Roberto Coronado – Economist, Federal Reserve Bank of Dallas

Fed economist sees growth for closelytied U.S. and Mexico economies; China getting into maquila supply picture

Federal Reserve economist Roberto Coronado will report recovery from the Great Recession continues – but rather sluggishly, and the numbers haven't quite reached prerecession levels.

Yet, for the U.S. and Mexico there's hope. It just might take a little more entrepreneurialism and realization of the dependency each side of the border has on the other.

Is there a rebound in manufacturing in line with the rebound in the economy?

Roberto Coronado: economist, Federal Reserve Bank of Dallas: During the last recession both Mexico and the U.S. suffered.

The manufacturing sector was perhaps one of the sectors that got hit the hardest. It was a contraction in manufacturing of roughly 20 percent in both nations. Manufacturing has been recovering since summer of 2009. We have not reached prerecession peak levels.

What can you tell us about growth rates as well as the fear of inflation?

Typically in recession inflation basically contracts signifi- cantly. This time around the recovery has been different in that it has been quite sluggish. The economy in the U.S. is growing around 2.5 to 3 percent over the last seven quarters and that inflation feels quite low inflation today when you look at "headline" inflation it is hitting around 2 percent. When you look at the core inflation -- that is taking out energy and food prices -- it is running around 1 percent. We don't believe inflation pressures are built up in the economy mostly because there was a significant recession and there is a lot of spare capacity sitting around the U.S. economy.

How closely joined are the industrial sectors of the United States and Mexico?

They are very closely related. Mexico's economy depends significantly on the U.S. In particular, the industrial sector correlation coefficient is about 95 percent, they are highly correlated. They are extremely synchronized.

What do you see as far as GDP growth in Mexico?

Most analysts expect Mexico to grow around 5 percent this year and 4.5 percent next year. We just received the GDP data for the first quarter of 2011 and it is in line with those forecasts.

The data shows the GDP grew about 4.6% in the first quarter, so it looks like Mexico is set to have three good consecutive years of GDP growth: 5.5 percent last year, around 5 percent this year and roughly 4.5% next year.

How does Mexican GDP growth affect disposable income for the Mexican consumer?

For example, El Paso, Texas retail main drivers from across the border include manufacturing, maquiladora activity and Mexican shoppers crossing the border to buy goods and services. The shopper with a strong peso means that a Mexican national can now buy more dollars with fewer pesos and that should be good news for retail activity in El Paso. According to our estimates roughly 16 percent of the retail in El Paso is because of Mexican nationals. We are talking about Mexican nationals spending in El Paso around $1.4 billion every year. That translates to $3.8 million dollars per day. That is significant.

Let's go down river to look at Reynosa on the Mexican side and McAllen on the U.S. side. How related are their economies?

Border cities are quite alike in the sense that they depend on trade between the U.S. and Mexico. In this last recession El Paso-Juarez and Reynosa-McAllen behaved completely different. El Paso basically weathered the recession because of Fort Bliss. El Paso had a very mild recession.

El Paso managed to have a contraction of about 4 percent. Laredo was at about a 20 percent contraction. McAllen saw a 16 percent contraction. Why the difference? El Paso in 2009 saw huge spending at Fort Bliss military base.

In the lower Rio Grande valley, they are still suffering, dancing around the bottom, because of the violence reducing Mexican shopping on the U.S. side. About 50 percent of retail in Laredo is from Mexican nationals, a third of retail in McAllen is from Mexican nationals. Because of the violence those shoppers don't come from cities adjacent to the border, nor from the interior such as Monterrey, San Luis Potosí or Zacatecas. They typically drive. Those roads are not safe and they are not driving into Laredo or McAllen and the retail sectors in those cities are suffering significantly and still very depressed.

What is the relationship between maquiladora employment and employment for adjacent cities on the U.S. side of the border?

Texas border cities are the cities that benefit the most from the maquila activity across the border. For El Paso, according to our estimates, a 10 percent increase in maquila output in Juarez leads to a 3 percent increase in overall employment growth in El Paso. The 3 percent might sound small, but when you apply it to the last 20 years that 3 percent represents of one in every four jobs created in El Paso that could be attributed to the maquila activity in Juarez. That's quite significant -- 25% new jobs because of the maquilas in Juarez.

When you move down the valley to McAllen it is one in every three new jobs – 33 percent of the new jobs in McAllen is because of maquila. For Laredo and Brownsville, it is one in every 10 new jobs. Texas border cities benefit in the sectors of transport, warehousing, finance, insurance, real estate and general services.

Why so much the fear about obtaining financing, capital and protecting cash reserves?

This time around we had a significant recession -- this recession came along with a financial crisis and that basically destroyed the mentality -- not only business people, but banks. Recovery is underway, banks have plenty of liquidity sitting in their vaults but the rules have changed for them as well. They have to comply with stricter rules and therefore the credit requirements have risen significantly.

You don't see a lot of activity in the financing. Businessmen complain about lack of financing. Bankers complaining about the lack of strong demand for loans, but they also complain about stricter rules. Financing is still quite weak in the economy, and that is perhaps one of the reasons why the recovery has been quite anemic. As you see more financing available you should begin to see stronger growth in the underlying economy.

To what extent do maquiladoras account for a significant portion of the U.S. - Mexico trade?

U.S. - Mexico trade lies in manufacturing products. Roughly two-thirds of the U.S. - Mexico trade is intra-industry, meaning manufacturing within sectors. The maquilas are the main drivers behind that significant trade flow. Half of Mexico's exports are maquila exports. They are quite significant.

How significant is the automotive sector when it comes to exports from Mexico?

It is quite significant! Mexico plays a very important role in North America's automotive production. Mexico now produces around the same number of light vehicles as Canada, each about 17 percent of the overall production in North America. The U.S. produces the rest. Mexico exports today approximately 2 million units of vehicles per year into the U.S. market. Six years ago Mexico was exporting 1 million units. According to experts, in 2015 or 2016 Mexico will export roughly 3.5 million units. So in the next five years we are going to see a growth of about 50 percent in Mexico's automotive exports into the U.S. markets. The automotive sector has become the main sector of trade between the U.S. and Mexico

What could automotive and other industrial growth in Mexico mean for supply chain from the U.S? It seems as though El Paso and maybe the cities down river have missed an opportunity to become a primary supplier to the maquila industry

It is hard to address but generally speaking you are correct. Cities like McAllen and El Paso supply the maquilas, but they don't supply to the extent you would wish they would. There are all kinds of explanations: lack of entrepreneurship activity; lack of financing; lack of volume; significant fixed cost, especially in the automotive sector. It is hard to achieve economies of scale.

Border cities have not taken advantage of maquila proximity over the past 40 years. It is never too late to start. The markets are there and the opportunities are there for the suppliers to engage in the maquila activity.

Direct materials - items or components - that go into the final product seem to offer more of a value in the supply chain. What more do El Paso and other border-based suppliers need to understand about that market?

Typically 90 to 95 percent of maquila inputs come from outside Mexico. China's entry into the WTO changed dramatically the supply chain. Before China entered the WTO, the U.S. was supplying up to 90 or 95 percent of maquila material needs. Today it is only 55 percent with the rest coming from Asia. China has taken significant advantage of the maquila program and they now supply roughly 10 to 15 percent of the maquila needs, so there is certainly a market that perhaps U.S. border cities should look into. Many of them have been displaced already by Chinese suppliers, but there is still a market.