The Romance with Mexico

In Southern California during the 1960s, twirling the AM radio dial could be an adventure. In addition to the mainstream stations, like KNX and KFI, broadcasting at the normal “clear-channel” power of 50,000 watts, every now and then you would hit a station so powerful that it could make the whole radio shake, like a boom box before its time. When this happened, it meant that you had encountered the “Big X,” a station that blasted English-language programming from towers in Tijuana to the huge market north of the border. There must have been some schedule and regularity to the Big X’s broadcasts, but at the time it seemed that they would show up at unpredictable hours and positions on the dial, drowning out stations that were normally there. In its heyday the Big X had featured the legendary disk jockey Wolfman Jack, who was later depicted at a station in central California in the movie American Graffiti.

I took the existence of this station as an early lesson in the difference between what governments can control and what technology can achieve. The US Federal Communications Commission had its master plan for keeping order on the airwaves, by assigning positions on the broadcast spectrum, limiting emission power, and even classifying call letters by region. (The familiar regional scheme generally has “W” stations east of the Mississippi and “K” stations west of it. The Big X’s very name seemed to be a mockery of this system, or perhaps an extension of its riverine logic, with “X” stations south of the Rio Grande.) The FCC’s writ did not reach across the border to Tijuana, but the Big X’s signals easily reached back the other way.

The sensible way to deal with the Big X, of course, would have been through some kind of cross-border agreement, so that each country’s stations would abide by common rules and not blow each other off the air. A grander version of such logic lies behind proposals for a US-Mexican free-trade agreement, toward which the Congress took the first step last spring.

The impetus for such an agreement actually came from the Mexican side. After his election in 1988 at the age of forty, President Carlos Salinas de Gortari began a series of economic reforms that were in their way as remarkable as the economic changes in Eastern Europe at the time. He sold state-owned industries to private investors; he had a famous showdown with a corrupt labor boss who had in effect run the state petroleum industry; he reduced government spending, lowered tariffs, and generally applied market-style reforms like those he had studied at the Kennedy School at Harvard. Shortly before Salinas took office, the Mexican inflation rate had been 200 percent per year; this year it is about fifteen. Eight years ago, the Mexican economy was one of the weakest in Latin America; now it is probably the strongest.

Salinas is far from solving Mexico’s endemic problems of corruption, rapid population growth, and poverty but his administration has so far been less corrupt and more imaginative than its predecessors. Mexico’s economic policies had long been influenced by fear of domination by outsiders, especially the gringos to the north. The Mexican constitution, for instance, prohibited foreign interests from investing in or controlling the country’s natural resource industries, especially petroleum. Salinas, by contrast, began issuing invitations to foreigners and making public gestures of friendliness toward them. He enrolled his children in the Japanese school in Mexico City. He traveled to Japan and Europe in search of investment, and he was invited as the featured speaker at the World Economic Forum in Davos in February of last year.

As it turned out, the Davos meeting was dominated not by discussions of Mexican economic reforms, as had been planned, but by the changes in Eastern Europe that had immediately preceded the meeting. On the final day of the Davos gathering, when Mexico was supposed to be at the fore-front of the conferees’ minds, there was a dramatic panel discussion in which the new prime ministers and presidents of all the Eastern European countries appeared together for the first time. According to one report, it was on the long flight home from Davos that Salinas decided he couldn’t count on attracting the immediate attention of European investors, who would for the foreseeable future be engrossed in their own continental affairs. Japanese investors also seemed apprehensive about putting their money into an economy that had long been chronically unstable. Salinas decided instead that Mexico’s best hope lay in the Americas, and that Mexico should try to be included in the free-trade agreement that had just been negotiated between Canada and the United States.¹ (By this gesture toward the North Americans, Salinas reawakened the interest of the Europeans and Japanese, who have since announced plans to increase their investment in Mexico.)

This represented a significant change for Salinas himself, as well as for his country. In the fall of 1989, as the US-Canadian agreement was about to be signed, Salinas said that Mexico should definitely steer clear of it, because of the obvious differences between its economy and the other two. He later told a French reporter that he had altered his position “because the world is changing so quickly, and I’ve had to follow the rhythm of the world.”²

Salinas sent representatives to Washington in the spring of 1990 to discuss the possibility of a North American Free Trade Agreement, which would remove most of the tariffs, import quotas, regulations, and other restrictions on trade and investment among the United States, Canada, and Mexico. Each country has announced that certain policies and restrictions are off-limits, and won’t be touched by treaty negotiations. Mexico, for instance, says that it must stand by its constitutional prohibitions on foreign entry into the oil business, along with other parts of the Mexican legal code. The United States has emphasized that it will try to extend its environmental protection policies into Mexico. Otherwise, chemical plants, paper mills, and other potential polluters could simply move south of the border and avoid cleanup costs. But the general intent of the agreement is to permit businesses to move more freely across borders. Under current Mexican laws and policies, American high-tech firms that want to sell in the Mexican market usually have to take on Mexican partners, build research centers in Mexico, and otherwise pay to enter the market. Under current American policies, Mexican citrus growers and some other farmers are simply forbidden to sell in the US during certain seasons, and garment makers and other manufacturers are subject to tariffs. The idea of a free-trade agreement is to remove these encumbrances over a period of several years.

The Bush administration responded favorably when Salinas suggested free-trade negotiations. Such a plan seemed to represent an extension of free-market principles, rather than protectionism; supporting it was a way of rewarding Salinas for his economic reforms. After Iraq invaded Kuwait that summer, Bush was additionally grateful to Salinas (as Morton Kondracke pointed out in The National Interest) for pumping more Mexican oil and thereby supporting the embargo against Iraq.

In response to the Mexican initiative, therefore, the Bush administration began to argue that region-wide free trade was the way for the US, Mexico, and Canada all to prosper. Administration officials have also implied, rather than explicitly stated, that any plan that made Mexican society more stable and prosperous would be good for the United States. In response to frequent predictions that Europe and East Asia were evolving into trade blocs dominated, respectively, by Germany and Japan, the United States, administration officials have said, could take satisfaction in the formation of a New World trading zone potentially stretching from Alaska to Argentina. With a trading bloc of the Americas in prospect, the US would seem to be prepared for whatever surprises the international economy might hold. Ideally (according to prevailing reasoning in Washington), the US could use the prospective bloc as a bargaining tool, to keep the Europeans and Asians from walling themselves off: if they wanted to sell in the Americas, they would have to keep their home territories open to US trade. And if the others nonetheless persisted with trade-fortress plans, the US would have a comfortable base in this hemisphere.

Unfortunately, this bargaining-tool concept of an American trade bloc ignores some crucial questions of scale. The economies of Western Europe are together larger than the US and Canadian economies combined, and they may eventually integrate many of the East European economies. Mexico’s entire economy adds only 2.5 percent to the current US-Canadian total. The economies of Japan, Korea, Taiwan, and the Southeast Asian nations are together roughly as large as that of the US—and are growing so much more rapidly that Japan’s economy alone may be larger than the economy of the US within fifteen years. During the last decade, Asian economies as a group have grown five times as fast as those of Latin America. A bloc-by-bloc division of the world that ties the US economic future much more tightly to the Americas is not so promising for the US.

This spring, Congress gave the President “fast track” authority to negotiate a treaty with Mexico. This is a commitment by Congress to accept the treaty as the administration negotiates it and to vote for or against it, instead of amending or revising its terms. Republicans voted almost unanimously in favor of granting this authority. The Bush administration urged them on with the argument that a vote against “fast track” negotiations would be a “vote of no confidence: no confidence in American farmers, American workers, American entrepreneurs.” Most Democrats in the House voted against it, arguing simply that American workers would lose their jobs to Mexicans. But Hispanic Democrats from the Southwest were enthusiastic about the plan, as a step toward closer US-Mexican relations. With their support and that of the Republicans, it carried in the House, and won easily in the Senate. Negotiations are now under way, with both the Mexican and US administrations eager to get the plan through Congress by next spring, before it can become an issue in the US presidential campaign.

Entirely apart from whether the proposal might help the US economy, the political debate over it is useful simply because it will concentrate attention on issues of trade policy that are usually neglected. Most economic decisions boil down to questions of how to balance theory and practicality. According to the economic theory that is now dominant in the US, governments should never interfere with business, since regulation always costs someone money. But in practice, governments always have other goals besides sheer economic efficiency in mind—protecting the Arctic environment, for example, rather than opening it for oil exploration, keeping children in school and out of factories rather than leaving this decision to market forces, protecting some inefficient industries rather than letting the communities that depend on them collapse all at once.

During the last five years the European community, to a degree many once thought impossible, has been able to combine its economic and non-economic goals. Its leaders have acknowledged certain interests that are not economically “rational,” such as France’s desire to keep relatively inefficient farmers on their land, but has still moved ahead toward economic integration and deregulation.

The United States has sometimes shown a similar ability to act on two principles at once. Immigration law, for instance, reflects the belief that immigrants are an economic benefit to the country—but also the knowledge that absorbing them can be difficult and disruptive. Therefore, the US accepts more immigrants than any other country, but doesn’t just open the borders. The political consensus has been that immigration will proceed more smoothly, and more immigrants will ultimately be accepted, if there are some guidelines and controls. In each case—European integration and American immigration policy—the debate never became purely theoretical. The French were familiar with the German economy; Americans knew what immigrant communities were like. Most Americans have a mental picture of Mexico, however imprecise it may be, and hardly any at all of daily life in Singapore or Taiwan. This may make it easier to blend theory with reality in discussing trade policy toward Mexico.

The books and reports under review about the US-Mexican trade proposal are, in effect, attempts to apply the immigration policy model to economics. (For the record: I know one of the authors of the Economic Strategy Institute book, Clyde Prestowitz.) They all agree that opening up markets is usually good and that an agreement with Mexico can be beneficial to both sides. But, they say, the mere fact of lowering trade and investment barriers between the countries will not automatically help the United States, and Americans should pay close attention to the precise terms of the deal. The papers from the Economic Policy Institute, or EPI, are mainly devoted to warnings about how a US-Mexican agreement could go wrong. The book by Prestowitz and Cohen for the Economic Strategy Institute, or ESI, is a more comprehensive argument about how the US could turn the agreement to its benefit.

A recommendation to pay attention to details might sound mindlessly obvious, if applied to any commercial contract, or to an international arms-control treaty. But it represents a challenge to the economic orthodoxy sustained by most economists and proclaimed by the Bush administration. The classic free-trade argument holds that reducing barriers is virtually always good, regardless of the details. The less a government interferes with the flow of money and products, the fairer and more efficient international competition will be. The companies that make the best products will prevail in the markets, and customers will take advantage of their higher quality and lower prices. When Bush administration spokesmen have explained the US-Mexican deal, they have generally defended it in an axiomatic formulation: it lowers barriers, so it must be good. Therefore, to say, as the ESI and EPI authors do, that a free-trade agreement will be desirable or not, depending on its details, is in itself significant.

Robert Kuttner’s The End of Laissez-Faire, which was published last year, demonstrated how powerful the orthodox belief had been in shaping American policy after World War II. America’s postwar goals for the world were, on the whole, liberal: to promote democratic political systems and foster market-based economies, which would also help to contain the Soviet influence. But, for reasons Kuttner elaborates at length, the US government convinced itself that liberal goals were inseparable from laissez-faire means. That is, it argued that if governments just stopped interfering, economies would automatically grow in the optimal way.

This lesson was at odds with America’s own eighteenth- and nineteenth-century experience, in which the government actively built canals, promoted agricultural research, trained engineers, and in other ways tried to improve the conditions for industrial development. The lesson was also completely at odds with what the Japanese, Koreans, Germans, and French actually did during the postwar period, as they actively used government policy to help their economies grow. The US did not penalize them for this deviation, Kuttner said, because keeping them as allies against the Soviet Union was more important than any other goal.

Instead of preaching, Kuttner’s book concluded, the US should have learned that a government can sometimes achieve a liberal goal by moderately intervening in the economy, rather than standing back and letting market forces lead where they will. For instance, the Japanese and Korean governments have for decades tampered with interest rates and banking rules, in order to convince citizens to save more, and companies to invest more, than normal market forces would justify. The financial markets have therefore been technically less “efficient” and rational than America’s, but much more effective in amassing capital for industry to use.

Kuttner devoted much of his book to an explanation of one of the great, recent failures of laissez faire: the experiment in freely floating currency-exchange rates. In the early 1970s, Richard Nixon revoked the traditional American promise to redeem dollars for gold at a flat rate of $35 per ounce. In the late 1980s, the major industrial powers agreed to intervene actively to keep exchange rates from bobbing wildly up and down. During the period in between, currency values were left largely to forces of supply and demand. In theory, active and unregulated currency-trading should have efficiently found the “right” price for the yen, mark, and dollar. In practice, currencies shot wildly up and down in speculative swings, with terrible effects on the real economies of the major countries. When businessmen could not predict what their costs in marks, dollars, or yen would be six months from now, they were reluctant to make investments that would be amortized over ten or twenty years. From that experience, Kuttner said, the major powers concluded that they should intervene to limit currency swings. A modest amount of guidance and interference would lead to a system that was freer and more productive for its participants.

In the case of the Mexican trade deal, the laissez-faire hypothesis is that simply removing tariffs and other restrictions will help both sides. The United States will sell more computers, pharmaceutical products, and wheat in Mexico. Mexico will sell more oranges, radios, and jeans in the United States. Because Mexico now imports about two thirds of its capital goods from the United States, the increased Mexican exports themselves will help the US economy. For every additional shirt a Mexican factory sells to an American under the free-trade deal, some American will have sold additional thread, or machine tools, or packaging equipment to companies in Mexico. The International Trade Commission, which produced the major governmental study of the likely effects of a free-trade agreement, predicted that the US would export more automobiles, electronic equipment, and clothing to Mexico with the deal than without. This promising conclusing, however, rests on two dubious assumptions: (1) that no existing American factories will relocate to Mexico in order to save on labor costs, and (2) that factories already in Mexico will continue to rely on American components, even though the agreement, strangely, makes this less attractive than it is now.³

The Economic Strategy Institute (ESI) book, The New North American Order, and the Economic Policy Institute (EPI) papers concede that a deal with Mexico can be economically desirable for both countries. They agree that it makes strategic sense for America to promote prosperity and social stability within Mexico. But they challenge the assumption that a free-trade agreement will automatically help manufacturers in the United States. In particular, they challenge several crucial economic assumptions that the Bush administration has made in promoting the deal.

Probably the most important assumption is that the huge difference in pay and overall living standards between the countries will lead to a mutually beneficial division of labor, by sending the appropriate jobs to the appropriate locations. Common sense seems to suggest that this would occur. Jobs that don’t require elaborate production equipment or highly refined skills will gravitate to places where the labor is cheapest. More highly skilled jobs will stay in the higher-wage United States. Americans will make fewer of their own shoes, but will sell more pharmaceuticals and telecommunications systems to the Mexicans.

The rougly five thousand maquiladora assembly plants, which American and Japanese firms have set up on the Mexican side of the border, illustrate the expected process. Inside the plants, young Mexican women (usually) sit at benches welding or riveting together the parts of a TV or computer. The parts themselves come from outside Mexico, usually from the United States, which is where the finished products also go. The more the maquiladoras sell to the United States, the more they have to buy from the US.

The ESI and EPI authors say that this picture of future US-Mexican interactions is probably misleading. Wages in Mexico, they argue, may be permanently, or at least artificially, lower than wages in the United States. As a result, the agreement could shift more high-value work out of the US than it creates.

The basic problem outlined in both reports is that in modern capitalism some of the ingredients of production are much more mobile than others. Money flows very easily from country to country. It flows much more easily into Mexico than it did ten years ago, because the country has removed many of its restrictions on foreign investment. Under the new agreement, it would flow more easily still, since American companies could invest in plants in Mexico and export their products back to the United States without paying tariffs. Technology moves almost as easily as money. If you want to make very advanced hard-disk computer drives, you mainly need the right tools for shaping the disks. You can build a factory that contains them almost anywhere on earth. But people do not move as easily as money and technology do, not even between Mexico and the United States. The result of this uneven mobility, according to the reports, is an international labor market that becomes skewed in strange ways.

When advanced factories are set up in Brazil or Thailand or Mexico, they are almost as productive as those in the United States. The machinery makes most of the difference, and, as the reports emphasize, it can be moved. The people who work in these plants are often at least equal to their American counterparts in training, and usually superior in their gratitude for the job. But because they compete in a labor market full of shoe-shine boys, peasants, and tens of millions of the underemployed, the pay for these Mexican (or Brazilian or Thai) factory workers remains depressed.

The resulting imbalances between pay and productivity can be quite dramatic. The economist Harley Shaiken, of the University of California at San Diego, has done studies of automobile factories on both sides of the border which are cited in the ESI and EPI reports. Plants making engines in Mexico are on average 80 percent as productive as plants in the United States, but their wages are only 6 percent as high. Steel plants in Brazil are 60 percent as productive as those in America, but Brazilian workers earn only 10 percent as much.

Eventually the wage gap between the US and Mexico will shrink to some extent. Wages for skilled Mexican workers will be bid up, to reflect their greater productivity and the fact that workers with such skills are not easy to find. Wages for American factory workers have already been forced down, reflecting the fact that there is less demand for labor. But the gap can remain large for a very, very long time, since its fundamental cause is the immobility of labor. The US-Mexican border is obviously porous, but people can’t move as easily as they can from state to state within the US. If workers could move freely from country to country, many more Mexicans would be earning higher wages in the United States. Robert Blecker, an economist from American University in Washington, has prepared the accompanying chart showing wage movement in North America over the last decade. (See Figure 1 on the following page.) Since 1982, when oil prices collapsed and the third world debt crisis began, Mexico’s productivity has gone up by more than 10 percent. In the same period, its wages have fallen, in real terms, by more than 30 percent, mainly because the value of the peso has fallen so dramatically.

Jeff Faux and Richard Rothstein of the Economic Policy Institute point out that, according to estimates prepared by the International Trade Commission, eliminating the trade barriers that existed between Mexico and the US in the 1960s would have closed the wage gap between the countries by 18 percent. Lower trade barriers tend to equalize wages because they encourage investors to view workers on either side of the border as part of one big labor pool. The barriers that still remain are much lower than those prevailing in the 1960s, Faux and Rothstein say. Therefore, removing them should have even less effect. They add:

Another factor limiting Mexican wage increases will be the probable displacement of large numbers of subsistence farmers who will not be able to compete with highly mechanized US grain farmers in a free trade regime [because the prices of freely imported US grain will be much lower]. Some Mexican farmers may find work in fruits and vegetables (which are not so mechanized) for export, but the net result will undoubtedly be the displacement of millions of peasants. Rural workers, flooding the industrial labor markets, will put further downward pressure on wages which could more than offset any labor market tightening effects of increased investment.

In the long run, of course, international wage differences are a force of nature, which all companies and economies must adjust to. But this raises the second question about optimistic American assumptions: whether the adjustment will work out best if the government declares a hands-off policy and simply lets it happen, instead of trying to guide and shape the result.

As the ESI book points out, a useful test case occurs in Asia. The economic relationship between Thailand and Japan is roughly comparable to that between Mexico and the United States. The main difference is that Thailand and Japan don’t share a border, and people can’t move easily back and forth between them. (This year Japan has roughly doubled its expulsions of illegal aliens who have come to work in the country’s construction sites, small factories, and urban “entertainment” industry. More Thais were deported than any other nationality.)

When the value of the yen roughly doubled, between 1985 and 1987, Japan suddenly became a very expensive place to produce anything. A gap between pay and productivity opened up between Japan and Thailand much like the one that now exists between the United States and Mexico. Since 1985, Japanese companies have poured investments into Thailand, so they can make ball bearings, VCRs, auto parts, and many other goods much more cheaply than they could at home. Foreign investment in Thailand was almost ten times bigger in 1990 than it had been in 1985, and Japan accounted for most of the increase.

The consequence of this investment has been to place both countries in a stronger position in world trade. Japan no longer exports the ball bearings, VCRs, and so forth that are now being made in Thailand. But it sells Thailand the recording heads and other high-value components that go into VCRs, the machine tools that make ball bearings, the construction equipment that builds factories, and the computer systems that run production lines. As a result, Japan’s trade surplus with Thailand has actually increased in the last five years, as Japan’s factories have relocated there (see Figure 2, “Thai Japanese Trade, 1983–1990”), and the products Japan sells to Thailand have become more sophisticated and hightech. Thailand, in turn, sends most of the goods made in these factories out as exports to other countries (not Japan). Although its trade with Japan has run larger and larger deficits, Thailand has shown increasing surpluses with the rest of the world, especially the United States. (See Figure 3.)

By itself a trade surplus is meaningless. But if it is achieved with higher value exports and a strengthening currency, it means that a country is succeeding by the most important economic measure: its people are earning more for their work. (The United States, on the other hand, has had big trade deficits with a falling currency.) “Japan has been able to use its size-able and growing foreign investments to turn its low-wage neighbor into an export platform to the rest of the world for Japanese companies’ products, thereby improving the competitiveness of both countries,” the ESI study says.

A symbiosis resembling the one between Japan and Thailand could also happen between the United States and Mexico, according to the ESI authors, but it will not automatically occur. The crucial element in the Asian case was Japan’s determination to integrate Thailand’s production with Japan’s in order to export to other countries, rather than merely shifting production to Thailand to take advantage of lower wage rates and sending the products back to customers in Japan. As costs rose in Japan, Mitsubishi or Hitachi factories there specialized in making complex, high-value components. These were shipped to Mitsubishi or Hitachi factories in Thailand, where lower-paid workers assembled them into finished products. The finished goods were typically reexported, principally to the United States.

American multinationals will not automatically take a similar approach, the ESI study says. Their typical strategy has been to move most or all manufacturing operations to lower-cost sites overseas, and then to bring the finished products back into the United States rather than exporting them elsewhere. The net effect has been to lower costs for American consumers and to create jobs for managers and financiers in America, but also to increase the US trade deficit and eliminate manufacturing jobs in the United States. The Japanese approach, by contrast, sustains its trade surplus and leads to more highly skilled manufacturing jobs within Japan.

The contrast between the US and Japanese corporate strategies is one factor behind the most socially destructive economic trend of the 1980s: the growing gap in income between Americans in the professional/ financier/manager class and everyone else.⁴ Japanese corporations, with government guidance, act in such a way as to keep the largest possible share of highly skilled jobs inside Japan, which helps to narrow the differences between high and low incomes and to give Japan a more level distribution of income than is the case in the US.

American corporations have generally looked for the cheapest sites from which to serve the American market—and, according to these reports, will do so with Mexico unless the government provides otherwise in the free-trade deal. In advocating a free-trade agreement with Mexico, the United States, according to the ESI report,

was about to repeat in its dealings with Mexico many of the mistakes made in previous trade negotiations during the post-World War II era…. Major differences among various kinds of capitalism were being assumed out of existence, with most Americans displaying as little understanding of the true nature of Mexican economic reforms as they have displayed of the Japanese economy…. The United States was planning on entering the talks armed with only a slogan: Free Trade. It was following an approach that was once acceptable in an age of overwhelming American economic predominance, but that we can no longer afford.

In place of the slogan, the reports propose a number of very detailed incentives that would have the effect of stimulating growth and development in Mexico without intensifying the problems the United States already has. The agreement should “discourage the development of Mexico as first and foremost an export platform into the United States” for companies based in Japan and elsewhere, the ESI book says, and instead should promote a kind of complementary industrial relationship, like that between Japan and Thailand. Doing so will entail government “interference,” such as carefully negotiated “rules of origin” to determine whether products from Mexico are really made there, or are simply bolted together from imported components.

For example, the agreement might specify that if goods from Mexico are to enter the United States duty-free, at least 60 percent of their value must have originated in Mexico (or the US), not somewhere else, particularly Japan. “Rules of origin” can be a nightmare to administer. To take one instance, the US Customs Service is now accusing Honda of having rigged its accounting rules to inflate the “North American content” of its cars. Cars made in Canada or the US, whether in American- or Japanese-owned factories, must be at least 50 percent “North American” in content in order to pass duty-free across the US-Canadian border. Honda says its cars are well above that level; Customs says they are well below. Still, “rules of origin” are not any harder to enforce than those of the IRS or the SEC, which we consider necessary despite their complexity.

European negotiators have more or less successfully applied just such rules in preparation for their integration next year. American and Japanese companies have been investing in new factories and laboratories within Europe, so they can be counted as European “insiders” in 1992. Europe almost certainly has more investment with such rules than it would have had without them. The United States could apply similar guidelines to its relations with Mexico.

The guidance will, of course, be more effective if the United States follows the other part of the Japanese and, to a degree, European formula: developing the educational system and providing the investment incentives that will support an economy with high wages and high technology. But that won’t be resolved during the next year, and the agreement with Mexico might be.