There is a rising star in Latin America. And it is not the a member of the BRICs, but Mexico.
Mexico has received consisten attention regarding its security challenges, but things have started to change over the past few months. In August, Nomura published a report that forecast Mexico would become Latin America’s number-one economy by 2022, stating that “the recent relative outperformance of the Mexican economy to Brazil could prove to be long lasting.”
That’s a controversial argument when considering Brazil’s explosive growth during the past years. While its recent economic performance has been weak, this does not imply that South America’s giant will not be able to recover. Or does it?
Brazil’s rapid economic growth was not only due to a favorable macroeconomic outlook and the timely implementation of much-needed reforms, but also, and more importantly, to China’s insatiable appetite for natural resources. The Chinese government has been progressively increasing its presence in foreign markets to guarantee a steady supply of resources, especially energy. This is critical for the Chinese Communist Party, as its legitimacy rests on providing good economic prospects to its population.
Thus, it is not surprising that China’s trade relationships with Latin America are heavily concentrated in a relatively small number of countries and sectors, as Kevin Gallagher and Roberto Porzecanski point out in their book the Dragon in the Room. A negative consequence is the primary commodity dependency this builds for Latin America—the case of Chile with its copper and Argentina with its soybeans.
Yet, what is especially preoccupying is that, by focusing on the production of primary resources, countries may reduce their competitiveness in specialized manufacturing. Some analysts worry that, coupled with structural deficiencies, this may lead to deindustrialization. In the case of Brazil, as explained by the Economist, “manufacturers have been hobbled by a strong currency, high interest rates, high taxes, poor infrastructure and a poorly educated workforce.” Add to this direct competition from Chinese companies benefitting from cheap imports from Latin America and strong government support, and you have a recipe for disaster.
The honeymoon between China and Latin America seems to have ended. Though China’s money is still tempting, especially when facing low GDP growth, Latin American governments have (or need to) come to the realization that there is no such thing as an “East-South fraternity.” The Chinese government has its own particular interests and its actions are geared to fulfill them. As Carnegie Endowment’s Wei Hongxia explained in a recent panel, China’s agenda with Latin America, more than anything, responds to its domestic dynamics.
This is precisely why Mexico is in a comparatively better position than Brazil, and why it has the potential to become Latin America’s largest economy.
For one, Mexico was probably the one Latin American country for whom the expansion of China’s presence in the hemisphere was not a honeymoon, but a nightmare marked by bitter competition. After gaining admittance to the WTO in 2001, China quickly overtook Mexico as the U.S.’s second-largest trading partner. According to a Barclays report, Mexican manufacturers “experienced their largest contraction of the pre-Lehman crisis period.”
To get a better sense of these numbers, consider that from January to October 2012, about 78 percent of Mexico’s total non-oil exports were sent to the United States. In 2004, it amounted to 89 percent of such exports. Now, Gallagher and Porzecanski find that, from 2000 to 2006, over 80 percent of Mexican non-oil exports to the U.S. faced a direct or partial threat from Chinese competition. Mexico lost market share in 11 of its top-20 exports to the U.S. and only gained in two products. Meanwhile, China gained market share in 18 of the 20 sectors most important for Mexico’s export industry.
Mexico also started experiencing a drop in its oil production in 2005, which, fortunately, was offset by an increase in international oil prices. But it was still clear that something needed to be done. The only way to compete with China was to become more productive and innovative.
As the U.S. and Mexican economies have started recovering, it has become clear that Mexican manufacturers have started regaining their position within the American market. Exports have been going up, contributing to a 3.8 percent GDP growth, higher than other developing countries and the United States. According to the Barclay’s report, Mexico’s productivity grew 12.8 percent from 2009 to 2012, due in part to higher capital per worker. In other words, Mexican manufacturers have become more competitive. Meanwhile, the World Economic Forum (WEF) raised Mexico 13 positions in its competitiveness rankings from 2010 to 2012.
But this alone does not explain Mexico’s advantage; after all, Brazil was graded higher in the WEF’s ranking. The other crucial factors have to do with changes in China’s economic structure, especially regarding wages and manufacturing.
Though the Chinese economy fared relatively well during the financial crisis, it became evident that it depends too much on global growth. Therefore, its government has started refocusing manufacturing toward its domestic market, one of the highest-growing in the world. This new direction has already been endorsed in China’s 12th Five-Year Guideline, which ends in 2015. Thus, the changes will continue. In the meantime, expect its GDP growth to remain slower.
China’s wage structure has also been changing. The increase in the country’s per-capita GDP has had obvious effects in consumption patterns and wage demand. In short, Chinese workers are becoming more expensive, rendering the benefits from outsourcing and offshoring less clear. Add to this an increase in transportation costs because of oil prices and China’s distance from the West, as well as communication and product design difficulties because of language.
Not surprisingly, some American companies, such as General Electric, are returning home and building new plants in Mexico. In fact, the country has become a high-tech hub for the manufacture of airplane parts and cars in recent years. Manufacturing cycles are closely linked with the U.S., making this synergy benefit both countries. As Seele and Wilson explain: “the competitiveness of our two countries is closely linked, and improvements in productivity in one nation make a co-manufactured product cheaper and more competitive on the global market. That is to say, growth in Mexico or the United States will boost exports from both countries.”
The coupled effect help to explain Mexico’s current advantage vis-à-vis its Latin America counterparts. Brazil’s economy, on the other hand, “has been stagnant for much of the past year, hit by fallout from the European debt crisis, slower growth by key trading partner China and homegrown problems such as a manufacturing sector struggling with high taxes and a strong local currency.”
In The Rise of the Virtual State, Richard Rosecrance argues that, as nations evolve and face their particular challenges, some are going to specialize in services and high-tech products, rising to the top of the global manufacturing chain. Others will have no option but to specialize in the manufacture of basic commodities. Rosecrance makes this sound necessary for global welfare, but he misses the point. Innovation is the key to competitiveness. High-tech, high-skilled products are considered the “cherry-at-the-top” of a country’s economy.
In this respect, Sino-Latin trade dynamics had a different effect in Mexico than in the rest of Latin America. While it deepened resource dependence and a degree of deindustrialization for the latter, it forced an increase in competitiveness for the former. Mexico is striving to advance in the global manufacturing chain. Much work remains to be done, especially vis-à-vis Mexico’s regulations, monopolies and vested interests. But the new government and its most recent actions, such as the labor reform, are a step in the right direction.