Topic Category: Economy

Once again confounding its skeptics, Mexico is showing increasingly strong signs of rebounding from the financial crisis that shook its economy earlier this year. Thanks to the stiff economic discipline being administered under President Ernesto Zedillo's recovery plan, Mexico's large trade deficit is turning around, the peso has stabilized, inflation is dropping, and investment is returning more quickly than expected.

International financial observers have offered praise for this progress. But it should not be forgotten that while Mexico is choosing to follow the right path, it is also a difficult path. Mexico is redoubling efforts to modernize its economy and also imposing tough short-term hardships to get its financial house in order. This course shouldn't be taken for granted.

All one has to do is look a little further south - to a country like Venezuela - to see what might have been. After a brief economic boom earlier this decade, Venezuela was hit by a severe downturn from which it has yet to recover. High interest rates and political turmoil in 1993 precipitated a crisis that caused foreign investment to flee. Unfortunately, Venezuela's populist, but protectionist, response only made the situation worse. Investment continues to slump badly; inflation and interest rates remain sky-high. Analysts project Venezuela's economy will shrink for a third consecutive year.

A Surprising Turnaround

The picture for Mexico is much different. Despite the severity of the recent crisis, indicators point to a surprisingly strong turnaround - and renewed growth by year's end.

Why is Mexico on the road to recovery while Venezuela stagnates? Both have vast natural resources and had similar economic profiles going into the 1980s - large public sectors and a dependence on oil exports. Both resorted to protectionism and nationalization in times of crisis.

For Mexico, the point of departure came after the 1982 debt crisis, which precipitated a period of protracted economic stagnation. At that time, Mexico imposed many of the same policies Venezuela follows today - nationalizing banks, imposing capital controls, and keeping itself closed behind stiff trade barriers. The result was years of negative per capita growth.

Learning a hard lesson, Mexico rejected the state-managed model and opened itself to free markets and liberalized trade. Now most of Mexico' s economy has been privatized. It has a diversified, competitive export sector. Where oil was once the primary export, it now represents only 10 percent of exports - and manufactured products have surged to account for 79 percent.

The success of its export sector reflects Mexico's efforts to hold fast to its program of modernization rather than return to the protectionism of the past. When the recent crisis hit, the Zedillo administration maintained its determined commitment to free-market policies.

The results have been clear, and positive. New trade figures show a strong correction in Mexico's previous trade imbalance. A 32.1 percent surge in exports and a more moderate 7.5 percent decline in imports has resulted in a trade surplus of $ 3.7 billion for the first seven months of 1995.

Other key indicators are also improving quickly. Stringent fiscal and monetary measures have created a public sector surplus and rapid decline in interest and inflation rates, which skyrocketed earlier this year. The peso has restabilized at about six to the dollar, and Mexico's stock market is up more than two-thirds after hitting rock-bottom last February. Almost 90 percent of Mexico's troublesome tesobono (treasury bond) short-term debt has been retired, and both the government and private sector have been able to reenter the capital markets sooner than expected.

Another key sign of economic turnaround is continuing investor confidence. The American Chamber of Commerce found in a recent survey that capital investment in Mexico by member firms is expected to actually increase in 1995 by 5.1 percent, in spite of the crisis.

Some of this will flow into new privatization and investment openings - in telecommunications, satellite operations, power generation, rail transport, secondary petrochemicals, and ports - resulting from President Zedillo's economic plan.

Continuing direct investment also reflects an important trend in US-Mexican trade: the growth of production partnerships. Production sharing - where manufacturing is divided up to take advantage of local efficiencies - is an increasingly significant business strategy for improving global competitiveness.

One of the primary goals of the North American Free Trade Agreement is to encourage expansion of business partnerships among North American firms, to more successfully counter the fierce competition of imports from the Far East and Europe.

So far, evidence shows this strategy is bearing fruit. A July 1995 study published by the US International Trade Commission reports that nearly half of Mexico's exports to the United States now come from production partnerships, and that "having US materials processed or US components assembled in Mexico increases the competitiveness of US producers of labor-intensive articles with Asian producers in the US market."

This is a positive trend for US businesses and workers. Goods produced with Mexico as the partner contain a much higher portion of US-made content than products from other countries. This means retaining US jobs that might otherwise have been lost.

Mexico as Global Test Case

Over the last decade, Mexico has been an important test case for the free market/free trade model of development. This model was envied and largely adopted by developing economies throughout Latin America and the world. But the alternative of protectionism and closed doors continues to lurk in the shadows.

Last December, unfortunately, Mexico also became a test case for the dangers of economic integration in the new world of volatile international capital markets. Capital that flowed in quickly showed a disturbing predilection to flow out even more quickly when spooked by signs of political and economic trouble.

Fortunately, Mexico chose a path out of crisis based on steadfast adherence to free markets - while also pressing ahead with important legal, judicial, and political reforms. This commitment, with help from the US-led international financial package, has laid the foundation for a remarkably quick rebound.

Mexico's recovery remains very much in the US interest. Alternatives to continued economic partnership and integration, wisely, have not been seen as realistic options by either country. That is a partnership we should continue to cheer.

This article was published in the Christian Science Monitor, September 20, 1995.
Topic: Economy
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While the recent financial crisis is still weighing heavy on Mexico, increasing evidence shows the stage is being set for the Mexican economy to make a surprisingly strong comeback.

According to a newly released 1995 Investment Climate Survey by the American Chamber of Commerce in Mexico, planned capital investment by the 374 foreign and domestic firms in Mexico that responded to the survey will increase by 5.1% this year, from $5.9 billion in 1994 to $6.2 billion in 1995. Nearly 91% of all respondents indicated that long-term prospects for growth in Mexico are favorable. Of the American-owned companies surveyed, 95.4% expressed such confidence.

This continuing confidence comes on top of recent trade figures that show a strong correction in Mexico’s previous trade imbalance. The December peso devaluation, along with Mexico’s growing export potential, has resulted in an improvement of more than 120% in that country’s trade balance from January through April, 1995, compared to the same period last year. On December 13, 1994, the peso was worth 3.45 to the dollar. After dropping to more than 7 to the dollar earlier this year, the peso has stabilized at around 6. As a result, Mexican exports have become less expensive and are expanding rapidly. Total Mexican exports to the world are up 32.9% and maquiladora exports are up 20.9%.

As Mexican global exports increase, components and materials used in Mexico’s sizable production-sharing sector are rising commensurably. And since most of Mexico’s co-production components and materials are imported from the United States, U.S. exports to Mexico are also rising—benefiting U.S. business and workers. According to the Mexican Government, maquiladora imports have increased by 33.9% from January through April, compared to the same period last year.

Mexico’s export-led recovery is evident in border towns like Tijuana, the site of the largest number of existing co-production facilities. According to Ciemex-WEFA, an economic research group based near Philadelphia, 160 new plants are likely to spring up south of the Mexican border in the next year and a half. And as these plants begin exporting globally, they will import more components and materials from the United States—strengthening North American competitiveness compared to Europe and East Asia.

Pirouz Pourhashemi, owner of Magnotek Manufacturing, Inc., a Mexican producer of injection moldings and a maquiladora operator, is very confident about what he sees in Mexico’s future. Pourhashemi, who has operations on both sides of the border, says that since the devaluation his exports have increased substantially. Because 90% of his assembly materials are sourced from the United States, he will need to increase his imports from the United States to meet his growing production needs.

The May 1995 production-sharing report published by the U.S. International Trade Commission indicates that Mexico has an advantage in the assembly of products such as electronic components, among others. High-tech companies in California’s Silicon Valley and Orange County tend to choose among co-production sites in cities such as Tijuana, Tecate and Mexicali in the Mexican state of Baja California Norte, or sites in East Asia.

Baja California’s proximity to California allows U.S. plant managers to live in Southern California, and provides for greater operational oversight, faster turnaround, and lower transportation costs than East Asia. These advantages, coupled with Mexico’s competitive labor rates, make for a very attractive manufacturing location.

In addition to growing U.S. investment in this region, Asian companies are also making substantial manufacturing investments in Northern Mexico. Asian investors are helping to transform Tijuana into one of the world’s largest television manufacturing locations. Sony, Hitachi, JVC, Matsushita and Toshiba, five of the eight largest Japanese TV manufacturers, have major assembly plants already located there or plan to begin production in the region. South Korean TV manufacturers such as Samsung and Daewoo also have or are in the process of establishing facilities there. And the Los Angeles Times reports that two Chinese delegations visited industrial parks in Tijuana this year in search of sites for textile and toy factories.

These investments are being spurred by the rules of the North American Free Trade Agreement (NAFTA). Under NAFTA, only North American-made products are accorded duty-free status. Non-North American manufacturers need to produce in North American to satisfy the agreement’s rules of origin. In most cases, a product must satisfy content requirements, and in some cases must satisfy both transformation (which demand specific changes in tariff classifications) and content requirements.

For example, hair dryer parts imported into Mexico from Japan and South Korea will arrive under parts classifications. When assembled with North American parts, the sum of the parts becomes a hand-held dryer. At this point, tariff transformation rules will have been satisfied, but percentage content requirements must now be met demanding that at least 50% of the value of the components originate in North America.

Under this new trade regime, Mexican companies, U.S. companies operating in Mexico and non-North American companies manufacturing in Mexico will source more and more components and products from the United States.

The AmCham Mexico report reflects this growing trend in co-production, as well as the strength businesses see in Mexico’s overall economic fundamentals. The confidence being shown in Mexico’s growth potential by North American and non-North American firms—who continue to establish mutually beneficial partnerships and trade relationships with Mexico—should be a cause for considerable relief on both sides of the border.

This article appeared in The Exporter, July 1995.
Topic: Economy
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The full impact of the Asian economic crisis on U.S. exporters and importers is yet to be seen. However, given a textile or apparel manufacturer's level of export dependency on the region, it may be necessary to focus on new markets. Given the level of import dependency, it may be wise to further scrutinize your existing sources of supply or look for new ones.

Understanding the Asian Crisis

A number of factors led to the Asian economic crisis. Thus, during the 1990s, Southeast Asian countries increasingly pegged their currencies to the U.S. dollar. After mid-1995, the dollar began to appreciate vis-à-vis the Japanese yen and major European currencies. Shortly thereafter, China devalued its currency. As time wore on, Southeast Asian exports became more expensive and less competitive, and pressure mounted on exchange rates.

As foreign investment flowed into East Asia, a rising share was directed into speculative real estate ventures, which promoted a building boom that fueled domestic demand and stimulated imports. Bankers borrowed a great deal of money from abroad, much of it in U.S. dollars at lower interest rates than could have been obtained domestically, and they did not always lend it wisely.

Loans were made to domestic developers in local currencies, that in turn, became exposed to exchange risks. Compounding weakening financial systems and unsustainable exchange-rate regimes were fragile legal and regulatory systems.

As China opened its doors to foreign investment, capital was diverted there from East Asian countries. Unprepared for this, Thailand, which had few investment controls in place, and failed to address its current account deficit, invest in higher technology manufacturing/infrastructure, or sufficiently educate its labor force, found it could not compete with China in labor intensive sectors.

In late 1996, increasing numbers of foreign investors began to question Thailand’s ability to repay its loans, and proceeded to move their money out of the country. Fearing this would result in a loss of value in the Thai baht, in February 1997, foreign investors and Thai companies began to convert the baht into U.S. dollars — accelerating a loss of confidence in the currency.

In response, the Thai central bank began buying up the baht with its dollar reserves and raised interest rates in hopes that this new demand would increase the currency’s value and make baht-based savings and bonds more attractive investments. The rise in interest rates, however, made borrowing more expensive and drove down demand and prices for stock and real estate. With diminished reserves, the central bank was forced to float the baht, resulting in its downward spiral.

Since it took many more bahts to pay off dollar-denominated loans, defaults become common. Investors and businesses in neighboring Philippines, Malaysia and Indonesia concluded that these economies shared some of the same weaknesses as Thailand. Fearing the local currencies would also tumble, they began converting them into dollars, resulting in a self-fulfilling prophecy. Malaysia, compared to Thailand, was better able to compete with China in low technology sectors. However, its economy was not able to support the country's mega-projects and poor real estate ventures that had diverted huge resources.

Exports of Textile and Apparel Have Secured Many Benefits

During the past decade, U.S. exports of goods and services accounted for one-third of U.S. economic growth. From 1988 through 1997, they rose from $430.2 billion to $932.3 billion, an increase of 117 percent. In 1997, the Office of Economic Affairs, Executive Office of the President reported that U.S. exports of goods and services supported 12 million American jobs. What’s more, workers in jobs supported by exports (directly or indirectly) typically earn 13 percent more per hour than the national average, while workers in jobs supported directly by exports earn 20 percent more.

Companies that export expand their employment base approximately 20% faster than others, and are 10% less likely to fail. Thus, a primary economic goal of the United States is to maintain a high and rising standard of living. In order to achieve this, the United States, which accounts for only 4% of the world’s population, needs to sell to the other 96%.

In 1997, U.S. manufacturers exported almost $17 billion of textiles and apparel globally. This represented an increase of 46 percent over 1994. During this period, exports of yarn rose by almost 47 percent; exports of fabrics increased by 35.9 percent; exports of made-up and miscellaneous textiles edged up 32.5 percent; and apparel exports jumped by 57.5 percent. As a result, the companies and workers responsible for these achievements benefited a great deal.

U.S. Export to be Down

Prior to the crisis, more U.S. merchandise trade crossed the Pacific Ocean than the Atlantic, and in 1997, U.S. exports to Pacific Rim countries reached almost $194 billion. This performance is unlikely to continue in the short-term. This year, U.S. exports to East Asia are anticipated to decrease. How much is unknown at this time.

According to Federal Reserve Chairman Alan Greenspan, “With the crisis curtailing the financing available in foreign currencies, many Asian economies have no choice but to cut back their imports sharply. Disruptions to their financial systems and economies more generally will further dampen demands for our exports of goods and services.”

During the first two months of 1998, U.S. world exports of textiles and apparel rose 7.63 percent. This was dragged downward by a decrease in exports to Asia. Thus, During January and February of this month, U.S. world exports of textiles and apparel to the Association of Southeast Asian Nations (ASEAN) was down by almost 21 percent. ASEAN is comprised of Malaysia, the Philippines, Singapore, Thailand, Brunei, and Indonesia. In other examples, exports of apparel during this period was down more than 83 percent to South Korea and 53 percent to Thailand.

The Impact on U.S. Regions

Certain regions that are more dependent on exports to East Asia will be affected to a greater extent than regions that are less dependent. Western states, such as Washington, Oregon, Arizona, California, and Alaska, are expected to be affected the most, due to their higher concentration of general exports to East Asia which include aircraft, semiconductors, electrical equipment, and processed foods.

Parts of the farm belt, the industrial Midwest and Southern states will be affected to a lesser degree. The Northeast, including New York, New Jersey, Pennsylvania, and Connecticut, should be impacted the least since a smaller percentage of their exports target the affected region.

In 1996 (most recent available statistics by state), 29% of U.S. merchandise exports were shipped to the “Asian 10,” which is comprised of China, Hong Kong, Indonesia, Japan, Malaysia, Philippines, Singapore, South Korea, Taiwan, and Thailand. Of these countries, the economic crisis more severely affected Indonesia, Thailand, Malaysia, Philippines, and South Korea, whose currencies experienced significant devaluations.

Eight states, however, exported at least 50% of their goods to the “Asian 10” in 1996. New Mexico exported 68.8% of its goods there; followed by Hawaii with 64.6%; Oregon, 63.9%; Alaska, 57.9%; Nebraska, 55.7%; Washington, 54.6%; California, 51.9%; and Idaho, 50%. California was the biggest global exporter by far among all U.S. states. And the “Asian 10” are among California’s top 22 export destinations. As a result, the Asian weakening demand for imports will impact California to a greater extent than many other states. Five states — Florida, Michigan, Montana, North Dakota, and Vermont — shipped 10 percent or less of their exports to the “Asian 10.”

U.S. Import Will Rise — But Not as Much as Predicted

Analysts predict that in 1998, U.S. imports from Asia will rise significantly resulting in a large U.S. trade deficit. Thus, imports from Asia of low technology-produced goods, where materials and other inputs are sourced domestically, including textiles and fabrics for apparel, is anticipated to increase in large amounts.

Jim Schelley, vice president and general manager of the New York City-based CIT Group/Commercial Services, has been financing the apparel industry in Southeast Asia for 20 years. He said, Japan, China, Malaysia and the Philippines pose the most immediate threat to U.S. manufacturers due to more competitive export prices as a result of the Asian currency devaluations. In terms of the textile industry, Schelley contends "these countries are able to use domestic raw materials for the manufacturing of textiles" and "will not hesitate to compete on price with goods produced in the U.S."

On the other hand, imports from East Asian manufacturers who typically source their components outside their countries, and require foreign currencies to buy them, is not expected to rise as fast. Thus, when a country's currency depreciates by half its value, it takes twice as much of that currency to import the same value of goods as it did before. As a result, it will import less because costs are twice as high.

Impoverished by currency devaluations and a precipitous drop in domestic demand, Analysts predict that East Asian manufacturers will attempt to work off inventories and export themselves back to health. Japan, with economic and financial problems of its own, will not provide the economic engine required to absorb additional imports. As such, the U.S. market is expected to become primary target, with Europe following, putting downward pressure on domestic and foreign prices.

In the long term, these predictions may be accurate. However, thus far, U.S. imports of textiles and apparel from East Asia have not risen significantly. U.S. imports of textiles and apparel from Latin America, for example, have not been replaced by less expensive East Asian imports. One reason for this: many of the Latin American production facilities are owned by or have long term contracts with U.S. firms. As a result, imports of textiles and apparel from Latin America has not changed very much.

Keep a Close Eye on Asian Import Sources

In terms of sourcing product, it would be wise to ensure that your suppliers are, in fact, able to purchase their inputs and ship you your goods. Schelley cautions, "If your company is doing business in Asia, you need to reevaluate your risks and question past assumptions. In situations like this, the greatest risk can usually be found in the supply chain."

Schelley said South Korea, Indonesia and Thailand are in poor standing compared to other East Asian countries and "face a long, grueling journey back to economic prosperity." "These countries have such severe financial and liquidity problems that companies simply cannot get working capital. Even the Korean subsidiaries of U.S. Fortune 500 companies have been unable to get letters of credit from Korean banks." Consequently, suppliers in these and other Asian countries may not perform as they have in the past.

Investment Opportunities Likely to Increase

U.S. direct investment in Asia on a historical-cost basis jumped by 74 percent from 1991 through 1995 to reach $126 billion. This rate of growth is 42.6 percent higher than the rate of growth in U.S. direct investment worldwide. However, investment in the region is expected to decline over the next few years, holding down growth rates there.

In an attempt to lure fresh investment, East Asian companies will increasingly seek foreign partners with the ability to provide capital and technology. In return, they will make attractive offers that will provide lucrative opportunities. And severe adversity in East Asia is forcing adaptations that would not have been politically feasible during favorable economic times. The crisis has become an impetus to liberalize investment laws and open sectors once reserved only for domestic companies.

This article appeared in Americas Textile International, June 1995.
Topic: Economy
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With the precipitous fall of the peso beginning in December 1994, and the financial turbulence that followed in Mexico, many short-term economic projections and business plans have changed.

In the auto industry, Chrysler, Ford, General Motors, Nissan, Mercedes-Benz and Volkswagen currently produce in Mexico. Since the economic crisis, their plans for expansion have been put on hold. Other auto and parts producers, such as BMW; T&N PLC, a British auto parts manufacturer; Daewoo of South Korea; Honda Motor Co.; and Italy's Fiat Auto S.p.A. which had intended to enter the Mexican market, have applied the brakes.

From 1990 to 1994, U.S. exports of auto parts to Mexico increased 58%. This growth trend, however, will not continue into 1995. Domestic automobile consumption in Mexico has slowed considerably. Consequently, U.S. exports of OEM auto parts to Mexican-based automobile manufacturers will also slow. However, some relief will be provided.

In 1993, approximately 10.9 million vehicles were on the road in Mexico. This represented a growth of 63% from 1983 to 1993. About 3.2 million vehicles or 30% were concentrated in the Mexico City metropolitan area. The average span life of these vehicles has decreased during the past decade to 10 - 12 years. With a reduction in buying power caused by a devalued peso, the purchasing of new automobiles will be put off for a later date, raising the average car life span. Consequently, the need to repair older models will increase the demand for auto parts -- but this will not be enough to offset the overall decline in demand projected this year.

Additionally, in order to receive Nafta status on parts shipped between Mexico and Canada, the rules of origin require 60% North American content (62.5% for autos, light trucks, engines and transmissions, and to 60% for other vehicles). To conform, Japanese and other non-North American auto producers will need to increase their North American content if they wish to receive the benefits provided by Nafta.

Exporting to Mexico

U.S. exporters of auto parts to Mexico have enjoyed much success. In 1993, the United States held almost 70% of Mexico's auto parts import market. The United States was followed by Japan, with 7.5%; Germany with 6.2%; Brazil with 5.9%; Italy with 2.7%; China, 1.5%; and Canada with 1.4%. Under Nafta, U.S. market share will increase even more.

There are two major end-users of auto parts in Mexico: the auto makers, which account for 2/3 of the total market, and the aftermarket, which accounts for 1/3 of the total market. The OEM market for auto parts was estimated at $5.4 billion in 1993. Mexican domestic production supplied 49% of demand. The aftermarket auto parts market was estimated at $2.7 billion in 1993. Domestic production supplied 65% of demand for this market, while imports satisfied 35%. In the aftermarket, dealerships, both large and small, and large independent repair shops continue to be the most important buyers of auto parts.

The automotive industry is very important for Mexico. During 1992, it represented 2.5% of GDP and 9.7% of manufacturing GDP. And according to a Mexican government agency, it employed about 504,000 workers, 15% of the total manufacturing work force. The auto parts industry in Mexico employed around 260,000 persons during 1993.

Prior to the economic crisis, the Mexican auto parts sector comprised more than 500 auto parts manufacturers, 165 maquiladoras, over 1,000 new car dealers, and 10,000 replacement parts distributors. The aftermarket has been very dynamic, having grown at an average annual rates of 10% in the past few years.

Next year, when positive growth is once again anticipated in Mexico, the demand for auto parts will pick up. Items in demand will likely include connecting rods; fuel injection tracks; valves; automatic transmissions; turbochargers; electronic engine management systems; power steering; steering wheels, columns and boxes; radiators; anti-lock braking systems; suspension parts; body parts and stampings; insulated wiring sets; engines; tires and tubes; plastic molded products such as bumpers, panels and gas tanks; and emission, exhaust equipment, and catalytic converters.

Japanese Competition Has Affected U.S. Auto Parts Producers

After having controlled its domestic market unchallenged for several decades, U.S.-owned auto makers have seen their domestic market share decline from 95% to 65% over a period of three decades. Consequently, U.S. suppliers of auto parts to U.S.-owned auto manufacturers have and continue to undergo a restructuring perhaps more painful than that of the auto makers.

According to the Office of Technology Assessment, U.S. imports of Japanese parts have grown rapidly in the past decade. Japanese transplant assembly plants in the United States 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.

As a result of greater Japanese competition, the Big Three have put intense pressure on their U.S. parts suppliers to adopt just-in-time delivery, requirements characterized by low inventories and express delivery, and to reduce costs. In an effort to become more efficient and reduce costs, many U.S. suppliers will likely relegate low value-added and labor-intensive production to Mexican maquiladoras.

Since Nafta was implemented, there has been a proliferation of partnerships between U.S. and Mexican companies, many of which have entered into production sharing agreements. This cooperation will be accelerated as a result of the peso devaluation (see "Devalued Peso Will Increase U.S./Mexican Production Sharing" in the March 1995 issue of the Exporter). A sizable portion of this production sharing is likely to be in the manufacturing of auto parts. Thus, U.S. suppliers of auto part components will benefit.

This article appeared in The Exporter, June 1995.
Topic: Economy
Comment (1) Hits: 8340

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.
Topic: Economy
Comment (0) Hits: 3273

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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