Kevin Gallagher “Guadalajara: The Silicon Valley of Mexico?” March 8, 2005

Kevin Gallagher in the CLAS Conference Room on March 8.

-Professor Gallagher's Powerpoint presentation (warning: 3.8 MB file)
-Professor Gallagher's book page for Free Trade and the Environment

(See also: Guadalajara: The Silicon Valley of Mexico? By Raymundo M. Campos-Vázquez)

Guadalajara: The Silicon Valley of Mexico?
By Lifang Chiang

Guadalajara has been dubbed the “Silicon Valley of Mexico,” powered by a decade-long wave of U.S.-led foreign direct investment (FDI) in high technology production. In characterizing the effect of this capital inflow both in Guadalajara and throughout Mexico, Professor Kevin Gallagher, of Boston University, highlighted two themes during his CLAS presentation: “globalization” and “concentration.”

The consolidation of oligopolistic practices by such U.S.-based conglomerates as IBM and Hewlett Packard, which together comprise 80 percent of foreign direct investment activity in Mexico, has resulted in the “violation of basic conditions of the market” throughout Mexico. Other barriers to sound investment include an overvalued peso, the absence of effective policy response, and fierce competition from other countries. Despite the promise, foreign direct investment has to date yielded little positive spillover effects for the broader Guadalajara community or for Mexico.

Mexico needs foreign direct investment

The situation is paradoxical, given the promise that FDI holds for countries seeking productivity spillovers. Mexico, and less developed countries (LDCs) in general, regard foreign direct investment as a “real gem” because of its ability to create productivity spillovers, spur innovation and growth , and provide jobs. This desire is compounded by the “absolute drought of investment,” hindering overall economic growth and development. Mexico is still only at the mean global income level. Meanwhile, more than half the Mexican population lives in poverty as defined by the World Bank, with sizable underemployment and informal sector participation. FDI would provide a more stable form of foreign exchange to allow the construction of plants, and would provide the “backward linkages” and “forward linkages” needed to stimulate the local economy. In other words, it could provide inputs for emerging technologies, and could also contribute to the spinning off of newer companies and products.

Why firms invest in Mexico

There are many reasons why Mexico is attractive as a destination for foreign direct investment. These include the country’s proximity to the U.S., its domestic markets, reduced tariffs under NAFTA, treaty rules of origin which facilitate bilateral trade, the maquila programs, favorable exchange rates and existing infrastructure. These factors helped to drive investment demand. For the nine-year period from 1994 through 2002, the overwhelming majority of investment dollars in Mexico, some 97 percent, was foreign in origin, primarily from the U.S. However, this investment proved a mixed blessing, as local suppliers saw an 80 percent decline in business and joint research. Moreover, research and development projects resulting from such investment was limited. One notable success story was the firm Electronica Pantera, an R&D firm that assists with projects to improve the efficiency of the low wage assembly process.

The Geography of FDI

Due to regional trade agreements, 90 percent of printed circuit boards must be manufactured in North America. Guadalajara in particular was deemed attractive for this type of manufacturing because it has unique infrastructure and a long history of electronics work, along with universities hosting a number of engineering programs and hence, a skilled workforce. To what extent has such foreign direct investment in Guadalajara “spilled over” or translated into the well-being of the overall regional community, with regards to both economic development and the environment? To answer this question, Professor Kevin Gallagher conducted fieldwork in Mexico from October 2003. So far, he has conducted 70 interviews with plant managers.

Major U.S. companies such as IBM and HP outsource their equipment manufacturing work to companies such as Selectron, Flextronics and Samina-SCI, which in turn conduct much of their assembly work in Mexico under FDI arrangements. Gallagher noted that FDI peaked in 1995 and nosedived after 2000. The electronics clusters in Mexico are centered in the following regions:

Mexico City: Products are made to sell to domestic markets in a metropolitan region with 20 million people and a sizeable middle class

The Northern Frontier: Audio-visual equipment is assembled for quick export back to the United States

The Western Region: The state of Jalisco, especially the area around Guadalajara, has emerged as an IT industry hub

Human capital spillovers from FDI?

Much of the manufacturing work which foreign direct investment has brought into Mexico has been at the lower end of the production process. In this arena, little workforce training is provided or needed, given the shift to short-term contract employees and the small number of domestic firms positioned to take advantage of spillover in manpower and employment training. One of the few success stories is IBM’s training center and the spin-off activity in job training which it has created. Nonetheless, in the FDI-led high technology production sector, two thirds of workers in the sector are women under the age of 30, the majority of whom have short term contracts from one to three months in duration. Only 3 percent of these workers have employment contracts longer than one year.

Under Mexican law, no foreign firm can own more than 39 percent stake in a company based in Mexico. IBM tried to negotiate a 100 percent control deal with the government; ultimately, an agreement was reached where a certain percentage of the suppliers had to be local. Meanwhile, slow progress has been made in moving up the technology value chain. Microchip, a foreign-owned company which conducts R&D and employs 64 workers, was recently bought by Intel. Moreover, a group of Mexican engineers are working with Hispanet, a counterpart group of Mexican-Americans from Silicon Valley working to acquire the necessary venture capital to start firms in their native country.

Environmental spillovers from FDI?

The lack of contact with local suppliers by foreign firms stymies what opportunity exists to “green the supply chain.” Ideally, foreign firms can help foster the transfer of cleaner technology and better environmental management. For instance, the European Market has strong regulations regarding pollution content and will not purchase computers built with lead: production plants in Ireland and Hungary are meeting these standards. However, the United States does not have a comparable regulation, largely because American consumers do not demand these stricter standards. It is only by requiring that exports meet the demands of green consumers, that foreign companies and countries can influence environmental standards in the countries with which they do business. Requirements for higher standards by local systems suppliers would also enable the greening of the supply chain, but that is not forthcoming in Mexico. For example, the number one driver of environmental compliance lies in having an adequate volume of inspections on site; however, the State of Jalisco employs only three occupational health inspectors.

Why so few spillovers?

Professor Gallagher discussed barriers to entry into global supplier networks, which largely have to do with the twin forces of concentration and globalization. These include such factors as the growing incentives for firms such as IBM and HP to import inputs rather than to outsource to Mexico, compounded by a slowdown in U.S. demand.

China’s accession to the WTO was also cited as a growing challenge. Whereas Mexico has five firms with the ability to engage in contract manufacturing, China has 35 such firms. Meanwhile, Chinese wages in this sector are little more than half those of Mexico.

The lack of effective political intervention has also stymied investment. The macroeconomic uncertainty in Mexico, e.g., peso overvaluation, is a prime example of insufficient policy response. Other domestic challenges include the lack of local productive capacities and lack of domestic and regional markets. Moreover, trade agreements such as NAFTA and now, CAFTA, have proven insufficient in providing the policy space for promoting FDI and positive spillovers.

Preliminary results

The evidence indicates that foreign direct investment has yielded little by way of domestic spillovers. The spillovers that did occur were not allocated by the market. Rather, foreign investment has crowded out domestic investment. Despite the promise of foreign direct investment, overall investment in Mexico has stagnated. Hence, Guadalajara has yet to emerge as the “Silicon Valley of Mexico.”

Kevin P. Gallagher is Assistant Professor in the Department of International Relations at Boston University. He spoke at CLAS on March 8, 2005.

Lifang Chiang is a Doctoral Student in the Department of Geography.

Original Event Description

Despite the fact that Foreign Direct Investment (FDI) has been the cornerstone of Mexico’s economic policy, it has not generally produced the “spillover” in technology and know-how that policy-makers hoped for. Is Guadalajara the exception to this lackluster record? To what extent has Guadalajara, known as “Mexico’s Silicon Valley,” managed to create domestic spillovers? Prof. Gallagher will discuss what has been done in Guadalajara and what lessons other Latin American countries might draw from that city’s experiences.

Kevin P. Gallagher is Assistant Professor in the Department of International Relations at Boston University and a Research Associate at the Global Development and Environment Institute (GDAE) at Tufts University. His most recent books are Putting Development First: The Importance of Policy Space in the WTO and IFIs (forthcoming, Zed Books, 2005), Free Trade and the Environment: Mexico, NAFTA, and Beyond (Stanford, 2004) and International Trade and Sustainable Development (Earthscan, 2002).