Globalization of Industry Through Production Sharing

EMILIO CARRILLO GAMBOA

GLOBALIZATION IS A KEY TREND in the business world today. The evolution of supply, demand, and environmental factors is driving companies toward operating as if a homogeneous worldwide market existed in their industries. Many forces are pushing for globalization. A decade of peace and increasing governmental advocacy of free trade in all the major developed countries has lowered trade barriers and given a renewed impulse to global trade. In the 20-year period from 1970 to 1990, world trade will have more than doubled in importance, from 12 percent of total world production to 27 percent (McKinsey and Company, Inc., 1987).

Since demand has become homogeneous across borders, producers of major consumer goods today can use similar marketing concepts and approaches to reach the entire Western world. Thus, globalization presents both a major threat and a major opportunity, particularly in developed countries. Industries and companies that previously enjoyed relatively safe home markets now find themselves faced with the possibility of new competition from companies that had never attempted to market products in their part of the world. Globalization has made worldwide competitiveness critical for survival. However, the conquest of global markets will be the reward of the most efficient producers.

To achieve worldwide competitiveness, many managers would quickly move any factory anywhere in the world where they could get cheaper or better materials, labor, and vendors, and where laws and governments were more congenial. More and more manufacturers make parts and subassemblies in different areas of the world and then assemble the complete products elsewhere and sell them in global markets. The location of competitive producers changes constantly, and factories move repeatedly to find the most favorable locations.



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Globalization of Technology: International Perspectives Globalization of Industry Through Production Sharing EMILIO CARRILLO GAMBOA GLOBALIZATION IS A KEY TREND in the business world today. The evolution of supply, demand, and environmental factors is driving companies toward operating as if a homogeneous worldwide market existed in their industries. Many forces are pushing for globalization. A decade of peace and increasing governmental advocacy of free trade in all the major developed countries has lowered trade barriers and given a renewed impulse to global trade. In the 20-year period from 1970 to 1990, world trade will have more than doubled in importance, from 12 percent of total world production to 27 percent (McKinsey and Company, Inc., 1987). Since demand has become homogeneous across borders, producers of major consumer goods today can use similar marketing concepts and approaches to reach the entire Western world. Thus, globalization presents both a major threat and a major opportunity, particularly in developed countries. Industries and companies that previously enjoyed relatively safe home markets now find themselves faced with the possibility of new competition from companies that had never attempted to market products in their part of the world. Globalization has made worldwide competitiveness critical for survival. However, the conquest of global markets will be the reward of the most efficient producers. To achieve worldwide competitiveness, many managers would quickly move any factory anywhere in the world where they could get cheaper or better materials, labor, and vendors, and where laws and governments were more congenial. More and more manufacturers make parts and subassemblies in different areas of the world and then assemble the complete products elsewhere and sell them in global markets. The location of competitive producers changes constantly, and factories move repeatedly to find the most favorable locations.

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Globalization of Technology: International Perspectives This paper analyzes the factors that have led developed and developing countries, especially the United States and Mexico, to adopt this system, termed “production sharing.” It examines the results of production sharing to date and discusses possible policy options to achieve the best results of this global trend. EVOLUTION OF PRODUCTION SHARING FROM THE POINT OF VIEW OF THE DEVELOPED COUNTRY: THE U.S. CASE Production Sharing and Industry Life Cycles In discussions of the changing international division of labor, manufacturing industries are often classified as either traditional industries that use stable, widely understood technology to make relatively simple products or high-technology industries that use rapidly developing technology to make a continuous stream of quickly obsolete new products. The traditional industries have generally been associated with fairly labor-intensive technologies. Because of persistently low wages in the Third World and the relatively low investment needed to begin to produce these products, these industries have led the burgeoning exports of manufactures produced in developing countries. The high-tech industries, in contrast, depend for their success on access to the specialized resources required for research and development and highly complex production processes. These industries have therefore been located in the industrialized countries. As products mature and technology diffuses, high-tech products eventually become traditional products, and production moves to more competitive locations abroad. The phenomenon of production abroad may be viewed as a system geared to retaining competitiveness for firms in developed countries after a product has entered the downside of the product cycle. That is, the firms that developed the product continue to produce profitably by eventually relocating or subcontracting assembly production facilities in low-wage developing countries. When this strategy works, these firms generally have some other competitive cost advantages, such as access to capital, marketing administration, or technology, since an indigenous firm producing standard products in its native business environment presumably could do so at no greater and possibly at lower cost. Also, production processes must permit such a division of labor, and transportation costs should not be an excessive component of total costs. Growth in Production Sharing Assembly abroad has grown dramatically during the last few decades. Before wage differentials became an important factor in world trade, co-

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Globalization of Technology: International Perspectives production, linked to technology and skill specialization, was primarily a phenomenon of industrialized countries. Thus, production sharing among industrialized countries has involved sophisticated goods with technologically advanced production processes. Production sharing between industrial and developing countries is a comparatively recent phenomenon, and has been stimulated by improvements in transport and communications. The emergence of overseas assembly activities was a natural result of growing worldwide competition in the manufacturing industry in the postwar period. As Western Europe recovered and Japan quickly became an important industrial power, the United States was the first to face new competition because its wages were so high relative to those throughout the rest of the world. As domestic labor-intensive production became less and less economical, U.S. firms began breaking production into stages and carrying out the labor-intensive processes in countries where wages were low. In response to essentially the same conditions, the industrially advanced countries of Europe imported low-cost laborers, and Japan turned to automation when wages rose. Although firms in all industrialized countries have engaged in foreign assembly, U.S. firms have done by far the most. Because of a higher degree of protectionism, European countries have carried out comparatively little production abroad. In Japan, such activities have been used primarily as a means of penetrating foreign markets, although it appears that more recently Japanese companies have reimported a growing volume of products assembled for them abroad. On the other side of the coproduction relationship, the principal participants are developing countries in the Far East and the Caribbean Basin. Tariff Provisions 806 and 807 Products assembled abroad reach the U.S. market under tariff items 806.30 and 807.00 (henceforth 806/807), which permit the duty-free entry of U.S. components sent abroad for processing or assembly.* Since 1966, U.S. 806/ 807 imports, which totaled $22 billion in 1983, have grown faster than the rapidly growing U.S. import bill, rising from less than 4 percent to almost 10 percent of total U.S. imports of merchandise in 1983. The growth has been much more rapid in relation to imports of selected groups of manufactures. U.S. imports under sections 806/807 are largely confined to motor vehicles and parts, apparel, and various types of electrical equipment. Almost all the motor vehicle imports come from industrialized countries, and almost all other 806/807 imports come from developing countries. Mexico’s share of U.S. 806/807 imports has risen dramatically since 1969 *   This section is drawn from Flamm and Grunwald (1985).

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Globalization of Technology: International Perspectives TABLE 1 U.S 806/807 Imports from 15 Countries, 1969 and 1983 (millions of dollars)   1969 1983 Country of Assembly Total 806/807 Imports Value of Duty-Free U.S. Components Total 806/807 Imports Value of Duty-Free U.S. Components Industrial countries Federal Republic of Germany 627.4 11.6 2,736.7 58.9 Japan 137.9 25.4 6,489.6 175.5 Canada 340.1 118.7 1,425.9 467.0 Developing countries Mexico 150.0 97.9 3,716.9 1,908.7 Malaysia 0.4 0.1 1,203.2 695.7 Singapore 11.6 3.8 983.3 275.9 Philippines 5.2 3.5 725.9 455.6 Republic of Korea 23.8 15.9 575.6 340.4 Taiwan 68.7 23.8 568.5 100.7 Hong Kong 91.4 51.3 448.1 72.2 Haiti 4.0 2.4 197.4 139.4 Brazil 4.1 2.5 193.1 27.4 Dominican Republic 0.1 0.1 161.0 111.6 El Salvador 0.2 0.1 79.6 45.3 Colombia 0.4 0.2 29.8 20.0 Fifteen countries listed above 1,465.3 357.3 19,534.6 4.894.3 All countries 1,841.8 442.6 21,845.7 5,447.1   SOURCE: U.S. Tariff Commission (1970, pp. A-57, A-87), and special tabulation from the U.S. International Trade Commission, 1983. (see Table 1). In that year Mexico’s share was 8.2 percent. By 1983 it reached 17 percent, surpassing almost three to one the imports from any other developing country. Mexico is now second only to Japan in its share of total U.S. 806/807 imports. Organizational Arrangement of Production Sharing Much of the 806/807 trade is internal to the multinational operations of U.S. firms. In 1969 the U.S. Tariff Commission found that more than half the value of duty-free components reimported under 806/807 tariffs came from U.S.-owned investments. The remainder came from U.S. firms dealing with independent contractors and jobbers abroad and from foreign firms securing U.S. components for their exports to the United States. In most respects, this trend has continued into the 1980s. The principal exception is

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Globalization of Technology: International Perspectives the apparel industry. In 1969, according to the U.S. Tariff Commission, about four-fifths of the apparel imported under 807 was assembled by contractors or jobbers dealing with foreign subcontractors in which they had no financial interest. EVOLUTION OF PRODUCTION SHARING FROM THE POINT OF VIEW OF THE DEVELOPING COUNTRY: THE MEXICAN CASE Factors Contributing to Mexico’s Importance as a Production-Sharing Site It is not surprising that Mexico has become an important partner in assembly activities abroad, since U.S. firms can gain substantial competitive advantages by operating there. At least three major factors led to this situation. Proximity is one such factor. Mexico, a developing country, shares nearly 2,000 miles (3,200 kilometers) of border with the United States, a country that has one of the highest wage rates and is by far the largest producer in the world. The border is easily accessible, and transportation to any other overseas trading partner is available. In addition to the proximity of the two countries, they share similarities in geography and culture. Many U.S. entrepreneurs and business executives have conducted business in Mexico, and for historical reasons as well as through migration, Mexico’s culture is diffused throughout many parts of the United States. Many Mexican professionals and government officials are fully bilingual, so business in Mexico can be carried out almost completely in English. The main advantage derived from the location of new assembly operations, called maquiladoras, in Mexico is low-cost access to the U.S. market. A site in Ciudad Juarez is about the same distance from U.S. markets as a Chicago site is (see Figure 1). Similarly, a site in Tijuana is hard to improve upon as a point from which to reach the southern California market. Shorter distances translate into still other advantages. Because products can take as little as 2 or 3 days to reach their destination, inventory cycles can be cut considerably. Short travel distances also provide operational advantages, the most important of which are low investment in warehouse space and greater production flexibility. Also, because Mexico and the United States are in the same hemisphere, production-related communications that have to be handled indirectly when working with plants located in the Pacific Rim sites can be dealt with by telephone calls between managers in U.S. plants and producers in Mexico. Demography is the second factor that has made Mexico an important production-sharing partner. The United States, like all developed countries, will experience a shortage of young people entering the labor force and available for traditional manufacturing jobs. A few figures illustrate this

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Globalization of Technology: International Perspectives MILEAGE FROM CHICAGO TO: FROM CIUDAD JUAREZ TO: NEW YORK 831 NEW YORK 2,299 LOS ANGELES 2,113 LOS ANGELES 790 DALLAS 933 DALLAS 625 SAN FRANCISCO 2,205 SAN FRANCISCO 1,170 ATLANTA 722 ATLANTA 1,694 AVERAGE 1,351 AVERAGE 1,316 FIGURE 1 Mexican transportation advantage. trend. As of 1984, the U.S. economy employed 105 million people. Employment since 1975 has been growing approximately 2.2 percent annually. For this period, the average number of jobs created in the American economy has been approximately 2.1 million per year. However, the population of 18- to 65-year-olds will increase at a rate of only 0.8 percent per year for the rest of the century, with 1.2 million people annually reaching working age. Thus, on average, if the patterns of the past 10 years prevail, the number of jobs created will exceed the number of people entering the work force by approximately 900,000. In sharp contrast to the situation in the United States, about 20 million people were employed in Mexico in 1986. However, the number of 18- to 65-year-old people will increase by nearly 3 percent per year for the rest of the century, with an average of 1.5 million people annually entering this age group. Thus, each year, 300,000 more people will reach working age in Mexico than in the United States. The U.S. economy is currently about 20 times the size of the Mexican economy (see Figure 2). However, during the rest of the century, the Mexican

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Globalization of Technology: International Perspectives FIGURE 2 Relative size of Mexican and U.S. economies, 1985 (billions of dollars). economy will have to incorporate into its labor force more people than the U.S. economy. Thus, the most pressing political problem for Mexico will be the creation of jobs. To avoid extensive migration from Mexico and even the possibility of unrest, U.S. policymakers should also favor job creation in Mexico. This imbalance between the two countries in numbers of jobs and workers available will create a large wage differential that will persist for many years to come. The present Mexican economic crisis is another factor that makes production sharing an attractive option. Mexico’s economic development strategy during the 1950s, 1960s, and early 1970s was characterized by a stable, annual 6 percent gross national product (GNP) growth rate without significant inflation. This was achieved by a public spending policy that kept government finances in equilibrium by assigning the private sector an enhanced role in economic activities. Equally important was that a trade policy based on import substitution permitted the creation of a major industrial infrastructure throughout the country and also financed the education of the majority of the Mexican population. However, the Mexican government had to change this development strategy in the 1970s because it did not result in the transfer of greater numbers of people from redundant, informal economic activities, such as street vending, into productive jobs. In an all-out effort to promote job creation in both the public and the private sectors, the governments of Luis Echeverria (1970–1976) and José Lopéz Portillo (1976–1982) increased the level of public-sector spending through greater budget deficits and foreign debt. However, the results achieved were minor. Despite average GNP growth slightly higher than that in the

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Globalization of Technology: International Perspectives previous development period, the Mexican economy started on increasingly complex cycles of stop-and-go growth and dangerous levels of inflation. The collapse of oil prices brought the present foreign debt crisis and the need to restructure the economic development strategy of the country. After the crisis exploded in 1982, the government implemented a stabilization program that included measures to increase the attractiveness of production sharing. The first was a general trend toward opening the economy and eliminating trade barriers. This trend has culminated in Mexico’s joining the General Agreement on Tariffs and Trade (GATT) and gradually eliminating quotas and import permits for duties in the import sector. Second, the peso was devalued severely. Between mid-1981 and December 1982 the peso value fell from four U.S. cents to sixth-tenths of a U.S. cent, an 83 percent devaluation. Consequently, during this short period, the peso went from being seriously overvalued (by 30 to 40 percent) to being seriously undervalued. It has stayed undervalued ever since, through continuous slip-page of the parity rate of the peso. Consequently, the real cost of unskilled labor has declined and the cost of labor has become competitive with labor costs in other newly industrializing countries (see Figure 3). Simultaneously, the economy entered a drastic recession that depressed the cost of skilled labor of all types, including professionals and managers. Thus, additional advantages can be seized by hiring highly qualified workers, including managers and technicians, at a fraction of the cost of those in the United States or elsewhere. As a result of the crisis, other key U.S. imports have also become extremely FIGURE 3 Mexican industrial hourly wage rate advantage, including benefits (dollars per hour, unskilled labor). NA indicates not applicable. SOURCE: International Labor Organization and International Monetary Fund.

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Globalization of Technology: International Perspectives competitive. Energy is abundant and inexpensive in Mexico, as are many other industrial inputs that Mexico supplies worldwide. Examples of these are copper, silver, lead, zinc, ammonia, polyvinyl chloride, ethylene, fertilizers, cement, glass, cotton, essential oils, and coffee. Organizational Arrangement for Production Sharing The Mexican authorities realized the potential for production sharing in the mid-1960s. At that time, Mexico instituted its border industrialization program to increase the advantage of its proximity to the United States. This program was aimed at absorbing the potential border unemployment arising from the 1964 termination of the bracero or temporary worker program between the United States and Mexico. It allowed duty-free entry of machinery and components for processing or assembly within a 12-mile (20-kilometer) strip along the border, provided that all imported products were reexported. Thus, none of the output of assembly operations could be sold in Mexico. Subsequent Mexican legislation and administrative regulation expanded the scope of the maquila, first by exempting the maquiladoras from the Mexicanization requirements of Mexican majority ownership, and second, by permitting the establishment of maquiladoras anywhere in the country, subject to approval by the authorities. Foreign technicians and managerial personnel may reside in Mexico if their presence is considered necessary for the efficient functioning of the maquiladoras. Finally, as a part of the maquiladora promotion decree of August 1983, a firm may sell up to 20 percent of its production in the Mexican market if it complies with a minimum Mexican content requirement, established on a case-by-case basis by the Mexican Secretariat of Commerce and Industrial Development. Customs procedures and other government formalities have been eased, as a further attraction to maquila operation. Industrial parks have been promoted along the border, as well as in the interior. Production organization has taken three main forms. The first involves subcontracting with another Mexican firm to assemble an item to specification. With this arrangement, both investment requirements and institutional barriers are low, and the risk of the operation is therefore kept to a minimum. The second configuration is the so-called shelter operation. This is actually a joint venture in which the shelter provider puts up real estate, installs the plant, and provides day-to-day management, whereas the foreign firm provides equipment, specialized installations, and crucial know-how. This arrangement best uses the complementary skills of each party and consequently may be the strongest long-term configuration. Maquiladoras fully owned by foreign parent companies, however, remain the most prevalent form of production sharing in Mexico today and account for the majority of the maquila output. Since 90 percent or more of the output

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Globalization of Technology: International Perspectives is for the U.S. market, most of these subsidiaries are U.S. owned or controlled. In the past, most of the U.S.-controlled maquiladoras were subsidiaries of medium-size multinational enterprises. More recently, however, some of the giants in U.S. industry have established assembly operations in Mexico. At least 100 of the Fortune 500 companies had maquiladoras as of 1986. In addition, three of the largest Japanese firms and four of the top European consortia operated assembly plants in Mexico as long ago as 1978. Growth of Production-Sharing Operations in Mexico: Size, Product Mix, and Location Since 1965, when the border industrialization program got under way, a significant number of assembly plants have been established almost every year. In 1986 there were 844 plants, employing 250,000 Mexicans. Although this number is significant, the maquila labor force is only slightly more than 1 percent of total Mexican employment. The value added by the maquiladoras in Mexico has been increasing sharply since the beginning of the border industrialization program. In 1986 it reached $1.285 billion, surpassing tourism and border transactions as a source of foreign exchange for Mexico. Mexican assembly activities cover increasingly wide ranges: from toys and dolls to sophisticated electronic equipment (see Figure 4). Most of the plants are concentrated in six towns along the border, from Tijuana on the Pacific Ocean to Matamoros opposite Brownsville, Texas, near the Gulf of Mexico. Plants concentrate along the border to minimize the distance between assembly plants and their supply sources and markets, which are in the United States. Border towns also have a very bilingual population, and the labor force has a large cultural influence from the United States, which makes it easy to train workers in modern methods. In 1983 about 11 percent of the total, or 67 plants, were in the interior of the country. This proportion, although small, has been increasing because job creation at the border has created labor shortages in these towns and wages are increasing faster there than they are in the interior of the country. As good communication and transportation facilities become available in the interior, firms will find the labor cost differential attractive and will increasingly locate in the interior of the country. A case in point is Yucatán, which by air or sea is close to the East Coast of the United States and is experiencing a healthy growth of maquila activities. The plants are now situated throughout the country, including the three largest cities of Mexico City, Guadalajara, and Monterrey. Issues of Assembly Operations in Mexico Because so many foreign firms are involved in Mexican assembly activities, Mexicans and others have extensively debated its merits for the country.

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Globalization of Technology: International Perspectives FIGURE 4 In-bond industry value added by activity, 1982 (percentage of total value added). Classification of activity. SOURCE: Mexican Ministry of Programs and Planning. Benefits have been questioned, and serious negative effects on the Mexican economy and society as a whole have been attributed to the assembly arrangements. The critique centers on three principal issues: the absence of significant linkages of assembly activities to the Mexican economy; the effects on the labor force and on society in the areas where maquiladoras are concentrated; and the vulnerability of maquiladoras to swings in the U.S. business cycle and their general dependence on decisions made outside Mexico. Linkages with the National Economy A persuasive argument can be made that the foreign-owned assembly services have not extended their benefits sufficiently to the rest of the Mexican economy. First, only a trivial percentage of the materials used in these operations is of Mexican origin. That percentage has hovered around 1.5 percent of the total use of components and supplies during the period from 1975 to 1983. In the plants in the interior, however, the use of domestic materials has been considerably greater, ranging from 4 to 15 percent of total materials used. Next, most of the jobs created are for unskilled workers. The labor force, therefore, receives little training. Although many of the assembly plants use sophisticated equipment and tech-

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Globalization of Technology: International Perspectives nology, there is a low level of technology transfer to the rest of the Mexican economy. Furthermore, only part of the wages paid to assembly workers are spent on Mexican goods and services, because the population near the border routinely shops across the frontier for a significant proportion of its requirements. Thus, it is argued that the income generated by assembly production for foreign manufacturers will provide only a limited stimulus to the Mexican economy. There is little doubt that linkages can be improved. The experience of Hong Kong, the Republic of Korea, Taiwan, and Singapore seems to prove that assembly activities will eventually integrate assembly production into the national economy. However, to break the vicious cycles that have prevented further linkages of the maquiladora operations to the rest of the economy, specific policy actions must be undertaken. This issue will be discussed later. Employment According to several recent studies, the employment generated by the maquiladoras does not absorb traditional unemployment and underemployment. A striking aspect of the labor force in Mexican assembly industry is that women represent more than three-quarters of the total (see Figure 5). Most are quite young and have not previously been in the labor force. Relatively few of the female maquila workers are heads of households and most provide only supplementary income for their families. Thus, maquila workers in Mexico are drawn from a sector of the population that has never worked or sought work before. Therefore, one of the main original objectives of the Mexican border industrialization program, which was to absorb the rural male migrant workers left stranded by the termination of the FIGURE 5 Number (in thousands) of employees, by sex, in maquila activities. SOURCE: Mexican Ministry of Programs and Planning.

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Globalization of Technology: International Perspectives bracero arrangement with the United States, has not been accomplished by the establishment of assembly operations. The preponderance of female workers in assembly production, however, is not confined to developing countries. A greater proportion of women in the labor force is a universal phenomenon of modern economic development. Social adjustments of this type are painful, but they are a part of the contemporary process of economic development. The introduction of assembly activities into particular regions of Mexico has accelerated the need for this kind of adjustment. The Dependency Issue The Mexican assembly industry was affected to some degree by the U.S. recession of 1974–1975. Some maquiladoras closed down, and many workers were laid off. The effect of the recession was concentrated in the maquiladora operations of the electrical and electronic assembly industries. Apparel and textiles industries were not affected; employment in these sectors even increased slightly in 1974–1975. Although the effect of the recession was swift and severe, assembly activities bounced back relatively quickly. A sharp rise in Mexican wages aggravated the effects of the U.S. recession during that period. Mexican wages in dollar terms increased because the parity between the peso and the dollar was kept constant, despite a large inflation differential between Mexico and the United States. Wage increases continued to outpace Mexican inflation until 1976, reaching a level 24 percent above the 1970 level in real terms. Wage costs in assembly firms rose with the nominal wage increases. Minimum wages in U.S. dollars doubled between 1971 and 1976. It is therefore not surprising that many of the less efficient assembly operations could not bear the cost pressure and had to close. However, after the devaluation of the peso in 1976, employment levels quickly recovered. Although the growth of the assembly industry in Mexico after 1982 can be related in part to the devaluation in that year, the effects of the recent recession in the United States confirm the conclusion drawn from the experience of the mid-1970s: The downward trend of U.S. business cycles is reflected to a much smaller degree, if at all, in Mexican assembly activities for U.S. firms. The shakeout of unstable firms took place, but output and employment expanded with fewer plants, as U.S. companies transferred more of their labor-intensive operations to low-cost locations abroad. In summary, the dependency issue merits concern. Assembly production may be more sensitive to external economic conditions and decisions than are some other economic activities within Mexico. After all, foreign assembly has been directed exclusively toward exports, and it is natural that sales will depend on foreign markets. These activities are also tied to foreign decisions, either through the operations of foreign subsidiaries or through international subcontracting. However, declines in assembly operations that were attrib-

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Globalization of Technology: International Perspectives uted to U.S. recessions were relatively mild and short-lived. These effects were particularly small compared to the decline in Mexican manufactured exports during this period, not including assembly, which dropped more than 14 percent in 1975. Policy Implications for the Developing Countries: The Case of Mexico Assembly production is extremely significant for developing countries. Although it is not the primary engine of economic development, the assembly sector has been an important generator of income, employment, and foreign exchange. Despite their positive and important contributions, however, assembly activities have been regarded with some ambivalence by policymakers of developing countries. Although it is clear that national enterprise in Mexico has not gained as much as it could from assembly activities, it is unlikely that Mexico would be better off without them. The alternatives to employment in assembly activities—unemployment or underemployment—are generally much less desirable. Given the availability of large, underused resources, assembly production offers the host country significant economic opportunities. There should be two main policy objectives regarding production sharing. One is to preserve and enhance the competitive advantages of Mexico as a production-sharing site; the other should be to promote a tighter linkage of assembly activities to the rest of the economy. To enhance the competitive advantage of Mexico, it will be necessary to continue implementing the following policy guidelines: Competitive exchange rates and salary structures. Growing evidence suggests that assembly activities are highly competitive in the global environment and that the international outsourcing of production by firms is responsive to cost changes. Therefore, if Mexico wants to promote growth in its maquiladora sector, it will have to continue pursuing competitive exchange rate policies. The streamlining of administrative procedures. This deserves a high priority. Bureaucratic rigidities in the issuance of permits by regulatory authorities have fostered delays in both establishing and operating firms and should be tenaciously combated. Enhancing its transportation and telecommunication infrastructure. This will permit fuller exploitation of the advantages of proximity and culture that Mexico has with its key production-sharing market. Multinational firms will find the facilities to which they have become accustomed in their domestic dealings. In the case of Telefonos de Mexico, a special effort has been made to provide state-of-the-art telecommunications to

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Globalization of Technology: International Perspectives all the industrial parks with significant assembly activities, offering quality levels and service similar to those across the border. In linking the maquiladora industry to the rest of the Mexican economy, it can be affirmed that existing policies of free trade zones, in-bond arrangements, waiving of requirements of national ownership and content, and similar measures are designed to expand assembly operations. However, further specific policies should be pursued to better integrate the maquila sector to the rest of the country. Support of assembly activities should be aligned with the general trade policy of the country. Mexico is dismantling a protectionist trade policy that has been in place for almost 40 years because its present macroeconomic condition foresees a continued shortage of foreign exchange, and also in light of the faster growth experienced in newly industrialized countries that have opted for an open economy. Mexico has recently entered the GATT and is actively substituting quotas and import permits for duties. Mexico is also promoting direct foreign investment and embarking on an all-out effort to develop its non-oil export sector. These policies will affect assembly production very favorably. Heightened competition arising from trade liberalization will force national firms to reduce costs and increase quality, and therefore facilitate greater participation of national enterprises in assembly activities. With lower costs, firms could reduce prices of products that could serve as inputs for the assembly plants. Competition would also raise their standards of performance so they would be able to meet the more stringent requirements of export production, as both potential suppliers to and operators of assembly plants. Thus, trade liberalization policy might help increase the percentage of Mexican materials in assembly products and the participation of local capital in export activities. Along with trade liberalization, special incentives might be needed to induce national capital to venture into assembly activities as suppliers or operators. A strong inducement would be to eliminate all restrictions both on production for the domestic market and on assembly for exports. This would permit the fuller use of capacity in existing plants and reduce the risk to national capital of investment in assembly plants. Fluctuations in both domestic and foreign business can be smoothed if operations can be shifted between production for the domestic market and production for export. The attractiveness of assembly activities to local enterprises could be enhanced further by lifting the restriction on the sale of in-bond assembly products to the domestic market. Although these sales would not be exempt from customs duties on imported materials, they would make assembled items available to the domestic economy at a lower cost than if they had to be reimported after their return to the United States. Permitting the use of in-bond subassemblies as inputs for goods destined for the domestic market could also benefit producers as well as consumers by lowering costs and increasing the quality of the final goods.

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Globalization of Technology: International Perspectives One step in the right direction is the recent regulation that permits local sales of up to 20 percent of total production in exchange for an increase in the national content of the product. Firms willing to increase local content will be rewarded with domestic sales as they work to make local enterprises more efficient suppliers of components to assembly plants. Indigenous industry, once it becomes a supplier of assembly plants, will support greater access to local markets by foreign assembly subsidiaries. At the same time, the relaxation of the export requirements of in-bond production will attract national capital into assembly production. Issues of Production Sharing in Developed Countries The transfer of labor-intensive operations abroad benefits the industrial countries by lowering the cost of assembled goods to the consumer. However, it alters the wage and profit rates in the domestic economy and fosters the equalization of factor prices internationally. Import competition reduces the incomes of specific workers in exchange for general improvement in economic well-being. The obvious objective of U.S. firms in transferring assembly work abroad is to reduce the cost of production, which means lower prices to consumers. If the estimated cost savings from Mexican operations amount to approximately $10,000 per worker, the total direct savings to the U.S. economy from Mexican assembly production was roughly $2.5 billion in 1986. Although this represents less than 1 percent of U.S. value added in manufacturing, savings in cost on individual products are substantial, and the gain in welfare to purchasers, although concentrated in only a few products, is significant. For producers, small differences in cost can spell the survival of a firm. There is evidence that production arrangements with other countries have allowed certain businesses to remain internationally competitive in the face of serious threats from imports. In exchange for these benefits to an industrial country, the displacement of workers in an industry going abroad is the principal negative effect. Unskilled operators in manufacturing jobs made up only about 8 percent of U.S. employment in 1978. The continued displacement of these unskilled workers will mean the end of their relatively high income in Western industrialized nations. Trade theory predicts that wages as well as other factor prices will be equalized across countries, and continued downward pressure on real wages of the unskilled manufacturing workers seems likely. Policy Implications for the Developed Countries Recent and growing criticism of free trade in general, and offshore production sharing in particular, centers around a strong ideological belief that the key objective of trade policy is the maintenance and creation of jobs.

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Globalization of Technology: International Perspectives Adopting only this perspective, a more protectionist trade policy could perhaps be justified for the short term. However, for the wealthiest economy in the world, there are other key objectives that should also be pursued by trade policy and that clearly favor the increase of world trade and production sharing. Among these are: an increase in the welfare of society at large through access to cheaper and better products and services through foreign trade; and a geopolitical advantage that the United States and the Western world derive from advancing peaceful development. Protectionism, in its search for job protection, deprives the majority of society of the cheaper goods that free trade brings and will also create insurmountable tension among countries. Also, protectionism may deprive the less developed countries of the foreign exchange they need to import essential goods to their economies and service their debts. This will result in further economic stagnation and greater political instability, with farreaching effects for the welfare of Western society. Possible consequences include a threat to the world financial system. More countries will be forced to act unilaterally and turn their backs on the Western economic system in search of internal political support. They will then be forced to search for support in other geopolitical forces, including nondemocratic political regimes. Finally, greater foreign migration will be unavoidable, regardless of restrictive legislation and massive policing of borders. Inevitably, market pressures will cause a fall in prices of abundant resources. The growth of the world’s labor force will increase, according to some estimates, by 50 percent in the remaining years of this century. An additional 750 million people will enter the labor force by the year 2000, of whom 680 million will come from Third World nations. Developed economies must continue upgrading their labor forces to avoid competition that would erode the standard of living of their less-skilled laborers. Therefore, they should institute a system of transfers to ease the pain of displaced workers who are forced to move, search for new employment, and acquire new skills, so that they will not have to bear the total weight of socially desirable changes in trade and manufacturing arrangements. At the same time, developed countries should keep striving to maintain a balanced trade pattern by keeping international exchange rates flexible and correcting huge trade deficits. Also, an effort should be made to reduce the economic dependence of debtor nations. Efforts of debtor nations to earn dollars to service their debt have caused American exports to these nations to decline precipitously. These debtor countries that must maintain their balance of payments in equilibrium, in spite of having to serve the tremendous burden of their foreign debts, are forced to export more goods and import fewer goods. A long-term adjustment of debt-service requirements would

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Globalization of Technology: International Perspectives enable debtor nations to import more from the United States and other developed economies and simultaneously to focus development efforts on reinvigorating their internal markets and strengthening domestic forces for long-term economic growth. It is also in the best interests of developed economies to institute policies that promote the reorganization of industry and the redeployment of production stages in which developed countries are no longer competitive. If an orderly process of production reorganization is deemed desirable, developed countries should give high priority to removing barriers such as quotas and voluntary restraints that are particularly burdensome to the poor countries. U.S. policy should also promote the streamlining of tariffs 806/807 to make those provisions more efficient and better link assembly activities to the domestic host economy, without diminishing the incentives to use U.S. materials. Tariff 807 could be broadened to include operations such as cutting, mixing, and processing of U.S. components abroad, while still permitting them to be brought back to the United States duty free. This would also extend the opportunities for local participation in assembly production, and at the same time, it might also broaden the use of U.S. components. An additional step to the creation of linkages would be a selective application of a removal of duties from goods assembled in countries where the United States has key geopolitical interests. Thus, including the tariff exception, the value added abroad would encourage greater use of foreign inputs. This would ultimately benefit U.S. consumers with lower-priced goods. Developed countries should also fight to dispel the image of assembly production as an enclave in the host economy, an image borne out by the strikingly small percentages of local materials used in these operations. A special effort should be made to provide incentives for the United States and developed country subsidiaries to provide the necessary technological expertise that domestic suppliers need to efficiently supply assembly operations. It is also clear that subcontracting with local firms in developing countries is more conducive to technology transfer and the establishment of linkages than is operating assembly plants abroad through U.S. subsidiaries. The subcontractor in the developing country not only benefits directly from working with the U.S. principal but may also transfer the knowledge acquired to production for domestic markets, thus spreading the effects. CONCLUSIONS The world economy has passed successively through more comprehensive stages of integration. Markets for traded goods, and more recently, financial markets, have merged across national boundaries into a truly international structure. Labor markets are also in the process of being integrated into an

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Globalization of Technology: International Perspectives international system, partly through migration, but mainly through trade in the changing global pattern of the international division of labor. Coproduction can be seen as a principal feature of the international organization of industry. Firms in industrially advanced countries collaborate with firms in developing countries to manufacture a variety of products to the mutual benefit of both countries. The implication of much of what has been described here is that policy should smooth the way for more sophisticated coproduction stages between industrial and developing countries. As developing countries advance, they should be able to increase the levels of subcontracting, local capital participation, and national materials in assembly activities. As long as sharp differences persist between wages in economically advanced countries and those in less developed regions, the rationale for assembly production abroad will remain. The significance of the international reorganization of product flows within a single industry is that the present high wages for unskilled labor in the United States and other industrialized countries will no longer be insulated from international competition. Technological advances in the United States are unlikely to offset this trend, so that what remains is a fundamental long-term policy choice for industrial societies. One choice is to face a reduction in the comparatively high standards of living of the least skilled, and with it, a period of social and political turbulence. The other alternative is to deliberately eliminate those sectors of the labor force that are in direct competition with workers in developing countries through investment in education and training. This, in effect, shifts the composition of the labor force to more highly skilled occupations. Given the social cost of an unplanned transition that suddenly eliminates the unskilled workers from the industrial work force, large-scale investment in upgrading the U.S. work force should be the preferred choice. From the Mexican point of view, a coherent medium-term development policy should be aimed at creating jobs for the rapidly growing labor force. Job creation should be the number-one priority of Mexican policymakers. The maquiladoras and production sharing should be one of the main pillars of this strategy. Not only are they labor intensive and big foreign exchange earners, but the capital investment needed to create a job in this sector has been estimated to be around six times lower than that in the traditional manufacturing sector. Therefore, both countries should adopt production sharing enthusiastically as an alternative to be fostered instead of a malady to be remedied.

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Globalization of Technology: International Perspectives BIBLIOGRAPHY American Chamber of Commerce of Mexico, A.C. 1986. Mexico’s Maquiladora In-Bond Industry Handbook. Mexico, D.F. Arthur D. Little Mexicana, S.A. de C.V. 1986. Crisis y Apertura Internacional: Oportunidades y Amenazas para el Empresario Méxicano. México, D.F. Drucker, P. 1969. The Age of Discontinuity: Guidelines to Our Changing Society. New York: Harper & Row. Drucker, P. 1980. Managing in Turbulent Times. London: Pan Books. Drucker, P. 1986. El Cambio en la Economia Mundial. Mercado de Valores 25 August 1986, 811–816. Flamm, K., and J.Grunwald. 1985. The Global Factory: Foreign Assembly in International Trade. Washington, D.C.: Brookings Institution. McKinsey and Company, Inc. 1987. Shaping effective responses to the globalization challenge. Unpublished manuscript. Ohmae, Kenichi. 1985. Triad Power: The Coming Shape of Global Competition. New York: The Free Press. Tellez, L. 1986. Essays on Real and Financial Aspects of an Open Economy: The Mexican Case. Ph.D. dissertation, Massachusetts Institute of Technology. Telmex. 1986. Telecommunications Services for the Maquiladora Industry: A TELMEX Future Perspective. México, D.F. U.S. Tariff Commission. 1970. Economic Factors Affecting the Use of Items 807.00 and 806.30 of the Tariff Schedules of the United States. Publication 339. Washington, D.C.: U.S. Tariff Commission.