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South Dakota and the North American Free Trade Agreement.

Introduction

As can be observed throughout the state, South Dakota's international involvement is becoming increasingly important. Last year, for example, Morgen Manufacturing in Yankton and Hutchinson Technologies in Sioux Falls were awarded the Presidential "E" Award for excellence in exporting; Daktronics of Brookings signed another multi-million dollar contract to supply scoreboards for the 1994 Winter Olympic Games in Norway--it also supplied similar equipment for the 1988 Winter Games in Canada. During the past year South Dakota also hosted several Asian trade missions for the purpose of selling agricultural products to their nations.

The number of foreign tourists visiting South Dakota also seems to increase continuously. The great success abroad of the movie "Dances With Wolves" seems to have contributed considerably to this boost. Many foreigners just love the concept of the "Old West" and the wide open spaces the state has to offer. If the Deadwood world-class resort complexes proposed by movie star Kevin Costner and his brother, Dan, ever come into being, international tourism may become even more important for South Dakota.

Foreign investments located throughout the state contribute many jobs. For example, Rapid City gained more than 300 new positions last year when Spiegel, the German mail order giant, established a branch there. The majority of the Black Hills gold mining companies are also foreign owned and even its largest ski resort represents a foreign investment.

Importing is also quite important for South Dakota, as many firms require foreign components for their finished products. Gateway 2000 of North Sioux City, one of America's most successful firms, imports more than half of its components. And how would a firm like Alumax of Yankton operate without aluminum, which could not be produced here if bauxite imports were impeded in any way?

One of the most recent international developments which might impact South Dakota to a considerable degree is the likely establishment of a North American Free Trade Agreement (NAFTA). If enacted it (NAFTA) will create the largest trading block of the Americas.

North American Free Trade Agreement

The Canada-United States Free Trade Agreement (FTA) was initiated in 1989. The negotiations to include Mexico in a larger trading bloc culminated by the signing in August of 1992 of the North American Free Trade Agreement by President George Bush, Prime Minister Mulroney, and President Salinas de Gortari. This will eventually eliminate trade barriers and will implement strong rules of investment and intellectual property rights among the three countries.

A key aspect of the NAFTA agreement is the accession clause that ensures the continuance of economic integration throughout the Western Hemisphere. The future enactment of the Western Hemispheric trading agreement has initiated in many Latin American countries the incorporation of the democratic philosophy and the abdication of the state-dominated, protectionist economic policies, in favor of free-market policies of trade liberalization, privatization, and fiscal discipline. The success of the regional arrangements depends on member countries' capacity to diversify and penetrate into the markets of industrialized countries, along with a willingness to move towards more liberalized regional trade. Latin America is the most U.S.-oriented market in the world. It is natural for the U.S. to seek production\sharing operations and other kinds of alliances. The United States is the most important market for Latin America.

President Salinas of Mexico has established his country as a miracle of economic advancement by guiding it toward economic independence. As he has accepted free trade as the path to economic development, he has rejected the politically expedient option of protectionism that's so common in the Third World. This will require the United States to look at Mexico as an equal and not poor relation. Mexico, as a result, stands out as an example to the rest of Latin America of what can be accomplished in the democratic and economic arenas. President Salinas made the point for Mexico and its Latin neighbors when in his first meeting with President-elect Clinton in Houston he stressed, "We want trade, not aid."

Mexico's first step into the global economy was the maquiladora program, started in 1964. The maquiladoras are Mexican production facilities that assemble or manufacture goods that will be sent back to the country of origin. Today, there are over 2000 maquiladoras of which 68% are owned by the U.S., 25% operated by Mexico, 4% by Japan, 2% by Europeans, and 1% by other Southeast Asian countries and which employ over 452,000 Mexicans. The maquiladoras can import input and machinery from the U.S. without paying taxes in Mexico and the finished goods sent to the U.S. market pay tariffs based only on the value added in Mexico. This preferential treatment and the low labor cost, together with the proximity to the world's largest market and its technology explains the flourishing success of this program.

When NAFTA is enacted January 1, 1994, access for the Mexican economic sectors, such as the maquiladoras would create a two-way street in which exporters, domestic consumers, and fledgling producers could all become active participants in a global market with full access to all goods. Such economic boom would improve economic conditions in Mexico to the point that U.S. aid could be reduced and the market for U.S. goods would be markedly increased. Currently, under some circumstances, companies are permitted to sell up to 50% of their output in the Mexican market. Under NAFTA, this limit will be eliminated and companies will be allowed to sell up to 100% of their product in Mexico.

However, certain aspects of the Mexican constitution and economy concerned the United States of America and Canada. The domination of the gas trade by PEMEX, the nationalized petroleum company, has been limited by the revoking of the company's veto power. While it is unlikely that the executives won't fight these actions, negotiations went better than expected. These negotiations included the U.S. request for freer investment in petrochemicals and an end to Mexican gas and electricity subsidies. However, as more companies are building in northern Mexico, the need for oil will increase and the United States can respond to this demand. The U.S. oil industry is disappointed by its failure to win greater access to Mexico's state-owned oil industry.

As Mexicans spend an estimated 70% of their salary on U.S. goods, Mexico represents a large market for products, such as automobile parts, oil and gas fields equipment, industrial plant design, engineering and maintenance equipment, machine tools and metalworking equipment, pollution control equipment and hotel and restaurant equipment. The only necessary step to be taken is to improve distribution of these products in Mexico.

U.S. trucking companies will be allowed to carry international cargo into northern Mexico by 1995 and the rest of Mexico by 1999. This would mean North American trucking companies' service area would extend from the glaciers of Alaska and tundra of northern Canada to the sun-drenched beaches of the Yucatan Peninsula.

Under NAFTA, the new rules of origin will require NAFTA goods to contain 60%-70% regional (U.S., Canada, Mexico) components. An example of the importance of such requirements is the U.S. businessperson's concern over Japanese companies' entrance into Mexico and the establishment of the country as a launching pad for more Japanese production. This agreement requires that Japanese carmakers in Mexico must increase their minimal content of the North American parts and labor to qualify for duty-free status.

Prospects look good for the U.S. construction industry as tariffs will be eliminated for construction equipment. This is while Mexico enforces tariffs on U.S. construction competitors, like Japan and Europe. Caterpillar, Inc. predicts an increase of $35 to $40 million in sales annually to Mexico.

The telecommunications, banking, and high technology establishments are expected to benefit the most from the trade accord. Mexico will face down its high tariffs on computers and computer parts to the levels in the U.S. and Canada. The computer's main circuitry, the motherboards, must be made in the region. Computer parts imported from outside the region must be incorporated into other parts to qualify for duty-free trade among the three countries. This will benefit the computer industry in the U.S. Most tariffs on electronics and communication equipment will end immediately. This will make it easier for U.S. and Canadian companies to participate in Mexico's ambitious telecommunication program. U.S. financial institutions will be permitted to fully function in the Mexican market. They will be allowed to establish subsidiaries in Mexico. Transitional barriers will be eliminated by January 1, 2000. The U.S. high technology entertainment, and consumer goods producers would obtain substantial gains from the intellectual property rights.

Under NAFTA, Mexico would open its doors to U.S. agricultural products, such as corn, grains, oilseeds, livestock, and many other commodities by eliminating tariffs that range between 10-20% and import licensing requirements. Of particular importance to trade are the tariff barriers on corn and dry beans for Mexico and orange juice and sugar for the U.S., that are to be phased out over fifteen years. Sugar trade between these two countries will continue, but the U.S. sugar industry will be protected by world-wide quota. This will obviously affect the Caribbean sugar market. Mexico will end licensing requirement for wheat, corn, poultry, eggs, cheese, and non-fat dry milk. The advantage for the Mexican farmers is significant. For example, the average tariff for Mexican farm goods imported into the U.S. is 4%, but Mexican melons entering the U.S. market is 35% and for squash is 26%. This is to protect the fruit farmers of Florida and California.

From a Wall Street Journal poll, some 81% of executives say they are strongly or mostly in favor of the North American trade accord. Just 12% oppose the pact. The majority of the respondents to this poll did not judge any industry as a victim of NAFTA. The textile factories and apparel industry in the U.S. will be negatively affected.

According to the Institute of International Economics study, the exports to Mexico have increased significantly since President Salinas took office in 1988. Thus, United States has a trade surplus with Mexico that is expected to reach $10 billion in the near future. This will further increase with the implementation of NAFTA.

Industrial Economic Research Fund, Inc. has concluded that reduced tariffs and non-tariff will lead to an increase of total U.S. TABULAR DATA OMITTED employment of 44,500 (10,600 in agriculture, 7,800 in miscellaneous non-electrical machinery, 6,300 in communications machinery and 6,100 in metal products etc.). KPMG Peat Marwick, economic policy firm says that employment won't be significantly affected, but real income should increase 3% to 4%.

While the Institute of International Economics agrees that Mexican exports will dislocate 112,000 U.S. workers over the next ten years, this loss will be overwhelmed by 242,000 new jobs created by exports to Mexico after 1995. Such forecasts lead to the U.S. commitment of several billions of dollars over the next five years for re-training workers to assume new employment and/or newly created jobs under NAFTA. It is believed that the net increase in employment and the lower labor cost in Mexico will make Mexican workers the greatest beneficiaries of the Free Trade Agreement.

Even with the optimistic potential of the North American Free Trade Agreement, President Clinton has stressed, in his conversations with Prime Minister Mulroney, that he will not re-negotiate the agreement, but will seek supplemental agreements over labor and environment.

Summary

While the latest Institute for International Economics study predicts that NAFTA could create a net gain of 171,000 U.S. jobs, it is difficult to come up with estimates for South Dakota.

It is perhaps of interest to note that trade between Canada and South Dakota increased considerably since the U.S.-Canadian Free Trade Agreement came into effect in 1989. The state's exports to our northern neighbor more than doubled by 1991, reaching a level of about $105 million. On the other hand, South Dakota exports to Mexico grew by only about 25 percent over the same period, reaching a level of about no more than $6 million.

TABULAR DATA OMITTED

Considering that in 1991, Mexico accounted for only 2.6 percent of the state's total exports, one can indeed make a good case that a trade pact with the Pacific Rim nations would make much more sense for South Dakota, as some of the Asian countries are much more important importers of the state's products, especially if grains are included. South Dakota's top 20 export markets in 1991 are listed in Table 3. Several of South Dakota's Asian customers have expressed strong reservations about NAFTA, suggesting that trade expansion between the U.S. and Mexico would be at their expense. In other words, our Asian clients fear that instead of creating trade, NAFTA might to a considerable degree divert trade away from them. The question this raises for South Dakota is whether NAFTA will result in a net gain of jobs for the state, or a possible net loss.
TABLE 3
SOUTH DAKOTA'S TOP 20 EXPORT MARKETS IN 1991
Country Total $ Value
Canada $104,514,057
Netherlands $29,803,670
Fed. Rep. of Germany (West Germany) $23,994,816
Hong Kong $11,363,108
Japan $8,857,188
United Kingdom of Gr.Britain & Northern Ireland $6,969,549
Mexico $6,104,595
Thailand $6,001,436
Switzerland $3,378,823
France $3,018,509
South Korea $2,157,128
Australia $2,108,141
Belgium $2,016,737
Philippines $1,935,900
Italy $1,865,617
China (Taiwan) $1,828,715
Singapore $1,645,115
Egypt $1,608,297
Kuwait $1,442,746
Argentina $1,385,205
TOTAL $221,999,352
Source: Adjustments to data from U.S. Bureau of the Census,
Foreign Trade Division by the Mass. Institute for Social &
Economic Research (MISER), University of Mass., Amherst.


Recently it was reported that an Asian company was looking into the possibility of investing in an Indian Reservation, reportedly to avoid possible difficulties after the People's Republic of China gains control over Hong Kong. However, one might at least speculate whether the real reason might not be to avoid NAFTA-related trade diversions.

South Dakotans should also ask if the ratification of the NAFTA treaty might risk lowering the state's chances of attracting such investments as the one proposed by Ag Processing of Omaha. After Mexican sugar will gain free access to the U.S. market (where sugar prices are about 300 percent higher than in the world market), will it still make sense to produce corn sweetener in Jefferson?

Another "front-burner" issue is the likelihood that South Dakota will lose jobs to Mexico. Wages in South Dakota are almost ten times as high as they are in Mexico and a number of area firms have already moved their operations south of the U.S. border. When a small firm transferred its manufacturing from Erwin, SD to Mexico a few years ago, it reduced employment in that small community from 104 to a mere four. A few years earlier many South Dakotans lost their jobs when Zenith moved its assembly line, involving about 1,500 jobs, from Sioux City to Mexico.

As mentioned earlier, both former President Bush and President Clinton have proposed special funds for retraining Americans who lose their jobs as a result of NAFTA. And it should be noted that adjustment assistance was provided to several hundred Aberdeen workers after Control Data shifted its operations from that city to the southeast Asian nation of Malaysia. Canada has experienced a similar shift of jobs to its southern neighbor, the United States, which probably explains why last fall 73 percent of all Canadians were reported to have opposed the U.S.-Canadian Free Trade Agreement. There are indeed speculations that Prime Minister Mulroney's political party might lose the next elections over this issue.

Returning to the topic of trade, the U.S. Department of Commerce reported that food products made up more than half of South Dakota's exports to Mexico. Industrial machinery and computers accounted for about forty percent of the remaining exports. Recent news reports indicate some interest in selling South Dakota livestock to Mexico for breeding purposes, perhaps raising the risk that in time Mexican beef might enter the U.S. market like the competition South Dakota ranchers face from Canada.

Regardless of the issues raised, it will be in South Dakota's interest to closely follow developments in Mexico. The ratification of the NAFTA treaty should represent a major boost for the economy of that Latin American country, and, as Governor Mickelson has suggested, Mexico might become one of South Dakota's most important export markets.

BIBLIOGRAPHY

Dornbusch, Rudiger. "North American Free Trade: What It Means." Columbia Journal of World Business, Summer 1991. Volume XVI, Number II. pp.72-77.

Galaz, Gomez, Morfin, Chavero, Yamazaki, Deloitte, and Touche, Tohmastsu, Mexico's Maquiladora Book. San Diego: HPW Partners, Inc., 1989.

Garner, Lyn. "Mexico Making Few Energy Concessions in U.S. Trade Talks." The Oil Daily. 27 July 1992. 1-2.

Masur, Sandra. "The North American Free Trade." Columbia Journal of World Business, Summer 1991. Volume XVI, Number II. pp.98-103.

OVERVIEW: THE NORTH AMERICAN FREE TRADE AGREEMENT. Washington, D.C.: Office of the U.S. Trade Representative, August 1992. 15.

Ostroff, Jim. "Mexico Free Trade Vital to Profit, AAMA Told." Women's Wear Daily. 11 May 1992.

Saghafi, Massound M., "Maquiladoras' of Mexico and The North American Free Trade Agreement," in Proceedings of Pan-Pacific Conference IX: A Business, Economic, Technological, and Educational Exchange, 1992.

Trimbull, Mark. "Trade Deals Opens Doors for Manufacturers." The Christian Science Monitor. 13 August 1992. 7.

United States, Cong. Senate. North American Free Trade Agreement. Washington D.C.: August 12, 1992.

Wu, Terry and Neil Longly. "The U.S.-Canada Free Trade Agreement: A Model for a U.S.-Mexico Free Trade Pact." Columbia Journal of World Business, Summer 1991. Volume XVI, Number II. pp.60-71.

Diego Salazar, Ph.D., is Professor of Statistics and Production at the School of Business, University of South Dakota. Benno Wymar, Ph.D., has been on the faculty at the School of Business, University of South Dakota, Vermillion, since 1968 and is Professor of Economics.
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Author:Salazar, Diego; Wymar, Benno
Publication:South Dakota Business Review
Date:Mar 1, 1993
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