Mexico: Dethroned by China in Low-Cost Export Competition
Nov 12, 2002
stratfor.biz
Summary
China has dethroned Mexico as the most competitive low-cost export platform for the world's developed countries. As a result, pressure is growing for Mexico's political and business establishment to liberalize and deregulate the economy more quickly, but manufacturers are leaving Mexico more swiftly than politicians can react. In the coming year, the flow of Mexican migrants to the United States likely will swell.
Analysis
For more than a decade, Mexico has been marketing itself to the world's wealthy industrial nations as the most economical place for foreign companies to set up manufacturing and export operations. It has been quite successful, and Mexican trade and Foreign Ministry officials frequently boast that theirs is the only developing country that has free trade agreements with both the United States and the European Union.
However, in reality China has dethroned Mexico as the world's champion low-cost export platform. Since 2000, hundreds of manufacturing companies based in Mexico systematically have been wooed to China with an investment promotion plan called "One Stop Shop," costing Mexico nearly 300,000 jobs.
This program has been advanced aggressively in Mexico by U.S.-based investment recruiters for Chinese corporations, whose goal is to capture at least half of Mexico's maquiladora industry.
Maquiladoras -- mainly foreign-owned companies based in northern Mexico that export products assembled from imported components -- account for more than half of Mexico's exports. They also have been the leading force in the rapid climb in Mexican international trade since the North American Free Trade Agreement (NAFTA) went into effect Jan. 1, 1994. For instance, in 2001, Mexico's maquiladoras exported more than $77 billion of assembled products -- mainly to the United States -- and imported more than $60 billion of component parts, chiefly from U.S. suppliers.
However, Mexican exports to the United States fell 3.3 percent in 2001 to $131 billion, while China's exports to U.S. buyers climbed 2.3 percent to $102 billion, according to the U.S. Census Bureau. Moreover, during the first half of 2002, foreign direct investment (FDI) in Mexico dropped 15 percent to only $6.1 billion, while FDI in China rose 19 percent to $24.6 billion, according to China's Ministry of Foreign Trade and Cooperation.
China's one-stop shop scheme offers Mexico-based manufacturers an attractive combination of incentives, including significantly lower labor costs, income-tax breaks for investors, help with raw material supplies, technical support, a dynamic research and development infrastructure, ready-made factories at low lease rates and even free land for large companies that create lots of jobs.
Mexico is hard-pressed to compete. The average manufacturing wage in Mexico is about $1.40 an hour, compared with 60 cents an hour in China. Mexico's top corporate tax rate is 35 percent, compared with 10 percent in China, and electricity costs are 40 percent lower in China. Mexico also does poorly against China in the areas of technical support, R&D and providing a business-friendly regulatory environment. One sign of all this is the swift drop in Mexico's global competitiveness ratings. According to the World Economic Forum's most recent annual survey, Mexico has slipped from 34th to 51st place out of 75 countries in the study.
The Mexican government has been slow to react to China's push to lure away manufacturers, and what little it has done has been mainly defensive, like threatening to accuse China of illegally subsidizing investors at the World Trade Organization. However, battling China at the WTO will not solve Mexico's crisis because the causes of its rapid decline in competitiveness are local, not external.
Over the past decade, Mexico tied its fortunes to an economic strategy that focused on being an attractive export platform and that fused the Mexican and U.S. economies under NAFTA. Mexico's strongest selling points were its cheap labor and geographic proximity to the U.S. market.
NAFTA consolidated those advantages and in less than a decade enabled Mexico to displace Japan as the second-largest U.S. trading partner, vaulting it into the ranks of the world's top 10 trading nations. However, since NAFTA was implemented, Mexico appears to have become complacent about its long-term competitive prospects, and now it is paying the price.
Geographic proximity to the United States and Canada will remain an important competitive advantage for high-tech industries that grapple with frequent design changes and which need constant technical support from parent companies. Mexico is still only a four-hour flight from most U.S. cities, while the closest Chinese cities are at least an 18-hour, non-stop flight away.
However, Mexico cannot out-compete China on labor costs, which tend to be anywhere from one-third to one-half lower in China. Nor can it beat China right now on factors like tax-breaks and corporate tax ceilings, supply logistics and the regulatory environment. These obstacles will remain as long as Mexico's political establishment continues to resist needed reforms.
These reforms include labor and tax law revisions, streamlining of the ponderous and frequently corrupt government bureaucracy, more effective sharing of federal resources with state and local governments, and opening important sectors such as the energy industry up to foreign investment.
However, since Vicente Fox became president of Mexico in mid-2000, his opponents in Congress have steadily blocked proposed economic reforms. As a result, Fox stopped pushing these initiatives in Congress and focused instead on maintaining a tight fiscal policy and matching the U.S. inflation rate. This strengthened the Mexican peso, boosted its financial markets and won the country three investment-grade ratings. But it also ignored Mexico's declining competitiveness, which in turn encouraged some U.S. companies that invested in Mexico under NAFTA to relocate to China.
Although the need for Mexico to regain its edge is clear, political prospects for the kinds of reforms the country needs are not bright. Fox lacks a majority in Congress, and Mexico's ruling elite and population largely oppose faster economic liberalization -- especially in energy -- due to fears that the United States swiftly would encroach upon Mexico's economic sovereignty.
As a result, Mexican legislators and bureaucrats likely will continue to reject or postpone regulatory, legal and institutional reforms, which means the flight of Mexican maquiladoras to China will increase in the next year or two.
This will cost Mexico hundreds of thousands more jobs and will continue to affect its export volumes to the United States. At the same time, the growing flood of cheaper Chinese products into Mexico will crowd out competing domestic products and likely force more corporate shutdowns and layoffs.
With more than 1 million Mexicans entering that country's workforce each year, a tightening job market likely will encourage many to migrate to the United States in search of better-paying jobs.
For the Fox administration, this means that securing a bilateral immigration agreement with the Bush administration will become even more critical, given that migration to the United States would be the most immediate way of reducing social and political tensions in a job-starved Mexico.
The U.S. economy needs a steady supply of imported labor, but a combination of U.S. government worries about illegal immigration, new strikes by militants and drug trafficking from Mexico likely will offset political and corporate urgings to allow more Mexican workers into the United States.
U.S. corporations doing business in Mexico, meanwhile, are focused more on promoting Mexican economic reforms favorable to exporters than on lobbying Washington for a bilateral immigration deal with Mexico City. Many of these U.S. companies also are among the hundreds of foreign investors that have relocated part or all of their Mexican-based manufacturing activities to China over the past two years. |
