IV International Trade and Investment Liberalization: Mexico’s Experience and Prospects (2024)

A Historical Overview

In Mexico, import substitution policies and restrictions on foreign investment were a major part of the postwar development strategy. High tariffs and a wide-ranging import-licensing system on competing imports were put in place to encourage import substitution and a high degree of self-sufficiency. The 1982 balance of payments crisis initially led to a further tightening of Mexico’s trade regime. Reliance on quantitative import controls reached the maximum degree of restrictiveness in 1982, and duties on selected items were increased further (the maximum tariff was 100 percent). Duties were particularly high on consumer goods and agricultural items. At this time, import-licensing requirements, or “prior import permits” (PIPs), were the primary policy tool used to control imports. In late 1982, virtually all imports required a prior permit. Finally, exchange restrictions reinforced trade restrictions.

As a result of the protective system, the overall incentive structure favored production for the domestic market. The average rate of effective protection for the home market was high, and the range of effective protection rates wide. Although some direct incentives for exports were provided, there was a distinct bias against exports. In the 1970s and early 1980s, the external competitiveness of most tradable goods industries deteriorated and non-oil exports were slowed by the combination of an appreciating exchange rate and severe import restrictions.2

Policies with respect to foreign direct investment were based on Article 27 of Mexico’s Constitution, which specifically forbids foreign control of natural resources and other parts of the “national patrimony” and on the 1973 “Law to Promote Mexican Investment and Regulate Foreign Investment” (LFI). The LFI specifically reserves certain economic activities for the Government and others for Mexican nationals. The first category includes petroleum and other hydrocarbons, basic petrochemicals, development of radioactive minerals and the generation of nuclear energy, mining in specified cases, electricity, railroads, telegraphic and wireless communications, and other specified activities. The second category includes radio and television, automotive transportation and transportation on federal highways, domestic air and maritime transportation, development of forestry resources, gas distribution, and other specified activities.

As a result of the implementation of restrictive investment policies, foreign direct investment played a relatively small and declining role in Mexico prior to the mid-1980s. The only form of foreign direct investment favored by the authorities was under the maquiladora (in-bond industry) program.3 Maquiladora establishments were allowed to be 100 percent foreign owned, whereas other ventures were restricted to minority foreign ownership.

Implications of Traditional Trade and Investment Policies

By the early 1980s, the long-term implications of the extensive protection of the domestic economy became apparent. Trade and exchange restrictions limited trade flows and severely distorted the relationship between international and domestic prices. The import substitution policy promoted and protected an industrial sector that was generally inefficient and therefore unable to compete in international markets. The wide disparities in effective protection across industries meant that resource allocation remained significantly distorted.

The restrictive legal and regulatory environment for foreign direct investment had deterred non-debt-creating capital inflows and instilled a structural bias in favor of foreign debt accumulation. As a result of its long-standing restrictive foreign investment policy, Mexico had, in 1985, the lowest share of foreign investment of any large nonsocialist country (about 5 percent of total gross fixed investment).4

Together with the marked recovery of domestic demand in 1984 and an appreciation of the peso in real effective terms, this trade policy stance contributed first to a deceleration of non-oil export growth, and then to a decline in 1985; at the same time, voluntary non-debt-creating capital flows dropped. Faced with such developments, the authorities adopted a far-reaching program of unilateral trade and investment liberalization. Trade and investment policies were revised in stages to replace prior import permits by tariffs, ensure greater transparency of the effective protection structure, and reduce tariff dispersion.

Changes Prior to July 1985

During the first stage of trade liberalization, from early 1983 to July 1985, Mexican markets were only selectively opened to foreign participation, by relaxing the prior import permit requirement; at the same time, tariffs were raised and the tariff structure was rationalized, including through reducing tariff dispersion. The process began with a simplification of the import tariff schedule,5 moderate reductions in import-licensing requirements, and some reductions in the number of items covered by official import reference prices. During this stage, import-licensing requirements for intermediate and capital goods that were not manufactured in the country were eliminated.6 Overall, these liberalization measures remained limited in scope and by the middle of 1985 quantitative restrictions (import licenses and official reference price) still applied to about 75 percent of total imports. Moreover, restrictions continued to apply for nearly all items that could be produced domestically.

Regarding foreign direct investment, the authorities began to liberalize Mexico’s foreign investment regime in the mid-1980s, moving away from a restrictive interpretation of the LFI in a series of successive regulations. The effects of such liberalization were manifest in an upward trend of foreign investment.

Trade Reform Policies During 1985–90

The trade liberalization process was accelerated in July 1985 with a major liberalization of Mexico’s trade and investment regimes. In stages, Mexico’s trade reforms have reduced the coverage of quantitative restrictions, as well as the level and dispersion of tariffs. Import licensing was phased out gradually, while the use of official import prices was discontinued. To a lesser extent, the number of products subject to export taxation and control also has been reduced.

Liberalization of Foreign Investment

The liberalization of regulations concerning international trade was complemented by a liberalization of foreign investment regulation. The Government aims at increasing foreign investment inflows to $5 billion a year during the early 1990s, as compared with an average of less than $2 billion in the 1980s. Consequently, efforts to attract foreign direct investment have been intensified in general by a more lenient interpretation of the 1973 LFI and, in 1989, by the revision of the regulations regarding foreign investment in Mexico.

Approval and licensing procedures for foreign investment have been streamlined since 1983. Initially, the Mexican authorities conducted a selective policy of promoting foreign investment, with special emphasis in areas related to non-oil exports and the transfer of technology, within the legal framework defined by the 1973 LFI. Steps were taken to simplify the administrative procedures for initiating and approving foreign investment projects to increase the flow of foreign capital into selected sectors. During the period 1983–85, more than 150 projects with 100 percent foreign-owned capital were approved.

In May 1989, significant regulatory changes were enacted.11 These “Regulations of the Law to Promote Mexican Investment and Regulate Foreign Investment” were designed to increase the inflow of investment capital by providing legal certainty and by clarifying investment rules. The regulations simplified the procedures for authorizing investment projects, relaxed limitations on foreign ownership by widening the range of activities open to foreign investors, and lengthened the duration of permits for certain activities.12 Also, foreign investors were allowed to own 100 percent of enterprises valued up to $100 million without need of approval from the National Foreign Investment Commission, provided that certain conditions were met.13 Finally, the new regulations on foreign investment reduced some of the barriers to entry by foreigners into the Mexican stock market. Under the new regulations, foreigners may hold certificate of participation in neutral investment trusts, which provide holders with pecuniary rights but no voting rights. As a result of the adoption of these regulations, almost 73 percent of the economy is now open to 100 percent foreign ownership without prior approval by the Mexican Government.

Contribution to Macroeconomic Performance

The comprehensive liberalization of Mexico’s international trade and investment regimes has helped reorient the system of incentives, and restructure the country’s productive base, resulting in a shift in the base of Mexico’s growth from domestic to external markets. The replacement of import quotas by tariffs improved the fairness of the trade regime and may have allowed an increase in capacity utilization in the tradable goods sector.14 Also, confronted with stronger foreign competition, companies have increased their efficiency. The manufacturing sector in particular has experienced a marked increase in productivity. Because Mexico’s trade liberalization has implied a major restructuring of domestic industry, it made Mexico’s participation in a North American Free Trade Area a realistic objective.

Also, trade liberalization measures have helped moderate pressures on consumer prices through greater external competition and have permitted access by Mexican producers to inputs at international prices, which has helped export performance and the recent acceleration of economic growth.15 Finally, success in controlling inflation and in attracting foreign capital has helped lower nominal and real interest rates, which has reduced significantly producers’ costs. This in turn has dampened further inflationary pressures and helped sustain Mexico’s external cost competitiveness.

Balance of Payments Structure

Partly as a result of the major changes in incentives, the structure of Mexico’s balance of payments has changed significantly since 1985. Non-oil exports have performed well, and automotive products, other machinery and equipment, chemicals, iron and steel products, electrical and electronic goods, and textile and clothing have become major export items.16 The value of non-oil exports (excluding proceeds from the maquiladora industry) increased by 275 percent between 1985 and 1991, while the share of non-oil exports in total export receipts rose from 32 percent in 1985 to 70 percent in 1991. More specifically, the share of manufactured exports in total export receipts increased from less than 30 percent in 1984–85 to 56 percent in 1990–91. In the event, manufactures have replaced petroleum as Mexico’s main source of foreign exchange proceeds. Also, the aggregate index of concentration of Mexico’s export base has improved significantly.17

The diversification of Mexico’s export base has reduced the vulnerability of the balance of payments to changes in oil prices. The economy may be somewhat more vulnerable to recessionary conditions in the economies of Mexico’s main trading partners, but Mexican exports have withstood reasonably well the recent recession in the United States.

Throughout the liberalization process, the maquiladora industry has continued to be one of the most dynamic sectors in the economy. Domestic value added by in-bond industries increased by 326 percent between 1985 and 1991 to reach $4.1 billion, while employment in this sector rose from 212,000 workers in 1985 to 472,000 workers in 1990. As a result, net proceeds from these operations have represented an increasing proportion of Mexico’s foreign exchange earnings, rising from 3.5 percent of total earnings in 1984 to 8.1 percent in 1990.

As expected, trade liberalization has been associated with a surge in merchandise imports. However, as a result of the more appropriate incentive structure prevailing in the economy, these imports have helped modernize Mexico’s production and export bases, enhancing the country’s medium-term external prospects. Imports of consumer goods registered the strongest percentage increase during the period under review. The value of consumer goods imports has registered a 660 percent increase since 1984 and doubled its share of total imports, to represent 15 percent of total merchandise imports in 1991. In absolute terms, however, the growth of imports has been concentrated in capital and intermediate goods. Capital goods imports, boosted by efforts to rebuild an aging capital stock, increased in value by 335 percent during the period 1984–91, while the value of intermediate goods imports increased by close to 310 percent.18

While both export and import indicators reflect the increasing outward-orientation of the Mexican economy, the growth of exports has not kept pace with that of imports. As a result, the merchandise trade account (excluding net proceeds from the maquiladora industry) has shifted to a deficit position since 1989. However, beyond the liberalization of Mexico’s trade system, the shift to a merchandise trade deficit and the widening of the current account deficit since 1989 reflect the greater availability of foreign financing related to a large extent to Mexico’s renewed access to voluntary foreign financing.19

Another implication of Mexico’s liberalization efforts has been the marked growth registered in foreign direct investment and portfolio investment. Foreign direct investment increased from an annual average of $750 million in 1982–85 to $4.8 billion in 1991. Also, portfolio investment rose from $0.5 billion in 1989 to $7.5 billion in 1991. These trends, associated in large part with a repatriation of flight capital, have contributed to the emergence of large surpluses in the capital account of the balance of payments.

The Proposed North American Free Trade Area

In June 1990, the Presidents of Mexico and the United States announced their intention to pursue the establishment of a free trade area between the two countries. During the 12 months that followed, informal discussions were held on a free trade agreement, first on a bilateral basis, then on a trilateral basis when Canada announced in February 1991 that it would join in the negotiation of a North American Free Trade Agreement.

Formal negotiations with the United States and Canada for the establishment of the NAFTA began in June 1991, after the U.S. Congress granted the U.S. Administration “fast-track” negotiating authority. After 14 months of negotiations, agreement was announced on August 12, 1992. The treaty is scheduled to come into force on January 1, 1994, after approval by the legislatures of the three signatory states.

The objectives of the agreement are to eliminate barriers to trade, promote conditions of fair competition, increase investment opportunities, establish effective procedures for the resolution of disputes, and promote further trilateral, regional, and multilateral cooperation (see Box 1 for the main provisions of the NAFTA).

The NAFTA provides for the gradual elimination of tariff and nontariff barriers to the movement of goods, services, and capital in the zone over a 10–15 year period. In sensitive sectors, the NAFTA provides special transitional safeguard mechanisms. Regarding agriculture, Mexico would convert its nontariff barriers into tariffs and phase them out over a 10–15 year period. After 15 years, the agreement will guarantee total market access in agriculture. The agreement would totally eliminate quotas on textiles among its parties. It would also create free trade in services, opening Mexico’s telecommunications market and its insurance market. Finally, the NAFTA breaks new ground for trade pacts by including provisions on the environment.

To ensure that NAFTA benefits are accorded only to goods produced in North America, strict rules of origin are specified, which would vary by sector. For instance, in the automotive sector, 62.5 percent of parts, labor, and other costs must be added in North America for a car or truck to qualify for lower duties. For computers, only 20 to 40 percent of a computer’s value need to be North American to qualify.

The negotiating parties expect that, through stimulating trade among the three countries and expanding investment opportunities, the NAFTA will spur economic growth, generate employment, and enhance the competitiveness of North American producers. The Mexican authorities in particular expect that Mexico’s expanded access to the North American market will open new opportunities for Mexican companies, help generate employment in Mexico, and increase wages. The NAFTA would reduce Mexico’s vulnerability to unilateral actions by its trading partners and would thereby reduce the uncertainty faced by Mexican producers, both through the rules being negotiated and the envisaged dispute settlement mechanism. Improved prospects for gaining access to foreign markets would help generate economies of scale, and hence efficiency gains in a number of sectors.

Also, the NAFTA is expected to improve Mexico’s position in the current international competition for capital. Secure access to the North American market would be an added incentive to investors willing to exploit Mexico’s comparative advantages. The corresponding financing flows and imports of modern technology through foreign direct investment would be an important element of Mexico’s modernization strategy and would strengthen the country’s production base and external competitiveness. Greater access to goods from Canada and the United States would give Mexicans a wider choice of products at lower prices. Finally, Mexico’s prospective participation in the NAFTA has been seen as a sign of the irreversibility of the recent structural reforms, including trade liberalization, and has already contributed to heightened interest on the part of potential investors.20

The North American Free Trade Agreement will contain an accession clause that would facilitate the subsequent entry of other Latin American countries into the NAFTA. In that sense, NAFTA can be seen as a first step toward a wider trading region encompassing all the Americas.

Contributing to a More Open Trade System Within Latin America

In the context of a broader process of regional economic integration in Latin America, Mexico is involved in three separate trade initiatives: one with Chile, one with Colombia and Venezuela, and one with the five Central American countries. The free trade agreement between Mexico and Chile has been signed already.

After nine months of formal negotiations, Chile and Mexico signed on September 22, 1991 an Agreement of Economic Complementarity. The agreement was facilitated by the fact that both countries already had implemented comprehensive liberalization of their international trade regimes and had been implementing macroeconomic and financial policies that had helped them improve their medium-term external viability. Also, consensus in both countries exists on the potential benefits to be expected from free trade.

The agreement involves a program of reciprocal trade liberalization that eliminated nontariff barriers for most goods on January 1, 1992 and will reduce tariffs in a four-year period. Beginning in 1992, a maximum tariff of 10 percent will be applied to 95 percent of the tariff categories. The treaty also provides for the liberalization of maritime and air transport. Regarding investment, the two nations pledged to grant favorable treatment to the other partner. Finally, the treaty envisages an arbitration structure to settle trade disputes. It is expected that the agreement would help raise trade flows between the two countries to $500 million by 1996.

On January 11, 1991, the Governments of Mexico, Costa Rica, E1 Salvador, Guatemala, Honduras, and Nicaragua signed an Agreement of Economic Complementarity, providing for the gradual establishment of a Free Trade Area between the six countries by the end of 1996. It is envisaged that the agreement will be implemented through a series of bilateral treaties, partly because of the economic heterogeneity of the six countries.

Finally, in April 1991, Mexico, Colombia, and Venezuela announced a plan to establish a free trade zone by July 1994. The nature of the agreement would be basically the same as in the agreement with Chile. A Memorandum of Understanding defining the rules of the negotiations has been agreed upon.

Box 1.

Main Provisions of the NAFTA

Source: “Description of the Proposed North American Free Trade Agreement’” prepared by the Governments of Canada, the United Mexican States, and the United States of America. August 12, 1992.1 Under TRQs. no tariff would be imposed on imports within the quota amount. The quantity eligible to enter duty free under the TRQ will be based on recent trade levels and will grow generally at 3 percent a year. The over-quota duty—initially established at a level designed to equal the existing tariff value of each nontariff barrier—will progressively decline to zero during either a 10- or 15-year transition period, depending on the product.2 The net-cost method is based on the total cost of the good less the cost of royalties, sales promotion, and packing and shipping. It also sets a limitation on allowable interest.3 Excludes government procurement, financial services and energy-related services, air services, basic telecommunications, social services, and maritime industries.

1

In addition to commitments to reduce tariffs and phase out quantitative restrictions (QRs), Mexico signed the GATT codes on licensing procedures, antidumping, customs valuation, and technical barriers to trade.

2

Traditionally, export taxes played a relatively minor role and were applied mainly to petroleum products and agricultural exports. Similarly, export controls or prohibitions applied to a limited number of items.

3

Under the maquiladora program introduced in 1965, component and raw materials needed for maquiladora operations are imported duty free. The finished products are then exported (mainly to the United States) with the manufacturer paying U.S. tariffs on the value added in Mexico only.

4

See United States International Trade Commission (1985), p. 185 and (1990).

5

The number of tariff categories was reduced from 13 to 10, but tariffs remained in the 0–100 percent range.

6

This included the provision of unrestricted authorization for certain essential items, such as Pharmaceuticals; the exemption from prior authorization for some 1,703 tariff items; the shift of certain raw materials and intermediate goods not produced locally to the free exchange market; the automatic approval of permits for 275 essential inputs for small and medium enterprises; the permission for unrestricted imports of machinery up to $100,000, subject to certain requirements; and selective authorizations to address problems associated with the scarcity of some items or oligopolistic practices in certain sectors. Concurrently, however, imports of 1,850 items were prohibited for protective reasons and to discourage the consumption of luxuries, and import quotas were set for a number of items; import authorizations for most of the items subject to prohibition or quota had not been granted since late 1981.

7

Starting January 1, 1991, imports of new automobiles were allowed up to a limit equivalent to 15 percent of domestic sales while the liberalization of regulations affecting imports of light trucks will enter into effect in 1993 and those for heavy trucks in 1994.

8

It was announced that by October 1988 tariff rates would be in the range of 0–30 percent, with not more than five tariff levels.

9

The terms of Mexico’s accession to the GATT allowed for maximum tariff barriers of 50 percent ad valorem until the end of 1994. Given the significant reduction in tariffs that has been achieved, Mexico has moved beyond its commitments in the context of the GATT.

10

Some basic food items and medicines continued to be exempt from duties or subject to lower tariff rates.

11

See Pastor (1989) for a discussion of these changes.

12

In particular, the May 1989 regulations liberalized investment in telecommunications services (up to 49 percent of foreign equity was allowed), secondary and tertiary petrochemical products, tourism-related businesses, and financial services. To that extent, the liberalization of foreign investment has facilitated the privatization process since several state-owned companies that were or are being sold have been opened to foreign equity investment, including companies in the telecommunications and banking industries.

13

The regulations provide for automatic approval upon registration of investment projects that meet six criteria: (1) the project is funded by foreign resources; (2) it is expected to provide permanent jobs and enhance workers’ training facilities; (3) it is deemed to involve “adequate technology” and to satisfy environmental requirements; (4) the investment in fixed assets before beginning operations amounts to the Mexican peso equivalent of $100 million or less; (5) cumulative net foreign exchange receipts are expected to balance within the first three years; and (6) industrial projects are located outside Mexico City, Guadalajara, and Monterrey. Projects that do not meet these six criteria are subject to authorization by the Foreign Investment Commission on a 45-day lapse-of-time basis.

14

For an analytical discussion of the impact of a replacement of quotas by tariffs on capacity utilization and the fairness of the trade regime, see Sahay (1990).

15

Ize (1990) concluded that trade liberalization in Mexico may have played an important role in stimulating exports and investments but the author found no evidence that it had contributed to price stabilization.

16

An increase in nontraditional exports during the initial stages of liberalization has been observed in a number of countries, see, for example, Krueger (1978).

17

The Gini-Hirschman concentration index, which is a standard indicator of the degree of diversification of a country’s export base, dropped from 68 in 1985 to 45 in 1990. The higher the value of the index (i.e., the closer it is to 100), the more concentrated the country’s export base. The Gini-Hirschman index is denned as:

where X_i is the value of the rth export good, and X is the total value of exports.

18

In 1991, intermediate inputs represented 63 percent of total imports and capital goods represented 23 percent of Mexico’s imports.

19

This aspect of Mexico’s recent experience is discussed in Section VII.

20

In that regard, the U.S. administration has stated that a NAFTA would lock in the process of trade liberalization in Mexico and assure even greater access for U.S. exports in the future. A free trade agreement would secure U.S. access to Mexican markets by preventing possible future movement toward more protectionist policies. By providing a guarantee against future protectionist trade policies, a free trade agreement would improve confidence in the Mexican economy, boosting Mexican growth and demand for imports, particularly from the United States. See Office of the U.S. President (1991).