Economics 560 Case Study 2 Shifting Gears: Ford Motor Company in Mexico

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1. Consider the Mexican government’s Auto Decrees between 1962 and 1982. Does the government appear to be motivated by (a) the theory that factor mobility replaces trade or (b) the theory that factor mobility augments trade (or (c) both)? Explain, using evidence from the case. In a Heckscher-Ohlin model the ability of factors to cross national borders in response to factorprice differentials leads to the replacement of trade in goods and the attainment of the same welfare gains as with free trade. When the production process can be divided into parts, foreign investment can lead to increased welfare and augmented trade. The 1962 Auto Decree eliminated imports of cars. This seems to rely upon trade replacement: capital investment in Mexico will yield the same gains as would be available through trade. The 1972 and 1977 Auto Decrees limited imports of car parts by requiring that any import be offset by an export of the same value. This also reflects a belief that limiting imports will encourage foreign investment (and domestic investment) to produce the car parts locally. (So also did the domestic content requirement in the 1983 Auto Decree.) There is also evidence of the trade-augmenting role of foreign investment. The 1977 Auto Decree allows firms to meet their export requirements through the activities of maquiladoras they own: these rely upon dividing the production process into parts and siting some activities in maquiladoras. In these plants, US investments lead to an augmenting of trade. 2. Ford’s decision in 1984 was to invest to make high-quality Fords in Mexico for sale throughout the world. Which of the O,L,I explanations for foreign investment motivated that choice? Explain your reasoning, using evidence from the case. Ownership, location and internalization are