Zai Jian Zhongguo, Bienvenidos a México: Production Trend Moving from China to Mexico – Regulatory and Practical Considerations | Sheppard Mullin Richter & Hampton LLP
Zai Jian Zhongguo, Bienvenidos a México: Production Trend Moving from China to Mexico – Regulatory and Practical Considerations |  Sheppard Mullin Richter & Hampton LLP

Zai Jian Zhongguo, Bienvenidos a México: Production Trend Moving from China to Mexico – Regulatory and Practical Considerations | Sheppard Mullin Richter & Hampton LLP

In recent years, a wide range of trade actions pursued by the United States, foreign and domestic policies in the United States and China, reputational risks, and supply chain breakdowns have driven a tendency for more and more production to move from Asia to Mexico. The Biden Administration has made no secret of its desire to encourage US manufacturers and their component suppliers to relocate production from China to Mexico.[i]

Trade Acts of the United States

The US regulatory factors behind this trend include:

  1. Free trade agreement: Entry into force in 2020 of the US-Mexico-Canada Agreement (USMCA),[ii] which increased the regional value content requirements for a wide range of products;
  2. Special import duties: United States Aggressive Imposition of Section 301,[iii] as well as traditional anti-dumping and countervailing duties on many Chinese products;
  3. Export restrictions: The addition of many additional Chinese entities to the U.S. lists subject to national security-related export restrictions and the consequent due diligence challenges regarding Chinese companies’ involvement in military programs or ownership or control of listed entities;
  4. Prohibition of forced labor: Issuance of additional US import bans[iv] and other sanctions[v] on products with content derived from the Xinjiang region, derived from US policies aimed at forced labor and treatment of the Uighur people; and
  5. Extra-territorial application of US export controls: The introduction of the new foreign direct product rules,[vi] which has hampered the ability of semiconductor manufacturers to supply many parties in China in third countries.

Industry-specific impact

For a wide range of industries, the result of these USMCA incentives, combined with the more restrictive rules for China, has been a push to move much of the production to Mexico that would otherwise occur in China or elsewhere in Asia.

Implications of the car industry

We expect the car industry in particular to increasingly move production to Mexico. As early as 2020, following the entry into force of the USMCA, Asian automotive component suppliers began expanding production in Mexico. For example, some suppliers now extract copper in Mexico, which is then used to increase the regional value content of the local production of components. In addition, the COVID disruption in the manufacture of automotive components in Wuhan, known as the Detroit of China, has pushed several manufacturers out, often to Mexico.

Implications of the fashion industry

The clothing sector may have acted as a less likely candidate for such a move because it is generally subject to the rule of origin of yarn feed. This rule requires that spinning and extrusion of yarn and subsequent production stages take place in a USMCA territory in order for the resulting garments to be imported duty free into the United States, Mexico or Canada. Even in this sector, however, the USMCA has made a number of exceptions that have resulted in an incentive to relocate some clothing production to Mexico. The single transformation rule allows textiles and yarns of foreign origin to be used for certain specific products, as long as the cutting of the fabric or knitting to form, and all subsequent processes, are carried out in the USMCA territory.

There are also USMCA regulations that allow the use of certain non-USMCA fibers, fabrics and yarns that are destined to be in short supply. In addition, there are quota provisions that allow the USMCA duty-free processing of specified quantities of non-originating fabric or yarn that has undergone significant processing in a USMCA area. And there is also a special U.S. / Mexican unification clause that allows duty-free processing when importing into the United States under HTSUS subheading 9802.00.90 for goods collected in Mexico from fabric that is completely shaped and cut in the United States.

In addition, the focus on the use of forced labor in China has pushed more clothing companies to stop buying cotton from China. For this reason, we also anticipate that further clothing industry production will move to Mexico from Asia.

US and China’s foreign and domestic policies continue to drive relocation

In addition to the U.S. regulatory factors driving this trend of relocation from China to Mexico, both U.S. and China’s foreign and domestic policies are strengthening the trend. After the 2020 election, some observers wondered if there could be a meaningful reset of US-China relations and a consequent thawing of US restrictions on China. But it certainly has not happened. The change in the US administration in January 2021 did not lead to any significant easing of the above import and export restrictions for China. Moreover, there is no reason to believe that much will change in the coming months and years.

The policies that drive this relocation trend are not one-sided. China’s inability to join the United States and its European and other allies in a firm resistance to the Russian invasion of Ukraine has only increased the strain on US-China relations. Some manufacturers even choose the China-Mexico move based on political risk from a potential conflict involving Taiwan, which could result in U.S. sanctions and Chinese counter-sanctions. To these legal and regulatory factors must also be added the unique Chinese response to the COVID pandemic. China continues to try to adhere to a zero-COVID policy, which has become extraordinarily difficult in light of the wildly contagious Omicron variants. Shutdowns and supply chain disruptions in China have been in the headlines for weeks and look set to remain so for the foreseeable future.

Reputation risks

In this new era of environmental, social and management awareness (ESG), corporate boards are also weighing the reputational risks of continuing business in China. Aside from the import bans and sanctions related to forced labor, some manufacturers are leaving China due to the reputational risk of being accused of indirect attachment to forced labor.

Supply chain breakdown

The increasing breakdown of supply chains is also contributing to the relocation trend. The global shipping backlog has quadrupled shipping costs. Inflation in transportation costs and continued disruption in shipping are causing companies to approach their production.

Results of the move

The trend is reflected in Mexico’s economic statistics. The Mexican Economic Secretariat reported that the country had a total of $ 32.9 billion in foreign direct investment in 2019, and that this fell to $ 29.1 billion in 2020 during the pandemic. For the first two quarters of 2021, however, the Secretariat reported $ 18.43 billion in foreign direct investment, a significant return to growth. The International Monetary Fund estimates that total Mexican GDP will be $ 1.37 trillion by 2022, a solid increase from the pre-pandemic level of $ 1.26 trillion in 2019. It remains to be seen how large Mexico’s manufacturing sector will be. , but we see an opportunity for continued significant growth.

Interestingly, though, this trend means less Chinese-manufactured content of the products concerned does not necessarily mean less Chinese property rights of manufacturing. Chinese companies have been well represented among those increasing their investment in Mexico in response to the higher RVC requirements of the USMCA. In fact, about a third of the investment in electronics manufacturing in Mexico currently comes from Asian countries, much from China, but also from Japan and South Korea.

Restrictions on manufacturing migration

However, our knowledge of the rules and the USMCA rules suggests that there will be some limitations to how far this trend can go, especially as it concerns Chinese companies expanding in Mexico, for the following reasons:

  1. 5G: Chinese companies and their affiliates seeking to relocate electronics manufacturing to Mexico must still avoid 5G and other manufacturing areas that will serve parties in China such as Huawei, which are excluded under the foreign direct products rule;
  2. Xinjiang: Chinese companies affiliated with Xinjiang will remain subject to US import restrictions to the extent that they are subject to customs and border protection bans or if their Mexican production is to be dependent on Xinjiang raw materials or components; and
  3. Listed entities: Although the Bureau of Industry and Security generally considers a Mexican company producing in Mexico to be Mexican (regardless of ultimate Chinese ownership), the BIS bans under Part 744 Entity List,[vii] the military end-user rule,[viii] and the Xinjiang sanctions extend wider, requiring careful due diligence by U.S. companies that will supply technology to or import products from such Chinese-owned facilities in Mexico.

The above factors will limit the number of high-tech Chinese enterprises that can benefit from relocating production to Mexico, and even outside of high-tech, it will limit the opportunities for Xinjiang-dependent enterprises.

Caution must be exercised not only by Chinese companies wishing to expand production in Mexico, but also by other companies (in Asia or elsewhere) wishing to expand there because they still need to avoid Chinese sourcing (e.g, from Xinjiang), which would trigger a US import ban, comply with foreign direct product restrictions if they sell their Mexican production to China, comply with the presumed export rules when posting staff (e.g, from China) to Mexico, and last but not least, carefully apply the labyrinthine USMCA rules of origin when deciding whether their production flow will result in a final product that meets the applicable USMCA rules of origin and can enter the United States. , Canada or Mexico duty free.

FOOTNOTES

[i] See e.g. Brookings, Supply Chain: USMCA Forward: Building a More Competitive, Inclusive, and Sustainable North American Economy (February 2022), available at https://www.brookings.edu/essay/usmca-forward-building-a-more-competitive-inclusive-and-sustainable-north-american-economy-supply-chain/.

[ii] Also see Implementation of the United States-Mexico-Canada Agreement, 19 USC Ch. 29 (2020).

[iii] See Section 301 of the U.S. Commercial Code of 1974, 19 USC § 2411 (2018).

[iv] See Uyghur Law on the Prevention of Forced Labor, Pub. L. 117-78 (2021); and Section 307 of the Tariff Act of 1930, 19 USC §1307.

[v] See designations according to Executive Order 13818, which builds on and implements the Global Magnitsky Human Rights Accountability Act.

[vi] See 15 CFR § 734.9.

[vii] See 15 CFR § Part 744, Supplement No. 4.

[viii] See 15 CFR § 744.21

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