-BUSINESS-+ -REVIEW- Bureau of Business Research • College and Graduate School of Business • The University of Texas at Austin NAFTA Revisited The Impact of the North American Free Jrade Agreement on Maquiladora Employment by William C. Gruben Assistant Vice President Director, Center for Latin American Economics Federal Reserve Bank of Dallas DECEMBER 1998 T he rapid employment growth of the Mexican in-bond plants, or maquiladoras, lists prominently among the most conspicuous industrial phenom­ena occurring in the wake of the North American Free Trade Agreement. In the four years from December 1993, the month before NAFTA went into effect, to December 1997, employment increased by a striking 71.5 percent in the maquiladoras. In contrast, during the previous four-year period ending Decem­ber 1993, maquiladora employment grew by only 25.1 percent. This recent dramatic growth in maquila­dora employment would seem to substan­tiate the expectations of NAFTA naysayers. Many of them consider the maquiladora program a natural vehicle for their versions of the worst abuses of the agreement-although no one who sup­ports free trade would see such growth in that light. These critics have much in common with opponents of the maquiladora program itself, who have, for more than thirty years, claimed that maquiladoras "take American jobs." But has this been the case? What effect, if any, has NAFTA had on the employ­ment growth in maquiladoras? Why the Controversy? Until 1964, Mexican agricultural workers (or braceros) were admitted, . under a special program, into the United States for temporary employment. In that year, the U.S. government cancelled this temporary worker program, prompting the development of the maquiladora program. The Mexican government established maquiladoras as an employment alterna­tive in the manufacturing sector for braceros who had lost their agricultural jobs. The program took root and grew, and, at present, maquiladoras account for more than half of all manufacturing employment in Mexico's border states. Under the maquiladora system, plant, equipment, and processing inputs pass duty-free into Mexico. These inputs are subject to rules concerning the export of most of the output, which, for the most part, goes to the United States. Typically, inputs come from the United States as well, meaning that maquiladora products exported to the United States are subject only to duties on the value added by Mexican manufacture. Generally, these duties have been very low because maquiladora products entered the United States under the General Agreement on Tariffs and Trade (GATT) system of preferences, a special low tariff program for imports from developing nations. Under these rules, Mexico qualified as a developing nation. Despite the background of the program as a compensatory effort, the maquiladora plants in Mexico quickly sparked contro­ versy in the United States. Comparing Supporters of the ma­quiladoras contended that the relocation of these manufacturing plants to Mexico simply reflected a broader phenomenon: the globalization of manu­facturing. Employment Growth in the Maquiladora Industry 1993-1997 Total Change Month/Year (thousands) (percentage) Dec 1993 546.6 1.62 June 1994 582.1 6.50 Dec 1994 600.6 3.18 June 1995 645.4 7.46 Dec 1995 681.2 5.55 June 1996 750.7 10.20 Dec 1996 803.1 6.98 June 1997 897.3 11.73 Dec 1997 938.4 4.58 Source: lnstituto Nacional de Estadistica Geograffa e Informatica Mexican wages with those in other developing countries as well as with those in the United States, opponents of the maquiladoras argued that the program facilitated efforts by U.S.-owned and other firms to take advantage of the lower wages that Mexican workers would be willing to accept to work in these factories. As firms that had formerly employed low-skilled U.S. workers set up manufacturing operations in Mexico, foes of the maquiladora program argued that these plants were importing not just American inputs, but American jobs as well. On the other side, supporters of the maquiladoras contended that the reloca­tion of these manufacturing plants to Mexico simply reflected a broader phe­nomenon: the globalization of manufactur­ing. The more relevant issue, they as­serted, concerned where else these plants could have located. According to the supporters' script, competitive pressures dictate that these assembly facilities be located in low-wage countries-and if not Mexico, then somewhere else, most likely Asia. (Indeed, as maquiladora proponents argued, lower wage Asian countries predate maquiladoras as export platforms for U.S. manufacturing operations.) This argument noted that, although created by Mexican law, maquiladoras are part of a global response to great reductions in communications and transportation costs. These reductions made it possible for large firms to manage a far-flung network of plants ;issembling products to be marketed in the industrialized world in general and in the United States in particular. Maquiladoras in the Age of NAFTA Just as NAFTA critics predicted, maquiladora employment grew much more rapidly after the agreement was in place than during the four years preceding implementation. But, in fact, is there a connection between the dramatic employ­ment increase and the free trade agree­ment? Growth in Number of Maquiladora Plants 1993-1997 Year Total Change (percentage) 1993 2,166 4.4 1994 2,085 -3.7 1995 2,104 0.9 1996 2,411 14.6 1997 2,717 12.7 Source: CIEMEX-WEFA, Maquiladora Industry Analysis, September 1998. There are reasons to wonder why NAFTA ould produce a positive effect on maquiladora employ­ment. There are reasons to wonder why NAFTA would produce a positive effect on maquiladora employment. For one, trade liberalizations under NAFTA offer some tariff breaks previously available only to participants in the maquiladora program. Second, in some circumstances, nonmaquiladora plants enjoy more flex­ibility than maquiladoras that produce the same product but under stricter environ­mental regulations imposed by the Mexi­can government. (As NAFTA's liberaliza­tion timetable dismantles more trade barriers and increases the agreement's duplication of duty-free benefits once special to the maquiladora program, more and more firms may be dissuaded from incurring the extra waste processing costs required to be maquiladoras.) Finally, the maquiladora program will be effectively phased out beginning January 1, 2001. At that time, NAFTA will become the only basis for duty-free treatment of imported inputs to assembly plants. Although there may still be reasons to register under the maquiladora program-for example, for now, the duty-free provisions of the maquiladora program are more liberal than those of NAFTA-these reasons are not complemented by anythillg in the North American Free Trade Agreement. So Who's Right? The anti-maquiladora forces point to the effects of low wages on maquiladora growth while the maquiladora advocates maintain that in-bond plants would locate in other low-wage countries if they did not operate in Mexico. And each side of this c;lebate can substantiate its argument with econometric studies on both maquiladora employment and output fluctuations. Studies that support the opponents' expla­nation of employment fluctuations apply the ratio of the dollar value of Mexican manufacturing wages to U.S. manufactur­ing wages. These studies suggest that, as the ratio of Mexican manufacturing wages falls relative to U.S. wages, maquiladora employment will increase. Similarly, a ratio is applied in studies that support the argument that maquiladoras belong to a global network of manufacturing opera­tions and that plants that did not locate in Mexico would migrate to other relatively low-wage countries. In this case, it is the ratio of the dollar value of Mexican manufacturing wages to the dollar value of Asian manufacturing wages. In this scenario, as Mexican wages fall relative to Asian wages, maquiladora employment may be expected to increase. However, measures of the impact of NAFTA on maquiladora employment in general, and on the rapid post-NAFTA growth o~ maquiladora employment in particular, must take into account other influences on maquiladora employment fluctuations. For example, the above arguments neglect the effect of demand on fluctuations in maquiladora employment. To characterize links between maquiladora activity and U.S. demand, studies have used either U.S. GNP1 or the U.S. indus­trial production index2 as an expression of demand. Historically, then, fluctuations in maquiladora employment have been explained using one of three types of variables. In my analysis, I applied mea­ sures from each of the three categories: a measure of percentage changes in the ratio of dollar-denominated Mexican manufac­ turing wages to U.S. manufacturing wages; a measure of percentage changes in the ratio of Mexican manufacturing wages to an average of manufacturing wages in Hong Kong, Korea, Singapore, and Taiwan; and finally, to capture the effects of fluctuations in U.S. demand, a measure of percentage changes in U.S. industrial production.3 Using these measures, I analyzed the effects of NAFTA on the growth of maquiladoras. The final results of this econometric analysis indicate that a negative correlation exists between maquiladora employment and the wage variables with a positive correlation between maquiladora employment and demand. What is most interesting about the results, however, is the persistently What is most interesting is the persistently negative and insignifi­cant role of NAFTA in the recent growth in maquiladora employment. negative and insignificant role of NAFTA in the recent growth in maquiladora employ­ment. This finding runs contrary certainly to the allegations of NAFTA opponents such as H. Ross Perot and others.4 While no one can deny that the rate of growth in maquiladora employment has been re­markably rapid since the implementation of the North American Free Trade Agree­ment in 1994, the expansion apparently has little to do with the agreement itself. Notes 1. Gruben, William C., "Do Maquiladoras Take American Jobs: Some Tentative Econometric Results," Journal ofBorderlands Studies (spring), 31-45, 1990; and Lila Truett and Dale B. Truett, "Maquiladora Response to U.S. and Asian Relative Wage Rate Changes," Contemporary Policy Issues, Vol. XI, No. 1 (January), 18-28, 1993. 2. Hernandez, Jose Luis and Rodolfo Navarrete Vargas, "Determinantes de! crecimiento de! empleo en la industria maquiladora de exportacion en Mexico," in Maquiladoras: Primera a Reunion Nacional Sabre Asuntos Frontierzos, ed. Arturo Garcia Espinosa (Monterrey: Asociacion Nacional de Universidades e Institutos de Ensenanza Superior and the Universidad Autonoma de Nuevo Leon), 221-247, 1987. 3. The dependent variable, it should be noted, is percentage changes in maquiladora employment. 4. Perot, Ross and Pat Choate, Save Your Job, Save Our Country: Why NAFTA Must Be Stopped Now, New York: Hyperion, 1993, and Economic Policy Institute and the United States Business and In­dustrial Council Educational Foundation, The Failed Experiment: NAFTA After Three Years, 1997. + Opinions expressed in this article do not reflect the opinions ofthe Federal Reserve System or ofthe Federal Reserve Bank ofDallas. Other important economic indicators ofthe maquiladora industry in the years immediately preceding and following the implementation ofthe North American Free Trade Agreement: Maquiladora Production Indicators 1989-1997 (in billions of current dollars) Indicator · 1989 1990 1991 . 1992 1993 1994 1995 1996 1997 Gross production 12.5 14.1 15.8 18.9 23.1 25.9 31.2 42.3 54.8 Foreign raw materials 9.45 10.5 11.7 14.l 17.6 19.9 26.2 35.8 46.5 Mexican value added 2.34 3.06 3.61 4.12 5.52 5.98 4.96 6.45 8.28 Domestic raw materials 0.15 0.19 0.22 0.28 0.32 0.31 0.32 0.56 0.57 Maquiladora value added 2.06 2.45 2.79 3.26 3.78 4.12 3.2 3.99 5.29 Wage income 1.55 1.85 2.13 2.63 3.07 3.38 2.48 3.16 4.17 Nonwage income 0.51 0.60 0.66 0.62 0.71 0.74 0.71 0.83 1.11 Source: CIEMEX-WEFA, Maquiladora Industry Analysis, September 1998. Texas Business Review 4 December 1998 Hourly Compensation for Production Workers 1988-1997 (U.S. dollars) hourly compensation 20---------------------------------------------------­18 16 14 -..--Mexico 12 • Maquiladoras A Average NICs 10 )( United States 8 6 4 2 o_.,_--~-----.----------..---~----------------.....--....----... 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 NIC=Newly industrializing country. Source: For wages including benefits for direct labor, CIEMEX-WEFA, Maquiladora Industry Analysis; for others, U.S. Department of Labor. Maquiladora Employment by Occupation 1988-1997 (number of employees) thousands 800-.------------------------------------.. 700 600 500 400 300 -.._-Technicians A Administrative 200 100 oU:;::l:;::ISS!:;:!:;:~~~:::..J 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 Source: CIEMEX-WEFA, Maquiladora Industry Analysis. Texas Business Review is published six times a year (February, April, June, August, October, and December) by the Bureau of Business Research, University ofTexas at Austin. Subscriptions are available free upon request. Views expressed in this newsletter are those ofthe authors and do not necessarily reflect the position ofthe Bureau of Business Research. Research and service activities of the Bureau ofBusiness Research focus on the ways Texas industries can become nationally and globally competitive. The Bureau is policy oriented and dedicated to public service. The Bureau is located on the sixth floor ofthe College of Business Administration building. BUREAU OF BUSINESS RESEARCH P.O. Box 7459 Austin, Texas 78713-7459 Change Service Requested Editor: Managing Editor: Sales Office: General: WWW Bruce Kellison kellison@mail.la.utexas.edu Sally Furgeson sallyf@mail.utexas.edu (512) 471-5179 (512)471-1063 fax danhardy@mail.utexas.edu bbr@uts.cc.utexas.edu http://www.utexas.edu/depts/bbr/tbr/ From Local to Global ••• Texas Business Review in 1998 • October "The Great Pension Reform": AFOREs and the Future of Privatized Retirement in Mexico, Tapen Sinha, Ph.D. Lessons from Mexico: The Role of Financial Institutions in Market Crises, • Dilmus D. James and David A. Schauer August The Boom in High-Tech Business Services: A New Impetus to Economic Development in Texas, Niles M. Hansen Rethinking High Tech in Texas: Policy Challenges, Elsie L. Echeverri-Carroll, Ph.D. June • It's All in Your Head: The Promise of Intellectual Property, Walter Bratic CPA • • and Patrick Mclane • Tracking Tech Transfer in Texas Public Universities, from Texas Higher Education Coordinating Board • A~il • On-Line Recycling: Waste/Material Exchange in the Electronic Information Age, : Mina M. Dioun, Ph.D. • Texas as a Net Energy Importer: Does It Matter? Milton L. Holloway, Ph.D. : • February • Austin Sui Generis? The Strength and Resilience of the High-Tech Complex, Dr. : Michael Oden • 0196 REFERENCE-GEN LIBRARIES UNIV OF TX AT AUSTIN PCL 2.430 S5466 CAMPUS ) Announcements After a distinguished tenure as Associate Director of the Bureau of Business Research and Editor of Texas Business Review, Dr. Lois G. Shrout resigned both positions in September to pursue other opportuni­ties. Everyone at the Bureau is grate­ful for the vision and direction she brought to the programs and initia­tives of the BBR and for her longtime devotion to the Bureau's mission and staff. We wish her all the best in her new pursuits. With this issue, we wel­come Bruce Kellison, the new editor of TBR and the new associate director of the Bureau of Business Research. Both the two-volume set and the CD-ROM versions of the 1999 Directory of Texas Manufacturers ' will be available in early 1999. For more information or to order by phone, call toll free 1-888-2 l 2­ 4DTM; fax, (512) 471-1063. +