Mexico’s economy has performed well relative to other major Latin American economies in recent years, largely because of its thriving manufacturing sector. Unlike Brazil and Argentina, whose manufacturing sectors are slumping, Mexico has continued to see solid growth because of its integration with and dependence on the U.S. market. Although low global oil prices will put pressure on Mexico’s economy, the performance of the manufacturing sector — especially in high-end manufacturing — will be a key driver of Mexico’s economic growth this year and beyond.
In the late 1980s and early 1990s, Mexico underwent a profound economic and political reorganization. The economy liberalized, culminating in the North American Free Trade Agreement. Major state-owned companies privatized, transforming Mexico from a closed economic and political system into an export-oriented industrial economy. As a result, trade increased between Mexico and the United States, and a manufacturing belt sprung up at the countries’ shared border. From 1990 to 2000, Mexican trade became even more closely tied to the United States. In 1990, the United States accounted for 69 percent of all Mexican trade; by 2000, it accounted for nearly 80 percent.
But at the turn of the century, China’s special economic zones became cost-competitive alternatives to Mexican factories. Mexico responded by making more valuable products, such as automotive, aeronautical and electronic products. Thus, even though clothing exports dropped 43 percent (from $7.6 billion to $4.3 billion) between 2002 and 2012, automotive exports increased by 152 percent ($27.9 billion to $70.3 billion) and electronic exports increased by 73 percent ($43.3 billion to $74.9 billion) over the same period. Asian alternatives to high-end products notwithstanding, these Mexican products remained cost-competitive because of NAFTA.
Moreover, rising wages in China have once again shifted the equation in global manufacturing. Average manufacturing labor costs in Mexico are now almost 20 percent lower than in China, whereas in 2000, Mexico’s labor costs were 58 percent more expensive than China’s. There is also an important regional distinction that should be taken into account. A significant portion of U.S. export-oriented middle- and high-end manufacturing takes place in northern Mexico, especially around Monterrey, which is major steel producing area where GDP per capita exceeds $40,000. The electronics industry is also important and contributes greatly to the economy of northern states like Chihuahua, Baja California and Tamaulipas. On the other end of the spectrum, low-end manufacturing of goods like clothing and textiles is continuing to expand in southern Mexico, in cities like Campeche and Veracruz, making this particular region a beneficiary of China’s growing labor costs.
Since the implementation of NAFTA in 1994, Mexico’s real GDP climbed by about $383 billion to nearly $1.3 trillion. This growth, which placed Mexico second in Latin America and 15th in the world in terms of GDP, rose primarily because of the advantages that come with Mexico’s proximity to the United States. Mexico has planned its economic strategy around these advantages, which include short transport distances to the world’s largest consumer market and low wages compared with those of the United States — low wages that have spurred investment in manufacturing (with the United States as a leading investor) for decades. The manufacturing value-added sector now makes up 18 percent of Mexico’s GDP.
The Manufacturing Sector’s Current Status
This orientation toward the U.S. market and the diversification of Mexico’s manufacturing production has benefited the country significantly in recent years. While Brazil and Argentina (which, along with Mexico, make up more than 80 percent of Latin America’s manufacturing output) have seen a slump in their manufacturing sectors due to both countries’ slowing economies and growing restrictions within their Mercosur trade bloc, Mexico has performed much better. In large part this is structural: Mexico has been much more open in its economy and supportive of free trade than Brazil or Argentina, which have followed a protectionist import-substitution model. The South American countries’ overall trade with the United States is also much lower than Mexico’s. As a result, Mexico’s manufacturing output increased by 3.4 percent in the first nine months of 2014, while Brazil and Argentina’s contracted by 1.8 and 2.4 percent respectively.
Several subsectors are driving this manufacturing growth, most notably in high-end manufacturing, such as the automotive, plastics and aerospace industries. Mexico’s auto sector has been particularly strong, experiencing double-digit export growth every year since 2010. The plastics industry, which is valued at more than $20 billion per year, has averaged 13.4 percent growth in exports over the past five years. Meanwhile, Mexico’s small but burgeoning aerospace industry based in the central state of Queretaro has grown even faster in recent years.
On the lower end of manufacturing, there has also been steady growth, though not as rapid as in much of Mexico’s high-end manufacturing. Exports of textiles have averaged 9 percent growth over the last two years, while clothing exports have averaged 3.5 percent growth. This suggests that the high-end sectors concentrated in northern Mexico are more attractive within the country’s manufacturing sector and are larger, both in terms of growth and absolute value, than the low-end sector in southern Mexico.
Outlook and Broader Implications
One of the factors impacting Mexico’s economic growth this year will be the accelerating U.S. economic recovery, although growth for the first quarter of the year is likely to be small. As mentioned previously, a substantial portion of Mexico’s manufactured goods are exported to the United States, and U.S. demand for these products will increase as long as the U.S. economy continues to build momentum. Mexico’s manufacturing output is projected to increase between 4 and 4.5 percent for 2015 and 2016, and the Boston Consulting Group expects that the manufacturing sector could add between $20 billion and $60 billion to Mexico’s economy through 2018.
All of the subsectors that have performed well in recent years are also projected to continue strong growth in the coming years. The growth rate for plastics is expected to accelerate to 6 percent in 2015, while the automotive and aerospace sectors are projected to sustain strong growth for the next several years. Machinery and appliance manufacturing could also see strong growth, and exports of textiles and carpets are likely to continue to see moderate growth.
However, some less positive factors will also affect Mexico’s economic performance. Although Mexico’s security situation has not significantly harmed the country’s manufacturing growth, water availability in the country could become a long-term constraint in manufacturing development. Falling oil prices and a difficult global economic environment have also put more immediate pressures on Mexico’s economy. Crude petroleum is Mexico’s largest export. Because of lower global oil prices, Mexico’s central bank recently cut its growth outlook for this year from 3-4 percent to 2.5-3.5 percent. Meanwhile, the peso fell by 13.1 percent during the course of 2014 and has fallen another 1.4 percent in 2015.
Low global oil prices also have important regional ramifications. From a manufacturing perspective, low oil prices can be a boon, especially for manufacturers of goods such as plastics and machinery. On the other hand, low oil prices add to employment problems and push wages down in Mexico’s primary oil-producing zones, which are low-end wage zones in the country’s south. For Mexico’s state finances, this is a broader problem, and there is no short-term fix. The government thus will have to rely on tax reform to close the gap somewhat until Mexico’s energy reforms begin benefiting the energy sector. But overall, the strong performance and growth prospects of Mexico’s manufacturing sector, particularly high-end manufacturing, will continue to boost the country’s economy for years to come.
“Mexico’s Manufacturing Sector Continues To Grow is republished with permission of Stratfor.”