it generated more foreign currency in 2017 than the oil industry, remittances and tourism combined. It maintains a positive and growing balance of trade, with a surplus that grew from 18.7 to 70.7 billion dollars between 2009 and 2017. Some 83.2% of the total exported by the industry goes to the United States; while 53.6% of its imports come from that country.

The auto revolution is in full swing. 

Judging by this performance, Mexico remains safe from the negative effects of worldwide restructuring in the automotive industry. The largest global car manufacturers are already in the country and until now, there has been no reduction in their production capacities. The cancellation in 2017 of Ford's project to build a plant in San Luis Potosí is the only event that could be attributed to the so-called “Trump effect.”

What's more, it is highly significant that the GM plant in Ramos Arizpe, Coahuila managed to emerge from the company's ongoing restructuring by substituting production of the Cruze for that of the Blazer.[4] But the signal sent by the manufacturer should not go unnoticed. The ascent of Mexico in automotive manufacturing is based on a global value chain and production segmentation that could undergo changes with the arrival of the new techno-industrial paradigm. Although it is difficult to determine the true extent of this transition and the time it will take to consolidate, the capacity of large global companies to reinvent themselves cannot be overlooked.  

GM has already shown us how to finance this conversion: resources will come not from surpluses from operations but from savings by closing plants and from choosing the most competitive costs in facilities that “survive.” How much longer can the current export platform model be maintained? How will plants of both assemblers and suppliers in Mexico be transformed? What measures should be implemented to renew the competitive advantages of automotive manufacturing in the country? These are some of the basic questions that we must begin to resolve in light of the creation of a new scenario where electric cars will dominate, connected to the network and self-driving.[5]

The issue of technological progress adds another factor of uncertainty to go with Trump's intervention in the renegotiation of NAFTA, now called USMCA. Subject to approval by each nation's legislature, the future trilateral agreement calls for an increase in regional content value from 62.5 to 75.0 percent to qualify for preferential tariffs. A second modification establishes that 40% of the vehicle value should come from a wage zone of at least 16 dollars an hour. Meanwhile, a third modification requires that 70% of the steel and aluminum content of the car be manufactured in North America.

While it is true that up to 60% of the vehicle's value can be produced in an affordable wage zone for Mexico, of less than 16 dollars an hour, it is also true that a major change to the supply chain is shaping up to make the installed production capacity compatible with the new trade regulations. In this context, questions have resurfaced about the viability of an export model based on low wages and about the limited capacity to add value internally to goods traded abroad.

Any prospective analysis of the automotive industry in Mexico should take into consideration both the trade and the technological factor. The scenarios have changed; we do not know if they have changed “dramatically,” but they have changed in such a way that it forces us to take a new look at the development of this industry in the country.

Foreign investments already announced for the automotive industry in Mexico amount to around 10 billion dollars over the next four years.[6] A significantly lower amount for productive capital inflows than the recent past: from 2007 to 2017, foreign direct investment (FDI), in the country's automotive industry was 45.1 billion dollars, an average of 4.1 billion dollars per year. Just in the last four years (2014-2017), the cumulative was 25.5 billion dollars of FDI, which represents an average annual inflow of 6.4 billion dollars. We should not lose sight of the fact that between 2007 and 2017, automotive FDI contributed 27.2% of the total received by the manufacturing sector and 37.6% between 2014 and 2017.

If looked at closely —and in contrast specifically to the presidency Enrique Peña Nieto, against which many things will be compared—, we notice a big drop in automotive FDI for the simple reason that the cycle of large transfers of capital to build and benefit the export platform has ended, and because practically all car manufacturers are already in the country, with the exception of the Chinese. Two adverse factors must be added to this: the effect of the new trade treaty and the impact of technology.

 

CLUSTERS AND REGIONAL IMPACT OF THE AUTOMOTIVE INDUSTRY

 The automotive industry prospered in Mexico under the protection of an active state policy. To geographical location and relatively low wages were added a series of incentives that promoted the arrival of direct foreign investment, the arrival of the major car manufacturers and the development of a domestic industry integrated into the value chain of each of the terminal companies. 

The 2003 Decree to promote competitiveness of the terminal automotive industry and boost the internal automobile market is part of this strategy and includes a series of administrative facilities, measures to support acquisitions by state, municipal or federal governments as well as support to encourage the arrival of new productive investments—or the expansion of existing ones— conditioned on training and hiring Mexicans, or on undertaking research and development activities in the country.

Likewise, the Strategic Program for the Automotive Industry 2012-2020, incorporated into the National Development Plan 2007- 2012, reinforces the strategy outlined in the 2003 Decree, supports the formation of clusters and assigns them a preponderant role in connecting companies, academia and government as well as in training highly qualified professionals and technicians.

Regional clusters and business organizations have emerged that, with federal and local support, coordinate to lobby, generate competitive advantages, and establish homogeneous working conditions. Results from these regional agglomerations have been uneven and, although there are 12 business groups of this type, the most relevant for their level of development are those in La Laguna, Guanajuato; Querétaro; the State of Mexico and Nuevo León.

Closely related to this dynamic of industrial agglomeration, it has been documented that in those areas where the automotive industry is located, the productive apparatus loses its capacity for diversification and employment generation concentrates around this activity. The states that have experienced a greater dependence on the automotive industry are Puebla, Morelos, Aguascalientes, Guanajuato, Nuevo León, Coahuila and Sonora.

Added to this specialization is a growing disconnect between the technological and innovative capabilities of the automotive sector and working conditions. New plants or new work units in old plants generate jobs with lower salaries and benefits. The well-known paradox of an economy growing in innovation and technological development where social inequality grows at the same time can be seen in the automotive industry in Mexico. There is also a gap between the terminal industry and that of auto parts: in the first, the median salary is 9.9 times the minimum wage; in the second, 4.8 times. Of the total number of workers in the sector, 87.7% are in auto parts.

The automotive industry has received privileged treatment because of its importance to the economy: employment, exports, and foreign exchange. However, the internal market, the reduction of inequality, wage recovery and public investment have been neglected. We know that states offer all sorts of fiscal stimuli, subsidies and exemptions, but the policies of promoting local procurement have not produced the expected results.

The virtual absence of Mexican companies with the potential to become part of the value chain prevents the establishment of transnational companies from translating into local development. The main link is, by far, employment and neither companies nor authorities have so far implemented effective strategies to go beyond this point.

 

A POSSIBLE SCENARIO 

Technological trends and the new trade framework suggest some processes whose interaction would result in less investment, less foreign exchange and employment stagnation. Under the USMCA, the value chain must be adjusted to face new import quotas from the United States. Part of the installed capacity in Mexico cannot be used to supply the North American market.

Plants oriented to North America and Europe must produce the models that are successful in mature markets. Product cycles and pressures to keep wages low will be important. There could be threats to move production to other countries.

Total foreign investment is expected to drop to at least one third of what has been recorded in recent years. The phase of new investment is ending and that of export platform maturity is beginning. This is important for entities that in recent years have depended on investments in this industry, such as Chihuahua, Coahuila, Puebla, Guanajuato and the State of Mexico.

 

PROPOSALS FOR A STRATEGY TO SUPPORT THE AUTOMOTIVE INDUSTRY

How will the new government face the pending issue of developing the domestic supply chain? Will it promote the dissemination of technologies from the Fourth Industrial Revolution? How will federal entities support automotive specialization? Will other sectors be promoted to diversify the industrial structure of these states? Are local governments willing to discourage protective union contracts? Will innovation policies be implemented where local participants play more active roles? Will a dialogue open up between workers, government and business? In our opinion, a new government strategy for the automotive sector should consider the following measures:

State-of-the-art designs. 

 

1) Rethink procedures, visions and objectives so that the automotive industry generates the maximum benefit possible at the local level. Stop thinking that the car companies are hermetic entities that can do nothing more than provide jobs at very low salaries but that require high-quality manpower. This means finding out what they are like on the inside (lessons can be learned from what China has achieved) to decide what and how to negotiate for “the spoils” (knowledge, technology, etc.) locally or nationally.

2) Implement a higher education program, backed by companies in the sector, to study the digital revolution, new manufacturing, materials and alternate energy sources in depth.

3) Create a methodology and/or capabilities to monitor the technological transition, with special attention to monitor the possible decisions of companies already established in Mexico (ideally, a technological transition observatory). Do not forget that surges in new technology originate in the national headquarters of leading companies.

4) Create counseling for salary transition: where, how much and with what actors to negotiate. Strengthen relationships with trade union organizations, nationally and globally, who promote democratic trade unionism.

5) Broaden the view of the automotive industry in Mexico and analyze the relationship between a successful productive model (in terms of quantity and profit) and a dysfunctional national mobility model from the perspective of social, economic and environmental efficiency. The country's urban areas are continuously expanding and both internal mobility and interconnection are based on the automotive model of intensive, technologically mature use. Mexico has not asserted its great market capacity —nor its supply capacity— to reorient its mobility model towards the new frontiers of the electric car adapted to the country's urban landscape.

 

The step taken by General Motors and the new trade regulations foreseen for the automotive sector in the USMCA are warning signs that cannot be ignored. The performance of automobile and auto parts manufacturing has placed Mexico among the world's most important producers. Until now, the “paradigm of the Mexican car,”[7] maintains its economic rationale and remains safe from the negative effect of global automotive industry restructuring, but for how long?

 

 

[1] “GM fabricará la nueva generación del Chevrolet Cruze en México: Invertirá 350 millones de dólares en su complejo de Ramos Arizpe,” Autocosmos, March 23, 2015.

[2] “Cierre de planta de GM: Cinco razones que llevaron a la automotriz estadounidense al drástico recorte de plantilla,” BBC World, November 27, 2018,

/www.bbc.com/mundo/noticias-46366901>

[3] “General Motors México, la menos afectada por reestructuración mundial,” Net Noticias, November 26, 2018, 348af64a/general-motors-mexico-la-menos-afectada-por-reestructuracion-mundial/>

[4] Es oficial: GM hará en Ramos Arizpe la nueva Blazer, pese a amenazas arancelarias de Trump,” Vanguardia Mx, June 23, 2018

[5] “Industria automotriz apuesta por vehículos eléctricos y software: KPMG,” Expansión-CNN, January 23, 2017,

[6] “Se invertirá hasta 10% más en sector de autos: Deloitte,” El Economista, October 7, 2018 /www.eleconomista.com.mx/empresas/Se-invertira- hasta-10-mas-en-sector-de-autos-Deloitte-20181007-0100.html>.

[7] Cars assembled in Mexico have cost advantages (especially labor costs) and an important market horizon in General Motors' strategy (a product in the maturity stage with marginal modifications).