Publish in Perspectives - Monday, July 25, 2016
Thanks to NAFTA, automotive companies can use an engine from Mexico and a transmission from Canada, and then build the car in the U.S. and still enjoy preferential treatment. Here Ford's Louisville assembly plant. (Photo: Ford)
Before NAFTA, that what was produced in Canada was for sale in Canada. With NAFTA, these plants are integrated. Meanwhile, close to 40 percent of what the U.S. imports from Mexico is derived from U.S. sources, up from 5 percent 20 years ago. (Photo: Wharton)
NAFTA has been big boon for auto sector in US, Mexico and Canada.
In 1992, Independent presidential candidate Ross Perot made opposition to the North American Free Trade Agreement (NAFTA) the cornerstone of his national campaign, warning voters that because of huge wage differentials between the U.S., Canada and Mexico, “There will be a giant sucking sound going south.”
Even now, 20 years after NAFTA was enacted in 1994, the trade agreement’s legacy remains enshrouded in controversy, not only in the United States, but in Canada and Mexico as well.
How much of Perot’s dire forecast came true? What kinds of benefits, if any, has NAFTA brought to the economies of the U.S. and Mexico? Will it ever be possible to know, for sure, what the world would have been like if NAFTA had never been enacted?
During the heated debate that proceeded its enactment, prominent economists and U.S. government officials predicted that NAFTA – a trade agreement aimed at liberalizing trade between member countries — would lead to growing trade surpluses with Mexico and that hundreds of thousands of jobs would be created. “But the evidence shows that the predicted surpluses in the wake of NAFTA’s enactment in 1994 did not materialize,” notes Robert Scott, chief economist at the Economic Policy Institute, a left-leaning think tank in Washington, D.C.
What kind of evidence? “Jobs making cars, electronics, apparel and other goods moved to Mexico, and job losses piled up in the United States, especially in the Midwest where those products used to be made,” says Scott. “By 2010, trade deficits with Mexico had eliminated 682,900 U.S. jobs, mostly (60.8 percent) in manufacturing.”
Claims by the U.S. Chamber of Commerce that NAFTA trade has created millions of jobs “are based on disingenuous accounting, which counts only jobs gained by exports but ignores jobs lost due to growing imports,” he adds. “The U.S. economy has grown in the past 20 years despite NAFTA, not because of it. Worse yet, production workers’ wages have suffered in the United States. Likewise, workers in Mexico have not seen wage growth. Job losses and wage stagnation are NAFTA’s real legacy.”
A CLOSER LOOK AT JOB LOSS
How much of these job losses can be attributed to the impact of NAFTA? Wharton management professor Mauro Guillen has a very different view, suggesting that without NAFTA, many jobs that were lost over this period would probably have gone to China or elsewhere. “Perhaps NAFTA accelerated the process, but it did not make a huge difference. At the same time, a lot of jobs were created in the U.S. that wouldn’t be there without the Mexico trade. I’m not just talking about Texas or California or Arizona…. Many of the products made in Mexico are designed in the United States. So there are a lot of jobs created here.”
Walter Kemmsies, chief economist at Moffatt Nichol, an international infrastructure consultancy, notes that close to 40 percent of what the U.S. imports from Mexico is derived from U.S. sources. “This is the symbol of the success of NAFTA.” Twenty years ago, he estimates, that percentage was less than 5 percent.
Overall, has NAFTA been a good thing? Morris Cohen, Wharton professor of operations and information management, states that for many years, “economists have been arguing about whether global trade is a net benefit or net cost; who are the winners and who are the losers. There has been lots of ink spilled on that issue. The consensus from my perspective is that trade is generally a good thing; it helps to elevate the standard of living and it raises the level of economic activity on both sides. But there’s a net transfer sometimes, and definitely the notion of winners and losers. We don’t have the luxury of being able to have done the experiment [to find out] what would have happened had there been no NAFTA.” Or, he adds, to figure out to what extent the conditions that exist today are a result of NAFTA, or not the result.
Two decades ago, says Guillen, “People knew that trade within NAFTA would increase, so the U.S., Canada and Mexico would trade more with each other. We [also] knew that low-wage manufacturing was going to move to Mexico from Canada and the U.S. And of course, part of this also moved to China and other locations, but Mexico has the advantage of proximity to the U.S.”
He acknowledges that Mexico has a surplus with the U.S. in trade – “and NAFTA accelerated that. But the U.S. runs a trade deficit with 90 percent of the countries in the world. So Mexico is not unique. In fact, the U.S. also runs a deficit with Canada, and that’s mostly because of oil and gas.”
If NAFTA had not been signed, Guillen adds, “the jobs would probably have gone to China or somewhere else; most jobs have relocated to China. The U.S. had a trade deficit with Mexico of $54 billion [in 2013], but with China, it was [a deficit of] $318 billion, so the [U.S.] deficit is five times bigger with China than with Mexico. In other words, you would calculate, maybe for every job we have lost in the U.S. to Mexico, five [jobs] were lost to China.”
While conceding that many U.S. high-wage manufacturing jobs were relocated to Mexico, China and other foreign locations as a result of NAFTA, Cohen argues that NAFTA has, on balance, been a good thing for the U.S. economy and U.S. corporations. “The sucking sound that Ross Perot predicted did not occur; many jobs were created in Canada and Mexico, and [the resulting] economic activity created a somewhat seamless supply chain — a North American supply chain that allowed North American auto companies to be more profitable and more competitive.”
MAJOR IMPACT ON THE AUTO SECTOR
Before NAFTA went into effect in 1994, the automotive sector throughout North America was insular and regional, and most vehicles were developed for the markets in which they were sold, notes Michael Robinet, managing director of IHS Automotive, a consultancy based in Michigan. “The rest of the world didn’t want our vehicles” because they lacked the size and mileage demanded by its consumers. South of the U.S. border, Mexican administrations pursued a policy known as “import substitution,” which is antithetical to free trade. Protected by high import duties, import licenses and quotas, Mexican plants were notorious for producing shoddy goods unpopular even in their domestic market.
As recently as 2008, Japan exported almost twice as many cars to the United States as did Mexico. This year, however, Mexico will export 1.69 million vehicles to the U.S., surpassing the 1.51 million vehicles exported by Japan to the same market. By 2015, Mexico will export 1.9 million vehicles to the U.S., surpassing Canada as the largest exporter to the U.S.
Overall, Mexico’s output of vehicles reached 2.93 million units in 2013. By 2020, almost 25 percent of all North American vehicle production will take place in Mexico, compared with only 10 percent in Canada and 65 percent in the United States. For both the U.S. and Canada, those numbers will represent a considerable decline in their share of the North American production pie. Massive recent foreign investments made by Asian and German brands in Mexico include Mazda’s facility, with an estimated annual production of 185,000 vehicles; Nissan’s, with an annual capacity of 149,000 vehicles, and Audi’s, set to open in 2016, with annual capacity for 150,000 vehicles.
Like Mexico, Canada’s automotive sector has long been dominated by U.S.-owned firms, even before NAFTA. “The U.S.-owned auto industry in Canada has been producing cars for generations,” notes Cohen. “But it used to be, before NAFTA, that what was produced in Canada was for sale in Canada, and it was a much smaller market. Now with NAFTA, these plants are integrated. Some components or sub-assemblies are sent back to the U.S. It is as if there is no border, as if it is one economic zone.” The quality of Canadian-made vehicles is now on the same world-class, highly competitive level as those made in the U.S. and Mexico, he notes.
All this activity has had a predictably negative impact on the U.S. share of all North American automotive jobs, which dropped from 64.5 percent in 2000 to just 53.4 percent in 2012. By 2012, 39.1 percent of all automotive jobs in North America were in Mexico, up from 27.1 percent of such jobs in 2000.
According to Robinet, “NAFTA has driven down our costs,” making it possible for an integrated North America — as a single manufacturing platform — to become a major force in global automotive trade. Thanks to NAFTA trade preferences, automotive companies in the U.S., Canada and Mexico “can use an engine from Mexico and a transmission from Canada, and then build the car in the U.S.” and still enjoy the NAFTA preferential treatment, so long as 62.5 percent of the value of that vehicle comes from within those three countries. Nowadays, the “vast majority” of vehicles built in North America have at least 75 percent (combined) value-added from those three countries, while some have well over 90 percent of North American value-added.
Meanwhile, Mexico’s emergence as an export-focused automotive manufacturing center is having a growing impact on other sectors of Mexico’s economy as well, Guillen notes. “We have seen, since the beginning of NAFTA, that productivity has increased in pretty much all of the export-oriented industries [in Mexico], especially manufacturing, where it has more than doubled.”
That is to be expected for several reasons, he says. Before NAFTA, “there were automobile plants in Mexico, but they were not really oriented toward the U.S. market. They were mostly for the Mexican market, and they were not very efficient. So in anticipation of NAFTA, and during the NAFTA period, American companies, the Japanese and South Korean firms have invested in world-class factories — with the best equipment — for the export market, which is primarily the U.S.” So part of the increase in productivity is due to better equipment in new plants. Another part is training of the labor force, for the same reason. These were cars made for export, so they needed to be well-done cars. The third reason is that Mexico, in general, even without NAFTA, would have made progress. “People have brought in better machinery,” on which workers have been trained, and educational levels, in general, have improved.
Guillen argues that “you see the same things in electronics, especially appliances, automotive parts, furniture” and other sectors such as aerospace and computers. However, the trend is more visible in the automotive sector because there are less than two dozen vehicle assembly plants in Mexico. “That’s why one decision by Nissan or Volkswagen – for example, to set up a world-class factory — makes a big difference. You can more readily see the changes in the automotive industry, but it is happening in the others too….
“Now think of where Mexico would be today without NAFTA,” Guillen adds. “Today, Mexican migration to the U.S. has come to a halt. There are Central Americans coming to the U.S. – but virtually no Mexicans. That’s because Mexico is doing well. So just imagine, without NAFTA and with Mexico not doing that well, we would have had the additional problem of an unstable Mexico with lots of people wanting to come to the United States.”
BEHIND NAFTA’S SUCCESS
Robinet identified several factors, beyond comparatively low wages, that are responsible for NAFTA’s impact on North American trade in recent years:
--The stable peso/dollar exchange rate: Before NAFTA, the dollar-peso exchange rate fluctuated widely, but the Mexican government “keeps inflation under control.” If you build a car in Japan, for example, you have no control over the yen/dollar relationship, Robinet noted. Facing that uncertainty, “manufacturers have learned that you need to build where you sell” – or close to it, as in the case of factories along the U.S.-Mexico border.
--The growing availability of Mexican suppliers: Nowadays, “everyone wants suppliers within one hour of the assembly plant,” said Robinet, and they are plentiful in key Mexican clusters of activity. Although it may be less costly to buy some components in China, for example, automotive companies are “beating the drum” to source more and more of their components as close as possible to final assembly. They don’t just ask how much a component costs, but “how much will it cost me to ship it here?”
---Mexican public policy: Mexico’s governments, whether of the conservative PAN party or the more populist PRI party (currently returned to office) are interested in developing a global auto industry, unlike that of China, which has focused its long-term strategy on capturing a dominant share of its (much larger) domestic market. Thus, Mexico’s government has opened the country to multinationals that have increased their scale of production, driving down prices not just for made-in-Mexico car exports, but also for cars sold to Mexico’s burgeoning middle class. To further facilitate this integration outside of North America, Mexico has forged tariff-free or reduced-tariff agreements with 44 countries around the world.
Robinet says that Mexico has become “not only the crossroads of automotive trade in the Western Hemisphere,” but it is “enhancing and augmenting its transportation infrastructure. When it comes to transportation, Mexico is in a sweet spot; you don’t need to go through the [Panama] Canal.” Before NAFTA, Japanese exporters had to go through the Canal, which has bottlenecks and is costly.
Meanwhile, Kansas City Southern Railway’s cross-border intermodal volume in Mexico will continue to expand not just because of Mexican manufacturing growth, but because of the strong advantage rail has over the trucking industry south of the border, says Patrick Ottensmeyer, chief marketing officer at Kansas City Southern. The railroad has seen high double-digit quarterly intermodal growth inside Mexico, as the U.S. and other manufacturers of automotive, white goods and other products have shifted production to Mexico. He agrees that manufacturing in Mexico for export to U.S. consumer markets has become more attractive as a result of the recent rise in Chinese labor and transportation costs.
MEXICO’S HAVES VERSUS HAVE-NOTS
Has the success of Mexico’s automotive sector accentuated the imbalance between NAFTA’s winners and losers? Some Mexican critics worry about the income inequality between those industrial workers who have benefitted from the country’s globalization and those who have been shut out of those benefits, especially the rural poor.
Guillen says he “completely disagrees with those economists who say this has generated inequality. Whenever there is this kind of growth process, especially when foreign investment comes in, you always get that inequality. Are you better as a country – or worse off? Ask the 30 percent of Mexicans who got well-paying jobs. Without NAFTA, they wouldn’t have those jobs, because those jobs would be in China or somewhere else.” Guillen contrasts the Mexican situation with that of the U.S., where “we are generating inequality because the lower wages are either stagnating or going down. How do they go down? When a factory worker is earning $35 an hour, gets laid off and has to go to the service sector and only makes $12 an hour.”
Overall, Guillen states, “NAFTA has been great for Mexico. The only doubts are about whether it has been good for the United States. I believe it has been, but there is more of a mixed balance between losers and winners [in the U.S.]. For Mexico, it is a total success. The problem in Mexico, though, is that the export industry there has not been big enough to employ everybody in a large population…. Inequality has been produced, not because the wages of low-wage workers got lower, but because a significant number of workers are now receiving higher wages.
“It is obviously good, but it would be even better if, instead of only 30 percent of Mexican workers earning those very high wages for Mexico, you could get 70 percent of the workers.” For that to happen, Mexico will have to overcome its shortage of capital, he adds.
Despite such imperfections, Kemmsies believes that “NAFTA is on the cusp of being a great success,” but he also worries that “Mexico will kill the golden goose before it lays an egg” by imposing export taxes on foreign firms doing business there before those firms are fully convinced they should be in Mexico for the long haul. “Mexico has to worry about overplaying its hand” before the global automakers and other foreign investors have sunk their roots more firmly into Mexican soil.” Given the fragile state of the global economy – and the uncertainties surrounding Mexico’s ambitious reform efforts — many foreign companies “are still scared and risk averse. We are not [yet] past the start-up stage in Mexico.”
Republished with permission from http://www.knowledge.wharton.upenn.edu -- the online research and business analysis journal of the Wharton School of the University of Pennsylvania.
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