China's Role 

By: Ralph Watkins

        The competition between Mexico and China in the United States and other key export markets is gaining increased attention. As Mexican exports to the United States fall and unemployment rises, the maquiladora industry continues to wait for a significant rebound in the U.S. market and renewed export growth for these operations.

        Rising concerns regarding Chinese competition also are evident; Mexico ’s Secretary of the Economy reportedly alleged that Mexican manufacturers may be facing market-distorting practices that have given rise to their complaints that Chinese products competing in Mexico and its key export markets could be benefiting from unfair trade. Several Mexican industry sources expressed concern about the government’s apparent indifference to the loss of relatively low-technology jobs in the maquila industry.

        This article examines the competition between Mexican and Chinese manufactured goods in U.S. and other foreign markets, the product segments in which each country is a leading supplier, and the factors that influence the related investment decisions about location of manufacture.

        Mexico was the second-largest supplier of imports to the United States in 2001; China ranked fourth. While U.S. imports from Mexico fell by 3.1 percent ($4.2 billion) in 2001 to $131 billion, imports from China rose by 2.5 percent ($2.5 billion) to $102 billion.

        Although it may be tempting to attribute these import changes to plants moving from Mexico to China , this hypothesis does not hold up under scrutiny. In fact, falling petroleum prices chiefly accounted for the decrease in the value of U.S. imports of Mexican crude petroleum: $1.9 billion in 2001. This decrease accounted for nearly one-half of the total decline in imports from Mexico . Much of the increase in U.S. imports from China and remaining decrease from Mexico can be attributed to the machinery sector (in which imports from Mexico dropped by $686 million and imports from China rose by $878 million), and to the textiles and apparel sector (in which imports from Mexico dropped by $640 million and imports from China rose by $414 million).

        Within the machinery sector, these data did not indicate a shift in competitiveness away from Mexico towards China . The largest machinery sector decreases in U.S. imports from Mexico in 2001 were of wiring harnesses for motor vehicles ($347 million) and of transformers ($297 million). As with Mexico , imports of transformers from China also fell in 2001, by a similar $216 million. Rather than a shift to China , the 8-percent decline in imports of wiring harnesses from Mexico largely reflects the 10-percent decrease in U.S. production of automobiles and trucks in 2001.

        As for increased imports of machinery from China , the sector category in which imports grew by the largest amount in 2001 was household appliances, with a $410-million (17 percent) rise to $2.8 billion. However, there was no shift of production from Mexico to China inasmuch as imports of household appliances from Mexico grew by $320 million (21 percent) to $1.8 billion. Producers with assembly plants in both Mexico and China benefited from relatively low interest rates in the United States , which led to increased home purchases and household improvements, including new appliances. U.S. producers’ shipments of household appliances rose by $902 million (4 percent) in 2001 to $24.3 billion.

        However, in the textile and apparel sector, there appears to be evidence of a shift in sourcing from Mexico to China . According to Nora Ambriz, executive director of the National Textile Chamber, 200 textile and apparel plants closed in Mexico in 2001, putting 60,000 employees out of work. That does not translate to companies shifting production to China .

        Rather, customers of companies that produce apparel in Mexico are increasingly buying cheaper apparel made in China and in other low labor-cost countries, or are losing their share of the U.S. apparel market to companies that import from such countries. The 10.1-percent decrease in textiles and apparel production in Mexico in 2001 compares with just a 2.2-percent reduction in U.S. producers’ shipments of apparel and other textile products in the United States . This decline also reflects recent weaker demand in the United States for products made in Mexico that was exacerbated by the Sept. 11 attacks and recession.

Mexico ’s leading products in the U.S. market

        Mexico’s competitive advantages over China are its proximity to the United States, North American Free-Trade Agreement (NAFTA) rules of origin, low labor costs relative to total costs for key products (e.g., certain computer equipment), and quota- and duty-free treatment for apparel in the U.S. market. The leading manufactured products for which Mexico had a competitive advantage relative to China in the U.S. market in 2001 were motor vehicles and parts; televisions and video monitors; radio and television broadcasting equipment; and measuring, testing, and controlling instruments. Mexico is the sixth-largest motor vehicle producer in the world. Finished vehicle exports to the United States amounted to $21.3 billion in 2001, compared with $0.9 million for China

        The Mexican passenger vehicle industry is highly integrated with that of the United States, largely as a result of NAFTA, and is composed entirely of subsidiaries of foreign manufacturers that determine the local product mix and local production levels as part of their regional, and even global, vehicle manufacturing strategies. The rationalization of motor vehicle production in the NAFTA region has led automakers to focus their Mexican operations primarily on small car and light truck production for the entire North American market. A high percentage of Mexican passenger vehicle production is for export, mostly to the United States.

        Because of its strategic geographic location, level of manufacturing competence, and existing automotive manufacturing infrastructure, Mexico has been chosen as the lead North American assembly site for numerous new vehicle programs. The Mexican industry has demonstrated significant improvements in labor productivity, product quality, and competitiveness; vehicle quality is reportedly on par with vehicles built in the United States or Canada; and some industry observers report that despite extensive reliance on manual labor, many Mexican plants have better labor productivity than comparable U.S. and Canadian plants.

        Mexico is also a significant producer of auto parts, and accounted for 28 percent ($14.5 billion) of U.S. imports in 2001. By comparison, auto parts imports from China accounted for just 2 percent ($1.3 billion) of U.S. imports in 2001. Many U.S. and foreign auto parts producers have established facilities in Mexico in response to automaker preferences for local suppliers. Some of these auto parts manufacturers have multiple facilities in Mexico that supply local vehicle assembly plants as well as produce for export to vehicle assembly operations in the United States. Delphi, for example, manufactures auto parts in 47 plants in Mexico and is the largest private-sector employer there, with nearly 50,000 employees in maquila operations. Yazaki Corp., a Japan-based auto parts producer specializing in wiring harnesses, is the second-largest employer under the maquila program, with 27,500 workers at 28 plants.

        Mexico is the leading supplier of television receivers and video monitors to the United States, accounting for 59 percent ($5.1 billion) of U.S. imports in 2001. China accounted for just 3 percent ($263 million). The principal U.S. producers began to shift the assembly of television receivers to Mexico in 1968, taking advantage of lower labor costs there to be more price competitive with imports from Japan.

        Sony was the first foreign television producer to invest in the United States, building a factory near San Diego in 1972. Other Japanese companies soon followed, with several buying existing U.S. producers. Within a few years, Sony, Mastsushita, Hitachi, JVC, Sanyo, and Sharp established television receiver assembly plants in the Tijuana area. Sharply reduced labor costs in Mexico after the devaluation of the peso in 1983 encouraged many of these companies to shift more of their production to Mexico. Relatively high U.S. tariffs on television receivers and picture tubes, and the requirement under the NAFTA rules of origin that televisions from Mexico must have a North American-made picture tube to qualify for duty-free treatment under NAFTA, led four Japanese companies to invest in picture tube production facilities in the United States and two Korean companies to build picture tube plants in Mexico.

        Given the substantial investment in North America for picture tube and television glass production, and the 15-percent ad valorem average rate of duty on such non-NAFTA-origin products entered into the U.S. market, North American companies are reluctant to transfer production of picture tubes and sets out of the region. So far, the only operations of these companies to be moved involve the assembly of computer monitors; reasons include Normal Trade Relations duty-free treatment by signatory countries of the Information Technology Agreement, excellent supplier networks in Asia, and consolidation of manufacturing facilities stemming from the significant downturn in technology industries.

China’s leading products in the U.S. market

        China’s competitive advantage over Mexico in certain sectors stems from significantly lower compensation for manufacturing workers and, more recently, a well-developed supplier base for most industries. Also, some foreign companies invest in China, hoping eventually to sell their resulting products to the Chinese domestic market. While waiting for the market in China to develop, the bulk of products made there must be exported. Manufactured products for which China is a leading supplier to the U.S. market (and Mexico is not) include sewn products, such as footwear, apparel, luggage, and dolls, and other labor-intensive, relatively low-technology articles such as toys, games, sporting goods, lighting fittings, furniture, cameras, and air-conditioning equipment. Within these product categories, imports from China tend to be less sophisticated or entry-level articles with the exceptions of apparel and footwear.

        For leading products imported from China, assembly in Mexico has not been a serious option. Historically, U.S. producers experienced intense competition from low-wage locations in Asia (e.g., Hong Kong, Korea, and Taiwan). Also, these locations offered an educated labor pool, well-developed seaport and customs infrastructure, tax incentives, and export processing zones that permitted duty-free entry of imported components. Even with the maquila program, Mexico could not compete with the Asian Tigers.

        By the time the devaluation of the peso in 1983 made Mexican labor costs competitive with those of the Asian Tigers, multiple segments of U.S. industries were dominated by imports from the Tigers. Many companies were faced with the choice of supplementing their higher-value added U.S. production with imports from Asia or losing market share. Some stopped producing altogether and became brand-name marketers, licensing the use of their name and designs to producers in the Tigers rather than setting up competing assembly plants in Asia.

        Mexico became more competitive with imports from the Tigers in the mid-to-late 1980s because of efforts by the administrations of Presidents Miguel de la Madrid and Salinas de Gortari to reduce trade barriers, attract foreign investment, modernize the industrial base and national infrastructure, and join the General Agreement on Tariffs and Trade. Lower labor costs because of the devalued peso were also very important. At the same time, it was becoming increasingly difficult to find workers in Taiwan, Hong Kong, and Korea who were willing to sit at sewing machines or stand at assembly lines with limited opportunity for job advancement. Many companies in Taiwan and Hong Kong began shifting their most labor-intensive assembly operations to China in the 1980s. As a result, assembly of those products in Mexico was not an option.

        Because sewing operations are labor-intensive, China is the world’s dominant supplier of labor-intensive sewn products and accounted for 88 percent of U.S. imports of dolls in 2001; 64 percent of footwear; and 51 percent of luggage, handbags, and flat goods. Italy and Spain are competitive in the latter two categories, basing their positions in the U.S. market on reputations for high quality. The ratio of labor to total production costs also is quite high for toys and games, giving China a competitive advantage over most other sources. Production processes for these articles involves metal stamping, plastic molding, and/or cutting paper, and then snapping and/or gluing parts together. Packaging for toys and games is also labor-intensive, often costing more than the actual production of the toy or game.

Head-to-head competition

        The principal competition between Mexico and China for foreign investment dollars (and job creation–or job maintenance in the case of Mexico) lies in the production of apparel; computer equipment; telephone equipment; household appliances; and electrical assemblies, such as transformers. As noted, there is both anecdotal and statistical evidence that Mexico is losing jobs to China in the apparel sector, even if manufacturers may not be shifting production to China, per se. Although existing data indicate that China has a dominating competitive advantage in the sewn products industries, the question is how Mexico can compete in the U.S. market with China in the apparel sector? The answer is clear: preferential market access under NAFTA, competitively priced labor in key products, proximity to suppliers and markets in the United States, and U.S. import quotas.

        Under NAFTA, duties on most apparel imported from Mexico were phased out by 1999. By contrast, the average rate of duty on apparel from China is about 17 percent ad valorem. Production in Mexico became even more attractive for U.S. apparel companies with the 50-percent devaluation of the peso during December 1994-January 1995.

        More recently, a number of U.S. and other foreign textile producers established integrated factories in Mexico, making thread from Mexican-grown cotton or Mexican-origin petrochemicals, and then producing yarn, fabric, apparel, and other textile articles. At the same time, Mexican labor compensation in manufacturing rose by 25 percent in U.S. dollar terms during 1999-2001. Higher labor costs in Mexico combined with a weak market for apparel in the United States led some of the U.S.-owned integrated textile mills to close and lay off thousands of workers.

        Hundreds of Mexican-owned factories that supplied apparel to U.S. brand-name marketers closed as their customers switched to lower-cost suppliers in Asia. Quotas have limited the growth of imports of apparel from China into the U.S. market, effectively preserving a share of the U.S. market for other countries, such as Mexico. However, the WTO Agreement on Textiles and Clothing (ATC) calls for the gradual and complete elimination of import quotas on textiles and apparel established by the United States and other importing countries under the Multifiber Arrangement (MFA) and predecessor arrangements by Jan.1, 2005. Although potential changes could occur in the global pattern of trade resulting from the final completion of the quota phase-out required by the ATC, this matter is not within the scope of this article.

        U.S. producers of telephone and computer equipment were under intense competitive pressure in 2001. As global markets for each shrank, U.S. producers’ shipments of computers and storage devices fell by $24.3 billion (22 percent) to $86.7 billion, and shipments of non-defense-related communications equipment dropped by $32.2 billion (29 percent) to $78.8 billion. At the same time, U.S. imports of computers, peripherals, and parts decreased by $15.8 billion (18 percent) to $74.5 billion and imports of telephone and telegraph apparatus declined by $5.0 billion (15 percent) to $27.2 billion.

        These two industry segments, experiencing like competitive conditions, reacted similarly with regard to the pressure to reduce costs. The use of contract manufacturers and rationalization of production is important in both sectors. One contract manufacturer, Celestica, purchased the production assets of Lucent Technologies in Monterrey and supplies customers with telephone switching equipment and related components. Motorola manufactures one type of cell phone (used primarily in Latin America) in Chihuahua, Mexico, and another type in China. Hewlett Packard (HP), which makes computer equipment in Guadalajara for markets throughout North and South America (but has plants in China as well), focused its production in Mexico on those products for which the company determined that Mexico had an advantage in total costs of production.

        According to an HP official, relative labor costs comprise a smaller portion of the total cost of production for certain computer equipment than for certain telephone equipment, creating less pressure on producers of certain types of computer equipment to shift production to China. That conclusion is supported by trade data. In 2001, U.S. imports of computers, peripherals, and parts from Mexico increased by $1.3 billion (15 percent) to $10.4 billion, whereas imports from China declined by $122 million (1 percent) to $10.5 billion. However, for telephone and telegraph apparatus, imports from Mexico fell by $251 million (5 percent) to $4.4 billion, whereas imports from China rose by $280 million (10 percent) to $3.2 billion.

        For the remaining products where imports from both Mexico and China are both competitive in the U.S. market, the data do not support concern over a shift from Mexico to China, at least not in 2001. In that year, U.S. imports decreased from both Mexico and China especially for electrical transformers, static converters, and inductors. As already noted, imports of household appliances increased from both Mexico and China.

Ralph Watkins is an analyst with the United States International Trade Commission.