Mexico: ready to take on China?

Sometimes it is easy to forget that one of the biggest and most affluent emerging markets lies next door to the United States. Yes, I’m talking about Mexico. 

While Mexico has suffered rising violence and stagnant economic growth in recent years, changing labor and fuel costs are beginning to make a powerful case that Mexico, not China, may be the most attractive base for many types of manufactures. This is particularly true for heavy and bulky items such as cars and household appliances.

This news couldn’t come at a better time. Since 2006, conflict between Mexico’s government and drug cartels, and among the cartels, has increased significantly, leading to a dramatic spike in murders, as well as kidnappings, extortions, and other violent crimes. The drug war has upended stability in what was one of Latin America’s more peaceful countries, and invited comparisons to Colombia’s darkest days (although Mexico’s murder rate still remains low compared to Brazil, Colombia, and Venezuela).  

The Wall Street Journal’s excellent interactive map documents the grim picture. The northwestern states of Chihuahua and Sinaloa have experienced the most pain. However, violence has also surged in areas that once had little of it. 

Particularly hard hit has been Monterrey, Mexico’s third-largest city. Monterrey is home to world-class corporations such as CEMEX, Grupo Alfa, and FEMSA. It is also the site of many of Mexico’s largest factories, set up to export of manufactured goods to the US and other markets. Although only two hours by car from Texas, Monterrey has always managed to avoid the problems of other border cities – at least until now.  

Monterrey’s murder rate rose from about 100 in 2009 to 600 in 2010. Related crimes, such as armed robberies, kidnappings, and extortions, rose in tandem.

The result of this mess is that many people have emigrated to the US. These new emigrants are disproportionately wealthy and well-educated. My local paper, the Austin-American Statesman, recently ran an interesting story documenting the flight of wealthy Mexicans to Austin, as well as the other major cities of Texas. The volume is such that Austin and other cities have set up offices to actively recruit emigrants.

Lorenzo Zambrano, the CEO of CEMEX, and arguably Monterrey’s most prominent citizen, has used the bully pulpit of Twitter to actively campaign against emigration.  Calling the émigrés “cowards,” Zambrano has argued, “We must retake our city.”

Fortunately, help may be on the way. According to a research note released on Tuesday by RBC Capital Markets, Mexico’s share of US imports rose to 12.5% last year, the highest level in a decade. At current rates, Mexico is on pace to overtake Canada within the next five years to become the US’s second-largest source of imports, after China.

Perhaps more important is the fact that Mexican labor wages are now at parity with China’s. The new reality is described in the beyondbrics blog: “While Chinese wages were roughly 300% cheaper than those of Mexico a decade ago, wage inflation in China and wage stagnation in Mexico have combined to close the gap to almost zero.”

Beyondbrics also points out the second, obvious fact that China is a lot further away from the US than Mexico. If oil costs remain as high as they are today, rising transport costs will give Mexico an edge, particularly when it comes to heavy and bulky items.

To capitalize on these favorable economics, Mexico’s government must make the case, through words and actions, that the drug-related violence will not threaten new manufacturing investments. If it can do so, Mexico has a wonderful opportunity to redefine its economy and initiate a virtuous cycle where more young men can aspire to jobs in factories, and not drug cartels. Of course, such a transformation will not be easy, but its possibility is good news for Mr. Zambrano, Monterrey, and all of Mexico.

Written by David Gates for Emerging Markets Blog

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