China’s Latin American Ground Game and YOUR Business

Increasing enmity between China and the West, stemming from China’s increasingly aggressive actions regarding Taiwan, China’s COVID-zero policy and a whole host of other issues have caused foreign companies that do business in or with China to reassess. See Nancy Pelosi’s Visit to Taiwan is Really Bad for Your China Business and Sourcing Product From China Just Got Even Riskier.

With all that has been happening, the international manufacturing lawyers at my firm have been seeing an uptick in phone calls and emails from companies looking to leave China. Most of these companies want to know more about Mexico. Some of these companies are actually Chinese and Taiwanese.

I asked my good friend Andrew Hupert to explain what is involved in moving manufacturing from China to Mexico, in large part by comparing the two countries. I chose Andrew for this near-Herculean task because he has spent so much time in both countries navigating their manufacturing systems from the inside. My law firm frequently consulted with Andrew when we first started doing China legal work in a big way and at that time Andrew was living in China. Though Andrew had for decades tied his life and career to China, like me, he was one of the early proponents of a post-China manufacturing world. So much so that Andrew moved to Mexico, reinvigorated his Spanish language skills and began helping companies — especially companies looking to leave China — navigate Mexico. Who better, then, to write about what it takes to leave China (in whole or in part) for Mexico than Andrew Hupert?

Andrew has already written the following five posts on the differences between China and Mexico manufacturing, and I urge you to read all five of these:

The below is unofficially part six of what has become a long-running series, with no end in sight. This episode deals analyzes how China’s actions in Mexico and in Latin America as a whole could impact YOUR business.

Over to Andrew for (the unofficial) part 6. . . .

 

China is responding to its ongoing tension with the U.S. and EU in some surprising ways – including setting up manufacturing and distribution hubs in Mexico and increasing its involvement in Latin America. What does this have to do with your business? More than you think.

1. The End of the Story First

Chinese manufacturing is definitely coming to Mexico, probably. The first wave of Chinese (and Taiwanese) tariff-avoiders are already setting up shop, with mixed results. The second wave of supply chain shifters and brands targeting U.S. markets MAY already be starting. Chinese producers like Hisense, though not national champions, have the heft to attract upstream suppliers and extend distribution networks. But the potential (yet mostly unforeseen) consequence is that Chinese tech, management, resources, and market access will change the way Latin America in general – and Mexico in particular – does business. And that could be good or bad for you. Probably bad.

There are three trends pertaining to CHINESE Chinese companies. These are the Chinese companies that are not Western-managed, not Taiwanese, not Singaporean, and not international firms. For now, we are going to ignore the state-owned, state-influenced, or independent designation, and look at general trends in China-Mexico business.

2. Basic Environmental Factors

Chinese companies are just as inconvenienced, disadvantaged, and harmed by bad commercial relations as you are. Chinese analysts are looking at three factors in deciding Mexico’s role in their 2023 plans.

a. USMCA (NAFTA2/T-MEC)

On Nov 18, 2018, the USMCA (U.S., Mexico, Canada Agreement) replaced the old NAFTA. If you hear someone say “NAFTA 2″ or ‘NAFTA Junior”, they are almost certainly referring to the USMCA (or T-MEC in Mexico). Here’s an example from the USMCA pertaining to automobiles that explains why this treaty is pulling manufacturers into Mexico: “One of the most significant portions of the USMCA stipulates new trade regulations for automobiles and automotive parts. Under NAFTA, cars and trucks with at least 62.5% of their components manufactured in one of the three participating countries could be sold free of tariffs. The USMCA increases that minimum requirement to 75%. At the same time, the USMCA stipulates minimum wages for workers in the automotive manufacturing process: 40-45% of the work done on eligible vehicles must be accomplished by workers earning at least $16 (USD) per hour.” The bottom line is that there will be tariff-free exports from Mexico to U.S. markets IF local content is greater than 75%.

b. China’s Belt and Road Initiative and Mexico

Though China’s Belt and Road Initiative (BRI) will be an important factor when discussing Argentina, Brazil, and much of the rest of LatAm, most international trade lawyers see the USMCA precluding Mexico from taking part in BRI because it provides that “Entry by a Party into a free trade agreement with a non-market country will allow the other Parties to terminate this Agreement on six months’ notice and replace this Agreement with an agreement as between them (bilateral agreement).”
This provision effectively requires Mexico choose between the U.S. market and Chinese investment. Mexico will definitely pick the U.S. market.

c. IMMEX/Maquiladora/Shelter Facilities

Used more or less interchangeably with Maquiladora (if you are searching online use both), the IMMEX arrangement offers important tax benefits to companies that produce products in Mexico for export to the United States or Canada (mostly). The main benefit is a rebate of VAT paid on materials used to produce products for export. As a special incentive, companies can partner with specialized “shelter companies” that will fast-track the application process while “extending” their business registration and tax benefits to clients, so smaller operations can be up and running in Mexico quickly. Though it’s likely many of those involved in negotiating this agreement assumed its beneficiaries would be pretty much just U.S. firms, its beneficial terms apply to anyone. Even your Chinese competitors.

So, with those basics understood, let’s look at the three classes of Chinese companies coming to Mexico and the rest of Latin America. Pay special attention to how these developments will affect your business, and what you can do to secure the best possible outcomes NOW.

The three classes of Chinese companies going to Mexico and their ground games:

i. Shelter from the Storm

These are the regular, everyday Chinese manufacturers and brands that have learned to operate internationally faster than most of their U.S./Euro counterparts. They have also read up on Mexico’s tax laws, treaties, and the all-important IMMEX and Shelter programs that allow established Mexican partners to extend access to overseas-based manufacturers EXPORTING FINISHED GOODS from Mexico. Foreign manufacturers with a Mexican shelter arrangement can expect most of the VAT on their imported materials to be refunded, provided that their finished goods are for export — Mexico wants the jobs, not the market competition.

This category covers a big range of Chinese businesses, but for now let’s look at these guys as smaller players/ opportunists who believe their advantage comes from moving faster than the stodgy SOEs they cooperate/compete with. These are the pre-planners who see their competitive advantage coming from their bet on the next big Chinese initiative before the Chinese government announces it. These firms are usually B2B suppliers to MNC production chains. They simply started expanding into Mexico in their own version of China Plus One Strategy so as to avoid tariffs, and/or take advantage of the IMMEX program. These independent firms showing up on the Mexico-U.S. border are largely pioneers and trailblazers, and more indicative about what may happen than what is trending on the ground now. Up until now these have been fairly modest investments, but there are a few interesting trends you should watch.

ii. Supply Chain Magnets

The Chinese version of outsourcing. These brands (both consumer and B2B) are big enough to attract their own “up streamers” –- other Chinese manufacturers that feed their supply chain. Hisense, a Shandong producer of electronics and mobile technologies is the latest high-profile tenant at Chinese-owned Hofusan Industrial Park in Monterrey. Hisense is a listed H-share company with nearly US$20 billion in annual revenue and it has relationships with major brands such as Sharp, Toshiba, and Hitachi, in addition to maintaining its own Hisense brand. Other even bigger Chinese companies are expressing interest in Mexico, and ZTE, Xiaomi, and CNOOC are all already active investors. Huawei is dancing around the edges of the region, making vague noises about “LatAm design centers”. These big, connected companies are likely to “blaze the supply-chain trail” from Asia to North America. Mexico is the king of Free Trade Agreements (13 with 50 countries), and Chinese firms will have little trouble sourcing from their Vietnam branches (since Vietnam and Mexico are both members of the CPTPP treaty) until China can figure out how to do a separate Free Trade Agreement with Mexico. The bad news about China’s developing supply chain in Mexico? You may be third in line for capacity, output, and connections — after Chinese and local firms.

iii. Game Changers

Chinese brands and manufacturers won’t have much trouble making the move to Mexico and the rest of LatAm, but their impact will be limited. We’ll see more Chinese firms on the ground, better contract manufacturing options, more EV makers, more automation providers, but nothing that will radically shift the way Mexico or LatAm do business.

There are, however, several “game-changer” deals in various stages of completion that do have the potential to alter Latin America’s commercial landscape and I’ve mostly been watching the following three:

d. Hofusan Industrial Park

Hofusan Industrial Park is located just outside Monterrey in Nuevo Leone, Mexico, around 150 miles from the Texas border. [Use Mex – 85 to US-83N, then Exit 145A to Tx-130, and then I-410 E to El Paso.] Hofusan addresses a major gap for Chinese managers relocating to Mexico — the lack of a natural networking environment. The Chinese “overseas management playbook” involves packing off a veritable boatload of managers, support staff, and technical people to the new country. I don’t know if these Chinese companies plan on repeating their incredibly unpopular tactic of importing their own labor force, as they have done for Asian and African investments, but I would expect to see a much higher portion of PRC staff as compared to American staff with U.S. businesses.

Hofusan would have been pretty easy to dismiss until recently, as it was largely empty, overlooked, and misunderstood. Now that some major “magnet” Chinese brands (Hisense is confirmed, but apparently there are other heavy hitters in discussion) have signed leases, we’ll get to see if it has the power to attract clusters of upstream suppliers. If Hofusan is successful in rebuilding the “industrial hub” approach that has been so successful in Shenzhen, Dongguan, and countless other Special Economic Zones in China, it will be a double-edged sword for both Mexico and your supply chain. The good news is that China will organize, finance, and assume the risks of building up industrial clusters. This will make it much easier for you to replicate your China supply chain in Mexico. Mexico will benefit from an uptick in investment funds and local employment. But this trend will see Chinese influence in Mexico skyrocket. U.S. and EU negotiators are hampered by anti-corruption laws and a deep and abiding fear of criminal types. Chinese negotiators are way more “flexible”. That may result in a long-term, sustainable competitive advantage for Chinese entities that you may be buying from or competing with.

e. Ganfeng Lithium and Sonora Lithium Clay

Lithium is a huge potential resource for Mexico, but the deposits in the Sonoran Desert are found in clay (which is bad) and not brine (which is good) like the deposits in Argentina, Bolivia, and Chile. Mexican President Lopez Obrador (AMLO) has nationalized all mining, refining, and ownership of lithium as part of his controversial energy reform. But did AMLO just recently partially “un-nationalize” it? The situation is in flux.

Gangfeng Lithium is the Chinese miner/refiner that felt the sting of Mexico mining nationalization, as it was their assets that were (possibly) seized by the AMLO administration. But, Ganfeng is one of the few companies claiming to have the know-how to profitably refine clay-deposited lithium into industrial-grade material. Mexico wants to control its own national resources, but it also wants to develop its EV business. Lithium may be “white gold”, but that refers to the refined mineral. When it comes to lithium (and many other rare-earth minerals), the trick isn’t the mining, it’s the refining.

If Mexico and Gangfeng come to terms, it may be great news for Mexico’s EV industry, but it raises some disturbing possibilities. Mexico (and many other LatAm countries) see nationalization of resources as a legitimate tool for economic and social management. Up until now, the biggest argument against nationalization has been the inefficient management by politicians who had no idea how to run businesses. China’s CCP has been more successful than most other socialist/communist parties at managing industries (for good or ill). If regional leaders start taking Chinese advice along with Chinese investments and loans, we might see a quiet shift of LatAm economies towards Chinese style SOEs and with that a repeat of the trends and practices we have seen in China.

f. Chancay Port, Chancay Peru

China doesn’t just build infrastructure – it integrates multiple, massive infrastructure projects at a scale unmatched anywhere in the world. There is a project in Peru that all China/LatAm watchers need to follow; the Chancay Port construction being led by COSCO Shipping Lines. Here is how COSCO describes this project:

The Chancay Port Terminal will be a multipurpose port that will mobilize containerized cargo, general cargo, non-mineral bulk cargo and rolling cargo, becoming a regional trade hub and South American maritime node to Asia and Oceania. The geographical position, current and future connectivity of the port of Chancay will contribute to the decongestion of other port management centers by providing shorter times, greater efficiency, and better competitive conditions for users, boosting the country’s economy, boosting exports and generating new business opportunities.

This will be an integrated project, consisting of a port facility, a manufacturing/processing hub and a dedicated highway connecting the two. If the future of manufacturing is “dark mega-factories” that are so automated that they don’t bother turning on the lights, then Chancay is the LatAm prototype. Imagine a scenario where cutting-edge mega-factories (not unlike the Shanghai TESLA facility, with which I’m assuming the Chinese planning authorities are quite familiar) are integrated with multimodal rail, air, and surface transport links. Raw materials are trucked into the front, and finished goods destined for U.S. or European markets are shipped out the other side. Oh, and you need a PRC passport to get through the gate. Think it can’t happen in Peru? It can happen there and it can happen elsewhere as well.

There are well-meaning skeptics who think that China doesn’t have the soft-skills firepower to maintain cordial, productive relations with decision-makers from other cultures. Though it’s true that Chinese cross-cultural skills aren’t exactly “best in class”, it will not necessarily impede them from exerting influence in LatAm. In official negotiations with Chinese counterparties, you can expect opacity, intransigence, aggression, and dishonesty, but these are “features, not bugs”. They know how you feel about them, but they also know how much you want the negotiation finalized, and they know about the promises you have already made to HQ, and they work with all of this. Chinese negotiators routinely close deals with U.S., SE Asian, African, Western European, and Eastern European counterparties that simply do not like negotiating with Chinese counterparties, but do it anyway because that’s what their jobs call for. This is especially pertinent to Latin American negotiators, who have long sought a viable counterweight to U.S. interests.

3. Final Word

We’re seeing the outline of an America First approach to international trade in Mexico. In this story, you are the scrappy young David squaring off against a familiar Goliath. All you can really hope for in the way of support from your home country is that they honor the agreements they’ve already signed and that they not start any new conflicts or geopolitical disaster, and as far as LatAm goes, you stand a pretty good chance of getting that. But within a few years, Congressional sub-committees and outraged cable personalities will demand to know how we lost our very own Latin American neighborhood to that insidious, silver-tongued China. But if China really is winning in Mexico and elsewhere in Latin America, it’s mostly just because they are showing up, and the U.S. and Europe pretty much aren’t.

Plenty of MNCs with existing capacity in Mexico have been steadily expanding capacity and deepening ties here, and we’re not seeing too much of a Chinese presence on the ground yet. But there seem to be two different supply chains in the world –- the one that runs through China, and everything else. The China supply chain attracts purchasers and buyers that see cost as their only significant metric, even if large-scale, centralized production in a specialized hub (favored by the government) offers low flexibility and no transparency in exchange for the lowest available prices. Outside China, procurement and operations people are starting to see the value in moving supply chains closer to markets and using a wider range of metrics to track success. For those looking to sell into the U.S. market, Mexico offers some very powerful incentives. Time, however, is not necessarily on your side. If you don’t develop your presence in Mexico and Latin America before China can replicate its supply chain networks there, your future counterparty in your next LatAm negotiation may very well be a representative from a Chinese SOE, and how is that going to play with your compatriots back home?

 

Andrew Hupert splits his time between the United States and Mexico (mostly Saltillo and Oaxaca) where he helps international businesses expand or adjust their supply chains. After over 20 years in Asia (Shanghai, Taipei, HK, Saigon), Andrew decided to follow his own advice and move his operations closer to home. You can contact Andrew at [email protected], or connect with him on LinkedIn.