Is Mexico’s Economy Set To Emerge From China’s Shadow?

Those assets are counterbalanced by major challenges including an entrenched informal economy, rampant organized crime, widespread opposition to the president's reforms, and income inequality. Still, O’Neill’s optimism is contagious, particularly among those who stand to benefit from a Mexican economic boom.

An executive at one of the country’s largest employers, Germany-based Volkswagen AG (FRA:VOW), told IBTimes he has no doubt that Mexico is on the uptick. “Its privileged geographical location makes it a bridge between North and South America, but also between the Atlantic and Pacific spheres,” Thomas Karig, vice-president for corporate relations at Volkswagen de México, observed.

Volkswagen began building cars in the country in 1964 and now employs approximately 16,500 workers. “In 1965," Karig said, "Mexico’s auto manufacturers produced a total of 100,000 cars. In 1980, this had grown to half a million, still only for sale on the domestic market. In 2013, three million cars were manufactured in Mexico and 80 percent of that total was exported to the world markets.” Volkswagen de Mexico has led the nation's increasing output in auto manufacturing, from 13,000 cars in 1965 to 516,000 in 2013, 80 percent of which were for export.

Another big factor pulling Volkswagen toward greater commitment to Mexico is the North American Free Trade Agreement, which, according to Karig, provides the country with a “unique competitive advantage, especially for the automotive sector. There is no other major car-producing country from which you can export duty-free to big car markets like the U.S., Mercosur, Europe and Japan.” (Mercosur is a trading block comprising Argentina, Brazil, Paraguay, Uruguay and Venezuela, with associate members Bolivia, Chile, Colombia, Ecuador, and Peru.)

Conditional Optimism

NAFTA was also an incentive for Canada-based aerospace and transportation company Bombardier Inc. (TSE:BBD.B). “Being part of NAFTA is a big advantage,” said Alfredo Nolasco, the company’s chief country representative in Mexico. “All the efforts that Mexico has done to be an open economy are very productive. Without an open economy, Bombardier wouldn’t be in Mexico and wouldn’t have the activities, and the strength to grow that we have in the railway and aerospace sectors.” Currently Bombardier employs about 4,000 people at its two main Mexico facilities.

Nolasco says President Nieto’s proposed reforms -- from opening up the oil sector to foreign investment to making it easier for Mexicans to borrow money -- are welcome. “We have to be in an environment of competitiveness, of free trade, open economies, of transparency, of rules of engagement,” Nolasco said. “Mexico is and will remain an important partner.”

Nolasco’s optimism, however, has conditions. “Many of the constitutional reforms have passed in Congress, but now Congress and senators have to provide the secondary laws and all the regulatory work,” he said. Bombardier, the world's largest train manufacturer, is interested in participating in all of the tenders on as many as six Mexican passenger rail projects, he added, though the government has yet to open the bidding. “We have in front of us, through the national infrastructure plan, at least six projects about rails that are going to be coming in the next year or year and a half," Nolasco said. "We want to get rid of that veil of uncertainty that many people say happens in Mexico. We are clear that we are dealing with a serious country that is working to have equal rules for everybody. We are convinced that all authorities are working in that sense.”

In addition to blue-chip companies such as Volkswagen and Bombardier, some smaller businesses are choosing to manufacture in Mexico rather than China, the country's chief competitor on that front. Wisconsin, U.S.-based EVCO Plastics began molding in Mexico in 2001 when the company formed a joint venture with an already established facility earning about $1million in sales per year. After implementing new operating systems and procedures, and modernizing equipment, sales boosted to $1million per month. Today their growth is controlled and they can decide which new customers they want to work with.

"The young employees coming out of the tech schools and universities come to us well-educated and prepared to jump into the manufacturing arena,” said Steve Richardson, business unit leader at EVCO. "And because Mexico is a neighboring country [to the U.S.], we lose significantly less production time than we would if we sent work over to China. It allows for more efficient turnaround, and at a lower cost.”

China’s higher wages, the rising value of its currency versus the dollar, and shipping costs all working in Mexico’s favor. In 2013, consulting firm AlixPartners estimated estimated manufacturing outsourced to China would cost the same as the U.S. by 2015.

Richardson acknowledged that there are concerns. “I do think that Mexico's financial reforms have a ways to go,” he said. “There is still a large barrier in getting funding to invest in facility advancement and in adding equipment."

Pact For Mexico

Nieto’s reforms, known as the Pacto por Mexico, or Pact for Mexico, propose a shift in the way Mexico does business. The reform package -- signed a day after Nieto was inaugurated in December 2012 -- consists of almost 100 initiatives agreed to by the country’s three main political parties, and include educational, tax, telecommunications and energy reforms. Of those, the latter is the most controversial. In early January 2014, Petroleos Mexicanos (PEMEX), the state-owned oil company, sold $3 billion worth of 30-year bonds -- a record for an emerging-market corporate issuer. In December, President Nieto helped enact a new energy law that ends PEMEX’s 75-year monopoly on oil production. Soon, foreign investors will compete for refining, petrochemicals and hydrocarbon transport. Some economists say that PEMEX’s output could jump as much as 60 percent by 2025, and the increased drilling could boost the country’s GDP growth from 2013’s 1.2 percent to as high as 6 percent in the coming years.

In a January report issued by Capital Economics, an independent macroeconomics research company, economist David Rees predicted Mexico will outperform its regional peers thanks to growing U.S. industry and manufacturing demand, but he projects real GDP growth of 3.7 percent in 2014 and 4.3 percent in 2015.

“The U.S. now accounts for about three-quarters of Mexican exports, equivalent to around 25 percent of GDP. Accordingly, when U.S. industry does well, Mexican industry tends to follow suit,” Rees wrote in the report, adding that Capital Economics expects industrial production to continue to expand by around 5 percent per year, leaving Mexico as Latin America’s relative outperformer. Rees’s team projects that U.S. growth will accelerate at around 3 percent next year, which means Mexico’s manufactured exports will remain strong.

While economists debate the degree to which Mexico will boom, many average Mexicans remain dubious -- at best.

Sten Maldonado, a mezcal exporter based in Oaxaca City, doubts that he and his business partners will benefit from the proposed reforms.

“The reforms will benefit only a small part of the population, while for the majority of rural or semi-rural Mexico, things will become more complicated,” said Maldonado, who exports Las Danzantes mezcal to the U.S., Germany, Spain, the U.K., Singapore and Australia. The certified mezcal industry produces about 2 million liters per year compared with the much larger tequila industry, which produces more than 200 million liters annually. But mezcal’s popularity is growing, and so is business for Las Danzantes, which distinguishes itself from other distributors by its sustainable and fair trade practices.

A global boom for Mexico would obviously be welcome, yet, Maldonado said, “Traditional business models and corruption tends to unbalance the speed of development for the population, and will put strong pressure on the natural resources.”

Rejecting Reforms

A quick glance at the current exhibit on display at Oaxaca City’s Espacio Zapata art gallery offers further evidence that not everyone is on board with the reforms that are supposed to drive Mexico's ascent as part of MINT. The gallery, a cooperative where young artists are provided affordable workspace and a place to showcase their work, recently included among its works paintings with clear -- and negative -- references to politicians and PEMEX, including an exhibit titled “Reformas Estructurales Fascistas” (Fascist Structural Reforms).

“The reforms are not good for the real people living here," said an artist who goes by the name Yescka who rents space at the studio. "They are only helping those in corporate business. The reforms do not help me or the workers. We don’t have democracy. We need to stop the corruption. There are a lot problems. The young people don’t have the education to work or to get a good job. There are jobs in the factories, and they don’t pay well.”

Minimum wages in Mexico range from $63.77 Mexican pesos (approximately $4.91 USD) per day to $67.29 Mexican pesos (approximately $5.18 USD), which is discouragingly low and pushes millions to seek income in the entrenched informal economy. About six in 10 Mexicans -- 30 million people -- work for payments made under the table, according to Mexico’s National Institute of Statistics and Geography. Mexico City’s Tepito, a labyrinth of stalls spanning 72 city blocks, holds Latin America's title for the biggest black market. Out in the open but still unmeasured and untaxed, such markets are the workplace for 60 percent of Mexico’s population. Many of them trade pirated or counterfeit goods, are not contributing to taxes, and have no social protection or insurance.

Such informal -- and therefore comparatively unstable -- economic underpinnings point to inherent weaknesses in Mexico's workforce and financial base, both of which could influence its efforts to become a global economic powerhouse. Also of concern is increasing lawlessness in parts of the country, largely as a result of the drug trade, and the potential for social unrest as a result of the widening gap in income for rich and poor.

Yescka, who once worked in the informal economy, now sells art to buyers from Germany, Switzerland, Sweden, Spain and the U.S., but, he noted, “The gap between the rich and the poor is growing. The government is more concerned with foreign investors than its own people. We need better education, towns with hospitals, support for farmers; the list goes on and on. Right now our politicians don’t listen to the people,” he said.

Take Heed From Dr. Doom

Economist Nouriel Roubini recently hosted a session at the World Economic Forum in Davos, Switzerland, titled “Are the BRICs in midlife crisis?” O’Neill’s predictions did not all come true: In 2001, he predicted an average growth for the BRIC countries of 6.6 percent per year from 2011 to 2020. But now it seems that only China is hitting that target. The International Monetary Fund raised the 2014 growth forecast for China to 7.5 percent, but meanwhile, the MSCI Emerging Markets index is down more than 10 percent during the past 12 months, with BRIC countries leading the fall. Brazil’s economy is projected to grow only 2.3 percent in 2014 – a sharp contrast from its GDP growth of 7.5 percent in 2010. Russia’s currency is in a sharp decline as its growth shrunk to 1.5 percent in 2013, and the IMF foresees a growth to 2 percent in 2014. India’s central bank just increased its lending rate as it tries to address inflation and stagflation. Its projected growth in 2014 is 5.4 percent.

Roubini later blogged that the BRICS (he includes South Africa in this group) are hurting because the commodity super-cycle is probably over. Roubini argues that the BRICS failed to implement second-generation structural reforms that are more micro-based and boost productivity growth. He says the BRICS need to open up their economies more and foster private-sector development. When easy sources of growth like commodities are gone, he says, sources of fast growth such as global trade, innovation and investment in new technologies are harder to tap.

He isn’t entirely pessimistic, though. Roubini says some developments are still in the BRICS’ favor. Urbanization, industrialization, the catch-up from low per-capita income and the rise of the stable middle class are all positive changes.

If Mexico can learn anything from O’Neill’s predictions and Roubini’s warnings, it’s to think beyond commodities and invest in infrastructure and human capital.

Last year the OECD reported that Mexico has one of the highest income inequalities in the world. In 2010, the average incomes for the top and bottom 10 percents was 29:1 in Mexico, which means that a person in the top 10 percent there has an average income almost 3,000 times that of someone in the bottom 10 percent. By comparison, the 2010 ratios in Denmark were 5:1; in Canada, 8:1; and in the U.S., 16:1. Mexico’s gap was the highest value across OECD countries in the report.

Given all of that, recent predictions that MINT will catapult Mexico into the upper echelons of the global economy leaves people such as Yescka doubtful. “Jim O’Neill says that we may be thriving in 20 years, but we want it now," Yescka told IBTimes. "People are poor now.”