The Future of Site Location Decisions Outside the U.S.
The Trump administration’s desire to impose large tariffs on companies that manufacture overseas and ship products into the U.S. has left more questions than answers — and this protectionist policy is an oversimplification of what’s really at stake.
Since his first tweets in early December indicating that companies will pay a 35 percent border tax if they locate offshore and try to sell their products back into the United States — the President has reiterated the idea on numerous occasions. His tweets have given us much to think about, but given the response from officials in Mexico (and other countries), and from Republican leadership and various industry leaders, we are still left with more questions than answers at this point. In this article, I will explore several interlocking issues that could play a role in influencing site location decisions in Mexico and other locales.
A “Border Tax”
On his first full business day, President Trump reiterated his desire to impose a 35 percent border tax on products that are produced in foreign countries and imported into the United States. Early on, Republican leadership communicated that it will not go along with such a measure. Speaker Paul Ryan (R-WI) and House Majority Leader Kevin McCarthy (R-CA) both indicated in December that they would prefer to lower federal taxes and ease government regulation as a means to improve the United States’ competitive position in manufacturing — as opposed to erecting barriers to trade such as the proposed 35 percent tax. Trump has indicated that he will support a reduction of the top corporate income tax rate from 38 percent to as low as 15 percent and would reduce regulation by as much as 75 percent. Both of these actions would be greatly welcomed by beleaguered manufacturers. Even with these measures, he continues to insist that a 35 percent border tax is both necessary and fair.
Passage of such a tax appears to be far from a done deal at this point, and there are several questions that remain. Does the President have unilateral power to impose such a tax or does he need the approval of Congress? Would such a measure comport with the rules of the World Trade Organization (WTO)? It appears at this point that the U.S. could not impose such a tax without running afoul of the WTO.
With that said, if the tax were to be imposed, the question would then arise as to what portion of a product’s value would actually be subject to the tax. For items manufactured in Mexico, anywhere from 40 percent to 70 percent of the value of the manufactured good is non-Mexican, depending on the product. If the tax is assessed only on the Mexican value added, the cost of the product could be increased by 15 percent to 20 percent. Given that most of the non-Mexican value of products manufactured or assembled in Mexico is of U.S. origin, such a tax could have the unintended consequence of being detrimental to U.S. suppliers.
Further complicating this issue is that some Republican lawmakers are now talking about implementation of a “border-adjusted value-added tax.” This tax could be as high as 20 percent, and presumably would be levied on the non-U.S. value of products and services. The tax would be imposed once an import is consumed in the United States. Many proponents of such a tax concede that it would not boost U.S. exports and, in fact, would increase the prices paid by U.S. consumers. President Trump has already panned the idea as overly complicated.
Dismantling NAFTA and Protectionist Sentiments
On his first business day, the President also signed an executive order to formally withdraw the U.S. from the Trans Pacific Partnership (TPP), an agreement negotiated by the Obama Administration with 11 countries in the Pacific Rim. That same day, he told a group of business leaders that he supported trade, but wanted to bring manufacturing jobs back to the United States. The new President says he favors bilateral agreements over trade deals with multiple nations such as TPP and NAFTA — stating one-on-one agreements would make it easier to effectively deal with individual countries that engage in unfair practices. The President has already communicated with leaders in both Canada and the U.S. that he wishes to renegotiate the terms of NAFTA, specifically stating that Mexico has gained a “one-sided” advantage over the U.S. Combined with his repeated desire to build a wall along the southern border, the message has drawn particular ire in Mexico. In fact, Mexican President Enrique Peña Nieto canceled a meeting with Trump scheduled for the end of January because of the President’s repeated insistence that Mexico would pay for the wall.
The concern for many is that this rhetoric (along with the continued threat of a 35 percent “border tax”) is protectionist in nature, and will ignite trade wars that could lead to another global recession. Mexico and China, in particular, have already signaled retaliation if the Trump administration follows through on the border tax.
With the level of globalization that now exists in manufacturing, it is difficult for any nation to easily address trade imbalances, particularly in individual industrial sectors. Let me illuminate: the United States’ top-10 trading partners (Canada, China, Germany, Japan, Mexico, France, India, South Korea, Taiwan, and the UK) represent 67 percent of all U.S. trade, including 62 percent of all U.S. exports. While the U.S. has an overall trade deficit with nine of these nations (all but the UK), the U.S. has a trade surplus in multiple economic sectors with each one. For example, the U.S. has an overall surplus of trade with Mexico in 16 sectors, including food products, chemicals, plastics, metals, and aerospace products. Regarding China, over half of the $319 billion trade deficit with the U.S. is comprised of consumer electronics and electrical products such as household appliances. On the flipside, the U.S. has significant trade surpluses with China in transportation equipment (both cars and aircraft), as well as agricultural products.
Countries around the world will not likely stand idly by as the U.S. erects barriers to trade. Mexico and China, in particular, have already signaled retaliation if the Trump administration follows through on the border tax.
The automotive industry has received particular attention from the new administration — and the industry has some structural challenges that are not easily addressed. Specifically, the U.S. automotive industry has made billions of dollars of investments in Mexico and other foreign locations that cannot be easily unraveled. Additionally, the industry has a robust mix of both domestic and foreign suppliers. While there are over 100 different car models assembled in the U.S., only eight models have values that are at least 75 percent U.S. origin — and the top five are produced by Japanese automakers Toyota and Honda. The Toyota Camry, manufactured in Georgetown, Kentucky, and Lafayette, Indiana, has more American value than any other car produced in the United States. BMW’s South Carolina facility is the only location that produces the X3, X4, X5 and X6 SUV models — and over 70 percent of production (about 280,000 units) is exported to foreign countries. This makes BMW (a German company) the United States’ single largest exporter of light vehicles. Our policymakers should be mindful of the potential negative impacts on these U.S. facilities (as well as future location decisions) should our actions ignite a trade war.
It should also be noted that the U.S. exported more than $55 billion in automobiles in 2015 (8.2 percent of global exports), representing more than two million vehicles. Additionally, the U.S. has a trade surplus in aerospace with nine of 10 of our top trading partners. Bottom line — while trying to address deficits in individual sectors with these countries through taxes and other barriers, agricultural and manufacturing jobs (including automotive and aerospace) could be at risk in the U.S. as countries retaliate with countermeasures.
Currency Exchange Rates
In recent years, the U.S. dollar has gained strength against most currencies around the globe, making it more costly and creating challenges for the U.S. to attract foreign direct investment. The value of the peso versus the dollar is a particularly double-edged sword.
The peso has lost almost half of its value versus the U.S. dollar since the end of 2014, and almost one third of that devaluation has occurred since the election of Trump last November 8th. The peso stood at approximately 18.5 to the dollar on Election Day, and fell to 19.7 (a 6.5 percent devaluation) within 24 hours. Now, more than two months after the election (January 23rd), the peso stands at 21.4 to the dollar, a devaluation of 15 percent — the largest such 60-day devaluation since late 2009. The decline of the peso has made Mexico more financially attractive to global manufacturers. In fact, manufacturing wages across Mexico cost less in U.S. dollars today than two years ago. Some industry leaders have said that the decline in the peso’s value could sufficiently offset the implementation of a potential border tax.
The other side of this issue is that the declining peso makes it more difficult for Mexican businesses, governmental entities, and consumers to buy goods and services from the United States. Over the past two years, U.S. exports to Mexico have declined by approximately 12 percent in both food and petroleum-related products — and the traditional trade surplus the U.S. has maintained with Mexico in agricultural products has been wiped out in the last two to three years. While it is not the responsibility of the United States to “prop up” the Mexican economy, we must nonetheless understand that a worsened economy in Mexico will increase instability in that country and will almost certainly exacerbate illegal immigration. The U.S. needs an economically healthy Mexico for both immigration and security reasons.
Impact On Location Decisions
Companies are interested in how potential policies of the Trump administration will impact their current offshore/near-shore operations, as well as future decisions for where they may locate manufacturing facilities. While some decision-makers point to the devaluation of the peso as an offset to a potential border tax, others have indicated that a new border tax could materially influence them to reduce Mexican production in favor of adding production in the U.S. We expect that companies will probably decide to hold off on making decisions until such time that specific policies are adopted by U.S. officials. We anticipate that there should be some clarity within the next several weeks and months. Until then, we are left with more questions than answers.
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