Mexico: Happy Anniversary, Senior Presidente

With a year under his belt, President Felipe Calderon celebrated his first anniversary in good spirits. The Mexican economy grew 3.7% y/y during the third quarter, beating the 2.8% y/y growth rate that was posted during the previous period. The government passed an important tax reform, which will add 1.2% of GDP in revenues. Although the fiscal reform did not achieve the intended goal of widening the contributor base, it should help reduce tax evasion and avoidance. At the same time, new forces are breathing life into the Mexican industrial sector. Unfortunately, President Calderon still faces important challenges at home that will prevent Mexico from achieving its full potential.

The winds of change are blowing across the Mexican industrial landscape. A decade ago, Mexico was the light manufacturing base for the U.S. However, China’s incorporation into the WTO was a heavy blow for Mexican industry. Much of the Maquila sector was idled due to the onslaught of cheap Asian goods. However, two new forces are fueling a revival. The first force is the growing protectionism in the U.S. Asian firms are using Mexico as a launch pad to penetrate the U.S. market. This is particularly evident in the television sector, where Asian manufacturers are moving their assembly operations into Mexico. Not only does this give them better access to the North American market, it helps them avoid the damage that often occurs during the long journey. The second force is the rapid escalation of health and pension benefits in the U.S. The spiraling costs, along with rising energy prices, are squeezing automobile manufacturers, forcing many to decamp to Mexico. The exodus is not limited to the automobile manufacturers, much of the auto parts industry is also heading south. Today, automobiles and auto parts represents 20%, or $50 billion, of Mexican exports to the U.S. This is several times larger than Mexican oil exports. The same is happening in the aerospace industry. Insurance premiums are weighing heavily on all labor-intensive industries in the U.S., forcing them to seek friendlier markets. Some experts believe that, in less than 10 years, Mexican aerospace components will outstrip automotive exports. These two forces are the reasons why net foreign direct investment (FDI) continues to pour into Mexico, despite the staunch competition from the other side of the Pacific.

Unfortunately, President Calderon still faces important challenges at home. The first, and most pressing, is the war against the drug cartels. The escalation of violence in Mexico is reaching Colombian proportions, with gruesome massacres of policemen, politicians, reporters and innocent bystanders. The drug lords are penetrating the Mexican political and military systems, using their enormous resources to corrupt and secure control. The drug industry is also moving some of its distribution into Mexico, creating new social problems in urban areas. At the same time, President Calderon faces an increasingly hostile political environment. He was able to wrest important concessions out of the major political parties, but there was a cost. Esther Gordillo, the leader of the Teacher’s Union (SNTE), defected from the PRI and was instrumental to President Calderon’s victory. However, she is cashing in her chips, securing lucrative concessions for the teachers unions, which will end up absorbing most of the additional revenues generated by the fiscal reforms. She is also blocking all initiatives to revamp the Mexican education system, a crucial element needed to increase the value-added content of the manufacturing process. Unfortunately, Mexico needs to improve its education system in order to move up the development curve.

As President Calderon completes his first year in office, he is accredited with several successes. He accomplished important reforms. The Mexican economy is on a solid track, and it has none of the excesses that are evident in the other parts of the region. However, Mexico still faces important challenges at home, especially on the social and political fronts. Unfortunately, President Calderon’s closest ally may the greatest impediment to Mexico realizing its full potential.