Essay/Term paper: U.s investment in mexico

Essay, term paper, research paper:  Economics

U.S Investment in Mexico


Economics 580
Dr. Leon
Haitham Boukhadour
Fall 96

Mexico has established itself as one of the biggest emerging markets in
the world today. It has exhibited many of the signs of a high growth economy,
offering several advantages to prospective investors. Some highlights of the
Mexican economy include " single-digit inflation, a balanced public budget, real
economic growth (presently at a rate of 12 percent), a deregulated economy and a
favorable investment climate" (Risk Management/ June 94, P.32). Mexico also
possesses a strategic geographic location as a gate way to Latin American
markets.

Mexico is among the fastest- growing export markets for the United
States. In 1985, Mexico became the third largest market for total U.S. exports,
behind Canada and Japan. In 1992, Mexico surpassed Japan as the second largest
export market for U.S. manufactured goods. Mexico now accounts for $1 out of
every $10 of total U.S. exports.

After the passing of NAFTA, bilateral trade was quite balanced in 1994,
with the U.S. registering a surplus of $1.3 billion, virtually unchanged from
1993. However, there was a sharp increase in trade opportunities, as both import
and export growth exceeded 20 percent. One-fifth of the total trade that occurs
between the United States and Mexico was created in 1994.

One of the major sectors that holds a large promise for the U.S.
manufacturers is that of the automobile industry. The Mexican market for auto
parts is expected to grow by 24 percent from 1994 levels to $16.9 billion in the
year 2000. It is also expected that NAFTA will help increase the U.S. export
share of the Mexican market to around 70 percent by the year 2000. In the long
run, Mexico's location could profit the U.S. industries that establish
themselves there, through an expanded free trade area in Latin America, which
could include Argentina, Brazil, Venezuela, and Chile. Such expansion could
prove crucial to the U.S. industry, as a strong export orientation helped
sustain industry growth. Exports increased from 18.5 percent of total output in
1989 to 27.2 percent in 1991. And the level of employment which could be
attributed to exports increased from 116,500 in 1989 to 154,200 in 1991.

Mexico also offers some intriguing possibilities in terms of production
facilities for U.S. based firms. In 1994 alone Mexican car and truck production
totaled 1.173 million units, up 8.6 percent from 1993. The Mexican government
had along term plan in terms of automobile production in Mexico, and it is in a
phase now that favors foreign investors and exportation out of the Mexican
market. Check the figure bellow to see how the plan has progressed so far.

Assembly Manufacturing ISI Export Promotion Liberalization
1925-1962 1962-1969 1969-1989 1989-

In previous years there were many barriers to trade, to date some still
exist while many have been lifted or reduced substantially. U.S. firms seeking
to take advantage of low Mexican wages, established many joint ventures in
Mexico. These plants were known as maquiladora plants. These plants started as
basically a "screwdriver and nuts operation" where firms merely assembled their
cars in Mexico with no real manufacturing performed within these plants. There
were several obstacles to the U.S. firms taking full advantage of the low
Mexican wages. For a long time in Mexico, any cars sold domestically within
Mexico had to contain 60 percent locally produced parts, including the engine.
That rule has changed requiring 34 percent locally produced auto parts , falling
to 29 percent by the year 2003 through NAFTA measures.

Another major impediment to full-scale car production in Mexico was the
20 percent import tariff imposed on auto parts imported into Mexico. Also cars
imported into the U.S. that were produced in Mexico used to incur a 2.5 percent
duty.

Since NAFTA's implementation at the beginning of 1994, half of all U.S.
exports have been eligible for zero Mexican tariffs, including machine tools,
electronic equipment, and computers; components vital to the operation of the
plants. NAFTA reduced Mexico's auto parts tariff from 20 percent to 10 percent
on January 1st, 1994 and lowered other barriers. And cars coming into the United
States no longer incur a 2.5 percent duty.

As a result of NAFTA, auto-makers have started integrating their Mexican
plants into their North American operations, shifting mid-size to luxury car
productions to their underutilized plants in the Midwest, while producing
smaller sized cars in Mexico. Mexico will probably become a center of small-car
production. That is what the local market favors, and lower labor costs will
make small-car production more profitable. U.S. firms cannot survive by merely
using Mexico as an exporting platform, rather, they do need a strong internal
market and local revenue.

Several obstacles still persist. The Mexican government continued to
open the Mexican market to foreign investors following the implementation of
NAFTA. Inflation dropped to about 7 percent in 1994, down from the high of 150
percent in 1987. However several factors deteriorated the outlook for the
Mexican market. Namely an unresolved peasant uprising in Chipas, Political
assassinations, and a series of high profile kidnappings. All of those
contributed to investor skepticism towards Mexico.

The devaluation of the Mexican peso, which went down as much as 50
percent against the dollar, was a mixed blessing. Though it lowered payroll
costs, which make up roughly 80 percent of a typical maquildora's operating
budget. It had several negative effects. For one the worker morale was
negatively affected. Also as stated above, a strong local market is crucial for
sustaining growth and profits. With the devaluation of the peso, auto sales in
Mexico dropped 70 percent in the months following that crisis, also, the price
of automobiles in Mexico went up 10 percent in pesos, despite being discounted
20 percent in dollar terms. Several U.S. firms are restructuring within Mexico
in response to that devaluation, which helps their exports out of Mexico, but
not their local market shares. They have announced cutbacks in production, and
an increase in payrolls for their Mexican labor in terms of the peso.

As a result, in 1994, vehicles that were destined for foreign sales
increased by 20.8 percent, while those for domestic sales dropped by 28.6
percent. And in 1995, export production jumped to 700,280 vehicles, while
production for Mexico shrank to 373,210 vehicles.

All of these factors have deteriorated some of Mexico's automobile
investment prospects. For example, Thrall Car Manufacturing, an Illinois-based
rail-car builder, has put a hold on plans to start operations in Mexico. Most
firms in the United States and Canada are adopting a more cautious attitude on
business ventures in Mexico. Some of the reasons are the uncertainty of NAFTA
benefits, Mexico's unstable financial exchanges, and the devaluation of the peso.
The devaluation, more than anything else, is the real stumbling block for any
company considering a Mexico venture. Most Mexican based firms have a dollar-
based debt but peso-based profits. When the peso loses value, repaying the debt
becomes a major task. Also current interest rates offered by Mexican banks
fluctuate between 20 percent to 60 percent. While U.S. banks offer some relief,
with a rate of 16 percent to 17 percent, it is still a counter productive rate.
Most businesses cannot support a debt of 17 percent and still survive.

As can be seen there major advantages, along with many risks for U.S.
firms to open a plant in Mexico. There are ways for minimizing the risks, such
as raising the capital abroad and undertaking local partners. But in general the
outlook for the Mexican market should be a cautious one until the full effects
of the NAFTA agreement are realized.

References

Higgs, Richard. "Mexico a lucrative market for U.S. suppliers, consultant says"
Automobile News Feb 13th 1995: 86.

" Economic woes take toll on Mexican workers" Automotive News Feb 13th 1995: 86.

Jenkins, Rhys. " The political economy of industrial policy: automobile
manufacture in the nearly industrializing countries" Cambridge Journal of
Economics 19 (1995): 625-636.

"NAFTA fans trade fire for U.S. auto suppliers" Rubber-and-Plastic-News-II Dec
13th 1993: 4.

" NAFTA's effect on the Mexican Economy." Risk Management Jan 1994: 32.

"Weak peso applies brakes in Mexico" Wards-automotive-Reports Jan 16th 1995: 1.