Why you should pay attention to free trade treaties

27 09 2006

Globalization, transnational companies, global sourcing and outsourcing, free trade, do any of these terms sound familiar?

Obtaining products and raw materials for the lowest price possible is a fundamental concept in business. Today organizations are looking for manufacturers and locations worldwide where they can find lower costs of production in order to remain competitive.

Combine the factors of: quality control, low cost production, logistics costs, and the time involved to get the product to market from the factory, and you understand the challenge of doing business and sourcing products in today’s global economy.

To truly determine the final cost of the product, all these factors must be calculated. This will determine which country offers the best competitive advantage. Make sure you are analyzing any existing free trade agreements when you are seeking suppliers globally.

Free trade treaties between countries have a significant impact upon the final cost of goods. These free trade agreements eliminate the tariffs and taxes on imported and exported goods between the countries involved, depending upon their concentration or percentage of “local” or national raw materials (including labor), as specified in the free trade agreement.

Free trade agreements between countries are of great importance and value only if are exclusive and not accepted by all trading countries. The more free trade is embraced by the international community (through treaties or elimination of import and export tariffs) the less impact the current free trade agreements have in determining competitive advantages for a single country.

Here is a simple example of how the NAFTA (North American Free Trade Agreement) free trade treaty between Mexico and the USA, would favor the US supplier over a Chinese supplier.

Example of free trade agreeement competitive advantage:

US supplier to Mexico. If I want to purchase paint made by a US paint manufacturer and have it shipped to my warehouse in Mexico, my total cost to bring the goods to my warehouse in Mexico would be the cost of the paint, plus freight and customs clearing costs. There is no import tariff on this product due to the NAFTA free trade treaty. It would take 4 – 6 days to arrive in my warehouse in Mexico once the product has been shipped from the USA.

US paint $ 20.00 + Freight $ 4.00 + Customs $ 1.00 = $ 25.00 total cost of the US product in my warehouse in Mexico

Chinese supplier to Mexico. If I purchase the same product, from the same transnational company, but it is manufactured in China. Transportation time is 40 days from date product is shipped from China.

Chinese paint $14.00 + Freight $ 8.00 + Customs $ 1.00 + Import tariff (13% of CIF value) $ 2.86 = USD $ 25.86, total cost of the Chinese product in my warehouse in Mexico.

In this example the final cost of the product is $ .86 lower from the US supplier as compared to the Chinese supplier, despite a lower initial product cost. Factor in the financial cost and time required to move the product from the factory to my warehouse, and the lowest final cost in this case would clearly come from purchasing product from the US supplier.

Mexico’s aggressive free trade strategy

Since the 1990’s Mexico has bet heavily on international free trade agreements as a method to improve their competitive advantage and increase their manufacturing base and attract foreign investment.

Mexico has signed 11 existing free trade treaties and 2 complementary economic agreements with 42 countries. It is the only country in the world to have standing free trade agreements with North American and the European community.
The free trade agreements have greatly increased international competition (imports) in Mexico (good for the consumer).

Free trade agreements have allowed Mexican exports to increase and reach destinations and markets that were closed before due to tariffs and costs. There has been increased foreign investment from countries that desired to use Mexico’s free trade competitive advantage for international manufacturing and export projects.

The Mexican manufacturers and suppliers of the national Mexican market were given a “sink or swim” option. Virtually overnight (many of the treaties were phased in over a period of 3 – 10 years), their previous protected market was filled with imported goods (more competition, lower cost, higher quality).

Those that have survived the “invasion”, have had to improve their efficiency, quality and costs. Making them much more competitive in todays global economy.

Britannica’s Definition of free trade:

“Policy in which a government does not discriminate against imports or interfere with exports. A free-trade policy does not necessarily imply that the government abandons all control and taxation of imports and exports, but rather that it refrains from actions specifically designed to hinder international trade, such as tariff barriers, currency restrictions, and import quotas. The theoretical case for free trade is based on Adam Smith’s argument that the division of labour among countries leads to specialization, greater efficiency, and higher aggregate production. The way to foster such a division of labour, Smith believed, is to allow nations to make and sell whatever products can compete successfully in an international market.”

Related Links

Mexico and international free trade agreements

How to do business in Mexico, Part 26

29 06 2006

Mexico Business Framework, Immigration Law, Corporate Practices, Incorporation Checklist

David Spencer has an excellent site outlining Mexican law, forms of doing business, corporate practices, working with Mexican legal counsel, immigration law and basic taxation rules and regulations.

Really great information here:

Mexico Business Framework Link

Incorporation Checklist for Mexico Link

The Immigration Law of Mexico Link

Mexico’s Code of Best Corporate Practices Link

Working with Local Counsel in Mexico Link

Related Links:

DavidSpencerLaw.com Link

How to do Business in Mexico, Part 16

26 06 2006

Payments, Invoices and Banking

There is a huge underground economy in Mexico, no invoices, no taxes, no paperwork. Estimates of the size of the underground economy run as high as 60% of the GNP of Mexico. At some time you will be confronted with a person or business who provides services or products and will ask if you want an invoice or not…..with a difference of 15% in the final cost if you chose to avoid the invoice (no invoice = not tax deductible). This 15% is the I.V.A. (national value added tax). Avoiding the I.V.A. is illegal. Estimates of the size of the underground economy run as high as 60% of the GNP of Mexico.

Sending checks as payments through the mail is virtually unknown in Mexico. Due to the problems with mail theft and fraudulent checks, the majority of business checks are hand delivered. There are an army of men and women, who physically go to customer's offices, drop off the invoices, and come back for the payment check at a later date. Totally inefficient in terms of costs and time, however that's the way the system works in Mexico.
Electronic payments and funds transfers have begun to appear in the last 5 years, and the larger companies are now using this system for payments and receivables. There is a very large percentage of Mexican businessmen who are not confident of the security and password controls (there have been numerous cases of e-bank fraud).

It is necessary to physically appear in your bank to make routine deposits, withdrawals, changes or modifications to your accounts. This seems odd to U.S. citizens. The banking system in Mexico depends heavily upon providing personal identification for each transaction, and it is highly recommended to establish a relationship with your bank officials and tellers in order to facilitate business. The ATM banking machines are becoming part of everyday life for all Mexicans, and direct payroll deposits to employees accounts are now very common among medium and large companies.

Disclaimer – This information is based on personal observation, experience and interpretation. I might be completely wrong about all of it.

How to do Business in Mexico, Part 13

13 06 2006


The national tax authority in Mexico is called the “Hacienda”. This is similar in function to the Internal Revenue Service in the US.

The tax system in Mexico is complicated, with strict controls on transfer pricing for transnational companies, and limited tax advantages for companies seeking to avoid taxes by re-investing in their existing businesses.

Claudia Avila Connelly of AMPIP provided the following information about taxation in Mexico:

The taxation system in Mexico is primarily concentrated in the federal system. The three primary taxes are the I.S.R. (Impuesto Sobre la Renta) which is a proportion of salary, IMPAC (Impuesto al Activo) tax on assets, and I.V.A. (Impuesto a Valor Aggregado) a value added sales tax of 15%.

At the state level the only tax is the I.S.N. (Impuesto sobre Nomina), tax based upon payroll, this rate varies between states. For example in Queretaro there is no I.S.N, while in other Mexican states might vary between 0% – 2%. This may be waived depending upon the social impact and generation of employment by the investment project Other costs at the state level that may be negotiated would be the public property registration, which represents a percentage of 2% to 5% of the value of the building.

At the municipal level the only tax that exists is the Predial (property tax). There are other costs related to the construction license and title change. All of these can be negotiated as incentives but any concession granted to the investor, must be previously approved by the local town administration, with evidence of the session minutes where it is clearly stated that the concession has been granted by the administration, and signed by all members.

It is the employer’s responsibility to retain, pay, and report the taxes and income for workers (unless they are private contractors). The average Mexican worker will not ever have to fill out an income tax form.

The difference in tax law between the US and Mexico is enormous. One of the most frightening aspects for US trained accounts is that there are modifications to the Mexican tax code every month. This means that your accountants must update their knowledge of the tax code and the changes on a monthly basis.

As with all tax laws, there are “grey areas” that will be interpreted differently by the tax authority and the entrepreneurs and corporations.

Mexico has a huge underground economy, with estimates that up to 60% of the commerce and services are not registered with “Hacienda”, and do not pay taxes. This puts pressure on the legally registered businesses, and Hacienda seeks to audit and verify that those registered business are conforming.

This has caused a great deal of controversy, and the term “fiscal or tax terrorism” has been used by angry businessmen who want “Hacienda” to focus their efforts incorporating those businesses outside of the system, instead of re-auditing those who are captive in the system

Tax reform is a big issue currently in Mexico, and I believe that in the near future steps and legislation will be introduced and approved to simplify the tax code and streamline the system.

I strongly recommend a good accountant, a good internal auditor and a good external auditor for any business dealings in Mexico.

Disclaimer: The ideas presented are personal opinions and generalizations based upon 25+ years interacting, living and working in and with Mexico. None of this may be true, it may be completely false, use the information at your own risk