Topic Category: Trade & Finance

The emerging North American Free Trade Agreement (NAFTA) will have a considerable effect on manufacturing in both Mexico and Canada. Contrary to popular belief, the primary NAFTA effect on manufacturing in Mexico does not involve inexpensive Mexican labor or preferential access to U.S. markets. U.S. firms have enjoyed easy access to Mexican labor for two decades. Instead, the greatest changes brought about by NAFTA are on Mexican foreign direct investment and intellectual property protection.

The United States and Mexico have had the apparatus in place since the 1960s which has allowed U.S. firms to manufacture in Mexico and import those products into the U.S. virtually or entirely duty free. Consequently, the North American Free Trade Agreement provides little additional duty reduction benefits. Further liberalized Mexican investment legislation under NAFTA, however, affecting U.S. direct investment, and intellectual property protection, potentially has the greatest affect on manufacturing in Mexico.

NAFTA greatly affects manufacturing in Canada as well. With the understanding that Canada cannot compete with Mexico or other developing countries in terms of low-cost, labor-intensive manufacturing, Investment Canada has shrewdly defined its advantages and set out to seize its target. Based on attractive direct investment laws, R&D tax abatement policies, sound infrastructure, and a well educated labor force, Canada has successfully positioned itself to attract high technology manufacturers well into the twenty-first century.

Based on anticipated trade diversion, the Free Trade Agreement has important implications for U.S. firms considering manufacturing in East Asia or other locations in Latin America.

For 20 years, the United States and Mexico have had three programs in place allowing each other to ship merchandise back and forth virtually duty free. Because these programs already provide for conditions very similar to free trade in the movement of goods, the effects of NAFTA here are limited. According to the United States International Trade Commission, any increase in maquiladora production is likely to be small because NAFTA provides little additional duty reduction over current programs. These programs include the Mexican Border Industrialization Program (BIP), U.S. Special Tariff 9802.00.60 and 9802.00.80, and the General System of Preferences.

Mexico’s BIP, has allowed U.S. companies to ship components and production equipment into Mexico free of duty for assembly or processing utilizing Mexican labor. Eighty percent of the participating Mexican facilities, commonly referred to as maquiladoras or in-bond assembly plants, are located in the country's northern border zone. Under this program almost all the finished products must then be exported.

The BIP was established in 1965 by the Mexican Government for the purpose of providing employment for Mexico’s rapidly growing population along its 1,950-mile border with the United States. Unemployment in certain border cities exceeded 70% following the termination of the Bracero program by the U.S. under which Mexicans had been allowed to work in U.S. agricultural industries. The BIP sought to attract foreign manufacturing facilities (that would not compete with Mexican producers), technology, and know-how.ß The program stipulated that all foreign-owned assembly operations be located within a 20-kilometer strip along the U.S.-Mexican border. This regulation has since been terminated.

Harmonized Tariff Schedule of the United States (HTS) provision 9802.00.60 and 9802.00.80, which replaced Tariff Schedule of the United States (TSUS) provision 806.30 and 807, allow U.S. materials, assembled or processed in Mexican maquiladoras, to be shipped back to the U.S. incurring duty only on the foreign labor and any non-American components incorporated in the final product. Note, U.S. imports under subheading 9802.00.80 accounted for 44% of Mexico's exports to the United States in 1989. This special U.S. tariff classification applies to all countries.

Over the past four years, a large portion of U.S.-Mexican trade has been attributed to rapid growth in the Mexican maquiladora industry, one of the most successful sectors in Mexico. As of January 1992, maquiladora plants numbered 2,113 employing 469,614 Mexican workers. This represents approximately 11% of all industrial labor in Mexico. Based on continued strong growth, some estimates peg employment at between 1.7 and 2.25 million workers by the year 2000, representing about 25% of the Mexican industrial labor force.

The General System of Preferences (GSP) is a special U.S. tariff classification that has allowed Mexican products to enter the United States duty free. A large portion of Mexican products enter the United States under this tariff classification each year. In 1991, about 12.5% of Mexican exports to the United States entered under this classification.

Foreign Investment

Recently implemented investment laws in Mexico offer foreign investors greater opportunity. Thus, on May 16, 1989, Mexican president Carlos Salinas de Gortari implemented a liberalized revision of the regulations governing all aspects of domestic and foreign investment in Mexico. These revisions allow foreign investors the following: to own 100% of many types of businesses; automatic approval of many projects, and a formal response within 45 working days on pending applications; to increase holdings in existing operations to majority share under certain conditions; to joint venture in sectors previously reserved for domestic investors; the creation of new financial instruments permitting participation in capital markets; and investment in coastal and border areas. The new openness of the Mexican economy is illustrated by the fact that more than two-thirds of Mexico’s total Gross Domestic Product (GDP) is already accessible to 100% foreign ownership.

Intellectual Property Protection

In the past, intellectual property (e.g. patent and trademark protection) had not been afforded sufficient Mexican protection. As a result, many foreign companies, fearing their technologies and products would be copied, withheld their technologies from the Mexican market. However, the Law for the Promotion of Industrial Property, effective June 28, 1991, provides legislation similar to that existing in many highly developed, industrial countries.

Mexico’s 1976 Law of Inventions and Trademarks established a 10-year non-renewable protection term for patented products. In 1987, when the patent and trademark law was modified, this term was extended to 14-years non-renewable by an amendment. The Law for the Promotion of Industrial Property extends the life of a patent to 20 years and allows for the patenting of animal species, alloys, foods and beverages, biotechnological processes, and chemical products, including pharmaceuticals, fertilizers, pesticides, herbicides, and fungicides.

Trademarks are protected by the same laws as patents. The 1991 Law for the Promotion of Industrial Property has extended trademark protection from 5 to 10 years with the possibility of an unlimited number of renewals. Prior to the enactment of the new law, many considered previous legislation adequate, but not enforced. Trademarks may now be transferred in cases of corporate mergers.

Under a North American Free Trade Agreement, investment access and property protection is expected to become more enticing. Thus, NAFTA legislation is anticipated to have a considerable impact on manufacturing in Mexico.

The prospect of a North American Free Trade Agreement has given Mexico greater international credibility and abated investment fears. A NAFTA would offer Mexico secure access to U.S. and Canadian markets at a time when global protectionism is on the rise. This is extremely important Asian and European firms. Additionally, a NAFTA would somewhat tie the hands of future Mexican presidents preventing a political or economic policy turnaround. Thus, greater Mexican stability is key to American long-term planning and investing.

Mexican-Based Manufacturers to Locate Further South

NAFTA could reduce the incentive for U.S. owned factories to locate along the border. Similar to content requirements established under the United States-Canada Free Trade Agreement, NAFTA content requirements stipulate that a minimum percentage of North American components must be incorporated in the finished products for that product to be considered a North American product. Once NAFTA is fully implemented, this status will allow these product to be traded in North America duty free. Whereas 9802.00.60 and 9802.00.80 permits only the U.S. content portion of the product to enter the U.S. duty free, NAFTA content rules will allow Mexican or North American products manufactured in Mexico to enter the U.S. entirely duty free even though North American components equal a minimum of 51% (62.5% for vehicles) of the finished product. Thus, the incentive to use U.S. components will be reduced. (U.S. firms currently supply 98% of materials and components used in maquiladora production). Consequently, the incentive to locate near the U.S.-Mexican border, close to traditional suppliers, is also reduced.

Several other incentives exist for U.S. plants to move away from the border. For example, the maquila employment demand is expected to grow by approximately 10 to 20% each year. Currently, a shortage of labor, water, utilities, and housing exists in Mexican border towns. The border region can not sustain greater stress forced on its infrastructure or environmental degradation caused by new production facilities. Therefore, U.S. manufacturing firms considering establishing facilities in Mexico may be forced to locate in larger metropolitan areas. Under NAFTA, restrictions preventing U.S. maquiladoras from selling their products in Mexico will be eliminated. For this reason alone, manufacturers will consider locating closer to large consumer markets. With the exception of Mexico City, Monterey and Guadalajara, the Mexican government has eliminated location restrictions.

The main concern of locating in Central Mexico is the poor infrastructure, especially the antiquated telecommunications system, housing, schools, health care, and roads. Greater transportation costs are also a concern. In response, the Mexican government has taken steps to improve the phone system. Mexico’s government controlled telephone company (Telmex) has been sold and several U.S. phone companies have established fiber optic lines in Mexico. The government has proposed the creation of new highways linking major cities together, and has deregulated the trucking industry to promote competition and efficiency. As the nation prospers, more funds will be allotted to infrastructure.

Mexican Labor Force

Between 1985 and 1987, Mexican average hourly earnings, including benefits, fell 34% from $1.60 to $1.06; the result of a severe economic downturn. Recent strong growth and sound fiscal policy has resulted in higher wages. Thus, in 1991, Mexican average hourly wages, including benefits, equalled $2.17. Mexican maquiladora wages, plus benefits, equal $1.56. In the same year, U.S. and Canadian wages, including benefits, equalled approximately $15.45 and $17.31 respectively.

Mexican average wages, including benefits, are approximately 39% less than those in Hong Kong, 50% less those in South Korea, and Singapore, and 51% less than those in Taiwan. In terms of minimum daily wages, in December 1991, the daily minimum wage rose to $4.33 based on the exchange rate December 19, 1991 exchange rate.

The Mexican labor force is characterized by growing productivity, a fast improving literacy rate (currently at 87%, one of the highest in Latin American), and a family-oriented society. Overall, organized labor in Mexico encompasses 35% of the labor force. Along the border, it is generally acknowledged that Mexican labor unions are more powerful in eastern cities, especially Matamoros, and less so in western cities. In Tijuana, for example, unions are almost non-existent.

Asian and European Firms are Establishing Plants in Mexico

Japanese firms have been profiting from Mexico’s Border Industrialization Program for some time. Japan is the fourth largest investor in Mexico after the United States, Great Britain, and Germany. Mexico is an attractive destination for Japanese investment for several reasons. One of the most important reasons is Japan's desire to lessen its dependence on Middle Eastern oil. Other obvious reasons include the close proximity of the U.S. market and inexpensive Mexican labor.

Current Japanese capital is primarily invested in Tijuana and Ciudad Juarez: the former, a popular electronics manufacturing area and the latter, a popular automobile parts manufacturing area. By some estimates, the Japanese employ over 7,500 workers in Tijuana alone. Although Japanese assembly operations embody mostly Japanese parts which are dutiable upon U.S. entry, the inexpensive Mexican labor more than compensates for the difference. Under NAFTA, unless the Japanese manufacturers source the majority of their components from North America, they will be forced to pay duty on the entire product. (These Japanese-owned operations use more U.S.-made components than do their counterparts in Japan). In January 1991, the Japanese operated a total of approximately 70 plants, comprising almost 5% of all maquiladoras.

In addition to the U.S. and Japan, Sweden, France, the Netherlands, Dutch Antilles, England, Finland, Taiwan, Spain, Germany, Canada, and South Korea now operate maquiladoras in Mexico. The four Asian Tigers - Taiwan, South Korea, Singapore, and Hong Kong - are expected to invest to a greater extent in Mexican for several reasons. One of the most important has to do with their recent graduation from the Generalized System of Preferences.

U.S. Manufacturers in Asia May Relocate to Mexico

Unless the majority of their markets are in the Orient, Many American manufacturing firms operating there will likely relocate their plants to Mexico. An obvious major advantage to the U.S. firms is Mexico’s close proximity. This significantly reduces transportation and communications costs and problems. This has and will continue to 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 and easy accessibility to Mexico facilitates plant visits from component suppliers, corporate research and development experts, engineering specialists, and the final customer. As Mexico continues to receive favorable publicity, this will improve the American business community's perspective on manufacturing in Mexico as a means to combat intense competition from abroad.

According to Bob Broadfoot, Managing Director of Political & Economic Risk Consultancy, Ltd. located in Hong Kong, U.S. investment in South East Asia is different than it was ten years ago. Today, most U.S. manufacturing firms based in the Orient produce primarily for the regional markets, not North American markets. Consequently, NAFTA will not have much of an effect. However, stated Mr. Broadfoot, many U.S. manufacturers based in Singapore manufacture electronic products primarily for the U.S. market. Many of these firms will likely relocate to Mexico. For various reasons, Zenith Electronics Corp. plans to shift about 600 jobs from its plant in Asia to Mexico. Thus, As Mexico continues to receive favorable publicity, this will improve the American business community's perspective on manufacturing in Mexico as a means to combat intense competition from abroad.

NAFTA Effect on Canada

With the understanding that Canada cannot compete with Mexico in labor-intensive industries, it has shrewdly shifted its resources to industries where it has a competitive edge. Although the emerging North American Free Trade Agreement is not responsible for this reality, it will help define the advantages and disadvantages of locating in Canada. With this in mind, the Canadian government has tailored Canadian investment policies to suit the needs of its target market: manufacturers of high-technology goods.

Canadian-based companies enjoy the benefits of a skilled, cost-effective labor force, which has proven itself to be productive and adaptable to rapidly changing technologies used by technology-intensive manufacturers. The low rate of employee-turnover, coupled with the availability of a highly-qualified labor professionals has made high technology manufacturing more productive in Canada than operations in low-wage countries.

Its modern transportation and communication infrastructure facilitates access to offshore suppliers and international markets. Thus, Canada received the highest rating for transportation, communications, and power supply infrastructure among the G7 nations in a 1990 survey of international business leaders by the World Economic Forum. Additionally, in 1991 the United Nations cited Canada as the best place to live.

Canada's legal system is recognized for effectively enforcing international contracts and intellectual property. Importantly, Canada promotes innovation by providing one of the most generous tax treatment for scientific research and development in the industrial world. Additionally, many firms located in Canada have commented on the ease of obtaining export permits and blanket export licenses compared to the bureaucratic difficulties encountered in the United States.

According to the Canada's Investment Development Program, Canadian corporations are more profitable than their U.S. counterparts. Thus, Canadian based subsidiaries typically match or exceed the profitability of the parents. Most of the world's largest international companies, including almost all the Fortune 500 companies, have operations in Canada.

A large number of multinational have recently announced plans to increase investment in Canada. Dow Chemical is currently investing some $800 million in Alberta for the construction of a new plant and related underground storage facilities, and plans to double the size of its existing polyethylene plant. The Ford Motor Company announced it has chosen its Canadian subsidiary to manufacture a new generation of cars and engines. Ford plans to invest $800 million in the project by constructing new automobile parts and casting plants and by retooling existing assembly plants. AT&T recently announced it will begin to manufacture communications equipment in Canada. It plans to manufacture circuit packs for fibre-optic telephone transmission equipment. Other investors include Chrysler, General Electric, 3M, Union Carbide, and Pratt & Whitney.

Manufacturing in Latin America

Due to the growing importance and attractiveness of Mexico to the United States, NAFTA is expected to promote U.S. trade and investment in Mexico, a portion of which will be at the expense of other Latin American countries. The trade and investment diversion effect is of such a concern to regional countries that many are strongly pushing for a docking procedure to quickly and easily accede to NAFTA. Thus, unless a trade agreement of the Americas is established in the near future, and unless South America is the primary market, U.S. companies manufacturing there will find Mexico a more attractive location.

This article appeared in Plants Sites & Parks, November-December 1992.
Topic: Trade & Finance
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