New challenges for the maquiladoras: legal and policy implications of NAFTA Article 303 for United States-Mexico trade.

Author:Gantz, David A.
Position:North American Free Trade Agreement - Import duties on non-NAFTA origin raw materials, parts and components

    The North American Free Trade Agreement (NAFTA) (1), which entered into force on January 1, 1994, has greatly stimulated the expansion of trade within North America. In particular, the phased elimination of tariff barriers for trade in goods that "originate" in North America, along with provisions that facilitate and protect foreign investment, have encouraged an increase in total regional trade from about $350 billion in 1993 to $670 billion in 1999, a 91 percent increase over the six-year period. (2) Such increases in intra-regional trade, although perhaps at a slower rate, are likely to continue during the first decade of the Twenty-first Century. Foreign investment also continues to increase, to an estimated $13.2 billion in 2000, up from $11.6 billion in 1999. (3) In 2000, the United States accounted for about $9 billion worth and Canada, about $500 million; (4) NAFTA sources thus represented about 72 percent of Mexico's total foreign investment. (5)

    However, major changes affecting intra-NAFTA trade have recently taken place, on January 1, 2001, as mandated by NAFTA's Chapter 3. (6) These changes constitute the most significant modifications of the NAFTA trading system since 1994, and have major implications for future trade, particularly exports from Mexico to the United States and Canada under the Maquiladora (border industries) system (7), and investment in Mexico designed to produce finished goods for export to the United States and Canadian markets.

    Until 2001, if materials, parts and components imported into one NAFTA country (e.g., Mexico) from outside North America were made into finished goods, and the finished products were then exported to the United States or Canada, Mexico was not required to collect normal "most favored nation" (MFN) import duties on the non-NAFTA materials, parts and components. (8) Yet, on January 1, 2001, as required by Annex 303.7, Article 303 of NAFTA was implemented, sharply limiting such duty waiver or remission. (9) Mexico is now required to collect MFN duties (frequently in the 12-18% range or higher) on non-NAFTA parts and components that are in excess of the import duties assessed on the finished goods entering the U.S. or Canada. (10) However there are exceptions for those industries covered by Mexico's new special sector programs (PROSEC) or where products are imported under the provisions of one of Mexico's many other free trade agreements. (There are also limited exceptions for goods entered under bond for transportation or imported and exported under the same condition, as for testing, cleaning, repacking, etc., for duty-free shop. (11)) Also, under Article 304, existing duty waiver programs tied to export performance are eliminated. (12)

    In most instances, U.S. or Canadian duties on Mexican (NAFTA) originating finished goods now or within a very few years will be zero; as of 1999, tariffs had been eliminated on 80 percent of all tariff items in intra-regional trade. (13) Consequently, most non-NAFTA parts and components imported into Mexico became fully dutiable as of January 1, 2001, again except--and this is a very broad except--where special sector programs provide otherwise. (14) (For U.S.-Canada trade, such duty remission on non-NAFTA parts and components was limited after January 1, 1996.) (15)

    The impact of these changes will be most pronounced on sourcing patterns for Mexican manufacturers exporting to the United States and Canada, particularly for the many "maquiladoras" (16) that are currently purchasing some parts and components or raw materials from outside the NAFTA region. United States and Canadian producers are also subject to the restrictions, but U.S. industry is much more self-sufficient than Mexico's, and U.S. most-favored-nation import duties on most imported parts and components are zero or near-zero. (17) In Mexico, in contrast, import duties on parts and components are in the 12-18 percent ad valorem range, and only about 3.2% of the parts and components used by the maquiladoras are sourced in Mexico. (18)

    The more than 3,700 maquiladoras licensed under Mexican law (19) produce finished goods primarily for export or components for use in the production of exported goods. Of all the industrial sectors, the maquiladora sector is the most dynamic in the Mexican economy. At it's peak, the sector employed nearly 1.3 million persons, 28 percent of Mexican manufacturing employment in 1999, the nation's largest single source of foreign exchange, recently surpassing petroleum and far outdistancing tourism. (20) Although maquiladoras are concentrated in electronics, transportation (including autos and auto parts) and textiles, they involve a variety of manufacturing activities. (21) Maquiladoras were responsible for a total export value of nearly $80 billion in 2000. Approximately 20 percent represents Mexican value added, while the remainder consists of imported parts and components. (22) The impact on the United States is particularly significant, given the fact that about 80% of the maquiladoras are U.S. owned and the United States exports billions of dollars of parts and components to Mexico for assembly there, probably over $45 billion worth in 2000, representing directly at least one million U.S. jobs. (23)

    However, the changes that occurred on January 1, 2001 also impact upon United States importers (other than those whose products use only North American materials), and governmental institutions involved in or regulating intra-NAFTA trade including the United States Customs Service (USCS). (24) Among the major legal, economic and policy issues raised by the changes are the following: Are Mexico's new regimes for manufacturing operations legal under NAFTA and the World Trade Organization agreements?

    If Mexico assesses import duties on non-NAFTA origin raw materials, parts and components, thereby increasing the manufacturing costs of the finished product, will a significant number of the producers move their facilities elsewhere in Latin America, or to Asia, with adverse employment and investment implications for Mexico (and the United States)?

    Alternatively, if duty-free importation of non-NAFTA parts and components is permitted to continue under the new special sector program, will that practice discourage investment in production of parts and components in Mexico, keeping the Mexican materials content of maquiladora- produced goods at the current 2-3 percent levels, (25) and foregoing new jobs and technology transfer?

    If maquiladora employment declines significantly, or even increases more slowly, where will Mexican workers ready to enter the work force find jobs (legally or illegally) except in the United States?

    With the many changes taking place in the world economy, will the value of Mexico's preferential access to the United States and Canadian markets under NAFTA be reduced to the point where it is no longer a substantial incentive to new Mexican investment and job creation?

    It is easier to ask most of these questions at the present time than to answer them, in part because the NAFTA mandated changes are so recent. Assessment is also complicated by the fact that the implementation of NAFTA continues to take place simultaneously with other, global trade-liberalization measures. These may reduce the effect of the tariff advantages Mexico enjoys in the United States and Canadian markets under NAFTA. For example, the tariff reductions resulting from the "Uruguay Round" of the General Agreement on Tariffs and Trade (GATT) negotiations resulted in a reduction of average tariffs imposed by developed countries by 45 percent, from 5.5 to 3 percent, and by 28 percent for developing countries, from 14.9 to 10.7 percent. (26) While U.S. tariffs remain high in some areas, such as textiles and apparel, footwear, chemicals, small trucks, color picture tubes, the reduction or elimination of world-wide tariffs has reduced the level of tariff preference that can be offered by the United States, Canada, the European Union, Japan and other developed countries in free trade areas. (27)

    Also, preferential access to the United States market for manufactured goods from developing nations world-wide, and particularly in the Caribbean Basin, Andean nations and Africa, has been expanded in recent years. Other trade developments such as the impending membership of China in the World Trade Organization, (28) and the entry into force on July 1, 2000 of a free trade agreement between Mexico and the European Union, (29) will necessarily affect investment in and trade with Mexico as well.

    Investment and production in Mexico--entirely apart from customs issues--is significantly affected by the strength of the U.S. economy. A weakening U.S. economy may cause production cutbacks, worker layoffs and even plant closing regardless of changes in the NAFTA customs regime, or in circumstances where the NAFTA changes are the "straw that breaks the camel's back" in the ongoing corporate analysis of costs and benefits of doing business in Mexico.

    Whether these changes in the longer run will offset the advantages of producing goods in Mexico for the United States market--convenience of shipping and travel, a favorable investment regime, political stability, among others--remains to be seen.

    In Part II, this article reviews the operations of the maquiladora system, historically and under the early NAFTA period, 1994-2000. In Part III, I analyze the Article 303 changes and their impact on the maquiladora system, along with the contemporary external factors, including WTO tariff reductions, China's entry into the WTO, and the Mexico-European Union Free Trade Agreement, that are most likely to affect maquiladora-based U.S. trade with and investment in Mexico. Finally, in Part IV, I present a necessarily preliminary assessment of the impact of these developments. Throughout, I focus primarily on Mexican production and investment in Mexico, although I briefly discuss other...

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