Brazil Mexico 2: Mexico wins again

In the red corner: local contentism and currency war. In the blue corner: free trade and a floating currency. And the red camp wins with a technical knock-out in round one.

That was the surprise result of the clash of two economic models in Mexico City on Thursday, as Mexico went down without a fight before Brazil’s demand that it re-write a 2002 car trade accord. The nimble Mexican featherweight gave way to the lumbering heavyweight from Brazil.

It’s a dispute that says a lot about how each country sees its place in the world and what sort of business environment each proposes.

The bilateral accord, signed in 2002 and in effect from 2003, had long favoured Brazil but recently turned in Mexico’s favour as its manufacturers took advantage of the stronger Brazilian currency and their own investments in productivity. Under Thursday’s agreement, Mexico will limit its auto exports to Brazil to an average of $1.55bn for three years, down from $1.7bn last year.

Brazil’s auto industry is based on “local-contentism”. Unlike older, nationalist forms of protectionism, this accommodates manufacturers from all over the world, as long as they manufacture in Brazil.

General Motors, Ford, Volkswagen and Fiat were for decades the big four of Brazil’s auto industry. They have been joined more recently by the likes of PSA Peugeot Citroën, Honda, Hyundai and others. All benefit from stiff import tariffs and a big and expanding Brazilian market. As well as assembling vehicles in Brazil they must also source a large share of components locally, so Brazil has a big and thriving autoparts industry, too.

Brazil’s tax and labour laws, among other factors, make these manufacturers less competitive than foreign rivals. But they are well protected and, in any case, the government is fighting a currency war on their behalf.

Mexico’s auto industry is based on free trade. Thanks to Nafta and other agreements, Mexico’s car makers are like an off-shoot of Detroit, or vice versa. They are immersed in the global supply chain, preferring not to care where a component is made as long as it can be bought at the best price. (Although under the 2002 agreement with Brazil it sources 30 per cent of components locally – the revised accord increases that to 40 per cent.)

Mexico’s notably inactive central bank lets the currency float along with trade flows.

Who wins? Brazil’s auto makers will, as they say in Brazil, be singing victory on Friday. Mexico’s negotiators lost – though keeping the accord alive was better than scrapping it, which Brazil had threatened to do.

In the long run, however, Mexico wins. Protectionism doesn’t work. That’s why successful economies get rid of it. Creating shield after shield for inefficiency only encourages – guess what?

Related reading:
Brazil Mexico 1: Mexico wins, sort of, beyondbrics
Mexico bows to Brazilian pressure on auto exports, Reuters
Mexico: auto superstar, beyondbrics
The high price of booming Brazil, FT
Local supply policy tests Petrobras, FT