Is China's Economic Success a Threat to Mexico? PART 2 OF 3

Is China's Economic Success a Threat to Mexico? PART 2 OF 3

By Leonard Sahling and Thomas Finley
ProLogis Research Group

Leveling the Playing Field

Two recent changes in U.S. trade treaties enabled China's exports to the U.S. to escape the downdraft from the U.S. recession. The bigger and far more important change was China's admission into the WTO (World Trade Organization) in December 2001. The other change involved the activation of NAFTA's Article 303 on January 1, 2001. Article 303 requires Mexico to levy normal duties and tariffs on certain imports of materials, parts, and components. (See below for details.)

China's admission into the WTO was the culmination of its 15-year quest. Members of the WTO are supposed to confer most favored-nation status to all other members. Accordingly, once China joined the WTO, the U.S., along with other members of the WTO, was under pressure to align its duties and tariffs on imports from China to be no greater than the lowest duties and tariffs imposed on like goods imported from any other member country. (Free trade agreements like NAFTA, however, are designed to eliminate tariffs and duties completely between and among the signatories.)

In accord with its responsibilities as a WTO member, the U.S. has lowered the duties levied on manufactured exports from China, enhancing the competitiveness of those exports within the U.S. While the duties levied by the U.S. on imports from Mexico are zero (thanks to NAFTA) and, thus, below those levied on like imports from China, the playing field is no longer tilted in Mexico's favor as much as it used to be.

Helping to level the playing field even more was the WTO Agreement on Textiles and Clothing (ATC). It calls for the gradual and total elimination of import quotas on textiles and apparel that had been established originally by the U.S. and other signatories to the multinational Multifiber Agreement. When combined with Mexico's unfettered access to the U.S. market (as conferred by NAFTA), those quotas had enabled Mexico's textile and apparel manufacturers to grow their businesses during the 1990s and become the U.S.'s leading importer.

Under the ATC, the Multifiber Agreement quotas are to be phased out gradually over a 10-year period ending on January 1, 2005. As those quotas are phased out, Mexico's textile and apparel manufacturers correspondingly lose their preferential access to U.S. market and are thrown into direct competition with manufacturers from all around the world. China's textile and apparel manufacturers have proved themselves particularly adept at taking advantage of this more level playing field.

Additionally, Article 303 of NAFTA was activated early in 2001. It requires that Mexico levy normal duties and tariffs on all imports of materials, parts, and components from non-NAFTA countries that are then manufactured into finished goods and exported to the U.S. or Canada. When NAFTA entered into force on January 1, 1994, Mexico was permitted to postpone the implementation of Article 303 until January 1, 2001.

When its exemption from Article 303 ended on January 1, 2001, Mexico began to collect full normal import duties on those non-NAFTA materials, parts, and components that would end up in finished goods exported to the U.S. or Canada. Those duties clustered in the range of 12-to-18%. Many maquiladora factories have had to cope with sizable increases in their production costs and commensurate erosions in their competitiveness.2

In sum, those two changes in U.S. trade treaties are one-time events that have not altered Mexico's comparative advantages vis-à-vis China or any other country. Relative wages are unchanged, relative distances from the U.S. market are unchanged, and so are all the other factors that constitute comparative advantages. Once the prices charged by Mexican exporters and their Chinese rivals have adjusted fully, Mexico's non-oil exports to the U.S. should revert to a growth path parallel to its pre-2000 trajectory, and so should China's exports to the U.S. (Refer back to Exhibit 1 in part 1)

Tempest in a Teapot

Contrary to popular opinion, not all of Mexico's non-oil exports to the U.S. have lost market share to their Chinese rivals. Several recent research studies have painstakingly compared, industry by industry, whether the market shares of Mexico's exports to the U.S. have increased or decreased in recent years in relation to the market shares of China's exports to the U.S. [e.g., Watkins, July 2002; and Berges, et al., 18 December 2002]. What they generally conclude is that roughly two-thirds to three-fourths of Mexico's manufactured exports to the U.S. have remained competitive and are either holding their own or expanding their market shares.

Certain Mexican industries that export to the U.S., however, have lost market share to their Chinese rivals. The ones with the biggest losses in market share are those producing sewn goods (apparel, footwear, luggage, and dolls), toys and games, commoditized electronics equipment, and furniture [Watkins, July 2002, pp. 13-16]. These products, we note, tend to be laborintensive, less bulky (and thus less expensive to transport), less technology-intensive, and commoditized.

By the same token, certain other Mexican manufacturing industries appear to have maintained their competitive edges over their Chinese counterparts in exporting to the U.S. Among the industries that are least at risk are motor vehicles and parts, radio and television broadcasting equipment, instrumentation, household appliances, and other kinds of machinery. These products tend to be less labor-intensive, more technology-intensive, and bulkier — thus benefiting from Mexico's highly skilled workforce and its close proximity to the U.S.

Mexico's proximity to the U.S. constitutes its foremost comparative advantage as an outsourcing destination. While many observers pay lip service to geographic proximity, analysts at Merrill Lynch have gone the extra mile and searched for realworld examples where proximity to the U.S. trumps wage disparities in deciding where to outsource production [Berges, et al., Merrill Lynch, 18 December 2002].

Merrill Lynch's research highlights three situations where global companies will prefer to locate their manufacturing plants in Mexico primarily because of its proximity to the U.S.: (a) when product specifications are complex and subject to frequent change, requiring close supervision by a company's engineers; (b) when inventory cycles are short, so that the 5-to-6 weeks that it takes to ship goods from China to the U.S. are unacceptably long; or (c) when products are bulky, so that high freight costs end up offsetting the production cost savings.

ProLogis' customer-base in Mexico teems with case studies of the overriding importance of Mexico's proximity to the U.S. One of its customers produces custom-fitted window-treatments and guarantees seven day delivery anywhere within the U.S. Another manufactures wire harnesses for the automobile industry. Its facility produces 38 different configurations and has been designed to handle short production runs on brief notice, to meet the just-in-time requirements of its customers. A third customer, which just recently expanded its facility, manufactures multiple lines of several different kinds of medical diagnostic equipment for sale in the U.S., including fetal monitors, treadmills, and automated circuit-board control devices. Its production runs tend to be short, and a group of highly trained industrial engineers oversees a rigorous quality control program that involves extensive product testing and troubleshooting when defects are detected.

Whether Mexico's manufactured exports will be able to maintain (let alone, expand) their current market shares in the U.S. remains to be seen. Given existing wage disparities between Mexico and China, it will be an uphill battle for such labor-intensive industries as apparel, textiles, footwear, toys, and games. But other Mexican industries should fare better. What Mexican manufacturers must continue to do is to move up the value-added ladder and concentrate on those industries and products that best reflect Mexico's competitive advantages.

2 To cushion the negative impact of Article 303 on its exports, the Mexican government has implemented the so-called PROSEC program. Under this program, Mexico has reduced or eliminated import duties on those parts and components that (a) are imported from non-NAFTA countries and (b) are used in certain targeted manufacturing industries. While the PROSEC program initially covered just the electronics and electrical sectors, it has been widened to 22 sectors, including furniture, toys, sporting equipment, footwear, textiles and apparel, and automotive products. [Gantz, 2003, pp. 30-33].