It Makes Sense for the US to Start Looking South

 

The term “Latin America” is broadly used to refer to countries south of United States. However, there are meaningful differences among these countries that are at varying stages of economic, industrial, political and institutional development. The region has come a long way from the days of military dictatorships. Nowadays, with the exception of Cuba, elections are in every case the means to reach public office. Even in cases where democracy has been hindered by questionable practices or constitutional amendments in countries like Venezuela or Argentina, the voice of the people commands attention.

On the economic front, middle-income countries like Chile, Mexico, Brazil and Colombia have a rapidly growing middle class that is sturdily supported by encouraging demographic conditions. Brazil and Mexico, with 200 million and 118 million inhabitants respectively, enjoy a clear demographic bonus, since the population between 18 and 65 years of age is larger than the combination of those below and above that range. In terms of the aspiration to become a developed country, Chile leads the pack with a per capita yearly income of US$18,700 dollars, which is two times that of China (considering purchasing power parity) and nearly 40% that of the average American Citizen. Furthermore, Chile has shown a stable economic environment for the past two decades, and is arguably the strongest legal system, and the least corrupt country in the region.

A noteworthy mistake when looking south is to think of this region as if it were homogeneous. Certainly, these countries share problems: concentration of wealth and a prevalence of plutocratic oligarchies, educational systems with ominously weak public schools, societies where success is still more a function of skin color and social networks than of hard work and merit, weak rule of law, and corruption at different levels. However, they also share extraordinary potential.

Countries like Chile and Brazil face a similar challenge, new generations of voters are moving slowly to the left. In the case of Brazil, the colossal size of the state is a huge burden, a problem shared with Venezuela, the most extreme situation. There are 111 undersecretaries in the Venezuelan executive power, including three recent additions by President Maduro: the undersecretaries of “Social Media”, of “Knowledge from the Ancient Cultures”, and of “Extreme Happiness”; this is not a joke, or it’s not meant to be. In both cases, governments have become so large that they are likely to crowd out private investors for generations to come. A loud, extremely entitled, and numerous bureaucracy has the capability to make or break candidacies to public office. If we include teachers among this constituency, powerful unions of teachers in the region form the largest obstacle to reform public education, not unlike what happens in some developed countries. The SNTE, the national union of education workers in Mexico, is the largest union in Latin America.

Some countries have been clearly decimated by populist governments, mainly Venezuela and Argentina, but also Bolivia and Ecuador. In other cases, populist politicians have surprisingly embraced market practices, like Ollanta Humala in Perú, while others who campaigned from the left have become pragmatic leaders, as is the case of former guerrilla José Mujica from Uruguay who flies in commercial airlines, donates his money to the poor, and shunned the presidential palace, preferring to remain in the small farmhouse where he has always lived.

A clear block of pro-market countries is trying to become a united counterweight to the entrenched populist movement of the countries in the ALBA block. Mexico, Colombia, Perú and Chile are forming the Trans Pacific Alliance, meant to enhance their commercial reach, but also to allow economies of scale, while increasing their presence abroad. They are even considering the possibility of opening pooled embassies in remote locations.

Latin America shares a feeling of American neglect. This region does not represent a military threat, is not a cradle for terrorism or extremism, and although Mexico is the third trading partner of the US, with whom 500 billion dollars of goods are exchanged every year, the economic relationship with China seems to command more attention. It is here where an important opportunity is presented.

It is clear that energy self-sufficiency in the United States will translate into a shift of geopolitical priorities. The perception of the American people that there is little to show for the high human and economic cost paid for the incursions into Iraq and Afghanistan, will arguably lead to a consequential change in America’s foreign policy. This may be a good moment to refocus on Latin America.

As a very significant example of what can be achieved, it is important to analyze the impact that NAFTA has had on Mexico, the second largest country in the region. This trade agreement has created jobs on both sides of the border, and has made it possible for products manufactured in North America to be globally competitive. Furthermore, if we analyze the extraordinary improvement in the productivity and efficiency of American industrial companies, a big part of it has been derived from more nimble supply lines that have benefited from the re-shoring of industrial capacity back from China into the United States, and from “near-shoring” to Mexico.  This trend will be accelerated due to the very low cost of American energy derived from the production of shale gas.

NAFTA, however, accomplished something much more important, and far less evident: it made it impossible for Mexican politicians to consider alternative paradigms. Since NAFTA, Mexico has leaped from basic low-cost assembly plants and textile production, to export high-tech machinery, electronics, aerospace products and computers that accounted for 17% of Mexico’s GDP last year, ahead of China, and trailing only Germany and South Korea. Mexico is now the fourth largest exporter of cars in the world. Auto output is expected to reach four million cars and light trucks by 2017. Foreign direct investment into the car and auto parts sector netted US$7.7 billion dollars in the past seven years.

Mexico went from being an exporter of oil, silver and other commodities, to 84% of its exports being of manufactured products, by far, the largest in the region and one of the largest in the world.

The Mexican economy and millions of Mexican jobs depend on trade. This is the consequence of NAFTA. This is a condition that prevents any potential Mexican political party in power from being tempted to experiment with alternative economic models. This argument transcends every aspect of Mexican life, from the development of infrastructure, to the priorities in its higher education system. In excess of 650 thousand young Mexicans are currently attending engineering schools. Its supply of graduates will exceed that of the United States, Germany or Brazil.

While constituencies of other countries in Latin America are shifting left, the Mexican Congress has recently approved meaningful structural reforms that are likely to have a huge impact on Mexican competitiveness. Mexico will try to transition from being a country that today is economically appealing due to low unitary labor costs, to one where world-class production standards are the main reason to attract international investors. In the long run, it is quite clear that Mexico will only be able to break away from the “middle-income trap” if it can prove that its labor force is ready to add more value by being better trained, by having better access to state-of-the-art capital equipment, better infrastructure, and a sturdier rule of law.

The most relevant among the reforms introduced by this administration is the energy reform that will enable private participation in oil production, which has been banned since the “Oil Expropriation Act of 1938”, that nationalized assets of foreign oil companies in Mexico. The recent constitutional amendment had been deemed politically impossible, and previous administrations had been dissuaded from even attempting superficial changes. However, the initiative presented by the Peña administration to reform the constitution passed both houses of the Mexican legislative with at least two third majorities, supported by the right wing opposition, the PAN. Majorities at the 32 state legislatures endorsed the initiative within 72 hours of its introduction.

The Peña presidency has accomplished in little over a year in office more than what the three previous presidents achieved in 18 years in power. The main challenge is to increase potential output growth of the Mexican economy from around 3.5%, where it previously was, to 5.5%-6% levels, where it could be taken by addressing meaningful bottlenecks like energy and labor rigidity. Mexicans pay two times what Texans pay for electricity used for industrial production, and four times in the case of residential use. With the new energy reform -if secondary legislation is approved in the way in which it is being introduced- private companies will be able to produce electricity, sell surplus production, and even import from the US.

The monopoly of Pemex to produce, distribute, import and export oil, gasoline and petrochemicals would come to an end. Just last year, the subsidy to maintain gasoline prices in line with those in the US cost Mexican taxpayers in excess of eleven billion dollars, three times the budget of the UNAM (National Autonomous University of Mexico), the largest university in Mexico with 330 thousand students. The accumulated inefficiencies of the state monopoly have certainly hindered economic growth.

It is quite clear that the “Mexico Moment” is a realistic bet that can be based on meaningful structural reforms, the shift in the Chinese economic model, the resurgence of American manufactures, and the fall of grace of BRIC countries, which means that many emerging markets investors will be searching for a place where to park their money. Mexico has quickly become a logical candidate, and the recent upgrades of Mexican sovereign credit ratings from Moody’s and Standard & Poor’s seem to confirm the trend.

It is important to realize that the future of the American economy will be defined by two trends that clearly place the potential of the United States significantly above that of the European economy, and of that of other developed countries: the technology revolution and the energy revolution. The first one reaps the huge benefits of Silicon Valley and of the trends to digitalize manufacturing processes. No country on earth is better positioned for this 21st century industrial revolution than the United States. The energy revolution originated by the production of shale gas has given American industry energy costs where Americans pay less than one fourth of what Europeans pay for Russian gas, and half of what they pay for electricity. At this moment, dozens of European companies –Airbus, BASF, Michelin, Rolls Royce, Royal Dutch, Siemens– are in the process of moving capacity from continental Europe to the United States, mainly to “right to work” states. This move is being underpinned by a clearly nearsighted green energy policy in the European Union that has prematurely imposed the utilization of expensive renewable energy, causing growing subsidies and fast scaling costs.

The Mexican Energy Reform allows Mexico to become part of the colossal change that will make North America –Canada, United States and Mexico- the new “Middle East” and the most desirable platform for companies that want to remain cost competitive. Mexico shares shale oil fields like Eagle Ford that extends from Texas into the Mexican state of Coahuila. Even prior to the approval of the energy reform, Mexico was destined to receive a US$10 billion investment for new car plants –Audi, BMW, Ford, General Motors, Hyundai, Mazda, Nissan– expected in the next three years.

Mexico is also likely to become a major destiny of investment from American oil giants like Exxon Mobil, Conoco Phillips or Chevron. The geological frontier of Mexican oil and gas production is promising, although also challenging. The easiest Mexican oil fields like Cantarell, one of the richest in the world, are close to being exhausted, and now it will be necessary to have access to state-of-the-art technology and deep pockets. American oil companies, however, have the perfect profile to excel managing such complex projects.

The extremely low energy costs in the United States is enabling the rebirth of its manufacturing capacity, the Made in the USA brand is making a strong comeback. If we consider that at least one third of every manufactured product exported by the US is currently made in Mexico, this trend is likely to benefit both countries.

However, what is seldom acknowledged is the voracious Mexican appetite for American goods. Exports to every major trading partner of the United States declined at least 5% since 2008; only exports to Mexico grew, as Mexicans continue favoring American products. As purchasing power improves in Mexico, its imports of American goods grow. In 2002, Mexico imported US$97.4 billion from the US, in 2012 that figure reached US$200 billion. Among other things, Mexico is the third largest agricultural export market of America.

There is no country on earth with such clear preference for American goods and services as Mexico, where US$25.4 billion of US commercial services were bought in 2011. Nearly half (49.1%) of all merchandise imported by Mexico last year (January to November) came from the US. Mexico imported more American products than China and Japan combined, more than the BRIC (Brasil, Rusia, India, China) block combined, and almost as much as the whole European Union combined.

Mexico is a clear example of how a larger economic integration with the United States translated into prosperity for both countries. Mexican companies invested US$28 billion in the United States in 2012, while 13 million Mexican tourists visited the US in 2010. Familiar brands like Entenmanns, Sara Lee, Thomas English Muffins, Boboli Pizza Crust, Borden Milk, Weight Watchers Yogurt, Mission Tortillas, Ready-Mix Cement, Tracfone cell phones, Saks Fifth Avenue, and the New York Times, all have either Mexican controlling shareholders, or very important Mexican presence. Most flat screen TV’s in the American market and Blackberry phones are made in Mexico. On top of that, it is estimated that at least six million American jobs depend on exports to Mexico.

Thanks to its growing presence as a world-class manufacturer and exporter, Mexican economic stability has also translated into very welcome political stability south of the American border. While the developed world battles with high public and private debt and fiscal weakness, Mexican public debt is 38% of GDP, and most of it is denominated in pesos, making Mexico immune to foreign exchange shocks.

The growing oil production coming not only from Mexico but also from Colombia and Brazil, would accelerate American self-sufficiency at a moment where dependency from the Middle East could prove to be precarious. Relying on supply from the American hemisphere would likely allow the United States to have a more aggressive policy to export natural gas to Europe. This would probably be the most effective way to hinder post-Crimea Russian overconfidence.

Demographically, a smarter and more comprehensive immigration policy would permit the orderly support from young Latin American workers and educated professionals, which would clearly alleviate the demographic challenges of an aging American population.  It is important to realize that the 33 million Mexicans living in the US, 12 million of them born in Mexico, today generate a GDP of 1.5 trillion dollars, which would place them between Australia and Spain, as the 13th largest economy in the world, 20% larger than the GDP produced by 118 million Mexicans in Mexican territory. A more free flow of immigrants in and out of the United States would translate into a booming economic activity that would strongly benefit both countries. It is important to recall that in the last years more Mexicans have left the US than those who have entered.

Latin America can strongly benefit from American investment likely to leave China and the Far East, as China shifts its economic model from one addicted to ever growing levels of investment, that produce a large surplus that is exported, to one where domestic demand is the catalyst for more sustainable -although arguably lower- economic growth.

Finally, the United States needs to acknowledge that the fight against organized crime south of the border becomes every day more of a shared problem. Clearly, criminal organizations have developed regional structures where economic and institutional weakness is exploited by organizations in search of ports, airports and cooperating authorities; Venezuela is a perfect example.

Latin America would benefit from American state-of-the-art surveillance and intelligence technology, and of its capacity to train law enforcement professionals. From the Latin American perspective, the United States has not done enough to compensate for a problem that is funded by tens of billions of dollars of American demand for “recreational” illegal drugs, and fought with American weapons illegally exported south. If these criminal organizations continue to grow, the war will progressively be fought in American territory. On the other hand, without a regional approach, it is entirely possible that even if Mexico were successful eradicating this malady, were these gangs to migrate to smaller countries, the US would have to face the problems of narco-states forming in its own hemisphere, if cartels were forced to migrate south. According to some estimates, the US imports US$40 billion of illegal drugs each year from Mexico. This is 3% of Mexican GDP, however, it is equivalent to 50% of Guatemala’s, 100% of Honduras’, and 85% of El Salvador’s. These countries do not have the resources to face such formidable foe.

This is a perfect moment to look south. America will be the developed country that benefits the most from the energy revolution that is just starting, and from the technological revolution well underway. Strengthening ties with Latin America will foster economic and political stability, and prosperity south of the border will translate into investment opportunities and growing profits for American companies. This is an opportunity that should not be wasted.

Mr. Suárez-Vélez  is the founding partner of SP Family Office and was previously president and CEO of ING Private Wealth Management. He has been a contributing economic and political analyst to numerous Spanish language media outlets. His books on the Mexican and world economies have topped the Mexican bestseller list. 

One thought on “It Makes Sense for the US to Start Looking South”

Leave a Reply

Your email address will not be published. Required fields are marked *