California's New Latin American Trade Strategy Based on Flawed Data

By Jock O'Connell


(This is the actual text of the article as it appeared in the Sacramento Bee Forum section on Sunday, March 7, 1999.)

Befitting the remarkable surge in California's export trade with Mexico in recent years, both Governor Gray Davis and the Legislature seem anxious to re-focus the state's international trade programs — long preoccupied to the point of near obsession with the Pacific Rim — toward Latin America. It's a policy shift that, though ripe with promise, is not without peril.

A mere four weeks after assuming office, Davis led a high-profile delegation of political, business and academic leaders from California on a mission to Mexico, a trip which featured a well-publicized meeting with Mexican President Zedillo. By contrast, Pete Wilson waited until his second year in office before journeying outside the country, and George Deukmejian did not make his first foreign trip until the start of his second term.

Soon after the Governor's return from Mexico, he reaffirmed his commitment to boosting Latin American trade by naming Christopher M. Campaña to run the state's International Trade and Investment Division. Before joining Davis's gubernatorial campaign last year as a press aide, Campaña had been involved in Spanish-language broadcasting.

Meanwhile, upstairs in the capitol, key legislators have been moving in the same direction. In the Assembly, Speaker Antonio Villaraigosa (D-Los Angeles), who had accompanied the governor on the Mexico trip, has called for the opening of a California trade office in Buenos Aires. Over in the Senate, Sen. Richard Polanco (D-Los Angeles) has introduced a measure appropriating a half million dollars for that same purpose.

An outpost in the Argentine capital would be California's third trade office in Latin America. The first, in Mexico City, was opened in 1989. Another office in Sao Paolo, Brazil, has budget authorization but has not yet been opened.

Those backing this new emphasis on Latin America presumably view it as a winning trifecta. The most evident beneficiary of steps to develop new export markets in Latin America would be California's economy. According to commonly used (but, as we shall see, highly misleading) state-of-origin trade data, South America buys a mere 2 percent of California's overall merchandise exports.

The new policy focus also advances an immeasurably important social goal by emphasizing that our hemispheric neighbors -- often vilified as a source of illegal immigration and contraband -- are actually valuable and respected business partners.

Finally, the new dignity with which the administration officials and legislative leaders treat the peoples of Latin America does nothing to tarnish their images in the eyes of California's growing population of Latino voters.

That's the considerable upside. The downside is that, in a political milieu that wants initiatives to show palpable results before the next election, the Governor and the Legislature may be under-estimating the potential for disappointment.

For one thing, the optimal strategy in global commerce is one that is sufficiently diversified to mitigate the ill effects of a collapse of one regional market. California will not be well-served by a new policy that merely substitutes one preoccupation (Latin America) for another (East Asia).

More importantly, though, care should be taken not to create expectations that cannot be met. If diversification is important, so too is patience. Indeed, there are three major reasons why the new focus on boosting California's trade with Latin America courts a severe let down.

The first and most obvious is the very real danger that economies throughout Latin America will unravel over the next few months. Already, much of Latin America is expected to fall into recession this year. Brazil's well-publicized woes are significantly adding to the region's troubles, while Venezuela's new president has all but declared an economic state of emergency, and Colombia's economy has just seen its worst performance since 1931. Political rivalries involving control of President Carlos Menem's ruling party in the run-up to the next presidential election may prevent the Argentine government from taking steps needed to fend off economic contagion from Brazil. And, in Chile, industrial production in January was off 6.7 percent compared to the same period last year while unemployment rose 2.2 percent over the same period.

Large corporations throughout Latin America but especially in key countries such as Brazil, Argentina and Mexico are shut out from raising international money unless they are willing to pay punishingly high interest rates. And the macroeconomic remedies being used to shore up the region's economies — even higher interest rates and deeper cuts in public expenditure — will further stifle demand for foreign products. What lasting effect these strains will have on often fragile democratic institutions and already dwindling respect for free-market economics is anybody's guess.

Yet even if the economic prospects for Latin America were brighter, it does not follow that a more aggressive state trade promotion campaign would yield a demonstrably higher volume of trade with the region. Against the backdrop of California's trillion dollar economy which exports as much as $150 billion in goods and services annually, an office staffed with perhaps two or three international business professionals surely cannot be expected to have a significant material impact on trade flows. The real value of such outposts is more symbolic. Which is precisely why opening export promotion offices in large, viable regions historically under-served by California exporters makes a good deal of sense -- if only we knew which regions these are.

For the third major reason for exercising caution when jumping on the Latin American trade bandwagon is that the data underlying our understanding of California's export trade are not at all reliable and are becoming less so every day.

The often overlooked fact 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, or how much trade contributes to the state's economy, or how many of the state's residents are employed in export-related jobs.

In fact, the process by which state export data are collected is quite indifferent to the question of where the exported merchandise was actually manufactured, grown or processed. Instead, what really matters is the location of a party known as the Exporter of Record on the official Shipper's Export Declaration filed with U.S. Customs. For it is this information that determines the cargo's state-of-origin.

Now, 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.

There is no question that crossborder trade between California and Mexico has increased significantly in recent years. But much of this growth has been fueled by shipments to a burgeoning maquiladora industry along the border. For California-made products bound for Mexico's industrial and population centers, though, transshipment via Texas offers decided advantages and cost-savings to shippers.

A glance at a map will quickly reveal why. Mountain ranges in Mexico run north-south, severely inhibiting east-west traffic. Due to these natural barriers and to the historically limited demand for east-west trade between the country's northern population centers, Mexico's east-west transportation corridors have not been highly developed in the northern border region.

In addition, Mexico's principal population and industrial centers are directly south of Texas along the nation's most extensive overland transportation network, the Northeast Corridor. As a result, overland shipments from California to, say, Monterrey or Mexico City are apt to be routed east along the US Interstate highway system or on parallel rail lines before crossing the Texas-Mexico border and entering the Northeast Corridor.

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.

As a binational report on transportation infrastructure issues observed in 1998, the relatively high cost and low-availability of warehouse space in Mexico has led to a significant investment in new space being added north of the border. "These large, centralized storage points, located north of the border along east-west trade routes such as I-10, fit the distribution needs of both U.S. and Mexican shippers for both U.S. domestic and U.S.-Mexico international trade, particularly in Texas."

The end result is that Texas receives credit for an unknown but probably very significant volume of California goods bound for Mexico. And there is every likelihood that this distortion in our understanding of binational trade flows will only become more acute in the future as more and more manufacturers adopt the practice of out-sourcing the distribution of their output and as other logistical innovations are introduced.

The pivotal role Texas plays as a transshipment point for trade with Mexico is similar to Florida's with respect to trade with South America. The major difference, obviously, is that whereas most of Texas' trade with Mexico moves by truck or rail, Florida's transportation links with Central and South America are by air and sea.

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 1996, Florida-based manufacturers 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 allege.

Why should anyone other than a few policy wonks sweat the implications of these flaws in the state export data? The problem is that a lot of businesses, economists, and government officials all base their understanding of California's export trade on data that are becoming less and less reliable.

Blurring our picture of California's export trade is bad enough. Perhaps even worse is having to watch as Texas and Florida receive credit for much of our handiwork. But there is no question the worst disservice done by the current export data system involves how it has distorted and perhaps even poisoned our perceptions of how vital California's commercial relations with Latin America truly are and how intertwined California's economic destiny is with our Latin friends.

As for state trade policy and programs, the remarkably sudden collapse of once vital markets in East Asia should remind us of the virtues of building a fully diversified export trade. But while there are ample reasons to pursue a more vigorous trade strategy in Latin America, it is also clear that a more nuanced, sophisticated, and -- above all -- patient export development strategy will be required.

So long as the available data suggested that California companies were largely shunning trade opportunities in Latin America, it was reasonable to call for a broadly focused campaign of selling California firms on the possibilities of trading with Latin America.

But now that it appears that California industry enjoys a much more extensive trading relationship with Latin American than hitherto assumed, the appropriate trade development programs need to be more nuanced and carefully targeted. For the one unmistakable fact that emerges from the puzzle of faulty trade figures is that the engine has been working pretty well; it was the gauge that needed fixing.

Copyright (c) 1999 by J.A. O'Connell