While the dramatic drop of the peso and the ensuing financial turbulence in Mexico has shaken investor confidence, the devaluation is also laying an important foundation for long-term growth in Mexico's economy. Expanded "production sharing" is a cornerstone of that foundation.

An increasingly prevalent strategy for improving business competitiveness, production sharing has permitted U.S. materials assembled, processed or improved abroad to be shipped back to the United States incurring duty only on the foreign added value. This has allowed some low-skill, labor intensive manufacturing processes to be conducted in lower-wage countries, while the high-skill, capital intensive processes are retained in the United States. U.S.-Mexican production sharing is expected to increase as a result of the Mexican peso devaluation -- and that will benefit both countries.

The production sharing program has been an important part of the global competitiveness strategy for many U.S. manufacturing firms and has been responsible for generating new jobs. According to the U.S. International Trade Commission, it also has been responsible for retaining jobs that would have been lost due to intense foreign competition.

The program is provided for under U.S. tariff classifications 9802.00.60 and 9802.00.80. The former classification includes products made of metal. In 1992, leading imports under this provision included aircraft parts and wrought aluminum, principally sheet used in beverage containers and foil used for consumer packaging. U.S. imports under the latter classification include all non-metal products and is a much larger share, accounting for 98% of both provisions.

The benefits derived from U.S. production sharing have been enhanced when used in conjunction with Mexico's Border Industrialization Program, now commonly known as the maquiladora program. Mexico's maquiladora law allows the Government to grant licenses permitting companies to import components and machinery free of duty under bond. The components are assembled, processed or improved and eventually exported (a small percentage is sold in Mexico after import duties are paid). Most of the finished goods are exported to the United States. Because these goods incur no duty in either country and are subject to low-cost labor, their costs are more competitive internationally.

This, combined with other factors, has resulted in Mexico becoming the United States' largest production sharing partner, accounting for 33% of total U.S. imports under 9802.00.80 in 1993. From 1991 to 1994, Mexican production sharing exports to the United States increased more than 60% and accounted for almost half of all Mexican exports to the United States.

Of all the countries currently participating in the U.S. production sharing program, Mexico, by far, utilizes more U.S. components in the finished products. U.S.-made components account for over half the value of U.S. imports from Mexico under 9802.00.80; U.S. parts typically account for only 25% of the value of such imports from Asian newly industrialized countries. Because of this, U.S. industry and labor benefit more from greater co-production of goods with Mexico, compared with goods co-produced elsewhere.

Steve Jenner, principal of Jenner and Associates, a San Diego-based management consulting firm whose clients include U.S., European and East Asian-owned manufacturing facilities in Mexico, believes Mexican production sharing will continue to increase, and more rapidly since the peso devaluation occurred. According to Jenner, "As a result of Nafta, more and more U.S. and foreign-owned companies are establishing production sharing facilities in Mexico. The recent devaluation of the Mexican peso will accelerate the trend."

Zenith Electronics Corporation has announced plans to discontinue sourcing their picture tubes for projection television sets in the Far East and begin manufacturing them in Mexico. They are not alone. Ralph Watkins, Chief of Miscellaneous Manufactures Branch of the U.S. International Trade Commission, the division that handles production sharing, has begun to research the emerging shift in production from East Asia to Mexico. Watkins says this relocation from East Asia to Mexico -- which began with the Nafta and is likely to accelerate as a result of the peso devaluation -- is "very real."

As more non-North American and U.S. producers shift production from East Asia to Mexico, they will also source more of their components and materials in the United States. This will boost jobs in the United States. According to the U.S. International Trade Commission, existing Japanese and Korean-owned maquiladoras, particularly those assembling televisions in Tijuana, will be placed at a competitive disadvantage unless they source more of their components from the United States.

The rules of origin established under Nafta favor television manufacturers like Zenith, RCA and Magnavox because their televisions embody a greater number of U.S. components. Under the trade pact, a minimum component requirement is necessary in order to classify the goods as North American, allowing them to enter any North American country at a reduced duty rate or duty-free depending on the Nafta duty phase-out schedule.

The Commission predicts that Asian television manufacturers will either open plants in North America to produce picture tubes and other key parts, insist that important parts suppliers move production to North America, or shift sourcing to existing U.S. parts suppliers.

In light of recent U.S. assistance to Mexico to help end the economic crisis, Jenner says that foreign investors have come to believe that the United States is deeply committed to ensuring Mexico's economic and political stability. This, he adds, is generating renewed post-crisis confidence and will ultimately promote greater investment in Mexico.

While some of the new production anticipated in Mexico will replace existing manufacturing in East Asia, a significant portion will be new production intended to fill rising North American and world demand. Donald Michie, Vice President of the El Paso-based Nafta Ventures Inc., a firm that assists companies to establish production facilities in Mexico, understands this very well. He says Far Eastern suppliers of electronic components, for example, have put a quota limit on their shipments to North American customers in an attempt to better satisfy the growing demand for these components in East Asia. Consequently, Michie projects that more production of these parts by North American-owned plants is likely to fill the void left by Far Eastern suppliers and take place in Mexico.

Nike currently maintains production facilities in South Korea, China, Indonesia, Taiwan and Thailand. Keith Peters, Director of Public Relations for Nike, Inc., says that his company began considering establishing a plant in Mexico back in mid to late 1994 in order to fill fast growing demand for its footwear products. Third quarter earnings of last year were up 37% and second quarter earnings rose 34%, indicating a healthy demand for its products.

A new plant in Mexico, Peters notes, may be used to fill demand in Mexico and the United States. Currently, Nike sources its materials from five countries. Supplies for a new Mexican plant may be sourced in North America, Peters says.

It is noteworthy that relatively few Mexican exports to the United States compete directly with U.S. goods. Instead, they compete more with non-Nafta countries. As a result, an increase in Mexican exports to the United States is expected to displace East Asian exports -- reducing the U.S. trade deficit with that region of the world.

Under Nafta, all duties on North American goods traveling between the United States, Mexico and Canada will be phased out. This will negate the duty elimination benefits derived from tariff classification 9802 -- but spread the benefits of production sharing throughout all of North America. Consequently, Mexico's maquiladora program will become unnecessary and is slated for termination on January 1, 2001.

Since Nafta was implemented, there has been a proliferation of joint ventures and strategic alliances between U.S. and Mexican companies. This cooperation should only accelerate with the peso devaluation. The benefits derived from this teamwork will continue to make the United States, Canada and Mexico more globally competitive -- at a time when regional trade alliances are becoming increasingly important in the world economy.

This article appeared in Mexico Business, June 1995.

John Manzella
About The Author John Manzella [Full Bio]
John Manzella, founder of the Manzella Report, is a world-recognized speaker, author of several books, and an international columnist on global business, trade policy, labor, and the latest economic trends. His valuable insight, analysis and strategic direction have been vital to many of the world's largest corporations, associations and universities preparing for the business, economic and political challenges ahead.

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