INSTITUTE OF MANAGEMENT STUDIES, BANARAS HINDU UNIVERSITY

A minor project report on

“Impact of USMCA in the Automotive Sector of Canada, Mexico and the United
States”

Submitted In Partial Fulfillment of the Requirements

For the Degree of

Masters of Business Administration

In
International Business (MBA- IB)
(2018-2020)

Submitted By Under the Guidance of

Raghupatruni Revanth Dr Amit Gautam

MBA - IB (Sem- II) Associate Professor
18423BIB033 IM (FMS), BHU
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 CANDIDATE’S DECLARATION

I hereby declare that the work presented in this report entitled “Impact of USMCA in
the Automotive Sector of Canada, Mexico and the United States” in fulfillment of
the requirement for the award of the semester II of Master of Business Administration
(International Business), submitted in Institute of Management Studies (BHU),
Varanasi.

It is an authentic record of my work carried out during my semester under the

guidance of Dr. (Prof.) Amit Gautam. The work reported in this has not been
submitted by me for award of any other degree or diploma

Date - 10th November, 2019

Place - Varanasi (Raghupatruni Revanth)

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 CERTIFICATE

This is to certify that the Project work entitled “Impact of USMCA in the
Automotive Sector of Canada, Mexico and the United States” submitted by
Raghupatruni Revanth in fulfillment for the requirements of the award of Master of
Business Administration Degree in Institute of Management Studies, BHU Varanasi
is an authentic work carried out by her under my supervision and guidance. To the
best of my knowledge, the matter embodied in the project has not been submitted to
any other University / Institute for the award of any Degree

Date : Dr. Amit Gautam

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 ACKNOWLEDGEMENT

It gives me tremendous pleasure in acknowledging the valuable assistance extended to

me by various personalities in the successful completion of this report. As a part of
curriculum for MBA (IB), I have undertaken project study on the topic “Impact of
USMCA in the Automotive Sector of Canada, Mexico and the United States”.

I sincerely acknowledge my indebtedness & gratitude to all those who have helped
me for completing this project work with their guidance, information and
encouragement.

I would like to convey my sincere thanks to my esteemed guide Dr. Amit Gautam for
his guidance and sustained support in helping me to complete my project.

Raghupatruni Revanth

(MBA IB)

2nd Semester

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TABLE OF CONTENTS

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Abstract

One of the major FTA signed that led to a tremendous change in the world trade is
NAFTA which came into force on January 1st, 1995 and involved three countries
namely Canada, United States and Mexico. After twenty three years of its
implementation, the United States observed certain drawbacks in the current
agreement and started negotiations for certain changes in the current FTA and after a
mere discussion of three years, the representatives of three countries got to sign a new
deal and got to dissolve the existing NAFTA where certain modifications were made.
When it comes to the automobile sector, many changes have taken place when
compared to that of the previous agreement where the major changes included the
local content requirements of the manufactured vehicles and the minimum wage. The
existing minimum wage levels and also the content requirements doesn’t seem to
support the growth of Mexico in the automotive sector where this paper analyses the
variables that are going to effect the automotive sector with change from NAFTA to
USMCA and also the companies behaviour with the change.

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Introduction

After the negotiations that got to carry about 13 months, all the three countries that
were involved in FTA namely the United States, Canada as well as Mexico got to
declare that they called off the existing trade agreement and instead they decided to
come up with a new one with many updated norms and named it USMCA where the
letters of the FTA stands for the three countries involved in it. President Donald
Trump mentioned that “USMCA is a great deal for all three countries, solves the
many deficiencies and mistakes in NAFTA, greatly opens markets to our farmers and
manufacturers, reduces trade barriers to the U.S. and will bring all three Great
Nations together in competition with the rest of the world.”

The officials shafted the purpose of USMCA is as to promote the interests of trade of
the United States in the continent and then mark its presence in the global
environment and then enhance the best business and trade culture for the development
of the country.

1.1 Differences between USMCA and NAFTA

The following table mentions the differences in provisions in NAFTA and USMCA
across various sectors

Category USMCA NAFTA

Dairy USMCA requires Canada Initially, the import quotas

to make its dairy market were in play in Canada
open for US farmers to where their dairy farmers
trade and sell milk and this were actually taken care
happened after a lot of
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 negotiation by US as it of.
could be highly benefited
from it.

Disputes According to the new FTA Earlier the system is quite

deal, Chapter 11 of the different where Chapter 11
rules gets to settle the comes into play if there’s
disputes between that of any sort of dispute
United States and Mexico between the government
while chapters 19 as well and the FTA. Issues such
as 20 gets to settle the as dumping of goods in the
disputes involving Canada home country as well as
and United States. imposing subsidies are
actually taken care by the
chapter 19. If there’s any
dispute that is arising
between countries, it is
chapter 20 that comes into
play.

Currency In this new deal a currency No currency chapter

chapter was included provision is actually
where it actually prevents included in that of the
the three countries to existing FTA where the
prevent intentional business executives always
devaluation of currencies find a way to eliminate the
where it is mentioned that risk while transaction of
the currency exchange is various currencies.
actually governed by the
existing market
system. However it can be
seen that all the nations got
to follow free floating rate

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 and this wouldn’t make
much of a difference but
there’s is a possibility that
it could give an advantage
of leverage of US with
countries such as China.

Sunset Clause Initially, the United States Sunset clause wasn’t

pressurized the present in the existing
government fora sunset FTA where on the interest
clause, where NAFTA can of the partner anyone can
actually be killed after five withdraw by giving a
years. So after a lot of notice period of 6 months.
negotiation, a term of 16
years was settled to that of
the sunset clause
mentioning that the
problems of the USMCA
have to fixed every six
years.

Automotive Industry In the new deal, it has been The existing FTA or the
mentioned that the FTA in play mentions that
automotive manufacturers the car has to be
must atleast make sure that manufactured atleast 62.5
atleast 75 percent of it is percent in the home
manufactured in the region country to keep it away
to keep it away from the from the tariff barrier. In
tariff barrier. Also it is the earlier deal, there was
mentioned that atleast $16 nothing mentioned about
of the wages have to be the minimum wage deal all
provided for the workers in all.

Intellectual property There is certain amount of Initially, it was 50 years in

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protections and digital liberalisation where the the terms beyond the life
trade provisions copyright life is indeed of the author that a
increased from 50 to 70 copyright is valid and for
years on the whole. certain drugs, the period is
Guarding rights for various actually 8 years.
essential medicines were
also done here, and for a
particular category of
drugs, the term extended to
10 years from 8 years
where the motto is to
safeguard the medicines
from falling into the
competition bracket all in
all.

In terms of International trade, the new FTA requires its members to

 Consider the Patent Law before ratifying or acreding it on the whole

 Follow as well as maintain the standards that are set by the Patent Law Treaty.

The Economic Action Plan 2014 (Act 2, Statutes of Canada 2014, Chapter 39) has
many plans listed which have to be enforced under the Treaty of Patent Law and they
haven’t been implied yet and proper plans mmust be taken to make sure that they
come into existence soon.

Patent term adjustment for unreasonable granting authority delays The USMCA
specifies that a party will provide for a patent term adjustment to compensate for
patent office issuance delays. Patent term adjustment may accrue if the patent is
issued more than five years from the date on which the application is filed or three
years after examination is requested, whichever is later.

Initially for the patent term, United States has the provision for twenty years but the
new treaty gets to dismantle the Canadian existing laws.
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Under this provision, Canada was given a time of about four and a half years to
implement it and Canadian representatives agreed to it.

For all the rest of the changes made, Canada must get to implement the changes
within five years of the date on which the USMCA enters into force.

1.2 Impact of NAFTA in US automotive sector

It has to be understood that the automotive sector of North America has become one
of the thoughts to ponder over for the United States.

When you consider the HS data code 8703, the trade deficit of the United States rose
to $126 Billion where the imports were about $180 billion while the exports could
only manage upto $54 billion. This resulted to the US interference in the current
NAFTA scenario.

1.3 USMCA provisions in the Automotive sector

The major changes that took place in USMCA when compared to that of NAFTA are

1. The existing FTA required the manufacturers of the passenger car vehicles to use
use the parts manufactured in North America atleast 62.5 percent not the barrier is
increased to 75% under the effect of USMCA and this is indeed done with an aim to
induce the automakers to use more of the parts produced in North America for the
betterment of the region’s auto industry as well as to skip the trade barriers within the
FTA region.

2. The USMCA also mandates that automakers manufacture 40% of their motor
vehicles in facilities where assembly workers are earning at least US$16 an hour.
While average wages are even higher than that for auto assembly workers in Canada
and the U.S., they are not in Mexico, where a number of U.S. automakers have shifted
production in recent years to take advantage of the lower costs.

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3. According to USMCA, it is implied on the Mexico workers that they get to form
collective bargaining units and with that they can establish a union based management
environment on the whole.

4. This new agreement also guarantees Canada as well as Mexico from the United
States that there wouldn’t be any sort of future potential tariffs that are to be imposed
on that of the automakers of the two countries and in particular this law referred to the
passenger vehicles that are manufactured in the United States and then export it to the
United States, Also this law referred to that of the auto parts as well manufactured in
the two countries.

1.4 Provisions related to rules of origin of various automotive goods

Initially, the new agreement focused vigorously on defining the class of the
automotive good that is to be looked at.

Advanced Technology Vehicle (a) According to the rules of USMCA, it is nothing

but an electric vehicle or propulsion vehicle or a series hybrid vehicle (b) a vehicle
that is autonomous and follows the code 8703 and 8704 and this is in accordance with
the class 4 or class 5 subcategory all in all.

Heavy truck is nothing but a vehicle that gets to possess the 8701.20, 8704.22,
8704.23, 8704.32, 8704.90, or 8706,51 and it is not applied for a vehicle that is not in
use as of now on the whole.

Light truck follows the subheading of 8704.21 or 8704.31, and even off road used
vehicles aren’t considered in this regard

Marque isn’t a vehicle but rather it’s trade name that is used by the vehicle
assembler; where he gets to use the model line that includes a group of vehicles with
the same chain or model name.

Motor vehicle assembler means a producer of motor vehicles and any related
persons or joint ventures in which the producer participates; new building means a
new construction, including at least the pouring or construction of new foundation and

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floor, the erection of a new structure and roof, and installation of new plumbing,
electrical and other utilities to house a complete vehicle assembly process;

Passenger vehicle follows the HS code of 8703.21 through 8703.90 but it is actually
not applied for (a) a vehicle with a compression-ignition engine classified in
subheading 8703.31 through 8703.33, or a vehicle of 8703.90 that possesses both
propulsion by motor as well as that of the compression ignition engine;

(b) a motor vehicle that has either three or four wheels;

(c) vehicle used in terrains or

(d) a terrain or even a motor home..

Under the provisions of USMCA, it is mentioned that the total content requirement is
indeed carried out or calculated on an average basis of each fiscal year on every
producer and indeed he got to use any one of the following categories, on the basis of
either all motor vehicles in the category or only those motor vehicles in the category
that are exported to the territory of one or more of the other Parties:

(a) the same model line of motor vehicles in the same class of vehicles produced in
the same plant in the territory of a Party;

(b) same category of vehicles that are indeed produced in a same manufacturing plant
all in all.

(c)either in the model line which is same or should be in the same class of products
defined

(d) any of the other model that is decided by the parties

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Literature Review

NAFTA indeed had a significant impact not only on the countries involved in it
namely Canada, USA and Mexico but also on the enitre world. Especially in the
automotive industry, the three countries saw a tremendous change than what was
before. Belem I Vasquez Galan, Olajide S Oladipo(2009) in their research work
analysed the significant impact of the liberalisation of trade and also the capital inflow
in the form of foreign direct investment in the country on the real growth. With the
aid of econometric approach where the use of certain time series analysis tools got to
blurt out the fact that exports is the main reason why Mexico has been growing and
this is indeed a proof of export led growth paradigm on the whole. Another result that
came out as a result of this research is that there is no impact of the foreign direct
investment on the output of the country where they observed that the foreign direct
investment is taking place only because of that of NAFTA and it individually hasn’t
contributed. So, with the evidence he proved that the growth of Mexico is mainly due
to NAFTA which is also allowing Foreign Direct Investments to flow inside the
country.

Ketharina Mariel, Stefan Minner (2015) got to analyse the impact of set duties and
drawbacks of NAFTA on all the three countries involved in it. The outcome of their
research actually got to provided what are the ways in which practical networks in a
strategic form can be built with the rules of NAFTA so that the organisation can get to
maintain economies of scale. Also the result analysed what is the financial implication
of the duties and how the production network has to be manufactured based on that.

Ketharina Mariel, Stefan Minner (2017) understood the available ways about the
local content requirements that NAFTA countries should hold and presented a model
based on that. Also they got to consider the impact of the exports as well as imports
on the products who failed to meet the local content requirements and pay the duties
and through their research they found out that the fixed costs of a manufacturing unit

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gets to play a major role in meeting the local content requirements set by the rules on
the whole and also they mentioned that this should be in accordance with the plant
utilisation as well. They used the method of Benders decomposition as there is a non
linearity in the mixed integer and they also used the feedback system to improve the
efficiency levels on the whole. The result showed that the run time can be improved
significantly than when piecewise integration is used. In the analysis part, they
mentioned about the local content requirements of NAFTA and also the various
methods that can be used in order to calculate the local content requirement between
the products and also they got to compare the methods. Usage of computational
methods showed the efficiency with which Bender’s decomposition technique
actually works.

Sherman Robinson, Keren Thierfelder (2018), got to analyse the after effects if the
existed any trade war between Mexico, Canada and USA where Mexico and Canada
get to form a FTA region where US will be on the other side. It mentioned that if such
a possible scenario happened, there is a huge chance that the United States will get to
impose tariff duty of 25% on the imports from Mexico and Canada and also the other
two countries get to reciprocate it and they don’t imply the trade restrictions on each
other. He analysed that there could be a case of severe unemployment in Mexico
where about 8 million jobs are lost. Also the real exports get to decline in Mexico by
9% as the United States is is the prime source of its exports which account upto 72%
and even if Mexico gets to strengthen its trade o all the Latin American countries, it
wouldn’t be a success to compesate that of the loss in trade of that with the United
States. Here, US has also a considerable effect where the real exports of the country
will decline with both the NAFTA countries as well as non NAFTA countries all in
all. Also in the long run, Mexico as well as Canada would indeed be involved in free
trade with the European Union as well as various other countries in the world and
with this, there is the possibility of the disintegration of North America. If such a
scenario takes place, United States will get to become more and more protectionist
where it would have the smallest decline in the real output. Canada and Mexico will
have a greater decline in the real output. The conclusion of this research is that though
US can get to become more isolated in the global economy if NAFTA is totally
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dissolved where Canada as well as Mexico seek FTAs with other countries,
dissolution of NAFTA will have a significant effect in the countries of Mexico and
Canada than that of United States. They even concluded that both trade war and
dissolution of the agreement get to have a negative impact on the countries where the
dissolution has a more significant impact all in all.

Dan Cuiriak, Lucy Cuiriak, Ali Dadkhah, Jingliang Xiao got to quantify the trade
as well as the economic impacts of NAFTA where they considered three scenarios for
it, the first one suggested what if United States withdraws from NAFTA and the
second one suggested only Canada and United States were part of NAFTA and the
third one suggested the dissolution of NAFTA where in all the three cases it was
found that Mexico was the country which got to be affected a lot followed by Unityed
States and then followed by Canada where the major influence of it on the global
economy is done is when NAFTA is totally dismantled.

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Problem Statement

With the change in the labour laws as well as the content requirements of the new
NAFTA policies especially in the automotive sector, it is indeed a question for the
companies in order to identify the automotive sectors whether a shift in the business
to the United States is profitable where the raw material is highly available in the
United States or would the shift in the setup still leads to have a negative impact on
the manufacturing companies on the whole. Also what is the implication of other
factors such as exchange rate while considering the shift.

Objectives

1) To find the impact of the labour laws combined with the change in content
requirements of USMCA with respect to Mexico and analyse the possibility of shift in
business

2) To examine the impact of USMCA on the strength of the Mexican Peso in the
recent times.

Research Design

1) The research design is quantitative and also descriptive in nature. Secondary data
has been collected from various sources.

2) Journal Papers, Trade Statistics and the exchange rate fluctuations were the sources
of the secondary data.
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3) The basic mathematical model of finding the Present Value of Annuity is used in
examining the overall cost incurred.

Findings

As per the minimum wage laws and market scenario, it is observed that the current
market wage for the automotive sector of Mexico is $7.84 while in Canada and the
United States it is $20. According to USMCA, the minimum wage requirement is $16
and it is implied that Mexican manufacturing companies should increase the wage to
that extent.

Also from the “Center for Automotive Research, Canada”, it is estimated that the
labour cost is about 4.2 % of the total price of the vehicle where the margin actually
reads about 10% for a normal passenger vehicle.

Also from the BCG Journal, it is seen that about 40% of the vehicles manufactured do
not follow the new content requirements in Mexico

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Figure 1 Non compliance units produced in Mexico

Sample For the simplification purposes, a passenger vehicle plant located in

Cuautitlan Plant, Mexico is considered which Is known to produce 61,000 Ford Fiesta
cars a year. Ford recently named a similar plant manufacturing Ford Fiesta in United
States and got to invest $1.6 Billion in the project. So the cost of set up of a similar
plant in United States is the same.

Assumptions

1) All the other factors except the change in wage rates as well as the content
requirements are fixed.

2) There is no inflation prevailing

3) There are no currency fluctuations and exchange risk

4) Salvage Value of the Mexican Unit is zero

5) Price of Ford Fiesta is uniform = $14,000 and the markup value on price is 10%

6) Market Wage rate of Mexico at present is $8

7) The overall values of 4.6% of the price is labour cost and 40% of the produced
units do not comply with the content requirements is to be taken same.

8) The tariff duty on the non-compliance unit doesn’t change and is 2.5%

9) All the cars produced were exported to United States

10) The average value of interestrate prevailing in Mexico is 7.5%

Calculation

Given 40% of the cars in Ford Fiesta plant do not confirm to the current COO
requirements

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= 40% of 61,000 = 24,400 cars

Cost of producing one car = Price - Markup value

= $14,000 * 90/100 = $12,600

So the total tariff duty to be paid by these cars in order to export it to United States

= Total Value of Each Car * Number of cars * percent of Tariff Duty

= $12,600 * 24,400 * (0.025)

= $7,686,000 per year

Initial Cost of Labour per car produced = $0.046 * 61,000 * $14, 000

= $39, 284,000

Since the labour wage is doubled increase in labour cost will be 100% which means
increase in labour cost is also $39, 284,000

Total Per Year Increase in cost = Increase in Content Tariff Cost + Increase in Labour
Cots

= $39,284,000 + $7,686,000

= $46,970,000

From the perspective of Ford, the present value of similar plant to be set up there is
$1.6 Billion.

Increase in annual cost in Mexico of Cuautitlan Plant = $46,970,000

Using the future value of annuity formula, estimating the number of years that equals
the future value of setting up new plant.

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$46, 970,000 [(1+0.075)n -1]/0.075(1+0.075)n = $1,600,000,000, where n = number
of years

On solving we get n = 16.98 years which is almost equal to 17 years

Exchange rate fluctuation observation

Though the value is based on the assumption that exchange rate is constant, it can be
mentioned that the scenario is hypothetical where exchange rate is not constant and
observations account for the same.
Declaration that NAFTA can be dissolved anytime soon- 9th June 2018.

Exchange rate reversed the direction from strengthening Mexican Peso to Weakening
it. Within one month the Mexican Peso fell from 18.48 to 20.4561 per dollar.

USMCA signed Date - November 30, 2018

Similar Trend as above was observed where the Mexican Peso fell to 20.24 pesos per
dollar. This shows that Mexican Peso was being affected with USMCA.

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Limitations

Since the project is carried out under certain assumptions due to dearth of certain
private data, there are certain limitations concerning this project

1) Exchange rate fluctuations can affect the cost and exchange risk isn’t considered.

2) Normalising the cost for every car wouldn’t be in the same basis and for certain
cars labour costs might be more and for certain costs labour costs might be less.

3) Impact of change in wages in the United States is neglected

4) All the other factors of USMCA aren’t considered.

5) Comparitive advantage and customer demand due to increased cost neglected.

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CONCLUSION

From the laws of USMCA, it can be observed that there is indeed a sunset clause in
play which can dissolve USMCA after 16 years as well. Since from the NPV analysis,
we observed that the variable cost increased per unit in Mexico would be equal to the
cost of shift in the United States after 17 years, if the manufacturers decide to see
beyond 17 years, they could go for immediate investment but would be highly risky
as after 16 years, USMCA can remain or can be dissolved as well. So, if the short run
goals are considered there need not be any shift from manufacturing in Mexico but
there’s a chance that high wages could trigger certain amount of unemployment in
Mexico. However with the increase in costs, the overall cost of production increases
decreasing the profitability of the company. Also investors should consider the
exchange rate fluctuations as well in this scenario.

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References

1) Belem I Vasquez Galan, Olajide S Oladipo(2009),

Have liberalisation and NAFTA had a positive impact on Mexico's output
growth?
Journal of Applied Economics Volume 12 (May 2009), pp. 159-180

2) Ketharina Mariel, Stefan Minner (2017),

Benders decomposition for a strategic network design problem under NAFTA
local content requirements
Omega Institutional Journal Volume 68 (2017), pp. 62-75

3) Sherman Robinson, Keren Thierfelder (2018),

NAFTA collapse, trade war and North American disengagement
Journal of Policy Modeling Volume 40 (May-June 2018) pp.614-635

4) M.E. Burfisher, S. Robinson, K. Thierfelder

The impact of NAFTA on the United States
Journal of Economic Perspectives, 15 (1) (2001), pp. 125-144

5) Ciuriak, L. Ciuriak, A. Dadkhah, J. Xiao

The NAFTA renegotiations, what if the US walks away?

C.D. Howe Institute Working Paper (2017)

5) Office of the United States Trade Representative

https://ustr.gov/trade-agreements/free-trade-agreements/united-states-mexico-canada-
agreement

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