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Southern Exposure: Emerging Business Opportunities for Sacramento Area Firms in Latin America

By Jock O'Connell

Comstock's Business Magazine, February 2000.

Jesus Fernandez regards himself one of a growing number of winners in the expanding world of hemispheric trade. Last October, the partner in a West Sacramento financial consulting firm accompanied a dozen Sacramento-area business people on a trade mission to Mexico organized by the Northern California World Trade Center. According to the center's executive director, Brooks Ohlson, this trade mission has become an annual affair, giving small and medium-sized companies in the trade promotion organization's service area (which ranges from Vacaville to Tahoe and Redding to Turlock) a chance to meet prospective customers as well as suppliers in Mexico.

Like Fernandez, most of the other trade mission participants came home with valuable leads to lucrative export opportunities south of the border. For Linda Davis, President of the Sacramento Municipal Utility District's Board of Directors, the mission served a different purpose. She went to identify potential suppliers for the electrical utility's massive demand for photo-voltaic panels, cables, wires, switches, transformers, and compact flourescent light bulbs. "We buy from companies around the world. Finding a reliable source of supply in Mexico could result in significant cost savings for SMUD and our rate-payers," she explained.

Interest in doing business with Mexico -- not to mention with the countries of Central and South America -- gained added momentum early last year when California Gov. Gray Davis and Mexican President Ernesto Zedillo exchanged official visits. By traveling to Mexico within a month of his inauguration on January 4, 1999, Davis signaled the end to a period of divisive political rhetoric that had made many Mexican business people leery about dealing with California. Not content with merely enhancing the atmospherics of trade, the governor also announced his intention to put the state's resources fully behind the expansion of cross-border trade.

Prominent among his specific initiatives was one calling for the establishment of 15 Mexican trade centers at community colleges located throughout the state. These trade centers -- the one serving the Sacramento area is run by the Los Rios Community College district -- will offer intensive training in Mexican business practices, language and culture to California business people to help them expand their opportunities in Mexico.

For their part, California legislators are weighing plans for a series of teleconferencing centers statewide that will help smaller California businesses meet "face-to-face" with prospective business partners in Mexico. Other trade-support programs — some of which tap the expertise of the University of California and California State University faculties — are likewise being examined.

New initiatives are not limited to Mexico. California, which has had a state trade office in Mexico City for several years, is also in the process of establishing similar outposts in Sao Paolo, Brazil and Buenos Aires, Argentina.

The new level of excitement about hemispheric commerce is attributable to a historic wave of profound economic and political reforms that have been giving rise to exciting new commercial opportunities -- along with new uncertainties -- for U.S. companies doing business throughout Latin America. With varying degrees of emphasis, the region's countries have been jettisoning protectionist policies in favor of the free-market while simultaneously reducing the state's direct role in economic affairs. At the same time, major free trade zones have been established in both North and South America.

The effects of these developments have been most evident in the case of our nearest and largest Latin American trading partner. Not only does Mexico absorb about two-thirds of all U.S. exports to Latin America, it recently surpassed Japan as California's leading export market.

The Mexican economy has continued its steady, if uneven, recovery from the recession -- the country's worst in 60 years -- that followed the sharp devaluation of the peso crisis in December 1994. Fearing that our neighbor's economic woes would spill over the border, the Clinton administration in early 1995 engineered a controversial economic support program that included $20 billion from the U.S. and over $40 billion from European and Asian lenders. The bailout helped Mexico rebuild its foreign currency reserves and reduce its debt.

The remedy worked -- with a lot of help from the maquiladoras, foreign-owned factories in Mexico that import duty-free components and raw materials to make goods for export. With the peso's devaluation lowering Mexico's already rock-bottom labor costs and with NAFTA ensuring access to the vast U.S. market, manufacturers from around the world flocked to Mexico. The ensuing explosion of exports from $49.5 billion in 1994 to $94.6 billion by 1998 saved the country from a repetition of the economic doldrums of the 1980s, Latin America's so-called "Lost Decade."

Far from faltering, Mexico staged a remarkable economic recovery: The country paid off its $13.5 billion loan to the United States more than three years ahead of schedule and has since recorded sixteen straight quarters of economic expansion.

Further to the south, an unprecedented process of economic integration has been underway. Most notably, MERCOSUR (the common market of Argentina, Brazil, Paraguay, and Uruguay) emerged in the past decade as a hemispheric market second in size only to the North American Free Trade Area. Trade among the MERCOSUR countries roughly quadrupled during the 1990s as member nations followed neighboring Chile's lead in embracing free market economic reforms. During the same period, U.S. exports to South and Central America more than doubled, although recent economic problems in the region did lead to an abrupt 20 percent decline in U.S. exports to the region during 1999.

Despite ample export opportunities for small and medium-sized U.S. firms, prospective exporters should exercise considerable caution, particularly when it comes to interpreting business news reports and especially when deciphering trade data.

For example, it is essential for any firm considering the Mexican market to recognize that there are actually two Mexicos with which the United States does business. The first is a developing economy of nearly 95 million souls. The other is a virtual entrepot economy comprising the maquiladoras: manufacturing plants largely owned by U.S., Asian and European corporations, largely managed by expatriate personnel, and largely unconnected with the domestic economy in which most Mexicans live and work. It is this ‘‘Gringo Archipelago'' that dominates two-way trade between Mexico and the United States, accounting for nearly three-quarters of all cross-border shipments in recent years.

Paradoxically, the North American Free Trade Agreement proved to be a boon for the maquiladora sector. Though NAFTA's primary purpose was to eliminate trade barriers between the U.S., Canada and Mexico, the trade pact importantly codified new legal protections for foreign investors and foreign companies operating in Mexico. As a result, the number of registered maquiladoras increased from 2,122 at the time of NAFTA's implementation in January 1994 to over 3,000 today.

Major steps are being taken to integrate the maquiladoras into Mexico's economic life. For one thing, most of the latest maquiladoras are being established in cities well beyond the border and closer to the nation's industrial and population centers. Even so, the maquiladoras remain a virtually distinct and separate economy. The latest Mexican government statistics reveal that less than 2% of components assembled annually by companies participating in the program are bought from Mexican suppliers. Everything else, including machinery used to manufacture or assemble finished products, comes from Asia and Europe but mainly from the United States.

The maquiladoras' significance in the context of US-Mexico trade should not be understated. According to Robert Collier, the San Francisco Chronicle's Latin American correspondent, Mexico's ranking among California's leading export markets would plummet to 11th were the maquiladoras removed from the trade equation.

The dominant role of the maquiladoras adds an ironic twist to the usual dynamics that drive bilateral trade. Normally, exports from A to B would rise or fall depending on, all other things being equal, changes in B's demand for imported goods. Yet, with such a high percentage of what we ship to Mexico soon making its way back to us in the form of finished goods, it's been the U.S. market's insatiable demand that has largely fueled the phenomenal rise in cross-border trade.

What this means, of course, is that a slowdown in the U.S. economy in the months or years to come will more than likely precipitate a commensurate fall-off in both imports from and exports to Mexico. Indeed, it was to lessen its exaggerated dependence on the U.S. market (or Alan Greenspan's whimsy) that prompted Mexico to sign a free trade agreement with the European Union late last year.

What is California's stake in U.S.-Mexico trade? The California Trade and Commerce Agency reports that California exports to Mexico increased 6.9 percent through the first nine months of 1999 to $10.6 billion, over a half billion dollars more than the Golden State shipped to Japan during the same period. That's certainly impressive. Yet, the truth is that no one really knows how much California firms really export to Mexico. Nor do we know how large a percentage of California's export trade with Mexico involves the shipment of components and subassemblies to the maquiladora industry. Nor do we have reliably accurate figures on California's exports to the principal economies of South America.

The reason for this astonishing gap in our knowledge about California's export trade is that the so-called state-of-origin export data -- the figures most commonly cited in government reports and newspaper articles --- were never intended to reveal how much a particular state's companies are exporting. Instead, what really counts in determining a cargo's state-of-origin is the location of a party known as the Exporter of Record on the official Shipper's Export Declaration that must accompany all export shipment worth more than $2500.

To be sure, the Exporter of Record and the product's manufacturer may be one and the same. However, because more and more large exporting companies are cutting costs by outsourcing logistical functions such as transportation and distribution, the likelihood is growing that the Exporter of Record will be a party wholly unconnected to the manufacturer. The two parties may not even be in the same city or even in the same state.

This distinction between the producer of merchandise and the Exporter of Record is scarcely trivial. For if the actual manufacturer is located in Rancho Cordova but the Exporter of Record is a warehouse manager in Laredo, the shipment will almost certainly be officially credited as an export of Texas.

Further contributing to the distortion of trade data, overland shippers have been making greater use in recent years of a practice more commonly associated with airlines -- the "hub-and-spoke" system -- that allows for several clients located over a large geographic area to be served by one centralized distribution or warehouse facility. Other large or frequent shippers send containers to the border region where loads are consolidated, broken, or held in inventory for shipment beyond the border to a retail outlet or other end-user. With warehouse space at a premium in Mexico, few shipments south of the border move directly from manufacturer to end-user.

There is no question that crossborder trade between California and Mexico has increased significantly in recent years. But much of this growth has taken the form of shipments to a burgeoning maquiladora industry just over the border in Tijuana and Mexicali, a fact which helps explain why California's exports to Mexico continued to surge despite the anti-California sentiments reportedly voices by many Mexican businesspeople in reaction to the anti-immigrant rhetoric that infected California politics during the mid-1990s.

Due to the method of data collection, what is reported as California exports to Mexico include shipments that may have originated outside of the Golden State but which cross the border through San Diego or Imperial counties en route to maquiladoras in Tijuana and Mexicali. Meanwhile, for a large but unknown percentage of California-made products shipped to destinations elsewhere in Mexico, a funny thing happens — they often wind up being officially credited to Texas.

Mexico's principal industrial and population centers are due south of Texas along a major transportation corridor. For California goods bound for these markets, transshipment via Texas offers decided advantages and cost-savings to shippers. Once these cargos arrive in Texas, however, they are commonly held in warehouses north of the border before being shipped on to retailers, distributors or manufacturers in Mexico. That's why Texas appears to do much more business with Mexico than is actually the case.

The pivotal role Texas plays as a transshipment point for trade with Mexico is similar to Florida's with respect to California's trade with South America. One transparent indication of Florida's role as a transshipment point for goods produced elsewhere but which are reported as Florida exports comes from comparing export data with manufacturing data. In one recent census of manufactures (1996), Florida-based manufacturers reportedly produced some $2.2 billion worth of industrial machinery and computers. But state-of-origin trade data for the same year show that Florida exported more than twice as much ($4.6 billion) of the same category of merchandise. That a hefty chunk of the $2.4 billion in exported merchandise not manufactured in Florida came from California is not an unreasonable presumption. Nor is it unreasonable to assume that South America is a market for much more than the two percent of California's export trade that the official data continue to allege.

These data collection shortcomings help explain why the Sacramento area's exports seem so modest in relation to the size o the region's economy. According to official U.S. calculations, Sacramento ranks 66th among the nation's major metropolitan areas in overall merchandise exports. Exports from the Sacramento area increased by 61 percent -- from $1.08 billion in 1993 to $1.73 billion in 1998 -- the latest year for which complete figures are available.

Surprisingly, Sacramento's trade with Mexico is almost ludicrously low — a mere $34 million in 1993, rising to $70 million in 1997 before falling off to $62 million in 1998. During the same period, Sacramento area exports to South America soared from a trifling $17 million in 1993 to $81 million in 1997, before tapering off to $72 million in 1998.

Such data cannot be believed. There is every indication that Sacramento area companies are significantly more active in the nation's export trade. It is just that much of what this region ships to the rest of world passes through hands that unfairly receive credit for the shipment. That's the bad news. The good news is that federal authorities are taking some major steps to improve the reliability of the nation's export trade. Included among these changes are measures to better identify the real source of goods being shipped abroad.

While NAFTA has eased or eliminated many of the reasons U.S. firms may have had for being reluctant to do business with Mexico, engaging in business in much of the rest of Latin America still involves significant risks.

The first and most obvious is the very real danger that economies throughout South America will unravel. Much of the region is either in the midst of or just emerging from recessions. Although showing some signs of recovery, Brazil's economy remains a question mark. The nation's well- publicized troubles over the past year significantly added to the southern hemispheric tribulations. Venezuela's president has all but declared an economic state of emergency while the country wrestles with a new constitutional system. Colombia's economy has been experiencing its worst performance since 1931. Argentina's new government may or may not be able to summon up the political will to fend off economic contagion from Brazil, while in Chile industrial production has slowed markedly in 1999, the country's worst economic showing in 16 years.

Savvy exporters will always find lucrative markets despite adverse political and macroeconomic circumstances, just as shrewd importers will identify reliable suppliers. Fortunately, for the less experienced exporter, plenty of help is available. A useful starting point for local companies interested in doing business with Mexico is Northern California World Trade Center, located on the second floor of the Sacramento Metropolitan Chamber of Commerce at 917 7th Street in Sacramento. (Tel.: 916-447-9827). Another is the Center for International Trade Development at the Los Rios Community College district which is located at 1410 Ethan Way in Sacramento. (Tel.: 916-563-3200). The California Trade and Commerce Department's Export development Office is headquartered in Long Beach. (Tel.: 562-590-5965; Email: expdev@commerce.ca.gov). California's Mexico City Trade Office is located at Paseo de la Reforma 265, Piso 14, Col. Cuauhtemoc 06500 Mexico, D.F. (Tel: 011-52-5- 533-1111; Email: director@californiaagency.com.mx).


Jock O'Connell (www.jockoconnell.com) is a consultant who tracks and analyzes economic and political developments affecting international business. He also writes frequently on world trade issues for the Los Angeles Times and the Sacramento Bee.

His email address is Email: jockoconnell@gmail.com