By Allison Fedirka
Throughout the year, Geopolitical Futures is chronicling the growing distinction between the Eastern and Western hemispheres, a cornerstone of our 2016 forecast. Eurasia is in chaos with significant economic problems affecting the European Union, Russia and China – all the major powers in the Eastern Hemisphere. Meanwhile, the Western Hemisphere enjoys stability due to the absence of economic crises, political turmoil and military conflict in the region. While we have taken close note of negatively performing economies, we would be remiss not to also highlight countries that are faring well during these turbulent economic times and Mexico is among these exceptional economies.
The Mexican Economy Has Emerged
Contrary to the views presented by mainstream media, Geopolitical Futures does not consider Mexico to be an emerging economy. We have our own framework for identifying emerging economies using the baseline examples of China in the late 1970s and present-day Ethiopia. These economies were and are in the midst of transitioning from primarily rural economic activities towards low-skill, basic-level manufacturing in industries such as textiles, footwear and basic electronic assembly. This level of manufacturing requires few skills of a cheap labor force. It does not need specialized infrastructure. During this process, a country experiences a period of high growth compared to the rest of the world’s growth performance. By these criteria, Mexico is far from an emerging economy.
Discussing the emerging status of a country’s economy is difficult due to the lack of any concrete, uniformly applied definition. Investors and economists first started to circulate the ‘emerging markets’ label at the International Finance Corporation (IFC) in 1981. This term was part of the promotional material used for launching the IFC’s first mutual fund investments in developing countries. The coining of the BRICS acronym – Brazil, Russia, India, China and later South Africa – in 2001 and these countries’ subsequent high-growth periods created an obsession with the concept of emerging economies. With four out of the five BRICS countries in the middle of an economic slump, financial and economic analysts began looking for the next “it” group of emerging markets. One of the groups that has frequently circulated as a possibility is the MINT countries: Mexico, Indonesia, Nigeria and Turkey.
Noticeably absent from this discussion is a clear consensus on the definition of an emerging economy. Economists have discussed at length ways to distinguish emerging markets collectively from developed ones, as well as ways to differentiate them from one another. Many of the definitions currently circulating tend to be qualitative in nature and vague, using words like progress or advancement without any concrete benchmark. Some identify these markets by their higher potential investment returns and higher risk. And others look at characteristics such as local debt, equity markets, banking systems and regulatory bodies. Ultimately, many have defined an emerging economy based on comparisons to other economies considered the most developed – the U.S., Japan and European nations.
Considering Mexico’s annual GDP totals about $1.4 trillion, making it the 15th largest economy in the world, calling the economy “emerging” is counterintuitive and inaccurate. First of all, the distribution of Mexico’s population reflects that of an industrialized economy. Only 21 percent of the population lives in rural areas, meaning nearly 80 percent lives in areas considered urban. By comparison, 19 percent of the U.S. population is considered rural, as is 81 percent of Ethiopia’s population. A high rate of urbanization results from the development of industrial activities. Urban areas expand to accommodate factories and other industrial facilities, encroaching on nearby rural areas and farmland. The populations begin to migrate from rural areas to urban ones because of the concentration of jobs in the cities.
Additionally, Mexico already has a well-developed industrial base. Mexico’s manufacturing production tends to have large value-added components, meaning they go beyond basic manufacturing. Value-added industrial activity accounts for 34.5 percent of Mexico’s GDP, according to the World Bank. Among Mexico’s top five exports (by share of total exports) are vehicles, electronic equipment, machines/engines and medical equipment. These four categories – all of which are high value-added manufactured goods – account for 60 percent of the country’s exports. The World Bank also reports that 62 percent of Mexico’s GDP comes from the services sector. Basic economic and manufacturing development is a prerequisite for an economy to develop a strong services sector. That services account for 62 percent of Mexico’s GDP indicates the country already has a well-developed industrial base that has helped establish and grow a strong services sector.
There is also value in comparing where Mexico stands in relation to other major world economies. As previously mentioned, Mexico ranks as the world’s 15th largest economy. It is also ranked the 22nd most complex economy out of 124 countries in the economic complexity index. This index measures the diversity of exports and their sophistication. Japan and Germany top the list, while Mexico’s rating is on par with European economies such as Denmark, the Netherlands and Belgium. It also ranked higher than other developed economies like Norway, Spain and Canada. In addition, Mexico has been a member of the Organisation for Economic Co-operation and Development for over 20 years. This group includes highly developed economies in Europe, as well as the United States and Japan.
Shielded from the Exporters’ Crisis
With this clearer understanding of the Mexican economy, we can now see how it fits in with the international economic system. The global economy is currently undergoing a structural shift away from export-oriented economies – Geopolitical Futures refers to this shift as the crisis of exporters. While this has proven devastating for some economies, Mexico’s position in the global economy allows it to remain relatively unscathed by this shift. Whereas other countries depend heavily on China as an export destination, Mexico depends heavily on the United States. Any economic downfall experienced by Mexico in the remainder of this decade will be cyclical in nature.
Prior to 2008, the global economy rewarded countries that were very efficient exporters. This all began to change in 2008 when the U.S. and Europe entered their respective financial crises. Even the most efficient of exporters have an Achilles’ heel – dependence on demand from export markets. When the U.S. and EU understandably reduced consumption during this period of economic hardship, it had a tremendously negative impact on countries whose economies relied heavily on exports. In particular, China’s economy felt the effects of reduced consumption by these two major markets. While it took a few years to set in, China’s economy has now started to feel the effects of lost export revenue, at the same time that its massive growth spell has been slowing down for structural reasons.
When we look at Mexico’s place in this new global context, the picture is positive. The crisis of exporters dramatically impacts those countries where exports account for a large portion of total GDP. In Mexico, exports represent only about 32 percent of GDP. This alone means Mexico is only moderately exposed to the exporters’ crisis. There are countries with higher exposure, like Germany, where exports make up about 45 percent of GDP, and countries with lower exposure, like the United States, where exports account for only 13.5 percent of GDP. However, the nature of Mexico’s export destinations significantly reduces the country’s vulnerability to the export crisis. The United States – a relatively stable market – imports 80 percent of Mexican exports, while only about 1.3 percent of exports go to China.
The United States is by far Mexico’s most important trading partner and the driving force behind the Mexican economy. For this reason, the U.S. economy merits a closer look. Thanks to a large domestic market, the U.S. has been able to limit its dependency on exports and, therefore, exposure to the international system. As the world’s single largest economy, the U.S. alone produces nearly a quarter of the world’s GDP. This provides a very large market for Mexican exports. Furthermore, the North American Free Trade Agreement combined with a well-developed highway system across relatively flat terrain makes makes the U.S. a very accessible market for Mexico. Lastly, it should be noted that more growth is still expected in the U.S. Real GDP grew 2.4 percent in 2015 and international institutions like the International Monetary Fund and World Bank project 2.6-2.8 percent GDP growth this year. In other words, the U.S. will continue to be a healthy market for Mexican exports.
While this close trade relationship with the United States has helped protect Mexico from the current crisis of exporters, it also makes Mexico vulnerable to cyclical fluctuations in the U.S. economy. In 2009, Mexico’s GDP contracted by 4.7 percent in response to the 2008 financial crisis in the U.S. The U.S. averages a recession every six to seven years. Given the last U.S. recession ended in 2010, we can expect to see another recession sometime between now and the end of this decade. The exact moment it will hit is hard to pinpoint. The U.S. economy has built up inefficiencies since 2010, which will be exacerbated by low interest rates. A cyclical recession is inevitable. In the U.S., this usually starts with a major decline in stock markets with the actual recession setting in about six months later and lasting a year or two. Given its almost symbiotic economic relationship with the U.S., Mexico will likely also see an economic slowdown shortly after the U.S. that will last about just as long.
While Mexico enjoys a dynamic economy and strong trading relationship with the U.S., the economic benefits are not equally distributed throughout the country. Rarely do large, diverse countries experience an even distribution of income and economic activity among their populations. Mexico is no exception. The map below illustrates how two different economies coexist within one Mexico. This dual economy will present the greatest challenges to Mexico as it grows and develops.
Mexico’s National Institute of Statistics and Geography generated this data by measuring and computing several development indicators, including housing infrastructure, basic furnishings, quality of life, overcrowding, health, education and employment levels. The higher a state’s standard of living, healthcare, education, employment, etc., the higher its ranking on the map. There appears to be a rather clear demarcation between highly ranked states in Mexico’s northern and central areas, with low ranking states located in the south. Correlating with these rankings is economic activity in each state. The states with a ranking of five or above are home to advanced industry production and/or are strategically located near the U.S. border where there is a heavy flow of commerce. Industrialized states in particular have been strong targets for foreign direct investment in recent years. The states ranked three or below tend to have economies dependent on agriculture, primitive industry and some hydrocarbon production. These states also tend to have more informal, low-wage laborers and higher poverty rates.
These coexisting economies produce differing social and political challenges and require distinct policies. This situation in and of itself is not necessarily bad for Mexico. The coexisting economies mean the country has two avenues for pursuing growth and can take advantage accordingly, depending on which economies will fare better in the present economic conditions. The discrepancy between the two economies is also the source of many social problems. As a result, the national government finds itself facing the challenge of trying to balance the different interests of its population.
Additionally, Mexico faces three other structural challenges before it can fully capitalize on its economic potential: security, infrastructure deficit and informal labor. It is widely known that drug cartels exist and run niche, local economies in parts of Mexico. In economic terms, these groups generate billion dollars of revenue annually that eventually enters local economies. However, the accompanying security problems greatly deter economic development efforts and discourage investment.
Mexico also has issues when it comes to infrastructure. The World Economic Forum ranks Mexico in 59th place of 140 countries in terms of infrastructure development and efficiency. When broken down, transportation infrastructure fared better, ranking in 36th place, while electricity lagged behind at 86th. Estimates put the country’s infrastructure deficit at at least $60 billion. The government is aware of this deficiency and has decided to expand the National Infrastructure Program. This program was updated in 2014 and calls for $590 billion in total spending within a five-year period. Just over 40 percent of this amount will go towards energy projects. However, translating goals on paper into reality is much easier said than done. Long-term projects require vigilance and slow, continued progress. Frequently, such projects are subject to delays, short-term spending cuts, budget overruns and, at times, even outright cancellation.
Lastly, there is the question of Mexico’s enviable labor market. The country enjoys a favorable long-term demographic curve, with a robust young labor force that can step in to boost the economy for decades to come. One major challenge to taking full advantage of this labor market is the strength of the informal economy. At the end of 2015, Mexico’s informal labor market totaled 57.5 percent of the working-age population. From 2003 to 2012, this informal market on average generated 26 percent of Mexico’s GDP annually. Bringing more workers into the formal economy will not only mean more revenue for the government through taxation but will also make workers eligible for social security and other employee benefits that will improve workers’ quality of life.
None of these challenges are insurmountable; however, overcoming them will not be easy. They require medium- to long-term solutions that may run beyond the terms in office of those officials supporting policies that aim to address these problems. Despite these structural issues, Mexico has managed to become a robust, industrialized economy making it an attractive partner and destination for investment. Its positive growth trajectory will not be hampered by the exporters’ crisis and any decelerated or negative growth will be cyclical and temporary.