Mexico’s first trade surplus in four years might, at initial glance, seem to confirm one of the arguments against the North American Free Trade Agreement. One of NAFTA’s key benefits was supposed to be guaranteed access to Mexico’s growing consumer market. The peso devaluation, however, has made our exports to Mexico more expensive, reducing Mexican purchasing power. Should we concede Ross Perot’s “I told you so”?

Far from it. A closer analysis of the trade figures shows that appearances can indeed be deceiving. While the dramatic drop in the peso is making life difficult for Mexico in the short term -- and suppressing demand for U.S. exports -- the devaluation’s long-term impact will provide a substantial boost for both the Mexican and U.S. economies.

That’s because a lower peso will spur a significant increase in “production sharing” among North American countries. This will mean more jobs and growth in the U.S. and Mexico -- at the expense of our Asian and European trade competitors.

Production sharing, or “co-production,” is an important component of the NAFTA partnership, and will be further enhanced by the new currency situation. We are already seeing evidence of this. The latest trade figures point to several revealing trends.

The first is that Mexico is making a dramatic turnaround in its trade deficit. In February 1995, Mexico ran a world trade surplus of $452 million, its first monthly surplus in four years. Mexican global exports for the first two months of 1995 increased 31.3%, while imports declined 1.6%. This means Mexico is making good progress towards a key goal of its economic recovery plan -- reducing the huge current account deficit that helped spark the peso crisis in the first place.

But while this is good news for the long-term -- because boosting Mexican exports helps stabilize its shaky economy and a healthy Mexico is good for the United States -- the trade data contain additional information that helps offset the downside of a substantial decline in U.S. exports to Mexico.

A closer look shows that much of Mexico’s drop in imports is coming from a reduction in consumer goods imports, which declined 20.3% for January and February. Significantly, though, intermediate good imports to Mexico continued to grow, by 5.7%, over the same period last year. This is due in large part to Mexico’s increasing participation in production sharing.

A growing global business strategy, production sharing splits up the manufacturing process to take advantage of local efficiencies. A portion of the manufacturing and assembly process is done in one country, a portion in another, to make the most competitively priced goods from various inputs of production. From 1991 to 1994, Mexican production sharing exports to the United States increased more than 60%, and accounted for almost half of all Mexico’s exports to its trade partner to the north. Currently, U.S./ Mexican co-production accounts for one-third of total U.S. global production sharing.

While the peso devaluation is causing a sizable short-term slowdown in Mexico’s economy, it is also lowering Mexico’s cost of manufacturing -- and that should spur further growth in U.S./Mexico co-production alliances. Facilities previously located outside of North America now have greater incentive to relocate to Mexico. Zenith Electronics, for example, will discontinue sourcing picture tubes for projection television sets in the Far East and begin manufacturing them in Mexico.

Why is this good for the U.S.? Because Mexican co-production imports contain roughly 50% of U.S.-produced content -- a much higher portion than goods from other parts of the world, such as Asia and Europe. Production sharing imports from Asia typically consist of only 25% U.S.-made content. Furthermore, relatively few Mexican imports compete directly with U.S. goods and services. Instead, they compete more with U.S. imports from non-NAFTA nations.

Because of this, a good portion of the expected increase in imports from Mexico will replace U.S. imports from other parts of the world. Unlike non-NAFTA imports, the higher U.S. content of goods co-produced and imported from Mexico translates into thousands more jobs for Americans as well as Mexicans. That’s why U.S./Mexico trade is best measured, not just by which country has a trade surplus or deficit, but by the growing number of partnerships and co-production.

The U.S. International Trade Commission (ITC), which has been studying the issue closely, reports production sharing has helped retain many U.S. jobs that otherwise would have been lost to intense foreign competition. An ITC analyst also confirms that relocation of production sharing from East Asia to Mexico is indeed likely to accelerate as a result of the peso’s devaluation.

As more co-production shifts from Asia to Mexico, the ITC suggests, the more the U.S. will benefit. Because of NAFTA’s rules of origin and other factors, U.S. and non-NAFTA companies who co-produce in Mexico will be at a competitive disadvantage unless they source more of their previously non-NAFTA components and other production content from the United States.

Recent tariff increases by Mexico on a number of products imported from non-NAFTA nations should further fortify North America’s co-production base. Mexican apparel production has been hit hard for several years from inexpensive Asian imports flooding the market. Thousands of small and medium-sized companies have been bankrupted, despite anti-dumping duties levied on Asian imports. The devaluation provided some relief. However, since much apparel production in Mexico is based on imported materials -- now about 40% more expensive -- additional action was needed.

The new Mexican tariffs -- to the level allowed by the WTO -- make Asian imports more expensive, and Mexicans will seek lower-cost products to replace them. U.S.-Mexican co-produced goods, which are cheaper, competitive and locally-produced, can fill the vacuum. U.S. trade with Mexico already reflects increased preference for U.S.-Mexican co-produced goods over Asian imports.

With NAFTA, the U.S., Canada and Mexico sought to improve their overall competitiveness, productivity and economic growth vis a vis the rest of the world. The devaluation and new trade deficit with Mexico shouldn’t be too hastily bemoaned. Yes, it is giving Mexico’s beleaguered economy a boost, at the cost of a short-term drop in U.S. exports.

But the trade deficit is also evidence of a longer-term and beneficial shift of our production base to a greater reliance on North American content and production-sharing partnerships. This will help reduce U.S. trade deficits with our Asian and European neighbors, and provide more business and job opportunities for the U.S., Canada and Mexico. That’s good news for all North Americans.

This article appeared in the Journal of Commerce, April 12, 1995.
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John Manzella
About The Author John Manzella [Full Bio]
John Manzella is a world-recognized author and speaker on global business, emerging risks, and the latest economic trends. He's also founder of both the ManzellaReport.com and Manzella Trade Communications, Inc. His latest book is Global America: Understanding Global and Economic Trends and How To Ensure Competitiveness.




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