At the bicentenary of the birth of its independence movement this year, Mexico stands at a crossroads: the country has made great progress but faces challenges that threaten its long-term prosperity.

After almost three centuries of Spanish domination, Mexico began its fight for political independence in 1810. In 1917, this federal country, made up of 31 states plus the Federal District (the capital city), adopted a new constitution, designed to ensure permanent democracy. Today, it is the world’s biggest Spanish-speaking nation with 107 million inhabitants and has the world’s 13th largest economy. It has been a member of the Organisation for Economic Co-operation and Development – dubbed the rich nation’s club – for the past 16 years. In 1993, the Mexican parliament ratified the North American Free- Trade Agreement with the US and Canada.

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The great divide

Socially and economically, Mexico is a highly divided country with some neighbourhoods with a GDP per capita at the level of Germany, and others at the level of Burundi. The country’s economy and FDI inflows are expected to recover markedly in 2010, following a severe recession. However, the deteriorating security situation in the country is threatening its longterm economic health.

Mexico’s economy is forecast to grow by more than 5% this year, following a steep contraction of -6.5% in 2009, according to credit rating agency Standard & Poor’s. Last year, total FDI fell by 50% to $12.52bn but is expected to rise by 75% to $16.6bn this year, says Promexico, the national government agency that promotes foreign investment in Mexico. In 2008, total FDI was $23.68bn and during 2007, a record year, it hit $27.3bn. “Mexico witnessed one of the worst declines in GDP for any country in the world last year,” says Mauro Leos, a senior credit officer at Moody’s, the credit ratings agency. “Trade linkages with the US are very strong and suffered a great deal in 2009. The automotive sector is key for Mexico and in the US that sector went through considerable turmoil, which adversely affected the Mexican industry.

“A strong rebound is taking place this year, but that really represents a bounce effect following the dramatic decline last year.” Joydeep Mukherji, director of the sovereign ratings group at S&P, says: “Mexico saw the sharpest contraction in the whole of Latin America last year. However, nothing broke down: the banking system is still in relatively decent shape, as is the corporate sector. “The economy is very vulnerable to the US. It bounces back as soon as American consumption picks up.”

Destination Mexico

According to the Economic Commission for Latin America and the Caribbean, which is part of the UN, at $12.52bn Mexico was the third biggest recipient of FDI in Latin America last year, after Brazil and Chile, at $26bn and $12.7bn, respectively. Traditionally, low labour costs in Mexico have made the country internationally competitive and during the past three decades it has built up a strong manufacturing base, exporting mainly to the US. However, some Mexican cities and states have made an effort to move up the value-added supply chain. For example, in 2009 Mexico had the most manufacturing investment projects in aerospace worldwide, according to Promexico. Aerospace clusters have developed in specific regions, mainly in Mexico City, Guadalajara, Monterrey, Queretaro and Baja California. The main capabilities of the companies involved in the industry include system design, engineering development, manufacturing design and system integration.

Spreading the wealth

Overall, Mexico City is the leading destination, attracting 224 inward investment projects from 208 companies between January 2003 and May 2010, according to greenfield investment monitor fDi Markets. It accounted for 13.7% of all projects destined for Mexico and 19.1% of companies investing in the country. During the past two decades the city has transformed itself into a high value-added manufacturing and services hub. Its workforce is well trained and has a high productivity rate. The city accounts for 80% of scientific research carried out in Mexico, some 75% of the country’s jobs in financial services and 26% of the national workforce employed by higher educational institutions.

Over the past 20 years, Nuevo León state has witnessed strong growth in the auto parts, aerospace, food processing, development and financial services sectors. Today, it accounts for 11% of Mexico’s total manufacturing output and more than 1800 foreign companies are established in the state. Sonora state is particularly strong in aerospace, automotive, IT and renewable energy. The north-western aerospace cluster accounts for more than 50% of the sector’s total manufacturing activity in Mexico and has a solid base of electronic components manufacturing and assembly operations. It was home to the first aerospace composite manufacturing operation in the country, Daher Socata. Other hightech companies based there include Parker Hannifin, which manufactures sensors, hydraulic and pneumatic systems, ESCO Turbo Machinery, which builds turbine components, and Goodrich, which carries out precision machining of turbine parts.

Meanwhile, Chihuahua state is strong in advanced manufacturing, electrical and telecommunications, automotive and agribusiness. This year, US aircraft maker Hawker Beechcraft began construction of its second plant in Chihuahua with a $108m investment.

Causes for concern

Experts feel it is important that Mexico moves further up the value-added supply chain and opens up some industries, especially energy and telecommunications, to foreign investment. “Typically, in Latin America, two sectors – energy and telecoms – have been important recipients of FDI,” says Mr Leos. “In the case of Mexico, the energy sector is dominated by the state and the telecoms sector has a monopolistic structure. There are many restrictions on foreign investment in these two sectors.

“Until now, there have not been clear indications that security concerns have affected economy activity, including FDI. Restrictions in the energy and telecoms sectors have had a more significant negative impact on investment prospects. However, if security concerns continue to mount there is a risk they will impact on long-term investment decisions.”

Drug-related violence, once limited to Mexico’s northern states, now appears to be spreading to other parts of the country, including the logistically important Durango state. Alexandra Haas Paciuc, director of the business bureau to the UK, Ireland, Portugal and South Africa at Promexico, says: “The violence provoked by groups of organised crime is focused on certain areas of the Mexican territory. “Although this is a very serious phenomenon, it has not determined the decisionmaking of companies that contact Promexico in terms of their investments.

“Certain businesses have expressed concern, but once they visit Mexico and speak to other business people, they start focusing on other factors, such as supply chain availability, logistics, level of skills and cost advantages.”

Experts are also concerned that Mexico is too dependent on exports to the US. In the first five months this year, total sales to the US amounted to $93bn, or 80.1% of total Mexican exports, according to Promexico. “The Mexican strategy is not to lower our exports to the US but to increase our exports to other markets,” says Mr Haas Paciuc. “We have done so very successfully by strengthening our commercial ties with the EU, Latin America and Japan, for example.

“In the first five months of 2010, sales to North America increased by 36.9%, while exports to Latin America increased by 45.3%. Our exports to the EU increased by 33.2% and we saw an increase of 54.8% towards Asia.”

Impressive figures

Between January 2003 and May 2010, fDi Markets recorded a total of 1634 investment projects in Mexico from 1088 companies. The average number of jobs created per project was 358. The leading sector was software and IT services, accounting for 9% of projects. The leading business activity was manufacturing, which accounted for 41% of projects. The top 10 companies accounted for 7% of all investment projects with US firms Wal-Mart, Home Depot and Hilton Hotels among the top 10 investors.

The top three source markets for investment into Mexico were the US, Spain and Canada, providing 42%, 9% and 7% of investment projects, respectively. The top three destination cities for inward investment were Mexico City, Monterrey and Guadalajara, providing 14%, 8% and 4% of investment projects. Mexico’s competitiveness on the world stage has improved in recent years. In the latest AT Kearney FDI Confidence Index, the country rose 11 places from the previous survey in 2007, reaching the eighth position worldwide. The only Latin American country that surpassed Mexico was Brazil in fourth position.

Since the birth of its independence movement 200 years ago, Mexico has developed into a proud and united country. It has seen its economy advance greatly and it became a magnet for FDI. However, the country must get on top of the security problem before it starts to do long-lasting damage to the economy.