Cross-Border Economic Bulletin - September 2001
Regional Manufacturing Clusters

Conventional wisdom holds that Mexico should expect a decline in maquila activity whenever the U.S. economy slows down. Recently, supporting evidence for this view has come from the conjunction of a drop in U.S. economic growth and the decline in maquila employment that began in November, 2000 and has carried through into 2001.

More ominously, some observers of the Mexican economy have argued that the current decline in maquila employment could be the beginning of a long term decline in manufacturing along the border. According to this view, Mexico’s border region cannot compete for investment once China enters the World Trade Organization.

This issue of the Cross Border Economic Bulletin argues that both views are wrong. While the U.S. slowdown has probably had a negative effect, other factors probably account for the bulk of the downturn in maquila employment. Most importantly, the appreciation of the peso makes investment in Mexico more expensive and exports less competitive, but in addition to the peso, the new maquila tax regime continues to be a source of uncertainty.

Regardless of these temporary factors, manufacturing is growing roots in the region which will be able to withstand a great number of shocks over the long run, including China’s entry into the WTO. The key points of this months Cross Border Economic Bulletin are:

• Foreign direct investment in Mexico and in Baja California declined during 2000;
• Nearly three-fourths of maquila employment in Baja California is in firms of U.S. or Mexican origin;
• A handful of industrial sectors account for the vast majority of maquila employment;
• There is a significant overlap between several of San Diego County’s regional clusters, as identified and defined by SANDAG, and Baja California’s maquilas;
• Overlapping industries can create regionally integrated economies that combine R&D with manufacturing in a more cost effective way than can be done elsewhere

Recent investment trends in Mexico and Baja California
When the peso or any other currency appreciates, it becomes more expensive for foreigners to invest in the country, since prices of land, labor, and capital, rise when measured in currencies other than the peso. Similarly, Mexican exports become more expensive and less competitive in foreign markets—or, alternatively, prices in foreign currency terms remain fixed and profit margins shrink.

Since the beginning of 2000, the peso has appreciated against the dollar nearly 15% in real (inflation adjusted) terms. Furthermore, given that the dollar has been relatively strong against the euro, the yen and other major world currencies, the peso has been extraordinarily strong against other world currencies. It is not surprising, then, that foreign direct investment, or FDI, (investment in real assets such as real estate, businesses, capital equipment, and other tangibles) declined in 2000, as shown in Table 1.

Table 1: Foreign direct investment in Baja California and Mexico, 1994-2000
(Millions of Dollars)

While foreign investment fell in 2000, the maquiladora industry continued to receive more foreign funds and captured a larger share of total investment, as shown in Table 2. Foreign investment in maquilas (Table 2) is a subset of the figures in Table 1

Table 2: Foreign investment in maquilas in Baja California and Mexico, 1994-2000
(Millions of dollars)

There are several potential explanations for the decline in FDI in 2000, including the peso, the impact of the U.S. slowdown, and uncertainty over the outcome of the Mexican presidential election. Given that the U.S. accounts for only about one-half of FDI, and that its economy did not begin to sputter until late 2000, it seems unlikely that it is a major part of the explanation.

Country of origin of Baja’s maquilas
Much of the recent literature on the maquiladora industry in Baja California has stressed the importance of Asian investment. This is perhaps at least partly responsible for the fear that China’s entrance into the WTO—signifying its integration into normal world trading practices—will entice a significant share of Baja’s maquilas to relocate. The geographical and cultural distance between China on the one hand, and Korean and Japanese businesses on the other, is not so great, particularly when it is acknowledged that both Japan and Korea have large investments already in place in China.

Table 3 shows the country of origin of the maquilas in Baja California. Firms from Japan and Korea account for about 22% of total employment, while firms from the United States and Mexico are responsible for over 72.5%. The remainder is mostly European in origin, and makes up the final 5% of employment. While it is possible for U.S. and Mexican based firms to leave for more distant locales, it is reasonable to assume that a move to China would be far more difficult than it might be for Korean or Japanese firms, and not only for reasons of cultural and geographical distance.

Table 3: Maquilas in Baja California, by country of origin

Economic sectors of Baja’s maquilas
Another consideration in thinking about the likelihood that some of Baja’s maquilas might relocate, is the degree to which the local maquiladora industry is part of a region-wide, binational, cluster (or agglomeration), of manufacturing firms. Economic theory is clear that under certain circumstances, firms in the same industry derive benefits from each other, causing the average level of efficiency to increase as the size of a particular industry grows. To date, there has been a great deal of interest in trying to analyze linkages between firms in San Diego and Baja California, but most of these efforts have been piecemeal or have been stymied by the lack of detailed sectoral data for the maquila industry.

On the U.S. side of the border, researchers at the San Diego Association of Governments (SANDAG) have identified 16 regional (San Diego county) clusters of economic activity. Economic clusters are defined by SANDAG as “inter-related industries that drive wealth creation in the region.” Unlike a traditional classification of economic activity, clusters “represent the entire value chain of a broadly defined industry.”

The following data is derived from a business directory of maquila firms. The data overlaps official Mexican government data, but rather than relying on the number of firms registered, it establishes positive contact with each firm before it is listed. This makes its total numbers somewhat lower than INEGI’s. In addition, the directory lists the detailed industrial category of the primary output.

Using the same classification scheme as SANDAG, and ignoring non-maquila firms in Baja California, at least four binational manufacturing clusters are visible in the region. These include the mature cluster (low growth but a primary driver of the economy) of computer and electronics manufacturing, and three emerging clusters (young, fast growing, increasingly important) of biomedical products, environmental technology, and recreational goods manufacturing.

Table 4: Regional manufacturing clusters

The presence of similar industries on both sides of the border does not establish the importance of cross-border linkages. Nevertheless, an interesting pattern is visible in Table 4. Specifically, San Diego’s firms are relatively small, on average, while Baja California’s employ 10 to 20 times more, on average. One interpretation is that firms in San Diego are involved in research and development activities, in which larger firms often have no particular advantage, while Baja California’s firms are engaged in manufacturing, where size and economies of scale come into play.

Taken together, these four clusters account for about 39% percent of maquila employment. The link between each cluster and its San Diego counterpart remains to be examined and is beyond the scope of this Bulletin. Nevertheless, the possible presence of binational clusters combining San Diego’s strengths in R&D with Baja California’s growing manufacturing capabilities, is an exciting prospect. This combination of strengths is rare in the world economy, and it should give pause to forecasters who believe that regional manufacturing is doomed.

The Cross-Border Economic Bulletin is prepared monthly by Dr. Jim Gerber, professor of economics at San Diego State University. It is underwritten by Concert, a global venture of AT&T and BT.