Maquiladora Industry Leaps Over Troubled Waters

Threats and Opportunities Abound

Mexico’s Maquiladora Industry just reached its 45 th anniversary! The industry, which officially began with a June 10, 1966 “Memorandum of Agreement” between federal ministers Octaviano Campos Salas (Industry and Commerce) and Antonio Ortiz Mena (Treasury), has grown to become Mexico’s most successful economic development program.

Today, the Maquiladora Industry is responsible for employing one out of three direct manufacturing workers in Mexico. It is also the main exporter in the country accounting for 65% of Mexico’s manufactured goods exports.

In addition, the Maquiladora Industry is by far the largest generator of Foreign Direct Investment for manufacturing and competes for the top spot with oil exports as a generator of foreign exchange for Mexico. But the success of the maquiladora industry in Mexico has not been easy. In fact, it has endured serious challenges from both external as well as internal forces.

Maquiladoras have come a long way in forty-five years. The early maquiladora plants were low investment, labor-intensive operations such as classification of retail discount coupons, sewing, and basic electromechanical assemblies. The 80’s saw automobile parts and components grow big-time and witnessed the first stateof- the-art electronics operations.

In the 90’s, the industry experienced a decade of strong growth and consolidation, a significant technological leap and the long-awaited geographical dispersion of operations throughout Mexico.

China and the U.S. recession sparked the 2001-2002 maquiladora crises which were like a forest fire, scratching 22% of the labor force and cleaning the landscape of marginal players and industrial sectors. This forced the survivors to make fundamental changes and a stronger and more competitive industry emerged by carving out new global market niches.

The US economic recovery and expansion of 2003-2007 helped the maquiladora industry recuperate and grow. But the most significant development at that time was the “rediscovery” of Mexico by the US and other Asian and European countries. These factors produced what may be called the 4th generation of maquiladoras which included new industrial sectors such as aerospace and medical and higher value operations such as design and engineering.

Then, in 2008, came the brutal blow of the global great recession, wiping off nearly 300,000 jobs and leaving a dreadful landscape of bankruptcies, empty industrial facilities and doubts about the future.

Today, at the threshold of a sluggish but seemingly plausible global economic recovery, Mexico’s Maquiladora Industry is adapting and reengineering itself to cope with the international and domestic conditions that lay ahead.

For the tenth time in its almost half of a century history, the Maquiladora Industry has to leap over troubled waters, struggling with old and new challenges and always alert to opportunities.

PERFORMANCE INDICATORS

Let’s recall that that Maquiladoras work under a customs regulation for export oriented manufacturing companies, that allows global companies to locate facilities in Mexico, import equipment and materials duty-free and take advantage of lower labor costs.

Federal regulations currently refer to this customs program and exporting industry as “IMMEX” or “Manufacturing, Maquiladora and Export Services Industry”. But for practical and semantic purposes, and by vox-populi, the sector will continue to be referred to as the Maquiladora Industry.

Exhibit #1 shows the performance indicators of Maquiladoras from 2007 through 2011. Currently, the number of plants in operation is 5,108 which is slightly below (3.8%) the peak level reached in 2009 of 5,301 plants.


Employment in Maquiladoras was at its highest level in 2007 with 1.957 Million workers. As a result of the recession, employment dipped almost 15% in 2009, promptly recovering about half of the losses in 2010. But the most recent data shows that the recovery of jobs stalled in 2011.

The indicator that best reflects the recession and recovery facts in the Maquiladora Industry is the one for exports. The recession dragged down production of Maquiladoras by almost 28% from 2008 at US$175 Billion to 2009 at merely $US$127 Billion.

In 2010, exports had a significant recovery at US$159 Billion, coming just 10% off the peak in 2008. For 2011, the Maquiladora Industry exports are expected to come just short of US$170 Billion.

And just like everywhere else in the manufacturing world, the Maquiladora Industry in Mexico learned to do more with less as evidenced by the productivity index for 2010 and 2011, which were about 10% above a “normal” year such as 2007.

AN OLD CRY

MEXICONOW has covered the Maquiladora Industry for almost ten years, and in that period of time there has been a constant cry from the industry regarding clear and permanent fiscal rules.

The Maquiladora Industry is basically regulated by the Ministry of the Economy and the Ministry of the Treasury. Originally, back in the 60’s and through the 80’s the Maquiladora Program was a very basic and simple set of customs and fiscal package of rules.

But later, when the Maquiladora Industry grew to a sizable generator of employment and foreign exchange and international trade agreements such as GATT and NAFTA took the stage, federal authorities started to change and complicate the rules for the Maquiladora Industry.

You may recall concepts such as “Rules of origin”, “Permanent establishment”, “Related parties”, “Maquiladora payroll tax”, “Rule #8”, “Annex IV”, “Flat tax” and others, along with a long parade of “Decrees” that have been mostly temporary provisions to regulate the Maquiladora Industry.

As of this writing, the industry still has a gun pointed to the head by the upcoming elimination at year’s end of a tax provision that will significantly increase the cost for Maquiladoras of doing business in Mexico.

International corporations typically have 5-year financial plans for their global operations. How can they plan when the rules change practically every year? The current decree for the industry does not provide any legal certainty since the authorities can do whatever they wish and may change the rules at anytime. In order to provide certainty, a decree must become part of the Mexican Customs Law. This is done so that any future changes would necessarily require a legislative process, not just the signature of the officials in turn.

In a related matter, there is also the increasing burden of compliance and reporting for customs and fiscal purposes. Industry managers harshly complain about the huge administrative cost they undergo with additional office personnel and professional accounting and legal fees just to comply with the regulations.

The World Economic Forum agrees, placing Mexico in rank #116 out of 139 countries in the “Burden of government regulation” category in their 2010-2011 Global Competitiveness Report.

We need to get back to basics. The original Maquiladora decree was clear-cut and simple. The more they keep patching the rules the harder and more expensive it gets to comply. The authorities should reach consensus with the industry, produce a reasonable set of rules that are easier to follow, and then convert them into law, for long term use by the industry.

COSTS AND COMPETITION

Mexico’s maquiladora industry is one of the world’s most successful economic development programs. But competition is growing. Even as Mexico’s Maquiladora Industry survived the China experience, there are still almost one hundred developing countries that have not yet established or matured their formal Economic Processing Zones for exports.

China is quickly closing the salaries’ gap advantage it enjoyed over Mexico, but behind China there are many low-cost competitors, such as Vietnam, El Salvador, Morocco and others that are aggressively getting into the global manufacturing supply chain.

While Mexico is still ‘reasonably priced’ compared to countries thousands of miles away, it must not be complacent and should strive for competitiveness throughout the Maquiladoras’ operating costs range.

The cost of electric power, domestic freight, telecommunications, higher management personnel, direct labor bonuses, administrative burden and other cost items are just out of line. They clearly need to be brought within global competitive parameters. Someone said: “Compared to the U.S., aside from beans and labor, everything is more expensive in Mexico”.

Here is where the structural reforms become so important. If Mexico does not become more flexible in its labor law and if it doesn’t break the dominant energy and telecom monopolies allowing foreign players to enter the market, its “Total cost” competitive offer to foreign and domestic manufacturers is in peril.

A NEW FOE

In early 2008, a new threat to the maquiladora industry started to emerge in Mexico. The federal government started a military camping in an attempt to crush organized crime.

This debatable effort sparked street violence with an escalating number of street killings since. Originally the bloodshed started in border cities but it has also contaminated other communities in the interior f the country. Also, as a secondary effect, and due to the high level of impunity, extortions, robberies and kidnappings have increased in some regions in Mexico.

Fortunately, there are no major events that have affected the Maquiladora Industry, but there is definitely a growing security concern in the minds of the Maquiladora operations decision makers. As a result, there have been fewer new maquiladora projects in the battered cities, and the country as a whole has definitely lost foreign manufacturing investment for this cause.

Logically, this new foe is a fairly large factor that weighs in the analysis and the decision making of new maquiladora projects, expansions and consolation plans. There is no objective way to make a forecast about this phenomenon.

The vast majority of Maquiladoras have reported that they have up scaled security measures, which evidently creates and additional cost, some have relocated foreign executives but none to our knowledge have suffered an important interruption or disruption of operations.

While we absolutely conclude that Maquiladoras are not a target of organized crime, it is certainly important for everybody in the industry to exercise prudence and be alert.

IS THE “SUPERPESO” BACK?

You may recall that the Mexican peso was one of the most battered currencies in the world during 1970-2000. The peso actually had to be demoted by 1,000 in that time period to simplify transactions.

Thereafter, during 2000-2008, as a result of the country’s macroeconomic stability, the peso gained strength and traded at about $10.50 to US$1.00. It was during this period that the Mexican currency earned the nick name of “Superpeso”, sustaining for eight years what seemed to be an endless overvaluation.

When the global financial crisis exploded in October, 2008, the peso experienced an overdue correction to about $12.80 per dollar, bringing back a much needed competitive exchange rate to Mexico’s exports and to the Maquiladora Industry. But over the last 12 months or so, quietly but surely, the peso has gained approximately 10% over the dollar, exchanging recently for as low as $11.50 to US$1.00.

Although the Mexican currency is very strong from the support of a healthy trade balance account and approximately US$30 billion worth of remittances by Mexicans working abroad, the gain in the peso exchange rate can be mostly blamed on a weakening dollar.

When we compare these two currencies versus the euro for the last 12 months, we find that the peso and the dollar have lost about 5% and 15% respectively. As a result of a weakening dollar, the price competitiveness of Mexican exports and processing costs of the Maquiladora Industry are trending in the wrong direction. Mexico was just fine at an exchange rate band of $12.50 – $13.00.

This is evidently an additional sign of Mexico’s need to diversify its international trade partners and foreign investors. Fortunately, this is already happening as more European and Asian firms increase their financial and manufacturing foot prints in Mexico, albeit not as fast as the country needs it.

The exchange rate dynamics of the peso and the dollar have more complications than one cares to know, but they definitely play a fundamental role in the planning of those firms active in the Maquiladora Industry. Most forecasts place the exchange rate leveling off at $12.00 through 2014.

Although this is not a satisfactory exchange rate for the competitiveness of Mexico’s Maquiladoras, the silver lining comes in the form of stability in spite of the 2012 presidential elections. There is not an important probability that Mexico will go back to the 80’s and 90’s “traditional” devaluations every time there was a change of President.


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NOT A LOST CAUSE YET

Mexico’s domestic content in maquiladora exports is below 4%. Unfortunately, Mexico originally did not design the maquiladora program to facilitate domestic industrialization; it was simply an economic development program to create jobs. And it still is.

What needs to be done is to convert the maquiladora program from a job creating and export function to an industrialization effort of domestic industry. This is easier said than done, as there are production, financial and marketing hurdles to overcome.

But one way to do it is to create a venture capital fund to support the efforts of potential Mexican entrepreneurs that are within the management or engineering ranks of Maquiladoras.

In fact, there are today several Mexican (owned and operated) successful domestic suppliers of parts and components to the Maquiladora Industry. Typically, the owner entrepreneur learned the ins and outs, and the know-who, of the Maquiladora supply chain by working many years for a global company’s operation in Mexico.

There are hundreds of potential domestic supplier entrepreneurs in the Maquiladoras. They need encouragement and capital from an institutionalized government or private entity to come forward with projects and proposals.

NOT ENOUGH ENGINEERING

Even though there are large engineering centers in Mexico by Delphi, GE, Honeywell and a few other large global corporations, the lack of engineering initiatives throughout most of the universe of Maquiladoras in Mexico is an important threat for the growth of the industry.

R&D and Design and Engineering activities are probably Mexico’s largest “area of opportunity”. Mexico spends in R&D less than 0.4 % of its GDP. This is a minimal amount compared to the OECD countries average of 2.26%. Likewise, Mexico’s R&D efficiency is well below Brazil, Chile, Colombia, Costa Rica, Argentina and Peru. And any comparison with South Korea or Japan is frankly embarrassing.

Maquiladoras should strive within their organizations to bring to Mexico some R&D or Design and Engineering functions. Even a start-up with a small group of three or five engineers will prove very fruitful and will strengthen the Mexican plant within the parent corporation and eventually lead to further grow of production volumes.

The design cycle in electronics and other industries is shrinking continuously and the need for new products is exponential. In order to stay profitable, companies need to develop more new products more frequently and faster.

New models become obsolete sooner and this favors Mexico. This is because new design and engineering changes for the U.S. can be turned around much faster from Mexico than from anywhere in the world and personal supervision from headquarters is very convenient.

To par other competing countries, Mexico’s federal government needs to substantially increase the tax and fiscal incentives for R&D and engineering, currently at a mere few hundred million dollars to the billion dollar level if it wants Mexico to reach a reasonable and dignified position in this extremely important area.

RECOVERY AND DIVERSIFICATION

The recovery of Mexico’s Maquiladora Industry from the woes of the 2008 recession is uneven for industrial sectors and cities and it is still highly dependent on the U.S. At the top of the recovery, we find the automotive sector of Mexico, which is breaking all previous export records of light vehicles and auto-parts. Mexico was at the right location at the right time to be a fundamental resource in the turn around of the ailing U.S. auto industry. Other sectors such as telecommunications equipment are not as lucky and are still struggling to rebound from their lowest employment levels.

Exhibit #2 clearly shows that the border cities are having a hard time with Maquiladora employment, while in general, cities in the interior, particularly in central Mexico, are back to their pre-recession employment levels, and some like San Luis Potosi and Ramos Arizpe (Saltillo) are ahead of the game.


Mexico’s Maquiladora Industry dependency on the U.S. economy and manufacturing sector continues to grow. While business common sense dictates that diversification is healthy for any business model, the current global forces indicate that this dependency will continue to be the case for Mexico in the years to come.

Fortunately, there is diversification in the Maquiladora Industry in terms of industrial sectors and country source of capital. But regardless of who produces or what is being manufactured, the vast majority of Mexico’s exports are shipped to the north, next door.

DE-GLOBALIZATION

The process of “de-globalization” is having a positive effect on Mexico’s Maquiladora Industry. Globalization (The reduction and removal of barriers between national borders in order to facilitate the flow of goods, capital, services, labor and technology) had a major setback with 9/11, which triggered significant restrictions in the international flow of goods and individuals. Also, the great recession of 2008 stroke a large blow to globalization as developed nations activated domestic job protection and import restriction initiatives.

Since the price of crude oil started to spike in the last few years, it became clear that supplying America from Asia was non-sense and that globalization was receding. Not conspicuously, world production value chains started a process of restructuring their global footprints, leading the way to a new wave or order that we have labeled as “Regionalization”.

Regionalization is simply the trend of reordering production value chains to better serve regional markets. In this fashion, regional production and logistics supply chains are reshaping and restructuring in Asia, Europe and the American continents. So what we will have in the long-term is manufacturing and logistics platforms to serve the different regional markets.

The recent surge of aeronautical industry Maquiladoras in Mexico, many of them of European origin, looking to supply U.S. customers from a “near-shore”, low-cost manufacturing platform is a clear evidence of the trend of Regionalization.

Evidence can also be found in the auto industry with several Japanese and European OEM’s locating assembly facilities in U.S. territory.

The ultimate testimony of Regionalization is provided by fairly large Taiwanese, Chinese and Indian facilities recently established and expanded Maquiladoras in Mexico to serve North American markets.

CONCLUSION

Once more, as it emerges from the most recent crises, Mexico’s Maquiladora Industry has proven its resilience and long-term viability. It adapts rapidly to changes and imbalances in the global and domestic business environments.

In the first decade of the Twenty-first Century, growth in the Maquiladora Industry in terms of employment has been moderate if compared to the 80’s and 90’s, but there is substantial progress in the value added of exports, the scope of industrial sectors and the level of processes sophistication.

And while economic struggles occur and challenges emerge, Mexico’s Maquiladora Industry survives and slowly but firmly, despite the setbacks, advances. Let us hope that Mexico makes the Maquiladora Industry experience an even more profitable and rewarding one for the next 45 years as it was for the last.

Sergio L. Ornelas has 30 years of experience in international trade and direct foreign investment. He has business degrees from Babson College, Southern Methodist U. and Harvard; he was head of the State of Chihuahua Industrial Promotion Agency in 1980-5 and General Director for Intermex Industrial Parks through 2000. He is MEXICONOW’s editor.
He may be contacted at: editor@mexico-now.com