NAFTA chickens out? Mexican poultry producers seek five more years of tariff protection from U.S. imports. Will delay help or hinder free trade? (Investment Guide).

Carlsen, Laura

Mexican farmers in January marched in the streets demanding that the government renegotiate the North American Free Trade Agreement (NAFTA). As the marchers protested, however, the country's trade officials quietly announced an extension of import tariffs on U.S. poultry. Mexico's five-year delay of free trade in chickens is considered by some as a NAFTA bust, but poultry producers on both sides of the border herald it as an innovative example of "NAFTA plus."

The great chicken debate will have consequences far beyond legs and thighs. Poultry is the first of a growing line of Mexican agricultural industries seeking relief from free trade. Mexican pork and beef producers are asking for prolonged tariff protection in the run-up to Mexico's mid-term elections in July 2003. The temptation to satisfy special-interest groups will be huge as Mexican President Vicente Fox faces an uphill battle to gain seats for his Partido Accion Nacional (PAN) in the 500-member lower house of Congress.

At the same time, the U.S.-Mexican poultry deal that effectively creates a 14-year transition to zero tariffs instead of the original 9 years will also serve as a precedent for the U.S. Central American free trade agreement. scheduled to be completed in 2003, and the Free Trade Area of the Americas, due to be finished in 2005. Agricultural issues are also front and center in the current round of global discussions in the World Trade Organization, which will hold a world ministerial conference in Cancun in September 2003.

Since the North American Free Trade Agreement took effect in 1994. Mexico's trade and investment has boomed. The country has become the No. 2 trading partner of the United States after Canada; total bilateral trade has almost tripled to US$235 billion in 2002, Direct foreign investment in Mexico has averaged more than $13 billion annually for the past nine years, more than four times annual average for the nine years before NAFTA. Thanks in part to a strong currency, Mexico in 2001 overtook long-time rival Brazil as the largest economy m Latin America.

Hard-boiled protectionism? Under the agreement, tariff protection for many politically sensitive industries, such as agriculture, was set to end at the start of 2003. Faced with the possibility of unfettered competition with U.S. agricultural producers in Mexico, Mexican farmers launched nationwide protests about US. dumping and subsidies.

Three weeks after tariffs dropped to zero on U.S. poultry imports, the Mexican government established a "provisional safeguard," which "stretches out the tariff schedule," in the words of National Chicken Council spokesman Richard Lobb. The measure restores the tariff on leg quarters to its 2001 level of 98.8% for a six-month investigative period, but industry officials on both sides of the border expect protection to be extended five years, decreasing 20% annually.

The safeguard was not a knee-jerk protectionist measure, Mexican officials say. "We knew perfectly well that in 2003 wed have zero tariff," says Cesar de Anda, president of Mexico poultry industry chamber, the Union Nacional de Avicultores. "So we went to work four years ago to find solutions."

That work consisted of talks with U.S. poultry associations to solve what the Mexicans say are unfair trade barriers and postpone opening of the Mexican market. Mexico is the third-largest market for U.S. poultry, but Mexico cannot export poultry products to the U.S. due to sanitary barriers, many of which de Anda claims have been imposed "often without scientific basis." In 2002 Mexico bought an estimated US$175 million worth of U.S. chicken, according to the National Chicken Council, yet Mexico exported zero chicken to the United States.

Despite low import quotas and high tariffs, U.S. exports to Mexico grew steadily since 1994 while still allowing growth in the domestic industry. Then imports rose sharply in 2001 when the tariff fell to 98% from 148% and even more sharply in 2002 under the terms agreed within NAFTA. But it was the 2003 zero hour that had Mexican chicken farmers sweating. "The zero-tariff would have been a disaster," says Jaime Crivelli, leader of an association of small poultry farmers in the Gulf state of Veracruz. "We've been producing for a long time and we're used to all kinds of problems, but this one really had us scared."

Chicken-and-egg. The question is: If everybody saw it coming, why wasn't the Mexican industry ready to compete? Because the 1995 Mexican peso crash left the poultry sector short on money to compete with North American companies, says de Anda. "It was a major blow to the Mexican economy that practically set us back five years," he says.

The 1995 devaluation tends to be the pat answer to explain NAFTA win-win scenarios gone sour. Indeed, investment fell off sharply due to the crisis, but the chicken-and-egg story is far more complicated than that. From day one, Mexico's chicken producers faced a peculiar problem that arose from the nature of the beast--or bird--itself.

The problem is, the U.S. poultry consumer is picky. "In the U.S., American consumers prefer the breast meat by a two to one margin," Lobb says. "However, the chicken by nature is almost half dark meat, so we have found that foreign markets are an excellent complement to the U.S. market because people in other countries tend to prefer the dark meat." The difference in consumer preferences together with free trade has meant the U.S. poultry industry cleans up. The U.S. Department of Agriculture reports that the industry's sales grew to $16.7 billion in 2001, a healthy 19% growth over 2000.

U.S. and world markets are complementary in a lucrative way for U.S. exporters, too. On the U.S. market, high demand has pushed the price of skinless, boneless breast meat to almost $4 a pound. The leg is considered a "sub-product," as reflected in its price--$0.69 a pound and sometimes less. Sales of premium, white breast meat and other value-added products such as chicken strips and nuggets make up 91% of sales in dollar terms and tend to cover costs of production and more. Thus exporters can afford to sell dark meat at very low prices.

Drawn and quartered. Mexico began to feel the full force of imported U.S. legs and thighs in 2002, as tariffs fell. "Around September the price dropped below cost for four or five months because of imports," says Crivelli, who produces 200,000 chickens a week on his farm near Cordoba, Veracruz. "Even if it's just legs and thighs, it influences consumption and sales of the whole chicken."

The average wholesale price of U.S. leg quarters sold in Mexico in the first half of 2002--including the 49.4% tariff--was 9.30 pesos per kilo. far lower than the national price of 12.86 pesos, according to the Mexican poultry industry. Worldwide, the United States exported in 2001 over 2.5 million metric tons of leg quarters alone, 37 times Mexico's domestic production of leg quarters and, in weight, a half-million tons more than Mexico's total chicken output. The United States, the world's No. 1 chicken producer, wasn't breaking a sweat to service Mexican demand.

Mexican industry also is much less efficient than U.S. Poultry operations, says Raymundo Garza of Mexican poultry company Gallina Pesada. He says one U.S. worker manages 200,000 chickens while in Mexico the ratio is 30,000 to one. Because Mexico relies on labor--albeit cheap labor--more than machines, greater human handling of birds increases the risk of disease.

With tariffs headed toward zero in 2003, U.S. chicken imports to Mexico growing and poultry producers demanding a delay in the opening, the Mexican government invoked article 801 of NAFTA that stipulates the right to apply safeguards when "imports cause a threat of serious damage to the national industry." U.S. companies now control a quarter of Mexico's poultry industry and supported the safeguard measure.

If Mexico's interests in applying the safeguard are obvious, the interests of the United States are less so. Poultry industry spokesman Lobb says that the safeguard does not represent a reverse for NAFTA, since the primary goal of the U.S. chicken industry is to establish a stable trading relationship.

Toby Moore of the U.S. Poultry and Egg Export Council is a little more explicit. "There were signals that the Mexican industry could initiate an anti-dumping action against the U.S.," he says, which would have meant a long and drawn out legal battle and provisional tariffs and penalties for alleged unfair trade practices. Mexican chicken industry head de Anda confirms those fears. "In many cases, import prices have been below the costs of production," he says. The safeguard taken in place of an anti-dumping complaint, de Anda says, is "a good agreement for both sides because we know there are many elements to demonstrate dumping, but we also know that a mechanism of negotiation is better than a mechanism of complaint."

Mexican farm organizations are demanding immediate renegotiation of the NAFTA agriculture chapter in current talks with the Mexican government, but de Anda says poultry producers still believe NAFTA terms can be used to solve problems. De Anda's Union Nacional de Avicultores is participating in the Mexican farm-government talks but since poultry producers chose the safeguard route instead of renegotiating NAFTA, he admits, "We're not very popular there."

U.S. and Mexican poultry representatives involved in safeguard negotiations noted that the U.S. government was the hardest partner to convince. For the industry on both sides of the border, NAFTA is a framework and what matters is what works. "NAFTA is riddled with loopholes, special exemptions and all this kind of thing." U.S. poultry industry spokesman Lobb says. "The important thing is that both sides are committed to promoting a solid and stable trading relationship between the two countries in chicken. And that's what this agreement is intended to provide."

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Low-flying Bird

Production costs in US$ per kilo in 2001

Brazil  0.38
U.S.    0.49
Chile   0.51
Mexico  0.78

SOURCE: Gallina Pesada S.A. de C.V.

Note: Table made from bar graph