Dealing with the rising sun: Mexico eyes a Japanese trade deal. (Spotlight).

A scheduled upcoming visit by Japanese Prime Minister Junichiro Koizumi could mark the start of an official round of free-trade talks between Japan and Mexico, a leading Japanese business leader told BUSINESS MEXICO.

Tadayuki Nagashima, executive director of the Japanese External Trade Organization in Mexico (JETRO), said Koizumi's visit to the annual Asia-Pacific Economic Cooperation (APEC) summit, to be held in Ensenada in October, could provide the impetus for formal negotiations.

"Hopefully when Koizumi comes to APEC, that could signal the start of official talks," said Nagashima.

So far, the nations have only convened committees aimed at studying the feasibility of a treaty, which would be on the order of Nafta or Mexico's recent accord with the European Union. The formation of the committees was timed to coincide with another state visit, that of Mexican President Vicente Fox to Tokyo in June 2001.

It's no secret that Mexico would like to complete an agreement with Japan in order to induce greater investment flows and make the country less reliant on U.S. investment capital, which accounted for 67% of the US$91 billion in foreign direct investment (FDI) that poured into Mexico from 1994 through September 2001. Japan in the same period contributed only 3.4% of the total, according to the Economy Secretariat. But JETRO notes that, including Japanese companies operating in the United States, Japan should be responsible for up to 20% of the Mexican FDI number.

A pact with Japan, the No. 1 Pacific Rim economy, would also mark a major Mexican beachhead in Asia where the country has so far established no bilateral free-trade agreement and is currently in formal negotiations with just one country, Singapore.

BOTH SIDES MULL FREE TRADE

Mexican trade policy over the past decade has rested on building free-trade synergies to enhance the country's investment profile and distinguish it from other developing economies. To date, Mexico has inked 10 free-trade agreements with a total of 31 countries, all of them but Israel located in the Americas or Europe.

But interest in an agreement isn't coming just from the Mexican side. Japan, which has historically favored multilateral mechanisms over bilateral deals, is emitting increasing signals that it too seeks a new two-way trade relationship with Mexico.

"We need to promote active FTAs (free trade agreements) in order to achieve the full benefits of expanded free trade," a key cabinet-level council of economic advisers told Koizumi last month, The Associated Press reported. Besides Mexico, Japan is analyzing FTAs with South Korea and Singapore, with whom talks are almost finished, officials have said.

But proponents say the Asian nation must act quickly on a free-trade pact with Mexico. If it dallies, Japan could face losing market share to both the United States, which is plowing ahead with plans for a hemisphere-wide free-trade arrangement by 2006, and Europe, whose 2001-implemented FTA with Mexico is rolling forward. Meanwhile, Mexico's 100 million-strong consumer market is burgeoning as the country emerges more fully from the mid-1990s economic crisis.

A signed treaty between the two nations could also help lock in safeguards for the total US$43 billion value of Japanese holdings in Mexico, the majority of which are concentrated in the border manufacturing arena. Existing investment-protection rules are inadequate, business leaders say, because they could be subject to judicial review or modification by succeeding governments.

A trade treaty would also bring about the eventual elimination of tariffs on intermediate goods used in the maquiladora industry, 7% of whose total workforce is employed by Japanese firms, according to JETRO. Although a mechanism already exists to provide non-Nafta in-bond manufacturers with some tariff relief on inputs, the scheme, called the Sector Promotions Program (Prosec), doesn't universally eliminate raw material duties levied on businesses from outside North America.

Another drawback: Companies must undergo an application process to take part in Prosec rather than receive the plan's benefits automatically. Unveiled last year, Prosec also could be subjected to amendment in future administrations.

"Prosec has helped some companies, but it doesn't totally cove all maquiladora inputs," Nagashima said.

Entrepreneurs on both sides of the Pacific have been beating the drum for a trade agreement for some time now.

"It is an urgent task for Japan to promptly conclude FTAs with major countries in Central and South America, such as Mexico and Chile, to reduce disadvantages for Japanese companies and gain a firm foothold in the region," a joint Japan-Mexico business council said in 2000.

The serious talk on a free-trade deal is coming at an opportune time for Mexico. Amid complaints that Mexico's "super peso" is making the nation uncompetitive as a manufacturing base, the Fox administration is working to avoid firms moving operations en masse to Asia, particularly China, where labor is cheaper. A trade agreement could prove an inducement to stay.

The government is also seeking incentives for non-Nafta partners after the trade treaty dictated maquiladoras pay duties on inputs from outside of North America starting in 2001. That stipulation gave birth to Prosec.

But it has been Mexico's strong currency and a subsequent rise in real manufacturing wages that have led the assembly-for-export firms to begin to seriously consider relocation. The U.S. economic slowdown has added to the momentum as companies put expansions on hold and look to lower expenses.

For Japanese electronics makers in particular,, China, with its seemingly limitless supply of cheaper labor, has seen its star rise as a more economical platform than Mexico, even if moving means assuming greater costs to transport finished goods to the U.S. market, Nagashima said.

Furthermore, a narrower parity exists in Chinese factories between management salaries and assembly-line wages. In Mexico, on the other hand, overseers are accustomed to drawing pay comparable to higher U.S. levels, he said.

Hurting Mexico also has been the fact that almost all the components needed to make finished electronics goods must be imported from outside Nafta, as Mexican, U.S. and Canadian manufacturers aren't competitive, according to the Japanese. And, although Prosec has helped drop tariffs on those mainly Asia-imported inputs, the tariff shelter is insufficient.

Plus, China offers fatter tax breaks for the maquiladora industry than does Mexico, Nagashima added.

"The belief that production lines should move from Mexico to China is increasing because production costs are much higher in Mexico than in Asia," Nagashima said, adding that some Japanese businessmen perceive Mexican labor costs as being twice as expensive as in China.

Japanese companies have already started pulling up stakes, although no mass exodus has yet occurred. In March, Canon Inc., Japan's largest office equipment maker, shut down its Tijuana inkjet printer plant, eliminating 450 jobs and moving production to Thailand and Vietnam. Following the Canon shutdown, the Japanese Maquiladora Association (JMA) warned that more moves are in the offing. The lobbying group attributed the Canon move to an unclear regulatory framework and the strong peso. The JMA added it would soon present Fox with a study on how Mexico can build back its manufacturing competitiveness.

Nevertheless, it's unclear whether Mexican wages have the room to drop to levels that are competitive with Asia. At the same time, the Mexican government hasn't indicated discomfort with the peso's strength, even though the currency has appreciated 5.8% in nominal terms from the start of 2001 through April 12, 2002. The inflation-wary Banco de Mexico, meanwhile, hasn't moved to weaken the currency except for a mild April loosening of monetary policy, which remains restrictive.

ENGINES RUNNING

While the scenario for electronics might look gloomy, another maquiladora sector, automotive, actually faces a stable--if not slightly positive--outlook this year, according to comments from Nagashima.

With carmakers favoring just-in-time logistics over more costly warehousing options, and U.S. consumers defying the recession to buy the latest models, Mexico has been able to use its geographical proximity as leverage over Asia in the auto sector, he said.

"Mexico remains suitable for automotive and autoparts," the JETRO director said.

One company testing Mexico's advantages is Toyota. Just five months ago, when analysts were still prolonging forecasts on when the U.S. slowdown would finally end, Toyota's North American manufacturing division announced plans to open a new assembly plant in Tijuana to make truck beds for the Toyota Tacoma pickups. The facility, which analysts said could eventually convert itself into a full-fledged manufacturing base, should start production in 2004. Currently, though, Toyota produces no vehicles in Mexico.

"With the installation of this plant, we are taking a solid step forward to reaffirm the confidence of Toyota in Mexico," Toshiaki Taguchi, Toyota Motor North America president and CEO, said.

Timed to coincide with impending lower tariffs on U.S.-made automobiles, Toyota also unveiled this April its first showrooms in Mexico--one in Mexico City and another in Monterrey. At press time, the company was making plans to roll out three more dealerships in the Federal District and one in Guadalajara.

It's not only Japan's powerful auto giants who are taking advantage of the synergies. Major first-tier autoparts maker Denso Corp. also announced recently it will build a US$48 million plant this year in Guadalupe City in the state of Nuevo Leon, increasing the value of its Mexican assets to US$83 million.

"We will continue to attain the local high-quality labor force in Guadalupe City and in Apodaca City (where operations are headquartered) to strengthen our global competitiveness," the company said in a news release.

That the aforementioned investments have taken place at all is surprising considering that the downturn has cooled U.S. demand and weakened growth in Mexico, which directs more than 80% of exports to U.S. markets.

However, consistent U.S. auto demand appears to have bucked the slowdown, and Japanese business says Mexico has more to lose from heightened long-term competition from Asia than from the cyclical downturn north of the border.

The slowdown also represents a kind of double-edged sword for Mexico because while it might check domestic growth, it also means cost-conscious firms might opt to relocate U.S.-based plants to below the Rio Grande, taking advantage of cheaper yet skilled labor, geography and Nafta.

OTHER FACTORS HURT GROWTH

Other factors are weighing on Japanese-Mexican commerce besides the global slowdown and brisker Asia competition, according to comments from a Japanese trade official.

For one thing, Japan's protracted domestic recession continues to have an effect on investment flows, said Shigetoshi Ikeyama, trade attache at the Japanese Embassy in Mexico.

"The Japanese recession is having an effect on Japanese investment in Mexico. All companies are very cautious regarding investment," he told BUSINESS MEXICO.

Japanese FDI commitments to Mexico dropped precipitously between January and September 2001, falling to a paltry US$62 million and well off the nine-month pace for 2000, when full-year investments totaled US$416 million. This year's number is also well off 1999, when Japanese FDI rang up to a whopping US$1.2 billion, according to the Economy Secretariat. The US$62 million figure accounts for only 0.3% of total FDI for the first nine months of 2001 and is in line with similar numbers from Finland, Denmark, the United Kingdom and the Cayman Islands. Still, a more representative figure of Japan's total investment in Mexico should be somewhat higher, according to JETRO, given that investments from U.S. subsidiaries of Japanese companies end up in the North America column.

Besides Japan's own recession, another long-running quandary that has negatively affected Japanese investment in Mexico has been crime, which forces firms to spend more money on plant security and bodyguards for executives, among other extraordinary expenses.

"The problem of insecurity is reflected in Japanese production costs. Clearly, it is a negative element toward greater Japanese investment," Ikeyama said.

Insecurity has weighed heavily on Japanese minds since the high-profile 1996 kidnapping of a Sanyo executive, who was later retrieved unharmed after a ransom was paid, according to an Associated Press report from the time. Following the kidnapping and during a crime wave fueled by the mid/'90s peso crisis, Sony Mexico President Shin Takagi warned then-President Ernesto Zedillo that Japanese firms could reduce investments or withdraw from Mexico if the security situation didn't improve.

Although crime statistics have dropped since reaching highs last decade, security was still enough of a concern in March of this year to prompt Japanese Ambassador Takahiko Horimura to warn that the situation was frightening off would-be investors, according to a Mexico City daily. Insofar as it would strengthen Japan-Mexico commercial ties, a free-trade pact could work to mitigate the crime effect on Japanese investment.

But striking an accord won't be automatic. The politically sensitive agriculture sector, in particular, likely will represent a major sticking point for both countries in any future negotiating round. Mexican industry also may chafe at the opening of commercial borders with the Asian manufacturing powerhouse. The reason: A Japan-Mexico free-trade agreement would be aimed at increasing Japanese investment exports to Mexico and not on boosting Mexican manufacturing shipments across the Pacific.

Also suffering from an agreement would be Mexico's current US$5.55 billion trade gap with Japan, a deficit that has increased 47% from US$3.78 billion in 1994, according to JETRO.

Nonetheless, the benefits of a free-trade deal--more investment protection, better access to Mexican markets and the elimination of input duties--appear to outweigh the costs for JETRO's Nagashima.

"I think it's necessary for Mexico and Japan to have a free-trade agreement," he said.

Robert Donnelly is a freelance writer and correspondent in Mexico of the online trade publication Chemical News & Intelligence.