March 8, 2005

Guest Column

By Stephen Poloz

Sr. Vice-President & Chief Economist

EDC

The trade triangle

A recent visit to Mexico City and Monterrey finds a busy, innovative and growing business community.

Nevertheless, worries about the China challenge are pervasive.

NAFTA was a path-breaking agreement.

Among other firsts, it brought together three economies at different stages of development.

Mexico had the advantage of low-cost labour, and many manufacturers in Canada and the U.S. were worried about losing their business to Mexico.

It has not turned out that way.

Companies have prospered within NAFTA and trade has boomed as specialization of production has occurred.

But now there is a refrain common to all three NAFTA partners — China could take it all away, given its lower cost of labour.

The voices of concern are especially loud in Mexico, whose very success is causing domestic costs to rise, seemingly robbing the country of its original comparative advantage under NAFTA.

What can Mexican companies do about it? Many commentators have suggested that Mexico should move up the value chain.

Canadian companies are being told exactly the same thing.

It sounds sensible in theory, but what does it mean, exactly, in practical terms?

To illustrate, think of a Mexican company whose main customer is an American company. The contract is up for renewal, and the Mexican company is worried that the American company is shopping the world for a lower-cost replacement.

A good tactic for the Mexican company is to anticipate that conversation and shop the world first on behalf of its American customer.

Whether the new source turns out to be China, Honduras, Guatemala, or some other lower-cost market, the Mexican company can outsource some of its production on behalf of the American customer.

The Mexican company then can offer the American customer a better price at contract renewal time, and retain the American customer, actually strengthening their relationship in the process.

The result of such an offshore arrangement is a trade triangle — by importing more value from abroad, Mexico can strengthen its ability to export to the U.S. and Canada.

In doing so, it can capitalize on its real comparative advantage, which is not low-cost labour but rather NAFTA itself, and its proximity to those markets, which permits rapid delivery of goods customized and finished in Mexico.

The Mexican company can then focus on making its trade triangle bigger, by bidding for more business with the same American company in the next links higher up the value chain.

This is really not different from what American companies have done in the past few years, globalizing their operations to increase productivity and reduce costs.

Canadian companies are doing likewise. The key to growth is to do it proactively for the American customer. The result will be more sustainable companies that can maintain and eventually expand their workforces.

The bottom line?

NAFTA has served its three partners well, and will continue to do so. Low-cost producers in other countries pose a challenge, but also offer an opportunity.

The idea is to get low-cost producers working for us — import more to export more, and build more trade triangles.

Stephen S. Poloz, is senior vice-president and chief economist at Export Development Canada. The views expressed in this column are those of the author and not necessarily of Export Development Canada.

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