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CHAPTER 1
INTRODUCTION
When NAFTA implementation began nine years ago, it created the world's largest free trade area, which now links 406 million people producing more than US$11 trillion worth of goods and services. The dismantling of trade barriers and the opening of markets has led to economic growth and rising prosperity in all three countries.
These effects should be greatest in Mexico, the least developed of the three.
This report reflects a perspective of NAFTA, the recent developments in the Mexican manufacturing sector, and analysis of the business situation in Mexico pre and post NAFTA in the manufacturing sector.
CHAPTER
NAFTA
NAFTA, the North American Free Trade Agreement is a trilateral trade agreement between Canada, the USA and Mexico allowing the free flow of products and services between countries. Mexico became a signatory to the agreement in 14.
According to Article 10 of the NAFTA, the objectives of this Agreement, as elaborated more specifically through its principles and rules, including national treatment, most-favored-nation treatment and transparency, are to
• Eliminate barriers to trade in, and facilitate the cross-border movement of, goods and services between the territories of the Parties;
• Promote conditions of fair competition in the free trade area;
• Increase substantially investment opportunities in the territories of the Parties;
• Provide adequate and effective protection and enforcement of intellectual property rights in each Partys territory;
• Create effective procedures for the implementation and application of this Agreement, for its joint administration and for the resolution of disputes;
• Establish a framework for further trilateral, regional and multilateral cooperation to expand and enhance the benefits of this Agreement.
The proposed North American Free Trade Agreement (NAFTA) aims at reducing and ultimately eliminating most of the remaining barriers to trade and investment among Canada, Mexico, and the United States. While it can be interpreted as a continuation of a prior trend toward increased economic integration between the three countries, NAFTA symbolizes a much larger change in economic relations, particularly between Mexico and United States.
If NAFTA works as its supporters posited, it should have a positive effect on income and employment in each of the three member countries. These effects should be greatest in Mexico, the least developed of the three. If there are no mutual benefits, then the agreement is unlikely to endure. The gains, however, depend on adding content to the framework provided by the agreement. This deepening must necessarily involve, among other things, more efficient customs procedures, understanding on common or compatible standards for industrial goods, working out sanitary requirements for food and pharmaceuticals products, enhanced environmental protection, and consistent standards for trucks that in due course will have the right to carry freight anywhere in North America.
The motivation of Mexico for initiating the negotiation of the NAFTA was principally of an economic nature. The Mexican government under the leadership of President Salinas was in the process of restructuring the Mexican economy to reduce its centrally planned character. It was gradually disavowing Mexico's long-standing policies of import substitution and antipathy toward investment by foreigners. Mexico had begun to see an acceleration of inward capital investment. Nevertheless, the government recognized that if the transition to an open market economy was to succeed without causing the kind of political upheaval which frequently characterizes economic reform programs, it would have to do everything reasonably within its power to accelerate and aid that transition. By negotiating the NAFTA the government of Mexico would offer an incentive to U.S. enterprises to move more quickly into the newly opened market by providing both a form of investment guarantee and by offering a level of preferential treatment both with respect to imports and investment.
CHAPTER
MANUFACTURING IN MEXICO
Overview
Mexico is considered a semi-industrialized country. Manufacturing accounts for 0% of the GDP and contributes % to the Mexican employment rate. It also accounts for 85% of all Mexican exports.
There are two distinct sub-sectors in manufacturing first is the light (maquiladora) manufacturing sector and the second is the capital-intensive manufacturing such as steel making and automotive manufacturing.
The North American Free Trade Agreement (NAFTA) has been a driving force behind the manufacturing sector's exponential growth over the past 7 years.
Many foreign companies are taking advantage of the Maquiladora program, where manufacturers pay little or no duty on raw material and capital equipment entering Mexico. The duty accrues only on value added material.
There are 4000 Maquiladora plants employing 1.6 million people in Mexico.
Three common business structures for manufacturing in Mexico are Wholly Owned Subsidiary, Shelter Programs and Contract Manufacturing.
In a wholly owned subsidiary, a foreign company owns 100% of the Mexican corporation. Sheltering programs involve partnering with a Mexican company that already has the infrastructure and expertise to quickly set up and run the business. Contract manufacturing is when a foreign firm enters into a legal agreement with a Mexican manufacturer to produce goods to defined specification and quantity.
Manufacturers in Mexico are able to produce cost competitive goods as a result of Mexico's labour force being much less expensive then the U.S. and Canada and other developed countries. The labour force is attractive as direct labour is readily available, easily trained and 50% of the population is under the age of .
Maquiladoras
One of the major differences between Canada and Mexico is the Maquiladora Industry. The word Maquiladora originates from colonial Mexico when Maquila was a fee charged by millers for processing farmer's grain. The industry is governed by the "Decree for Development and Operation of the Maquiladoras Industry" published in 18. This industry allows for the duty free importation of machinery and equipment for the assembly of semi-manufactured products and can have 100% non-Mexican ownership.
The advantages are obvious; the use of very competitively priced labour and a low fixed cost structure and the finished products can be exported back to the country of origin, to a third country or sold locally. Until recently only a percentage of manufactured goods produced by the Maquiladoras industry could be sold locally. In 000 it was 85% and today there are no limitations to sell to the Mexican local market.
Originally the Maquiladoras were only located along the Northern border, close to the intended market of the United States. Now 67% of the assembly line industry is located on the border the other % is in other regions. There are about 4000 maquiladora plants, which employ approximately 1.6 million people in Mexico. They include such industries as apparel, automotive equipment, electrical equipment, furniture and other consumers' goods.
Some companies of note include General Electric, Hallmark, and Ford. Exceptions to products allowed under Mexican law include petroleum, petrochemicals, other chemicals, arms, and items that contain radioactive elements. Maquiladora exports represent almost 50% of all Mexican exports, worth an estimated $6.5 billion as of 001 and 0% of all goods exported to the US.
07 new maquila plants opened in 001 in a variety of industrial sectors (see Figure 1), from automotive to consumer electronics.
Figure 1
Most direct foreign investment into Mexico continues to be maquila-related. Figure shows country of origin for the 07 new maquiladoras opened in 001.
Figure
Each Mexican city where maquiladoras are located vary in the type of product that is produced which results in a wide range of maquila production.
Figure shows Mexican Maquiladora Activity as of December 000 based on employment by sector
Figure
Foreign Ownership/Investment Opportunity
Foreign investment plays a key role in Mexico. In fact only the US and China receives more direct foreign investment than Mexico. It is stated by LATGO USA that one out of every four jobs in Mexico was created by foreign investment between 14 and 000. Of the foreign investment made in Mexico, 6% of it was in manufacturing.
The "Foreign Investment Law of Mexico" governs how foreigners can do business in Mexico. This breaks the economy down into classified and unclassified activities. Unclassified activities (about 67% of the Mexican economy) are the sectors of the economy where there is no limit to foreign ownership. Classified activities require approval for ownership and limit the amount of foreign ownership. There are geographic areas where foreign ownership of land is prohibited, 100 kilometers along the border, and 50 kilometers along the coast.
In general foreign investment has been and continues to be liberalized with negotiations underway for independent producers to generate and sell power. Mining companies must be 51% Mexican owned and financial services are highly regulated but investments in other industries up to US$00 million can be made with approval, which is generally automatic unless rejected within 0 days.
Labour Laws and Trade Unions
Labour is highly regulated in Mexico by the Mexican Federal Labour Law (FLL). Minimum wages are usually on a daily rate basis and vary from region to region. The workweek is 48 hours (6 days; 8 hours per day) maximum with appropriate overtime payment thereafter. There are mandatory employee benefits
• Profit sharing
• Year end bonus
• Nine vacation days
• Vacation day premiums
• Training and maternity leave
• Retirement savings system
• Federal Workers Housing Fund (INFONAVIT) contributions
There appears to be many challenges with labour in Mexico and a long awaited labour reform bill has yet to be passed. Unions have been corrupt in the past but times are changing. Many foreign organizations find it much better to work with their labour unions to deal with issues that are not covered by the current labour laws for the benefit of both parties.
Some large multinational manufacturers report their workforce to be skilled and highly motivated because of the long-term opportunities they offer both within and outside of Mexico. NAFTA has had another positive impact on the workers in Mexico as export-oriented manufacturing jobs pay 40% more than the remainder of the manufacturing sector in Mexico.
Mexican Manufacturing Areas of Concern
The following are the areas of concern for Mexico manufacturing
• Uncertainty concerning the fiscal regime.
• Recent over-valuation of the Peso, which has driven up wages and salaries.
• The lack of adequate education, health and other social security services.
• Inefficiencies in urban service infrastructure in the cities (water and sanitation).
• Bureaucratic red tape. For example government officials admit that it takes on average 10 days to set up a new business in Mexico. (Compared to one day in Canada).
• Personal security.
During a recent survey of executives from the manufacturing industry the following were issues raised
• Cost reduction was the overall strategy.
• Production was the most challenging operational issue.
• Preventive maintenance is the most widely adopted manufacturing practice in all plants.
• Primary cost reduction initiative has been improving process efficiency.
CHAPTER 4
PRE VERSUS POST NAFTA
The North American Free Trade Agreement was signed between Canada, U.S., and Mexico in 14, thus creating the word's largest free trade zone, comprising of 406 million consumers.
The impact of NAFTA was tremendous to Mexico. Total trade between Mexico and U.S./Canada tripled from $1B USD in 1 to $8B USD in 000. Further, employment in Mexico grew by 8% with the creation of NAFTA.
In particular, NAFTA boosted Mexico's export business. During the same nine-year period, Mexico's average exports increased by 1% per year, while the rest of the world grew by only 10%. NAFTA has spurred significant change within the make-up of the Mexican exports. For example, in the 180's, 80% of Mexican exports were oil. Today manufactured products make up 85% of Mexican exports.
Although the benefits of NAFTA are clear, there are some concerns. First, while the manufacturing sector has grown significantly, almost all of this growth has been in the maquiladora sector. These are foreign owned companies that are using Mexico as a low-cost provider of assembly services. Within these companies, there is very little research and development being done. Subsequently, very few new or complete manufacturing solutions are offered. Further more, approximately 0% of Mexico's exports are to the U.S. This has created an extreme dependency on the U.S. economy. For example, the economic slowdown that the U.S. experienced in 001/0 was nearly identically mirrored in Mexico.
While these concerns must be managed, it is undeniable that NAFTA has been the driving force behind the Mexican manufacturing sector's exponential growth.
CHAPTER 5
CONCLUSION
Manufacturing Benefits
Companies considering locations for manufacturing are attracted to Mexico over other countries for the following reasons
Labour advantages
• Labour force is much less expensive than in the U.S and Canada
• Labour is readily available and easily trained
• Employees have good work habits and work 48 hours per week
• Productivity averages 10% higher than in parent's other international subsidiaries.
Proximity to the United States market
• Materials and finished goods have shorter transit times and suppliers are closer and more responsive. Communication issues are less complicated.
• Border crossing is quick.
• Shipping is cheaper, plus materials can be shipped overland
Preferential US/Mexican customs programs
• Under Mexico's maquiladora program, manufacturers pay little or no duty on raw material and capital equipment entering Mexico.
• Manufacturers gain access to the 100 million Mexican consumer market; 100% of the maquiladora product can now be sold in Mexico.
Competitive advantage in the North American market
• Reduced costs NAFTA gives duty preferences to companies who manufacture in North America.
• Open market sell products in Mexico; sell components or finished products to other maquiladoras
The major advantages to manufacturing in Mexico are the relatively low cost for labour and the relatively low value of the peso. Under these conditions, labour and materials are paid for in pesos and the finished goods are paid for in dollars. This is a great combination for increased profits and return on investment.
In summary, the advantages listed above highlight a compelling business environment for investment in manufacturing in Mexico. In spite of the political uncertainty and the immaturity of good fiscal management we believe that Mexico is an ideal location in which to manufacture.
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