Ay Caramba!

Unless you happened to see Ross Perot slurping a nearly empty drink while on vacation in Cancun, there hasn't been "a giant sucking sound" coming from south of the border since the North American Free Trade Agreement (NAFTA) was enacted in 1994.

With U.S. employment and wages at record highs, the fear spread by Mr. Perot and free trade opponents that Mexico would steal away tens of thousands of good-paying U.S. and Canadian manufacturing jobs hasn't come true.

What is happening is automotive manufacturing in Mexico is undergoing a metamorphosis from low-tech assembler to globalized powerhouse.

Believe it or not, Mexico's auto assembly plants now are equal to those in the rest of North America in quality and labor productivity - and sometimes better. That means that Mexico's plants increasingly are finding themselves on the "A" list as the lead assembly site for key new products.

DaimlerChrysler Corp. makes its much-ballyhooed PT Cruiser in Toluca. Volkswagen AG has one factory in the world making its New Beetle, and it's in Puebla. Ford Motor Co.'s Focus is raising the bar for the lower end of the segment, and Hermosillo is one of two North American production sites for the compact car. General Motors Corp.'s first crossover vehicle, the Pontiac Aztek, goes into production this year at its Ramos Arizpe plant, followed by the Buick Rendezvous. Silao was the lead plant for launching GM's all-new Suburban/Yukon XL full-size sport/utility vehicles. Nissan Motor Co. Ltd's Aguascalientes facility is the sole supplier of the '00 Sentra for North America.

In fact, Ward's AutoInfoBank reports that since 1993, Mexico's share of North American production has increased by nearly two percentage points. And PriceWaterhouseCoopers predicts vehicle production in Mexico will rise from 1.5 million units in 1999 to 2.5 million units by 2005-'06.

Suppliers also are flocking into Mexico, while at the same time some Mexican suppliers such as Sanluis Rassini (brakes and springs) are expanding into the U.S.

"It's a strategic location to the U.S., and a gateway to Central and South America," says Gabriel Renero of Deloitte Consulting in Mexico City.

And it's becoming more than just a prime location for manufacturing. Ciudad Juarez is home to Delphi Automotive Systems' largest technical center. It has garnered seven U.S patents since 1995 and filed 84 records of innovation in 1999.

DCC completed all of the engineering work in Mexico for its Ram Charger that debuted in late 1998.

Foreign investment of all kinds is flowing into the country to the tune of $11 billion a year, and automotive investment is one of the biggest chunks. DCC says it will invest $1.2 billion in its Mexican operations by late 2001. Nissan and its suppliers spent $800 million on the Sentra program alone, plus there are plans to begin production of Renault vehicles - the Scenic and Clio - in 2001-'02, with a $400 million investment over six years. VW has earmarked $1 billion for growth in Mexico over the next four years, and GM is expanding at Ramos Arizpe.

There is no reason to believe the trend will slow. NAFTA will completely phase out all automotive-related tariffs by 2004. That's the same year local content demands kick in stipulating all cars and trucks must have 62.5% of North American content to enjoy duty-free status throughout the continent.

Mexico also is establishing a free trade pact with the European Union that will begin erasing import duties as early as July (see sidebar, p.55). By 2003, Mexican exports to the EU will enter duty free. All tariffs between Mexico and Europe will disappear at the latest by 2007. "It opens a lot of opportunities to Mexico," says Carlos Horacitas, DaimlerChrysler's director of government relations in Mexico.

The World Trade Organization says Mexico overall was one of the developing world's "star performers" last year.

While the rest of Latin America increased exports only 2% in 1999, Mexico's exports grew by 13.5%. And while the rest of Latin America imported 12% fewer goods than last year, Mexico's imports grew an impressive 15%.

NAFTA has been a key enabler in the country's move to the forefront of automotive production because it is knocking down tariff barriers that made exporting an expensive option. Low manufacturing wages that top out at about $20 per day are playing a part in Mexico's transformation, too.

But manufacturing experts such as Ron Harbour, president of Harbour and Associates Inc., a manufacturing consulting firm, say the importance of Mexico's low wage rates is overrated, and often canceled out by the high cost of in-bound and out-bound freight. "Bottom line, it's not a labor rate issue," he says

Just back from a visit to a Ford plant in Hermosillo, Mr. Harbour says it easily ranks as one of Ford's best. Many Mexican plants in fact are standouts in quality and productivity. "The low labor costs are just icing on the cake," he says.

"It's a bigger factor in site location decisions for some companies than it is for others," says Mike Flynn, associate director for the Office for the Study of Automotive Transportation (OSAT) at the University of Michigan.

"The behavior of the Japanese (in North America) says to me that the Japanese are less concerned about labor cost than the Big Three are. I think it's also true if you look at the pattern of GM. GM is more concerned about labor costs than Ford or Chrysler. Companies have different approaches to wages. The cost of wages in assembly operations is not terribly high. You get different estimates, but it's not a huge proportion."

Unlike many other North American plants that frequently have workforces that passively or actively oppose lean manufacturing techniques, Mexican plants are instituting them with a vengeance, Mr. Harbour says. Their workforces and management are hungry for change, and eager to improve. "The manufacturing folks in Mexico have run with lean manufacturing techniques. Their application of lean has been deep and rapid, and it's paying off with quality, cost and productivity improvements," Mr. Harbour says.

The only reason the labor productivity of Mexican plants doesn't look even better is because low labor costs discourage investment in expensive robots and automation. Mexican plants typically have only a handful of robots, whereas plants in the U.S., Europe and Japan often have hundreds.

Despite high levels of manual labor in areas such as the body shop, where workers wield big spot welding guns instead of robots, many Mexican plants still have better labor productivity than comparable U.S. or Canadian plants. For instance, DaimlerChrysler's Ram Pickup plant in Saltillo ranked ahead of its Ram Pickup plant in St. Louis in last year's Harbour Report analyzing plant efficiency.

Ford's Hermosillo facility was ranked as the 6th most efficient subcompact car assembly plant in North America last year by Harbour, and GM's Ramos Arizpe plant was ranked 10th.

This is a difficult pill to swallow for many who still have the perception that Mexican plants are overstaffed with unskilled, uneducated workers.

In fact, analysts say workers in most Mexican assembly plants now have as good or better education levels than their counterparts in the U.S. Technical expertise is high. "The skills of Mexican workers," says DCC's Mr. Horacitas, "have improved a lot in the last 10 years." And so have the working conditions.

"We have a plant in Matamoros that has about 18 million consecutive man hours worked without a lost-time or incapacitating accident," says Michael Hissam, regional manager of communications for Delphi in Ciudad Juarez, one of many northern border cities reaping the benefits of the industrial boom.

During a visit to Volkswagen's Puebla plant two years ago, WAW found absenteeism and employee turnover at under 2%, well below U.S. industry averages at the time, which were around 6%.

Harbour and Associates noticed another trend in Mexican plants as well: a strong dedication to the Japanese concept of poka-yoke, error proofing production processes with simple, low-cost solutions.

In many U.S. and Canadian plants Mr. Harbour has visited, personnel are either unfamiliar with the poka-yoke concept or have opted for expensive solutions costing hundreds of thousands of dollars.

Besides impressive productivity improvements, Mexico is making surprising gains in quality as well.

George Owens, manager of product research at J.D. Power & Associates in Agoura Hills, CA, says the quality of vehicles built in Mexican plants has been steadily improving and now is in the same league as that of vehicles built in the U.S. and Canada. DCC's Toluca plant, which built Neons and the Sebring convertible prior to getting the PT Cruiser, was ranked by J.D. Power last year as DCC's fourth highest quality plant overall in North America. Knowledgeable sources say most of GM's, Ford's and DCC's Mexican plants rank at or near the top in their internal rankings of plant quality.

Volkswagen's big plant in Puebla is another one of Mexico's success stories, Mr. Owens says. The previous-generation VW Golf and Jetta and other models it once produced suffered from serious quality issues, he says, but the plant has since made major strides in reducing the number of complaints U.S. consumers have about its latest products.

While the future looks promising, Mexico still has a long way to go before it can be considered on par with other great automotive nations, such as Germany, Japan and the U.S.

Its political environment and economy remain unstable. Inflation is too high, and most Mexicans can't afford to buy the cars and trucks they are building in ever-increasing numbers.

What's more, every six years or so, after a major national election, Mexico has a penchant for plunging into prolonged economic crisis. In December 1994, for instance, the value of the Mexican peso crashed and vehicle sales plummeted by some 60% in 1995.

Another major national election is coming up in July. As usual, the Institutional Revolutionary Party (PRI) is leading the polls during national campaigns this spring; it has been in power for 71 years. But candidates from the National Action Party (PAN) and the Democratic Revolution Party (PRD) are mounting the strongest challenges in recent memory. Mexico can't afford to have an election cause another economic collapse.

The country's continued instability has taught automakers and their suppliers to focus mostly on export production. That attitude is keeping Mexico in the minor leagues. In 1991, domestic consumption accounted for 63% of Mexican output, says Mr. Renero of Deloitte Consulting. In 1999, Ward's data shows that portion dropped to 29.6% of the total.

"You have to have a domestic market to be truly world class," says U of M's Mr. Flynn.

Auto sales in Mexico hit a record 682,316 units in 1999. But with a population of some 90 million, that's still small time. Banks are part of the problem. They're weak from lack of capital and huge portfolios of bad loans due to the peso crises, explains Mr. Renero.

For example, Bancomer, the second largest bank in Mexico, grants about 1,200 loans annually - compared with 3,500 in 1992. Annual loan interest rates are a discouraging 30% to 40%, compared with under-10% car loans in the U.S. Inflation spent most of 1999 between 12% to 13% in Mexico, compared with the low single digits in the U.S.

The supplier network also needs to improve. Protected for years by foreign ownership regulations, it is highly fragmented, and there are many incompetent firms, analysts say. Furthermore, infrastructure is weak and water is growing increasingly scarce.

Meanwhile, even with the influx of better paying jobs, a huge portion of the Mexican populace can't afford life's most simple necessities. That's one reason why guards must be hired to watch trains carrying vehicles to the U.S. in order to prevent stowaways from hitching a free ride across the border.

Kara Alkire, research associate at the U of M's OSAT, relates another circumstance that would never be encountered in other top-notch automotive markets. Some workers apparently are leaving their jobs - billed by manufacturers as well-paying for the sector - for summertime migrant labor in the U.S., where they can make more money. Gone for a relatively short period, these migrant workers know their manufacturing jobs will be available when they return because of labor shortages and training issues presented by prospective new hires.

"I heard that's a real issue, particularly for the assembly plants in the northern areas," Ms. Alkire says.

While Mexico's continued weaknesses in these areas may be viewed as job security for U.S. autoworkers, others view Mexico's quality and productivity improvements with growing fear.

Most statistics indicate NAFTA is benefiting all three countries. "Every day 20 million U.S.-built components come into Mexico," Delphi's Mr. Hissam says.

Economists estimate the maquiladora sector (Mexican factories that import foreign components, assemble them with low-cost Mexican labor and then export the finished assemblies to foreign markets), which goes beyond the auto industry, supports up to 10 million U.S. jobs. And Deloitte Consulting says vehicle exports from Canada to Mexico have been growing by 12% annually since NAFTA's introduction.

Still, there are lingering concerns that a U.S. recession could create the sucking sound of jobs southward predicted by Mr. Perot six years ago.

"It hasn't materialized yet. But wait until you get through a downturn before completely writing it off," says U of M's Mr. Flynn.