Alan Russell Selected as Guest Speaker
Alan Russell, Co-Founder of the Tecma Group of Companies was invited to be a guest speaker at the MexicoNow event in El Paso, Texas. An audience of over 500 interested listeners heard Alan describe NAFTA and taxation issues. The video plays for 30 minutes and is a valuable view for anyone considering doing business in Mexico.
[00:28] Alan: Thank you everyone. We’re living in interesting times. How boring would it be if we didn’t have these challenges in front of us, right? It’s a good time to be alive, and a good time to do business between these dynamic countries of US and Mexico. These colliding cultures are creating opportunities that we have yet to unfold, or even understand.
Now, you’ve heard a lot this morning, a lot of data about how it’s affecting our various industries. A lot of experts are putting forth their studies and data, on how the projections might turn out, may not turn out. If I leave you today with the impression that I have a political opinion on how this goes, I’ve not done my job. I want to give you some information that you can take home with you. It’s not whether this is good or bad, it’s about the facts on the table, and whether it’s important. My goal is to give you that data in a positive way so we can see what the outcome, potentially, will be.
None of us know exactly what’s going to happen, but I promise you one thing: it’s not going to happen as fast as you think, and it’s not going to happen as you might fear. We have a lot of opportunities in this crisis, and we want to make sure we seize the moment. The real question is, what is the worst case scenario, and how would that worse case scenario turn out; how would it look? It’s just not that bad, when you look at the numbers.
We’ve heard about NAFTA, and how wonderful NAFTA has been. I was around for a while before NAFTA became into play. This is me seven years before NAFTA began. I want you to not the air of confidence, and the look of determination on my face, okay? And the dark hair. Now, if you think NAFTA has been easy, look at me now. We were promised a whole lot of things with NAFTA, like the transition would be smooth, the trade would be easy, and the borders would be open, and moving back and forth with our products was going to be the common place. Those of you who do this on a daily basis, know that’s not exactly how it turned out.
It’s said that El Paso alone lost more than 20,000 jobs when NAFTA was implemented. An interesting thing happened, and as those 20,000 jobs were being lost in the manufacturing sector, in 1994, the unemployment rate in El Paso was 12%. By 2000, it was 7%, and now, 5%. So, with the change that came in losing those jobs; and they didn’t all go to Mexico. They went all over the world, primarily the textile and electronics industry. As those jobs left, a backfill of jobs occurred. And those were paying jobs. The point is, for every action, there’s a reaction, and that’s what creates the opportunity. Change can be uncomfortable; especially when you’re not in control of it. But as businessmen, we have to seek those opportunities, look where the change is occurring, and develop the opportunity where it looks like it’s possible.
The history of NAFTA. It was envisioned as a way to reduce trading costs, increase business and help North America be more competitive in the global marketplace. I think that that, probably was true, and it happened that way, but it took a long time to develop NAFTA. Negotiations started as early as 1986, and the program was not truly under negotiations until 1989. [05:00] It was 1994 before it was enacted. It took five years of a whole lot of smart people working on it to develop all the what ifs, and how it would work.
As we see this change, even though it’s, okay, today is the change, that doesn’t mean it’s implemented expeditiously. The people in charge have got to be cautious, because they don’t want to put a bunch of companies out of business. They want companies to evolve, and be able to react to those changes. It was envisioned, the objectives were to eliminate barriers, cross border barriers, to trade and facilitate cross border movement, and goods, and services, and promote conditions of fair competition and race on a global basis. I’d say the second part is true, that if any guy in this room feels the facilitated ease of trade across the border, we’re doing more paperwork, we’ve got more staff, more energy, more people facilitating those movements than ever before. It didn’t exactly reduce those effects. But, it has a positive effect.
When I told you El Paso lost 20,000 jobs, at the same time, in 1994, there was a peso evaluation. That triggered a banking crisis. The economists referred to it as the tequila crisis. Since it occurred in Mexico, the tequila crisis, then one of my favorite economists says that El Paso and the other border regions got the hangover out of that, so there’s always a cause and effect, but they recovered quickly. They made a difference in all our lives as trade began to increase.
NAFTA gets credit for all of the increased trade between the US and Mexico. Let’s bear in mind that the trade between US and Mexico was on a fast pace anyway. Did NAFTA – should it get full credit for all those changes? Possibly not, we may be in the same position with or without NAFTA. So, we shouldn’t be so fearful about what would happen if NAFTA wasn’t here. What if NAFTA has renegotiated? It’s not the holy grail. There was life before, and there would be life after, should that possibility occur.
Now I’m encouraged you heard our senior speak, just before the break, about Wilbur Ross. He is Trump’s pick for a trade commerce trade secretary. I think it’s the secretary of commerce, which facilitates trade. Really is the person that would be in charge of negotiating any deals related to redoing NAFTA, or implementing new rules, especially as related to duties, tariffs, etc. Wilbur Ross is a multi-billionaire that made his fortune taking over poorly run companies, and turning them around in China, and some of the other Asia-Pacific countries. We could’ve done worse. I think we’ve got a good guy out of this chaos. He has to be yet confirmed, but once he’s in place, I think we’ll see somebody that understands the importance of trade between our two countries, and will help facilitate that, and improve it.
His attack, what we see preliminarily , are based around the rules of origin. Let me explain that. We heard a little about it earlier, but let me give you an example. What irritates him, is that in countries, can others – are able to import products in Mexico duty free. How does that work? Without the permission of the other two countries – US and Canada – Mexico implemented what is referred to as the sectoral program. That was to attract foreign investment from Asian countries, and other countries as well. If it was a product, or a component that wasn’t made in Mexico, wasn’t considered a competitive product to Mexico, Mexico would say, sure, bring it on in, [10:00] because it helps create employment for an investment, and instead of it being an 18% duty rate coming into Mexico, they reduced it to 2%, or sometimes 0%. They called it the sectoral initiative, the sectoral programs.
Some of the Asian countries took advantage of that, and are still taking advantage of that. It’s a loophole, right? All countries have loopholes. Tax, codes, whatever it is, there’s ways you can maneuver to deal with them in a positive way. These countries have taken advantage of it. They can import, let’s say, an instrument cluster for an automobile. Let’s say it’s made in China, or Japan, or an Asian Pacific country. They can import it into Mexico under the sectoral program, Duty Free. It goes into a car, and that car qualities under NAFTA. So the car can be imported in the US, duty free. Those components, coming from a non NAFTA country, gets into Mexico duty free under the sectoral, gets installed in the product, imported in the US, duty free. That’s a loophole. That’s where we see Wilbur Ross, and his team, will focus on NAFTA. When we’re talking about renegotiations of NAFTA, I think that’s where the target will be. That’s not bad for us. Just think about it.
If it’s harder for an outside supplier, let’s say China; I’m not beating up China, I’m just using it as an example because it’s the biggest one out there. So, we will increase the cost of them importing their product into the US, or into North America, and to Mexico. That will give suppliers that are already here, US or Mexico, more opportunity. We’re going to see increased foreign investment from North American companies, in Mexico and the US, that will supply that chain because they can do it without duty. It’s the action and the reaction. If we tax what’s coming from the Asian countries, and close those loopholes, it’s going to create opportunity for the companies that are already here, and for the ones who want to be here. We’ll see those Asian countries try to establish themselves in North America, which we’re already seeing a migration.
Wilbur Ross? Not so bad. The attack on NAFTA? Not so bad. We can see it evolving in a positive way. Remember I showed you a slide earlier on them working several years before NAFTA existed? If NAFTA didn’t exist, we would just go back to where we were. When we moved product from the US into Mexico, under what was referred to as sub chapter 9802, some people remember 807, if you’re old enough in this room, you remember some of those codes that we operated under, and it worked. We moved product across the border and it was under the harmonized tariff code, where if it’s US product going to Mexico, and then it come back from Mexico into the US, you can’t tax it, because it’s already US components, right?
You only imply duty on the value added. Meaning, the foreign content of the labor, and the overhead that occurred in Mexico. We were paying an average of about 2.5% of tax on products that we were bringing back into the US. That’s workable. That was not a very big trade; it facilitated trade under this 9802 program. If NAFTA wasn’t there, if NAFTA is modified, there’s ways that will continue, and we still, today, operate under 9802 sectors, especially textiles, steel, we still use 9802 as the trade mechanism to bring it back and forth. So, theoretically, it would just stay there.
Now, we’re going to talk about this little fella. There always seems to be an elephant in the room that’s not clear cut in what’s going wrong. I had the opportunity to spend 15 minutes of private time with Paul Ryan, the secretary, or the speaker of the house for the US on Sunday. The topic of conversation between us was the border adjustment tax. [15:00] Paul Ryan is all over this. Paul Ryan was head of the ways and means committee, before he became speaker of the house. That’s the committee that would design the tax that they’re focusing on. There was a lot of people against it, a lot of people for it, and the US administration, it would take only a few Republican naysayers to kill it before it became effective. We’re talking about, if becoming ineffective, what would happen if it did? So, the concept behind the border adjustment tax, is a proposed 20%. That sounds horrible. How we could we possibly live with the cost of our product being taxed 20% when it comes back to the US?
It’s kind of an innovative concept, and I had him explain it to me twice, because my hard head, it was hard for me to get around how this would work and be possible, without putting a bunch of companies out of business. The idea is, when you export to Mexico, you’re going to get a credit. You’re not going to pay anything right then, or get a credit that’s going to result in cash right then. When you import from Mexico, you get a debit. That would be balanced at the end of the year in a tax return, so it’d be a balance of imports and exports. We’d only pay the 20% on our deficit.
Let’s take it back and look at 9802. We can import into Mexico, and export. We get a credit. We add value, we bring it back, it’s a debit, or vice versa. The tax we would pay would just be on the value added. If we take the example that we’re talking about, you receive credit on the annual tax return for product 642. Some companies doe a lot of exportations; some companies only do importation. You receive a debit on your annual tax return for products imported. The penalty is – the idea is to create more incentive to do imports or exports, rather than be importing from a foreign country. Example: companies send materials to Mexico and receive a credit. Companies assemble products, bring them back, and they receive a debit. The taxes apply to the difference.
Here’s an example. One of the tech executives bought a washing machine from Best Buy the other day. The price was about $800, so this ended up being our example for this particular case. Let’s think about it in real terms. It’s an $800 washing machine. The materials and labor for that came out to a total of about $240. $96 of that were US components that were sent to Mexico to make the product, originally. The $144 was the foreign content that was added. That’s components from all over the world, and the labor component. When it comes into the US, that foreign component will be taxed the 20%. It sounds horrible, but look at the reality; that’s $29. $29 on an $800 item.
Then you’ve got the marketing, sales, and the profit that’s all built in, that’s not part of the VAT tax. It increases the cost of that washing machine $29. Not so bad. That’s still competitive. It’s still going to be any way you could make that washing machine, and give it to the US for any other price. Mexico has a tremendous advantage over any of these proposed profiles. We just need to stay calm, and watch this play out. The worst case scenario is just not that bad.
When we were talking to Paul Ryan, he was reassuring me that this was going to be a slow rollout; that it wouldn’t be instantaneous, that it’s not one day to the next. When I looked back at NAFTA, and how that worked, it was exactly this way. We likened it to an onion. When you peel a leaf off the onion, that represents one of the tariff codes. It took years to implement NAFTA. [20:00] I mean, some of the effects took 8-9 years before it was fully implemented. If we see smart people being in control of this, implementing the VAT tax, and unrolling it, like peeling the leaves off an onion, we can all react to it, better ourselves, and seek opportunities within that change, and grow our businesses as a result of it.
This isn’t going to happen overnight; it’s not going to be, boom! And then you have this tax in front of us. It’s going to be given time to react. Let me backup on this washing machine example. If you take that washing machine you brought into the US and paid the $29, so you’ve gotten a debit for having it go to Mexico. If you ship it to Canada, you get a credit back. If you ship it to Australia, you get a credit. It’s not just black and white, all that will be balanced out in a tax return at the end of the year. Remember the onion concept.
This is interesting. Where was your car made? It is said that 40% of all the cars coming out of Mexico is of US content. You look at the thousands, the 10,000 part that are in an automobile, that it takes to assemble it. You try to unravel that, and you think of the concept that, truly, were Siamese twins were to separate us at this point in our life, since 1994, the 30 years that NAFTA has been in business, would almost be impossible. We can believe that this is going to continue; we can have passion in it. Just watch it for the opportunity that’s going to create as this evolves.
We’re not able to change the course and change the tide. Of course, we’re talking to our congressman, we’re writing letters, we’re sending people to Washington to testify on our behalf. Truly, the cards are in play. As business people, we’ve got to see where the cards are being played, and how we’re best going to play them. If we have an ace, and it’s not up our sleeve, you can see the little bulldog down in the corner; he’s got it in his toe. That’s an ace of spades. Our ace is the relationship between Mexico and the US, and those of us in this industry. We will play that ace to our benefit, as this unfolds.
NAFTA and the BTA can evolve and change, embrace change. Let’s not be static. You’ve all been in companies before where there’s change; where there’s a new manager that comes in and is implementing change. There’s people that can adjust to change, and there’s people that resist i. I encourage us all to adjust; to embrace the change, and it will benefit us all in the long run.
In 31 years, I’ve seen – there’s a quote that goes along the line of, ‘we’ve seen a thing or two, so we can do things,’ and 31 years in this business, I have seen inflation, devaluations, several of them, in Mexico, three major recessions, the last one being the most horrible. We saw the violence period. I want to remind those in this room, and all the young people in this room can remember that just a few years ago, it was dark days in our industry. We had the violence period on top of the Great Recession, there wasn’t any business moving, other than what was here. Nobody was coming. When you think about this change, how horrible it could possibly be, just remember, this isn’t nearly as bad as what we’ve seen. We’ve been through multiple Presidential administrations on both sides of the border; political phases, assassinations, many things, and every year, every year in those 31 years, except the exception of 2009, which was the bottom of the Great Recession, trade increased between our two countries.
For 2016, I think the number will come over $600 billion of trade between our town countries. And again, it’s the effect of, there’s no way you can stop this. This reminds me of when I was a child, actually, I was a big child, working on our family farm. We would build a stock pond for the cattle. [25:00] It would be a couple of acres, water, lake, and it was just amazing that within a year or two, you could fish in that pond and catch fish. I asked my dad, ‘How in the world do fish get in there?’ And he would explain that it’s just life. You create the pond, you create opportunity, and life just forms. It comes. You know? It just evolves. There’s no way you can stop it. There’s no way you can stop creatures from growing and prospering in that pond of water. I say it a lot, and I believe it, that trade is like life itself. Alright? If there’s a will, there’s a way. You can’t stop trade. Where there’s opportunity, it will flourish. We may hit high center once in a while, and get stuck, and not sure which way we’re going to go, but if we can make a difference, and we can move forward with this changing tide, then we must embrace it at every opportunity.
One vision. One mission. One North America is what we’re all about. Thank you very much.
Audience: The border adjustment types, and, you know, your example, before the [inaudible]
Alan: Certainly, it’s going to be pushed to the suppliers. Ultimately, it’s going to be pushed to the consumer. The border adjustment tax, at the end of the day, will create higher consumer prices, at the end of the day. It’s very similar to the EVA, when we import something into Mexico, we import 16%, Right? Then, the distributor sells it to retail, they can get it back. The ultimate consumer pays it, then doesn’t get it back. It’s considered by some circles as a consumption tax.
By many economists, the consumption tax is considered to be the most fair tax in the world. 160 countries, this is Paul Ryan’s comment. 160 countries around the world have a consumption tax, or a VAT tax. Mexico is no exception. The US doesn’t have one, so that’s the idea. What the US administration is trying to do is to create a tax flow that will help offset income tax, and help lower the income tax in the US. All of us think that’s too high, but they have to get the money from somewhere, and this is the tax. The consumers pay it. The high end consumers that spend a lot of money are going to pay more tax. That’s the consumption tax concept. People that don’t spend a lot of money, that don’t have a lot of money to spend, are paying less. That’s creating the fair tax flow.
So, yes. The suppliers are going to pay it Because the OEMs are going to try and offset it. At the end of the day, the car’s going to cost a little more. If it’s staged properly and over time, it’ll cost more to get imports into the country from other than NAFTA nations, and it’ll all create a negative balance.
Host: One more quick question: How will the [inaudible] proposal help the US president create more jobs there?
Alan: The way I see it, the VAT tax will create more opportunity for US suppliers to compete. It’s going to cost more for foreign companies to get into the market. It’s going to be a slow effect, that’s why it has to be phased in over time. The VAT tax, what the President is looking for, is a way to get more money into the coughers, to offset his promises of lower income tax. That’s the chart.
Host: perfect. Alan, I want to thank you, on behalf of Mexico and the team. We really appreciate your time.
Alan: My pleasure.