Canada and Mexico have escaped the new global tariff on steel and aluminum, for now. That’s if President Trump gets “a good deal” on the North American Free Trade Agreement (NAFTA). Threatening to pull out of NAFTA might be a negotiating tactic, or it might even seem like a way to address the trade imbalance between the United States and Mexico. But its long-term impact on American manufacturing will be worse than people believe. That’s because since NAFTA was established in 1994, manufacturers have organized their production systems as if North American borders no longer mattered. Take the auto industry: car manufacturers here have built highly interdependent supply chains in which parts and major subassemblies flow freely back and forth, often crossing borders multiple times. A Chrysler 300 assembled in Brampton, Ontario, might have a 5.7 or 6.4 liter engine from Fiat-Chrysler’s Saltillo Engine facility in Ramos Aripe, Coahuila, mated to a transmission manufactured in Indiana, while a Chevrolet Tahoe produced at GM’s Arlington, Texas, assembly facility has 38% Mexican content. Even a Tesla Model 3 assembled in California has 25% Mexican content.
A current-model Chevy SUV on the production line at the General Motors Assembly Plant in Arlington, Texas, May 3, 2010. The plant is celebrating the 75th anniversary of their Suburban model SUV by rolling out a new 75th Anniversary Diamond Edition Suburban, with special guest, NASCAR (and Chevrolet) driver Jimmie Johnson.
So what happens if the U.S. pulls out of NAFTA? Over the short term, there won’t be a lot of change in factory footprints simply because car assembly facilities have a long cycle time to set up and put into operation. A very few brand new factories might get built in the U.S. instead of Mexico, as we have seen with the Toyota-Mazda facility recently announced for Huntsville, Alabama. And as with other Japanese transplant factories in the U.S., we might see some suppliers set up shop nearby because they are tied to their just-in-time production system.
For facilities that are already in place and running, don’t expect a lot of changes. You can’t just pick up a factory and move it; you also have to relocate the supply chain. Some products just won’t move – nobody in the U.S. wants to build wiring harnesses for cars, so they will have to continue to come from Mexico. Costs will increase as firms start to pay duties on parts or finished vehicles that cross the border, and those costs will have to be passed on to consumers. These are the obvious consequences that have been widely reported.
Longer term the effects will likely be more negative. If auto parts made in the United States become more expensive, manufacturers could choose to buy them elsewhere. For example, consider Toyota’s Tacoma pick-up truck, which is assembled in both the U.S. and Mexico with 65% U.S./Canadian content and either U.S. or Japanese made engines. Tariffs on U.S. made engines destined for Mexico could encourage the company to source more of them from Japan. After all, Mexico and Japan have an Economic Partnership Agreement so the trade barriers in that bilateral relationship are decreasing. Mexico has a network of 14 free trade agreements with 46 countries, which gives it preferential access to 70% of the world’s GDP, and its recent signing of the Trans-Pacific Partnership (TPP) will increase its competitiveness. It’s largest export markets in 2016 after the US were Canada, Europe, Colombia, Asia, and Brazil. Audi’s factory in San José Chiapawill become the sole source of its popular Q5 globally. At the grand opening, Audi chairman Rupert Stadler called it the “an important site for the export of our automobiles to customers all over the world.” 80% of Mexico’s vehicle production was destined for foreign markets, so it is an important opportunity for U.S. based parts makers.