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The USMCA: Mexico is open for business

22 May, 2019

Mark Hermans
Managing Director, PwC US
Rajiv Jetli
US Advisory Principal, PwC US
Carlos Zegarra
Partner, PwC US

Global trade has entered a new, uncertain phase. It’s time for manufacturers to reconsider where they build their products and source critical components.

One critical moving piece is especially close to home. Although some commentators may refer to it as NAFTA 2.0, the changes manufacturers will have to undertake to comply with the new US-Mexico-Canada Agreement (USMCA) aren’t just incremental. New regional value content (RVC) rules will require a greater percentage of a finished product’s components must be made in one of the pact’s signatory countries.

While USMCA is not law yet and politics may delay its ratification, the recent escalation of trade tensions between the US and China greatly increases Mexico and Canada’s already-high value as trade partners. Much of the tariffs the Trump administration imposed in 2018 and 2019 hit raw materials and finished goods produced in China, raising the cost to manufacturers of doing business there. Combined with rising wages for Chinese factory workers, tariffs, and the ramped-up RVC and labor-value content (LVC) rules incorporated in USMCA, the world’s most populous country is going to become a relatively less attractive destination for US manufacturers.

And these policy changes are happening against an uncertain economic backdrop. With many CEOs becoming increasingly cautious about the global economic outlook, according to PwC’s 22nd Annual CEO survey, conducted in 2018, reassessing the relative importance of China and Mexico in supply chains and manufacturing footprints makes good sense.

To prosper in this new landscape, manufacturers will need to take a hard look at their supply chains. Relying on China may not be as feasible as in the past, given current political pressures and trade uncertainty. But cost isn’t the only factor. Changes to any supply chain implicate many other business considerations including tax, such as transfer pricing impacts. Planning also may include supply chain changes; mergers and acquisitions; strategic sourcing; and additional pricing negotiations. It is important to conduct an analysis of the company’s current and expected trade and tariff situation using its customs data. It’s becoming increasingly important for manufacturers to be nimble, with customer-centric supply chains that are better able to respond quickly to changes in the market.

From an operations perspective, Mexico is an increasingly attractive option for manufacturers — assuming the USMCA is ratified (or, at the very least, NAFTA continues without modification). That’s because of what we like to call the 4 Cs: cost, capabilities, capacity and closeness. These critical factors come into play in Mexico in the following key ways:

Mexico has a strong manufacturing base. The country’s manufacturing output of $175 billion ranked in the global top 10, according to a 2018 Brookings Institution study. Its automotive sector is particularly strong, leading all exports. Precision machined parts are another area of strength.

Labor is readily available. Unlike in the US, where manufacturers can struggle to find enough skilled workers, manufacturers in Mexico find that it can be much easier to meet workforce needs.

Wages are relatively low. While not as inexpensive as China, labor costs in Mexico remain significantly below those in the US.

Proximity is key. Components manufactured in Mexico can be in American factories and stores for final assembly within days, much faster than parts made in China.

There are also potentially significant tax advantages of which manufacturers can avail themselves. The toll manufacturing business model (that is, maquiladoras) has already proven very effective, and a more sophisticated version could bring significant additional benefits, including significantly reduced tax impact on both the manufacturing and sales component of the business.

Though the opportunities offered by Mexico may be relatively clear, manufacturers who wish to seize them still have much work to do. Given that it can take two years or more to transition a plant to realign supply chains, now is the time for companies to reevaluate their North American manufacturing footprint. There will be many important questions for the C-suite to consider, including total cost, risk, location, and access to skilled labor.

Political risk will remain a key factor to monitor. It is not yet certain that the USMCA will be ratified by Congress. If the deal is not finalized by December, it may be delayed until after the US presidential election in November 2020. Even if the deal is delayed, Mexico’s tax and cost advantages will remain, and the agreement’s ratification will make the movement of goods even smoother. It’s not too soon to begin planning for the new trade landscape the agreement would usher in. With Mexico open for business, it should be a key part of those discussions.