McKinsey Quarterly

Beyond cheap labor: Lessons for developing economies

| Article

Buoyed by the North American Free Trade Agreement (NAFTA), Mexico in the 1990s was the bustling factory floor of the Americas. But since 2000, as China rose to assume that role, more than 270,000 Mexicans have lost assembly jobs, hundreds of factories have closed their doors, and Mexico's trade deficit with China has grown to more than $5 billion. The ubiquitous "Made in China" stamp, found on everything from toys to textiles to statues of Our Lady of Guadalupe, has become the incarnation of the single greatest perceived threat to Mexico's economic prosperity—and a symbol of the pitfalls of globalization.

Mexico's fears are not unique. China's economic surge and its entry into the World Trade Organization have sparked alarm across the developing world. In middle-income countries such as Brazil, Poland, Portugal, and South Korea, a rising standard of living makes their position as low-wage producers and exporters increasingly tenuous.

Rather than fixating on jobs lost to China, these countries should remember a fact of economic life: no place can remain the world's low-cost producer forever—even China will lose that title one day. Instead of trying to defend low-wage assembly jobs, Mexico and other middle-income countries should focus on creating jobs that add higher value. Only if more productive companies with higher-value-added activities replace less productive ones can middle-income economies continue down the development path. Even so, being part of the global economy requires these countries, like Lewis Carroll's Alice in Through the Looking Glass, to do a lot of running just to stay in the same place. Unfortunately, for too many of them the focus on China—and, more broadly, political rhetoric against globalization—are blocking reform efforts.

Blame China?

To developing countries watching foreign investors head east, China's economic prowess might seem invincible, but history suggests otherwise. Only 20 years ago, for example, the United States was convinced that the superior business models and industrial policies of Germany and Japan would shutter every last domestic factory door. In the 1990s, the United States fretted about the threat from the high-tech industries of South Korea and Taiwan, while presidential candidates warned of the "giant sucking sound" made by the migration of jobs to Mexico under NAFTA. These days, the United States is more concerned about the effect of China's economy on its trade balance and employment rate.

Nearly all countries worry about jobs lost to others—a fact often exploited for political ends. The demagoguery obscures the fact that countries must evolve to meet the challenges presented by new competitors outside their borders.

Mexico is a case in point. Like most middle-income countries, it has grown more prosperous through freer trade and liberalization. Its average household income is now more than twice the level in China and other low-wage countries, and its manufacturing wage rates reflect this increasing prosperity. But the maquiladora assembly operations that line the US border—often the most visible face of Mexico's entry into the global economy—are only a small part of the cause. Since NAFTA came into effect, in 1994, the country has received upward of $170 billion in foreign direct investment—more than three times the amount that India attracted. Yet less than 15 percent of this investment has gone to the maquiladoras; the vast majority has been motivated by a desire to sell into Mexico's large domestic market, not to produce cheap goods for export. Our research shows that non-maquiladora investments have generated a wide range of benefits for Mexico's economy by creating jobs, boosting competition and productivity, lowering prices, and enhancing consumer choice. Consider the impact of foreign investment on Mexico's automobile market: consumers can now choose from dozens of models, compared with just a few of them before. In the retailing industry, the price of fresh food in Mexico City is 40 percent below its level in 1993, the year before NAFTA opened up the economy. The lesson for Mexico and for other countries where jobs are going offshore is this: don't overestimate the value of low-wage employment.