The New Trade Routes

MEXICO
FINANCIAL TIMES SPECIAL REPORT | Tuesday April 17 2012
www.ft.com/mexico-trade-2012 | twitter.com/ftreports

Open economy brings rewards

Resistance to protectionism has created a leading exporter, says Adam Thomson

Inside this issue

Security Adam Thomson finds that despite the violence by gangs such as Los Zetas (right), investment is rising, even in the most violent states Page 2 Taking on China Success in beating the much bigger economy has confounded the experts in international trade, says Adam Thomson Page 2 Tourism The campaign in new markets to attract customers has paid off, says Adam Thomson Page 2 Agreements John Reed looks at various arguments over billions of dollars of inward investment Page 3

rive north along Highway 57 past the city of Quertaro and you will glimpse what is fast becoming the future of Mexico. On what used to be tracts of sun-bleached scrub and cactus sit internationally owned industrial plants that churn out everything from plastic-injection pieces to automotive parts. And all for export. Over the past couple of decades, Mexico has not only fulfilled its promise as one of the worlds leading exporting nations, it has also diversified its range of products and export markets. Six years ago, 90 per cent of exports went to the US, Mexicos huge northern neighbour. Today, that market is less than 80 per cent of the total. Trade is increasing rapidly with Central and South America, as well as with Asia. In November, Mexico asked to join negotiations on the Trans-Pacific Partnership (TPP), a bloc of Pacific countries that accounts for 30 per cent of global gross domestic product. Its vital that we are part of it, says Francisco de Rosenzweig, undersecretary for trade at the economy ministry. The country has moved steadily up the value chain, manufacturing more sophisticated goods in 2009, it was the worlds largest exporter of flatscreen televisions and even providing engineers to help design pieces for use in some of the worlds leading brands of cars and industrial engineering equipment.

Mutual benefit: Felipe Caldern, Mexicos president (centre) agrees to strengthen trade and commercial ties with Chile and Colombia

Reuters

We have an industrialisation platform that didnt seem feasible just five years ago, Jos Antonio Meade, finance minister, told the FT in an interview. This has led many companies that only a few years ago looked to China as their chief manufacturing centre to see Mexico as a better base when it comes to supplying the Americas. Siemens is in the process of bringing production of its high-voltage surge arresters to Mexico. Until now, the arresters,

which are destined for sale in the Americas and cost thousands of dollars each, have come from China and Germany. We dont just manufacture cheaply here, we can also carry out engineering and design, says Alfredo Phillips, Siemens government affairs and corporate communications officer in Mexico. In a sign of how much things have changed, the value of Mexicos manufactured exports in 1980 was equivalent to 2 per cent of GDP. By 2010, it was about

24 per cent, with much of that change in the auto sector, which represents 28 per cent of manufacturing exports. Oil exports, which were roughly 71 per cent of total exports in 1980, now only account for 13.8 per cent. Mexico is now the most open of the worlds leading economies. In 2010, the sum of imports and exports as a percentage of GDP, a principal indicator of openness, was 58.6 per cent. Compare that with China at 47.9 per cent, Russia at 41.9 per cent and the US with 21.6 per cent. Brazils

total trade in 2010 represented a meagre 18.5 per cent of GDP. Look forward and the picture is even more startling. HSBC in Mexico City estimates that trade, which totalled US$701bn last year, is likely to rise to 69 per cent of GDP this year, and a staggering 85 per cent by 2017. Sergio Martn, the banks chief economist for Mexico, estimates exports could double in six to eight years. This transformation stands out against a protectionist backlash in much of the rest of the

region. In February, Brazil, Latin Americas largest economy, announced it was considering abandoning a 2002 trade agreement on cars after imports from Mexico rose 30 per cent last year. Argentina tried to follow suit. By contrast, Mexico remained silent as it endured trade deficits with Brazil and Argentina for much of the first decade of this century, believing openness was in the countrys long-term economic interests. None of this success could have come about without a solid macroeconomic framework. Since the Tequila crisis of 1994-95, Mexican governments from both the centre-left Institutional Revolutionary party and the conservative National Action party have worked hard to put public finances in order. Public debt is a modest 36 per cent of GDP, while external debt has fallen from 16.5 per cent of GDP to 5 per cent. Economic growth 3.9 per cent last year is expected to be at least 3.5 per cent this year. International reserves at the central bank are near record highs of US$150bn. And inflation in the 12 months to March was 3.73 per cent down from 3.87 per cent in February and within the banks target ceiling of 4 per cent. Monetary policy has worked well for us, Agustn Carstens, Mexicos central bank governor, told the FT in a recent interview. Many would call that an understatement: since Mr Carstens became governor in January 2010, the central bank has not touched interest rates, which remain at 4.5 per cent. Mexico faces several challenges. The war on drugs has cost 50,000 lives in the past five years, and continues to
Continued on Page 2

Volkswagen John Reed describes the companys second-biggest plant, which served 12,671 chiles en nogada, a Puebla speciality, to its workers in one day Page 3 Domestic market Sales moved up a gear after reform was introduced, says John Reed Page 3 Politics Times have changed, says Adam Thomson Page 4 Aerospace John Reed looks at the success of the regions effort to create a cluster Page 4

FINANCIAL TIMES TUESDAY APRIL 17 2012

New Trade Routes: Mexico

Location provides competitive edge

Taking on China Success confounds trade experts, says Adam Thomson

hen Chrysler inaugurated the Fiat 500 production line in Mexico a year ago, it seemed that the conventional wisdom underpinning global trade dynamics had turned on its head. While the bulk of the US$550m investment to produce up to 120,000 of the retro-chic vehicles was made with the North American and South American markets in mind, it was also glaringly apparent to everyone at the ceremony that a proportion was also destined for China. I think it is the first time that a Mexican vehicle, at least in recent times, is to

be exported to China, said Felipe Caldern, the countrys president, at the launch. We always thought it was going to be the other way around. So did the trade experts. When China erupted onto the world manufacturing stage at the beginning of the century, most people in the know predicted bleak times ahead for Mexico. Unlike South American countries, for which Chinas growth meant a vast and hungry customer for their agricultural and mineral commodities, Mexico saw China as a seemingly unmatchable competitor in exactly the same things it was producing cheap manufactured goods. A decade or so on, not only has Mexico survived the onslaught but it has actually begun to gain market share of total US imports, the worlds largest import market. According

to figures from the United Nations Commodity Trade Statistics Database, Mexico accounted for 12.3 per cent of all US, non-oil imports in 2010. In 1999, prior to Chinas emergence as the worlds factory, its share was just 10.6 per cent. So what happened that nobody could foresee? First, climbing fuel prices have made transport much more expensive. The average annual US dollar price of a barrel of oil in international markets during the first four years of the century fluctuated around US$25. Yet since 2005, it has never dipped below US$50, and last year it was US$87. At the same time, Chinas once-rock-bottom labour costs have soared while those of Mexico have remained steady. According to a study by JP Morgan, Mexican wages were 237 per cent more than Chinese wages in 2002. Today, that

chasm has closed to a hairline crack of 14 per cent. Experts expect Chinese wages to overtake those in Mexico within five years. For many companies, those changes have made Mexico all the more attractive. In recent years, for example, Siemens, the German electronics and electriMexicos proximity to the US is an advantage, says Lorenza Martnez

cal engineering company, has been eyeing Mexico as a platform for manufacturing its high-tension energy transmission equipment. Whereas five years ago, it was all about the Brics [Brazil, Russia, India and China] and Mexico was not even on the map, we are now bringing more and

more manufacturing to Mexico, says Alfredo Phillips, Siemens government affairs and corporate communications officer in Mexico. Many companies that started to move some of their Mexico production to China in the early 2000s are viewing the benefits of being in Mexico with renewed attention. The list is long but includes Honeywell, the US conglomerate, and Intel, the chipmaker. One of Mexicos big advantages over China is proximity to the US market. According to Lorenza Martnez, undersecretary at the economy ministry, it takes between 20 days and two months to ship goods from China to the US. In the case of Mexico, it takes a maximum of seven days and often as little as two. The quicker times have gained relevance as US companies that depend on

inputs from third parties embrace just-in-time manufacturing, which has become more popular since the 2008 recession because it allows companies to reduce costs by holding smaller inventories. As Ms Martnez puts it, manufacturing in Mexico ends up allowing companies to reduce their overall costs of financing. One thing that has helped Mexicos case as a manufacturing base is its openness. Latin Americas secondlargest economy now has trade agreements with 44 countries, more than twice as many as China, and almost four times as many as Brazil. That means that companies can source from a wide range of countries, in many cases without having to pay duty on what they bring in for use in the manufacture of goods for export. Then are the little

things. Talk to US executives who have experience in Asia and in Mexico and they will almost invariably tell you that it is easier to do business closer to home. For one thing, Mexico is culturally much more similar to the US than China, and most university-educated people speak English. For another, it covers the same time zones as the US. That might seem like a detail but, says Carlos Bello, director-general of the Mexican Federation of the Aerospace Industry, receiving phone calls in the middle of the night gets tiring. All this has reawakened interest in a country that, just a decade ago, many had written off as an alsoran in the race to attract the worlds manufacturers. As Sergio Martn, chief economist for Mexico at HSBC in Mexico City, says: The country is consolidating its exporting vocation.

Open economy brings rewards

Continued from Page 1

Tourism Campaign to attract new visitors pays off

For years, Ivan Ignatievich has been going on family holidays in and around his native Russia. But last year, he tried something different: an allinclusive resort hotel south of Puerto Vallarta on Mexicos Pacific coast. Very nice, he said in a thick accent as he sipped on a pia colada by the pool. Very warm. Mr Ignatievich may not know it but he and his family are the new face of international tourism in Mexico. In the past two years, the number of visitors from the Bric (Brazil, Russia, India and China) countries, has increased at rates above 50 per cent a year. The surge is the result of the most aggressive campaign to promote tourism in Mexicos history. During the past two years, Gloria Guevara, the tourism minister, has been travelling the world, seeking out markets and working to make things easier for nontraditional visitors to go to Mexico. Its all about diversification and exploring new growth markets, she told the FT last month. The aim, she says, is to turn Mexico into one of the worlds top five tourist destinations by 2018 from 10th place currently. One aspect of that work has been to streamline and simplify the visaapplication process. As of May 2010,
The aim is to turn the country into one of the worlds top five tourist destinations by 2018 from 10th place Gloria Guevara

for example, any person holding a passport with a valid US visa can visit Mexico without further paperwork. In the case of Russia and China, the time it takes to receive a Mexican visa has come down from 45 days to just three. That, says Ms Guevara, has helped prise open a market that did not exist before. We realised that a lot of people were not coming because it was too difficult, she says. We have changed all of that. The broadening of Mexicos customer base has not come a moment too soon. The countrys image as a tourism hub has faced challenges in recent years as Latin Americas second-largest economy finds itself in the midst of a battle against well-armed drugs cartels. The violence has produced about 50,000 drug-related deaths since President Felipe Caldern of the National Action Party came to power at the end of 2006. Unsurprisingly, the news of decapitations, extortion and kidnappings has dominated much of the international press. The recent travel advisory issued by the state of Texas warning residents to avoid travel to Mexico a move

heavily criticised by the Mexican government has hardly helped. At the same time, the number of US citizens travelling abroad declined 10 per cent between 2008 and 2011 to 36m as the US financial crisis and ensuing global recession took hold. As the most popular foreign destination for Americans US visitors account for about 60 per cent of total Mexico has been particularly exposed. To counteract the falling numbers, authorities in 2010 began a media campaign in the US to promote the Mexico you thought you knew. Put simply, the strategy consists of promoting Mexicos cultural and geographical heritage beyond the traditional sun and beach profile. Among the new offerings are more than a dozen themed tours, including cuisine in the state of Puebla, archaeological excursions in the Yucatn peninsula and, of course, the tequila tour in the state of Jalisco. The idea, says Rodolfo LpezNegrete, who heads the countrys Tourism Board, is to attract a new crowd of North American tourists by offering a wider range of holiday activities. Mexico is so much more than beaches, he said. The tourism board is also about to launch a second advertising drive to reassure US citizens that Mexico is a safe destination in spite of the military-led offensive against the cartels. The campaign will consist of candid-camera interviews with people who have just returned home after spending their holidays in Mexico. So far, the strategy seems to be working. According to figures from the countrys immigration authorities, 22.7m tourists visited Mexico last year higher than the previous record in 2008. Meanwhile, Mexicos market share of US tourists travelling abroad has increased from 14.6 per cent of the total in 2008 to 15.3 per cent. For businessmen such as Carlos Berdegue, who owns the El Cid chain of hotels, the campaigns have helped build an average occupancy rate last year of 85 per cent an 8 per cent increase over the previous year. Im happy, he says. Things are definitely improving. International hotel groups are also upbeat. InterContinental Hotels Group expects its franchise holders to invest US$550m in Mexico over the next five years. Gerardo Murray, the groups vice-president of sales, says that the plan is to build 47 hotels around the country during that time. With prospects for the US economy improving slightly this year, Ms Guevara believes that the combination of recovering numbers from North America and new visitors from non-traditional markets will bring in 25m foreign tourists this year. If she is right, it would be a record.

Battleground for drugs cartels fails to deter multinationals

Security Adam Thomson finds investment rising, even in the most violent states
Against the low-slung mountains of northern Mexico, two gleaming white factory shells, each a quarter of a mile long, house one of the countrys more recent investments: the Lego plant. Production of the companys famous little coloured bricks this year is set to increase 45 per cent compared with last year when the Danish toy maker was already churning out one-third of its global supply from its Mexican plant. What is surprising is that this investment, an initial $197m in 2008, with another $100m in 2010, has taken place in the northern city of Monterrey, one of the main battlegrounds in recent years of the countrys fight against the drugs cartels. Two of the biggest organised crime groups have been waging a turf war in the city of about 4m residents, sometimes with shoot-outs in the centre and in broad daylight. Yet almost none of this has affected the numerous large multinationals that have chosen Monterrey to take advantage of its cheap and skilled labour, infrastructure and proximity to the US market. Ask executives of other multinationals in Monterrey and those words start to sound a little like a mantra. In spite of the violence, foreign direct investment is rising steadily all over Mexico. Last year, FDI reached $19.4bn, slightly lower than the $20.2bn in 2010 but still higher than the $15.9bn in 2009. Andrs Rozental, a former Mexican ambassador to London who runs a business consultancy, argues that the security factor depends on who you are. Almost all of the large multinationals with a sizeable presence are not overly concerned, he says. They spend money on the security issue, they dont like

Busted: arrested members of the Los Zetas drugs cartel in Monterrey on parade with weapons

Getty

Adam Thomson

it, its part of their bottom line. But they still feel that Mexico offers sufficient comparative advantage. One reason is that the violence is localised. Alejandro Poir, the interior minister, says most of the violence takes place in just 80 of the countrys 2,500-odd municipalities. Visit Quertaro, the peaceful and fast-growing hub for the aerospace industry and other high-technology manufacturing industries, and you will see what he means. But even in more troubled areas such as the northern border states, investment has been pouring in. A study last year by the economy ministry, found the border states accounting for 28.5 per cent of FDI between 2006 and 2010, the years the drugs war became a central issue for the first time. During the previous, relatively peaceful five-year

period, that figure was just 22.5 per cent. Another reason is size: it is much more difficult for the local arm of a drugs cartel to extort money from a large and mainly faceless, multinational than it is to demand protection money from the cornershop owner. How do they even know who to demand the money from? asks one executive in Monterrey. One area in which multinationals do suffer, however, is the supply chain. Josh Miller, general manager for Latin America at Control Risks, the consultancy, says companies often endure delays resulting from the theft of materials. They also have to be careful with their end-product, he says. Raw materials go missing, even chemicals and things that are really hard to resell. Mr Miller says many multinationals go to the huge trouble of using more than a dozen

separate transport companies just to spread the risk. In general, however, they continue to see Mexico as a good place to manufacture. Take Ternium, part of the Techint Argentine steel group, that is planning to invest $1.3bn over three years to the end of 2013. The investment is part of a boom that has seen the worlds leading car companies pour billions of dollars into the country in recent years. Ternium is building eight production units to service the automakers. In spite of the violence, there are cases of companies that took large portions of their production to China in the early 2000s only to move some of it back to be closer to the US. As Mr Miller says: The security situation is going to take a long time to wind down but businesses are not overly worried . . . people are fairly optimistic about investing here.

Nafta should look beyond its borders to the world

Guest Column
LUIS DE LA CALLE
International trade is under attack. Recession has tested commitments to keeping borders open as politicians beholden to domestic audiences have succumbed to the temptation of throwing up barriers for short-term economic benefit. But policymakers should remind themselves how important trade is for economic development. They need look no further than North America. In the almost 20 years since the North American Free Trade Agreement (Nafta), the benefits are clear. Trade volumes are much larger than expected. Mexico is the secondlargest supplier of non-oil goods to the US. It buys 13.3 per cent of US exports, more than Germany, the UK, Netherlands, France and Italy combined. Nafta also produced convergence in quality, variety, price and availability of goods; convergence in investment in technologies and environmental standards in manufacturing in Mexico; and macroeconomic convergence so Canada and Mexico boast low debt and deficit, low inflation and sound monetary policies. But we need to look beyond our borders. For all practical purposes, Nafta countries give each other little preference because most-favoured-nation duties are very low and each has negotiated a web of free trade agreements around the world. The challenge is to deepen integration to export to other regions, particularly Asia. The rebalancing of the world economy and eventual deleveraging mean the US will reduce its current account deficit. It is much better for everybody, but particularly Canada and Mexico, that the adjustment takes place via increased exports rather than fewer imports. To achieve that, increasing exports of finished manufacturing goods at competitive prices implies co-producing them with Mexico. And that requires even deeper industrial integration. Structurally, re-industrialisation is taking place for three reasons: the need by multinationals overexposed to China to diversify the inevitable shrinking of the US financial sector, which will result in more value-added generated in the real economy the revolution of shale gas, which will promote the return to North America of energyintensive industries that had migrated to Asia. In this context, North
Nafta countries should work to a more ambitious agenda

pose a serious security threat in some parts of the country. International companies, in particular those already established in Mexico, continue to invest. But there are doubtless many cases of companies deciding to stay away. Then there is the difficulty of competing in the domestic economy. Most leading sectors are dominated by one or two companies, which reduces competition, creates high barriers to entry and acts as a brake on investment. There is also the need to deepen local supply chains for international companies manufacturing in Mexico. These have begun to form but not at the pace most people would like to see. As Luis Rubio of CIDAC, a respected Mexico City think-tank, says: The government needs to provide incentives for suppliers to come to Mexico. However, Mexicos exporting success over the past 20 years and, in particular, since the 2008 crisis, has been remarkable. Clearly, this would not have happened without the benefit of Mexicos location. Sharing a 2,000-mile border with the US provides Latin Americas second-largest economy with a wealthy trading partner to which it can supply goods within 48 hours compared with between 20 days and two months in the case of China. But there are other factors that have made all the difference. First, Mexicos exporting vocation has been boosted by its predominantly young population. This window that began in 2006 is expected to provide an abundance of cheap labour until at least 2028. Some experts predict that the once-yawning gap between Chinese and Mexican labour costs will close, and even turn in Mexicos favour within five years. Mexico has an abundance of skilled and semi-skilled labour. The number of engineers graduating from US universities since 1999 has remained steady at 0.22 per 1,000 people. In Mexico, it has risen from 0.39 per 1,000 to 0.61, says Unesco. Inegi, the countrys statistics agency, estimates that 114,000 Mexicans graduated in engineering and technology in 2010, more than double the number in 1999. The second factor, and the backbone of Mexicos trade strategy, is the constant stream of negotiated accords with the countrys main trading partners, starting in 1994 with the US and Canada through the North American Free Trade Agreement. Since then, Mexico has negotiated 11 tariff-reduction accords and has agreements with 44 countries more than any other leading economy. That has given the country preferential access to two-thirds of the global economy. Little wonder that on a recent trip to Mexico City, Richard Fisher, president and chief executive of the Federal Reserve Bank of Dallas, described the country as an exporting powerhouse. Addressing journalists and analysts at the local stock market, he added: The moment has come to change our perception of Mexico.

Contributors
Adam Thomson Mexico City Bureau Chief John Reed Automotive Industry Correspondent Rohit Jaggi Martin Brice Commissioning Editors Steven Bird Designer Andy Mears Picture Editor For advertising, contact: John Moncure Phone +1 212 641 6362 john.moncure@ft.com or your usual representative All FT Reports are available on FT.com at www.ft.com/reports Follow us on twitter at www.twitter.com/ ftreports

American trade policy should go on the offensive and insist on the opening of relatively closed economies such as the Brics. It should also make progress on transport and energy. A first step would be to welcome Canada and Mexico to the Transpacific

Partnership (TPP). This would set the stage for engaging China and exert pressure to advance on the Doha agreement at the WTO. Nafta countries should work on a more ambitious agenda on services. On land transport, the pilot programme at the MexicoUS border should be expanded, and there could be an open skies framework for tourism and cargo. Other services where integration would work are healthcare, in which Mexico has an advantage for medical tourism; and education, which could lead to a student exchange programme. On energy, free trade is needed to ensure access to competitive natural gas, electricity and petrochemicals throughout

the region. Free trade on energy could be accomplished via the TPP bilaterally or, better still, unilaterally by Mexico moving to end the monopoly of Pemex, the state oil company, and the CFE, the governments electricity monopoly. And now that there are no import duties on regional trade, cumbersome border crossing have to be streamlined. The bombings of 9/11 tightened borders and trade has suffered. The law enforcement community often fails to grasp that barriers create an incentive to smuggle. Mexico has implemented a significant reduction of most-favoured-nation duties and, in December, it eliminated anti-dumping duties for goods coming from China. In addition, it accepted US and EU

technical and safety standards for electronics, certain medical devices and medication and others. This liberalisation leads to better prices for companies and consumers and less smuggling and acts as a disincentive to the informal economy. The recent trade agreements with South Korea, Colombia and Panama in the US are a signal that progress can be made. If necessary, Mexico should proceed on its own or with Canada. Open trade is a distinguishing factor that favours Mexico; progressing down that road would distinguish it more. Luis de la Calle is president of Hill+Knowlton Strategies Latin America and a former trade negotiator for Mexico of Nafta

FINANCIAL TIMES TUESDAY APRIL 17 2012

New Trade Routes: Mexico

German carmaker accelerates with global best practices

Volkswagen John Reed takes a look at the companys second biggest plant
Volkswagens car plant in
Puebla, Mexico, is North Americas largest, busier than any in the US Midwest or deep south. It is VWs second biggest after the carmaking groups massive home plant in Wolfsburg, Germany. The plant made 510,000 cars last year and claims to run Latin Americas biggest industrial canteen. In one day in 2010 it served to its workers 12,671 chiles en nogada, a Puebla speciality. But for anyone expecting to see a low-cost operation serving the US, this is no cheap maquiladora. The plant follows VWs global best practices, including use of natural light and recycling of rainwater and on-site green spaces. A German-made stamping press more modern than in most US car plants turns out each minute up to 64 parts that are welded by robots and assembled into Beetles and Jettas. Suppliers bring components on a just-in-time and just-in-sequence basis to cars on the line. The only feature that distinguishes it from VWs other factories in Bratislava, Chattanooga or Shanghai is a large statue of the Virgin of Guadalupe, Mexicos pre-eminent cultural symbol, swathed in green vestments and adorned with flowers and electric lights. Yet it is what is outside the plant that truly surprises: a sea of cars waiting to be shipped, not only north to the US and Canada but also west via Acapulco to China, Japan and Australia, or east to Veracruz and from there to South America or Europe. Puebla is VWs only plant in the world that makes the new Beetle, which can be ordered with rear end badges bearing the cars local nicknames: Fusca in Brazil, or Kfer in Germany. (For Argentina, the Jetta is rebadged the Vento because the name is a homonym for yeta, which means bad luck.) Mexico is the only country that has free trade agreements with all the big automotive regions: North America, Europe, Japan, and most of the countries of South America, says Thomas Karig, vice-president of corporate relations and strategy with Volkswagen de Mxico. From Mexico, you can export cars to these regions without them paying some import taxes. There are exceptions, though they only reinforce the rule of Mexicos open trade routes: the Puebla plant sends Jettas in kits to India and China, which protect their car industries with high import duties. Mexico has 45 free trade agreements with other countries, says Fred Diaz, who heads Chryslers Mexican operation, which also builds cars for Fiat. They represent over 1bn potential customers and 60 per cent of the worlds GDP. Mexicos web of free trade agreements is begetting further investments. Last year, VW began building a $500m engine plant in Guanajuato. The plant, with capacity to build 330,000 engines a year, will supply its carmaking operations in Puebla and Chattanooga, lowering logistics costs and allowing VW to meet origin requirements on local content. Mazda and Honda are building plants in Guanajuato to begin making cars says Jose Munoz, who heads Nissans operations in Mexico. All of a sudden, everyone has noticed Mexico is a very good place to export from. Two decades ago, before the North American Free Trade Agreement (Nafta), Mexicos car sector was closed, dominated by a few: Nissan, VW, General Motors, and Ford Motor. Nafta brought a wave of investment, mostly by US producers and largely in pick-up trucks that sell well in the US heartland just north of the border. Chrysler still makes Ram trucks in Saltillo in the northeastern state of Coahuila. More recently, Mexico has become a hub for small cars such as Fiats 500, which carmakers need to produce for the US because of tightening fuel-economy requirements, but struggle to make there competitively. According to OICA, the international carmakers association, Mexico was the worlds eighth-largest car producer in 2011, surpassing Spain for the first time. Eduardo Solis, president of AMIA, Mexicos carmakers association, says the sector generated net exports worth $32bn last year more than oil, tourism, or workers remittances home from abroad. Still, carmakers are not resting easy. The industry became a victim of its own exporting success recently, when the trade in cars with Brazil tipped in Mexicos favour. Braslia threatened to abrogate a sectoral FTA, before settling the matter with quotas. And while Mexicos car plants are hard at work, the industry does less of the core engineering and design work in-country than it does in Brazil and China. One exception is GM, which designs in Mexico interior trim and thermal engineering for many of its US-made trucks and crossover vehicles. Automakers also say Mexicos supply base needs to grow in depth. While most big Tier One suppliers have operations including Bosch, Johnson Controls, and Faurcia that build components in Mexico, their own tier two and tier three suppliers are thinner on the ground. We still need to develop the supplier base to get to the level of Korea and China, says David Rojas, GMs chief engineer at its Toluca centre. This is not just a task for the manufacturers but other players have to help, too.

All of a sudden, everyone has noticed Mexico is a very good place to export from
in 2014. Nissan is investing $2bn in a plant in Aguascalientes to complement its two existing Mexican plants. The free trade agreements . . . have helped Mexico develop very well in the automotive world,

Spat over exports damps down sales to Brazil

Agreements John Reed analyses arguments over investments of billions of dollars

hryslers plant in Toluca, west of Mexico City, is a showcase for the US carmakers growing international operations under its new Italian owner, Fiat. Like VWs bigger factory in Puebla, it also illustrates the fruits of Mexicos free trade with the world. Chrysler makes Dodge Journey sport utility vehicles, which are rebadged as Fiat Freemonts for sale in Europe and South America. Toluca also produces the Fiat 500 city car for North and South America including Brazil, which takes about 10 to 15 per cent of the plants output. The Fiat 500 is a good car in Brazil, says Santiago Pages, Chryslers vicepresident of manufacturing. Sergio Marchionne, Fiat/ Chryslers chief executive, said in January that the Toluca plant would soon be making Fiats Ducato vans for export to South America, too. Overall, the Mexican car industrys exports to Brazil have multiplied from fewer than 25,000 units in 2007 to 147,000 last year according to AMIA, the Mexican car-

makers association. The commerce in cars is not one-way: Volkswagens Brazilian-made Gol is a common sight in Mexico, as in Brazil are Mexican-built Jettas and Beetles. But this lively Latin trade route came under threat recently when Brazil threatened to abrogate a bilateral agreement providing dutyfree access for cars after the balance tipped into a $1.7bn surplus in Mexicos favour, thanks mostly to the strong real. The issue was raised at the highest level, including in a phone conversation in February between Felipe Caldern and Dilma Rousseff, the two countries presidents. The worst was

Its unlikely we will see the bilateral trade agreement come to an end
Guido Vildozo
averted when the two countries agreed on voluntary quotas that took effect from March 19, capped at $1.4bn this year, and rising to $1.6bn in the third year. Brazil, which is in a protectionist mood because of the pressure on its currency and economy, has vowed to resume duty-free trade after that. In Mexico, industry officials are feeling resentful, with some pointing out that

the agreement suited Braslia when the trade balance was running in its favour. Let me point out the very negative message Brazil is sending to the world: they only respect agreements when they are in their interest, says Eduardo Solis, AMIAs president. With billions of dollars of investments at stake, carmakers are indeed counting their blessings. The good news is that cancellation of the treaty could be avoided, says Thomas Karig, an executive with VWs Mexican operation. But some in the industry known worldwide for its cheerfully cosmopolitan disregard of borders are warning the trade spat could have unintended consequences that could ricochet back on Brazil. Nissan, Mexicos largest carmaker by domestic sales, is building a $2.6bn plant near Rio de Janeiro where it plans to begin producing cars in 2014. The Japanese carmaker has tripled its market share in Brazil recently, thanks largely to Mexican-built small cars. Our plan was to keep increasing that share based on exports from Mexico so that . . . when the plant started production we would have developed a network, sales channels and marketing operations, says Jose Munoz, president of Nissan Mexicana.

On line: production in Mexico of VW Jettas, which are a common sight in Brazil

Bloomberg

But with Mexican-built cars facing the new quota, some of Nissans dealers in Brazil might need to reconsider the investments they plan to make in sales and service facilities, Mr Munoz says. The quotas could also have an impact on Brazilian suppliers of flex-fuel systems, which Nissan planned to bring into Mexico to equip its cars made there to run on ethanol, which is popular in South Americas biggest car market. The effect is a negative one for Brazilian suppliers because we [might] say, Hey, we cant buy from you any more, says Mr Munoz. Brazil is brushing off the criticism: The agreement reached by Mexico and Brazil was a balanced one which will make it possible for both countries to programme investments in the automotive field, a spokesperson for the Brazilian Ministry of External Relations tells the Financial Times. In Mexico, carmakers are now engaged in negotia-

tions on dividing up the quota. Some are sceptical that Brazil will resume free trade in three years, as promised. We dont know

if we believe them, says one executive at a leading carmaker, speaking anonymously. Others are more optimis-

tic. There is significant posturing going on by both governments but given the importance to both of the automotive industry,

its unlikely we will see the bilateral trade agreement come to an end, says Guido Vildozo, analyst with IHS Automotive.

Domestic market Sales move up a gear after reform introduced

Nissans main car plant in Mexico is also the Japanese carmakers most productive in the world. The factory in Aguascalientes runs 24 hours a day, making a car every 55 seconds. The company is investing up to $2bn to build an additional plant in Mexico its third in the country to build small B segment cars. Nissan, which made its first car in Mexico a Datsun Bluebird saloon in Cuernavaca in 1966, commands an enviable 25 per cent share of the market. However, it believes it should be selling cars in even larger numbers. The reason: Mexicos domestic car market, awash with cheap imports, is dead in the water. Our current vehicle stock is oversupplied full of garbage, says Eduardo Solis, the plain-spoken president of AMIA, Mexicos carmakers association. The countrys car industry produced nearly 2.6m vehicles in 2011, a record number and 40 per cent more than 10 years ago. Mexican automobile exports have risen 53 per cent over the past decade to 2.1m, also an all-time high. But Mexican consumers bought just 906,000 new cars last year, slightly fewer than they did back in 2001. Imported vehicles are crowding out new car sales, especially at the lower end of the market. While carmakers offer a wide range of entry-level cars such as Nissans Versa or General Motors Chevrolet Spark, many Mexicans prefer to buy used. While the motorisation ratio an indicator watched closely by carmakers selling to emerging countries has more than doubled in Brazil and Argentina over the past five years, it has actually dropped in Mexico. Six years ago, Mexico sold 10 new vehicles per 1,000 inhabitants when Brazil was selling nine and Argentina eight, Mr Solis says. Today, Mexico sells eight per 1,000, and Brazil and Argentina about 20. Nissan estimates that the true potential of the domestic car market is about twice its actual size, or 1.8m units a year. Mr Solis says that 20 vehicles per 1,000 inhabitants would make for sales of about 2.2m vehicles a year. We are talking about the creation of 350,000 jobs, he says. Under the North American Free Trade Agreement, Mexico opened itself up to imports of used cars, provided they met Nafta regional requirements. Vicente Fox, former president, opened Mexicos borders further to the trade in them when he authorised the import of used cars 10 years and older in 2005. While the measure was ostensibly aimed at weeding out the polluting old cars Mexicans call autos chocolate, industry analysts say the measure brought in many more used cars. Sales were going up at twice the level of GDP but flattened out by 2007, says Guido Vildozo, industry analyst with IHS Automotive. Limits in access to car loans and the economic downturn in 2008-09 further depressed the market, he says. Elsewhere in the world, Poland another country that shares a long border with a richer neighbour, Germany has seen its local new car market stunted by the prevalence of imported clunkers. In South America, Peru gets many imports of used cars from Japan by ship. On July 1 of last year, Mexican President Felipe Caldern issued a decree aimed at tightening imports. However, industry participants say it is difficult for Mexicos government and federal states to act more decisively for fear it would look as if they were taxing the poor. We have been told there are a lot of little companies working in the grey car market, says Jose Munoz, president of Nissan Mexicana. Its not popular for any government to make a decision preventing the cars entering Mexico.

John Reed

Carmakers offer entry-level cars such as Nissans Versa but many Mexicans prefer to buy used

FINANCIAL TIMES TUESDAY APRIL 17 2012

New Trade Routes: Mexico

Manufacturing takes off

Aerospace John Reed examines the success of the regions effort to create a cluster

Politics Times have changed

Not long ago, presidential elections in Mexico were closely associated with economic instability. The crises the country suffered with every six-year political cycle were so common, and so predictable, they even became the subject of several books. So, as the country gears up for a national vote on July 1, it is a testament to how far it has come in 15 years that nobody is expecting so much as a blip. Investors have already discounted any effect the elections could have, says Sergio Martn, HSBCs chief economist in Mexico. Much of that has to do with good bookkeeping by governments since the mid1990s. But the other factor has to do with politics and, in particular, the presidential candidates proposals as the country looks ahead to the July election and beyond. What investors have found positive is that both leading candidates, Enrique Pea Nieto of the opposition Institutional Revolutionary Party (PRI), and Josefina Vzquez Mota of the National Action Party (PAN) are pushing reformist agendas to break down many barriers to faster growth. One of them is Pemex, the state oil monopoly and one of the worlds largest oil companies. Economists have long identified Pemexs monopolistic status, and the constitutional ban on it entering joint ventures with private companies, as a serious drag on the economy. In an interview last October with the FT, Mr Pea Nieto started the reformist zeal off by saying the country should introduce private investment into Pemex. Mexico, he said, had been a hostage to ideology, which had slowed development and dynamism in the energy sector. [Pemex] can achieve more, grow more and do more through alliances with the private sector, he said. Shortly afterwards, Ms Vzquez Mota of the ruling PAN said she would do the same as president. She also said she would form a multiparty cabinet to choose from the very best talent that Mexico has on offer. That suggests she, and perhaps some party members, would be prepared to work with the PRI to push reforms
Pea Nieto: Pemex can achieve more

isitors to Mexicos self-styled Aerospace Valley reach the site via an unpromising road that runs through arid land east of the central city of Quertaro. Canadas Bombardier, which arrived in 2007, is the sites anchor investor, and employs 1,800 people to build jet fuselages and tails. Others followed: HrouxDevtek, a Canadian supplier, Meggitt, which makes aircraft brakes, and Messier-Dowty, a unit of Frances Safran group, which manufactures landing gear. A 727 jet marks the spot of the National Aeronautic University of Quertaro, which trains young Mexicans to build and service aircraft. Ground is being broken on a second business park alongside. The scene would warm the heart of any advocate of the web of free trade agreements that have over the past 20 years transformed Mexicos economy. At Bombardiers factory, workers assemble tails for its Global family of aircraft, which will be sent to Toronto for final assembly. In a large building opposite, colleagues put together the fuselage and tail of the new Learjet 85, a carbon fibre aircraft which gets some of its parts from Belfast and goes for final assembly to Wichita. Quertaros aerospace cluster is also a lesson in how Mexico is climbing the manufacturing chain. The state of 1.8m people had its start with textiles, food and beverages in the 1950s. Auto parts suppliers came later, followed by companies such as Daewoo and Samsung

Totally wired: workers at the Bombardier factory in Quertaros cluster a lesson in climbing the manufacturing chain

Getty

to build home appliances. In the 1990s, the region made an effort to diversify as a low-cost centre for aerospace. General Electric opened a research and engineering centre in 1999. The city had an airport and land to develop the business park and looked for other foreign investors. Bombardier had been seeking somewhere to enlarge its manufacturing footprint. It also considered eastern Europe but settled on Mexico because of its low costs, sizeable domestic market, similar timezone and status as a beachhead for Latin America. We thought Mexico was a country that used lots of small business jets, says Ral Gervais, head of Bombardier Aerospace Mexico. It was also a new window to South America. Other regions notably northern states bordering the US have for years attracted US aerospace companies looking for a low-cost location. Cessna, Hawker Beechcraft and Fokker all have factories in the northern state of Chihuahua. For the Bombardier

investment, Quertaro competed against four shortlisted sites. Officials sought to strengthen their attraction with the aerospace university, a state initiative with support from the federal government. The school has trained more than 2,000 people for Bombardier since 2006. Organisers of the school studied other aerospace

Five years ago, you wouldnt have attracted a large aerospace company
clusters such as Seattle, Wichita, Montreal and Toulouse. It decided to concentrate on training in manufacturing, not design. We focused on the way Mexico could recover the time it has lost along the decades, says Jose Gutierrez, rector. Unlike similar schools in other aerospace clusters, it offers everything from basic training to graduate degrees.

Mexicos achievement in luring investors from aerospace, with its high standards of precision and quality, is considerable. Five years ago, you wouldnt have attracted a large aerospace company into Mexico, says Luc Beaudoin, president of AeroShores Management Consulting, which was involved in bringing Bombardier to the country. Significantly, the industry makes more sophisticated products as it grows, and is pulling in investments by suppliers. Bombardiers Mexican operation started with assembly of wire harnesses for aircraft an activity on which it was able to draw on similar skills in the region familiar from the auto industry. In 2008, Bombardier said the project had gone so well it would apportion work on the carbon-fibre Learjet 85 to Mexico. The jet, now undergoing certification for planned launch in 2013, is the first business jet to be made predominantly out of the lightweight material. Last October, Eurocopter,

a division of European aerospace giant EADS, broke ground on a $100m plant that will begin making helicopter and aircraft parts this year in Quertaro. The state, with its low costs, is touting itself as an opportunity for companies to hedge euro exposure. If you produce in the eurozone and sell in US dollars . . . right now its a big advantage for Mexico, says Jose Lopez, the states undersecretary of economic development and a driver of recent investments. Industry participants are comfortable with Mexicos niche as a workbench for the global industry. However, they say a national champion aircraft producer such as Brazils Embraer is probably not on the cards soon. Europeans and Americans have designed aircraft [for years] and we are decades from catching up with them, says Mr Gutierrez. But we could be the best place to manufacture an aircraft in terms of cost, quality, logistics, and being a model in North America and Central America.

to promote growth, such as in the areas of labour and tax reforms economist argue are badly needed. However, both are promoting a businessfriendly platform with economic stability at its centre. Even Andrs Manuel Lpez Obrador, the countrys veteran leftwing candidate, a distant third according to polls, extolled the importance of balanced books. But with less than three months to go, Mr Pea Nieto, a telegenic former state governor, leads the field by almost 15 percentage points, according to an average of six leading opinion polls. So what would a government under his leadership look like? And how effective would it be? Many Mexicans worry a return of the PRI, the party in power for 71 uninterrupted years before losing the presidency in 2000, would mean an erosion of democracy. After all, the Mexico before 2000 was a hierarchical, one-party system in which elections were rigged, political patronage was high and the voice of the citizenry was an irrelevant detail. Mr Pea Nieto argues those fears are unfounded. We are a new generation of politicians, one that grew up in this democratic regime, he says. Besides, he says, the PRIs record in opposition (unlike the left, it did not question the 2006 presidential election result in which Felipe Caldern of the PAN won by about 0.5 percentage points) is proof enough of its democratic principles. Yet Alfonso Zarate, a respected political analyst in Mexico City, says the past runs strong within Mr Pea Nieto in spite of his fresh face and youthful 45 years. He will try to rebuild what existed before both politically and economically, argues Mr Zarate. Meanwhile, Jorge Zepeda, a former editor of the countrys El Universal daily newspaper, believes the PRI is the same as it always was, and Mr Pea Nieto is simply a dinosaur with a young face. Even so, he also recognises the democratic process in Mexico since the PRI left power has brought important changes both in the power of the citizenry and the countrys institutions, such as congress. Public opinion is certainly more critical than it used to be, social networks and the press are more independent, the political opposition is articulated in strong parties, he said in an opinion article published on FT.com, the FTs website recently. Unless Mr Pea Nieto wins by a huge margin and the PRI obtains an overwhelming majority in Congress, unlikely in the light of recent poll numbers, those checks and balances are certain to ensure that Mexicos political past remains confined to the history books.

Adam Thomson