Moving Your Manufacturing From China: Look South (Again) to Mexico and Puerto Rico

The party is over for an increasing number of U.S. companies who danced with China’s communist rulers. Their giddy, devil-may-care pursuit of the China Price has now devolved into the dystopia of “Uyghurs for sale”. See China’s Other Supply Chain Infection — Forced Labor. When someone finally listened to their complaints about IP theft, the strongest response came in the form of tariffs that have wreaked havoc on their supply chains. As these companies navigate the painful decoupling between the U.S. and China, having—hopefully—learned valuable lessons, they should pay attention to opportunities closer to home… and even at home.

In a blog post last month, I wondered out loud why U.S. imports from Mexico aren’t even higher than the $346 billion ringed up in 2018. Having spent the last few days in San Diego, I almost want to run that blog post again. As I write these lines, I’m at the city’s airport, from where a traveler stepping off a domestic flight can reach one of Mexico’s most important cities in just over a half hour. In fact, the San Diego Trolley goes right up to the border crossing at San Ysidro. Mexico is so close you can hear cars speeding along Federal Highway 1D while you hike in San Diego’s backcountry. Mexican radio stations share the airwaves with American ones, providing updates on border crossing times. Should travel deeper into Mexico be required, a bridge will take you from the U.S. side directly into the Tijuana airport terminal.

But Mexico is not the only destination that should be revisited. A recent New York Post editorial reminds us that the U.S. commonwealth of Puerto Rico “was for decades a central hub of U.S. drug manufacturing”, calling for a return to that role to counter America’s “serious over-reliance on China for pharmaceutical production”.

As a youngster in 1980s Puerto Rico, I kept hearing three numbers—9, 3 and 6—in news broadcasts, conversations between adults, and political debates. As I grew older, I came to understand that those three numbers provided the economic foundation of the island. Section 936 of the Internal Revenue Code provided tax incentives for U.S. manufacturers operating in Puerto Rico. These incentives were a continuation of efforts “to help Puerto Rico emerge from a colonial past, transforming its largely agrarian economy into a manufacturing powerhouse”.

The effort, known as Operation Bootstrap, began with a series of tax breaks designed to attract manufacturers who would provide steady factory jobs.

For a time the plan seemed to work, as standards of living in Puerto Rico rose. Between 1950 and 1980, per capita gross national product grew nearly tenfold in Puerto Rico, and disposable income and educational attainment rose sharply, according to the Center for a New Economy, a think tank based in San Juan, Puerto Rico.

One of those tax breaks, enacted in 1976, allowed U.S. manufacturing companies to avoid corporate income taxes on profits made in U.S. territories, including Puerto Rico. Manufacturers, led by the pharmaceutical industry, flocked to the island.

To the extent that the Puerto Rico of my childhood looked and felt like a reasonable facsimile of the United States mainland, it’s largely because of la nueve treinta y seis—and in particular, las farmaceúticas—the jobs it created and the money it pumped into the economy.

Section 936 did have its detractors. Some in the U.S. saw the tax breaks as a form of corporate welfare, while some Puerto Ricans viewed them as an obstacle to becoming a U.S. state. The pressure eventually led to a 10-year phaseout initiated by President Clinton. Since then, the island’s economy has taken a nosedive.

The demise of Section 936 has had another dismal consequence. Although pharma has maintained a presence in Puerto Rico, “about 90 percent of the active ingredients (manufactured “precursors”) used by U.S. drugmakers now come from China”. This situation presents a two-layered threat. First, it means U.S. domestic capacity might be insufficient to deal with public health crises such as the current COVID-19 pandemic. Second, it gives China a powerful lever with which to exert pressure over the United States.

The Post views the return of pharma to Puerto Rico as a “no-brainer”, in order to boost both domestic drug production and Puerto Rico’s economy. Though the newspaper is generally unsupportive of “targeted tax breaks”, in the case of pharma “there’s a clear need for a national-security exception”. As the ongoing pandemic is demonstrating, the same can be said about a wide range of goods (for example, masks). The time is right to incentivize renewed production of such critical products in Puerto Rico and elsewhere in the United States.

And national security needs to be understood broadly. Take for example the issue of Central American migration—a very present concern for San Diegans and Tijuanans alike—which U.S. intelligence has consistently found to be a national security threat. The U.S. has to some extent helped create economic opportunities for Central American countries, most notably through the CAFTA-DR. According to the United States Trade Representative, as a unit, CAFTA-DR countries were the country’s 18th largest goods trading partner in 2018. Imports from the bloc totaled $25.5 billion, slightly more than from Australia.

Clearly, a significant production base already exists. Moreover, any improvement in economic conditions in these countries is in the best interest of the United States. Even leaving aside possible reductions in the number of immigrants (as happened in the case of Mexico as its economy improved), prosperous neighbors mean nearby markets for U.S. goods and services (in fact, the U.S. enjoys a trade surplus with the CAFTA-DR bloc), as well as stronger regional allies to combat threats such as drug trafficking, terrorism—and creeping influence by rival powers.

For decades, America’s China policy was characterized by engagement.

Burgeoning economic links gave both countries a stake in getting along. Despite China’s human rights abuses and other irritants, successive U.S. administrations sought to bring Beijing into international accords on trade, nuclear arms and other concerns, arguing that engagement would lead to economic and political reforms.

However, “the progress did not produce political liberalization or easing of strict economic controls”, leading to today’s more confrontational dynamics, in which geopolitical considerations are of renewed concern. In that environment, it makes sense for U.S. businesses to look to the south once again.