Ross Perot added his memorable “insight” to the debate over the North American Free Trade Agreement (NAFTA) when he warned that passage of NAFTA would create a “giant sucking sound” as U. S. employers shipped jobs to Mexico, where wages are lower than wages in the United States. As it turned out, many U. S. firms chose not to produce in Mexico despite the much lower wages there. Explain why it may not be economically efficient to move production to foreign countries, even ones with substantially lower wages.

Question

Ross Perot added his memorable “insight” to the debate over the North American Free Trade Agreement (NAFTA) when he warned that passage of NAFTA would create a “giant sucking sound” as U. S. employers shipped jobs to Mexico, where wages are lower than wages in the United States. As it turned out, many U. S. firms chose not to produce in Mexico despite the much lower wages there. Explain why it may not be economically efficient to move production to foreign countries, even ones with substantially lower wages.

Answer 1

To explain why it may not be economically efficient to move production to foreign countries, even ones with substantially lower wages, we need to consider several factors:

1. Transportation costs: Moving production to a foreign country entails significant transportation costs. These costs include shipping raw materials and finished goods, as well as the associated logistics and infrastructure expenses. These expenses can eat into the cost savings gained from lower wages.

2. Supply chain complexity: Moving production to a foreign country often means establishing and managing a complex supply chain. This includes sourcing raw materials, coordinating with multiple suppliers, managing quality control, and ensuring timely delivery. Maintaining an efficient supply chain across borders can be challenging and may lead to increased costs and disruptions.

3. Communication and cultural barriers: Operating in a foreign country necessitates effective communication and understanding of local customs and business practices. Language barriers and cultural differences can slow down decision-making, coordination, and problem-solving, which can impact productivity and efficiency.

4. Intellectual property protection: Some countries may have weaker intellectual property protection laws, making it challenging to safeguard proprietary technology, patents, and trade secrets. This can increase the risk of intellectual property theft, counterfeiting, or unauthorized replication of products, harming the competitiveness and profitability of firms.

5. Political and regulatory risks: Foreign countries may have different political environments, legal systems, and regulatory frameworks, which can introduce uncertainties and risks for businesses. Changes in government policies, trade agreements, or economic conditions can impact operations, market access, and profitability.

6. Quality control and product standards: Ensuring consistent product quality and adherence to international standards may be more challenging when manufacturing in a foreign country. Issues related to quality control, product safety, and meeting customer expectations can lead to additional costs, reputational damage, and potential legal liabilities.

Taking all these factors into account, it becomes evident that simply comparing wage differentials between countries does not provide a comprehensive understanding of the economic efficiency of production relocation. Companies must carefully assess these various factors and consider the overall cost-benefit analysis before deciding to move production to foreign countries.