NAFTA, yesterday and today

Manufacturing in MexicoHere we are, nearly three decades later talking about the North American Free Trade Agreement (NAFTA) once again, proposing renegotiation to make it more favorable to U.S. manufacturing. There were a lot of doubts about NAFTA back in 1990 and 1991—many uncertainties about how this deal would play out in a country we didn’t know much about back then.

The other day while cleaning out some old files (paper, not computer files, which gives you an idea of how old these are), I came across some articles and editorials I’d saved. (I think clipping good editorials and articles is a journalist’s “hoarding” problem.) One article in the Wall Street Journal, dated October 4, 1990, written by then manufacturing guru Peter F. Drucker, was titled, "Mexico’s Ugly Duckling—the Maquiladora." The maquiladora is a “twin plant” that companies set up, with one facility located on the Mexican border in the United States and another in Mexico. Drucker noted in his article that Mexico was the United States’ third largest trading partner after Canada and Japan. My, how things have changed!

Drucker provides a brief history of Mexico’s nationalist government starting in the 1860s, when the goal of President Benito Juarez was “to keep out the gringos by building a nation of self-contained Indian peasant farmers.” That didn’t work out so well, so European bankers and industrialists were brought in. (That explains why I met so many people living in Mexico City with Germanic last names!)

The currently fraught relations with Mexico and possible redo of NAFTA will have repercussions on both sides of the border, and they could be problematic for some U.S.-based plastics processors. Read “U.S.-Mexico breakup would hurt injection molders and suppliers on both sides of the border” to find out how.

The maquiladora, said Drucker, was Mexico’s “one economic success.” While Mexico restricted ownership or banned outright ownership of Mexican industries by foreigners, they came up with a novel idea. The maquiladora would allow parts to flow across the border into Mexico duty-free, become finished goods, then be exported to the United States, “subject to American duty only on the value added in Mexico,” a VAT or value added tax.

Drucker noted the dramatic evolution of Mexican industries thanks to the maquiladora phenomenon, starting out with simple assembly of parts and products by mostly unskilled, low-wage employees across the border using older equipment. It became an amazing success story, yet, as Drucker pointed out, the “maquiladora has been treated as Mexico’s ugly duckling rather than its swan. That it is unpopular in Mexico City is understandable. It flagrantly contradicts everything the Mexican intellectual holds sacred: A belief in statism and a deeply ingrained suspicion of the yanqui.”

At the time Drucker wrote this article, Mexico hadn’t yet realized what was to come thanks to the maquiladoras that opened a door between the United States and Mexico. It also provided Mexico with a way to attract foreign investment. At first, the maquiladoras were allowed to produce only for the U.S. market, Drucker explained, and “needed to develop its home market,” rather than rely strictly on exports. And it had to “bring back the billions of dollars in Mexican capital that fled the country during the decades of misgovernment,” said Drucker.

Well, here we are, nearly 27 years since Drucker wrote this WSJ article, and we’ve seen the evolution beyond maquiladoras to U.S. companies setting up large plants in Mexico, manufacturing both for export to the United States and many foreign countries, as well as for Mexico’s domestic market. We’ve seen the disruption of the China phenomenon and watched as many companies fled from Mexico to China for even lower-wage workers, then returned over the past decade to regain a foothold in North America and reap the benefits of NAFTA.

In my various visits to Mexico to tour medical facilities in Tijuana operated by medical device manufacturers in San Diego, automotive OEMs in Monterrey and Tier 1 suppliers in Juarez that operated large injection molding facilities and molding and manufacturing plants in Reynosa to a variety of manufacturing plants in and around Mexico City, I’ve seen the changes in Mexico’s manufacturing sector. With a young workforce educated in many of the large trade schools in the industrial hubs throughout Mexico, there are plenty of able—and willing—workers who are creating Mexico’s middle class.

I toured plants with molding equipment that was nearly as old as I was, in facilities that were dim and dirty, but cranking out plastic parts in spite of it. Within two decades things had changed. Instead of sending their old, used equipment to their facilities in Mexico, U.S. molders began installing the newest technology in bright, new manufacturing facilities complete with cleanrooms comparable to any molding facility you’ll see in the United States.

Mexico is now trying to repatriate the “billions” of dollars in Mexican capital that Drucker mentioned in his 1990 article. A recent report from Plante Moran, a tax consulting company for a variety of industries, noted that the Mexican government included a new repatriation program in its presidential decree issued on Jan. 18, 2017. “The program reflects Mexico’s efforts to encourage investment in certain strategic areas within Mexico and to incentivize Mexican companies to repatriate their liquid assets.

“Mexican entities holding funds outside Mexico can repatriate them at a reduced income tax rate,” said Plante Moran. “An eight percent income tax rate will be applied to the gross amount of funds maintained abroad before Jan 1, 2017, and repatriated to Mexico. The reduced income tax rate is a significant reduction from the Mexican corporate income tax rate of 30%. The program is valid for six months, starting on Jan. 19, 2017.”

It’s an interesting snapshot of the past and perhaps some view into the future of the United States. It might behoove the new administration to take a closer look at the relationship between the two countries, explore some of Mexico’s ideas about repatriation of profits and not be so quick to tear up NAFTA.

Drucker had his doubts about whether Mexico could make it long term, but if it does, he added, “a good deal of the credit will have to be given to the ugly duckling that no one loves: The management innovation of the maquiladora.”

Yes, the “twin plant” idea started the whole thing!

Read part two of this article by clicking here.

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