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Report on the Possible Effects
of a Japan-Mexico Free Trade Agreement on Japanese Industry

April 20, 1999

Working Group on Japan-Mexico Bilateral Treaties
Japan-Mexico Economic Committee

  1. Introduction
    1. Background
    2. Implication of a Free Trade Agreement with Mexico
    3. Framework
  2. Main Subject
    1. Impact of the Agreement on Trade Between Japan and Mexico
    2. Impact of the Agreement on Investment from Japan
  3. Conclusion
    1. Impact of the Free Trade Agreement
    2. Challenges for the Future
  4. Postscript

  1. Introduction
    1. Background
    2. On the occasion of the 22nd Japan-Mexico Businessmen's Joint Committee Meeting ,which took place in Tokyo in November 1998, President Zedillo suggested that conclusion of a free trade agreement might be needed to secure a free flow of trade and investment between Japan and Mexico, referring to Mexico's active efforts to conclude such an agreement with countries of the Americas and European Union (EU). Also submitted by private representatives of both sides was the idea of discussing bilateral trade/investment treaties as a step toward closer economic relations between the two countries.

      In January 1999, following these initiatives, the Japan-Mexico Economic Committee established the Working Group on Japan-Mexico Bilateral Treaties, headed by Mr. Takagi, Advisor, International Affairs, Matsushita Electric Industrial Co., Ltd., to examine the possible effects on Japanese industry if a Japan-Mexico free trade agreement were to be concluded in the future.

    3. Implication of a Free Trade Agreement with Mexico
    4. It is generally recognized that conclusion of a free trade agreement deepens bilateral/regional trade and investment relations, as proven by the examples of EU and NAFTA. In addition to this, it seems to have the following implications for Japanese industry to examine the possibility of a free trade agreement with Mexico.

      First, it is of great importance for Japanese industry to further strengthen economic relations with Latin America, which, endowed with abundant raw materials and labor, is regarded as one of the potential growth centers of the world economy in the 21st century. In particular, Mexico is expected to achieve significant growth in the future, based upon economic infrastructure consolidated through structural reform over more than 10 years.

      Second, Mexico has great importance as a production and export center in the Americas, owing to its domestic market of nearly 100 million people, as well as its network of free trade agreements, including NAFTA and others with Latin American countries. North American enterprises have already secured access to the Mexican market through NAFTA, and so will Europeans when the negotiations between Mexico and EU toward an FTA is concluded. Considering these facts, as well as the FTAA (Free Trade Area of the Americas) to be realized by 2005, it is urgent for Japanese firms to acquire equal conditions for competition with Americans and Europeans.

      Third, Mexico and Japan have long been building friendly relations in both the historical and social aspects. There is no political stumbling block between the two, and the atmosphere toward Japan is generally amicable in Mexico. It will be an especially important element for successful negotiations that the Mexican government expresses willingness to conclude trade/investment treaties with Japan.

      Fourth, as Japan has had no experience in concluding free trade agreements with other countries, strong political leadership will be needed to set a precedent. It is also of importance from this point of view that with little rivalry between the two industries, strong opposition will not be expected on the Japanese side.

      Taking the above factors into consideration, Japanese industry should actively promote a free trade agreement with Mexico if it gives much benefit and little damage to Japanese firms.

    5. Framework
    6. The Working Group on Japan-Mexico Bilateral Treaties consists of approximately 20 corporations in such areas as automobiles, electronics, parts, trading companies, banking, and mining, the majority of which have already launched business in Mexico. The members intensively held meetings from January to March 1999, as well as exchanged views with Mr. De la Calle, Undersecretary of Commerce and Industrial Development of Mexico.

      As a premise for the analysis, we set a model of a comprehensive "Japan-Mexico Free Trade Agreement" (hereinafter referred to as "Agreement") encompassing both trade and investment, which provides the elimination of all custom duties between the two countries after a certain period and the abolition of investment barriers, including performance requirements.

      II. Main Subject of this report refers to the effects of the Agreement on the trade and investment activities of Japanese enterprises, which play a major part in economic relations with Mexico. III. Conclusion gives a general estimation of the Agreement, as well as suggesting issues for further discussion.

  2. Main Subject
    1. Impact of the Agreement on Trade Between Japan and Mexico
      1. Automobiles (finished product)
        1. Strategies of Japanese firms regarding Mexico
          Japanese automobile producers regard the Americas as one united bloc in their business. Most of the parts used for their production in Mexico are supplied from NAFTA, and a majority of the automobiles they sell in Mexico are produced in NAFTA. These phenomena are attributed to their global strategies (e.g. automobile producers tend to think the production site should be close to the market), as well as the existence of the Mexican Automotive Decree (requiring a certain export/import balance and national integration in Mexico) and rigid rules of origin provided by NAFTA.

        2. Impact on exports to Mexico
          The Mexican tariff on automobiles is normally 20% to 30%, while among NAFTA parties it is 4.4% as of 1999 and will gradually be reduced to zero by 2003. Furthermore, also the import of European cars will become free when the Mexico-EU Free Trade Agreement enters into force. It is important, therefore, to eliminate custom duties by the Agreement from the viewpoint of competition against American and European producers.
          In particular, the export of rare models (e.g. high-grade cars, sports utilities, entry cars) and commercial vehicles will probably be increased by the elimination of custom duties and revision of the Automotive Decree.
          On the other hand, the export of ordinary cars from Japan is not expected to increase substantially, for in nearly all cases they are produced in Mexico or imported from factories in the U.S.

        3. Impact on imports from Mexico
          The import of automobiles from Mexico to Japan is not found at present, nor expected in the future. (There would be no impact of the Agreement, since the import of automobiles to Japan is already free.)

      2. Electronic Appliances (finished product)
        1. Strategies of Japanese firms regarding Mexico
          For Japanese electronics corporations, Mexico has a great importance as a large market in itself, as well as a production center for export to the American market (usually through Maquiladora regime). Contrary to automobile assemblers, they export a substantial amount of finished products from Japan, use lots of parts made in Asia for the production of TV sets, etc. for sales in the Mexican market, and import a certain amount of parts from Asia (though mainly from NAFTA) for the production of TV sets, etc. for export to the U.S.

        2. Impact on exports to Mexico
          The benefit of the elimination of custom duties in this area is expected to be large, since the export of finished products from Japan to the Mexican market is substantial, as described above. The export of information-related appliances, which are largely exported from Japan, particularly is expected to increase if the existing high tariff rate is abolished. Though new products sometimes cannot immediately be introduced in the Mexican market due to the present tariff walls, the lead time would be shortened by elimination of the custom duties. Those products that are currently produced in the U.S. for export to Mexico might possibly be substituted by products made in Japan, which would gain competitiveness by the Agreement.

        3. Impact on imports from Mexico
          As for this area, import to Japan is already free and would not be given any benefit by the Agreement. Indeed it is theoretically possible to export parts from Japan or Asia to assemble in Mexico and import the finished products to Japan, though it does not pay considering the transportation costs. The import of Mexican products to Japan, therefore, is scarcely expected to be increased by the Agreement.

      3. Parts
        1. Strategies of Japanese firms regarding Mexico
          Japanese parts suppliers promote export to and investment in Mexico in accordance with the strategies of automobile and electronics assemblers. Auto-parts for the Mexican market are imported partly from Asia, though mainly from within NAFTA. Japanese affiliates producing parts in Mexico import most parts from within NAFTA, but some from Japan, too.

        2. Impact on exports to Mexico
          Those parts that are imported from Japan for production for sales in the domestic market are imposed a tariff of 10% to 20%. If the Agreement eliminated it, Japanese firms would be able to export parts on the same condition as NAFTA parts. Then, besides those parts that are currently exported from Japan, some NAFTA or Asian parts might be substituted by Japanese parts. And in case an electronics assembler starts to produce a new item in Mexico, it would be able to import necessary parts from Japan even when it is difficult to find them in Mexico or the U.S. Furthermore, if the Agreement promoted production by Japanese firms in Mexico in the areas of electronics, etc., the export of parts from Japan would increase accordingly.
          Although legislation of a new regime for post-Maquiladora is now under way in the Mexican government, not all the tariffs on electronics/auto parts seem to be zero. The Agreement would have certain implications also in this regard.

        3. Impact on imports from Mexico
          There would be no direct impact of the Agreement on imports from Mexico to Japan, because Japan's tariff in this area has already been eliminated. (Some assemblers find it difficult to import from Mexico those parts specialized for production in Japan, while some are thinking of importing cathode-ray tubes for display monitors made in Mexico.)
          It is also pointed out that, by enhancing economic relations and the flow of information between the two countries, the Agreement might change the current situation where Japanese companies are unfamiliar with potentially available Mexican products.

      4. Other
        1. Impact on exports to Mexico
          When the Agreement enters into force, an increase will be expected in exports from Japan to Mexico of such items as power/petrochemical plants, chemicals, petrochemical materials, precision chemicals, pesticides, high-grade steels (tinplate, stainless steel, flat steel), high-grade steel plate for automobiles, etc., because the cost competitiveness of these products against those of NAFTA would be strengthened.

        2. Impact on imports from Mexico
          Although the import of agricultural products from Mexico to Japan is not very large so far, there is room for increase in the import of unique and qualified Mexican foodstuffs such as frozen concentrated juice, canned citrus fruits, etc., if Japanese tariffs on these items are eliminated.
          As for chemicals, nonferrous materials, coffee, cocoa, and beer, there would be no impact from the Agreement, because the import of these items to Japan is free at present.

    2. Impact of the Agreement on Investment from Japan
      1. Automobiles (assembler)
        1. Production for sales in Mexico
          Japanese assemblers in Mexico pay around 10% to 20% of tariffs for the parts they import from Japan for their production for sales in the Mexican market. Elimination of these tariffs by the Agreement would be a great benefit in terms of cost. This would give Japanese assemblers more variety of suppliers, including those in Japan, which would strengthen their competitiveness.

        2. Production for export
          Those parts that are used for production for export to the U.S., etc. can be imported freely at present by Maquiladora, PITEX, or other regimes. These regimes, however, are supposed to be changed from 2001 on, and it still remains to be clarified what kind of alternative measures will be taken. It is therefore important that the Agreement should guarantee Japanese investors the same benefits as ever.

        3. Performance requirements
          Currently those who manufacture automobiles in Mexico are required to fulfill the degree of national integration (34% as of 1999) provided by the Automotive Decree, as well as certain foreign currency balance (export/import=0.66/1 as of 1999) in the case of importing finished vehicles and/or auto-parts. While the Automotive Decree itself is scheduled to be abolished by the end of 2003, the reality of the Mexican automotive industry provokes suspicion that some investment barriers might remain from then on, especially against investors outside of NAFTA. It is highly important, therefore, that the Agreement should guarantee elimination of such performance requirements.

        4. Impact on future investment
          As described above, the Agreement would give various benefits to Japanese investors manufacturing in Mexico. As for the automotive sector, however, most producers have already allocated their production in the U.S. and Mexico as a bloc. So there seems to be little room for increase in their investment in Mexico, even if the Agreement is concluded.

      2. Electronics (assembler)
        1. Production for sales in Mexico
          As production for sales in Mexico largely relies on parts and equipment made in Japan and Asia (e.g. audio-visual appliances: Japan 5%, Asia 63%, color TVs: Japan 2%, Asia 73%), the elimination of tariffs on them would be of great help.
          If the import of Japanese parts is facilitated, the supply of finished products to the Mexican market would be strengthened. And gaining cost competitiveness by elimination of tariffs, made-in-Japan parts would possibly substitute those of other Asian countries, which would reduce days of transportation to Mexico and lead time for introducing new products in factories in Mexico.

        2. Production for export
          Production for export, which is mainly beamed at the North American market, largely depends on parts made within NAFTA so as to meet the rules of origin of NAFTA. But as for some items, parts made in Japan or Asia are also used (e.g. color TVs: NAFTA 75%, Japan 5%, Asia 20%). At present Maquiladora, PITEX and other regimes are applied to allow duty-free import from outside of NAFTA. These regimes will be changed from the year 2001 on. Although an alternative scheme (by which tariffs on parts for certain products will be reduced to zero or 5 percent) was announced in November 1998, some parts are out of its scope. It is also unclear whether parts for products that will be introduced in the future will be covered by the scheme. For this reason, it is desirable that the Agreement should guarantee the duty-free import of parts.

        3. Performance requirements
          Some point out the necessity of avoiding possible performance requirements, such as those regarding technology transfer or the establishment of headquarters in certain areas, for the future by the Agreement.

        4. Impact on future investment
          As investors in this area tend to decide their investment according to the demand in the North American and Latin American markets, the Agreement might not directly result in an increase of investment. Lots of benefits generated by the Agreement for production in Mexico, however, would promote relocation of their production sites there from the U.S. and Asia. But use of Japan-made parts would be limited in production for export to the North American market due to the NAFTA rules of origin.

      3. Parts
        1. Benefits of the Agreement
          As Japanese parts producers in Mexico rely largely on parts imported from Japan, they would receive great benefits from the elimination of tariffs on them by the Agreement.

        2. Impact on future investment
          On the other hand, if Japanese assemblers will import more parts from Japan as tariffs are eliminated, parts suppliers might possibly be obliged to reduce their investment. Some assemblers find it better to import parts from Japan from the viewpoint of quality, while some underline the importance of having suppliers close to the production sites in order to operate in the just-in-time scheme. And they have to maintain a certain level of local content concerning their production for export to North America in order to fulfill the NAFTA rules of origin.
          In any case, the Agreement would lead to a restructuring of local parts industries to a certain degree.

      4. Participation in Infrastructure Projects and Export of Industrial Plants
        1. Benefits of the Agreement
          Japanese companies rely largely on parts and equipment made outside of NAFTA, including Japan, when they participate in infrastructure projects in Mexico or export industrial plants to Mexico (e.g. ironwork projects: Japan 30%, Asia and others 15%, telecommunication projects: Japan 80%). The elimination by the Agreement of custom duties on Japan-made parts and equipment is expected to strengthen their competitiveness through a reduction of costs. Today Japanese firms are in a hard race against NAFTA firms, and will be the same against European firms when the Mexico-EU Free Trade Agreement is realized. Considering the fact that there will continue to be numerous mega-projects concerning infrastructure in Mexico in the future, it is notably important to bring Japanese investors onto a level playing field with Americans and Europeans.
          When Japanese investors are given credit by the Japan Export-Import Bank for participation in infrastructure projects or for export of industrial plants, they are conditioned to use Japan-made products for more than 30% of the total price of the export contract. The elimination of Mexican tariffs would help to satisfy this condition by enhancing the competitiveness of Japanese parts and equipment.

        2. "Buy Mexican" clause
          Currently Japanese investors are often imposed a "Buy Mexican" clause (usually 25%-40%) when they participate in projects of the Mexican government. If the Agreement abolished such requirements, they would have much advantage and might be able to accept more orders.

      5. Others
        1. Financial sector
          In this sector, only banks of the NAFTA parties currently are allowed to establish subsidiaries in Mexico. But Japanese banks have cleared the problem by investing in Mexico through their subsidiaries in the U.S. Also, they can serve customers in Mexico from their branches in California, etc. Even if Japanese banks were allowed to directly invest in Mexico, therefore, it is not evident whether they would actually make use of it. Yet direct investment in Mexico would spare them double checks by the American and Mexican financial authorities and operation costs for the U.S. subsidiaries.

        2. Mining sector
          Since all the equipment needed for production in this sector is supplied within Mexico and NAFTA, there would be basically no benefit from the elimination of custom duties. And now that 100% of foreign investment is permitted, there is no problem regarding investment. Therefore, the Agreement is expected to have no impact on this sector.

  3. Conclusion
    1. Impact of the Free Trade Agreement
      1. Benefits from Elimination of Custom Duties
      2. The elimination of Mexican custom duties could be expected to benefit Japanese companies in their export to and investment in Mexico in various ways (including participation in infrastructure projects and export of industrial plants). For example, finished vehicles and electronic appliances (particularly information-related appliances) made in Japan would be more competitive in the Mexican market by the elimination of heavy custom duties on them. And if the Agreement guaranteed duty-free import of electronics/auto parts from outside of NAFTA in spite of the scheduled changes in Maquiladora and other regimes, which would lead to reduced costs and give opportunities to more suppliers, production for export would also become more competitive. Also, the Agreement would help Japanese investors to participate in projects on the same conditions as Western investors by enhancing the competitiveness of Japan-made parts and equipment.

      3. Benefits from Investment Liberalization
      4. The aspect of investment liberalization is no less important. If the Agreement could avoid possible performance requirements, such as commitment to domestic integration, foreign currency balance, technology transfer, establishment of headquarters in certain areas, etc., investment barriers against Japanese investors would be substantially reduced. Also, elimination of the "Buy Mexican" clause in governmental projects would be a great advantage.
        While frequent changes in policies come up as obstacles to investment, particularly in Latin American countries, Mexico has found it difficult to unilaterally change its policies, at least against other parties, since NAFTA was concluded. Accordingly, it is expected that the Agreement would have certain effects also with regard to the continuity and stability of Mexican investment policies.

      5. Possibility of Increase in Trade and Investment
      6. The benefits mentioned above would allow Japanese companies a level playing field in the Mexican market to compete with North American firms and EU firms, as well as easier access to the NAFTA market. Furthermore, as Mexico extends its network of free trade agreements to other Latin American countries and Europe, Japanese firms would also benefit from it.
        Yet it is one thing that the Agreement would benefit export and investment by Japanese companies, and it is quite another that flows of export and investment would actually increase.
        In the automotive sector, assemblers have already established business strategies in the Americas as one united bloc, to which the Agreement would give no fundamental changes except for increase in the export of certain kinds of vehicles to Mexico.
        On the contrary, in the electronics sector, an increase in exports to Mexico, as well as a shift of production sites from the U.S. and Asia to Mexico, could be expected.
        Also the Agreement might dramatically stimulate acceptance of orders by Japanese firms concerning projects and plants.

      7. Benefits for Mexican Industry
      8. On the other hand, it is also possible that the Agreement might give Mexican companies the opportunities to promote business with Japan. For example, the average custom duties of Japan are as low as 4.9%, while high tariff rates still remain regarding certain items. Elimination of these high tariffs might increase exports from Mexico to Japan in the areas where Mexico has competitiveness.
        According to Mr. De la Calle, Mexican firms these days are starting to increase their investment abroad, seeking to acquire global-level technologies and commercial networks for international sales activities by buying foreign companies. Considering such a background, it is possible that the Agreement might promote investment from Mexico in Japan.
        Furthermore, as Mr. De la Calle and some companies have suggested, the positive effect of the Agreement on the business mind and its impact on the expansion of two-way economic relations should not be neglected.

    2. Challenges for the Future
      1. Development of Supporting Industry
      2. The elimination of custom duties would raise the competitiveness of Japan-made parts in Mexico, but that would not necessarily reduce the importance of local supporting industry for Japanese assemblers. For if assemblers wish to export to North America, they have to buy a certain amount of parts from local suppliers so as to meet the NAFTA rules of origin. Also, with a view to making the lead time shorter, assemblers would have an advantage by having suppliers close to them. It is essential, therefore, that the Mexican government should take effective measures for the development and enhancement of local supporting industry in cooperation with the Japanese public and private sectors. Such measures as tax exemption on machines and equipment, favorable measures for the maintenance of sophisticated equipment industries, etc. will promote investment by Japanese parts suppliers.

      3. Rules of Origin
      4. The Agreement would become more useful if it were well suited to the global strategies of Japanese companies. Concerning the rules of origin, for example, it is important to examine the possibility that Asia-made parts, added some value in Japan and exported to Mexico, can also be covered by the Agreement.

      5. Others
      6. In order to make the most of the Agreement to promote investment, the following reforms are desired on the Mexican side:

        1. Tax reform
          Investors in Mexico suffer from such measures as inflation tax and asset tax (the rate of which is 1.8% even if there is no profit) in the current tax regime. The solution of these problems is urgent.

        2. Infrastructure
          It still remains to build the infrastructure essential for investment, such as highways, ports, and water supplies. It is hoped that such infrastructure will be provided as soon as possible through privatization and private projects. At present, in many of the infrastructure sectors in Mexico, foreign investors' participation is limited to a certain extent. If such regulations are eased or abolished, there will be greater possibility for Japanese companies to cooperate for this purpose.

        3. Public security
          Last but not least, it is urgent to improve public security so that Japanese business people can do business in Mexico without anxiety.

  4. Postscript
  5. In the process of making this report, those companies that actually do business in Mexico have been analyzing the possible impact of a Japan-Mexico free trade agreement on trade and investment relations between the two countries through active discussion. They reached the conclusion that the Agreement would benefit both Japan and Mexico in various ways. As already mentioned in the introduction, Mexico is steadily promoting negotiations for free trade agreements with Latin American countries and the EU, following NAFTA. In this situation, Japan should accelerate its effort to conclude an Agreement.

    Trade and investment would expand through close interaction with each other. It is necessary, therefore, to consider the synergetic effect of concluding a free trade agreement and an investment treaty together in discussing treaties between Japan and Mexico.

    Although those sectors referred to in this report play a central part in Japan-Mexico economic relations, they are only a part of the whole of Japanese industry. It is essential that more intensive discussion on the impact of a Japan-Mexico free trade agreement on our country should take place on various occasions.

    Furthermore, it will be useful if Mexican industry also analyzes the impact of the Agreement on itself, followed by a dialogue between the two industries based on their respective results.

    It is strongly hoped that, through the efforts of the public and private sectors in Japan and Mexico, an agreement between the two will be realized as soon as possible in such a way as to give maximum benefit to both.

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