Business cycle synchronization between U.S. and
Mexico manufacturing industries
By: Christopher Ching
Abstract:
This paper provides evidence of stronger industrial production synchronization
between Mexico and The United States after the enactment of NAFTA, particularly due
to supply-links. The determinant of the supply-link will ultimately prove to be the
increase in intermediate imports to Mexico from the U.S… Before diving into
intermediate goods other factors are considered and tested. Previous historical data is also
reviewed suggesting that Maquiladoras are similar to FDI after NAFTA. Although the
conclusion is obvious, there is still much analysis of the situation in other perspectives.
This will help to gain an understanding for my final conclusion.
The North American Free Trade Agreement came into effect on January 1st 1994.
It helped to eliminate tariffs and investment regulations between the U.S, Mexico, and
Canada. By eliminating most tariffs and regulations we would expect to see an increase
in trade and foreign direct investment.
Prior to NAFTA, trade liberalization had occurred but on a much smaller scale. In
1947 Mexico had a closed economy, and it wasn’t until the mid 1960’s that Mexico had
let up on its trade barriers and regulations. It was the duty free Maquiladoras that started
it all. Almost like a preview of the future except on a smaller scale. Maquiladoras are
duty free foreign owned shop floors, but are limited to a twenty-kilometer radius from the
border. Mexico intermediate goods from the U.S. are tariff free. Those goods are then
assembled using Mexican labor and are re-exported back to the U.S. duty free. What this
essentially allowed was bilateral trading in its most early stages. At this time the use of
Mexican labor was controversial to both the U.S. and Mexican parties, but that is a topic
to be discussed later. What is important to understand is that before NAFTA was enacted
there was prior trade liberalization and FDI. Manufacturing sectors didn’t start to appear
in Mexico until the 1980’s. So it would only make sense to collect data from the 1980’s
and on, considering that I’m looking at industrial production synchronization. In 1986
Mexico joined the General Agreement on Trade and Tariffs; Mexico was officially an
open economy.
Before determining the causes of industrial production synchronization we must
classify what synchronization is, and at what point is there synchronization and nonsynchronization. The case between the U.S. and Mexico is special because of the
comparing economy sizes and development stages. At almost any point of time between
1980 and the present, the U.S. has dwarfed Mexico’s economy relative to GDP. The U.S.
has always been the developed country and Mexico the developing country. We must
understand that any affect Mexico has on the U.S. is minimal in a sense that it won’t
drastically alter the course of U.S. business cycles. This is not the same the other way
around. Depending on the point in time and severity of the situation, the U.S. has the
GDP size to drastically alter Mexico’s business cycles. It all depends on the situation at
hand.
There have been times in the past were Mexico has created its own turmoil. If you
look at figure 1 we can see in the year that NAFTA was enacted (1994) there was a huge
drop in Mexico’s industrial production GDP. The main cause of this recession was the
peso crisis. The devaluation of the peso discouraged imports into Mexico, and in theory
Mexico depends on imports to add value to then re-export later. If there was no peso
crisis of 1994 we possibly would have seen a correlation with U.S. industrial production.
Never the less Mexico’s individual economic situations can disrupt their own business
cycles and have little or no effect on U.S. business cycles.
The question still remains, were do we draw the line for synchronization and nonsynchronization? Looking at figure 2 we see a time series of percent changes for Mexico
and U.S. industrial production. The more similar the IP percent changes are for each year
the more synchronized there business cycles will be. From 1989-1995 there is less visible
correlation than usual. The most probable explanation for this is Mexican economic
turmoil that is not connected to the U.S., Like the Peso Crisis. Being able subtract these
types of situation from the data is hard maybe impossible, but would give us a better idea
of how NAFTA truly affected U.S.-Mexico synchronization. In the early 1980’s just by
looking at figure 2 we can see a lagged synchronization. This is not true synchronization,
but there is an obvious connection between the two countries. Most likely demand
related. After 1995 there are truer forms of synchronization, both correlating on time. To
be more specific if you look at table 3 and 4, differences in percentage changes can give
better perspectives on synchronization. Basically the lower the trend line remains on the
graph the greater the synchronization. In the early 1980’s of lagged synchronization the
trend line is high; therefore we consider this to be a time of non-synchronization. And
after the peso crisis of 1994 the trend line remains low. We will draw the line of
synchronization at any percentage difference less than or equal to 2, and anything above
2 is non-synchronized or unsynchronized.
Now that the line is drawn at what we consider to be synchronization and nonsynchronization, we conclude that after NAFTA was enacted in 1994, there is
synchronization. We will take the peso crisis into consideration, and assume that without
it we would see synchronization.
Within the NAFTA agreement there was obviously a factor that triggered IP
synchronization. To determine what and what are not factors that created IP
synchronization let’s start by looking at figure 5. U.S. imports and exports with Mexico
as a percent of their world trade is relatively low. We can immediately state from 1993 to
2001, U.S. trade with Mexico is too small for the U.S. to be connected to Mexico. This
data proves the U.S. economy is not strongly linked to the Mexican economy. In figure
6,7,8 Mexico trade with the US relative to Mexico’s trade with the world is given. Figure
7 shows the value of world trade compared to the value of U.S. trade. The positively
sloping lines are correlated and close together. Meaning that the majority of Mexico
exports go to the U.S... More specifically in figure 8 the percent of exports to the U.S.
compared to world exports has risen to stay above 80% after 1993.
This data is
meaningful because it shows Mexico’s connectivity with the U.S., but also after NAFTA
exports did increase. Data does show a correlation between synchronization and Mexico
exports to the U.S., but that does not mean Mexico exports are the direct cause of
synchronization. This upholds the demand side of the situation. With only a demand side
we would expect lags in synchronization. Going back to figure 2, on the left side demand
lags are visible. For example; if U.S. consumers are importing calculators from Mexico,
Mexico’s calculator business cycles will be dependent on how many calculators are sold
to U.S. customers over time. If U.S. customers stop buying calculators because currently
they are in a recession and consuming less, than Mexico is going to have a surplus of
calculators and eventually fall into a recession. The timing will be lagged because of
unpredictable U.S. market conditions by Mexico, and the calculator market not stopping
production until after the U.S. has fallen into a recession. This scenario is possible only if
Mexico was getting there calculator materials from either their own country or another
country and not through U.S. FDI. I say FDI because if Mexico was importing goods
through the U.S. and paying for it with peso’s then high U.S. inflation would mean a
better exchange rate for Mexico, but with FDI the peso exchange rate would only affect
the cost of labor and rent. U.S. FDI in Mexico who are paying with Dollars are
immediately affected by the recession and will supply less to Mexico from the U.S. and
slow down the production process immediately. Remember that before NAFTA was
enacted in 1994 there was U.S. owned Maquiladoras, but most likely a smaller amount
than post NAFTA. NAFTA increased foreign direct investment by taking away from
exchange rate differences and therefore demand lags.
Looking at the supply of intermediate goods (figure 9), imports from the U.S. to
Mexico has risen consistently from the beginning of the 1990’s. This could be because of
investor forecasting. Nevertheless, as the amount of intermediate goods increases we can
expect to see an increase in IP synchronization, because now there is a supply-link. U.S.
FDI in Mexico will import intermediate goods from the U.S. for production processing,
than those products will be re-exported to the U.S. for final sale. This is called vertical
trade or intra-industry. Figure 10 shows the correlation between intermediate imports
from the U.S. and total U.S. exports from Mexico to the U.S… This graph is highly
correlated after the enactment of NAFTA in 1994, and suggests that Mexico exports are
highly dependent on intermediate imports from the U.S… Figure 11 shows the
relationship between synchronization and intermediate imports from the U.S… What is
important to understand here is that as intermediate imports increase, IP synchronization
gets stronger. The graph suggests a negative relationship, because of the fall of the
synchronization trend line, but it is actually a positive relationship.
Before making a final conclusion that intermediate goods create a stronger IP
synchronization lets look at some statistics. Similar to figure 3 and 4 I took the annual
percentage differences from IP indexes, which was previously monthly data. I named that
to be the dependent variable. Next I took intermediate imports to Mexico from the U.S.
and divided it by Mexico GDP adjusted with the exchange rate. This is my independent
variable.
Dependent variable= |Mexico IP index percentage change-United States IP index percentage change|
Independent variable= intermediate imports to Mexico from U.S./GDP Mexico adjusted to dollar exchange rates
With this I came up with figure 12. The t-statistic is greater then 1.97, which implies only
a 5% chance of error. The coefficient is 20, which tells a great deal about the
intermediate-synchronization relationship. This means that for every 1% increase in the
intermediate goods to Mexico GDP ratio, there will be a 20% stronger synchronization in
percentage differences.
The data and evidence collected suggests that NAFTA’s creation of free trade has
helped to synchronize U.S. and Mexico IP business cycles. Free trade has made it more
efficient to run intra-industry markets and in turn has created more FDI then before. With
the increase of FDI, exchange rate differences are of little relevance to the disrupting of
synchronization with the exception of labor, rent, and utility costs (electricity,
water…etc). Previous Maquiladoras were limited in numbers and small compared to the
amount of U.S. FDI after NAFTA. Intermediate goods are the main determinant of IP
synchronization. Figure 11 helps to support this statement, showing the positive
relationship of intermediate goods to IP index percentage differences. As intermediate
goods increase, IP index percentage difference grows smaller. The coefficient of
determination with a T-statistic greater then 1.97 is 20. This high coefficient of 20 is
large enough to conclude that an increase in intermediate goods as a result of NAFTA is
strengthening synchronization.
Figure 1
Figure 2
Figure 3
Figure 4
Figure 5
Percent of U.S. exports and imports going to Mexico
Time
1980’s
Right before NAFTA (1993)
2001
Exports to Mexico
(1982) 3.7%
(1993) 8.8%
(2001) 14.2%
Imports from Mexico
(1986) 4.6%
(1993) 7.1%
(2001) 11.8%
Figure 6
Years
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
total exports
total exports to U.S.
20532
20409
23046
27167
26939
27166
51760
60882
79541
96000
110431
117494
136391
166199
158899
161235
164892
187812
13265
13454
16163
18837
18729
18657
43117
51943
66475
80673
94531
103306
120393
147400
140564
141898
144293
164522
Figure 7
% exported to US
64%
65%
70%
69%
69%
68%
83%
85%
83%
84%
85%
87%
88%
88%
88%
88%
87%
87%
Figure 8
Figure 9
Figure 10
Figure 11
Figure 12
1981-2006
b
coeff
sb,sa
R2,Sy
F,df
ssr,sse
t-stat
References:
20.63301557
6.899327409
0.271481958
8.943590416
70.76960345
2.990583625
a
6.92155004
1.199985563
2.812985089
24
189.9092427
5.768027759
“International monetary Fund,” www.imf.org
“Instituto Nacional De Estadisticia Geografia E Informacia,” www.inegi.org.mx
“The bank of Mexico,” www.banxico.org.mx
“The Federal Reserve,” www.federalreserve.gov
Articles:
U.S.-Mexico Trade: are we still connected?
Maquiladora industry: past, present and future
Maquiladora downturn: structural change or cyclical factors?
The nature and signifigance of Intra-industry trade
Did NAFTA spur texas exports?
U.S., Mexico deepen economic ties
Daniel Chiquiar, Manual ramos-Francia, “Bilateral Trade and Business cycle Synchronization
evidence from Mexico and the United States manufacturing industries,” 2004-2005.