Mexico’s Unique Window of Opportunity

Back in November, 2002 when MEXICONOW magazine was launched, times couldn’t have been worse for Mexico’s manufacturing industry.

That year proved to be devastating for maquiladora plants and other industrial operations. The “dot-com” recession and the “flock to China” syndrome forced literally hundreds of plant closures.

From a business standpoint it didn’t quite make sense then to start a publication to report on foreign investment, international trade, maquiladoras and the Mexican economy.

MEXICONOW was borne nevertheless.

At that time, our section “Mexico’s Industrial Real Estate Snapshot” was plagued with crosses. Industrial buildings were being vacated at an alarming rate. Our surveys revealed that about 60% of the operations shutting down shipped their production lines to China, approximately 10% went to Central America and Eastern Europe and the rest simply went out of business.

Mexico’s siesta was over, globalization was the new “buzz” word and NAFTA was a water leaking ship.

Although it probably was just a few drops in an empty bucket, MEXICONOW started to organize the “Mexico vs. China” seminars in Mexico and the USA. The intent was to compare the competitive offerings from each country.

Aided by company case studies, analysts and valuable information from GE, we soon found out that some products belonged in China and others in Mexico.

In general, commodity type goods with very high labor content and high volume / low mix production runs and products made for the Asian markets belonged in China; while products with low volume / high mix production runs, frequent engineering changes, custom made, bulky and in need of intellectual property protection and goods intended for the North American markets belonged in Mexico.

As things turned out, the recovery arrived and Mexico emerged stronger and ready to take further advantage of its geographical position and stream logistics.

The great recession arrived in early 2008. And as the sluggish recovery ensues, at the threshold of 2013, Mexico has a unique window of opportunity to improve its global competitive position.
Let’s explore why.

In our analysis, we will take for granted Mexico’s well known advantages, including our geographical position next to the still largest market of the world; as well as Mexico’s extensive network of free-trade agreements and its strong macroeconomic position and healthy debt to GDP ratio and competitive exchange rate.

Instead, in no particular order, we will review five additional variables and catalysts that are developing in Mexico and that may support higher rates of growth for the country in the mid-term.

THE NEW GAME OF POLITICS

As everywhere else in the world, in Mexico, the political situation has a very important influence in the productive sector.

Mexico has now held three Presidential elections in the last 12 years and has had two party changes at the helm. By most accounts, Mexico has a true electoral democracy, but it has not reached a true “legislative democracy” or what may be regarded as a gridlockless Congress.

For many years local and foreign businesspersons in Mexico have dreamt about the passing of structural reforms for Mexico to increase its global competitiveness. These reforms include gaining more flexibility in hiring and firing labor practices, the elimination of private and public monopolies in energy and telecommunications, the purging of dinosaur union leaders in education, energy and other sectors.

In addition, Mexico badly needs the government to work for the people and be set free from the sequestration by political parties. So Mexico also needs a political reform and more transparency and accountability from the administration.

As we transition to the new federal administration, there is a glimpse of hope that Mexico’s three-party political system will be able to start taking steps in the right direction.
Here is why.

The political parties have learned, albeit slowly, that in recent years there is no blank check for anybody. The relatively large numbers of independent voters in Mexico have the power to swing an election. The new government will be under much closer scrutiny by the people, other political parties and even other countries. Its reelection in 2018 is not guaranteed by any means.

The left party, the PRD has learned that extreme protests like the ones they made in 2006 are an absolute show stopper for independent voters.
If they would have avoided the non-peaceful protests back then, they would have probably won the recent election. For now, the PRD has shaken-off its non-illustrious and vindictive leader Lopez Obrador, and their new potential candidates will be very tough competitors in 2018.

Hopefully the conservative party, the PAN, has also learned its lesson after falling to the third position in the last election. Although very late in his administration, Mexico’s outgoing President Calderon, decided to be President and started to push a labor reform.

In summary, Mexico’s political players are maturing and have moved a bit higher in their responsibility to the people.

It is reasonable to expect positive signs of cooperation across the isles in Mexico’s Congress to pass a good portion of the long overdue structural reforms.
Mexico’s global competitiveness will benefi t immensely if this happens.

THE HIDDEN BENEFITS OF MEXICAN LABOR

Mexico is the low-cost manufacturing location for the North American region markets. And it is so mainly because of its low direct labor and technical personnel.

Somebody once said in a jokingly mode that “Except for beans and labor, everything in Mexico is more expensive that in the U.S.” Indeed, from a manufacturing costs perspective, electricity, communications, transportation, red tape, insurance, etcetera, are for the most part not very competitive in Mexico.

Mexico’s $2.50 rate for direct labor looks very competitive when compared to wages in the U.S., France, Canada and other developed economies. And as of late, even China is quickly closing the gap with Mexico’s labor rates.

But there are additional, significant benefits to manufacturers from Mexico’s labor that exist beyond the simple hourly cost figures.

For example, as a result of the functional and scheduling flexibility of workers in Mexico, many companies are able to increase productivity and reduce their investment in plant, equipment and inventory.

It is relatively easy in Mexico to be creative with working shifts and scheduling. Some firms are able to fit in 4 weekly shifts, or arrange for “6- work days + 2 free days” schedules, thus allowing running their machines and equipment longer.

Extra time is another tool used by many manufacturers. Workers are flexible and the marginal cost is very competitive.

So for example, if you need 5 production lines in a more rigid labor environment such as the ones that exist in the U.S. and France, in Mexico you may be able to obtain the same production volume with only 4 production lines.

Most direct and technical workers in Mexico are also eager to learn, which makes it relatively easy for human resource and production managers to have multi-task, multi-skilled personnel. This allows the company to have a lower headcount when compared to similar operations in a nonflexible labor market in developed countries.

In a nutshell, once you stack up the basic low cost per hour, the work-shifts scheduling flexibility, the relative lower cost of extra-time and the multi-skill characteristics of labor in Mexico, the savings to the manufacturer are very significant when compared to operating in a labor rigid location.

The increased productivity and turnover of production lines in Mexico also result in important savings in inventory carrying costs. As materials move faster through the production process, the inventory pipeline is leaner, faster and cheaper.

Many foreign production managers initially try to reproduce their country of origin’s plant workers footprint and scheduling. But they soon learn to take advantage of Mexico’s hidden benefits of labor.

And the global manufacturing community is taking notice as evidenced by the unprecedented inflow of Foreign Direct Investment in manufacturing.

DE-GLOBALIZATION

Some of the firms that went to China soon realized that they had miscalculated the total cost of manufacturing far away. They had focused on labor cost alone missing other important cost factors such as the training of workers, the financial cost of a longer pipeline of products across the ocean and the monumental price of reverse logistics for repairs among other cost factors.

As international companies started to realize the advantages of manufacturing close to the end markets, they underwent a process of redesigning their global manufacturing footprint. We have labeled this process as “The regionalization of manufacturing”.

In essence, because of 9/11 and a growing sense of international trade protectionism after the great recession, the world started to de-globilize.

International companies went from a globalization strategy to a regionalization strategy. Now, instead of producing for all markets from a few locations, firms have opted for regional locations to serve the close by, neighboring marketplaces.

Mexico is accruing great benefits from the regionalization of manufacturing as it is simply a natural location for those looking for a low cost manufacturing platform to serve North American markets.
Since the mid-2000’s, foreign investment started to pour into Mexico’s auto and electronics industries, and the medical, aerospace and food sectors also took notice.

THE GROWTH OF CAPACITY

CRITICAL MASS In spite of the economic recession, and perhaps arguably as a result of it, Mexico’s industrial capacity has been growing across the traditional sectors and new ones as well.

Mexico’s greatest and unprecedented industrial story is the one of the auto industry. Large investments by U.S., European and Japanese manufacturers will take Mexico’s light vehicle production from 1.2 million units in 2009 to over 3.5 million in 2015 as shown in the projection in Exhibit #1.

While the domestic market has a potential of reaching over 2 million units, the importation of used cars from the U.S. and the limited availability of consumer credit will cap sales at about 1.1 million units per year.

But the auto industry’s bright spot is the export markets with, Mexico’s 10% share of new vehicle sales in the U.S. and the expanding Central and South American markets.

Almost US$3 Billion foreign investment is headed to Mexico in 2011- 2013 to increase light vehicle production capacity. The new projects and expansions by Mazda, Honda, Audi, VW, Chrysler, Ford, GM and Nissan will leap Mexico’s auto industry to the seventh position in the world, and the fourth largest exporter.

This huge growth by the OEMs and their suppliers that will follow will create thousands of jobs. The problem will be the availability of workers and engineering talent to support this growth.

The electronics industry continues to grow as well. The process of regionalization is particularly evident in this industry as Asian companies continue to occupy industrial space in Mexico to serve the markets of NAFTA-land.


The savvy Asian electronics contractors such as Foxconn, Flextronics, Asus and others from around the world aggressively expanded their operations in the Bajio and the Northern border of Mexico. They regionalized their production by bringing the basic components of electronic goods to Mexico and conduct final assembly and warranty work at locations next door to the USA.

The electronics industry is expected to grow in the next few years at an annual rate of 5% or more and will reach exports of over US$75 Billion in 2015. Please see Exhibit #2.

The aerospace industry in Mexico is also booming and rapidly building supply chain clusters in Queretaro, Chihuahua, Baja California Norte, Sonora and Nuevo Leon.


The high value sector is set to reach exports in excess of US$12 Billion and employ over 60,000 direct workers by 2020, as shown in Exhibit #3.
In a nutshell, most industrial sectors in Mexico, whether mature or new are in an expansion mood. Global fi rms are rediscovering the benefi ts of manufacturing in Mexico and are betting heavily on it.

THE DEMOGRAPHIC BONUS

Mexico is known for its “young, trainable and hard-working” labor force. It is indeed a signifi cant competitive advantage in the global manufacturing marketplace.

The ample availability of young people in the academic pipeline and in the supply pool of labor is sometimes referred to as a “demographic bonus”. This is a very important variable in the development of a country. Let’s explore why.

Demographics is a complicated science where fertility, mortality, life expectancy, dependency ratios, migration and other factors shape the size and age of population in a given country.


Consider Germany, which is the country with the highest rates of manufacturing productivity in the world, but the median age is 45 year, so Germany is considered to have a “demographic defi cit” and this limits its domestic growth.

China, Mexico’s gigantic competitor for the past 15 years, currently has a median age of 36 years. It used to be 22 years in 1980, and it is expected to be 50 years by 2050, particularly if they continue with their “one-child” policy. They are not far from transitioning to having enjoyed a demographic bonus to a defi cit.

Our main international trading partner, the U.S., has a median age of 37. And if you happen to visit manufacturing facilities there, you will quickly notice that the working population on the production fl oors are in average, a lot older than 37.
Workers seem to prefer the more comfortable offi ce working environments.

Mexico’s median age, just as India’s, is 27 years.

At certain given population growth rates, as the population grows and the younger move to the economically active population and then to the older age groups, the trend leads to a relationship between the productive and the dependent population.

At a certain range, the population is at its best time and has the optimum scenarios for employment, investment and economic growth.

To synthetize a complicated analysis, Mexico’s demographic bonus’ peak started just a few years ago, around 2009, and will possibly last, at its prime, for the next ten years.

CONCLUSION

For many years Mexico has puzzled analysts. How can a country with so many resources and competitive advantages be a 3% to 4% growth economy, at best?

As measured by total output, GDP in constant dollars, Mexico ranks #14 in the economies of the world. But as measured by GDP-PPP or output adjusted by Purchasing Power Parity, which is more popular among economists because it takes into account relative costs and the infl ation rates of countries, Mexico currently holds position #11 in the world, as illustrated in Exhibit # 4.
The projection by the World Bank for 2017 with seasonal adjusted historic growth rates will bring Mexico to 10th place.

And when measured by GDP-Per Capita, Mexico apparently has a richer population, as shown in Exhibit # 5, surpassing China, Brazil and India.

But Mexico can do better, a lot better.

If Mexico grows at an annual rate of 6%, by 2020, it can become the # 8 economy in the world after China, the U.S., India, Japan, Germany, Russia and Brazil.

As the variables we reviewed above converge in the next few years, Mexico can expand employment, distribute its well better among the population, substantially increase its middle class and rescue the current third of the population from below the poverty line.

Mexico can no longer be a country of excuses, averages, privileges, monopolies, leaderless, gridlocks, corruption, crime, limitations and underground.

The people of Mexico deserve a much higher standard of living and the window of opportunity is unique, it is right in front and it is hard to miss.