Exploring the US-Mexico Trade Relationship

With the future of NAFTA potentially in jeopardy, we take a closer look at the significance of this relationship and the possible effects of change.

      

 

Summary
With the future of the North American Free Trade Agreement (NAFTA) in question and the potential for new tariffs on the horizon, there is a need to understand the underlying factors that drive the dynamics of the U.S.-Mexico bilateral trade relationship. This is a complex relationship that can best be understood by examining case studies at the national level and evaluating select U.S. states’ economies and their relationships with Mexico as well as the states’ relationships to the federal government. The first of this two-part Deep Dive examines some of the areas where the United States has the upper hand in commodity trades. It also shows that Mexico is in a position to more equally negotiate with the U.S. in the automotive sector.
  • Mexico’s growing dependence on imports to meet domestic gasoline demand, combined with the U.S. being the principal supplier, gives the U.S. strong leverage in this area.
  • Mexico has multiple options for sourcing its steel; therefore, the U.S. cannot exercise much influence over Mexico in this area.
  • Both countries would struggle to replace corn trade, however, given the role of corn in the Mexican diet, shifts in corn trade are much more dangerous for Mexico.
  • The complex, shared production network in the automotive industry puts the two countries on more even footing at a negotiation table in this area. 
Introduction
The trajectory of U.S.-Mexican bilateral relations has come into question with the election of President Donald Trump. He publicly campaigned on the promise of renegotiating or abandoning NAFTA (which has nearly eliminated trade barriers between the U.S. and Mexico) if acceptable terms were not reached. This issue remains at the forefront of U.S.-Mexico bilateral relations, which have become inundated with uncertainties.

The U.S.-Mexico relationship has always been a complicated one. Particularly low points in the bilateral relationship included a war from 1846 to 1848, U.S. seizure of massive amounts of Mexican land and an attack and subsequent seven-month occupation of Veracruz by the U.S. Navy and Marines in 1914. During much of this period in history, the two countries were on relatively equal geopolitical scales. However, while the U.S. catapulted forward in its economic and national development in the 20th century, a multitude of conflicts, internal power struggles and economic crises prevented Mexico from keeping pace with the U.S. The disparity between the geopolitical weight of these two countries grew. For much of the 20th century, the U.S. remained the uncontested power in North America, and in the 21st century, the world’s hegemon.
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With the future of NAFTA potentially in jeopardy, the time has come to take a closer look at this bilateral trade relationship. To evaluate the economic vulnerabilities of the U.S. and Mexico relative to each other, it is necessary to begin by examining the basic fundamentals of their trading relationship. Two dimensions of this relationship require analysis. The first is the U.S.-Mexico relationship at the national level, which will be the focus of this Deep Dive. The second dimension is evaluating the economies of select U.S. states and exploring their relationships with Mexico as well as the states’ relationships to the U.S. federal government. This will be the focus of a future Deep Dive.

In the first installment of this two-part series, we take the opportunity to comparatively study trade advantages between the U.S and Mexico at the national level. Below, we present four case studies on strategic areas of U.S. interest and explain to what degree they will give the U.S. leverage over Mexico, and vice versa, in any future trade agreement negotiations. We do not yet know the final fate of NAFTA, or precisely how changes will arise. However, it appears very likely the agreement will be modified in some way. Through the case studies below, we aim to assess the amount of leverage the U.S. and Mexico would have over one another in the event NAFTA were renegotiated or outright abandoned.
Oil and Gasoline
We begin with a case study of oil and gasoline, which are particularly problematic for Mexico in the bilateral relationship. Mexico is not only losing its economic influence over the U.S. in this area, but it is also increasing its dependence on the U.S. Mexico produces and exports crude oil, and the U.S. is among its destinations. However, Mexico’s influence in this area of the U.S. economy has been in decline since 2003. In that year, U.S. oil imports from Mexico peaked at 1.8 million barrels per day (bpd), accounting for 18.2 percent of all U.S. oil imports. Since then, shipments of Mexican oil to the U.S. have fallen, both in terms of volume and share of total U.S. oil imports. The latest U.S. Energy Information Administration (EIA) figures through November 2016 indicate that Mexico provides the U.S. with 7.3 percent of its imported oil, totaling 573,000 bpd.
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Mexico will not recover this lost space in the U.S. economy any time soon because the U.S. is becoming increasingly self-sufficient with energy production. First, U.S. shale production broke into the U.S. energy market in 2012 and has progressively gained space there. Additionally, U.S. oil production is not currently operating at full capacity, with production expected to increase this year and next. Current EIA estimates put 2017 production gains at 110,000 bpd and 2018 gains at 300,000 bpd. Meanwhile, Mexico’s state-owned petroleum company Pemex continues to experience production declines due to lack of investment, technological constraints, lower well pressure and decreasing revenue. The company’s database shows a continual decline of production from 3.37 million bpd in 2003 to 2.15 million bpd in 2016.

Parallel to these developments is Mexico’s heavy dependence on U.S. imports for refined gasoline. Due to declining production and increasing demand, Mexico has been increasing its gasoline imports. In the last decade, gasoline imports have more than doubled, with Mexico importing 204 million barrels in 2006 and 504 million barrels in 2016. Last year, according to Pemex, Mexico imported 62 percent of its gasoline. Six countries supplied these imports: the U.S., Netherlands, Spain, India, Bahamas, Netherlands Antilles, France and Trinidad and Tobago. However, the U.S. stands out among these suppliers as it provides 81 percent of Mexico’s imported gasoline. This means that roughly half the gasoline consumed in Mexico comes from the U.S., making Mexico highly vulnerable to any U.S. trade barriers that would affect gasoline trade. Ultimately, the U.S. does not need Mexican oil and thus Mexico cannot use control of this commodity to shape U.S. behavior. Conversely, the Mexican economy is very dependent on U.S. gasoline, so any change in the U.S. supply would impact Mexico’s economy and behavior.
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Steel
We have also decided to examine the steel trade since returning steel workers’ jobs to the U.S. was one of Trump’s major campaign promises. The World Steel Association reports that the U.S. produces more than four times as much steel as Mexico while China produces 44 times more steel than Mexico. In general, Mexico is a net consumer of steel and not a net exporter. Therefore, it does not pose a direct threat to U.S. steel workers’ jobs.

According to the U.S. International Trade Administration’s most recent reports, the U.S. exported 6 million metric tons of steel in the first three quarters of 2016, which accounted for 11.3 percent of total U.S. steel production. Canada ranks as the top destination for exported U.S. steel at 51 percent (approximately 3.4 million metric tons) while Mexico ranks as the second largest destination at 39 percent (approximately 2.6 million metric tons). This marks a 5-point decline in Mexico’s share of U.S. steel exports from 2014, just two years prior. Overall, Mexico received only 4.3 percent of total U.S. steel produced from January through September 2016. Its share of total U.S. steel production is small and declining. Although China presents a large threat to U.S. steel production and employment due to its steel surplus, Mexico comparatively does not.
 
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From the Mexican perspective, the U.S. International Trade Administration reports that U.S. steel accounts for 40 percent of Mexico’s total steel imports. Other leading sources of steel for Mexico include Japan (17 percent), South Korea (10 percent), China (7 percent) and Canada (5 percent). Mexico has also established steel trade ties with countries like Brazil, Germany, Russia, India, the United Kingdom and Spain. At first glance, this appears to give the U.S. trade leverage over Mexico in this area. However, the global steel market is currently oversupplied, so Mexico has other available options and can shift steel suppliers if the U.S. imposes unattractive trade barriers. The initial switch in suppliers may incur some short-term costs, but this is one limited area where Mexico enjoys a relatively high degree of maneuverability with potential suppliers.

Agriculture
Mexico depends almost entirely on the U.S. for its imports of both soybeans and corn. Mexico meets only about 10 percent of its soybean needs domestically; the rest is imported. The U.S. Department of Agriculture (USDA) projects Mexico will produce 505,000 tons of soybeans in the 2016-17 season while consumption will be about 4.8 million tons. The U.S. accounts for 93 percent of Mexico’s imported soybeans, with the remaining 7 percent supplied by Paraguay. Mexico ranks as the second largest destination for U.S. soybean exports and received 3.84 million tons of soybeans from the U.S. in the 2015-16 season. This amounted to 7.8 percent of total U.S. soybean exports and pales in comparison to U.S. soybean exports to China, which account for 55 percent of total U.S. soybean exports. In the coming 2016-17 season, the USDA projects that Mexico will import 4.3 million tons of soybeans, about 4 million tons of which will come from the U.S. At the same time, the U.S. is expected to export 55.79 million tons, which would decrease Mexico’s share in U.S. soybean exports to 7.1 percent.

Even in the greater picture of world agricultural trade, the U.S. holds a slight advantage over Mexico in the area of soybean trade because Mexico will encounter more difficulty replacing the U.S. as a supplier than the U.S. will encounter in replacing Mexico as a buyer. While Mexico already imports some soybeans from Paraguay, it would be challenging for Paraguay to replace the U.S. as Mexico’s primary supplier. This is because Paraguay only exports a total of roughly 5.3 million tons of soybeans annually, which is equivalent to only a tenth of total U.S. soybean exports. If Paraguay became Mexico’s sole supplier of soybeans, Mexico would demand three quarters of Paraguay’s export supply – and getting a country to shift that amount of their commodity export is a tall order.
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Mexican farmworkers hoe a cabbage field on Sept. 27, 2016, in Holtville, California. Thousands of Mexican seasonal workers legally cross the border daily from Mexicali, Mexico, to work the fields of Imperial Valley, California, some of the most productive farmland in the United States. John Moore/Getty Images
   
Furthermore, Brazil and Argentina produce 58.4 million tons and 9 million tons, respectively, but both of these countries export about 75 percent of their soybeans to China, whose demand for the crop is expected to continue growing this year. Little would be left over to export to Mexico if trade barriers made it necessary for Mexico to find a new supplier. Overall, global soybean production is not expected to increase dramatically this season, making it more difficult for Mexico to negotiate a share of soybean crops from other providers if the need arises. As for the U.S., 4 million tons of soybeans exported to Mexico is not significant compared to the 117 million tons the U.S. is projected to produce this season. Finding other buyers to absorb the extra 4 million tons would not be terribly difficult, given that world demand is not expected to drop.

When it comes to corn, however, a degree of interdependence exists between the U.S. and Mexico. As with soybeans, Mexico relies on imports to meet its corn consumption needs as it only produces enough domestically to meet about 63.3 percent of its needs, according to the International Grains Council. The USDA projects Mexico will produce 24.5 million tons of corn in the 2016-17 season while consumption will be approximately 38.4 million tons. Therefore, Mexico will need to import a significant amount of corn. The U.S. supplies 97 percent of Mexico’s imported corn, and the remaining corn imports are sourced from Brazil and Argentina. Mexico ranks as the leading destination for U.S. corn and received 13.58 million tons in the 2015-16 season. This amounted to 26.5 percent of total U.S. corn exports.

In the case of corn, the U.S. holds a great amount of leverage over Mexico. In part, this is due to the U.S.’ share in Mexico’s corn imports; it is also due, in part, to the importance of corn in the Mexican diet. In the 2016-17 season, the USDA projects Mexico will import 13.8 million tons of corn, of which about 13.39 million tons will come from the U.S. At the same time, the U.S. is expected to export 56.6 million tons, decreasing Mexico’s share of U.S. corn exports to 23.7 percent. Though feasible, it would be challenging for the U.S. to replace Mexico as a buyer of its corn and for Mexico to replace the U.S. as a supplier of its corn given the high volumes involved.
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Mexico currently imports 261,956 tons of corn from Brazil and 12,557 tons from Argentina annually. Unlike with soybeans, which both countries export primarily to China, Brazil and Argentina, corn exports are destined for more diversified markets. No single importer accounts for more than 16.6 percent of Brazil’s corn exports and 14.4 percent of Argentina’s. Therefore, there is space for Mexico to negotiate a share of these exports. The USDA also projects that Russia and Ukraine will see a boost in corn production in the 2016-17 season that will translate into exports. If Mexico began to import its corn from other sources, the U.S. would also need to look to multiple markets to fully absorb the 13.8 million tons of corn that would no longer be exported to Mexico.

The prominence of corn in the Mexican diet tips the scales and gives the U.S. more leverage over Mexico when it comes to corn. Corn is considered a food grain, rather than a feed grain, in Mexico, meant largely for human consumption. Corn serves as a major food staple in Mexico, especially among the poor. As observed in 2007, the country is very sensitive to volatility in corn prices or speculation on supply. This can cause severe economic disruptions and hardships in households and business across the country. In the past, this has resulted in unrest and protests. For this reason, Mexico needs a secure, steady corn supply. Any threat to the stability of the corn supply becomes a strong vulnerability for the country.
Automotive
We now move to a more complex and sophisticated area of the U.S.-Mexico bilateral trade relationship: the automotive industry. The first three cases examined simple commodities. The analysis in those cases is relatively cut-and-dry based on supply and demand. The automotive industry, however, is much more complex and involves a high degree of value-added components. In this space, production requires extensive supply chains, multiple assembly phases, importing input materials and exporting the final product to the market. Therefore, this case study will be fundamentally different than the previous three.

The automotive industry plays an integral part in both the American and Mexican economies. Mexico is currently the seventh largest vehicle producer in the world, and the automotive industry accounts for 3 percent of the country’s GDP, according the U.S. Department of Commerce. In the U.S., the automotive parts industry directly employs 871,000 people, according to a recent report by the Motor & Equipment Manufacturers Association. This accounts for 2.9 percent of total U.S. jobs and 2.4 percent of U.S. GDP. Including indirect and employment-induced jobs, the automotive parts industry impacts an estimated 4.26 million jobs in the U.S.

In this case study, we make an important distinction between finished vehicles and automotive parts. The U.S. does not export a substantial number of finished vehicles to Mexico, but it does export a large volume of automotive parts. In 2015, the U.S. Department of Commerce reported that $81.1 billion worth of U.S. automotive parts were exported to the rest of the world, of which $30 billion were exported to Mexico. This represents 53 percent of all Mexican automotive parts imports and 38 percent of all U.S. automotive parts exports. However, Mexico also exported parts to the U.S., and these exports were valued at $50 billion. This is almost triple the value of Mexico’s next largest auto parts export market, Canada, which received $18 billion in auto parts in 2015. Mexico’s automotive parts industry is highly vulnerable to U.S. trade behavior while U.S. exposure to Mexico in this area is comparatively less.

Creating further U.S. leverage over Mexico is the fact that Mexico is highly dependent on the U.S. as an export market for completed vehicles. Of the 3.4 million light vehicles produced in Mexico in 2015, 2.8 million were exported, and the U.S. received 2 million of these exports. The U.S. market accounts for 72 percent of Mexico’s light vehicle exports and 59 percent of Mexico’s total light vehicle production. Mexico’s next largest export market, Canada, is significantly smaller and accounts for 10.5 percent of exports or 8.5 percent of total production. Additionally, a large portion of Mexico’s foreign direct investment (FDI) comes from the U.S. The U.S. contributed to 53 percent of Mexico’s $28 billion of FDI in 2015, according to a study by the Wilson Center. The automobile industry was the top recipient of U.S. FDI in Mexico, receiving about $6 billion. This amount of FDI would not be replaceable overnight, thus giving the U.S. more leverage over Mexico in the automotive trade relationship.

However, the vertical production chain shared by Mexico and the U.S. does create a scenario in which it may be in U.S. interests to continue trade and integrated production with Mexico in the automotive industry. It is difficult to break down the exact percentage of U.S. imports from Mexico that have parts of U.S. origin by industry because many components cross over the U.S.-Mexico border multiple times before the finished product is assembled. This is due to the specialized skill sets and competitive advantages that each country has in particular assembly steps. However, a paper published by the National Bureau of Economic Research in 2010 suggested that 40 percent of all imports to the U.S. from Mexico have parts of U.S. origin.
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Even if a tariff was placed on Mexican imports, one could argue it would still be more cost-effective for U.S. companies to import completed vehicles from Mexico rather than restructuring the supply chain since Mexico still has some competitive advantages, such as lower labor costs and extensive infrastructure connectivity with the U.S. At the end of the day, however, a tariff is really an indirect tax that will affect the bottom line for U.S. companies. Depending on the level of these tariffs, U.S. companies may see reduced profits. The potential repercussions include fewer jobs and higher prices on finished goods, which would be felt by the American lower and middle classes.

The U.S. could also redirect its auto parts exports to the next largest vehicle manufacturer, China, but that is not necessarily the most viable option as U.S. exporters would face a separate series of Chinese tariffs. Reorganizing entire supply chains in a process as complex as automobile manufacturing is extremely difficult. Unlike grains – where you can find another supplier and buy the finished product as-is – there are many more costs and complicated logistics involved with revamping the automobile supply chain. Suppliers must have the workforce with sufficient expertise and technology to carry out their part of the process. This production is also dependent on factories, meaning that facilities must be located and properly outfitted for the specific production activity. The complexities of the production process make it difficult and costly to totally restructure. In this sense, Mexico and the U.S. have a type of mutual dependence on one another. Neither can break away from the other without incurring dramatic costs and threatening the livelihood of its automotive industry.
Conclusion
The three commodity case studies (oil and gasoline, steel, and corn and soybeans) illustrate that the U.S. and Mexico have an asymmetrical relationship with the U.S. being the stronger player. An exception is the case of the automotive industry, where closely integrated supply and production chains have resulted in an interdependence that is hard to break without suffering economic losses during the transition process. On a whole, when it comes to the bilateral trade relationship at the national level, the U.S. holds a much stronger hand at the negotiation table. When examining only the national level of the U.S.-Mexico bilateral trade relationship, it appears that Mexico will lose out if NAFTA is dissolved or significantly altered. However, this does not mark the end of our analysis as there are still reasons for Washington to avoid aggressively pursuing the reintroduction of trade barriers against Mexico. In our next Deep Dive, we will look at the cross-border trade of select U.S. states’ economies and their relationships with Mexico.

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