MEXICO: A Strategic Partner for North American Global Competitiveness

1. MEXICO: A Strategic Partner for North American Global Competitiveness J. Enrique Espinosa FoundingPartner SAI Consultores, S.C. November 7, 2013

2. AGENDA • NAFTA’scompetitivechallenge • Mexico, comparativeadvantage, today: • Labor supply • Logistics • Openessto capital flows • Macroeconomicconvergence • Structuralreforms: • Education • Telecommunications • Energy • Concludingremarks

3. I. NAFTA’scompetitivechallenge

4. I. NAFTA’scompetitivechallenge NAFTA and the BRICS as exporters of manufactures In 2012, thesetwo blocks representedabout a fifth of theworld’sexports of manufacturedgoods, roughlythesame share as in 2000. However,mostlyduetotherise of China, theirrelativeweight has changeddramatically. “Other” NAFTA and BRICS, 2012 Source: WorldDevelopmentReport, 2013; TheWorld Bank

5. I. NAFTA’scompetitivechallenge Choosingparnters to enhaceyourcompetitivestrengths NAFTA has inducedandeeperintegration of itspartners’ manufacturing industries: the US content of Mexican and Canadian exportsisremarkablyhigh. Thisfactsignalssusbtantialefficiency in productioncapacityallocationwithin NAFTA. Bycontrast, US content in China’sexportsremainsminuscule, and maywell decline in future, giventhatcountry’s industrial policymodel. Itishardtoanticipatethatthe TPP, currentlybeingnegotiated, willever induce NAFTA-likeintegrationamongitsmembers. Source: C. E. Wilson (2011), Working together: Economic ties between the United States and Mexico, Woodrow Wilson International Center for Scholars.

6. II. Mexico’scomparativeadvantage, today

7. II.1. Labor Supply Wagecomparisons No doubt, a critical factor in assessing North American global competitivenessisthecost of labor. • In thisregard, Mexicoclearly stands out as a strategic NAFTA partner. Whencomparedto labor cost in the US: • China´s labor costadvantange has beensteadlyeroding, and can be expectedtomaintiainthistrend in thecomingyears; • Bycontrast, Mexico’s labor costsnotonlyhavebeenstable and can be expectedtoremainthisway, buthaveacummulated a substantialdifferential vis a vis China. Source: AlixPartners (Costs and Complexity): Will China Remain the Low-Cost Country of Choice?

8. II.1. Labor Supply Demographicstructure in North America NAFTA • Thedemographicprofiles and theirprojectedevolutionclearlysuggestthat, theproportion of Mexicans in North American jobswill be growingsteadily. • Wherethosejobswill be located, however, remainsan open question: • ProductioncouldincreasinglymigratetoMexico; or • As manyfear, migration of workerstowardsthe US and Canadamaygrow; or • Both. Dependency Ratio* UnitedStates Canada * Ratio of populationolderthan64 over total workforce (15-64 yearsold) e/ Estimate Source: US Census Bureau, International Data Base. Mexico 20 10 0 10 20 Millons

9. II.1. Labor Supply Labor mobility (Immigration) Defyingconventionalwisdom, a recentarticle in theNew York Times arguedthat, for Migrants, Mexico is a new Land of Opportunity. The latest data availablesupportthisview. TOTAL: 301,795 foreignersonwork visas in 2011. Sources: NYT (Sep. 21, 2013), based on data from Mexico National Census, Pew Research Center and Mexico Interior Ministry.

10. II.2. Logistics Origin and destination of cargo flows Even a cursoryinspection of therailroadnetwork in North Americarevealsthatthedemographic and economic center of gravity of theregionrests of theUS Midwest and East Coast. Thisistheheartlandwheremost of the cargo flowsoriginate and are received. • Thecostinvolved in gettinggoodsto and fromthiseconomicheartland are critical and, especiallyregardinginternationaltrade, themain drivers of thiscost are: • Transportationcosts, mostlybyship in overseasflows, and by rail, which in turndependon; • Theprice of oil, as thisistheessential input for fuel usedbythesemeans of transportation; • Importdutieschargedongoods, accordingtotheirorigin. • Shippinglead times, especiallyunderjust-in-time criteria; NORTH AMERICA: Railroadnetwork Source: Taken from Samuels J.M. (2008): The Freight Railroad Renaissance.

11. II.2. Logistics Risingdifferentials as theprice of oilincreases Transportationcostfrom China tothe East Coast of the US are more than 2.5 times thecostfordeliveriesfromMexico. In addition, merchandiseimportedfrom China mustpay MFN dutieswhereasgoodsfromMexicoenterduty-free under NAFTA rules. Source: SAI, based on information from Rubin, J. (2008): Will Soaring Transport Costs Reverse Globalization?.

12. II.3. MacroeconomicConvergence Consistency of macroeconomicpolicies in North America has beenanimportantby-product of NAFTA that reduces risk, and thusreinforcestheregion’scompetitiveness. Today, thethree NAFTA economies show substantialconvergenceonkeyindicators: inflation, interestrates and foreignexchangestability. Source: SAI, based on data taken from INEGI and Banco de México.

13. II.4. Openessto Capital Flows A. Investors vote “withtheirfeet”… Absence of controlsto capital flowsisanadditionalcompetitiveadvantagerecognizedbothbyinternationalinvestors and businessconcerns. Thisisparticularlyapparent in BRICS and in Latin America. Source: AdaptedfromTheEconomist, (October 12, 2013)

14. II. Structuralreformsunderway

15. I. StructuralReforms: EDUCATION Measuring Labor Skills PISA tests* provide a broad, butinternationally comparable indirectyardsticktomeasurespecificskillsacquiredthrougheducation. • Thesetestsfocusonthreemajorareas: • Reading skills • Mathematicalskills; and • Scienceskills, • Grades in theseareastendto be highlycorrelated, so any of them can be usedto explore effectson labor productivity. • Years of schoolingisanother variable linkedtoproductivity. Source: SAI, basedon data takenfromJOBS: TheWorldDevelopmentReport 2013, TheWorld Bank. * PISA stands forProgrammefor International Student Assessment, is a worldwide study conducted by the OECD.

16. III.1. StructuralReforms: EDUCATION Theaveragenumber of schoolingyearsispositivelyrelatedto labor productivitity, buttherelationshipisrelativelyweak: thequantity of educationmatters, butnotthatmuch. Thequality of education, as measuredbythe PISA tests, appearsto be a much more significant factor in raisingproductivity. Therefore, effortstoimprovethisquality (especially in emergingeconomies) are clearlyjustified. Withthis in mind, earlytheseyear a comprehensivereform to Mexico’seducationlawswasapprovedbyCongress, and by a majority of statelegislatures. Source: SAI, basedon data takenfromJOBS: TheWorldDevelopmentReport 2013, TheWorld Bank.

17. III.1. StructuralReforms: EDUCATION • Notwithstandingstrongoppositionfromteachers’ unions, twokeychangesintroduced: • Mandatory, nationalevaluationof bothteachers and students, at all pre-collegelevels, federallyadministered; • Centralization of all labor relationswithteachers, to be administeredbythe federal government. • Statistically, thelong-termpayoff of improvingthequality of educationis quite significant: a 1% increase in PISA grades appearstoimprovevalue-added per workerbetween 6% (Mathematics) and 7% (Reading), whileraisingtheaverageyears of schoolingappearstohave a muchsmallerbenefit. Source: SAI estmation, basedon data takenfromJOBS: TheWorldDevelopmentReport 2013, TheWorld Bank.

18. III.3. StructuralReforms: TELECOMMUNICATIONS • Mexico’stelecoms are dominantedby a single privatemonopoly, whichcontrolsover 2/3 of mosttelecommarkets, whereservicesare overpriced and investmentisscarce. • Correctiveregulatorymeasureshavebeenjudiciallychallenged and effectivelyblockedby “temporary” injunctionsstay in place foryears. • However, underextensivereformsalreadyapprovedthisyear: • “Temporary” injunctionswill no longerapply • A new, constitutionallychartedregulatoryagency has beencreated, withexpandedpowers to, amongotherthings: • Establishassymetricalregulationtothedominantoperator; • Licensesnow open 100% to foreigners in non-broadcastingsevices; • Separationbetweeninfrastrutureproviders and sellers of retailtelecomservices Source: OECD

19. III.2. StructuralReforms: ENERGY Comparativecosts of natural gas A keycompetitiveadvantageforthe US as a manufacturinghubrests in itsdramaticallyexpandedavailability of economically-pricedenergyresources, especially natural gas, of whichthe US israpidlygrowing as a net exporter. Locatednextdoorto Texas, Mexico shares many of the geological features of themostenergyrichregion of the US, and has a strongpotentialtoreplicateitssuccessstory. However, todayMexico has one of themostrestrictiveregimesforthedevelopment and exploitation of thecountry’senergyresources: suchactivities can only be done by PEMEX, a statemonopoly. Source: International MonetaryFund.

20. I. StructuralReforms: ENERGY Theremoval of theseconstitutionally-establishedrestrictions, a highlysensitiveissue as manyconsiderthese a pillar of nationalsovereignty, iscurrentlybeendebated in theMexicanCongress, with a better-than-evenprospect of beingapproved. In theshort tomediumterm, thisreformwould open construction and operation of natural gas pipelines byprivatefirms, bothforeign and national. In turn, thisshoulddramaticallyimprovetheavailability of low-priced natural gas importedintoMexicofromthe US. Lateron, the new pipeline can distribute gas extractedfromMexicanfields, developed and exploitedbyprivatefirmsunderprofit and risksharingarrangements. US gas pipeline network Source: EnergyInformationAdministration, Office of Oil & Gas, Natural Gas Division, Gas TransportationSystem.

21. III.2. StructuralReforms: ENERGY In thelongerterm, thesearangementsshould open toprivateconcernsthedevelopment of deep-wateroilfields in Mexico’s exclusive economiczone, therebyreinforcing North American competitiveadvantage in energy. Expertsanticipatethat, iftheproposedreformisapproved, privateinvestment in Mexico’soil and gas sector mayequalover 3% of thecountry’s GDP overthenext 6 years, and maysurpasspublicinvestment as early as 2019. Source: Up to 2017, PEMEX data were taken from PEMEX's Business Plan 2013-2017. Private flows, and PEMEX data for later years are estimates by Marcos & Asociados(Mexico City).

22. IV. Concludingremarks

23. IV. Concludingremarks No single NAFTA partner can single-handedlysustaintheregion’scompetitiveedge, buttheyallhaveanexcellent chance of doing so bypreserving and expandingthebenefitscreatedbytheirpath-breaking free tradeagreementreached 20 years ago. Largely as a result of NAFTA, Mexicoalreadyoffers a substantialcontribution to North America´s global competitivenessgivenitsabundant and labor force, itslogisticadvantage vis a vis Asia in theregion’ssupplychain, and itsopeness to international capital flows. Thiscontributionisespeciallysignificant in manufacturing, but can alsobecome quite important in othermajorsectors of theregion’seconomy, such as energy and telecommunications. Last, butneverleast, competitivenessissomethingacheivedbyfirms, ratherthanbycountries. Thisiswhyeventslikethisconference are so important: theybringtogetherbusinessexecutives and advisorswho can translatepotentialopportunitiesinto concrete businessundertakings.