Larger in area than the UK, the Mexican state of Chihuahua snakes along the southern bank of the Rio Grande from New Mexico across the western one-third of Texas. More than any of Mexico’s 32 states, Chihuahua’s manufacturing sector has prospered under the 23-year-old North American Free Trade Agreement (NAFTA) with the USA and Canada. Compared with the automotive and electronics industries, aerospace was a relative late bloomer in Chihuahua, blossoming about 15 years ago and rapidly accelerating ever since.
In the past decade alone, Chihuahua has established factories that make the aircraft structures for Beechcraft, Bell Helicopter, HondaJet and Gulfstream; assemble the wiring harnesses for the Boeing 787 and Airbus A380; machine the majority of the components that make up Honeywell engines; and stitch together the passenger seats for Embraer commercial jets.
The state’s leaders hope to grow even further. The vision, outlined in a 2014 strategy document, is to develop a self-contained aircraft supply chain, with an ecosystem of suppliers throughout the state capable of making and assembling all of the structures and electronics required for a modern aircraft. Final assembly and flight testing may still need to be performed in the USA for regulatory reasons, but Chihuahua’s low-cost factories would do everything else.
In the near term, the top priority of the Chihuahua aerospace cluster is to expand its toehold in the commercial aviation market by establishing an MRO facility for single-aisle airliners. Negotiations continue with the likes of Singapore’s ST Aerospace and El Salvador’s Aeroman, but there is a new issue: politics.
Many new projects are now in a “wait-and-see kind of position”, says Jose Fuentes, a business development manager for American Industries, which recruits foreign direct investment on behalf of the Chihuahua aerospace cluster.
It’s no wonder that foreign investors are suddenly skittish. After enjoying bipartisan support in Washington DC for 22 years, the longstanding appeal of investment in Mexico collided with Donald Trump. The new US president ran for office on a populist agenda that featured dismantling the current structure of NAFTA, bringing “blue collar” jobs back to America and, famously, building a wall along the entire US-Mexican border. Since the new administration took office, Republican leaders in the House of Representatives have proposed a “border adjustment tax” to offset the fiscal impact of Trump’s proposals to lower the corporate and personal income tax rates in the USA. All told, the cost of trade with Mexico looks set to rise for US manufacturers.
Moreover, since the 8 November election US companies have learned to fear the unexpected presidential tweet singling out a company for moving jobs to Mexico.
“The underlying theme right now is uncertainty. We really don’t know how this is going to end up,” said Daniel Alanis, a partner and managing director for the Boston Consulting Group, addressing a 23 February conference in El Paso, Texas, called Mexico’s Manufacturing Supply Chain Summit.
Alanis painted a bleak picture for Mexican industry, with proposals now on the table for a less-permissive NAFTA regime and the imposition of a US tax on imports. “Those could significantly impact exports from Mexico into the US,” he said. “It could have a significant impact on the exchange rate, leading to inflation in the market. Ultimately, if companies start to leave Mexico... that could lead to higher unemployment in Mexico, potentially resulting in [more] crime.” As crime escalates, illegal immigration across the border could increase, inflaming tensions and leading to yet harsher restrictions on trade.
On the other hand, Alanis described another scenario from Trump’s planned intervention in US-Mexican trade policy, but with a more positive outcome. Since NAFTA was established in 1994, gross domestic product (GDP) for both countries has shown a strong correlation. A good economic year in the USA means a similarly positive trend in Mexico, while a bad year in America leads to a lower GDP in Mexico. Trump’s economic agenda is aimed at boosting GDP to 4% annual growth, Alanis says.
“If through the negotiations and the dialogue happening now... we can maintain the inter-relation of our economies and we can maintain the trade openness and collaboration, that can be quite positive for Mexico. The boost the Trump administration is planning in the US could mean increased growth,” he says.
But with such a broad range of outcomes, near-term decision-making in the industrial sector is likely to grind to a halt. “It could go one way or it could go the other way, so there’s a lot of uncertainty at this point in Mexico,” Alanis adds.
The shift in the political mood in Washington comes at a critical moment for the aerospace cluster across Mexico. Activity ranges from the border-region maquiladoras – small factories that process raw materials or assemble components – to Bombardier’s factories in the central highlands of Queretaro state.
After more than 15 years of double-digit annual growth measured in terms of exports, the Mexican aerospace industry showed signs of cooling off even in the months before Trump was elected. Last April, Mexico’s aerospace industry federation, FEMIA, estimated that annual exports in 2016 would grow to $7.5 billion, or a $1 billion increase compared with the year before. It was part of a steady march towards a yearly export objective of $12 billion by 2020.
But the reality fell well short of expectations. Final numbers are still being checked, but FEMIA now estimates that total aerospace exports from Mexico in 2016 amounted to about $7.2 billion. That growth is still impressive by global standards, but may signal that Mexico’s upward trajectory is finally slowing.
Indeed, newly elected FEMIA president Carlos Robles says the organisation is now reviewing the feasibility of the $12 billion target for 2020. To reach that goal now, Mexico’s aerospace exports would need to show a 13.6% compound annual growth rate over the next four years. That’s roughly equivalent to the 13.7% CAGR that the cluster achieved from 2002 to 2016, but significantly higher than the 7.69% clocked from 2015 to 2016.
Mexico owes its popularity as an aerospace manufacturing hub to two factors: its proximity to the USA’s top-tier suppliers and OEMs, and a seemingly inexhaustible supply of lower-cost labour. Those two factors encouraged commercial aviation suppliers to invest heavily in new factories in Mexico to accommodate the industry’s unabated decade-long growth surge. US business and general aviation manufacturers also outsource low-skilled machining and electronics work to Mexico; lower labour costs are attractive to an industry that was hit hard by 2009 financial crisis and has since seen only a sluggish recovery.
The rapid growth of aerospace manufacturing in Mexico, however, has also created a distorted internal supply chain. In most regional or national aerospace clusters, a few OEMs would be supported by successively greater numbers of smaller suppliers. Typically, a cluster would be represented by a multi-level pyramid, with the OEMs and tier-one suppliers forming the narrow apex above deeper and broader layers of lower-tier suppliers. In Mexico, the aerospace cluster is not quite an inverted pyramid, but the numbers of OEMs and tier-ones are disproportionately high compared with lower tiers of the industry.
The distorted make-up of the cluster is the product of a partly successful strategy. The original plan was to recruit the OEMs and tier-ones to Mexico, says Jose Rodriguez, chairman of the aerospace council of INDEX, Mexico’s national export promotion group. The presence of those top-level suppliers would, the theory went, attract internal and external investment in sub-tier supplier factories.
There are several exceptions to the rule. In Chihuahua state alone, Wichita-based Metal Finishing has opened a factory to provide special treatments for aerospace parts. A homegrown company, Altaser, has opened to meet demand for precision machining services for nearby suppliers, such as GKN Fokker and Kaman Aerospace. Such services are easily overlooked but are the lifeblood of a sustainable regional aerospace cluster in an era of highly specialised supply chains.
“We find it’s better to invest in suppliers than do things ourselves, and focus ourselves on the core business,” says INDEX’s Rodriguez, also a director for GKN Fokker in Chihuahua.
Mexico’s strategy successfully attracted most of the top brands in the aerospace supply chain, but the roster of lower-tier suppliers remains thin. And that shortage of homegrown support may act as a break on the cluster’s potential growth. In the absence of local suppliers, factories that make aerostructures must use US providers of special processes such as heat treatments and anodising, requiring a single part to cross the border multiple times before it is ready to be shipped with a subassembly.
Why the lower-tier suppliers have not invested in Mexico is not entirely clear, but there are several theories. Lower-tier US and European firms often lack the financial and industrial infrastructure to set up an offshore factory, Rodriguez says.
Mexico was also counting on a rich cohort of automotive suppliers to convert their services to support the burgeoning aerospace industry. Although the automotive sector is several times larger than aerospace in Mexico, it is hotly competitive. By contrast, aerospace programmes involve lower volumes, but generally offer more stability with comparatively long product cycles. But the migration of suppliers from automotive into aerospace has proved disappointing, so far.
“The local ones, they don’t want to [move into aerospace] or they are not ready for it,” Rodriguez says. “Because in automotive, they can recover the money faster. So they prefer to invest in the automotive industry even if it’s more risky. They take that risk.”
The uncertainty created by the Trump administration’s policy agenda could make that investment decision even harder, but there are mitigating factors. Most importantly, the commercial aviation industry is still growing. Robles, FEMIA’s president, attended a mid-February summit of Boeing’s global network of suppliers. The message from Boeing Commercial Airplanes during the summit was clear, Robles says: “We need all the help we can get to meet the backlog.”
Mexico remains attractive financially and geographically, if not politically, in the global supply chain. Ironically, the declining value of the peso against the dollar amid the post-election uncertainty only makes the country’s labour market more attractive. As Boeing ramps up output of single-aisles and potentially 787s, the company has called on suppliers to slash production costs, as airline customers demand “more for less”. Until Trump ascended to the White House, such a message would have made Mexico a natural option, especially if the cluster’s supply chain imbalance could be addressed.
In the current climate, such decisions are anything but simple. The border adjustment tax, although popular among Republican leaders in the House of Representatives, has not yet been embraced by their colleagues in the Senate. Questions have been raised over whether Trump has the power to summarily repeal NAFTA, a move that would unleash chaos in industrial supply chains. A comprehensive reform of the treaty seems more likely, but the negotiations could be lengthy; NAFTA required eight years of talks until ratification and several more years to be fully implemented.
In Chihuahua, the leaders of the aerospace cluster must navigate the interim period with little clarity on how the trading relationship with their northern neighbour will evolve.
“You have to see the glass half full,” says Chihuahua cluster business developer Jose Fuentes. “You have to hope for the best and prepare for the worst.”
Source: Cirium Dashboard
