On January 1, 1994, the day the North American Free Trade Agreement was implemented, approximately 50% of all U.S. exports to Mexico became duty free, accelerating trade flows. During the year, U.S.-Mexican bilateral trade rose 22%, up from $81.5 billion to $100 billion. U.S. exports to Mexico increased at about the same rate -- and almost four times faster than U.S. exports to the rest of the world. Mexico even edged up on Japan, competing for the United States' second largest trade partner status.

On December 20 of last year, however, the situation drastically changed. An attempted currency adjustment by the Mexican Government, that some say should have occurred earlier, but at a more gradual pace, accelerated out of control. The Mexican Government expanded its exchange rate band by 15% in an attempt to allow the peso to adjust downward. Within two days pressures mounted and the peso was allowed to float freely. Shortly thereafter, it nose-dived.

From December 20, 1994, to mid-March 1995, the peso dropped about 50% in value compared to the U.S. dollar. Like falling dominos, what began as a short-term liquidity crisis drove down confidence and sparked panic. The Mexican stock market dropped precipitously. Prior to this, Mexican political events pressured the situation.

The assassination of Luis Donaldo Colosio, the PRI presidential candidate and former Secretary for Urban Development and Ecology, raised question marks among foreign investors as to Mexico's political stability. The assassination of Francisco Ruiz Massleu, a senior ranking PRI official, added to the uncertainty. These events, combined with unrest in the southern state of Chiapas, further fueled investor unrest.

Stated by Carla Hills, former U.S. Trade Representative, "Mexico was forced to float its currency in the face of a $28 billion current account deficit it could no longer finance with capital borrowed from abroad." She said this, in addition to the assassinations and political unrest, raised questions about Mexico's ability to repay billions of dollars in debt coming due in 1995.

Mexican fallout quickly spread to Brazil and Argentina, whose stock markets fell, along with other developing countries worldwide. Investors received what some have referred to as a "wake-up call", reminding them that political and economic instability can largely affect growth prospects in developing countries.

As U.S. Treasury Secretary Robert Rubin said before a House Banking Committee on January 25, "the risks are not only in Mexico. Restoring confidence in Mexico will head off the spread of financial distress around the world." According to Rubin, more than two-fifths of U.S. exports are now destined for developing countries; and U.S. manufactured exports to these countries expanded by 65% between 1989 and 1993. If these economies endured an economic crisis precipitated by Mexico's market panic, U.S. exports would be largely affected causing a loss of jobs in the United States.

Many large Mexican companies have been hit hard by the crisis. Teléfonos de Mexico, the giant phone company, reportedly incurred a $862 million loss in foreign exchange in the fourth quarter of 1994. Cemex, an extremely large cement company by world standards, reported a $127 million foreign exchange loss. And Televisa, Mexico's media conglomerate, lost $142 million.

President Clinton's announcement on January 31 to provide Mexico with about a $50 billion U.S./international package of loans and loan guarantees was met with considerable relief in Mexico, as well as in the U.S. business community. After receiving the news, the peso gained value and Mexican interest rates on 28-day Government treasury certificates fell. Although economic indicators have fluctuated since then, signs point to greater stability.

The package includes a $20 billion credit line from the United States, $17.759 billion from the International Monetary Fund, $10 billion from the Bank of International Settlement, $1 billion from Canada, $1 billion from Latin American countries, and $3 billion from the international commercial bank.

As its North American partner, a sound Mexican economy is important to the United States. And the two countries have already benefited from NAFTA. According to the U.S. Department of Commerce, since NAFTA was implemented there has been a proliferation of joint ventures and strategic alliances between U.S. and Mexican companies. For example, Motorola established a joint venture with Baja Celular Mexicana of Tijuana in northwestern Mexico. The Florida-based Office Depot, which operates 388 office supply stores throughout North America, has signed an agreement with Mexico's Grupo Gigante.

A survey of 1,000 U.S. companies conducted in May 1994 by KPMG/Peat Marwick, a leading consulting firm, found that 57% believe that NAFTA will help improve the U.S. economy. Nearly 40% said their industry has already benefited in some way by the Agreement's passage.

The American Chamber of Commerce in Mexico conducted a survey of its members in the Spring of 1994. Of the 224 executive officers who responded, most expressed confidence that NAFTA would be beneficial to their productivity and profitability. The vast majority of respondents anticipated their U.S.-Mexican imports and exports would increase.

Coopers and Lybrand, another leading consulting firm, interviewed executive officers of 410 of the fastest-growing U.S. product and service companies. According to the report issued, for growth companies, NAFTA has meant export opportunities, not job relocations.

NAFTA opponents who predicted a mass exodus of U.S. jobs south of the border have been proven wrong by the facts. About 15,000 primarily low-wage, low-skill jobs were anticipated to be lost in 1994 due to NAFTA, according to U.S. Department of Labor estimates. The Agreement, however, was projected to support an additional 130,000 jobs in the United States from 1994 to 1995, based on U.S. Department of Commerce estimates released in late 1994. Overall, the Department of Commerce estimates that bilateral trade supports a total of almost 800,000 U.S. jobs.

In general, Mexican consumers feel that U.S. goods are superior in quality to European or Japanese goods. This has resulted in U.S. market share being very high in Mexico compared to other countries' market share in Mexico. And Mexicans have demonstrated a tremendous demand for U.S. goods, even though their incomes are low.

For example, in 1992, production workers in manufacturing industries in the European Union, previously called the European Community, received 748% more in hourly compensation than manufacturing production workers in Mexico; Japanese workers received 588% more. Nevertheless, on a per capita basis, Mexicans bought more goods from the United States than European or Japanese consumers. In 1992 Mexicans spent $440 or 44% more, per capita, than Europeans ($305) and almost 15% more than the Japanese ($384) on U.S. goods.

Even when calculations omit the amount of exports to Mexico that are re-exported back to the United States or to other countries, Mexicans still consume more than Europeans. According to the U.S. International Trade Commission, in 1992 about 21% of U.S. exports to Mexico were re-exported back to the United States. Many of these goods were components shipped back to the United States after being assembled or improved in some manner. If 21% of U.S. exports to Mexico are omitted from calculations, Mexicans still consumed $335 worth of U.S. goods, per capita, 10% more than Europeans.

Due to Mexican reductions and eliminations of duties under NAFTA, many U.S. companies anticipated increasing exports again in 1995. However, exports to Mexico this year will be likely down. How far depends on several factors, including the level at which the peso stabilizes and the degree to which the economy slows.

The WEFA Group, a leading economic forecasting firm based in Philadelphia, during the crisis anticipated U.S. exports to Mexico would decline to about half of original projections. This was among the most pessimistic projection and based on the peso stabilizing at 5.7 to the dollar. Prior to December 20 of last year, the peso equaled about 3.4 to the dollar. Also during the crisis the Dallas Fed reportedly estimated that 1995 exports to Mexico will fall to about $38 billion, from about $50 billion in 1994. Other projections show a less severe drop in exports.

Exports of consumer goods are expected to be most affected by the devaluation, according to David Hirschman, Director of Latin American Affairs of the Chamber of Commerce of the United States. And Mexican retailers are feeling the pinch. Stated by Robert Hall, Vice President of Government Affairs at the National Retailers Federation based in Washington, D.C., "Mexican retailers fear that the industry won't bounce back for up to five years." Other retailers are not as pessimistic, but have delayed expansion plans pending how quickly the economy recovers.

JC Penny was scheduled to open stores in Monterrey and Leon in March. Since the devaluation they have moved this to May. Footlocker also announced a delay in the opening of new stores. Dillards, which operates 227 stores in the United States, and Sax Fifth Avenue and were expected to open stores in Mexico in the very near future. However, their plans are unknown since neither has announced opening dates, which an industry analyst said was unusual. Wal-Mart, the largest U.S. retailer, is reportedly holding off on adding 24 new stores in Mexico.

Other industries expect a less severe impact. Reportedly, Avon, a direct seller of beauty products and jewelry, announced that it expects its 1995 Mexican performance to remain strong, despite the peso devaluation. Kodak, whose Mexican division generates $50 million in domestic and exports sales, expects the peso devaluation to have almost no effect on their business. Esco Electronics Corp., a manufacturer of defense and industrial electronics equipment based in Feruson, Missouri, reports that the peso's devaluation will have a negligible effect on their company.

Sam Baker, international marketing and sales manager for Buffalo-based Gaymar Industries, a manufacturer of medical devices, expects his exports to Mexico to be down this year, but pick up next year. "I'm basically optimistic about long-term growth trends in Mexico." Baker said he is confident in Mexico's ability to quickly get back on its feet.

George Rathke, international marketing director for the Association for Manufacturing Technology based in McLean, Virginia, is also optimistic about Mexico's future. His members are producers of machine tools and related products; two-thirds to half of which export to Mexico.

Rathke said prior to the crisis there was no indication of any kind of a problem in Mexico. "It came like an earthquake with no prior warning." He said, however, that the Mexican economy is built on a solid foundation and believes that the economic downturn resulting from the crisis will be "only a momentary blip." "Mexico will clean up the mess and move on. They'll get past this financial/economic correction." In the meantime, he expects many of his association members' exports to Mexico will be down at least this year.

On March 9th, Guillermo Ortiz, Mexico's Minister of Finance, announced an economic program designed to restore financial stability, strengthen public finances and the banking sector, regain confidence and reinforce the groundwork for long-term sustainable growth . The measures call for an increase in the national value-added tax from 10 to 15% and to eliminate some exemptions; reductions in government expenditures to 1.6% of GDP for fiscal year 1995; a rise of 35% in gasoline prices and 20% in electricity rates; a continuing of the floating exchange rate; and a 10% hike in the minimum wage.

As a result of the new program, in 1995 the Mexican Government expects a temporary increase in inflation of about 42%; a reduction of close to 2% in GDP; and a current account deficit of approximately $2 billion. Positive economic growth and lower inflation are predicted for 1996.

Michael Hart, an economist with Salomon Brothers, agrees with the Mexican administration's assessments. Stated by Hart, Mexican GDP for this year will drop by 2% and is likely to rise by 3.4% next year -- indicating a short-lived crisis. These projections are partly based on strong anticipated exports. Hart said Mexican inflation this year may reach 44.5%, slightly higher than Mexican estimates, and taper down to 15% next year.

Because the peso devaluation has reduced the cost of manufacturing in Mexico, the economy is expected to get a boost from an increased level of production sharing activities. Production sharing allows some of the low-skill, labor intensive manufacturing processes to be conducted in Mexico, while the high-skill, capital intensive processes are retained in the United States.

According to Donald Michie, Vice President of the El Paso-based NAFTA Ventures. Inc., U.S.-Mexican production sharing will increase and U.S. imports from non-North American countries will decline. As a result of these partnerships with Mexican firms, U.S. companies will become more cost-efficient and globally competitive. This adds to U.S. revenues and employment. Without this, many U.S. manufacturers won't be able to compete as well with producers in lower wage countries and may be forced to discontinue both the high and low-skill processes -- resulting in plant closings.

Production sharing also adds to Mexican payrolls, the strength of their economy, and their ability to buy U.S. products. Thus, the strategy enhances North American competitiveness compared to Europe and Japan: a primary objective of NAFTA.

This article appeared in The Exporter, April 1995.

John Manzella
About The Author John Manzella [Full Bio]
John Manzella, founder of the ManzellaReport.com, is a world-recognized speaker, author of several books, and a nationally syndicated columnist on global business, trade policy, labor, and economic trends. His latest book is Global America: Understanding Global and Economic Trends and How To Ensure Competitiveness.

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