A Strategically Vital Industry

By Don Quijones, Spain & Mexico, editor at WOLF STREET .

Volkswagen is not only the most audacious, most creative corporate fraudster of 2015 (though there are still three months of the year to go and competition is, as ever, fierce); it is also the newest entrant of the world’s elite club of too-big-to-fail corporations, as the German government itself admitted. But it is not just too big to fail in Germany, where its stock has suffered its worst week in history, losing 34% of its value; it is too big to fail in Mexico, too.

And just like any TBTF entity worth its salt, it will soon be getting a taxpayer-funded bailout from the Mexican government, albeit a tiny, token one.

A Strategically Vital Industry

The car industry is essential to the health of Mexico’s economy. In the last two years the country has overtaken global competitors like Japan, Brazil and Canada to become the biggest supplier of the world’s second biggest automotive market, the U.S, accounting for 18% of total production in 2014.

With wages in the $8 an hour range (compared with close to $40 an hour in Canada), a surplus of skilled mechanics and engineers, and easy shipping routes to the U.S. and Canada, Mexico is a perfect production center for the world’s biggest car companies. The fact that it’s a signatory of NAFTA as well as 44 other free trade agreements is an added bonus.

In 2014 the country’s light vehicle production climbed to 3.2 million vehicles. According to the Center for Automotive Research, global automakers poured $7 billion of new investment into the country. They include Chrysler, Ford, General Motors, Mazda, BMW and, of course, the self-confessed partners in auto-cyber crime, Volkswagen and Audi, whose Mexican operations are based in the central state of Puebla.

Although VW’s Mexico installations are not implicated in its more nefarious practices – the “defeat device” that deceived US consumers and regulators for years was allegedly designed and built in Germany – the carmaker’s travails are almost certain to heap even further pressure on the country’s economy.

When Volkswagen struggles, so does the state of Puebla. The huge manufacturing plant built on the city’s outskirts 50 years ago provides roughly a quarter of local GDP. Its supply chain consists of 150 companies, generating 78,000 jobs – most of them secure and highly paid, at least in local terms. What’s more, Volkswagen recently built a huge new state-of-the-art plant for its Audi subsidiary in San José Chiapa, Puebla.

In the words of my mother-in-law, a born and bred Poblana, there is not a single family in Puebla that does not have some level of exposure to the VW plant.

Bad News

The total estimated value of VW’s annual production in Puebla is around 90 billion pesos ($5.4 billion). A few months ago the German company even announced an additional $1 billion capital injection in its Puebla plant. But then this week, the metaphorical excrement hit the extractor fan.

Of the 324,000 vehicles VW manufactured in Puebla up to August 2015, almost half were exported to the U.S. They include the three TDI diesel models (Beetle, Jetta and Golf) that were discovered to contain code – the “defeat device” – that shut down the emission control system during regular driving, but turned it back on as soon as the car was plugged into an emissions testing machine. As BBC World reports (in Spanish), the average number of units exported to the U.S. is 115 per day.

And now those models are no longer going to be sold – at least not in their current form. As a matter of fact, it’s no telling how many (or how few) VW cars will be sold in the US in the wake of this gargantuan scandal. For Mexico, and Puebla in particular, that could be very bad news indeed.

“The sudden slide in sales of VW in the U.S. will be immediately reflected in lower production in Puebla’s plant,” wrote the director of the local daily Cambio de Puebla.

“We could expect a slowdown in production and maybe some layoffs next year,” warned the Director of International Business at the Monterrey Institute of Technology, Manuel Valencia.

A Tiny, Token Bailout

Naturally, fear and panic is beginning to spread in government circles. After all, good, well-paid jobs are on the line, and jobs mean votes. What’s more, Mexico’s fiscally challenged economy is already beginning to splutter and stall. The country’s exports fell 6.8% in August, the second consecutive month of declines. For the first time in three years, Mexico’s automotive exports shrank, by 3.2%.

“It goes without saying that there will be a reduction in (Volkswagen) vehicle demand in the U.S. and in other markets,” said the state governor of Puebla Rafael Moreno Valle. “That’s going to have an impact on the state’s GDP.”

To try to soften the blow, Moreno Valle has offered Volkswagen a tiny, token lifeline. The state of Mexico will buy 200 cars straight off the production line, which will be used as police patrol cars, he said. “We already have an agreement in place to buy new patrol cars and what better way to safeguard local jobs?”

The problem is that given the scale of VW’s U.S. business — last year alone it sold 366,970 units there — 200 cars are unlikely to make much of a dent in the company’s coming shortfall, or by extension save much in the way of local jobs. Perhaps if the scheme was extended to other Mexican states, in particular those on the frontline of the government’s misconceived, ill-fated war against organized crime, it might make more of a difference to the German car manufacturer’s income statement. Not only that, it could even help improve the chances of the country’s cash-starved police catching the much better equipped bad guys. Just don’t mention the emissions. By Don Quijones, Raging Bull-Shit .

When the government pushed a historic energy reform bill through the Mexican congress in 2013, it was hoped that it would serve not only to privatize but also modernize Mexico’s state-owned oil company Pemex so that it could compete with giants like Exxon. But it’s not working out that way. Read… Brilliantly Timed Oil Reforms Push Mexico into Fiscal Meltdown

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