Second of two parts

In the first part of this article, I recounted the story of the unlikely creation of NAFTA after Mexico ditched half a century of inward-looking, protectionist policies and proposed a free trade agreement to the United States, which eventually turned into the North American Free Trade Agreement, including Canada, in 1994. Also, we narrated how soon-after NAFTA’s trade started expanding fast, China’s entrance into the global world trade when it joined the WTO in 2001, began competing very effectively with Mexico in the U.S. market, as well as penetrating Mexico’s own domestic market, slowing the growth of trade between those two countries both ways. Finally, how this situation has changed dramatically in the last few years with China’s policies shifting towards expanding its internal market instead of the aggressive export-oriented strategy followed in the previous two decades.

China’s trade with the US and Mexico started growing extremely fast, in such a way that by 2009 it had become the second largest trading partner of both countries, a situation that continues until today, but in a very lopsided manner: China exports to both nations far more of what it imports from them. Last year the US trade deficit (merchandise) with China reached $365 billion and around $65 billion with Mexico. This situation has given rise to protectionist feelings and, in some cases, by the adoption of countervailing duties, as was recently the case with steel products in which both countries charged China with dumping.

China losing edge

But these trends that have been the feature of North America’s trade with China for the last fifteen years are changing fast. China is losing competitiveness vis-a-vis Mexico because of sharp increases in wages above gains in productivity growth; as the result of a demographic tendency towards aging of the Chinese population, that the new policy to allow an increase the number of children per family will not change; higher costs of transportation, although the dramatic fall in the price of oil will ameliorate to some extent this effect; and, finally, the relative strength of the yuan, versus most other currencies, including Mexico’s peso, that have depreciated substantially in the last year and a half.

The share of China’s exports to the US market, which back in 1990 was only 3.1%, shot-up to almost 20% by 2009 but has been falling to around 15% in the last two years. Meanwhile, the share of Mexico’s exports in the US market went from 6.1% in 1990 to 13.4% in 2014 and 2015. Interestingly, the undisputed main trading partner of the US, Canada, has fallen for the first time in recent history to second place due to the fall in oil and gas prices. Just between 2014 and 2015, its share fell from 16.6% to 14.5%, below China’s and slightly above Mexico’s. But according to projections of the Economist Intelligence Unit by as soon as 2018 Mexico will be the undisputed largest trading partner of the US, somewhat above China and more than two percentage points over Canada.

China is becoming less and less a low cost manufacturing base as the result of a combination of factors that have eroded their cost advantage considerably in the last few years, and its estimated manufacturing cost advantage over the US has shrunk to virtually zero over the last twelve years, which is one of the reasons for the re-industrialization of that country, and the growing number of manufacturing plants moving from China to Mexico, in many cases returning back after they left in the early 2000’s.

Mexico, US cost structures improve

Meanwhile, cost structures in Mexico and the US improved far more than in the other 20 largest exporting nations, as the result of low wage growth in real terms, sustained productivity gains, a relatively weak Mexican peso in the last 18 months and, even more fundamentally, much lower energy costs than anywhere else in the world. According to a Boston Consulting Group’s analysis, the US and Mexico are the current rising stars of global manufacturing and they estimate that Mexico now has lower costs than China on a unit-cost basis, and the rest of the world’s top ten exporters of merchandise – excluding China and Korea — are between 10% and 25% more expensive than the US.

China can no longer be considered a low-cost manufacturing base. The low-cost edge a key advantage for decades that allowed it to conquer the world export market until it became the US’ largest trading partner, albeit ephemerally as was mentioned earlier.

But the tables have turned. In the last twelve years, it’s estimated that China’s competitiveness vis-à-vis the US has shrunk from a 14% lower average cost adjusted for productivity differences, to virtual parity now, and with regards to Mexico, China’s competitiveness losses are even sharper. The reasons for this erosion are clear: skyrocketing labor costs that have more than tripled with respect to the US and quadrupled in relation to Mexico. The cost of energy is another key factor: the costs of industrial electricity and natural gas in China rose by 70% and 138%, respectively, in the same period, as they remained virtually flat in the US, although the price of natural gas fell by 50% thanks to the revolution in oil and gas extraction, while they also fell substantially in Mexico, as the result of its recently implemented energy sector reforms.

TPP impact

The future for NAFTA and China will depend very much on what happens, first, with the Trans Pacific Partnership (TPP), which is currently in the process of ratification by the national legislatures of the twelve signatory nations. It includes important Asian countries, like Japan and Vietnam, but not China. Another way to look at TPP, in which both Canada and Mexico are included, is to bring NAFTA’s protocols up to 21st century standards and incorporate all the issues that were not included in the original treaty signed in 1993, either because they were nonexistent, like cyber-commerce, or were not negotiated then, like homogenization of national standards in a myriad sectors of the economies that are today one of the main obstacle to free trade.

Leaders of member states of TPP

It has been suggested that the real hidden political objective of TPP is to eventually force China to adopt its far more stringent protocols in many issues, such a competitiveness policy, which TPP intends to change dramatically by assuring that all participating parties have similar laws on these matters. These new protocols would replicate those of the US in issues like consumer protection against fraudulent and deceptive commercial activities that could harm consumers, and procedural fairness in the application of the laws, a pending assignment in some of the TPP nations as well as in China. This chapter of the TPP negotiation will also ensure convergence in the structure and application of anti-trust and monopoly-busting rules and regulations.

The other key chapter of the proposed TPP is a much improved set of rules dealing with state-owned enterprises (SOEs) compared to those included in NAFTA, which includes commitments by the member nations to ensure that their SOEs make purchases of goods and services on the basis of commercial considerations and that they do not discriminate against the corporations, goods and services of other member countries. Among the provisions of this chapter, it is required that TPP nations provide their courts with jurisdiction over commercial activities of foreign SOEs operating in a TPP country, so they could not evade legal action by claiming sovereign immunity, providing rules that ensure that their administrative entities regulating commercial activities do so in an impartial manner.

Worries about the role of SOEs have grown in the last decades since they are increasingly operating in the global marketplace rather than exclusively in their own territories, as used to be the case, as they are increasingly engaging in international trade and investment. These provisions will cover subsidies, preferential financing and regulatory policies that favor SOEs by their national governments, while at the same time recognizing and ensuring the legitimate role of SOEs in the provision of public services.

Clearly these radical overhauls of the legal framework and protocols of the competitiveness and state-owned enterprises in TPP had very much in mind not only China but also Korea, which are not part of TPP currently but could join later, and where a veil of ambiguity prevails in these areas. My bet is that if TPP is ratified by the end of 2016, as now seems probable, within three years it would expand to incorporate China and Korea, which would represent the historical reset of North America towards Asia that the leaders of the NAFTA nations, led by President Obama, have toiled hard to accomplish.

Manuel Suarez-Mier is a Washington, DC-based independent consultant on economic and financial issues. He has taught economics and international finance at various universities in the US and Mexico and was Director of the Center for North American Studies at American University 2014-2015. His numerous posts include chief of staff of the Governor of the Bank of Mexico. He also was Mexico’s top economic diplomat in Washington at the time of the negotiations of the North American Free Trade Agreement (NAFTA) between the US, Canada and Mexico.

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