Tuesday, November 26, 2013

Is Mexico’s global competitiveness in jeopardy?

Mexico has experienced much growth thanks to its proximity to the US and the generous benefits of NAFTA. However, in what could potentially deter this growth, Mexico is getting set to enact tax changes that will have a major impact on its maquiladora industry, the backbone of much of the country’s growth.

The maquiladora industry dates back to the mid-1960s and was created by the Mexican government to improve Mexican employment and its economy. As such, the program subsidized foreign manufacturers to set up manufacturing facilities on the Mexican side of the US-Mexico border. With the adoption of NAFTA in 1994, the number of maquiladoras has expanded beyond the border and into the central part of the country and today, the industry represents 4.0% of Mexico’s GDP and 40.0% of exports. It is also the country’s second source of foreign exchange behind oil.

Similar to other “emerging countries”, over the past years, Mexico has enjoyed a rapid growth in its economy; however, its infrastructure has struggled to keep up and its rising middle class is now demanding improvements in domestic programs such as education. However, the country is now experiencing a slowdown and is in need to boost revenues to jump-start its economy. It is looking towards its maquiladora industry to help raise the needed revenue.

According to the Journal of Commerce, as part of a larger $14bn tax plan, maquiladoras will face an income tax increase from 17.5% to 30.0%  effective beginning in 2014 and an additional 16.0% value-added tax will be enacted beginning in 2015. Tax incentives such as food credit and housing subsidies for workers will also be eliminated. While it has yet to be signed by Mexico’s president,it is creating a stir.

How will this legislation affect Mexico’s global competitiveness? Although Mexico has many free trade agreements with countries world-wide, it remains heavily dependent on the US. In fact, it is estimated that 80% of maquiladoras are of US origin. This potential tax could possibly result in an increase in onshoring back to the US. There certainly has not only been political pressure to bring more manufacturing back to the US but the stubborn high unemployment rate and sluggish economy has also resulted in increasing competition among states to attract new businesses by offering generous tax benefits. Perhaps the Caribbean or Central America may even become alternative outsourcing locations?

 More importantly, it is unknown how this legislation will impact Mexico. In many ways, the growth of the automotive industry has helped shift the focus away from border maquilas as GM, Ford, Nissan, Volkswagen and other automotive manufacturers locate assembly plants to the country. These facilities generally demand advanced labor skills and the pay is higher than that of a traditional border maquila. Still, these facilities depend on maquilas. Will this tax increase jeopardize the country’s automotive industry?

Mexico is struggling with many issues as it attempts to break free of its “emerging country” status. Crime and corruption, a growing middle class, a slowing economy, poor infrastructure and much more needs to be addressed. While change is definitely needed, perhaps the government should also consider the privatization of state-own entities such as PEMEX and also work with industry leaders to address the many challenges to arrive at practical solutions.