U.S Investment in MexicoEconomics 580Dr. LeonHaitham BoukhadourFall 96Mexico has established itself as one of the biggest emerging markets inthe world today. It has exhibited many of the signs of a high growth economy,offering several advantages to prospective investors. Some highlights of theMexican economy include ” single-digit inflation, a balanced public budget, realeconomic growth (presently at a rate of 12 percent), a deregulated economy and afavorable investment climate” (Risk Management/ June 94, P.32). Mexico alsopossesses a strategic geographic location as a gate way to Latin Americanmarkets.
Mexico is among the fastest- growing export markets for the UnitedStates. In 1985, Mexico became the third largest market for total U.S. exports,behind Canada and Japan. In 1992, Mexico surpassed Japan as the second largestexport market for U.S. manufactured goods. Mexico now accounts for $1 out ofevery $10 of total U.S. exports.
After the passing of NAFTA, bilateral trade was quite balanced in 1994,with the U.S. registering a surplus of $1.3 billion, virtually unchanged from1993. However, there was a sharp increase in trade opportunities, as both importand export growth exceeded 20 percent.
One-fifth of the total trade that occursbetween the United States and Mexico was created in 1994.
One of the major sectors that holds a large promise for the U.S.
manufacturers is that of the automobile industry. The Mexican market for autoparts is expected to grow by 24 percent from 1994 levels to $16.9 billion in theyear 2000. It is also expected that NAFTA will help increase the U.S. exportshare of the Mexican market to around 70 percent by the year 2000. In the longrun, Mexico’s location could profit the U.S. industries that establishthemselves there, through an expanded free trade area in Latin America, whichcould include Argentina, Brazil, Venezuela, and Chile. Such expansion couldprove crucial to the U.S. industry, as a strong export orientation helpedsustain industry growth. Exports increased from 18.5 percent of total output in1989 to 27.2 percent in 1991. And the level of employment which could beattributed to exports increased from 116,500 in 1989 to 154,200 in 1991.
Mexico also offers some intriguing possibilities in terms of productionfacilities for U.S. based firms. In 1994 alone Mexican car and truck productiontotaled 1.173 million units, up 8.6 percent from 1993. The Mexican governmenthad along term plan in terms of automobile production in Mexico, and it is in aphase now that favors foreign investors and exportation out of the Mexicanmarket. Check the figure bellow to see how the plan has progressed so far.
AssemblyManufacturing ISIExport PromotionLiberalization1925-1962 1962-1969 1969-1989 1989-In previous years there were many barriers to trade, to date some stillexist while many have been lifted or reduced substantially. U.S. firms seekingto take advantage of low Mexican wages, established many joint ventures inMexico. These plants were known as maquiladora plants. These plants started asbasically a “screwdriver and nuts operation” where firms merely assembled theircars in Mexico with no real manufacturing performed within these plants. Therewere several obstacles to the U.S. firms taking full advantage of the lowMexican wages. For a long time in Mexico, any cars sold domestically withinMexico had to contain 60 percent locally produced parts, including the engine.
That rule has changed requiring 34 percent locally produced auto parts , fallingto 29 percent by the year 2003 through NAFTA measures.
Another major impediment to full-scale car production in Mexico was the20 percent import tariff imposed on auto parts imported into Mexico. Also carsimported into the U.S. that were produced in Mexico used to incur a 2.5 percentduty.
Since NAFTA’s implementation at the beginning of 1994, half of all U.S.
exports have been eligible for zero Mexican tariffs, including machine tools,electronic equipment, and computers; components vital to the operation of theplants. NAFTA reduced Mexico’s auto parts tariff from 20 percent to 10 percenton January 1st, 1994 and lowered other barriers. And cars coming into the UnitedStates no longer incur a 2.5 percent duty.
As a result of NAFTA, auto-makers have started integrating their Mexicanplants into their North American operations, shifting mid-size to luxury carproductions to their underutilized plants in the Midwest, while producingsmaller sized cars in Mexico. Mexico will probably become a center of small-carproduction. That is what the local market favors, and lower labor costs willmake small-car production more profitable. U.S. firms cannot survive by merelyusing Mexico as an exporting platform, rather, they do need a strong internalmarket and local revenue.
Several obstacles still persist. The Mexican government continued toopen the Mexican market to foreign investors following the implementation ofNAFTA. Inflation dropped to about 7 percent in 1994, down from the high of 150percent in 1987. However several factors deteriorated the outlook for theMexican market. Namely an unresolved peasant uprising in Chipas, Politicalassassinations, and a series of high profile kidnappings. All of thosecontributed to investor skepticism towards Mexico.
The devaluation of the Mexican peso, which went down as much as 50percent against the dollar, was a mixed blessing. Though it lowered payrollcosts, which make up roughly 80 percent of a typical maquildora’s operatingbudget. It had several negative effects. For one the worker morale wasnegatively affected. Also as stated above, a strong local market is crucial forsustaining growth and profits. With the devaluation of the peso, auto sales inMexico dropped 70 percent in the months following that crisis, also, the priceof automobiles in Mexico went up 10 percent in pesos, despite being discounted20 percent in dollar terms. Several U.S. firms are restructuring within Mexicoin response to that devaluation, which helps their exports out of Mexico, butnot their local market shares. They have announced cutbacks in production, andan increase in payrolls for their Mexican labor in terms of the peso.
As a result, in 1994, vehicles that were destined for foreign salesincreased by 20.8 percent, while those for domestic sales dropped by 28.6percent. And in 1995, export production jumped to 700,280 vehicles, whileproduction for Mexico shrank to 373,210 vehicles.
All of these factors have deteriorated some of Mexico’s automobileinvestment prospects. For example, Thrall Car Manufacturing, an Illinois-basedrail-car builder, has put a hold on plans to start operations in Mexico. Mostfirms in the United States and Canada are adopting a more cautious attitude onbusiness ventures in Mexico. Some of the reasons are the uncertainty of NAFTAbenefits, Mexico’s unstable financial exchanges, and the devaluation of the peso.
The devaluation, more than anything else, is the real stumbling block for anycompany considering a Mexico venture. Most Mexican based firms have a dollar-based debt but peso-based profits. When the peso loses value, repaying the debtbecomes a major task. Also current interest rates offered by Mexican banksfluctuate between 20 percent to 60 percent. While U.S. banks offer some relief,with a rate of 16 percent to 17 percent, it is still a counter productive rate.
Most businesses cannot support a debt of 17 percent and still survive.
As can be seen there major advantages, along with many risks for U.S.
firms to open a plant in Mexico. There are ways for minimizing the risks, suchas raising the capital abroad and undertaking local partners. But in general theoutlook for the Mexican market should be a cautious one until the full effectsof the NAFTA agreement are realized.
ReferencesHiggs, Richard. “Mexico a lucrative market for U.S. suppliers, consultant says”Automobile News Feb 13th 1995: 86.
” Economic woes take toll on Mexican workers” Automotive News Feb 13th 1995: 86.
Jenkins, Rhys. ” The political economy of industrial policy: automobilemanufacture in the nearly industrializing countries” Cambridge Journal ofEconomics 19 (1995): 625-636.
“NAFTA fans trade fire for U.S. auto suppliers” Rubber-and-Plastic-News-II Dec13th 1993: 4.
” NAFTA’s effect on the Mexican Economy.” Risk Management Jan 1994: 32.
“Weak peso applies brakes in Mexico” Wards-automotive-Reports Jan 16th 1995: 1.
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