Source: The Wharton Journal, Dic 11, 1995 The Wharton School, University of Pennsylvania

Latin American Perspectives: The Maquiladora Program Its Challenges Ahead

by Gerardo Benitez

Where will NAFTA take Mexico and its Maquiladoras? The series of Free Trade agreements have provided opportunities beyond belief for the industry. However, could Mexico be experiencing infrastructure saturation? What will be the effects of the corresponding bottle neck that will soon hit Mexico? Due to the drop in real governmental revenues as a result of the crisis, the only possible solutions to the problem might be the North American Development Bank and the new tax law on Maquiladoras. However, will they be enough? Will they have possibilities of success?

By the end of this article, I hope you understand some of the challenges and opportunities faced by the Maquiladora Industry as it prepares to enter into the 21st Century.

NAFTA and Free Trade Agreements Latin America:

President Salinas envisioned a grand design of overlapping free trade agreements permitting Mexico to exercise significant international influence. The strategy has permitted a limited entry of dutyfree products which appear to come from Mexico, but which actually come from other Latin American nations channelling the regions trade with the U.S. through Mexico's Maquiladora zone. Due to NAFTA and the wave of free trade agreements with Latin American Nations, Maquiladora operations have been fundamental changed. Imported inputs may now enter duty free. Furthermore, all Maquiladora goods can now be sold in Mexico; and through it to the rest of Latin America thanks to new free trade agreements. This process hopes to transform Mexico into the economic avenue for the entire region in the long term giving the Maquiladora industry a virtually unlimited market for its production.

Thus there is strong evidence to suggest that Mexico, as the region's free trade leader, is destined to play a crucial part in the development of hemispheric trade. Parts will now be sourced from most of the continent, and the entire continent will serve as a market for their produce. When the system is firmly in place, Mexican exports will be found as south at Tierra de Fuego and as North as Anchorage, Alaska.

The effects of devaluation and new the export promotion strategy:

Following the devaluation of the peso, the Maquiladora industry has grown substantially. During the month of July alone, the industry grew by an astonishing 52% in nominal terms to 2.54 billion pesos from the 1.67 billion pesos in July 1994.

This has been due to the devaluation of the peso by 120%, while dollar wages have actually decreased. For this reason, firms have moved quickly to capitalise on the situation; over 300 new Maquiladora programs have already been authorised and over have received permits to expand their operations. This explosive growth has been translated to 89,000 new jobs. To further augment growth, The Foreign Trade National Bank Of Mexico will increase its credits to the export sector by 30% in real terms, and at the same time The Financial Development National Agency will increase the allocation of resources by more than 25%, benefiting, small and mediumsized Maquiladoras by launching a program jointly with the commercial banks to support companies through risk capital.

It then comes as no surprise to see that during 1995 the Maquiladoras, along with the grupos, have been the only sector with accelerated growth in terms of both production and levels of employment. And there is little reason to expect any significant macroeconomic changes in the structure of the Maquiladora industry as long as Zedillio remains in power. In 1996 their high level of competitiveness and access to international markets, available through the series of trade agreements, will surely consolidate the Maquiladora sector's position as a key engine for growth within the Mexican economy.

The Infrastructure bottleneck

However, Mexico is finding itself in a dangerous situation, because by now, the border towns' infrastructure is virtually saturated, and they will soon be unable to accommodate more industrial plants unless infrastructure increases. And with Mexico's attempts to further industrialise its central core, ever more infrastructure capital would be needed to improve the highway systems.

Sadly enough, the inadequate state of Mexican infrastructure does not end in the highway system, it continues to such areas as public health, education, public transportation, water supply, sewage treatment, and environmental controls. Which means that on the Mexican side of the border, the infrastructure will soon be unable to absorb any more productive capacity, or new plants, without pulling the fragile socioeconomic fabric to pieces a term now coined as infrastructure saturation. Thus the claim by Ross Perot that millions of American jobs will move to Mexico with the signing of NAFTA might be true if the infrastructure were there to support those jobs: but it is not there, and just unemployed people available for hire is not enough.

The North American Development Bank as a solution?

Might NAFTA bring a solution? Under the pressure of NAFTA the two governments finally put the item on their agenda: the concept of a Border Development Bank. Politicians and environmentalists estimated that the cost of cleaning up the Mexico/US border area at between US $6.510 billion. However, U.S. federal and state officials recognised that every dollar not spent for social and economic infrastructure on the Mexican side leads to $2 of costs on the U.S. side. Hence The North American Development Bank was created exclusively to address environmental infrastructure concerns impacting the region within 100 km of either side of the U.S.Mexico border. This joint agreement was cemented through a relationship whereby each country has equal rights and obligations, and both contribute equally to the Bank's capital holdings. However, to fully capitalise the bank, Mexico will have to provide $225 million in paidin capital and $1.28 billion in callable capital, a sum which Mexico might very well be unable to afford considering the degree of nonliquidity that it is facing. Already, the plans for consulting two large sewer treatment plans have been frozen

I believe that although the devaluation has provided a great pull for Maquiladora growth, by 1996 the lack of infrastructure development will catch up with the industries reckless growth, driving the standards of living to barbaric conditions and strangling growth. The hopes for the newlycreated North American Development Bank, will remain a mere hope as long as Mexican governments lack the financial resources to borrow money, much less complete infrastructure projects like the sewage treatment plants needed in Tijuana or Nuevo Laredo.

What about the new "armslength tax law" as the other solution?

A possible solution to the problem might be Mexico's new "armslength tax law," which should address the role and responsibility that transnational companies have, or should have, in the matter of taxes. During the period JanuaryApril 1995 the government may have foregone up to some $500 million of corporate taxes associated with the exports of manufactured goods by transnational companies. One can easily visualise that $500 million spent on the border would go a long way to strengthen the region's infrastructure.

Previously, Maquiladoras were virtually untaxed, however with the tax reform to be published on December 28, a Maquiladora in Mexico would need to show the same revenue from its assembly services as an independent assembly factory would charge on the open market, increasing accounted profit levels, and with it income taxable by the Mexican government. The best part is that the overall tax is not likely to rise because increased tax payments to Mexico will reduce the amount of taxes that companies pay to the U.S. government. Thus we may expect investment into the Maquiladora industry will not be deterred, while at the same time, we might expect the new law to provide at least some funds to channel into infrastructure development. True, the new law will not solve the infrastructure saturation problem; however, what it might do is give both the industry and the government enough breathing time to wait for that long overdue period of growth that the IMF has promised.

Thus, this discussion suggests that in fact there are strong reasons to hope, however, at the same time there are a number fundamental structural problems with the industry. It would seem that the industry has been shaped by the misguided wishes of political leaders, and over the long term this has turned it the problem for both governments that it is today.

Even thought the industry has seen explosive grown rates, its growth is not a sustainable one, and the Mexican government will soon be hard pressed to provide adequate transportation and housing infrastructure for the new wave of unemployed moving. While there are some sources of assistance, most notably the new North American Development Bank and the new taxation laws, they will only solve the most drastic immediate cases. Mexico needs to provide jobs for the one million 18 year olds entering the work force every year. Should this time bomb explode Mexico will then find itself, as in 1810 and 1910, in the midst of revolution and civil strife. While the Maquiladora program provides some relief; how much more will the socially fragile Maquiladora system be able to take? My analysis leads me to think that the system will be able to sustain the explosive growth until the later stages of 1996. However, by that time the situation will become unbearable. Only growth in central Mexico will be able will be able to lift the burden from the Maquiladoras, but growth in that area has failed to materialise for the last 10 or so years.

Will Mexico, and its Maquiladoras, be able to cross the hurdle? In reality it is a dangerous game of chicken: either we grow, or we will find ourselves bogged down in a depression similar to the one in 1982 with the debt crisis. The challenge is to find the way to get Mexico back on the glorious path towards becoming the first roaring Latin American tiger. Given our past, meeting that challenge will call for the closest collaboration between the awakened hearts and minds of the people. Mexico deserves to become a nation of the Sun again; the question now is will the system hold in the mean time?