NAFTA and the Maquiladora Program — Southern Border Partners

Over the last 40 years, Mexico has made concerted efforts to open its economy and expand its industrial base. Starting with the Border Industrialization Program in 1964, Mexico has tried to lure foreign investment into the country through a series of trade, customs and economic policies. We have outlined below the key policies and how they affect manufacturing operations in Mexico.

THE MAQUILADORA PROGRAM

Overview

In 1965 the Mexican government established the in-bond or maquiladora program, a program that allows duty-free importation of raw materials, components and equipment needed for the assembly or manufacture of finished goods for subsequent export. The program originated from the need to industrialize northern Mexico and slowdown migration to the U.S. by creating jobs along the border.

Defined more precisely, Maquiladoras are foreign-owned, controlled or subcontracted manufacturing plants that process or assemble imported components for export. They operate under a special customs regime which allows the maquiladora to temporarily import into Mexico on a duty free basis, machinery, equipment, materials, parts and components. These items can be used for the assembly or manufacture of finished goods for subsequent export as well as administrative equipment such as computers, and communications devices, subject only to posting a bond guaranteeing that such goods will not remain in Mexico permanently.

A maquiladora program entitles the company to foreign investment participation in the capital and in management of up to 100% without need of any special authorization. The first maquiladoras were established in 1966 in Tijuana, Baja California and Ciudad Juarez, Chihuahua under what was referred to as the ‘Border Industrialization Program’. Currently, the maquiladora industry is ruled by the Decree for the Development and Operation of the Maquiladora Export Industry.

Maquiladoras are governed by special provisions in the Customs Law and the Foreign Trade General Rules issued annually by the Ministry of Finance (SHCP), as well as other laws of general application in Mexico, such as the General Law of Commercial Companies, the General Law of Ecological Equilibrium and Environmental Protection, the Federal Labor Law, and the Social Security Law.

Refer to the Legal and Incorporation chapter in the Information Center for information on:

Requirements to qualify as a maquiladora company,
Recognition of different types of maquiladoras,
Temporal importation information,
Restriction on products to be manufactured, and
Registration & start-up process including incorporation

Industry Size

There are 2,860 maquiladora companies operating in Mexico with nearly 90% of them in the border zone. These companies have a combined gross production of $85.74 billion and represent 55% of Mexico’s manufacturing exports. Major maquiladora locations include Matamoros, Ciudad Juarez, Nogales, Mexicali, Nuevo Laredo, Reynosa, and Tijuana. From a U.S. perspective, 70% of the labor-intensive Fortune 500 companies have maquiladora operations.

(Source: INEGI, Federal Reserve Bank of Dallas)

Maquiladora Employment

In Mexico, the export sector is the leading generator of jobs: more than half of the new jobs created between 1994 and 2000 related to export activity. Employment in the maquila sector has been steadily growing and maquiladoras are now responsible for over 15% of Mexico's manufacturing jobs. As of today, the maquiladora industry currently employs 1,137,862 people. Export-oriented manufacturing jobs pay wages nearly 40% higher than the rest of the manufacturing industry.

Mexico’s Border States account for most of maquiladora employment, though employment in the interior of Mexico has steadily increased during the last decade. Refer to the following graph from the Federal Reserve Bank of Dallas:

Main Maquiladora Sectors:

The electronics and automotive sectors are the two main sectors both in terms of employment and number of plants. The textile apparel industry is still important, though it has lost some ground in recent years. In contrast, manufacturers of electrical machinery, equipment and accessories are increasing their presence rapidly.

Moving Operations into Mexico

When moving operations into Mexico, foreign manufacturers have three options: establish their plant in Mexico by themselves; find a contract manufacturer, or rely on a shelter company.

A. Subcontracting

Companies can establish a subcontracting relationship with a U.S. or Mexican subcontractor with plants in Mexico. In this arrangement, the foreign firm normally provides the components or raw materials, specialized equipment, etc., while the sub-contractor carries out all the manufacturing or assembly work and takes charge of the import-export process as well.

B. Shelter Operation

Establishment of a shelter operation whereby the foreign company maintains control of the production process, providing research and development, raw materials, equipment, capital and often quality control. The shelter operator assumes responsibility for other associated operations, i.e., set-up, legal, accounting, customs and labor and serves as a liaison with the Mexican Government. The shelter company then usually charges the foreign company on a per hour/worker basis.

C. Direct Ownership

The foreign parent company establishes a Mexican corporation, which will carry out the manufacturing-assembly operations with direct control assumed by the foreign parent company. It is important to note that corporations can be 100% foreign-owned.

For more information on subcontracting and shelter operations, refer to our Shelters and Contract Manufacturing chapter in the INFO CENTER.

Specialized Maquiladoras

The current Maquiladora decree recognizes the existence of specialized maquiladora companies such as agro-industrial maquiladoras, as well as companies involved in the exploitation of mineral resources, fishing and forestry, service providers and companies operating as shelters.

Service activities may include repair services; maintenance of plants, machinery and equipment; telecommunications; personnel training and other types of support services needed by the maquiladora industry. There is also the possibility of establishing maquiladoras that offer services to financial institutions, such as check processing, credit card services, data-processing and telemarketing.

Types of Production

Maquiladoras may have different types of production, including the simple assembly of temporarily imported parts; the manufacture from start to finish of a product using materials from various countries, including Mexico; or any conceivable combination of the various phases involved in manufacturing, or even non-industrial operations, such as data-processing, packaging, and sorting coupons.

The PITEX Program

On May 3, 1990, the Federal Government enacted the PITEX PROGRAM, "Programa de Importación Temporal para la Exportación" (Temporary Importation Program for Exportation). This program is designed to assist Mexican companies by making it possible for them to enjoy the benefits of the maquiladora program, including importation of machinery, raw materials and packaging into Mexico for assembly or production without paying import duties with the condition that they are re-exported as a processed product.

However, PITEX companies that subsequently decide to sell part of their production in the domestic Mexican market are required to pay the corresponding customs duties and value added taxes.

The PITEX program allows the temporary import of the following goods:

Raw material, parts and components;
Containers, packaging materials and trailer containers;
Fuels, lubricants, auxiliary and perishable materials;
Spare parts for machinery used in the production lines;
Capital assets, equipment, instruments and molds, and
Equipment, devices and supplies intended for research, quality control, industrial safety, communications and related areas

On May 12, 2003, President Vicente Fox published in the Federal Official Gazette amendments to the “PITEX Decree”. The most relevant amendment refers to the concept of submaquila that was added to the PITEX Decree.

NORTH AMERICAN FREE TRADE AGREEMENT: NAFTA

On Dec 17, 1992, U.S. President George Bush Sr, Canadian Prime Minister Brian Mulroney and Mexican President Carlos Salinas signed the North American Free Trade Agreement (NAFTA), between Canada, Mexico, and the United States, which went into effect on January 1st 1994. NAFTA's main objectives, according to the official three-nation summary are:

Eliminate barriers to trade
Promote conditions of fair competition
Increase investment opportunities
Provide adequate protection for intellectual property rights
Establish effective procedures for the implementation and application of the Agreement; and
Establish effective procedures for the resolution of disputes and to further trilateral, regional and multinational cooperation

Mexico’s Trade Policy

During the last four decades, Mexico has made a dramatic transition from a relatively closed economy to become one of the most open countries in the world. This process began with Mexico’s entry to GATT in 1986, and continued with the signing of free trade agreements with 32 countries, including the North American Free Trade Agreement (NAFTA) in 1994.

Mexico is now one of the main trading economies of the world. According to the World Trade Organization, Mexico became the 8th biggest exporter and the 7th biggest importer worldwide in 2003, reaching $344.3 billion of merchandise trade. See figure below:

LEADING IMPORTERS AND EXPORTERS:

(Source: WTO, International Trade Statistics, 2003)

Mexico’s Network of Free Trade Agreements (FTAs)

Mexico has negotiated 11 FTAs:

Chile (1992)
North American Free Trade Agreement (NAFTA, 1994)
Bolivia (1995)
Costa Rica (1995)
Colombia and Venezuela (G-3, 1995)
Nicaragua (1998)
Israel (2000)
European Union (2000)
Iceland, Norway, Liechtenstein, and Switzerland (EFTA, 2001); and
Guatemala, Honduras, and El Salvador (North Triangle, 2001)
Uruguay (2003)

NAFTA in Numbers

When NAFTA implementation began in 1994, it created the world's largest free trade area, which links more than 406 million people producing more than $11 trillion worth of goods and services. Since 1993, the total volume of trade between the three NAFTA parties has expanded from $294 billion to $653 billion in 2003. Each day the NAFTA parties conduct nearly $1.8 billion in trilateral trade.

Mexico exported $149 billion in 2003 and is estimated to export $166 billion in 2004 to its NAFTA partners, a big leap over 1993 levels, the year prior to the start of NAFTA implementation, when it exported $45 billion. Over the past seven years, export growth has contributed to more than half of real GDP growth in Mexico.

(Source: Secretaria de Economia, Banco de Mexico, US Department of Commerce and Mexico’s Ministry of Economy)

U.S. – MEXICO TRADE

It is important to stress that Mexico is the third largest US trading partner, after Canada and China. The main Mexican exports to the U.S. include manufactured products (85.5%, mainly cars, and electronic equipment), petroleum products (11.3%), while the main U.S. exports to Mexico include motor vehicle parts, electronic equipment, and agricultural products.

Mexican exports to the US reached $146 billion ($163 billion 2004 estimate), while Mexican imports from the US reached $106 billion ($111 billion 2004 estimate). Trade between the two nations represents 39% of total NAFTA trade.

Note that Mexico has consistently experienced a trade surplus with the U.S. during the last few years. See figure below:

Mexico Trade Balance with the U.S.

NAFTA Rules of Origin

Only goods, which qualify under NAFTA’s rules of origin, are in a position to obtain reduced or eliminated tariffs. The purpose is to ensure that goods traded among the three NAFTA partner countries receive preferential tariff treatment. A certificate of origin must be obtained from the producer or exporter in order to treat the material as NAFTA originating.

There are four general rules of origin:

Criterion “A” on the NAFTA Certificate of Origin states that a good produced in the NAFTA territory (Mexico, the United States and Canada) will be considered to “originate” for NAFTA purposes if it is “wholly obtained or produced” in the NAFTA territory.
Under the second general rule of origin (referred to as origin criterion “B” on the NAFTA Certificate of Origin), a good will also qualify as originating if the materials which are not of NAFTA origin used in the production of the good undergo sufficient processing or transformation in the NAFTA territory.
Under the third general rule of origin (referred to as origin criterion “C” on the NAFTA certificate of origin), a good will qualify as NAFTA originating if all of the materials used to produce the good are NAFTA originating.
The fourth rule of origin (referred to as origin criterion “D” on the NAFTA certificate of origin) applies only in limited circumstances where a good and its parts are classified under the same tariff heading or subheading. In such circumstance, the good must meet a regional value content requirement.

Changes on Duties for Maquiladoras Resulting from NAFTA

The biggest change resulting from NAFTA, was the requirement that Mexico pass regulations by January 1, 2001, restricting the duty drawback and deferral characteristics of the Maquiladora Program. It was included in NAFTA because the U.S. Government felt the Maquiladora Program offered an unfair advantage to maquiladoras, since American manufacturers do not receive a drawback or waiver of duties on materials imported to produce goods for sale into the domestic market. In addition, the U.S. did not want producers who would benefit from duty-free entry of their products to the U.S. to also benefit from advantageous duty treatment of their inputs.

As a result, NAFTA’s Article 303 specifies that Mexico can no longer waive its duties for goods to be re-exported to the U.S. as long as re-exportation is a condition of the duty waiver. Foreign companies desiring to take advantage of lower production costs in Mexico must now pay Mexican duties for third-country components.

It should be noted, however, that Mexico found a way to comply literally with Article 303, and to continue to provide the Maquiladora Program and its benefits to foreign manufacturers by creating Industry Promotion Programs (Programas de Promocion Sectorial). This program allows certain industries that have traditionally imported components and parts not available in NAFTA countries to import such components and parts into Mexico at a new maximum tariff rate of 5%. In most cases the tariff rate will be 0%.
(Source: Fredikson & Byron P.A.)

A company moving manufacturing operations to Mexico may decide that it is more advantageous to operate outside the maquiladora program in order to avoid the restrictions of NAFTA’s Article 303. The debate of the advantages of NAFTA overtaking maquiladoras is open; the optimal company structure needs to be analyzed on a case by case basis.

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