Theoretical Aspects of Economic Integration

A theoretical basis for opening the Mexican economy and subsequently incorporating it into NAFTA was the export-led growth hypothesis. This approach pinpoints the export sector as the main determinant of economic growth. Traditional classical economic models have considered that free trade and international specialization encourages the productivity of the nations involved (^{Bhagwati, 1978}, and (^{Krueger, 1978}). Additionally, since the 1980s, new theoretical developments based on the endogenous growth theory have established new models underlining the determinant role of trade for economic growth. Among the pioneer papers, the models of ^{Grossman and Helpman (1991)} and ^{Romer (1991)} postulate that increased international trade promotes the expansion of specialized inputs. As a result, opening an economy to international trade increases the rate of economic growth in the long run.

A number of empirical studies have been carried out, based on a production function including exports, with the aim of corroborating the externalities of exports and spillover effects to the rest of the economy. The argument given to support this positive relationship is based on the effect of exports on the overall productivity of the economy according to the following considerations:

Subsequently, a number of empirical papers have published results in favor of exports as an economic growth engine. However, the findings are not homogeneous and the positive impact of exports on growth has not been completely proven by empirical research. To do that, it is necessary to consider the comparative advantages that determine the activities that produce long-term economic growth, such as externalities, technology, etc. (^{Feenstra, 1990}). Therefore, the experiences in Southeast Asia and China have their own particular set of economic conditions that might not be replicable in other countries.

The other literature that has been a basis for promoting free trade in North America is that regarding customs unions and free trade areas. Based on the objective of estimating the degree of maximization of national income (^{Kowalczyk and Davis, Donald, 1988}), several papers have found that the reduction of the highest tariff rate to the next highest level raises global well-being (^{Hatta and Fukushima, 1979}). However, the estimations have also been subject to debate, and other papers have found that the reduction in a single, not very high tariff has an ambiguous effect on world income (^{Vanek, 1964}).

Therefore, as a result of the opposite theoretical views with respect to the effects on the economy of trade expansion and the negative and positive effects of preferential trade agreements on economic dynamics, further empirical research is required. In particular, the economic integration of North America and its effects on Mexican exports needs to be studied, considering the expansion of China's international trade. China's trade with North America has transformed North American trade, as well as the structure and development of Mexican exports, particularly in manufacturing.

Success and Limitations of Mexican Trade in Manufactured Goods

One of the main features of Mexican export expansion under NAFTA has been the increasing share of manufactured goods within total exports. Therefore, the growing relevance of exports in Mexico's economic activity is mainly related to the dynamics of manufacturing exports. After NAFTA came into effect, the share of manufactures in Mexico's total exports increased from 79.22 percent in 1993 to 88.66 percent in 2001. As a result of the 2008 international recession, that percentage fell to 79.25 percent and then increased again to 82.78 percent in 2013. It is worth mentioning that in that year, the share of total exports within GDP was 36.95 percent, showing the importance of exports for the Mexican economy's performance (Table 1).

However, beyond the acclaimed success of manufacturing exports (^{Zabludovsky, 2005}), it is important to underline several shortcomings of the economic growth model based on manufacturing exports adopted in the Mexican economy. In the first place, the rapid growth of manufacturing exports has not been able to change the Mexican economy's uninterrupted manufacturing trade deficit. As seen in Graph 6, the trade balance of the manufacturing sector showed a deficit of US$19.064 billion in 1993, one year before NAFTA was signed. After 20 years, the manufacturing sector trade balance deficit continues: in 2013 it came to US$12.045 billion.

Source: Developed by the author using data from ^{INEGI (2014n)}

Graph 6 Mexico: manufacturing sector trade balance (1993-2013) (millions of USD). 

A second aspect of the Mexican trade in manufactured goods has to do with the uneven dynamics of the exports of manufactures. Only a few manufacturing activities account for the bulk of all manufacturing exports. Among those, the machinery and equipment manufacturing sector expanded rapidly between 1993 to 2013, at a 10.57-percent annual average growth rate, representing 74.59 percent of total manufacturing exports in 2013 (Table 2). Specifically, automobile exports represented 31.08 percent of total exports. Another important manufacturing activity that has exhibited accelerated growth has been the electric and electronic equipment, which grew an average of 8.65 percent a year in the same period, with a 22.38-percent share of total exports. Other manufacturing exports that stand out, though to a lesser extent, are metallurgic exports, food and beverages, and chemical products.

Table 2 Major mexican manufacturing exports (thousands of USD). 

Source: Developed by the author using data from ^{INEGI (2014b)}.

Therefore, it can be clearly stated that the dynamics of Mexican manufacturing exports are characterized by a strong concentration of exports in a very small number of manufactures. If we consider, as mentioned previously, that Mexican exports mainly go to the U.S., it can be concluded that Mexican manufacturing exports depend on the dynamics of the U.S. economy. This characteristic of Mexican manufacturing reflects this sector's high dependency on a single foreign market and the lack of diversification that significantly reduces its capacity to handle the recessionary shocks of the U.S. economy, as observed in the last economic recession of 2008 and 2009.

A third characteristic of trade in Mexican manufactures is related to manufacturing imports. The Mexican manufacturing sector has shown steady growth in imports, which has been even more important than the expansion of manufacturing exports. In 1993, manufacturing imports as a share of GDP was 9.03 percent, and by 2013, it had increased to 31.76 percent, which was higher than the 30.59-percent share of exports vis-à-vis GDP (Table 3). As a result, throughout the 20 years of NAFTA, the manufacturing sector has been characterized not only by a rapid expansion of manufacturing exports but also an even greater increase in manufacturing imports.

Table 3 Mexican manufacturing exports and imports (thousands of USD). 

Source: Developed by the author using data from ^{INEGI (2014c} and ^2014d).

The average rate of growth of Mexican manufacturing imports was 8.46 percent between 1993 and 2013. The import subsector that experienced the highest annual average growth rate was the machinery and equipment, with 9.90 percent. Within this subsector, the manufacturing activities that displayed the highest rates of growth in the period were machinery and equipment for transportation and communications, at 13.55 percent (Table 4). Another industry that showed rapidly increasing imports was that of electric and electronic equipment.

Table 4 Mexico's major manufacturing imports (thousands of USD). 

Source: Developed by the author using data from ^{INEGI (2014e)}.

A fourth aspect of Mexican manufacturing trade involves the varying results of the trade balance for the different manufacturing activities. On the one hand, the manufacturing activities with a positive trade balance between 1993 and 2013 were those related to the machinery and equipment subsector. Specifically, the transportation and communications activities experienced an important increase in their trade surplus, from US$7.26 billion in 1993 to US$53.41 billion in 2013. The manufacturing activity that was the driving force behind the accelerated expansion was the automobile industry, which in 2013 had a trade surplus of US$49.52 billion (Table 5).

Table 5 Main mexican manufacturing activities with trade surplus (1993-2003, thousands of USD). 

Source: Developed by the author using data from ^{INEGI (2014f)}.

Other manufactures that showed a trade surplus, though to a less significant degree, were machinery and metallic products, general hardware products, the mining and metallurgic sector, and machinery and professional and scientific equipment. Therefore, we can conclude that only a few manufacturing activities were successful in increasing their exports more than the amount of imports related to those activities.

On the other hand, most Mexican manufacturing activities showed a constant and increasing trade deficit from 1993 to 2013. Among the manufacturing activities that exhibited higher trade deficits in that period were the transport and communications subsector, whose trade deficit increased from US$2.89 billion to US$44.37 billion, with an average annual rate of 13.65 percent, and the chemical subsector, which increased from US$23.30 billion to US$13.37 billion (Table 6). Other manufacturing industries that exhibited trade deficits are plastic and rubber, electric and electronic equipment, steel, printing and publishing, and textiles and apparel.

Table 6 Main mexican manufacturing activities with trade deficit (1993-2003, thousands of USD). 

Source: Developed by the author using data from ^{INEGI (2014g)}.

Therefore, we can conclude that, on the positive side, after 20 years of NAFTA Mexico has succeeded in increasing manufacturing exports, but, on the negative side, they have been concentrated in a few sectors, while manufacturing imports have increased over all manufacturing activities. Therefore, as a whole, Mexico's manufacturing sector trade deficit reveals its inability to develop more balanced growth expansion as well as to be less dependent on the U.S. market.

Vertical Integration, the Auto Industry, And Mexican Manufacturing Exports

The expansion of the maquiladora industry during the 1990s has been well documented (^{Moreno-Brid, Santamaría, and Rivas, 2005}). The accelerated growth of Mexican manufactures was linked to the development of supply chains and their importance in the competition in global markets for low-cost intermediate inputs. About 50 percent of the volume of Mexico's manufacturing exports has been produced by the assembly plants (maquiladoras), which import intermediate inputs from abroad and, then, after assembling intermediate and final goods, export them back to the U.S. (^{Hanson, 2010}).

An important share of the trade between Mexico and the U.S. occurs within vertical integration chains, where inputs from the U.S. are transformed in Mexico and re-exported to the U.S. (^{Kose, Meredith, and Towe, 2004}). Therefore, supply chains related to the automobile, electronics, and machinery industries have played a major role in the expansion of Mexican foreign trade ever since the 1990s. Based on information from the Manufacturing Census of 2009 for the manufacturing sector and from statistics of the Manufacturing, Maquiladora and Export Services Industries, I estimated the maquiladora and exporting industries' share of the total manufacturing. The results showed that employment in maquiladora and exporting industries represented 40.82 percent of all employment in manufacturing (Table 7). Additionally, the estimations for the different manufacturing industries corroborate the importance of vertical integration for Mexico's manufacturing exports.

Table 7 Total employment in the manufacturing sector and the maquiladora export industry (2009). 

Source: Developed by the author based on data from ^{INEGI (2014h} and ²⁰¹⁴ⁱ⁾.

On one hand, production of manufactures for the domestic market, such as those from the food, beverage, and lumber industries, was carried out in large part in non-exporting plants. Only 7.92 percent, 16.25 percent, and 20.94 percent, respectively, of the labor force was working on exporting activities in the lumber and food and beverage industries. On the other hand, the aforementioned principal manufacturing exporting industries represented a large share of manufacturing industry workers. This is the case of computers and communications equipment, with 91.21 percent of jobs, followed by the basic metal industry with 87.40 percent, transportation and equipment, with 86.01 percent, and electric and electronic equipment, with 80.31 percent. We can conclude that an important proportion of manufacturing activity was concentrated in exporting industries and that the chief export industries were part of the vertical integration strategies of multinational corporations looking to reduce labor and transportation costs.

Additionally, the content of Mexican imports is concentrated in intermediate inputs between 1993 and 2013, increasing slightly to around 75 percent of total imports (Graph 7). The structure of imports reflects the importance of vertical integration to the dynamics of manufacturing exports and defines the characteristics of the expansion of that economic sector in Mexico.

Source: Developed by the author using data from ^{INEGI (2014o)}.

Graph 7 Mexican imports by type of goods (1993-2013). 

In particular, the establishment of NAFTA played an important role in the integration of the auto industry in North America which had already started to develop with the initial bilateral trade agreement between Canada and the U.S. in 1987. The gradual elimination of tariffs and non-tariff barriers and the protection of foreign direct investment (FDI) and intellectual property rights allowed faster development of vertical integration, particularly in Mexico's automobile and auto parts manufacturing industries. Therefore, beginning in 1994, the Mexican government decided to modify its industrial policy for the automotive sector by reducing its commercial protection and deregulating it to promote specialization and exports of automotive manufactures (^{Vega, 2014}). This promotion of the auto industry allowed trade in Mexican manufactured goods to benefit from NAFTA. Auto industry trade between the U.S. and NAFTA members over the last 20 years shows that U.S. imports within that sector represents twice the value of its exports (^{Hufbauer, Cimino, and Moran, 2014}).

From the end of the 1980s until 2002, Mexico's auto industry expanded under the umbrella of the global competition generated by both the foreign and U.S. automotive companies operating north of the border. As a result of the increasing loss of the U.S. auto market, the "Big Three" companies in the U.S. (General Motors, Ford, and Chrysler) launched new strategies by shifting production lines to Mexico and developing new models, such as sport utility vehicles and minivans, which allowed them to compete internationally.

However, beginning in the second half of 2007, automobile imports from Mexico and Canada began to drop, a trend that continued through 2008 and deepened in 2009. The data on automotive exports by firms located in Mexico showed that the U.S. Big Three experienced a sharp decrease in exports. As shown in the Table 8, Chrysler and General Motors plants located in Mexico reflected the bankruptcy and financial restructuring taking place in the company's U.S. headquarters, both of which exhibited a drastic drop in exports accumulated between June 2008 and June 2009, respectively. These two companies were followed by Ford Motors, with a fall of 38.4 percent and, to a lesser extent, by other companies of different national origins such as Renault, Nissan, Volkswagen, and Honda.

Table 8 Automobile exports by automotive companies located in Mexico (2008-2009). 

Source: ^{Asociación Mexicana de la Industria Automotriz, A.C. (2010)}.

All of this revealed that, although the crisis of the automotive industry was a problem related to the international economic recession, the U.S. car companies were the ones that experienced the most severe contraction in Mexico, therefore demonstrating the negative side of the integration of the manufacturing sector achieved by NAFTA.

China and the U.S. Market For Mexican Manufactures

With respect to the loss of some of the U.S. market share for Mexican manufactures, it is important to consider that the Mexican economy has not been able to evolve from the exporting phase of export assembly manufactures to a phase of original brand production based on the in-country design of outputs. Mexico's manufacturing sector has developed into an industry that assembles automobiles, auto-parts, and electronics based on labor-intensive processes oriented toward exporting inputs to the U.S. (^{Hanson, 1998}). This has put Mexico in the position of trying to compete with China for the U.S. market for manufacturing imports.

Between 2005 and 2010, total Chinese exports to the world increased at an average of 13.9 percent a year, which posed obstacles for the future growth of Mexican manufacturing exports. In particular, the rapid penetration of the U.S. market by Chinese manufacturing exports had a negative effect on the growth prospects of Mexican manufacturing exports to the U.S. Between 1990 and 2006, the average growth rate for Chinese exports to the U.S. valued in dollars reached 14.4 percent, while Mexican exports increased by 9.6 percent. As a consequence, since the beginning of 2003, exports from China to the U.S. have shown a greater value than the ones from Mexico (^{U.S. Census Bureau, 2010}).

In the year 2000, Chinese exports to the U.S. represented 8.2 percent of total U.S. imports; but by 2012, that share increased to 18.7 percent. On the other hand, Mexican exports, which represented 11.2 percent of total U.S. imports in 2000, barely increased their share to 12.2 percent in 2012 (Graph 8). The types of Chinese products that have gained the advantage over Mexican exports are manufactured goods, such as generators, transformers, electrical equipment, computers, telecommunications, and metallic products (^{Comtrade, 2015}).

Source: Developed by the author using data from ^{U.S. Census Bureau (2010)}.

Graph 8 China and Mexico's share of total U.S. imports. 

On the other hand, Mexican exports that have either maintained or increased their share include passenger vehicles, televisions, and fruits and vegetables. Therefore, we can conclude that Mexican exports have ceased to compete with similar exports from China in certain important manufacturing activities, although they have maintained an important share in the manufacturing activities related to the automobile industry and the agricultural sector, where localization advantages still exist that reduce transportation costs.

China and Mexico's Trade and Current Account Balances

As mentioned above, trade relations between China and Mexico have intensified since the 1990s. One of the main features of the trade between these two economies is Mexico's sustained and increasing trade deficit. Between 1999 and 2012, the trade deficit increased from US$791 million to US$27.52 billion and became the most important source of Mexico's foreign exchange outflows.

It should be mentioned that the increasing Mexican imports from China have concentrated mainly in manufactured goods. In particular, the Chinese exports that accounted for the highest value were electric and electronic equipment, nuclear reactors, machinery, optical and medical equipment, plastics, and iron and steel. Therefore, the composition of Mexican imports from China provides evidence of that economy's importance in trade in manufactured goods manufacturing in the NAFTA region. The Mexican economy's high dependency on manufactured goods from China, particularly intermediate and final goods, suggests that the functioning of the flows of trade among the NAFTA economies now also depends on China's participation.

Additionally, it is important to underline that the Mexican economy shows a surplus trade balance with the U.S., Mexico's most important trade partner in NAFTA, as well as with most of the economies in North and South America. In fact, in 2012, the Mexican economy had a US$102.73-billion trade surplus with the U.S., US$11.48 billion with South America, and US$1.42 billion with Central America (^{Banco de México, 2014}). However, on the other hand, the Asian economies also had large trade surpluses with Mexico. In particular, the two Asian economies with the largest trade surplus with Mexico are China and Japan. The Chinese economy had a surplus of US$51.22 billion followed by Japan, with US$15.04 billion.