The Perils and Promise of Mexico’s New Economy

Two weeks before Mexico’s presidential election Aug. 21, uncertainty clouds its economy. The peso is under pressure and the Mexican government is forced to borrow in dollars to keep essential foreign investment in the country.

The first year of the North American Free Trade Agreement has swelled Mexico’s trade deficit--the “giant sucking sound down south” that Ross Perot predicted has turned out to be Mexico’s developing economy pulling in imports from the United States. As industrial machinery and passenger cars flow south of the border, Mexico’s trade deficit could increase more than 20% this year, despite rising exports.

Election worries and peso weakness have driven up interest rates. Mexican government notes are above 15% and small business must borrow at 25% and more. Not surprisingly, economic growth is slow.

Many Americans will shrug at such news, and say they can never make sense of the economy to the south. But smarter Americans will be concerned and want to understand the perils and the promise of an economy that represents probably the greatest opportunity for U.S. industry in the world today.

They should look to Monterrey, this mountain-ringed city of 4 million people 140 miles south of Laredo, Tex., that is home to 7,000 manufacturing companies, including four of the five largest corporations in Mexico.

In Monterrey lie answers to such vexing questions as why $2 an hour labor does not mean competitive industry in today’s world. And how the Mexican people, now working in an economy in which the minimum wage is $6 a day, can hope to lift themselves to a standard of living on a par with that of Germany or Japan.

Alfa Corp., a Monterrey company with $2.35 billion annual sales in steel, petrochemicals, food, auto parts and diverse businesses, will open a $400-million steel mini-mill in December.

The new mill will employ the latest technology, some of it bought from Nucor Corp., the U.S. steel producer. And it will allow Alfa, whose mill workers make $2 to $3 an hour, to produce steel almost as cheaply as Nucor’s Arkansas plant, where the average pay is $16 an hour.

But wait a minute, why doesn’t two bucks an hour beat $16 hands down? “Infrastructure,” explains Enrique Flores, an Alfa vice president of finance. “Electrical energy costs more in Mexico, the railroads are less efficient than in the United States, our roads and ports are not as good.” Add it all up and you understand the drawbacks that keep developing countries poor.

That is what Mexico is trying to change with investments in roads, railroads and public facilities. Private investors built a toll road from Monterrey to the U.S. border at Laredo to help move goods faster and increase productivity in the economy.

Such investments can create a virtuous circle: 72% of Alfa’s steel, for example, goes to construction projects. If construction of better roads and more efficient plants can reduce infrastructure drawbacks, Alfa’s workers can produce steel less expensively leaving more money in the economy for other purposes. Among those purposes would be higher wages for the steelworkers, who could then make Mexico’s potentially vast consumer market more of a reality than it is today.

Many companies, U.S. and Mexican, are betting the consumer market will materialize. “Alfa is investing $80 million to $100 million a year in polyester for plastic bottles,” says Juan Luis San Jose, director of planning for Alfa’s petrochemicals division. Plastic bottle use is on the rise in Mexico, which is second only to the United States in per capita consumption of soft drinks.

Alfa also is investing in a joint venture with Payless Cashways of Kansas City to bring do-it-yourself hardware stores to Mexico. The company plans to open 25 stores in this decade, according to a report by D.A. Campbell & Co., a Los Angeles brokerage that specializes in Mexican securities. Other firms, with names like Home Mart and Builders Mart, are also bringing U.S.-style hardware to Mexico.

Do-it-yourself could be a booming business as rates for skilled tradesmen climb--even now plumbers command $20 a day in Mexico--and if more Mexicans become homeowners. But that’s a big if. There are almost no housing loans in Mexico, where mortgages can be for terms as short as two years and interest rates are prohibitive.

Yet today’s young Mexicans are filled with expectations of change. Mexico’s population is so young that fully one-third of its people are in school. In the Aug. 21 election, half the electorate will be voting for the first time. And those voters want what everybody in the world wants today, jobs and houses and lawn mowers and mortgages.

Indeed, it was to give its young people and companies access to the world’s low interest rates that Mexico’s government proposed NAFTA in the first place. Global interest rates are 7% and below, while rates in a land of underdeveloped capital like Mexico are three and four times higher.

That’s one reason Mexico is borrowing by issuing dollar obligations notes, at about 7.25%, rather than peso notes at about 16%. (Another reason is that investors fear peso devaluation after the election.)

The promise of Mexico today is that its people can earn a better life by becoming more productive.

The peril is that Mexico has opened its economy to more competitive global products before its own industries and infrastructure are able to cope. The world’s goods are flooding in now and as Mexico’s young consumers rush to buy them the danger is of renewed inflation.

There are no easy answers for Mexico. Devaluation of the peso could cause more problems than it would solve. And the election won’t be the answer to every prayer but simply another landmark in Mexico’s long development.

“We Americans should wish that Mexico succeeds,” says Tom Frost, chairman of Cullen/Frost Bankers Inc. of San Antonio, Tex., who first went to work in Mexico 44 years ago to gain experience.

“We’re an old country, those over 65 will be an expanding age group,” Frost says, “while Mexico is a very young country. If I were making goods, I couldn’t avoid going to Mexico because that’s where the future market will be.” That’s true, even though Mexico’s future is clouded with uncertainty today.