Part II: Chapter 2 FOREIGN DIRECT INVESTMENT

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Part II: Chapter 2 FOREIGN DIRECT INVESTMENT

(Revised March 2004 )

As noted in Part I, prior to the mid-1980s, Mexico had very restrictive economic policies not only with regard to trade but also to foreign direct investment. (Remember that foreign direct investment means the ownership and control of a business in a foreign country. This contrasts with portfolio investment, which basically involves lending money in another country.) Mexico, like many countries, was concerned about foreign ownership of companies in its territory. So Mexico had adopted policies which excluded foreign direct investment from certain industries and limited the remaining foreign direct investment to only minority foreign ownership. As Mexico changed its trade policies in the mid-1980s it also changed its foreign direct investment policies. The table on Page 2 shows the growth of foreign direct investment into Mexico in the 1980s. The NAFTA, which began in 1994, is the culmination of the opening of Mexico to foreign businesses.

Arguments Concerning Foreign Direct Investment

Those who believe that foreign direct investment is good for Mexico have made the following arguments. First, they have argued that foreign direct investment brings much-needed capital goods (machinery and equipment) into Mexico. These new capital goods create jobs. Second, they have argued that foreign direct investment brings new, advanced technology to Mexico. The new capital goods and the new technology will improve the productivity of Mexican workers and therefore raise their wages. Third, they have argued that foreign direct investment brings new managerial techniques and skills to Mexico. Fourth, they have argued that foreign direct investment increases competition, forcing the inefficient Mexican companies to improve efficiency. The result should be better-run Mexican businesses. And finally, they have argued that foreign direct investment brings in much needed dollars. These dollars can be used to repay Mexico's debt or to buy imported goods.

Other people have argued that foreign direct investment is not helpful, and indeed may be harmful for Mexico. They have argued, first, that the technologies that the Americans bring to Mexico may be inappropriate for Mexico. These technologies, appropriate for American conditions, rely on capital goods, not labor. As a result, few jobs may be created in Mexico. And those that are created would be mainly for unskilled workers. Second, they have argued that unemployment and underemployment are so great in Mexico that the new companies will have little effect on wages. And, since most of the jobs will be unskilled, little training will be provided. Thus, Mexican workers will not benefit. Third, they have argued that Mexican companies will not be able to compete with the American companies. Instead of more competition, there might actually be less as the American companies come to dominate. Fourth, they have argued that the initial inflow of dollars when the American companies locate in Mexico will be offset by the loss of dollars when the American companies take their profits back to the United States. Finally, they fear the loss of sovereignty for Mexico if foreigners control important aspects of Mexican economic life. Of special concern was the control over natural resources, such as oil.

DIRECT FOREIGN INVESTMENT

Year (1) (2) (3) (4)

1971 $3.2 Bil $271.8 Mil. 44.37% 55.63%

1972 3.5 265.8 49.21 50.79

1973 4.0 325.9 49.83 50.17

1974 4.9 442.9 41.12 58.88

1975 5.5 537.9 37.39 62.61

1976 6.2 654.1 51.51 48.49

1977 6.1 518.9 34.61 65.39

1978 6.6 820.5 26.12 73.88

1979 8.0 1,157.1 24.54 75.46

1980 10.6 1,736.1 28.58 71.42

1981 12.5 1,866.3 29.50 70.50

1982 14.2 1,391.1 44.62 55.38

1983 12.6 381.3 48.33 51.67

1984 11.3 456.3 52.81 47.19

1985 est. 10.2 563.3 61.10 38.90

(1) TOTAL DIRECT INVESTMENT (3) PERCENT SENT ABROAD

(2) PROFITS (4) PERCENT REINVESTED

Mexican Policies Concerning Foreign Direct Investment

The table above shows that during the 1970s and early 1980s, foreign direct investment increased steadily (although it was still quite low). Most of this foreign direct investment was in manufacturing, particularly in four areas: chemicals, food and beverages, transportation equipment (including automobiles), and electrical machinery. Although foreign ownership occurred in only a very small percent of Mexican industries, it was concentrated in large firms in the most important sectors of Mexican manufacturing. As you can also see in the table above, foreign-owned companies began remitting a higher proportion of their profits back to their parent companies in the United States. This meant that the American-owned companies in Mexico were contributing to Mexico’s balance of payments problems. This deterioration of Mexico’s balance of payments position affected Mexican policies towards foreign direct investment in the 1970s and 1980s.

Mexico had enacted the Law to Promote Mexican Investment and to Regulate Foreign Investment in February of 1973. This law guided Mexican policy toward foreign ownership throughout the 1970s and 1980s. Three industries --- transportation, communications, and energy --- were reserved either for the Mexican government or for 100% ownership by Mexican nationals. In other industries, foreign investment was allowed up to 49% ownership, unless permission to exceed this was granted by the National Foreign Investment Commission. (There was a loophole in this restriction. Some foreign companies used Mexican fronts, known as prestanombres or name-lenders, to hold the requisite 51% of the shares.) As you can see in the table, foreign direct investment in Mexico grew despite these restrictions.

This policy lasted through most of the 1980s. But on May 15, 1989, Mexico announced a new revision of its foreign direct investment laws. This time the focus was on encouraging foreign direct investment as part of the economic liberalization program of President Salinas. Foreigners could gain 100% ownership in certain industries, although banking, petroleum, mineral exploration, electrical generation, and broadcasting were still off-limits. In other industries (telecommunications and auto parts, for example), foreigners were allowed a 50% ownership share. Laws protecting foreign intellectual property rights were strengthened in 1991 (although enforcement remained weak). Restrictions on the use of land by non-Mexicans were liberalized. New laws were enacted making it easier to form corporations in Mexico. Finally, in July of 1992, Mexico agreed to allow foreign ownership of banks and financial institutions. All of this was a prelude to the negotiations for the NAFTA. Following the enactment of NAFTA, foreign direct investment into Mexico became more important, as expected. Foreign Direct Investment was responsible for 16% of all business investment spending in Mexico from 1994 to 2000, compared to only 3% in 1980 to 1985 (see the section on NAFTA below).

Case: The Computer Industry

The shift in Mexican economic policy from protecting against foreign direct investment to encouraging foreign direct investment is illustrated with the case of personal computers (PCs). Until 1981, there was no domestic computer industry in Mexico. Mexico imported the computers and the related equipment that it needed. At that time, the Mexican government decided to encourage the development of a Mexican computer industry. This was to be done by encouraging foreign direct investment. In the 1981 law, foreign companies could have 100% ownership of subsidiaries producing mainframe computers and minicomputers. However, they could have only 49% ownership of subsidiaries producing PCs. Imports of computers into Mexico were to be limited. American companies establishing subsidiaries in Mexico were required to export a certain percent of their production and to buy a certain percent of their parts and components from Mexican suppliers. With the 1981 law, production of mainframe computers and minicomputers increased, dominated by IBM. But the PC business remained small. Apple produced 40% of all personal computers in Mexico; yet, it did this at one plant with fewer than 25 employees. Purchases from Mexican suppliers also remained small as few companies in Mexico had the knowledge or skills to be able to be part of a supplier network for computers. Mexican PC companies were inefficient, product quality was below international standards (Apple continued to sell the Apple II in Mexico long after it was selling the MacIntosh in the United States), and the average price of a PC was 40% above the price in other countries.

In 1984, IBM proposed to the Mexican government that it be allowed to build a personal computer plant in Guadalajara. It proposed to spend $6 to 8 million and employ more than 80 people, but it required 100% ownership. IBM was hoping to take advantage of the growing, but under-served, Latin American market. It believed that it had a supply network from its production of mainframe computers and minicomputers. For Mexico, the proposal promised an immediate source of badly needed dollars. Not only would the $6 to $8 million dollars come into Mexico to build the plant, but IBM agreed to export 92% of the computers it produced there. It also provided a source of high-quality computers (the 8% that would be sold in Mexico) to help raise the efficiency of Mexican companies. And, the Mexican government hoped that the presence of IBM would encourage the development of related industries in Mexico --- such as software or peripherals (printers, modems, and so forth).

After some haggling with the Mexican government, IBM was finally allowed to build its PC plant. Its total investment in Mexico had by then been raised to $91 million. It had committed to use 65% local parts in production (later to be raised to 95%), to spend $40 million for financial and technical help to Mexican suppliers of computer parts, and to hold prices in Mexico to no more than 10 to 15% above American levels.

The building of the IBM plant began in January of 1986. IBM helped to establish a local dealer network, helped train local part and component suppliers, organized a Mexican semiconductor technology center, developed a software center to distribute software in Spanish, and entered into partnership programs with Mexican universities and technical schools (including providing scholarships for Mexican scientists). By 1988, Mexico was producing 10% of IBM's worldwide production of PCs. In that year, Hewlett-Packard was also given permission to have 100% ownership. There had been a definite shift from protection to liberalization.

Maquiladoras

One type of foreign direct investment activity that has been quite controversial for both Mexico and for America is the maquiladora industry. The term "maquiladora" is derived from the term "maquila"; in colonial Mexico, this was the charge collected by the millers for processing grain. Maquiladoras are those firms that assemble, or otherwise transform, components imported into Mexico and then re-export them back to the United States. This is also called "in-bond industry"; this term refers to the fact that the components were imported into Mexico under a bonded status to insure that they are not resold in Mexico.

The maquiladora program began in the mid-1960s, following the termination of the Bracero program, under which Mexican nationals could work legally in the

United States (see the chapter on Migration). The Mexican government feared large numbers of unemployed people in the border areas as its people returned from the United States. To offset this, it created the Border Industrialization Program. The border area was declared an export-processing zone, allowing companies that located within 20 km. (12 miles) of the border to import components into Mexico duty-free as long as the assembled products were re-exported. (A 1983 change allowed maquiladoras to be located virtually anywhere in Mexico except Mexico City.) Maquiladora firms were also exempt from laws requiring majority ownership by Mexican nationals. Most were 100% foreign (mostly American) owned, although a significant percent were owned by Mexicans. (Today about half of all maquiladoras are owned by Mexicans.)

The United States also acted to facilitate the maquiladora program. In the mid-1960s, Items 806 and 807 were added as amendments to the United States tariff code. Under these amendments, items assembled in Mexico could be imported into the United States with a tariff based only on the value-added (i.e., labor cost) in Mexico. The actions of the two governments created advantages for certain businesses. For example, Sony could bring components from Japan into the United States, paying a tariff only on the value of the components. Then, it could ship the components to Tijuana tariff-free. When the components were assembled in Tijuana, they would be shipped back to San Diego, with Sony paying a tariff only on the low value of the labor cost in Mexico. Sony gained from the tariff benefits and from the access to very cheap labor in Mexico. Many American companies took advantage of the same benefits.

The maquiladora industry experienced tremendous growth. In 1965, there were only 12 plants involved with a total employment of 3,000 people. By 1980, there were 620 plants employing nearly 120,000 people. By 2003, there were more than 3,000 plants in all of Mexico employing more than 1,000,000 people (a decrease from 1,300,000 people in 2000). Tijuana has become the “world Capital” of television set production (25 million sets annually). Guadalajara has become Mexico’s “Silicon Valley”.

There are several reasons that American firms chose to participate in the maquiladora program. (1) Most important was that doing so would lower their labor costs. Maquiladora workers can typically be hired for only a few dollars a day. For tasks, such as assembling, where there are few productivity differences between American and Mexican workers, these cost savings can significantly increase profits. Changes in technology have allowed standardization and "deskilling" of certain tasks, making it feasible to do these tasks in countries like Mexico with no loss of productivity. Several studies have found that maquiladora plants have productivity equal to plants in the United States. This cost advantage is enhanced by the fact that maquiladora workers are less likely to be unionized than American workers or even other Mexican workers.

(2)Second, maquiladoras offered American companies the possibility of 100% ownership in Mexico that, until 1989, was not available for other kinds of foreign investment in Mexico. (3) Third, maquiladoras offered American companies the opportunity to get-around American tariffs. The case of Sony in San Diego described above illustrates how this worked. (4) Fourth, American companies may have located in Mexico to escape American environmental regulations. As noted in the chapter on Mexican Foreign Trade, this effect is likely to be small. Industries with high pollution costs were not over-represented among maquiladoras while industries with high labor costs were. (5) Finally, corruption in Mexico is widespread. This corruption could allow American companies to define the location of their costs and their profits in such a way as to minimize their worldwide tax payments (i.e., they allow the costs to be higher and profits therefore to be lower in countries with higher taxes).

Many of these benefits to American companies were also offered by Korea, Taiwan, and Singapore. However, Mexico has the advantage of proximity to the United States. This lowers transportation and communication costs. It allows the American companies greater control over day-to-day operations. It also gives the management of the American subsidiaries the opportunity to live in the United States. In 1989, Korea, Taiwan, and Singapore lost their special tariff benefits under the General System of Preferences (a program that gave low tariff rates to developing countries) giving American companies even more reason to locate in Mexico rather than in Asia.

Beginning in the 1980s, the maquiladoras began to change. In some maquila industries, production became more capital-intensive. Many of these plants did actual manufacturing, as well as assembling. With the new capital, worker productivity became greater, as shown in the table below.

Year Plants Employees Value Added Per Worker

1968 112 10,927

1969 149 15,900

1970 160 20,327

1971 205 28,483

1972 339 48,060

1973 400 64,330

1974 455 75,977

1975 454 67,214 196 (-000,000)

1976 448 74,496 198

1977 442 78,433 189

1978 457 90,704 197

1979 540 111,365 197

1980 620 119,546 174

1981 605 130,973 175

1982 585 127,048 211

1983 600 150,867 200

1984 672 199,684 193

1985 760 211,968 207

1986 890 249,833 243

1987 1,125 305,253 224

1988 1,279 329,413 215

1989 1,518 393,658 218

1990 1,818 441,126 243

1991 1,819 431,694

1992 2,042 486,210

In its early years, the maquiladora program had not benefited those who were intended to be helped --- those who had been displaced by the termination of the Bracero Program. In these years, about 80% to 90% of the employees were young women. However, in the 1980s, the proportion of maquiladora workers who were male doubled to almost 40%. (Today, about half of workers are male.)

The type of industries found in the maquiladora program changed. In the 1960s, the maquiladora program was used mainly by small textile producers and assemblers of electrical equipment. By the mid-1980s, these still represented about half of the plants and 60% of the employment. But other maquiladoras were now found in production of transportation equipment, services, furniture, toys, shoes, processed foods, and so forth. Especially important is that much automobile production was done under maquiladora provisions. (Indeed, General Motors is the largest employer in Mexico.) And the location of the plants has changed somewhat. In the mid-1970s, only about 11% of the plants were found in the interior of Mexico. Problems in attracting Americans, in getting proper repairs, in transporting the goods, and in finding those skilled workers that were needed kept these firms from locating in the interior of Mexico. However, the percent of plants located in the Mexican interior rose to almost 18% by 1988 and to 27% by 1992. As a result, a higher percent of inputs were purchased in Mexico(6.0% compared to less than 2% previously). Thus, maquiladoras were fostering more skills and development in Mexico than previously.

Percent of Employment by Sector

1979 1982 1990

Transport Equipment 4.5% 9.7% 21.5%

Electric and Electronic Equipment 25.7 26.1 11.6

Electric and Electronic Materials 31.2 32.3 25.3

Other 38.5 32.0 41.6

The arguments about the effects of foreign direct investment on the Mexican economy was considered at the beginning of this chapter. But the maquiladora program has also been very controversial in the United States. Those who see the maquiladoras as beneficial for the American economy make the following arguments. First, they see the maquiladoras as creating jobs and income in the United States. These jobs also generate tax revenues for the areas along the Mexican border. As one illustration, because of the maquiladora program, Sanyo opened twin plants, providing 2,500 jobs in its Tijuana plant and 4,000 jobs in its San Diego plant. Second, they argue that the maquiladoras raise incomes in the Mexican border area. Some of this income leads to purchases in the United States. This benefits the retail merchants in the border areas. For example, Mexican nationals spend more than $1 billion shopping in San Diego County. Third, they argue that the maquiladoras themselves create a demand for American goods and services. Many of the materials they use are imported from the United States. Also, their existence increases the demand for transportation services, such as trucking and rail. Fourth, they argue that maquiladoras allow American companies to reduce costs of production. If this were blocked, the American companies would locate in Asia rather than produce in the United States. If they located in Asia, they would be less likely to buy American-made components and use American transportation. In an intensely competitive global economy, if the American companies could not locate in any other country, it is argued that they would probably go out of business. Finally, some have argued that, by providing jobs in the border area, maquiladoras may reduce Mexican migration to the United States. There seems little evidence to support this argument at the present time.