Why is Tesla Planning an Automobile Factory in Mexico? The Reasons May Surprise You.

Introduction

On February 28, 2023, Tesla’s president, Elon Musk, and Mexican President Andrés Manuel López Obrador announced that they had reached an agreement on the construction of a “gigafactory” for electric vehicle (EV) production valued at $1 billion at the outset, which could increase to $10 billion over time. The factory is to be built in the Santa Catarina suburb of Monterrey in Nuevo León, less than 140 miles from the border with the United States.[1] Mexican government officials suggested that the plant could produce a million vehicles a year, including Tesla’s Semi truck, Roadster and sports utility vehicles.[2]

Reports suggest that López Obrador had initially demanded that the factory be constructed near the newly built Mexico City airport, which is 565 miles further south, but consented to the Nuevo Leon location after further discussion with Musk on several difficult issues, including limiting Tesla’s demands regarding the available water supply. The details of the arrangements have not been made public and are probably not fully finalized, but based on the treatment of past large investments in auto production, it is reasonable to assume that Mexico’s state and/or federal governments have promised subsidies in the form of tax holidays, worker training, infrastructure improvements, or other benefits.

There is no clear timeline for construction or commencement of operations, but in other contexts Tesla has been able to move quickly. For example, the time between breaking ground and completing another Tesla facility near Berlin, Germany, was about 18 months — although citizen protests and various bureaucratic delays postponed the start of production until more than six months later.[3] Given López Obrador’s skepticism of foreign investment, it is perhaps surprising that after 14 months of negotiations, an agreement was finally reached, presumably based on the common sense of both sides.[4] The investment will be one of the largest — if not the largest — of López Obrador’s presidency, should it go forward.

This brief considers the potential benefits and downsides of the plan to build a Tesla factory in Mexico. Despite the many foreseeable challenges — including difficulties conserving water, using clean energy, and dealing with López Obrador’s government — the project will most likely move forward and could bring substantial benefits to both the U.S. and Mexico.

Why Mexico?

One can reasonably ask the question, “Why is Tesla — which already has large factories in Shanghai, China; Berlin, Germany; Austin, Texas (its corporate headquarters); and Reno, Nevada — adding another major investment, this time in Mexico?” However, in my view the better question, given the expansion of the auto industry in Mexico in recent decades, is “Why not?”

After all, Mexico has historically supported the international auto industry. In fact, during the past 30 years, virtually every major automobile company in the world (except for Chinese-owned firms) has constructed auto assembly facilities in Mexico. This list includes Volkswagen (the first beginning in 1964 with the iconic Beetle,[5]) as well as Stellantis/Chrysler, General Motors, Ford, BMW, Mercedes, Audi, Toyota, and Kia, (which also has facilities in Nuevo León). Thousands of auto parts suppliers have followed suit with investments of varying sizes, along with many producers of other goods designed to serve the U.S. market. This includes American, European, Japanese, Korean, and, more recently, Chinese companies. In the coming years, companies making EV batteries and components are likely to establish factories in Mexico. For example, the major Chinese producer CATL has reportedly been seeking a site for battery production in Ciudad Juarez, which is across the Rio Grande from El Paso and about 750 miles from Monterrey.[6]

As a result, the Mexican automotive industry today is by far the country’s leading industry. Mexico is now the sixth largest auto producer in the world, with 4 million autos and light trucks produced in 2019, representing $121 billion worth of cars and components. With the exception of Volkswagen, most of these facilities are located in northern states, with 80% of their auto production destined for export to the U.S.[7] Notably, in 2015, reported hourly labor costs for auto workers totaled $3.29, compared to $23.83 per hour in the United States.[8]

There are many reasons for Mexico’s popularity with the North American auto industry, and most remain relevant today. These include a ready supply of reasonably priced, skilled labor; quick truck access to the United States border and its interstate highway system; straight-forward integration with sister facilities and suppliers in the U.S. and Canada; relatively easy movement of parts and components among factories and across North American borders; and, most recently, duty-free trade for nearly 30 years under the North American Free Trade Agreement (NAFTA) and now under the U.S.-Mexico-Canada Agreement (USMCA) for goods that meet the applicable rules of origin.

The most recent beneficial reasons to invest in the Mexican auto industry were created by the Inflation Reduction Act (IRA), which specified that many EV batteries, battery parts, and materials originating in Mexico are eligible for consumer subsidies in the United States of up to $7,500 per vehicle.[9] These consumer subsidies are available to U.S. auto buyers regardless of whether their vehicles and batteries were sourced in the U.S., Mexico, Canada, or a combination of all three countries. One exception to these subsidy provisions is that, according to their manufacturers, many EV models — including some Teslas like the popular Model 3 rear wheel drive — are not likely to qualify for full subsidies for the next few years.[10] Still, to the extent that Tesla production in Mexico involves lower costs than in other countries, such savings could facilitate Tesla’s continuing efforts to undercut its competitor’s prices worldwide.[11]

Mexican-assembled vehicles and batteries also enjoy the same relatively relaxed sourcing rules currently applicable to EV battery components originating in other countries that have free trade agreements with the U.S., such as South Korea and Australia. Moreover, since the Biden administration considers the recently concluded critical minerals agreements with Japan and the EU to be "free trade agreements" under the IRA, batteries from these sources that are used in the assembly of vehicles in North America also qualify for all, or a large part, of the IRA's consumer subsidies.[12] (This assumes that U.S. courts will not enjoin the agreements should members of Congress argue in court that the agreements are unconstitutional because the negotiations bypassed Congress and/or were not subject to congressional approval.[13])

In addition to the all-important North American market, Mexican-made vehicles can also be exported mostly duty-free to the nearly 50 additional countries that have free trade agreements with Mexico or are co-parties to the Comprehensive and Progressive Trans-Pacific Partnership. These countries include the 27 members of the European Union, the UK, Israel, Japan, and Korea.[14] This mostly duty-free feature presumably affords Tesla, like other Mexican auto producers, additional flexibility in serving its worldwide markets.

Although probably not a make-or-break issue, another convenience for Tesla is that temporarily deploying employees from U.S. factories in Oakland, Austin, or Reno to Nuevo León requires only a relatively short airline flight compared to such countries as Germany or China. In addition, if American managers are needed in Nuevo León, there are thousands of candidates in the U.S. as well as in Mexico who are bilingual in Spanish and English.

Many of the auto producers located in Mexico focus their production on smaller cars, where profit margins are lower, or on small trucks, which carry a 25% tariff unless they are made in the U.S. or assembled in Canada or Mexico according to the USMCA’s strict rules of origin. Given these factors, if and when Tesla decides to produce a car that is smaller and less expensive than its Model 3, it seems likely that Mexico would be the preferred locale. Especially since vehicles made in Mexico would be subject to a relatively low 2.5% U.S. most-favored-nation duty upon importation into the United States, even if they fail to meet the USMCA rules of origin. A less expensive Tesla could also be marketed in Mexico (or other low-income countries), where a Tesla 3 with a current base model typically sells for $42,990[15] with an additional $20,000 required for a full load of optional accessories. (Of course, a Tesla 3 is likely to have limited market appeal in a developing country with a per capita GDP of about $10,000.[16]) Perhaps more significantly, in contrast, Chinese-made autos are currently subject to a 25% penalty tariff when imported into the United States today. This penalty tariff is applicable in the aggregate to over $300 billion worth of Chinese imports,[17] making it impractical to import Teslas directly from its Shanghai factory to the U.S., a situation that will last for the foreseeable future and, potentially, for decades. No such problem exists with Teslas considered made in Mexico.

Significant Downsides Accompany Investment in Mexico

Despite its advantages, Tesla’s plan for operations in Mexico does raise serious practical and legal questions related less to the auto industry and more to the many downsides of operating in Mexico in general. The first four years of the López Obrador administration have seen a series of various actions that are adversely affecting Mexico’s overall investment climate. These factors include:

• National government policies that oppose private foreign investment in favor of government-owned operations — particularly in petroleum, electric power, and mining — or that protect against encroachment on the independence of administrative agencies, the elections commissions, and the courts;
• Public opposition to wasteful spending on such “white elephant” projects as the Los Bocas oil refinery, an abandoned Mexico City airport, and a cross-isthmus train;
• Recent expropriatory actions taken against foreign investments in the petroleum, lithium mining, and clean energy sectors; and
• A national government that is difficult to engage with at most levels and is sometimes unpredictable or arbitrary in its dealings with private firms.[18]

In recent weeks, López Obrador has increased his rhetoric in relation to the role of the private sector in the Mexican economy. And even though he is currently only a year and a half from the end of his term, there is still plenty of time to take even more adverse actions that could trigger a formal trade and investment disputes. Yes, there are legal protections against arbitrary government action available beyond the Mexican court system. But for most business sectors, the investment protections available under the USMCA — particularly those related to expropriation — are reduced in scope compared to those under NAFTA.[19] 

These business concerns are in addition to increasing violence in many parts of the country, drug gangs that control major geographic areas,[20] endemic corruption at all levels,[21] and increased truck hijackings — even on the busy road from Monterrey to the U.S. border.[22] And while cartel risks are perhaps less severe in Nuevo León than in some other parts of the country, such as Matamoros,[23] they do exist. A recent visit to Nuevo León by members of the Center for the U.S. and Mexico at Rice University’s Baker Institute for Public Policy further revealed that state authorities feel besieged by crime and violence in surrounding states and fear that at any moment these problems could spread into their state. It thus seems likely that some of the employees that Tesla might want to shift to Nuevo León on either a short-term or permanent basis, could very well balk.

Energy Availability Is an Issue

In addition to the disadvantages already discussed, energy availability is a significant factor in a country where natural gas is not readily available and much of it must be imported from the United States. One indirect consequence of opposing foreign investment in certain industries such as electricity (dominated by the state-owned utility, Comisión Federal de Electricidad, or CFE) and petroleum (dominated by Pemex, the country’s most powerful state-owned company) is the increased difficulty of obtaining clean, dependable, and reasonably priced electric power in many parts of the country. This is because the CFE relies on “dirty” Pemex fuel oil for much of its electricity generation. Moreover, while Mexican law allows for the regulatory approval of independent power plants (such as those using clean energy), it appears that the government is no longer approving such plants.[24] It is possible that Tesla was able to negotiate approvals but, if so, that information has not been released to the public.

For companies such as Tesla, which are currently subject to a carbon neutrality pledge, or are likely to be in the future, new factories that rely on dirty power are a potentially complicating factor.[25] However, the CFE does have some natural gas available for manufacturing. It has also been increasing its monopoly over Mexico’s limited supply of natural gas by recently acquiring at least one major foreign-owned investor, the Spanish company Iberdrola, which operates natural gas plants in several Mexican states, including Nuevo Leon. This comes at a time when many such private firms are reportedly selling off their assets in Mexico because divestment “will let the company focus on markets where building a lower carbon economy may offer more lucrative opportunities.”[26] Presumably, Tesla will have access to the CFE’s expanded resources — although it is uncertain whether the availability of natural gas in Nuevo Leon will keep pace with rising demand over the next few years. Moreover, a Tesla auto assembly plant could rely on EV batteries produced in the United States. In this respect, it has been reported that Tesla is planning a joint venture with Chinese EV battery producer Contemporary Amperex Technology to be located in Texas.[27] If such a plant were to be built, it could supply batteries for Tesla’s operations in Nuevo Leon as well as elsewhere.

Conclusion: Potential Benefits Make It Likely the Project Will Go Forward

This brief was written in the very early stages of a mammoth project that could produce billions of dollars of investment, thousands of jobs, and a million vehicles a year, primarily for export — if it becomes operational. The project could still fail or simply be abandoned by Musk, or López Obrador could unilaterally seek to change or fail to deliver on essential elements of the agreement, most of which have not yet been publicly disclosed. However, despite the many potential challenges — including water conservation, clean energy, dealing with López Obrador’s government and possible union challenges facilitated by USMCA guarantees that will likely be invoked if the plan does not include independent unions from the outset[28] — it seems more probable than not that the project will ultimately go forward since both Tesla and Mexico would benefit greatly if it reaches fruition.

For the United States, these potential benefits are significant. The 800,000 to 1 million Teslas a year that could be imported into the United States from Mexico are likely to be cheaper, or at least no more expensive, than Teslas built in the United States. As such, they could contribute, even if only peripherally, to the Biden administration’s objectives of assuring that half of U.S. car sales by 2030 are electric[29] (despite “Buy American” policies) and reducing Tesla’s reliance on Chinese suppliers for batteries and battery components. For these reasons, the Tesla factory in Mexico seems likely to become a reality sooner rather than later.

Endnotes

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[1] Dave Graham and Daina Beth Solomon, “Tesla Plant Gets Green Light in Northern Mexico,” Reuters, February, 28, 2023, https://www.reuters.com/business/autos-transportation/mexican-president-says-tesla-will-build-major-plant-northern-city-2023-02-28/.

[2] Ibid.

[3] Sam Shead, “Elon Musk Breaks out the Dance Moves as he Opens New Tesla Factory in Germany,” CNBC, March 22, 2022, https://www.cnbc.com/2022/03/22/gigafactory-berlin-tesla-ceo-elon-musk-opens-electric-vehicle-plant.html.

[4] Graham and Solomon, “Tesla Plant Gets Green Light in Northern Mexico.”

[5] Chloe Henze, “Volkswagen de Mexico”, Historicalcalm.MX, April 5, 2023, https://historicalmx.org/items/show/75.

[6] Steven Loveday, “CATL Looks to Mexico for Battery Factories to Supply Tesla and Ford,” Inside EVs, July 18, 2022, https://insideevs.com/news/598917/catl-mexico-battery-factories-tesla-ford/.   

[7] See “Manufacturing in the U.S. vs. Mexico – Comparing Costs and Labor Force,” The Nearshore Company, February 28, 2022, https://www.thenearshorecompany.com/nearshore-insights/manufacturing-in-us-vs-mexico/.   

[8] David Hunkar, “Average Hourly Rate for Auto Workers in Select Countries,” TOPFOREIGNSTOCKS.COM, October 26, 2016, https://topforeignstocks.com/2016/10/26/average-houry-rate-for-auto-workers-in-select-countries/.  

[9] See “Fact Sheet — IRA EV Tax Credits,” SAFE Electrification Coalition, August 16, 2022, https://electrificationcoalition.org/wp-content/uploads/2022/08/SAFE_1-sheet_Webinar.pdf. 

[10] See “Electric Vehicle and Solar Assemblies,” TESLA, 2023, https://www.tesla.com/support/incentives.   

[11] See Gilles Guillaume, “Renault Reviewing Prices Worldwide after Tesla Cuts,” Reuters, April 17, 2023, https://www.reuters.com/business/autos-transportation/renault-brand-sales-bounce-back-q1-up-9-2023-04-17/ (noting Renault’s response to Tesla’s recent price cuts in Europe, Israel, and Singapore).

[12] See “U.S., Japan Strike Trade Deal on Electric Vehicle Battery Minerals,” CNBC, March 27, 2023, https://www.cnbc.com/2023/03/28/us-japan-strike-trade-deal-on-electric-vehicle-battery-minerals.html.  

[13] See “Ways & Means Trade Chair: Guidance on EV Tax Credits ‘Unconstitutional,” World Trade Online, March 31, 2023, https://insidetrade.com/daily-news/ways-means-trade-chair-guidance-ev-tax-credits-unconstitutional.   

[14] See “Mexico – Country Commercial Gide: Trade Agreements,” International Trade Administration, September 23, 2022, https://www.trade.gov/country-commercial-guides/mexico-trade-agreements. Mexico is also a member of a less extensive agreement, the Pacific Alliance among Mexico, Chile, Colombia, and Peru.

[15] Scotter Doll, “2023 Tesla Prices: How Much Does Your Favorite Model Cost?,” Electrick, March 9, 2023, https://electrek.co/2023/05/02/2023-tesla-prices-how-much-does-your-favorite-model-cost/. A fully loaded Model 3 costs $62,490.

[16] World Bank, 2021, https://bit.ly/3NJ3RkK.

[17] See HTSUS 9903.88.01.

[18] For example, in March 2023, Vulcan Materials, a major U.S. producer of construction aggregates, claimed that the Mexican government had without legal justification and against a Mexican court order sent armed military police and the military to occupy Vulcan’s Port facilities near Playa del Carmen. See “Statement of Illegal Occupation of Vulcan’s Property in Mexico,” Vulcan Materials Company, March 21, 2023, https://www.prnewswire.com/news-releases/statement-on-the-illegal-occupation-of-vulcans-property-in-mexico-301777931.html. 

[19] Under USMCA Chapter 14, a serious auto producer dispute with the Mexican government would be subject to mandatory international arbitration at the option of the investor, but only after exhaustion of local court remedies. Several of the major claims permitted under NAFTA Chapter 11, denial of fair and equitable treatment and indirect expropriation, are no longer actionable. Nor are claims based on denial of any right to establishment of an enterprise. Annex 14-4, arts. 14.D.3, 14-D.5.

[20]  See “Mexico’s Long War: Drugs, Crime and Cartels,” Council on Foreign Relations, September 7, 2022, https://www.cfr.org/backgrounder/mexicos-long-war-drugs-crime-and-cartels.

[21] Mexico currently ranks 126th (compared to 65th for China), with 1 being best and 180 being worst. See “Corruptions Perception Index 2022,” Transparency International, January 31, 2023, https://www.transparency.org/en/cpi/2022/index/dma.

[22] Nathaniel Parish Flannery, “Cargo Truck Hijacking is a Major Risk in Mexico,” Forbes,  March 1, 2003, https://www.forbes.com/sites/nathanielparishflannery/2023/03/01/cargo-truck-hijacking-is-a-major-risk-in-mexico/?sh=4e28dbe068b9.  

[23] Alfredo Pena and Matthew Barakat, “What We Know About the 4 Americans Kidnapped in Mexico,” AP News, March 7, 2023, https://apnews.com/article/mexico-americans-kidnapped-gulf-drug-cartel-2700637729e8f3a5065005231aa8d4d3.

[24] See David A. Gantz, “AMLO’s Energy and Investment Policies will Make Mexico Poor Again,” Rice University’s Baker Institute for Public Policy, August 4, 2022, https://www.bakerinstitute.org/research/amlos-energy-and-investment-policies-will-make-mexico-poor-again.

[25] And Texas, where Tesla has both production facilities and its headquarters, seems to be moving away from new clean electricity production as well (albeit from a very high current level of clean power production), with recent legislative proposals that would favor natural gas installations over windmill and solar power. See Umair Irfan, “Clean Energy is Taking Over the Texas Grid. State Officials are Trying to Stop it,” Vox, January 30, 2023, https://www.vox.com/science-and-health/23577512/texas-clean-energy-wind-solar-natural-gas-ercot-blackout. See also Justin Jacobs, “Texas Leaders Threaten Wind and Solar Boom with Legislative Push,” Financial Times, April 3, 2023, https://www.ft.com/content/f0f38eec-6cec-49bc-9390-ed4ac4402525.

[26] See Christopher Lenton, “CFE Strengthens Grip on Mexico’s Generation Sector, Adds 8.4 GW of Natural Gas Capacity,” Natural Gas Intelligence, April 5, 2023, https://www.naturalgasintel.com/cfe-strengthens-grip-on-mexicos-generation-sector-adds-8-4-gw-of-natural-gas-capacity/ (Quoting Adrian Duhalt, a research scholar at Columbia University, who also noted that the divestment by Iberdrola “reduces its footprints in a country where nationalistic policies in the energy sector seek to keep private players at bay.”)

[27] See Hudson Lockett and Edward White, “Tesla Boosts China Investment with Plans for Shanghai Battery Factory,” Financial Times, April 7, 2023, https://www.ft.com/content/37b2d801-4850-4aa5-a341-3da08b609913.

[28] See USMCA Ch. 23; Annex 31-A.

[29] See Ira Boudway, “More Than Half of US Car Sales Will be Electric by 2030,” Bloomberg, September 20, 2022, https://www.bloomberg.com/news/articles/2022-09-20/more-than-half-of-us-car-sales-will-be-electric-by-2030#xj4y7vzkg.

 

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