a n a l y s i s
Uncertainty and Growth in Mexico’s Maquiladora Sector
by James Gerber | March 2001

The past year has witnessed a number of developments affecting Mexico’s maquiladora industry, such as reworked tax regulations or phaseouts of tariff protections on imports from overseas countries required under the North American Free Trade Agreement (NAFTA). In some cases, the fine points of these
new arrangements have yet to be ironed out, and industry leaders are
warning that this uncertainty, coupled with gains in workers’ real wages,
could spell the end of the maquila boom. But ongoing growth in the sector
belies these predictions and suggests that other factors, not tax or
labor costs, account for the maquila success story. This raises some
interesting questions regarding the role that the maquiladoras can,
or should, play in Mexico’s development process.

Contacts:

Border Trade Alliance
Phone: (602) 266-7427
Email: info@thebta.org

Coalition for Justice in the Maquiladoras

Phone: (210) 732-8957
Email: cjm@igc.apc.org

Consejo Nacional de la Industria Maquiladora
de Exportacion
Phone: (5) 536-8292
Email: cnime@cnime.org.mx

SECOFI
Office of Industrial Development & Trade
Phone: (01) (800) 410-2000
Email: :
contacto@secofi.gob.mx

 

Web Sources:

Maquila Portal
www.maquilaportal.com

Mexican News & Labor Analysis
www.igc.org/unitedelect/
alert.html

Maquila Guide
www.maqguide.com

Maquila Solidarity Network
www.maquilasolidarity.org

Maquiladora Health and Safety Support Network
www.igc.org/mhssn

Twin Plan News
www.twin-plant-news.com/sect2.html

The debate between boosters and critics of Mexico’s maquiladora
assembly industry usually begins with the shared assumption that low wages
are the main reason for the industry’s existence. Maquiladora industry
promoters, for their part, argue that any changes in the existing economic
or legislative environment that lead to higher wages for workers will
effectively undermine the industry’s competitiveness and result in
a significant emigration of firms and jobs, as parent companies relocate
operations to countries with lower labor costs. Critics respond that the
industry’s dependence on low wages undermines its usefulness as a
development strategy for Mexico, since two important components of development
must be rising incomes and improved working conditions.
The origin of the assumption that the maquiladoras are dependent on
low wages is rooted in the history and early growth of the industry; its
current legitimacy derives from the economic theory of comparative advantage.
The idea behind comparative advantage is that nations trade in ways that
take advantage of their differences, and accomplish this by specializing
in the production of goods and services that intensively use their most
abundant inputs. Mexico is relatively well-endowed with unskilled and
semiskilled labor, while the U.S. is abundant in physical capital, scientists,
engineers, and other skilled workers. Consequently, Mexico has a comparative
advantage in the production of goods that intensively use low-wage labor,
while the U.S. has an advantage in the production of goods that are intensive
in science and engineering inputs.
If the maquiladora sector indeed represents purely comparative advantage-based
development, then it is simple to predict the evolution of the industry.
As Mexican workers gain skills, incomes are likely to rise, 1
and unskilled assembly production will move to a lower cost environment.
In other words, we would expect to see a movement of maquiladoras from
the northern tier of border states to the Mexican interior and perhaps
to Guatemala or Haiti or some other business-friendly, low-cost environment.
Hence, from the perspective of industry supporters, it would be important
for wages are held in check.
But the assumption that low wages are the main determinant of industry
location decisions has several problems. First, there is the unexplained
geographical concentration of several key sectors (e.g. electronics, cars,
and car parts) in production centers that do not offer the lowest available
wages, such as Tijuana, Ciudad Juárez, and Torreón. Existing
firms continue to expand their operations in these cities, just as new
firms continue to locate there. 2 Second, at
the national level, average real wages in the maquiladora industry have
steadily recovered the value they lost after the peso collapsed in late
1994 and 1995—still, the industry has continued to grow. 3
The focus on wages, and the assumption that they are the primary cause
of the industry’s performance, has led many industry critics and
supporters to overlook some additional reasons for the maquila industry’s
growth. In particular, the location close to the U.S. market (where transportation
costs are minimized) and the growing concentration of production in a
few manufacturing sectors indicate that factors other than wages are fostering
growth. The point is not that wages do not matter; they clearly matter,
both to firms and to workers. Rather, the point is that the industry’s
growth may be more robust than is generally appreciated and so wage increases
are not as detrimental to future growth as many people assume.
The Taxation Factor
Firms that take the availability of cheap labor into account when deciding
where to locate production are also very sensitive to changes in their
overall cost structure—tax expenses, for example—not just their
labor costs. Changes and uncertainties in tax laws, therefore, like higher
wages, might be expected to have a negative impact on maquila industry
growth.
The tax regime governing Mexico’s maquiladoras has seen a number
of changes in recent years. Under NAFTA, the import duty waiver historically
given to the maquiladora industry was to be eliminated by January 2001
at the latest. This introduced a significant element of uncertainty into
the tax planning of maquiladoras, in part because, until very recently,
the Mexican government was unable to specify a new import tax regime that
is NAFTA-compliant.
Uncertainties surrounding the new import tax were compounded by two
additional tax changes. First, the exemption of maquiladora imports from
antidumping duties was eliminated, beginning in January 2001. Then in
1998, the Mexican government suddenly introduced a new income and asset
tax regime for maquiladora industries. The latter increased the exposure
of maquilas to Mexican income taxes and has generated a great deal of
discussion and negotiation between industry representatives and various
governmental bodies.
Although the industry was able to anticipate the disappearance of its
import tax waiver, it had no certain information regarding the replacement
tax until the second half of 2000. The implementation of the new income
tax was impossible to anticipate, and the details of the liability it
creates for specific firms remains up in the air, both because there are
several alternatives under the current system and because the Mexican
government has stated that it will replace the current rules for taxing
foreign enterprises with an OECD-approved set of rules, which is expected
in 2002.
Yet, despite tax uncertainties and real wage increases over the past
five years, maquiladora employment grew at an annual rate of 14.4% between
January 1995 and October 2000. The pace of growth has been remarkable
and contrasts sharply with the notion of a fragile industry teetering
on the edge of uncompetitiveness due to higher taxes and rising wages.
The New Tax Regime
Not all the details of the new scheme for taxing maquilas have been
hammered out. But, regardless of the details of the final arrangement,
three points stand out. First, the policymaking process has been drenched
in uncertainty and indecision. Several conferences were organized to explain
the final federal rules for import taxes, but they offered little in the
way of solid information. Meanwhile, the new rules for income taxes are
so complex that they have required extensive clarification and the creation
of alternative tax rules—which have also been problematic. Second,
the taxes will indeed raise operating costs, although the extent of the
increase is still unknown. If nothing else, they increase the amount of
paperwork and the administrative costs of tax compliance. Third, the final
rules will be tempered by the desire to avoid damaging what has become
an extremely important source of foreign exchange earnings, employment,
and foreign direct investment for Mexico.
The major tax-related changes and uncertainties affecting the industry
include:
Changes in import taxes . Under NAFTA’s Article 303, duty-free
imports from non-NAFTA countries ended in January of this year. This pending
event prompted major industry and government concern over the past few
years, who feared that investment in the maquila sector by non-NAFTA countries
would fade away as a result. 4 And so in 1999
Mexico’s commerce department (SECOFI) announced that it would develop
sectoral programs (PROSECs) to protect the tariff-free entry of maquiladora
imports from non-NAFTA countries. PROSECs allow qualified applicants—both
maquila and non-maquila—to apply for reduced tariffs of 0-5%. PROSECs
cover most of the products coming into the maquiladora industry, including
electronics, electrical equipment, chemicals, textiles, and autos. The
main complaint at this point is that SECOFI has been slow to define the
process for applying to the sectoral programs, and was exceedingly slow
to specify the tariffs.
Changes in income and asset taxes . A second, much more complicated
tax issue concerns the income and asset taxes facing the industry. In
1998, the Mexican government announced that as of January 2000, the U.S.
parent companies of Mexican maquilas would be treated as though they have
permanent establishments (PE) in Mexico. This ruling requires them to
pay Mexican income taxes on the share of their income derived in Mexico
plus a 1.8% asset tax on their machinery, equipment, and inventories.
The National Association of Maquila Manufacturers (CNIME) opposes the
PE rules. CNIME points out that there is significant uncertainty regarding
how to determine the share of income derived from a Mexican operation
and that the lack of a tax credit in the U.S. creates a double taxation
situation. That is, firms would pay taxes on income derived from their
Mexican operations, and then face a tax liability for the same income
in the United States.
In response to the double taxation issue, the Mexican internal revenue
agency (SAT) and the U.S. Internal Revenue Service (IRS) worked out an
agreement called safe harbor. Under the terms of safe harbor, firms can
avoid the PE designation and its taxes by electing instead to pay a 6.9%
tax on assets employed in Mexico or a 6.5% tax on the production costs
of the maquila operation, whichever is greater. If profits are less than
either of these two amounts, companies have the option of signing an advanced
pricing agreement (APA) with the Mexican government, which outlines the
methodology used to calculate costs of production and the value of assets.
Theoretically the APA enables firms to pay lower taxes if they qualify
for the program.
Based on anecdotal evidence, representatives of the maquiladora industry
dislike all these options. First, the PE rules subject them to double
taxation. Second, the safe harbor and APA rules are set to expire in 2002,
when the OECD is scheduled to release a set of guidelines for taxing foreign-based
multinationals. The coming expiration of the safe harbor and APA provisions
renders them merely short-term solutions and denies the industry a clear
picture of its future tax situation. Third, the Mexican government has
been slow to approve the APAs that firms have already begun to use. Currently,
when a firm elects to use the APA method, it submits a proposal to the
government for evaluating its costs of operation and asset values. Firms
have complained that there is a long lag between the submission of a proposal
and a response from the government. This means that some firms are still
uncertain about their tax liabilities for previous years’ activities.
Antidumping duties . Another wild card for the industry is the
loss of its exemption from antidumping duties (ADD). ADDs are compensating
tariffs on imports that are levied when the import sells below “fair
market value” and a determination is made that the low price has
hurt a domestic producer. There are a number of current maquiladora industry
imports, particularly goods coming from China, that have ADDs imposed
on them. Prior to January 2001, the maquiladora industry was exempt from
these duties.
Growth of the Maquiladora Industry
In the give and take between the Mexican government and the maquiladora
industry, three points stand out. First, it seems reasonable to expect
a rapidly expanding industry to pay an average amount of taxes, particularly
when the industry requires significant investment in new public infrastructure.
Second, the government appears to be caught in a struggle between its
need to generate revenue and its need to foster industrial development.
This struggle is played out between SECOFI, the ministry of commerce and
industrial development, and the SHCP, the ministry of finance. The conflicting
agenda of these two agencies explains the delay in defining a new tax
regime. The fact that the maquiladora industry has become the leading
earner of foreign exchange and a major creator of formal sector employment
probably tips the balance of policy toward industrial development rather
than tax collection.

 

Average
annual growth rate of maquiladora employment in the 1990s
11%

Maquila
industry employees as of December 31, 2000
1.339
million

Total
industry payroll as of December 31, 2000 (in 1994 pesos)
25
billion

1999
maquila industry trade surplus
$US12
billion

Foreign
direct investment in maquiladora sector, 1999
$US11
billion

1999
contribution to Mexico’s foreign exchange holdings
$US23
billion

Sources:

INEGI, Banco de Información Económico, Industria Maquiladora de
Exportación, Indicadores Mensuales . Available online at:
http://www.inegi.gob.mx/ .
The growth rate is the author’s calculation. The 1990 monthly
average number of maquiladora jobs was 446,436. There was significant
regional variation in the growth rate; CIEMEX-WEFA, Maquiladora
Industry Outlook , vol. 13, no. 3.

 

Third, in spite of the uncertainty, the industry has continued to grow
rapidly. Among the possible reasons why uncertainty has not undermined
the industry’s growth is an increase in the lobbying skill of the
maquiladora industry. Industry leaders may be uncertain about the final
shape of tax policy, but they appear confident that it will not be detrimental
to the industry’s future growth prospects. Another reason for continued
growth is that the underlying conditions for growth are strong enough
to overcome worries about future tax liabilities, rising wages, greater
environmental enforcement, and other potential cost factors.
This last point is worth emphasizing, because it indicates that it may
be erroneous to think of the maquiladora industry as an assembly industry
based on low wages. If the growth inducing factors in the industry are
a result of something other than low wages, then both industry critics
and boosters may be wrong in their assumption that the industry’s
development is based solely on Mexico’s comparative advantage in
labor-intensive industries.
Trade and growth based on economies of scale is an alternative to explanations
based on comparative advantage. The theory of economies of scale (EOS)
asserts that the average cost of production declines as a firm increases
its size, at least up to a point. EOS limits the number of plants a firm
can build, since each one must be of a minimum size. In addition, transportation
costs play an important role, since they provide strong incentives to
locate production as close to the market as possible.
The industrial development of northern Mexico is a clear illustration
of the effects of EOS-based trade. Prior to 1986 or 1987, when Mexican
economic policy favored the production of import substitutes rather than
exports, there were strong incentives for firms to locate in or near Mexico
City. Since production incentives were oriented toward the domestic market,
high transportation costs and the need to produce in only a few locations
dictated that Mexico City was the logical location. After the opening
of the Mexican economy, however, the implicit incentives in Mexican economic
policy began to emphasize production for external markets. In Mexico’s
case, the largest external market is the United States, and the northern
border states are as close as possible to that market. Therefore, in order
to reduce transportation costs, and given that production of a particular
type must be confined to a few plants, the optimal location strategy is
to place the plants in as few locations as possible, each physically close
to the U.S. market. 5
This type of EOS are sometimes also referred to as internal economies,
since the scale effects are generated inside the firm. A second form of
scale economies is the external economy of scale. External economies occur
when the growth of an industry (in contrast to the growth of a firm) makes
the firms within the industry more efficient. External economies stem
from the ability of companies to share a common labor pool, a common supplier
base, including nontraded (legal, accounting, marketing, etc.) inputs,
and information about market trends. In the case of the maquiladora industry,
both the auto industry and the electronics industry benefit from their
geographical concentrations in Coahuila-Chihuahua and Baja California,
respectively.
Growth in the size of firms, increased clustering near the U.S. market,
growth in the number of firms devoted to related lines of production,
and intensification of the geographical concentration of products are
all indicative of an industry that benefits from both internal and external
economies of scale. All of these elements are to a degree self-reinforcing,
and as they develop, the industry becomes more rooted in the region.
This view of Mexico’s northern border assembly industries is not
entirely at odds with the traditional, cheap labor explanation for industrial
location. Some types of production—apparel, for example—are
far more sensitive to wage costs than other types. However, the EOS model
stresses the availability of particular labor services (e.g. accounting,
management, legal, and computer skills) and linkages to universities,
vocational schools, and secondary schools. Other important factors include
trade infrastructure, specialized parts manufacturing, and the informal
social networks of business people. By way of contrast, the low-wage hypothesis
emphasizes the steady supply of a pool of cheap, unskilled labor.
Another important difference between the EOS explanation of maquiladora
industry growth and the comparative advantage explanation is that the
former emphasizes the problems of urban congestion. On the border today,
regional infrastructure—roads, water, energy, telecommunications,
housing, schools, and health care—is stretched beyond capacity. Yet,
according to the EOS explanation, the maquiladora industry will continue
to concentrate growth in the northern tier of border states until the
congestion effects begin to choke off new growth. The congestion effects
of this growth are serious and are likely to intensify if the EOS explanation
is partly or entirely accurate.
As difficult as the problems of growth may be, dealing with them is
far better than having to deal with the problems of stagnation. Accordingly,
a high priority should be given to tackling issues such as the complete
absence of a municipal bond market, the difficulties of creating a cross-border
bonding authority, the need for decentralization of urban planning functions
from Mexico City to the states and cities, and the scarcity of affordable
housing.

Dr. Gerber holds BAs in history and economics from California State
University, Chico, and a Ph.D. in Economics from the University of California,
Davis. Since 1985, he has been teaching and doing research at San Diego
State University where he is Professor of Economics. He has taught economics
in Mexico and Canada and is currently Economic Research Fellow at San
Diego Dialogue, a public policy group devoted to fostering cross-border
understanding and cooperation. He is the author of International Economics
and co-author of North American Economic Integration: Theory and Practice.
In 2000, he was chosen by the SDSU Alumni Association as the outstanding
faculty member in the College of Arts and Letters at San Diego State
University. He can be reached at jgerber@mail.sdsu.edu .

Endnotes:
1 This assumes that the supply of Mexican labor is moderated
by the earlier decline in birth rates. It is conceivable, however, that
Mexico’s rapidly expanding labor force could overwhelm the upward
pressure on wages brought about through economic expansion and rising
skill levels. This has been a significant part of the story of past wage
stagnation.
2 Employment in the maquiladora sector grew 14.2% per
year in Tijuana from January 1994 through July 2000. The figure for Ciudad
Juárez was a more modest but still impressive 10.6% per year. INEGI,
Banco de Información Económica, Industria Maquiladora de
Exportación, Indicadores Mensuales . Available online: http://www.inegi.gob.mx/ .
3 Between January 1996, and October 2000, real average
maquila wages for all classifications of workers rose at the average rate
of 4.13 pesos per month in 1994 peso values. The increases varied by job
category, with higher level workers earning bigger increases. G.L. Schmaedick,
“Compensation, Inflation and Purchasing Power in the Mexican Maquiladora
Industry since the Devaluation of 1994” describes the occupational
variability in maquila wage increases in one border community. The estimated
average monthly increase in wages at the national level is based on the
author’s calculations using data from INEGI, Banco de Información
Económica, Industria Maquiladora de Exportación. Note, however,
that average real wages are still below the level they attained in the
mid-1980s, a pattern that applies across the entire Mexican economy.
4 See Jim Gerber, “Whither the Maquila?” San
Diego Dialogue , 1998, available at www.sddialogue.org .
5 Gordon Hanson, “Increasing Returns, Trade, and
the Regional Structure of Wages,” Economic Journal , 1997,
vol.107, pp.113-33. See also Paul Krugman, and Raul Livas Elizondo, “Trade
Policy and the Third World Metropolis,” Journal of Development
Economics , 1995, vol. 49, pp. 137-50.

Published by the Interhemispheric Resource Center’s
Americas Program . All rights reserved.
Recommended citation: “Uncertainty and Growth
in Mexico’s Maquiladora Sector,” Americas Program Analysis (Silver
City, NM: Interhemispheric Resource Center, March 2001).
Web location: http://www.americaspolicy.org/briefs/2001/bl76.html

 

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