Mexico as a Production Site for the Usa

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Whenever there is a long-term cost disadvantage in a country and a company is affected by maintaining a facility in the particular country, it damages the competitiveness of the respective branch. This issue can shape up as an incentive for a relocation and foreign direct investment targeting another country. Many multinational enterprises relocate parts of their business to countries with comparative advantages among other things. Foreign direct investment facilitates an international division of labor to take advantage of international trade opportunities.[6]

Balance of Payment

Foreign direct investment is an investment in a business by an investor from another country for which the foreign investor has control over the company purchased. It can be either a greenfield investment or an acquisition. Multinational Enterprises use foreign direct investment to reduce costs, to access markets and to access resources.[7]

Referring to the initial idea that a country is the production site of another country, the foreign direct investment flows between those countries have to induce intensified trade. In consideration of the cost advantages and the consequential global division of labor certain supply flows should be mirrored in the trade of balance. The supply flows from country A to country B are then a result of the new facilities that have been established in country A due to better conditions.

The term balance of payments often implies: a country's balance of payments is said to be in surplus by a specific amount if export goods sold and bonds sold exceed imported goods and paying for foreign bonds purchased by that amount. There is said to be a balance of payments deficit if the former are less than the latter. A balance of payment surplus might be accompanied by an accumulation of foreign exchange reserves by the central bank. With a pure float the central bank does not intervene at all to protect or devalue its currency, allowing the rate to be set by the market, and the central bank's foreign exchange reserves do not change, and the balance of payments is always zero.[8]

A country being a production site for another country allows to imply that the supplying country is very focused on the trade with the particular country and the supplied country is pursuing to invest into the supplying country. The predominant supply flows that target country B lead to a trade surplus for country A and the immense inflow of capital into country A leads to a surplus in the financial account of country A. If the central bank does not intervene and country A has a surplus in the current and financial account as a result of trade surplus and foreign direct investment, then the currency of that particular country will appreciate under ceteris paribus. In case the central bank should intervene, the foreign exchange reserves of country A increase under ceteris paribus. Because portfolio investment or derivatives are relevant for the exchange rate but not for proving whether a country is a production site, this paper focuses on the FDI and trade flows.

Three-Sector Theory

In addition to the trade flows and the balance of payment for determining a country as a production site the three-sector theory may also be applied. The theory consists of the primary, secondary and tertiary sector. Goods of the primary sector are the ones which are extracted directly from the earth for consumption or sale. The secondary sector is the part of the economy which transforms the raw materials into goods and the tertiary sector involves the sale or trade of services.

The theory implicates a structural change in the distribution of employment among the sectors. In three phases the employment moves from the primary sector to the secondary and tertiary sector. While developed countries are considered to have a high portion of employment in the tertiary sector, emerging markets are considered to have a greater share of employment in the primary and secondary sector.[9]

Following this logic, a country that is a production site has a high proportion of employment in the secondary sector and a smaller portion in the tertiary sector. A production site is regarded to deliver manufactured goods such as semi-finished and finished products. That is why the referred country must have a great proportion of employment in the manufacturing sector. In this context it is also important to compare the proportions with other countries in order to have reference values.

Free Trade Agreements and Areas

Through Free Trade Agreements the concerned countries try to gain trade advantages in the distribution of goods and an increase of their foreign trade. This conforms with the principles of the neoclassical trade theory which is based on the model of comparative advantages: welfare gains for all participating countries can be achieved through free trade between countries.

Moreover, economic growth and efficiency of the economy is affected negatively by trade barriers because of the inefficient use of resources. Since economies which do not have free trade zones, then only produce the goods and services that appear most attractive due to government intervention and not those which provide a comparative advantage. In actual fact this is the reason for trade and consequences of maintaining trade barriers are welfare losses for the countries. A complete liberalization of the world trade could have generated from 2005 to 2015 an additional income of 300 billion US dollars annually.[10]

In detail, free trade agreements abolish tariff and non-tariff barriers, such as export restrictions, import quotas or national standards. In recent free trade agreements other government intervention such as subsidies, assets in companies or the governmental control over patent law are restricted.

Several free trade agreements or multilateral agreements may result in a free trade area. Free trade agreements or areas represent the first stage of economic integration, since unlike in a customs union a free trade area maintains their national tariffs towards third countries. It is also worth mentioning that all free trade areas include the rule of origin which prevents distortions of competition and relocation of production. This rule ensures that goods are eligible for preferential treatment and thus can be imported duty-free into the contractual state when proven by certificate of origin. However, economic associations on higher level of integration such as customs union, common market and economic and monetary union are always free trade areas, too.[11]

- Regional Integration

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