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  November 30th, 2017 | Written by

NAFTA: Mexican Economy Faces Disruption No Matter What

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  • Mexico is in a tough spot when it comes to the renegotiation of NAFTA.
  • If NAFTA negotiations fail, the Mexican economy will shrink
  • Mexico may be in for trouble even if NAFTA survives.

Mexico is in a tough spot when it comes to the renegotiation of NAFTA. If the negotiations fail and NAFTA goes away, the Mexican economy will shrink, by anywhere from 2.6 percent, according to the Spanish bank Santander, to four percent, according to Moody’s Investors Service.

But Mexico may be in for trouble as well even if NAFTA survives. One of the main issues being pressed by the United States in the talks involves rules of origin. Those rules specify what proportion of regional content is required for a product to receive tariff-free treatment. For autos, 62.5 percent of its value must be produced within NAFTA to be imported tariff-free to the US from Canada or Mexico. Ratios of regional content vary from one product to another.

The US is trying to tighten up those rules during the negotiations, possibly requiring more North American and US content, and that’s where, Mexico may find itself in a pickle, if the parties agree to the US proposals.

For companies to prove they have the necessary regional content in their products, they must document the origin of parts used in production. This requires administrative costs and promotes inefficiencies, both of which would increase if the required content share rises.

The rationale for tightening content requirements tighten is that it would incentivize more trade within NAFTA. Car makers would presumably favor more expensive NAFTA auto parts over cheaper components from Asia in order to meet the content standards. But if the regional content requirement increases, there may come a point when it becomes cheaper to import parts from outside NAFTA and pay the tariff on the assembled vehicle.

At that point, a vehicle manufactured in Mexico would be hit with the same tariffs as cars imported from Asia and Europe and a competitive advantage for Mexico would go down the drain. Automakers might question whether Mexico is the best place for production.

That Mexico is concerned by NAFTA developments is evident from the fact it is exploring other trade avenues. Mexico is importing more corn from Brazil and Argentina, for example, while the US is still its major source. Look for more of these trading alternatives if it starts to looks like NAFTA will be going down the tubes.

On the bright side, half of Mexico’s exports to the US would still cross the border tariff-free even without NAFTA. But Santander forecasts is that export and import volumes would fall by 15 to 16 percent if NAFTA dies.