Topic Category: Economy

On January 1, 1994, the day the North American Free Trade Agreement was implemented, approximately 50% of all U.S. exports to Mexico became duty free, accelerating trade flows. During the year, U.S.-Mexican bilateral trade rose 22%, up from $81.5 billion to $100 billion. U.S. exports to Mexico increased at about the same rate -- and almost four times faster than U.S. exports to the rest of the world. Mexico even edged up on Japan, competing for the United States' second largest trade partner status.

On December 20 of last year, however, the situation drastically changed. An attempted currency adjustment by the Mexican Government, that some say should have occurred earlier, but at a more gradual pace, accelerated out of control. The Mexican Government expanded its exchange rate band by 15% in an attempt to allow the peso to adjust downward. Within two days pressures mounted and the peso was allowed to float freely. Shortly thereafter, it nose-dived.

From December 20, 1994, to mid-March 1995, the peso dropped about 50% in value compared to the U.S. dollar. Like falling dominos, what began as a short-term liquidity crisis drove down confidence and sparked panic. The Mexican stock market dropped precipitously. Prior to this, Mexican political events pressured the situation.

The assassination of Luis Donaldo Colosio, the PRI presidential candidate and former Secretary for Urban Development and Ecology, raised question marks among foreign investors as to Mexico's political stability. The assassination of Francisco Ruiz Massleu, a senior ranking PRI official, added to the uncertainty. These events, combined with unrest in the southern state of Chiapas, further fueled investor unrest.

Stated by Carla Hills, former U.S. Trade Representative, "Mexico was forced to float its currency in the face of a $28 billion current account deficit it could no longer finance with capital borrowed from abroad." She said this, in addition to the assassinations and political unrest, raised questions about Mexico's ability to repay billions of dollars in debt coming due in 1995.

Mexican fallout quickly spread to Brazil and Argentina, whose stock markets fell, along with other developing countries worldwide. Investors received what some have referred to as a "wake-up call", reminding them that political and economic instability can largely affect growth prospects in developing countries.

As U.S. Treasury Secretary Robert Rubin said before a House Banking Committee on January 25, "the risks are not only in Mexico. Restoring confidence in Mexico will head off the spread of financial distress around the world." According to Rubin, more than two-fifths of U.S. exports are now destined for developing countries; and U.S. manufactured exports to these countries expanded by 65% between 1989 and 1993. If these economies endured an economic crisis precipitated by Mexico's market panic, U.S. exports would be largely affected causing a loss of jobs in the United States.

Many large Mexican companies have been hit hard by the crisis. Teléfonos de Mexico, the giant phone company, reportedly incurred a $862 million loss in foreign exchange in the fourth quarter of 1994. Cemex, an extremely large cement company by world standards, reported a $127 million foreign exchange loss. And Televisa, Mexico's media conglomerate, lost $142 million.

President Clinton's announcement on January 31 to provide Mexico with about a $50 billion U.S./international package of loans and loan guarantees was met with considerable relief in Mexico, as well as in the U.S. business community. After receiving the news, the peso gained value and Mexican interest rates on 28-day Government treasury certificates fell. Although economic indicators have fluctuated since then, signs point to greater stability.

The package includes a $20 billion credit line from the United States, $17.759 billion from the International Monetary Fund, $10 billion from the Bank of International Settlement, $1 billion from Canada, $1 billion from Latin American countries, and $3 billion from the international commercial bank.

As its North American partner, a sound Mexican economy is important to the United States. And the two countries have already benefited from NAFTA. According to the U.S. Department of Commerce, since NAFTA was implemented there has been a proliferation of joint ventures and strategic alliances between U.S. and Mexican companies. For example, Motorola established a joint venture with Baja Celular Mexicana of Tijuana in northwestern Mexico. The Florida-based Office Depot, which operates 388 office supply stores throughout North America, has signed an agreement with Mexico's Grupo Gigante.

A survey of 1,000 U.S. companies conducted in May 1994 by KPMG/Peat Marwick, a leading consulting firm, found that 57% believe that NAFTA will help improve the U.S. economy. Nearly 40% said their industry has already benefited in some way by the Agreement's passage.

The American Chamber of Commerce in Mexico conducted a survey of its members in the Spring of 1994. Of the 224 executive officers who responded, most expressed confidence that NAFTA would be beneficial to their productivity and profitability. The vast majority of respondents anticipated their U.S.-Mexican imports and exports would increase.

Coopers and Lybrand, another leading consulting firm, interviewed executive officers of 410 of the fastest-growing U.S. product and service companies. According to the report issued, for growth companies, NAFTA has meant export opportunities, not job relocations.

NAFTA opponents who predicted a mass exodus of U.S. jobs south of the border have been proven wrong by the facts. About 15,000 primarily low-wage, low-skill jobs were anticipated to be lost in 1994 due to NAFTA, according to U.S. Department of Labor estimates. The Agreement, however, was projected to support an additional 130,000 jobs in the United States from 1994 to 1995, based on U.S. Department of Commerce estimates released in late 1994. Overall, the Department of Commerce estimates that bilateral trade supports a total of almost 800,000 U.S. jobs.

In general, Mexican consumers feel that U.S. goods are superior in quality to European or Japanese goods. This has resulted in U.S. market share being very high in Mexico compared to other countries' market share in Mexico. And Mexicans have demonstrated a tremendous demand for U.S. goods, even though their incomes are low.

For example, in 1992, production workers in manufacturing industries in the European Union, previously called the European Community, received 748% more in hourly compensation than manufacturing production workers in Mexico; Japanese workers received 588% more. Nevertheless, on a per capita basis, Mexicans bought more goods from the United States than European or Japanese consumers. In 1992 Mexicans spent $440 or 44% more, per capita, than Europeans ($305) and almost 15% more than the Japanese ($384) on U.S. goods.

Even when calculations omit the amount of exports to Mexico that are re-exported back to the United States or to other countries, Mexicans still consume more than Europeans. According to the U.S. International Trade Commission, in 1992 about 21% of U.S. exports to Mexico were re-exported back to the United States. Many of these goods were components shipped back to the United States after being assembled or improved in some manner. If 21% of U.S. exports to Mexico are omitted from calculations, Mexicans still consumed $335 worth of U.S. goods, per capita, 10% more than Europeans.

Due to Mexican reductions and eliminations of duties under NAFTA, many U.S. companies anticipated increasing exports again in 1995. However, exports to Mexico this year will be likely down. How far depends on several factors, including the level at which the peso stabilizes and the degree to which the economy slows.

The WEFA Group, a leading economic forecasting firm based in Philadelphia, during the crisis anticipated U.S. exports to Mexico would decline to about half of original projections. This was among the most pessimistic projection and based on the peso stabilizing at 5.7 to the dollar. Prior to December 20 of last year, the peso equaled about 3.4 to the dollar. Also during the crisis the Dallas Fed reportedly estimated that 1995 exports to Mexico will fall to about $38 billion, from about $50 billion in 1994. Other projections show a less severe drop in exports.

Exports of consumer goods are expected to be most affected by the devaluation, according to David Hirschman, Director of Latin American Affairs of the Chamber of Commerce of the United States. And Mexican retailers are feeling the pinch. Stated by Robert Hall, Vice President of Government Affairs at the National Retailers Federation based in Washington, D.C., "Mexican retailers fear that the industry won't bounce back for up to five years." Other retailers are not as pessimistic, but have delayed expansion plans pending how quickly the economy recovers.

JC Penny was scheduled to open stores in Monterrey and Leon in March. Since the devaluation they have moved this to May. Footlocker also announced a delay in the opening of new stores. Dillards, which operates 227 stores in the United States, and Sax Fifth Avenue and were expected to open stores in Mexico in the very near future. However, their plans are unknown since neither has announced opening dates, which an industry analyst said was unusual. Wal-Mart, the largest U.S. retailer, is reportedly holding off on adding 24 new stores in Mexico.

Other industries expect a less severe impact. Reportedly, Avon, a direct seller of beauty products and jewelry, announced that it expects its 1995 Mexican performance to remain strong, despite the peso devaluation. Kodak, whose Mexican division generates $50 million in domestic and exports sales, expects the peso devaluation to have almost no effect on their business. Esco Electronics Corp., a manufacturer of defense and industrial electronics equipment based in Feruson, Missouri, reports that the peso's devaluation will have a negligible effect on their company.

Sam Baker, international marketing and sales manager for Buffalo-based Gaymar Industries, a manufacturer of medical devices, expects his exports to Mexico to be down this year, but pick up next year. "I'm basically optimistic about long-term growth trends in Mexico." Baker said he is confident in Mexico's ability to quickly get back on its feet.

George Rathke, international marketing director for the Association for Manufacturing Technology based in McLean, Virginia, is also optimistic about Mexico's future. His members are producers of machine tools and related products; two-thirds to half of which export to Mexico.

Rathke said prior to the crisis there was no indication of any kind of a problem in Mexico. "It came like an earthquake with no prior warning." He said, however, that the Mexican economy is built on a solid foundation and believes that the economic downturn resulting from the crisis will be "only a momentary blip." "Mexico will clean up the mess and move on. They'll get past this financial/economic correction." In the meantime, he expects many of his association members' exports to Mexico will be down at least this year.

On March 9th, Guillermo Ortiz, Mexico's Minister of Finance, announced an economic program designed to restore financial stability, strengthen public finances and the banking sector, regain confidence and reinforce the groundwork for long-term sustainable growth . The measures call for an increase in the national value-added tax from 10 to 15% and to eliminate some exemptions; reductions in government expenditures to 1.6% of GDP for fiscal year 1995; a rise of 35% in gasoline prices and 20% in electricity rates; a continuing of the floating exchange rate; and a 10% hike in the minimum wage.

As a result of the new program, in 1995 the Mexican Government expects a temporary increase in inflation of about 42%; a reduction of close to 2% in GDP; and a current account deficit of approximately $2 billion. Positive economic growth and lower inflation are predicted for 1996.

Michael Hart, an economist with Salomon Brothers, agrees with the Mexican administration's assessments. Stated by Hart, Mexican GDP for this year will drop by 2% and is likely to rise by 3.4% next year -- indicating a short-lived crisis. These projections are partly based on strong anticipated exports. Hart said Mexican inflation this year may reach 44.5%, slightly higher than Mexican estimates, and taper down to 15% next year.

Because the peso devaluation has reduced the cost of manufacturing in Mexico, the economy is expected to get a boost from an increased level of production sharing activities. Production sharing allows some of the low-skill, labor intensive manufacturing processes to be conducted in Mexico, while the high-skill, capital intensive processes are retained in the United States.

According to Donald Michie, Vice President of the El Paso-based NAFTA Ventures. Inc., U.S.-Mexican production sharing will increase and U.S. imports from non-North American countries will decline. As a result of these partnerships with Mexican firms, U.S. companies will become more cost-efficient and globally competitive. This adds to U.S. revenues and employment. Without this, many U.S. manufacturers won't be able to compete as well with producers in lower wage countries and may be forced to discontinue both the high and low-skill processes -- resulting in plant closings.

Production sharing also adds to Mexican payrolls, the strength of their economy, and their ability to buy U.S. products. Thus, the strategy enhances North American competitiveness compared to Europe and Japan: a primary objective of NAFTA.

This article appeared in The Exporter, April 1995.
Topic: Economy
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The Peso Devaluation Will Promote the Transfer of U.S.-Owned Manufacturing Operations From East Asia to Mexico

The Mexican peso devaluation has made life difficult for many Mexican firms and will considerably slow economic growth there, at least for the short-term. However, there will also be a very positive impact in the medium and long-term.

By reducing the cost of manufacturing in Mexico, the devaluation should increase the trend toward North American production sharing -- to the benefit of both U.S. and Mexican firms. As a result, an increasing number of U.S. and foreign-owned firms currently manufacturing in East Asia for North and South American markets are likely to relocate more of their manufacturing operations to Mexico. This will boost U.S. exports of components to Mexico, which are widely used in Mexican production and assembly, strengthen the Mexican economy, and very importantly, increase North American global competitiveness.

According to Donald Michie, Vice President of the El Paso-based NAFTA Ventures, Inc., as a result of the devaluation, U.S.-Mexican production sharing, which accounts for about one-third of total U.S. global production sharing, will increase. Production sharing (provided under U.S. tariff classifications 9802.00.60 and 9802.00.80), has permitted U.S. materials assembled, processed or improved abroad, to be shipped back to the United States incurring duty only on the foreign value. This has allowed some of the low-skill, labor intensive manufacturing processes to be conducted in lower-wage countries, while the high-skill, capital intensive processes are retained in the United States.

This has helped U.S.-based companies become more competitive worldwide, prosperous and able to sustain or increase the number of higher-skilled U.S. jobs at higher wages. In turn, production sharing has created Mexican jobs, increased their standard of living and allowed more Mexicans to buy U.S. products.

Under Nafta, the 9802.00.60 and 9802.00.80 classifications are not as vital to U.S.-Mexican trade since the agreement phases out all duties on U.S. and Mexican products. However, by establishing alliances and combining strengths and resources to a greater extent through production sharing, U.S. and Mexican firms will become more competitive vis-a-vis European and Japanese firms. The concept of "Team North America," a primary objective of Nafta, has become a reality and is more vital to our economic interests in light of rapidly growing competing trade blocs.

U.S.-Mexican production sharing is anticipated to increase under Nafta. Predicted in 1992 by Bob Broadfoot, Managing Director of Political & Economic Risk Consultancy, Ltd. located in Hong Kong, unless the majority of their markets are in East Asia, many American manufacturing firms operating there are likely to relocate their plants to Mexico. He indicated that many U.S. manufacturers based in Singapore, for example, produce electronics products primarily for the U.S. market. Many of these firms, he said, will likely relocate to Mexico. Now that Mexican manufacturing costs have been reduced by the peso devaluation, this pace will likely accelerate. This trend is expected to make North America more self-sufficient. Stated by Michie, "U.S. imports from non-North American countries will decline."

John Taylor, Vice President of Public Affairs for Zenith Electronics Corporation, said that by the end of 1995, Zenith will discontinue sourcing their picture tubes for projection television sets in the Far East and begin manufacturing them in Mexico. In addition to using these tubes in their own sets, Zenith will also sell them to other television manufacturers. Nike, Inc. of Beaverton, Oregon, which makes most of its athletic shoes in Asia, reportedly announced in January that it is considering building a plant in Mexico.

Other factors, such as Mexico’s close proximity to U.S. markets, assuming the U.S. is a primary market, reduces transportation and communications costs. It allows many U.S. managers and their families to live in U.S. border cities, such as San Diego and El Paso, commuting the few miles across the border to their plants in neighboring Tijuana and Ciudad Juarez. Close proximity also helps facilitate visits from component suppliers, corporate research and development experts, engineering specialists, and the final customer.

Production Sharing Will Sustain U.S. Jobs That Might Have Been Lost

Lower skilled jobs are becoming scarcer and unemployment is increasingly commensurate with lack of education and skills. In 1990, although the U.S. unemployment rate averaged 5%, it reached 12% for those that had completed fewer than twelve years of schooling, according to Outlook 1990-2005, published by the U.S. Department of Labor. Similarly, it reached 6.3% for those that had completed high school, 4.2% for those who attained 1-3 years of college, and 2.5% for those who attained four or more years of college.

The occupational groups projected to decline or be among the slowest growing are more likely to be dominated by workers who do not have an education beyond high school. Conversely, groups on the list of occupations having the highest rates of growth are more likely to have workers with higher educational attainment. Thus, a skilled work force providing high value-added labor through the use of state-of-the-art technology is the only road to security.

Several years ago the U.S. International Trade Commission conducted a survey of U.S. companies involved in production sharing. When respondents were asked what they would do if 9802.00.60 and 9802.00.80 were eliminated, they indicated that they would increase reliance on foreign-made parts or suffer a loss of U.S. market share to foreign competitors not using U.S.-made components. Their responses, ranked according to frequency, were that without production sharing, they would:

  1. turn to foreign suppliers of components,
  2. drop labor-intensive product lines at their foreign assembly facilities and import these non-U.S. products from East Asia,
  3. move manufacturing of all products to East Asia,
  4. cut back U.S. production and target a niche of the market not threatened by imports, and
  5. go out of business.

It is clear that with the elimination of production sharing many high-skilled jobs in the United States and low skilled jobs in Mexico would be replaced by East Asian workers.

According to Robert Reich, U.S. Secretary of Labor, preventing the importation of products from low-labor cost countries would not solve any problems. Stated by Reich, "Even if millions of workers in developing nations were not eager to do these jobs at a fraction of the wages of U.S. workers, such jobs would still be vanishing. Domestic competition would drive companies to cut costs by installing robots, computer integrated manufacturing systems, or other means of replacing the work of unskilled Americans with machinery that can be programmed to do much the same thing."

North American Competitors Utilize Production Sharing of Their Own

For years Germany has had access to low-wage workers in Spain and Yugoslavia. Under the Guest Worker Program, Germany also allowed the immigration of foreigners in exchange for low-paying jobs. Since the fall of the Berlin Wall, Western Europe now has access to inexpensive and well-educated labor in Poland, Czechoslovakia, Hungary and, to a lesser extent, former East Germany, where wages often exceed levels of productivity.

Likewise, for years Japan took advantage of inexpensive labor in South Korea and today continues to employ low-wage workers in Singapore, Thailand, Malaysia, the Philippines, Indonesia, China and, most recently, Vietnam.

The question is not whether many labor-intensive, low-technology producers need to produce in low labor-cost countries -- many have no choice -- but rather, where to produce. For many reasons, those that need to seek low-cost labor are better off moving part of their production to Mexico than to East Asia. According to Michie, "Mexican production sharing imports contain approximately 50% U.S. value added which, if adjusted for the cost of Mexican labor, translates into more than 70% U.S. materials content." Conversely, Asian finished products embody few, if any, U.S. content.

Given these realities, combining U.S. and Mexican resources and strengths is extremely beneficial. Thus, "Team North America" will generate stronger economic growth and provide U.S. workers and firms with the best opportunities not just to survive, but to excel in the increasingly competitive global economy.

To Be Inserted by The Exporter

Arno Partner, Division Director for Latin America at the St. Louis-based American Soybean Association, reportedly said that U.S. soybean farmers shouldn't be hurt by the peso devaluation.

Dow Chemical reportedly said that the peso devaluation will have little, if any, effect on the company's operations in Mexico. Most of Dow's $150 million in annual sales to Mexico are exported from the United States.

Georgia-Pacific, a manufacturer of forestry products, reportedly saw its exports to Mexico rise by 40% in 1994. The company expects demands for its products to continue in 1995 despite the peso devaluation.

This article appeared in The Exporter, March 1995.
Topic: Economy
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U.S. exports to Mexico in 1994 were up an estimated 22% over 1993's numbers. By comparison, on a global basis, U.S. exports were projected to grow this year by 6%. This boom has benefitted U.S. exporters a great deal.

In the first quarter of 1994, many U.S. industry exports were up considerably from the same period last year. For example, transportation equipment was up 29.8%; electrical and electronic equipment, up 15.6%; industrial machinery and computer equipment, up 14.1%; fabricated metal products, up 31.5%; rubber and plastics, up 33.6%; Stone, clay and glass products, up 34.2%; printing and publishing, up 22.9%; forestry products, up 27.9%.

Agricultural exports to also rose considerably. From January to June 1994, for example, Corn (feed grain) was up 471%; beef and veal, up 54%; pork, up 45%; poultry and poultry products, up 28%; fresh fruits, up 78%; and vegetables, up 25%.

Unfortunately, 1995 will be different.

Peso Crisis Throws a Wrench into Mexican Auto Industry

The value of U.S. car exports to Mexico decreased 6% from 1992 to 1993, but increased a whopping 685% in 1994 to over $437 million, according to the U.S. Department of Commerce.

Mexican domestic car and light-truck sales were up in October 1994 by 32% compared to those of October 1993. Nissan recorded an increase of 183%; followed by Volkswagen, up 100%; Ford, up 8%; General Motors, up almost 2%; and Chrysler slightly down.

From January 1 to October 5, 1994, Ford Motor Company exported 18,000 cars to Mexico. This represented a huge increase from its 1,700 cars and truck exported there in 1993. Prior to the Mexican Peso crisis, Ford expected its exports from the United States and Canada to Mexico to top 50,000 vehicles in 1996.

Chrysler, Ford, General Motors, Nissan, Mercedes-Benz and Volkswagen currently produce in Mexico. Prior to the Peso crisis, Deloitte & Touche, the international consulting firm, estimated the Mexican auto market to grow by 8% during the next several years. Based on positive economic expectations, many auto producers had planned to expand upon or establish manufacturing facilities in Mexico.

Announced last October, Ford had planned to increase production capacity in Mexico to 108,000 cars annually beginning with the 1996 model year. The additional investment in Mexico would total about $60 million mainly for tools and equipment.

BMW reportedly planned a $600 million investment in car assembly, auto parts and distribution operations scheduled to begin in mid-1995. It chose to locate the assembly plant in Lerma, just west of Mexico City. T&N PLC, a British auto parts manufacturer, began building a plant on the grounds of a Chrysler de Mexico facility in the central Mexican city of Saltillo.

Reported in November 1994, Daewoo of South Korea had planned to invest about $350 million in a joint venture with Mexico's Creaciones Automotrices Nacionales (CANSA) to assemble automobiles in the municipality of Escobedo near Monterrey. Honda Motor Co. Ltd. planned to produce automobiles in Mexico within a two years. The company considered producing a smaller car for sale throughout North and South America.

Since the Mexican crisis, Italy's Fiat Auto S.p.A., which was negotiating a joint venture with Consorcio G. Grupo Dina S.A. (Dina), a Mexican truck and bus manufacturer, pulled out. The joint venture had planned to produce 100,000 cars a year in Mexico. And the Big Three U.S. auto makers have trimmed production plans for the Mexican domestic market. Until the dust settles, future plans of these producers are unknown.

The devalued Peso will boost the price of cars imported into Mexico, drop the value of dollar-based investments in Mexico, and lower the price of Mexican goods shipped to the United States and other countries. According to an industry analyst, prospective Mexican car buyers flocked to showrooms in order to buy before prices increased.

Although confidence in the Mexican economy declined as a result of the crisis, Mexico's solid economic base and entrenched free trade policies will no doubt overcome the adversity.

This article appeared in Export Today, March 1995.
Topic: Economy
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Peso Crisis Throws a Wrench into Mexican Auto Industry

The value of U.S. car exports to Mexico decreased 6% from 1992 to 1993, but increased a whopping 685% in 1994 to over $437 million, according to the U.S. Department of Commerce.

Mexican domestic car and light-truck sales were up in October 1994 by 32% compared to those of October 1993. Nissan recorded an increase of 183%; followed by Volkswagen, up 100%; Ford, up 8%; General Motors, up almost 2%; and Chrysler slightly down.

From January 1 to October 5, 1994, Ford Motor Company exported 18,000 cars to Mexico. This represented a huge increase from its 1,700 cars and truck exported there in 1993. Prior to the Mexican Peso crisis, Ford expected its exports from the United States and Canada to Mexico to top 50,000 vehicles in 1996.

Chrysler, Ford, General Motors, Nissan, Mercedes-Benz and Volkswagen currently produce in Mexico. Prior to the Peso crisis, Deloitte & Touche, the international consulting firm, estimated the Mexican auto market to grow by 8% during the next several years. Based on positive economic expectations, many auto producers had planned to expand upon or establish manufacturing facilities in Mexico.

Announced last October, Ford had planned to increase production capacity in Mexico to 108,000 cars annually beginning with the 1996 model year. The additional investment in Mexico would total about $60 million mainly for tools and equipment.

BMW reportedly planned a $600 million investment in car assembly, auto parts and distribution operations scheduled to begin in mid-1995. It chose to locate the assembly plant in Lerma, just west of Mexico City. T&N PLC, a British auto parts manufacturer, began building a plant on the grounds of a Chrysler de Mexico facility in the central Mexican city of Saltillo.

Reported in November 1994, Daewoo of South Korea had planned to invest about $350 million in a joint venture with Mexico's Creaciones Automotrices Nacionales (CANSA) to assemble automobiles in the municipality of Escobedo near Monterrey. Honda Motor Co. Ltd. planned to produce automobiles in Mexico within a two years. The company considered producing a smaller car for sale throughout North and South America.

Since the Mexican crisis, Italy's Fiat Auto S.p.A., which was negotiating a joint venture with Consorcio G. Grupo Dina S.A. (Dina), a Mexican truck and bus manufacturer, pulled out. The joint venture had planned to produce 100,000 cars a year in Mexico. And the Big Three U.S. auto makers have trimmed production plans for the Mexican domestic market. Until the dust settles, future plans of these producers are unknown.

The devalued Peso will boost the price of cars imported into Mexico, drop the value of dollar-based investments in Mexico, and lower the price of Mexican goods shipped to the United States and other countries. According to an industry analyst, prospective Mexican car buyers flocked to showrooms in order to buy before prices increased.

Although confidence in the Mexican economy declined as a result of the crisis, Mexico's solid economic base and entrenched free trade policies will no doubt overcome the adversity.

Protectionism in the Mexico Auto Sector Hurt the Industry

Through a series of regulatory proclamations known as the "Mexican Auto Decrees", the Mexican automobile industry has been essentially state regulated since 1925. The decrees established high tariffs on imports of finished automobiles and effectively encouraged joint ventures between Mexican and foreign firms to construct assembly and parts facilities in Mexico.

The Mexican government's second decree was issued in 1962. It increased the use of Mexican-made components in domestically produced models. The required domestic content of 20% was raised to 60%, and power train production, which is typically a capital-intensive process, was required to be manufactured in Mexico. Additionally, all imports of finished vehicles were prohibited and foreign ownership of parts producers were limited to minority shares.

By 1960, twelve Mexican assembly plants were producing 60,000 finished models annually. By 1970, production reached 188,000 units annually. However, quality was low, and producers continued to import parts despite high tariffs. Consequently, both costs and prices were high, which significantly contributed to a persistent Mexican trade deficit in the automotive sector.

In an attempt to reverse this, new Mexican laws required assemblers to export parts in relative proportion to their production intended for sale within Mexico. Despite rising Mexican exports of engines and power train assemblies, the trade deficit continued to worsen. By the early 1980s, U.S. auto makers began to feel the pressure of low-cost Japanese imports into the American market, and began to view Mexico as a possible site for future low-cost production.

In 1982, the Mexican debt crises resulted in a severe economic decline. Another auto decree was passed that further raised tariffs limiting imports and inhibiting outflows of pesos. Led by Ford, U.S. auto producers built several new and world competitive export-oriented engine and assembly plants. Investment in maquiladora parts production also rose. By the late 1980s, economic activity improved and Mexican sales increased. Mexican production in the 1980s fell from 600,000 units in 1982, to a low of 248,000 units in 1987, and up to 547,000 units in 1990.

The most recent auto decree in 1989 under former President Salinas continued the tradition of high tariffs, restricting ownership, and enforcing local content requirements. The provisions:

  1. permitted foreign firms 100% ownership of export-oriented plants, but only 40% ownership of suppliers serving the Mexican market;
  2. raised local content rules to 36% of the vehicles value for models sold in Mexico;
  3. required foreign assemblers to maintain a positive Mexican trade balance;
  4. allowed finished cars and light trucks to be imported into Mexico (beginning in 1991) for the first time in nearly thirty years, but limited market share to 20%, and required exports to positively offset imports by a ratio of 1.75 to 1 in 1994;
  5. set tariffs for finished vehicles and parts and continued to bar imports of used vehicles; and
  6. allowed Maquiladora plants to sell some of their output domestically.

The effect of these and past trade barriers resulted in a generally non-competitive industry characterized by small outdated plants producing with low productivity and high costs. In addition to this, Mexico's infrastructure is poor making it difficult to produce and transport goods efficiently.

Contrary to popular belief, U.S. assembly plants in Mexico were primarily there to satisfy government requirements and to get around high tariffs -- not to gain access to low-cost labor. According to the Office of Technology Assessment, "Mexico offers limited strategic options for the Big Three: while direct production costs are sometimes lower in Mexico, shipping costs back to the United States can eat up the savings and then some."

Mexican-owned automotive parts suppliers' level of cost-efficiency and quality are well below the levels of their maquiladora counterparts. The previous protection and regulation that governed their competitive environment has prompted little incentive to upgrade labor’s skills or to modernize its plants and equipment.

The maquiladoras are much better equipped and managed, and are able to generate sufficient economies of scale in low value-added activities. In fact, Mexican maquila parts production plants consistently outweigh the additional costs of operating in Mexico.

According to the Office of Technology Assessment, even though such production utilizes very low levels of technology, these plants buy only about 25% of their parts content from Mexican suppliers due to poor quality. In anticipation of greater competition under Nafta, Mexican firms have begun forming strategic alliances with U.S. and European firms in order to gain access to new technologies and more advanced management methods.

The U.S. Auto and Parts Sector Is Restructuring

From W.W.II to the 1970 and 1980, the U.S. auto industry enjoyed a comfortable oligopoly. However, over a period of three decades, U.S.-based auto makers witnessed their domestic market share decline from 95% to 65%. This has forced the industry to restructure, down-sizing and investing in state-of-the-art technology.

In a strategy many believe consistent with dumping, Japanese auto companies introduced attractive, high quality and low-cost vehicles in the U.S. market. While incurring a net loss, they gained a great deal of consumer loyalty and U.S. market share. Upon this success, Japanese companies increased prices by an average of 43% between 1985 and 1991. By the end of the 1980s, the Honda Accord was the best-selling car in America.

In the past, Ford, GM, and Chrysler manufactured most of the major components used in their assembly of automobiles, subcontracting smaller systems components, such as brakes, electronic components, seats, glass, and tires, to independents. In recent years, however, U.S. they have discontinued this and began relying heavily on a independent suppliers.

U.S. suppliers of auto parts are very possibly undergoing a more rigorous restructuring than the auto makers. According to the Office of Technology Assessment, imports of Japanese parts have grown rapidly in the past ten years, from $4 billion in 1984 to $11 billion in 1991. Japanese transplant assembly plants in the U.S. buy from many U.S. suppliers, but mostly low value-added parts, such as gaskets and hoses as opposed to gears and brakes, while continuing to import high value-added parts from suppliers in Japan. Thus, the Big Three models incorporate a U.S. parts content of about 88%, while Japanese transplant models have only a 48% U.S. content.

The U.S. auto industry employs about one million people. Approximately 600,000 work directly for the auto makers and their subsidiaries, while about 400,000 are employed by independent suppliers. From 1978 to 1991, employment of production workers by the Big Three dropped by 37%. Auto industry employment will continue to fall as productivity improves.

From the late 1940s to the late 1970s, real hourly wages rose steadily. By 1982, competitive pressures ended the tradition of annual wage increases. Average hourly wages for assembly workers fell in real terms by 3% from 1985 to 1991.

The Big Three have put intense pressure on their U.S. suppliers to adopt just-in-time delivery requirements characterized by low inventories, lean production and express delivery. In an attempt to meet this demand, many U.S. suppliers see relegating low value-added and labor-intensive production to Mexican maquiladoras as an easy means of cutting costs. Small U.S. suppliers face the toughest struggle and are therefore more likely to relocate production to Mexico. Note: U.S. imports of auto parts from Mexico increased from $1.3 billion in 1984 to $4.7 billion by 1991.

Auto Rules of Origin and Tariff Reductions Under Nafta

In order for a product to receive Nafta status or duty-free treatment, minimum content requirements must be satisfied. Starting from a base of 50% content for most North American products, the rules of origin rise to 62.5% for autos, light trucks, engines, and transmissions, and to 60% for other vehicles and parts.

Concern that Mexico could be used as an export platform by European and Japanese auto makers to secure preferential access to the United States has been well addressed in Nafta. Its stringent rules of origin were devised with the specific intention of retaining the Nafta advantages to Nafta members.

Under Nafta, the Mexican tariff of 20% on autos was reduced to 10% on January 1, 1994. The remainder will be phased out in equal increments over the next eight years. The Mexican duty of 10% on trucks was cut in half immediately upon Nafta's implementation. This will be phased out in equal increments over the following three years. The Mexican Auto Decrees will be phased out by January 1, 2004. Thus, the pre-Nafta requirement that an auto manufacturer's exports be 200% as much as it imports will be phased out as well.

Under Nafta, U.S protection which was not nearly as extreme as Mexican protection, will be phased out with little consequence on U.S. imports. Prior to Nafta's implementation, the United States had a tariff of 2.5% on cars, which was eliminated January 1, 1994; and 25% on trucks, which was reduced to 10% on January 1 and will be completely phased-out over the next 4 years.

Tariffs on most auto parts, in some cases as high as 6%, averaged from 3.1 to 3.7%. Many of these were already eliminated under Nafta while others will be eliminated over the next nine years. Buses and most auto parts imported from Mexico, however, entered the United States duty-free under the U.S. Generalized System of Preferences. Products from maquiladoras entering the United States under the tariff classification 9802.00.80 only had duties levied on the non-U.S. value-added content.

Nafta's Projected Impact on the U.S. and Mexican Auto Sector

According to the Office of Technology Assessment, some U.S. auto companies manufacturing in Mexico may move their plants to the United States -- since they will no longer be required to produce in Mexico in order to sell in Mexico after the year 2004. However, plants which produce primarily for the Mexican market and other Latin markets will likely find Mexico an attractive low-cost producer.

Prior to the Mexican Peso crisis, the Office of Technology Assessment projected that Mexican auto consumption could approach that of Canada's 10 years after Nafta is implemented. Although economic activity will be slowed, the market will again pick up. And with the immediate reduction in tariffs, Mexico's ill-equipped domestic auto industry is now subject to intense U.S. competition. This has and will continue to result in greater U.S. exports to Mexico. Again, the economic decline due to the recent crisis will slow this pace.

Although U.S. plants are becoming more efficient and solid sales of U.S.-built autos will continue long into the future, the number of Americans employed in the industry will decline -- as it has done for the past fifteen years for reasons extraneous to Nafta. Increased sales globally and to Mexico under Nafta is expected to only slow this process.

Many U.S. parts suppliers, however, may relocate more of their low value-added production to the Mexican maquiladoras in an attempt to become more competitive.

In the intermediate to long-term, Mexico's auto industry will likely become more efficient as investment increases and unproductive plants are closed. Although Mexican economic growth may be curtailed over the next few years due to the peso crises, a tremendous long-term potential exists for a rapidly growing Mexican consumer market. As this occurs, U.S. auto makers will be well positioned to gain the greatest market share vis-à-vis European and Japanese competitors.

This article appeared in Twin Plant News, January 1995.
Topic: Economy
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