US or Mexico? Japan’s auto industry torn over USMCA

Stringent content and wage rules under the new North American trade deal have forced hundreds of Japanese auto suppliers and material makers operating in the region to reevaluate supply chains, including whether to base future production in the U.S. or in Mexico.

Under the US-Mexico-Canada Agreement, which took effect on July 1, companies must produce 75% of its parts by value in the U.S., Mexico or Canada or face a 2.5% tariff when shipping them to the U.S. The now-defunct North American Free Trade Agreement, or NAFTA, had set bar at 62.5%.

For companies like Japanese parts manufacturer Showa, which sources some materials from Japan and does not meet the new threshold, the guidelines present a conundrum.

“Rather than move production to the U.S., we’ll consider boosting the regional content of our products,” said a Showa executive. The company produces power-steering systems in Mexico and propeller shafts in Canada, most of which are supplied to auto factories in the U.S.

Auto parts usually carry a gross profit margin of 10% to 20%, and additional tariffs could deal a heavy blow to the bottom line. While companies have until 2023 to adjust to the new threshold, Showa at some point will need to boost the regional value content of its products or move production to the U.S. to avoid tariffs.

Showa is not the only Japanese auto parts maker grappling with this dilemma. Sanden Holdings produces about 1.5 million clutches in Mexico, which are then exported to automakers in the U.S.

“Our regional value content is 50%,” a Sanden executive said. “We’ve been reshaping our supply chains since 2018, but we’re struggling to increase the percentage because there are few local companies that can process the materials we need.”

Sanden moved its entire Mexican production of die-cast air conditioner parts — enough for 800,000 vehicles a year — to the U.S. by the end of 2019. “We are continuing to respond to the new trade deal,” said Sanden President Katsuya Nishi.

Wage requirements are another major obstacle under USMCA. At least 40% of any vehicle must be made by workers paid $16 or more an hour to qualify for tariff relief. The rate — which is triple the average wage at Mexican auto factories — is intended to encourage more companies to move operations to the U.S.

While some parts manufacturers plan to increase wages or transfer production, such moves are costly. These companies need to maintain profitability by measuring those costs with a 2.5% tariff.

Steelmakers and other materials producers find themselves in a more difficult position than parts makers. Under the new trade deal, automakers need to procure at least 70% of the steel that they use from within the bloc to qualify for tariff-free trade. Although Nippon Steel and JFE Steel produce automotive steel sheet in Mexico, they import large quantities of materials from Japan.

Nippon Steel’s plant in northern Mexico imports more than 90% of the plates used to make steel sheet from Japan, but it has not taken steps to review its procurement plans recently. Noting that it has not received requests from automakers, a company official said it will watch what clients do now that the USMCA has taken effect.

In March, JFE brought online a steel sheet plant in the central Mexican state of Guanajuato that it built with U.S. steelmaker Nucor. This facility procures plates from Japan as well as from within the USMCA zone. Although it does not disclose specific numbers, it plans to eventually reduce the ratio of procurement from outside the USMCA zone to half.

It is not easy for steelmakers to change where they procure the plates from because there are few steelworks with blast furnaces in Mexico, and quality concerns also exist.

Having the trade deal take effect during the novel coronavirus pandemic also complicates matters. “We were considering moving production from Mexico to the U.S., but that is out of the question now,” said an official at Sanoh Industrial, which exports fuel pipes and other products from Mexico.

According to the Japan External Trade Organization, there are about 1,000 Japan-affiliated companies operating in Mexico, with auto-related companies accounting for 60%, or 650.

Toyota Motor, Nissan Motor, Honda Motor and Mazda Motor all have a presence there.

Another question is whether the administration of U.S. President Donald Trump, which pushed hard for revamping NAFTA, will be in power in January next year. Because of Trump’s push to increase American production, Toyota and others ramped up investment in the U.S.

“If Japanese carmakers plan to continue focusing on U.S. sales, they will have to revamp their supply chains from those best-suited for Mexican production to those best-suited for U.S. production,” said a consultant at Nomura Research Institute.

Companies in the auto sector will face the choice of whether to reorganize their supply chains to suit Trump’s “America First” policy.