The Southern Border and the Chinese Supply Chain

Regular readers of this newsletter know that we have been following the development of the Chinese supply chain being nearshored to Mexico.? While the primary effect of Chinese nearshoring is direct access to the US market, there is a secondary affect that could have an important impact.? As Chinese national champions / famous brands like BYD and Hisense draw in their second and third tier suppliers,? we can expect to see the development of an active market for materials, components, and finished goods.? There is even the possibility that Chinese-style contract manufacturing could develop just hours from the Texas border.?? The USTR and Congress, on the other hand, have thoughts.?

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End of the Story:??? China is going all-in on nearshoring to Mexico, and we’re already seeing the beginning of a Chinese network effect (i.e.: Houfusan Industrial Park).? While their primary purpose is to access the US market, we can expect the Mexican supply chain to start filling up with high-quality, low-cost (subsidized) Chinese parts and components – AT SCALE.? ?Mexico doesn’t have a CFIUS or other sophisticated screening process.? Mexico lets just about every project in if they can comply with IMMEX requirements and Mexican company registration rules – which are not particularly onerous.? As far as Mexico is concerned, these are 100% Mexican entities.

What does this mean to US nearshorers or sourcers developing their North American Supply Chain?? It’s complicated – and getting far more complicated by the day.? But here’s the exciting spoiler alert:?

The US Customs and Border Protection service reserves the right to decide if any given firm is “really Chinese” or “really Mexican”. ??

And if they are Chinese companies, then you can expect the full range of US responses – tariffs, executive orders (i.e.: UFLPA), and standard trade enforcement (USMCA, financial sanctions).

The bottom line – soon sourcers and nearshorers are going to start hearing some pretty great offers from Chinese nearshorers in Mexico.? As a general rule, the risk profile for this kind of trade is high, variable, and volatile.? The one exception is UFLPA (Uyghur Forced Labor Prevention Act), which you should treat as a radioactive 3rd-rail that will give you COVID and Dengue Fever.? We’ll go into details in a bit, but there is a very real possibility of forfeiture of your entire shipment for even the hint of a violation.?

?US Trade Policy on Chinese products

The only thing that US Democrats and Republicans agree on is that China is bad for US business.? It would be great if a bipartisan committee would develop a comprehensive, integrated policy coordinated with Mexico – but no.? Instead, we have a growing list of ad hoc restrictions, tariffs, and requirements that don’t seem to be overly concerned with enforcement or execution.? That is your problem.

Our research keeps pointing back to USCBP (US Customs and Border Protection) as the key player in the US effort to control Chinese imports from Mexico.? While Mexican customs and logistics pros are generally extremely knowledgeable and effective when it comes to USMCA – that’s for Mexican output.? Remember that Mexico doesn’t have an UFLPA, the CHIPS Act, or the Trade Act of 1974 (Sections 301).? These are US rules that will be applied once your goods hit Texas, California, or Arizona.? It’s possible that your Mexican experts will be able to stay current on the slew of new anti-Chinese regs that Congress is pushing, but in some cases these new rules are going to be just about impossible to comply with.? (Remember that China often considers data on the origin of materials and products to be state secrets.)? Complying with US regulations is your responsibility.? If your Mexican team is working with local-local suppliers, then you can operate with a high degree of confidence that you will be able to comply with USMCA rules.? The new package of anti-China rules, however, is going to be exceedingly difficult to work with.?

What Does This Mean To You?

Companies sourcing and partnering in Mexico for export to the US should look at the Chinese supply chain in Mexico as a double-edged?sword.?

On the one hand, Chinese suppliers may be your best bet for getting high quality parts at scale.? Independent Mexican producers tend to have artisanal roots, and their ability to ramp up from a 50-piece test order to 50,000 pieces a month can vary widely.?? Chinese factory managers, however, don’t seem to know how to turn down an order.??

The downside, however, is that it’s up to you to make sure you are complying with US Customs (and Treasury, Homeland Security, etc.).?? It’s on YOU.? Mexico doesn’t have a UFLPA or CHIPS act.? It doesn’t have a CFIUS.? The first time your products are seriously inspected, they’re already on the on the US side of the border.? ???

If you or someone you trust makes an honest mistake when sourcing from a Chinese nearshorer, then your entire shipment can be SEIZED and FORFEITED.? This applies mostly to UFLPA for now, but it can easily spread to other situations.? US Customs treats any goods from Xinjiang with the “rebuttable presumption” that they are made with forced labor. Unfortunately, China considers information about the origin of production to be a state secret - so rebutting is going to be tricky. ???

How does the US determine the nationality of nearshored firms?

1.????? Ownership? and control, including corporate structure and management.? Who is really in charge?

2.????? Operations and decision making.? This includes both strategic direction and day-to-day operations.

3.????? IP and technology.? If the IP and tech comes directly from China, the USCBP can determine it is a Chinese entity.?

4.????? Economic ties.? The US may investigate the local entities financial ties to China.

It’s important to note that US Customs does not rely solely on the “entities list” of specifically sanctioned companies.? It may determine the origin of any company, regardless of official registration.

Categories of Remedies

1.????? Executive orders.?

·?????? UFLPA, CHIPS, Inflation Reduction Act, and others.? There are often provisions within larger directives and executive orders that specifically target China, and they can be deployed against any entity that US Customs decides.

2.????? Trade and Financial restrictions.?

·?????? This includes Section 232 Tariffs and Quotas , sanctions, and CFIUS.

3.????? Section 301 of the Trade Act of 1974.?

·?????? This is the one Pres. Trump leaned into in 2018.?

4.????? Anti-corruption, Transparency and Compliance.?

·?????? FCPA (Foreign Corrupt Practices Act)

5.????? New & in process.

·?????? New rules are constantly going into effect all the time, including curtailing the de minimis tariff exception and adding new products to Section 301 (scheduled for Sept 27).

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Final Word: ??

The US reserves the right to determine the country of origin for anything being imported?into the US, so China’s efforts to set up a nearshoring base in Mexico may be in vain.? Or not.? We really don’t know yet – and that makes the Chinese supply chain in Mexico very risky.?

The giant MNCs have already managed the localization/regionalization of their supply chain.?

If you are new to Mexico nearshoring or sourcing, the Chinese supply chain is a double-edged sword.? On the one hand, it won’t be long before Chinese manufacturing networks in Mexico have at least some degree of the capacity that you experienced in pre-trade war China.? On the other hand, the attitude towards China in Congress is negative and getting worse – and any proposal that blocks cheap Chinese imports into the US is going to be well received.??

For now, it may be wise to err on the side of caution and stick to local Mexican supply chains.

?#globalism2