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Where is the Auto Industry Headed?

To Mexico, in large part, says Center for Automotive Research analyst Bernard Swiecki. More than on labor cost, Mexico has us beat on trade policy.

Automotive industry analyst Bernard Swiecki says U.S. auto makers are wedged between stricter emission standards and consumer appetite for big cars.

Automotive industry analyst Bernard Swiecki says U.S. auto makers are wedged between stricter emission standards and consumer appetite for big cars.

Bernard Swiecki is an analyst with the Center for Automotive Research, a nonprofit that has provided research for the U.S. auto industry for more than 30 years. CAR experts have frequently participated, along with the Alabama Automotive Manufacturers Association, in the annual Southern Automotive Conference.

Swiecki is the director of CAR’s Automotive Communities Partnership.

The South is continuing to be a focus of automaker investment, but most of the new plant investment is going into Mexico. What is happening in the South is a lot more like what is happening in the North, which has maintained a renewed investment by automakers and growth on the part of the supplier base. 

There has been an under-capacity in U.S. suppliers that is slowly starting to fill in. But with the case being that we are losing a lot of new assembly plants to Mexico, we are losing suppliers as well, certainly suppliers of those components that have to be made near the plant, such as instrument panels and headliners and seats — components that are just-in-time or difficult to ship.

Labor has a lot to do with it, but not as much as trade. There are quite a few automakers, especially European, using Mexico as an export hub. Suddenly Mexico has free trade agreements that are very attractive. They have trade agreements with 44 countries. The U.S. has trade agreements with 19 counties. A more accurate measure is that Mexico has free trade agreements that allow it to export to 60 percent of the world’s GDP. The U.S. has agreements with 14 percent of the world GDP. If an automaker is making a vehicle for export outside of NAFTA, it’s a tremendous incentive (to be in Mexico).

According to our analysis, if you are making a compact car — for which a high percentage of the total cost is labor — you save $674 per car by making it in Mexico, which is a lot of money. But if you are exporting that vehicle to a region where Mexico has a free trade agreement and we do not, the savings is much bigger. There was much press when Audi chose Mexico versus the U.S. for a plant that makes the Audi Q5. If they export it, they save $4,500 per vehicle in tariffs they don’t have to pay, and that’s tremendous.

In the last full year for which we have data, 2014, automakers invested $10.5 billion in the U.S. and $7 billion in Mexico. They basically are just under 70 percent of what we got last year.

Mexico is unique in the world with that many free trade agreements, but the U.S. is missing critical free trade agreements with countries like China, and very importantly, the European Union. 

The U.S.’s resistance to free trade is decades old. NAFTA itself was difficult to push through. Since then we have had free trade agreements with countries like South Korea and Colombia, but not access to Europe like all of Mexico has. If the Trans-Pacific Partnership negotiations are finished like they need to be, the TPP can serve as a model for the Transatlantic Trade Partnership, which is still in the early stages, and it’s too early to say if it has a realistic chance of being ratified. We are clearly behind. 

There are automotive reasons and broad economic policy reasons there is a tendency toward protectionism — the feeling that low cost countries will flood your market and give domestic producers unfair competition. In the automotive industry, the unions are a powerful part of that viewpoint, but it goes much deeper than that. There are decades of U.S. protectionism behind it. 

The union contract (announced in November, between the UAW and Ford, GM and Fiat Chrysler, for a top wage of $29 an hour) will not result in capacity shifts (within the U.S.). The Detroit Three’s contracts are pattern contracts, affecting all their plants in the U.S., so it doesn’t benefit them moving production from plant to plant. 

Right now the market is basically catering to the Detroit Three, with consumers favoring crossover sport utility vehicles and pickups — which Detroit is good at producing — and cheap gas prices. Those are the vehicles the Detroit Three are good at making, and there are plenty of margins to absorb the cost of any inequality in labor cost. Detroit is still disadvantaged (in labor costs) versus the (overseas) transplants, but it’s not as bad as it was a few years ago. 

We’re seeing a gradual shift where the Detroit Three are moving around their North American production base — so that more passenger cars are made in Mexico and more of the U.S. production base is trucks and crossovers. In a way, that’s good. The U.S. is retaining the vehicles with higher labor content and higher content of suppliers. While the economy is good, this will be good for the U.S.

But the concern is that in a few years, the U.S. could suffer a disproportionate volume hit from an economic downturn — certainly more of a hit than small cars. 

Regardless of what the market is demanding, we have the Corporate Average Fuel Economy standards that require certain fuel economy, such that a total company level of 54.5 miles per gallon must be achieved by 2025. Auto makers still have to meet these requirements as demand is being ratcheted up. 

There is absolutely a disconnect between the CAFE goals and the market voice in which the consumer preference is for inefficient vehicles with higher transaction values — at a time when there are very inexpensive gasoline prices. It has created an environment in which the consumer preference is different than that of the government regulations, which the automakers are being required to meet.

This dynamic will just grow more pronounced as we get closer to 2020 (next big target of CAFE) and the regulations are ratcheted up. Just this week, Ford announced it is spending $4.5 billion for development of electric vehicles. This is happening in a market that has, for a second year in a row, a decline in demand for electric vehicles. Whether the market is there or not, the automakers, all of them, are spending billions of dollars to meet the regulations. 

We have a situation where right now we are seeing consumer preference for the most expensive vehicles, with the average transaction value now at $34,000. Consumers are snapping up the more expensive vehicles and taking out seven-year loans. Even with the longer loan periods, the monthly payments are $400 per month. Vehicle spending on big and expensive vehicles, you could argue, is rational in a robust economy with cheap gas prices. But what is happening is that automakers have to meet stricter government regulations while trying to take full benefit of consumer buying preferences. And, with fuel economy and emission standards ratcheted up and vehicles becoming more sophisticated, companies’ central R&D is being strained. More of the local facilities will handle R&D.

Chris McFadyen is the editorial director of Business Alabama.

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