International Molding Report: Canada and Mexico: Key Partners in trade

This report is prepared for IMM by Agostino von Hassell of The Repton Group, who provides IMM’s monthly Molders Economic Index.

It seems like just about everyone today is fixated on the issue of trade with China, and with so much attention focused on the Far East, it can be easy to lose sight of our more traditional trading relations.

A review of the Mexican and Canadian markets will help us understand their current economic climates, including how their plastics industries have been affected by imports from China. Such an assessment should help U.S. manufacturers better appreciate the current industry trends and trade opportunities.

Mexico—Still a Land of Opportunity
With an ever-expanding consumer and manufacturing market, producers should not overlook potentially lucrative business opportunities in Mexico. In 2002, the Mexican plastics industry well outpaced the country’s otherwise lackluster economic performance, despite a recession in the United States, the destination of more than 90 percent of Mexico’s exports.

Again in 2003 the market is expected to grow by 4 to 6 percent, several points more than predicted for the economy as a whole, and industry experts see the important plastics industries of packaging and construction growing at an even faster pace.

Several key economic indicators have reflected this continual growth. While the U.S. recession contributed to an accelerated Mexican inflation rate of 5.7 percent in 2002, industry experts considered the rise mild and believe that stricter monetary policies scheduled to take effect this year should bring the rate below 4 percent.

Furthermore, the peso remains weak compared to the dollar and U.S. producers doing business in Mexico should continue to reap the rewards of this imbalance. It is also worth noting that the Chinese yuan remains around 20 percent stronger than the peso.

Though it’s true that Asian manufacturers have often been able to produce at rates 30 to 50 percent lower in cost than Mexican firms, Asian competition has not yet significantly penetrated the primary Mexican plastics industries of bottles, other packaging, or construction. Bottles and packaging represent roughly 43 percent of the Mexican plastics market; construction is estimated to comprise another 13 percent.

However, the potential impact of Chinese manufacturing on the Mexican market cannot be ignored. China has been increasingly successful in competing with Mexican plastics firms in the areas associated with toys, shoes, electronics, and housewares, which cumulatively account for around 25 percent of the plastics industry in Mexico.

Having acknowledged China’s growing influence in these selected areas, we must nevertheless remember that at the moment China accounts for less than 2 percent of the total plastics imports of Mexico, and that these imports are generally identified as low-tech, low-quality goods.

Despite the limited market penetration today, industry experts seem to feel that we can continue to expect large-scale, labor-intense production to migrate to countries like China. Driving this economic relocation are wages estimated at around $.50/hr (compared to $1.40/hr in the maquiladoras of northern Mexico), government tax incentives, lower levels of worker delinquency, and as a recent trade mission discovered, raw material costs 20 to 30 percent lower than those available on the Mexican market.

As a result of this competition, it is believed that Mexican plastics manufacturers will increasingly focus on more precise midrange production, a process facilitated by the decision of U.S. firms like Delphi to build research and development centers in Mexico.

It must also be remembered that Mexico still offers significant incentives to investors. These benefits include lower transportation costs, an especially relevant consideration when we recognize that by 1998, U.S. companies had captured more than 96 percent of all plastics imports used in Mexico’s maquiladora operations. This reality offers a strong rationalization for U.S. manufacturers to shift production closer to their end market.

Of course, lower tariff costs and the important ability to deliver just-in-time also gives Mexico a decisive manufacturing advantage.

Plastics Lead Canadian Manufacturing
Similar to Mexico, the Canadian plastics and molding industries are again expected to grow at a faster pace than Canada’s general economy in 2003. This disproportionately strong growth continues a 10-year trend in Canada, evidenced in 2002 when Canada’s GDP rose 3.3 percent while plastics shipments climbed 9 percent (the highest rate within the manufacturing sector) during the first three quarters of the year.

In particular, sales of film, sheet, bags, and pipe products rose at a rate exceeding 13 percent. Looking at the economy in general, it is worth noting that Canada’s central bank has recently decided to again raise its benchmark interest rates to 3.25 percent, based on projections of continued economic growth.

Potential U.S. investors who establish production ties in Canada can expect to benefit from Canada’s low core inflation rate of 3.1 percent and a Canadian dollar that, despite recent advances, remains $.31 weaker than its U.S. counterpart. These economic conditions help ensure lower manufacturing costs when compared to U.S. industries. One recent report produced by KPMG Canada claims that operation costs in the U.S. run on average 6.7 percent higher than in Canada.

On the other hand, for many U.S.-based manufacturers this higher production cost is frequently offset by their generally greater access to advanced technology, automated manufacturing systems, and capital investment. These advantages are particularly important when competing in Canada’s more highly developed industries. As support of this assertion, experts have pointed to U.S. exports of plastics packaging products to Canada, which experienced an average annual growth rate of more than 25 percent from 1999 through 2002.

However, one fact cannot be ignored: U.S. and Canadian manufacturers, like their counterparts in Mexico, have felt and will continue to feel the competitive effects of the growing Asian market of low-cost plastics goods. Again, those manufacturers that rely heavily on low-tech, labor-intensive production techniques will most acutely and immediately feel this pressure. Fortunately for the Canadian plastics industry, much of its domestic production has been designed to cost-effectively support specialized or niche industries like the automotive, electronic, and telecommunication manufacturers within Canada.

Because this specialization requires more precision or value-added production methods, the industry has been able to expand sales to comparable U.S. industries while minimizing the initial competition with low-tech Chinese plastics products. While the U.S. still accounts for the overwhelming majority of Canada’s imports, China ranks second, claiming 4.5 percent of the total import market.

Ironically, Canadian plastics manufacturers may themselves be undermining this insular position by helping China to modernize its plastics infrastructure through purchases of advanced high-tech machinery and molds. It is noteworthy that Chinese imports of Canadian plastics goods have dramatically decreased over the years while the importation of plastics processing machinery has risen.

North American Strategies
Adapting to this new world order is especially challenging for those U.S. producers who, like the majority of their Canadian and Mexican counterparts, operate small and medium-sized enterprises dispersed throughout the country and in each market segment. To address this new competitive environment, the U.S. and Canadian industries have witnessed significant consolidation efforts.

Other small producers have instead opted to embark on a manufacturing strategy that includes blended production. The practice combines North American advanced engineering and production skills with the low-cost production capacities of Asian markets. An example of this strategy is Global Tooling Systems (GTS) network. GTS is composed of several independent U.S. companies attempting to capitalize on China’s low production costs by organizing a network of more than 35 Chinese tooling shops.

Members can use a private website to solicit bids from a prequalified network of Chinese tooling shops, and GTS members can then work through project details with the winning contractor. The program enables U.S. businesses to easily reap the financial rewards of lower foreign labor costs while maintaining greater control over the total production process. This network allows GTS companies to handle the majority of design and engineering tasks domestically prior to farming out specific manufacturing operations.

The Shelter Program
For U.S. producers interested in capitalizing on the benefits of the Mexican manufacturing market while avoiding some of the more common headaches associated with running businesses in Mexico, a shelter operation offers one possible solution.

The 1989 law that established the regulations for maquiladoras also created the terms for shelter businesses. These businesses generally function as a department of their parent company in the U.S. and as such are eligible to receive substantial U.S. tax benefits and access to U.S. courts. In a shelter company a U.S. firm supplies the financial capital and all the necessary equipment, production materials, and important management personnel, while the Mexican shelter company shoulders all other operating and administrative responsibilities.

These duties typically encompass all accounting and HR functions (including taxes), environmental compliance, and facility management. One final benefit is that manufacturers can terminate a shelter operation and take full internal control if they choose. The U.S. embassy can provide interested firms with a list of shelter providers.

U.S. producers hoping to better adjust to the new, more intensely competitive environment of North America should also seriously consider the proposed strategy for assistance put forward by the current administration. While critics may rightfully lament its shortcomings (the plan gives little hope in the way of proactive safeguard or protection measures), the various export promotion, trade adjustment, export financing, and trade input programs do offer valuable guidance and advice to small businesses looking for ways to expand sales.

For example, U.S. Export Assistance Centers (USEAC) here and Foreign Commercial Service (FCS) posts abroad can be instrumental in identifying foreign customers as well as locating strategic partners for U.S. businesses looking to expand. Other federal programs operated through the U.S. Dept. of Commerce, the Small Business Administration (SBA), and various other agencies can help businesses finance export projects, subsidize training costs, and prepare and implement economic recovery plans.

Many of these programs are specifically designed to assist small and medium businesses, and represent a wealth of information and invaluable assistance. In today’s global market there is really no reason not to make full use of these services.

For businesses just beginning to enter the export market it would be wise to contact the Trade Adjustment Assistance Program (TAA; www.taacenters.org). The TAA Program for Firms offers technical and financial assistance to small businesses attempting to adjust to international competition. TAA is run through a network of 12 regional nonprofit organizations, called Trade Adjustment Assistance Centers, whose principal responsibility is to be an advocate for interested firms.

Importantly, TAAC representatives will prepare a company’s program application and help direct it through each phase of the program.

Officially, the TAA program falls under the funding auspices of the Dept. of Commerce, and the administration of its Economic Development Administration (EDA). However, in practice the TAA program functions independently.

The program itself is designed to assist firms to become more competitive by helping them to develop a strategy to improve important sectors such as marketing, manufacturing, engineering, information technology, and quality. To accomplish this mission the TAA offers qualified businesses an opportunity to participate in 50:50 cost-sharing projects. These matching funds can be applied toward “the cost of consultants, engineers, designers, or industry experts for improvement projects” in a variety of business areas. TAA financial contributions are capped at a maximum of $75,000 per company. In a recent independent study by the Urban Institute, participating firms’ sales grew by an average of 33.9 percent, a rate significantly higher than corresponding industry averages.

To capitalize on Trade Adjustment Assistance, U.S. firms must follow a two-step process. First, the company must petition the Secretary of Commerce for certification of eligibility. To be deemed eligible firms must (1) qualify as a small business by U.S. SBA standards (for the plastics and rubber industries a company must not employ more than 500 workers), and (2) demonstrate that they have been significantly damaged by foreign imports. As such, a firm must show that imports have significantly contributed to a decline in employment, sales, or production. The Secretary has to furnish a ruling on eligibility within 60 days after a petition is filed.

Once the Secretary has declared a company eligible, the firm must then submit to the Secretary an adjustment proposal and clearly list the technical assistance the firm is seeking. The proposal is the company’s detailed plan for economic recovery. The Secretary can provide technical assistance in preparing economic adjustment proposals. The Secretary has no more than 60 days after an application is submitted to approve or deny an adjustment proposal. If approved, a company is then eligible to solicit technical and financial support for up to two years.

Programs like these can provide a competitive edge to help U.S. manufacturers maintain or increase their market share.