Uncertainty in Mexico Inspires Only Caution

Shadows on the growing economic relationship between the United States and Mexico:

Kaufman & Broad, the Los Angeles-based home builder, has decided to pull out of Mexico after six years in which it built relatively few homes, mostly because a country without mortgages offers few home buyers.

Pulte Homes of Bloomfield Hills, Mich., has built more than 7,000 multifamily and single-family houses in Mexico--but only because mortgages were subsidized by U.S. employers and the Mexican government.

Bell Atlantic, AT&T;, MCI WorldCom, SBC Communications and other U.S. telecommunications companies have invested billions in Mexico, but have seen their dreams of serving a giant potential market frustrated by regulations and obstructions from Mexican competitors.

These are cautionary stories that get lost in the celebratory talk from Washington and Mexico City about a burgeoning Mexico, a robust new trans-border relationship between the two countries, a first brick in the building of a grand hemispheric prosperity.

To be sure, the talk contains truths: A new economic relationship has indeed grown up between the world’s largest economy, at $8 trillion in annual output, and its southerly neighbor with an economy one-twentieth the size.

U.S. business by now has invested $27.9 billion in Mexico--a number approaching the investments U.S. companies have in Japan or France--and Mexican companies have returned the compliment, with $1.94 billion invested in the U.S.

Trade in goods and services between the two countries has grown to $200 billion annually, including roughly $50 billion in items such as auto parts that are manufactured in the U.S., sent to Mexico for integration with other parts and shipped back to the U.S.

Six years ago, before the North American Free Trade Agreement went into effect, two-way trade totaled only $75 billion.

But the fact is that Mexico is moving too slowly for its own good: It loses ground daily to the needs of its swelling population. It remains a highly fragile economy, utterly dependent on the United States. For all its long-term potential, Mexico’s economy right now inspires only caution among many businesspeople.

Mexico in many ways has had it easy this decade, even allowing for the economic collapse that followed its peso devaluation in 1994. Its task was eased by an unprecedented economic boom in the U.S., a market to which Mexico was guaranteed access by NAFTA. Yet the economy has little to show beyond the beneficial effects of that accord. Current economic growth of 3% a year “is not fast enough” to create employment for the 1 million youngsters who join Mexico’s labor force each year, says economist John Christman of Ciemex-WEFA, the Mexico City arm of a Philadelphia-based research firm.

The solution, say Christman and other economists from both Mexico and the U.S., is that Mexico must change its economy faster and open more of its protected industries to global competition.

Mexico faces imperatives to resuscitate its banking system and reform its legal system, efforts that have dragged on for years. Now there are signs, experts say, that it will leave both tough tasks for the next president, who will be elected to a six-year term in next year’s balloting.

That sounds like a prescription for stagnation--or worse, if the U.S. economy loses steam as some expect.

Mexico’s banking system, burdened with at least $65 billion in bad loans, is to be rescued by a government program. But delays in the bailout are adding to its cost; Mexico City economist Rogelio Ramirez de la O estimates that the ultimate cost will be $100 billion.

In the meantime, almost no loans to business are being made, particularly to small companies or to foreign companies that might bring innovations to the economy.

Mexico also needs to overhaul its legal system so that global companies “can have confidence in the predictability of decisions under the law,” says James Jones, former U.S. ambassador to Mexico and now chairman of the Washington-based Council of the Americas, which represents 250 U.S. firms.

These are basic needs indeed: Mexico must pass a law allowing evictions so that mortgage loans can be made with some assurance of recovering property if borrowers default. It must reform its bankruptcy law so that banks and companies can be restructured and business can move on.

But fundamental legal reform will certainly be left for the next six-year presidential administration, experts say.

This makes the year 2000 doubly critical for Mexico’s economy, as delays in taking action add to the tensions that normally build up as one six-year presidential term ends and another begins. At such junctures in Mexico’s past, most recently in 1994, currency devaluation and severe economic downturns marked the passage.

Despite the serious obstacles, and despite decades of failed hopes for Mexico, there is a new confidence. “NAFTA has lent credibility to Mexico, that reforms will be made,” says Aldo Flores, a professor of political economy at the Claremont Graduate School.

“Mexico’s economy has one of the brightest outlooks available in the world,” says Robert Day, chairman of Los Angeles-based TCW Group, parent of the giant investment firm Trust Co. of the West.

Day acknowledges that most institutional investors don’t yet share his convictions, but he believes further reforms in Mexico will change perceptions.

Indeed, reappraisals are beginning. Standard & Poor’s has just raised its credit rating on Mexican government debt from “stable” to “positive,” saying the improved risk outlook reflects Mexico’s ties to the U.S. economy and its resilience last year amid turmoil in world financial markets as Russia and Brazil foundered.

Several factors support such confidence. One is that Mexico’s economy in this decade has been nurtured by long-term direct investment--the kind that builds factories and permanent places of business. The country is not burdened by short-term investments in Mexican government bonds as it was in 1994 or by foreign bank loans as it was in 1982--the kind of capital that becomes scarce when times get tough.

And Mexico’s economy has acquired new strengths, notably in a vast and growing auto parts and vehicle industry that now includes branch plants of most of the world’s leading auto makers from Japan, Germany, France and South Korea as well as the U.S.

Delphi Automotive Systems, the Troy, Mich.-based auto parts giant, is expanding production at its 53 plants in Mexico and adding to its technical center in Juarez in anticipation of increased sales to that multinational industry.

And although most suppliers to the industry remain foreign-owned, home-grown Mexican companies--such as Sanluis Rassini Autopartes and the Nemak division of Monterrey’s giant Grupo Alfa--are supplying global auto manufacturers and helping to make Mexico a base for exporting to South America and the rest of the world.

The car industry in Mexico has prospered despite its exposure to global competition, which makes it a model for other industries, such as electricity and petrochemicals, Mexican experts say.

Mexico’s energy market has begun to crack open to meet its need for power, creating opportunities for companies such as San Diego-based Sempra Energy.

Sempra is building three gas distribution systems in the northern Mexico states of Durango, Coahuila and Chihuahua, and has a joint venture investment in a power plant in Baja California.

That’s not the only instance of Mexico’s needs leading to U.S. opportunity. International Hospital Co., a small Dallas-based firm, has built and opened hospitals in Hermosillo and Chihuahua, in northern Mexico, and is building a third in Puebla, in central Mexico.

The hospitals, with 50 beds each and intensive-care and neonatal units, are designed to serve a Mexican middle class that traditionally came north to Houston and other U.S. centers for medical care.

Total investment in the three hospitals will amount to $90 million, says Lawrence Magher, the company president, who has financial backing from Capital Research, a major Los Angeles-based investment firm, from Bank of America and from Mexican physicians and private investors.

Such ventures demand a leap of faith, however. The difficulties of getting normal working capital and doing business in Mexico today are still daunting, Magher says.

Consumer financing is rare, so Associates First Capital, an Irving, Texas-based finance company with $8 billion in assets, has begun offering $300 consumer loans in Mexico. The venture is an initial step for Associates, which hopes to offer home mortgages if Mexico reforms its laws.

It’s not news, of course, that U.S. companies see an enormous potential growth market in Mexico’s 100 million people, half of whom are under 21. Some businesspeople have grown skeptical waiting for that potential to be realized.

In agriculture, California and Mexican growers who had hoped that NAFTA would lead to improved markets and technology transfers have been disappointed so far, says a spokesman for the United Agribusiness League in Irvine, which has members in both countries.

But others see opportunity as imminent. HEB Grocery Co., a San Antonio-based supermarket chain that does $7 billion in annual sales in Texas, plans to open 40 supermarkets in northern Mexico in the next five years. That will add to the five stores HEB has opened in the Monterrey area in the last three years. Those stores are not yet profitable, but HEB is moving ahead because of the growth potential, explains Howard Butt III, vice president for Mexico of the family-owned firm.

Butt is not alone. Wal-Mart Stores Inc. spent $1.7 billion two years ago to acquire Mexico’s Cifra supermarket chain, the largest in Mexico.

Money flows are not all one way. In a trend that will surely grow, major Mexican companies are reaching out to expand their markets with investments in the U.S. Some of Mexico’s wealthy industrialists, notably Carlos Slim Helu, are buying control of U.S. firms or expanding their operations here in telecommunications and other fields.

A visible example in Southern California: Grupo Gigante, a 182-store chain based in Mexico City that has $2 billion in annual sales, is investing $15 million to open three supermarkets in the Los Angeles area.

“There is a great market that is underserved by the large U.S. supermarket chains,” says Justo Frias, Gigante’s Santa Ana-based director of U.S. operations, who opened the Gigante USA store in Pico Rivera in May.

But trans-border business and investments are still a drop in the bucket compared with what they could be if Mexico’s business climate comes to be seen as reliable legally and financially.

Institutional investors controlling billions of dollars are looking for places to invest, and Mexico is seldom the choice, says Alexander Cappello, chairman of Cappello Group, a Santa Monica-based investment banking firm.

“Many investors see political, economic and currency risks in Mexico and say they’ll wait for the election to see what policies the new president will follow,” says a U.S. investment manager.

What will persuade them, says Jones, the former U.S. ambassador, is economic and political progress in Mexico--”development of its infrastructure, education of its population.”

Those were the goals NAFTA was created to serve five years ago. The agreement emphatically was not drawn up to take advantage of cheap labor--as opponents of the accord insist. Mexico’s poor wages and backward economy have been a costly burden to the U.S. as well as Mexico for decades.

Twice in the recent past, the U.S. government has had to mount a rescue effort for Mexico--in the 1980s and again in 1994-95.

Closer links to the U.S. economy were supposed to provide a solution to Mexico’s chronic weakness. And in the latter half of this decade, the links have begun to work by helping Mexico to weather adversity and recover.

Now, if Mexico musters the will to accelerate its reforms, the coming decade could be a time of growing prosperity on both sides of the border. That’s what institutional investors, and many ordinary Mexicans and Americans, are watching and hoping for.

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James Flanigan can be reached at jim.flanigan@latimes.com.

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Stakes Across the Border

Long-term investments by U.S. business in Mexico and by Mexican companies in the United States have shown an irregular growth pattern this decade, reflecting troubles in Mexico’s economy and investor doubts. Accumulated direct investment in industrial and commercial facilities, adjusted for annual depreciation and other factors:

U.S. Investment in Mexico (billions)

1994: $17

1995: $16.9

1996: $19.9

1997: $25.4

1998: $27.9

*

Mexico Investment in U.S. (billions)

1994: $1.1

1995: $.80

1996: $.75

1997: $1.1

1998: $1.9

Sources: Trade Partnership, Commerce Department

The NAFTA Engine

The North American Free Trade Agreement, enacted in 1994, has fostered Mexico’s role as an assembler of motor vehicles and parts. Mexico receives parts and subassemblies, adds to them, then ships the parts and vehicles to the U.S. or other countries. Dollar values of car and truck subassemblies and parts imported to and exported from Mexico before and since NAFTA:

Imports

*--*

Subassemblies Parts 1993 $6.9 billion $1.7 billion 1994 8.2 2.4 1995 6.7 1.8 1996 6.0 3.7 1997 7.8 4.2 1998 8.8 4.3

*--*

Exports

*--*

Vehicles Parts 1993 $4.9 billion $2.2 billion 1994 5.9 2.8 1995 9.4 3.3 1996 13.3 3.7 1997 13.9 4.0 1998 14.7 5.0

*--*

Sources: Ciemex-WEFA, State University of Guanajuato, Mexico