Recently, Latin America’s major economies have run into a number of problems, especially its largest economy, Brazil. However, Mexico has shown stability in the past few years. The country has managed to capitalize on both strong relative growth from U.S. domestic demand and successful diversification of its economy.
Good Relative Performance in 2015
Mexico’s real GDP rose 2.5% in 2015, a much better performance than the 0.9% contraction recorded by Latin America as a whole. During this period, Brazil was in recession and its real GDP contracted by 3.9%, while Argentina only grew by 1.2% (Chart 1).
Mexico’s progress continued into the start of 2016. The annualized growth in real GDP reached 3.3% in the first quarter of the year, the best gain since the spring of 2014.
While Mexico’s recent performance is relatively enviable, this has not always been the case during the past two decades. Mexico’s real GDP grew an average of 2.4% per year from 2000 to 2015. During this period, BRIC nations (Brazil, Russia, India and China) saw their real GDPs rise an average of 7.3% (Brazil by 2.9%, Russia by 4.1%, India by 6.9% and China by 9.5%). Mexico also underperformed compared to other Latin American countries like Chile (4.3%), Peru (5.2%) and Colombia (4.3%).
Over the medium term, the slower growth can be explained by several factors. Firstly, there is the close link to the U.S. economy, which went through two recessions during this period; in 2001 and in 2008-2009. Mexico’s institutional rigidity, political instability and lack of productivity also contribute to this relative weakness.
A More Stable, More Diversified Economy
Although growth has been moderate in Mexico, it has also been relatively stable. In contrast with several emerging nations, particularly in Latin America, Mexico did not experience the full effect of the commodity boom during the last decade. On the other hand, it did not suffer the recent recoil either. Mexico is enjoying stability thanks to a more diversified economy. The country is less dependent on the variances of international supply and demand for certain commodities. Conversely, it is more dependent on domestic demand.
Manufacturing is very important in Mexico, which allows the economy to be less dependent on natural resources. Mexican manufacturing accounts for 17.7% of GDP and 78.7% of the country’s merchandise exports. In Brazil, manufacturing accounts for just 11.7% of GDP and 34.8% of merchandise exports. Manufacturing clearly dominates in China, accounting for 30.1% of GDP and 94.0% of merchandise exports.
The auto industry is an important element in Mexico’s industrial boom. Prior to NAFTA, in 1993, Mexico exported 358,000 vehicles a year to the United States. In 2000, that number had more than doubled, increasing to 812,900 vehicles. In 2015, 1,380,900 vehicles were assembled in Mexico for the U.S. market. That’s more than Canada, which exported 1,332,500 vehicles to the United States last year. Also note that auto manufacturing sector has grown by 79.9% in Mexico since 2000, while it grew 24.1% in the United States and contracted 20.0% in Canada. Automakers have about twenty assembly plants in Mexico, and new plant investments have recently favoured the United States and Mexico over Canada.
Mexico’s main appeal for direct manufacturing investment is, of course, low labour costs. There is a huge gap between U.S. and Mexican hourly wages. According to the U.S. Conference Board, manufacturing labour costs (including direct benefits) were US$34.69 per hour in 2013 in the United States. In Mexico, that number is just US$6.76.
Exchange rate fluctuations are among the factors that affect foreign investor's decisions to invest in Mexico (compared to the United States or Canada, for example). After the shakeout in the mid-1990s, the peso has been on a long, slow downtrend versus the U.S. dollar. At the start of 2000, one U.S. dollar was worth about 10 pesos. It is now worth just over 17 pesos. The peso’s depreciation therefore boosts Mexican product competitiveness in the North American market, and adds to the low labour cost argument. This effect is also evident with regard to the Canadian dollar. A loonie was worth about 7 pesos at the start of the 2000s, and is now worth nearly 14 pesos. Canadian dollar appreciation against the greenback or Mexican peso can be one more argument against certain Canadian firms when deciding whether to expand (or keep) production here.
Mexico’s industrial boom and its economy’s relative stability hide weaknesses which are quite persistent. Income inequality, regional disparities, the prevalence of informal employment and problems with crime and corruption come to mind. These negative factors hurt the country’s reputation, affecting business confidence and curbing investment, particularly foreign investment. For example, the proportion of companies that wanted to set up outside of China and showed interest in Mexico fell from 70% to 29% from 2011 to 2014. Among other issues, these investors reported concerns over security and corruption scandals.
Mexico’s economy is very well placed to capitalize on the current growth cycle in the United States. The strong ties with its northern neighbours and greater industrial diversification mean that Mexico is less plagued by the problems currently facing many emerging nations. Over the longer term, it will no doubt be profitable to promote an increase in Mexican production. Making a larger proportion of its population wealthier would also be a good thing, to foster a middle class and sound domestic consumption. Achieving this would take more production investment, improvements to the education system, a stronger rule of law (to fight corruption and crime), and additional efforts to enhance worker productivity and rebuild a degree of trust in public institutions. Meeting all of these challenges would finally allow Mexico’s economy to achieve the development and growth that has often been promised, but never truly realized.