Back

The way for companies to climb the value-added ladder is to produce higher-priced goods. At the bottom of the ladder are the commoditized goods — i.e., mass-produced "widgets." Higher up the ladder are more expensive goods offering customized designs, sizes, and features tailored to suit the needs and specifications of particular markets or clienteles. Such customers demand and expect excellent workmanship and quality. Hence, factories that produce high-end goods need workers with above-average skills, expertise, and specialized training and are willing to pay premium wages to hire these high-productivity workers.

Mexican manufacturers have figured out how to climb the value-added ladder — and are doing so. Even as maquiladora employment and output have fallen during the past two years, their total value added has continued to climb. (See Exhibit 5.) Last year, for example, their total value added rose 8.9% even though total Mexican non-oil exports to the U.S. were flat.

A recent newspaper article documents one such strategy successfully implemented by a contract electronics factory based in Guadalajara [WSJ, March 5, 2004, p. A1]. After his factory's order book had shrunk 40%, the plant manager went after — and won — new orders for complex high-tech products that previously had been manufactured by small factories located in the U.S., where fully-loaded wage costs are five or six times what they are in Mexico.

Challenges Ahead

But Mexico cannot afford to rest on its laurels. Every country in the world, including Mexico, will face increasingly stiff economic competition from China. With a population of 1.3 billion people and a deeply ingrained entrepreneurial tradition, China will soon be flexing its economic muscles throughout the global economy.

If Mexico is to measure up to this daunting challenge, many experts are urging that it must begin addressing a number of critical issues:

We're not in a position to recommend which reforms are needed most urgently. But in light of the awakening giant in Asia, we think that Mexico would be well advised to establish its priorities and begin tackling them today, rather than mañana.

Back to Basics

The concept of comparative advantage, one of the economic principles taught in Econ 101, is the fundamental basis for international trade. It is the reason why international trade is a positive sum game.3

Comparative advantage underpins globalization. Any company that markets its products to the U.S. and is trying to decide whether to source its production in one country or another will assess each country's comparative advantages in light of the company's production and marketing requirements. General Electric, for example, recently had to decide whether to locate a new production facility in Mexico or China. Accordingly, one of its vice presidents conducted a detailed assessment that compared the two countries in terms of eleven criteria. (See Exhibit 6.)

Neither country, it turns out, totally eclipses the other. China outdoes Mexico in three criteria, including labor costs. In contrast, Mexico outdoes China in the other eight criteria, including geographic proximity, transportation costs, skilled labor/productivity, and protection of intellectual property.

Certain goods are thus more likely to be manufactured in China while others are better suited to Mexico. For example, the GE official who conducted the analysis concluded that, "Mexico is the better place for companies manufacturing products that are higher up the 'value-added chain' " [Watkins, July 2002, p. 19].

While every company probably would rank these eleven criteria differently and perhaps add a few new ones, the criterion involving the protection of intellectual property would be of critical importance to any company with patented trade secrets or copyrighted material. On this score, Mexico gets acceptable marks while China's record is spotty, at best.4

When global companies do relocate their sourcing operations from Mexico to China, there will be dislocations. Workers, both skilled and unskilled, will lose their jobs; and the factories where they worked will run fewer shifts or shut down.

But those dislocations will be temporary. After a while, the unemployed workers will find new jobs, and the factories will be retooled and put to alternative uses. In short, the Mexican economy will adapt. At various times, all industrial countries, including the U.S., find that they have to adapt to changing trade flows, technological innovations, and newly invented products.

In fact, the Mexican economy has already begun to adapt and adjust, according to numerous news reports in such publications as the Wall Street Journal and the Economist. Some of those new jobs will be at new maquiladora factories; some, at export-oriented non-maquiladora factories; and others, at factories turning out goods designed for the domestic Mexican market.

Concluding Remarks

Mexico's competitiveness "problem," we believe, has been greatly exaggerated. There's no compelling evidence of a sharp, systemic deterioration in Mexico's competitiveness during the past three or four years. Indeed, several recent research studies have concluded that two-thirds to three-quarters of Mexico's manufactured exports to the U.S. are either holding their own or gaining market share.

In short, the vast majority of Mexico's export industries are just as competitive today as they were three or four years ago. There is no crisis. Still, Mexico and every other country in the world will face increasingly stiff competition from China in the years ahead. No country, including Mexico, can afford to be complacent.

3 As you'll recall from Econ 101, in the elementary two-country, two-product case, citizens of both countries will end up better off through international trade, even if one country were more efficient at producing both goods. If each country specializes in producing the good at which it has a comparative advantage, they can jointly produce more of both goods than they could if each country had to rely on its own limited resources to produce both goods. When the surplus output is exchanged between the two countries, the citizens of both countries end up better off because they have more of both goods to consume.

4 A recent article in the New York Times reported that U.S. officials are pressuring the Chinese government "...to pledge this week to crack down on pirating and counterfeiting of software, DVD's, and other forms of intellectual property." See the article by Elizabeth Becker, "U.S. Expects Concessions on Trade from China," dated April 20, 2004, p. C1.