Have Mexico's Maquiladoras Bottomed Out? (Part II)

Have Mexico's Maquiladoras Bottomed Out? (Part II)

By William C. Gruben
Southwest Economy. Federal Reserve Bank of Dallas

Sectoral Differences

More than 80 percent of the Mexican maquiladora employment declines in 2001 and 2002 can be explained by changes in U.S. aggregate demand and increases in the cost of doing business in Mexico. Eighty percent, however, is not 100 percent. Clearly, more is required to explain maquiladora fluctuations than U.S. industrial production, the real exchange rate and wage rate fluctuations.

Chart 1 also presents indices of maquiladora employment for textiles and apparel, for electronics and for everything else (all other). Employment in both electronics and textiles and apparel maquiladoras grew faster than the all other group, but it also fell harder after reaching its peaks. By October 2003, employment in both industries was markedly below September 1998 levels. Although October 2003 employment in all other industries was also well below its peak, it was well above September 1998—farther above it, in fact, than employment in textiles and apparel and electronics was below it. Moreover, total maquiladora employment seems to have bottomed out. The relevant question here is whether the recovery of all other and perhaps electronics will offset the continued falloff in textiles and apparel.

Much of what made the two industries sink farther than all other reflects government policy. For textiles and apparel, the big policy change came in January 1994, when the North American Fr

ee Trade Agreement gave this industry a new set of rules for trade with the United States and Canada. Before NAFTA, China was the United States' principal source of textiles and apparel products. The special tariff breaks textiles and apparel received under NAFTA pushed Mexico past China to become the United States' No. 1 supplier. But in 2000, the United States gave some of the same trade openings to Caribbean Basin Initiative countries (which include the nations of Central America). In 2001, the United States extended other openings to China when it joined the World Trade Organization. Both China and the Caribbean Basin Initiative countries overtook Mexico in textile and apparel exports to the United States. Mexico seems unlikely to be able to compete again in the lowest wage, low-skill labor markets that much of this industry occupies.

The story of the electronics maquiladora employment fluctuations is more convoluted. The U.S. recession of 2000–01 began with a downturn in U.S. electronics-related industries associated with a worldwide slump in these industries. The relation between the downturn in U.S. industries and their Mexican counterparts is clear. Compounding the industry downturn, changes in real exchange rates and dollar-denominated manufacturing wages in Mexico during October 2000 through March 2002 were affecting the cost of doing business.

In 2001, a new NAFTA rule went into effect that made maquiladora operations more difficult, costly and uncertain in Mexico. NAFTA Article 303 outlawed tariff rebates for imports from non-NAFTA countries. For firms that imported from Asia for assembly in Mexico and subsequent export to the United States—a long-time practice of special importance to the electronics maquiladoras— Article 303 made Mexican operations more expensive overnight. Firms began to take their operations elsewhere.

The Mexican government attempted to counteract these tariff cost increases with subsidies administered through a program known as Prosec. Some maquiladora managers, complaining that Prosec's policies were mercurial and ad hoc, relocated their operations in spite of the program. Also, because electronics maquiladoras are especially sensitive to exchange rate fluctuations, the real exchange rate appreciation of 1998–2002 may have affected these plants more than others. Finally, the development of input supply chains in electronics made China a stronger competitor.

Outlook for Maquiladoras

While most of Mexico's maquiladora downturn in 2001 and 2002 can be explained by reductions in U.S. demand and cost-of-doing-business changes expressed through wage and exchange rate fluctuations, a significant share of the downturn is due to changes in trade policy and increased competition abroad in terms of supply networks and input costs. As the U.S. recovery continues apace in the wake of its 2000–01 recession, so should the resuscitation of Mexico's maquilas. The recent softening of the Mexican peso has not done much so far to make maquiladoras come back, but it helped to stanch their decline, and its more positive effects may still be ahead.

Policy changes raise questions as to when or whether the maquiladoras will soon regain their peak levels of employment or output, but it is hard not to think that Mexico's maquiladoras have already bottomed out, even with further declines in Mexico's garment industry.

About the Author. Gruben is director general of the Center for Latin American Economics and a vice president in the Research Department of the Federal Reserve Bank of Dallas

About Southwest Economy. Southwest Economy is published six times annually by the Federal Reserve Bank of Dallas. The views expressed are those of the authors and should not be attributed to the Federal Reserve Bank of Dallas or the Federal Reserve System.