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

MEXICO: A Strategic Partner for North American Global Competitiveness

J. Enrique EspinosaFounding Partner

SAI Consultores, S.C.

November 7, 2013

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I. NAFTA’s competitive challenge

II. Mexico, comparative advantage, today:• Labor supply

• Logistics

• Openess to capital flows

• Macroeconomic convergence

III. Structural reforms:

• Education

• Telecommunications

• Energy

IV. Concluding remarks

AGENDA

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I. NAFTA’s competitive challenge

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NAFTA and the BRICS as exporters of manufactures

I. NAFTA’s competitive challenge

In 2012, these two blocks represented about a fifth of the world’s exports of manufactured goods, roughly the same share as in 2000.

However, mostly due to the rise of China, their relative weight has changed dramatically.

Source: World Development Report, 2013; The World Bank

“Other” NAFTA and BRICS, 2012

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NAFTA has induced an deeper integration of its partners’ manufacturing industries: the US content of Mexican and Canadian exports is remarkably high.

This fact signals susbtantial efficiency in production capacity allocation within NAFTA.

By contrast, US content in China’s exports remains minuscule, and may well decline in future, given that country’s industrial policy model.

It is hard to anticipate that the TPP, currently being negotiated, will ever induce NAFTA-like integration among its members.

Choosing parnters to enhace your competitive strengths

Source: C. E. Wilson (2011), Working together: Economic ties between the United States and Mexico, Woodrow Wilson International Center for Scholars.

I. NAFTA’s competitive challenge

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II. Mexico’s comparative advantage, today

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No doubt, a critical factor in assessing North American global competitiveness is the cost of labor.

Wage comparisons

Source: Alix Partners (Costs and Complexity): Will China Remain the Low-Cost Country of Choice?

II.1. Labor Supply

In this regard, Mexico clearly stands out as a strategic NAFTA partner. When compared to labor cost in the US:

China´s labor cost advantange has been steadly eroding, and can be expected to maintiain this trend in the coming years;

By contrast, Mexico’s labor costs not only have been stable and can be expected to remain this way, but have acummulated a substantial differential vis a vis China.

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The demographic profiles and their projected evolution clearly suggest that, the proportion of Mexicans in North American jobs will be growing steadily.

Where those jobs will be located, however, remains an open question:

Production could increasingly migrate to Mexico; or

As many fear, migration of workers towards the US and Canada may grow; or

Both.

Demographic structure in North America

II.1. Labor Supply

Source: US Census Bureau, International Data Base.

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10-1415-1920-2425-2930-3435-3940-4445-4950-5455-5960-6465-6970-7475-7980-8485-8990-9495-99100+

United States

Canada

Mexico0 - 45 - 9

10 - 1415 - 1920 - 2425 - 2930 - 3435 - 3940 - 4445 - 4950 - 5455 - 5960 - 6465 - 6970 - 7475 - 79

80-8485-8990-9495-99100+

NAFTA

20 10 0 10 20

2012 Elders

Mexico 10.06United States 19.76Canada 23.17NAFTA 17.66

2030 Elders

Mexico 17.45United States 32.10Canada 41.40NAFTA 28.85

Dependency Ratio*

* Ratio of population older than 64 over total work force (15-64 years old)

e/ Estimate

Millons

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Labor mobility (Immigration)

II.1. Labor Supply

Defying conventional wisdom, a recent article in the New York Times argued that, for Migrants, Mexico is a new Land of Opportunity. The latest data available support this view.

TOTAL: 301,795 foreigners on work visas in

2011.

Sources: NYT (Sep. 21, 2013), based on data from Mexico National Census, Pew Research Center and Mexico Interior Ministry.

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The cost involved in getting goods to and from this economic heartland are critical and, especially regarding international trade, the main drivers of this cost are:

Transportation costs, mostly by ship in overseas flows, and by rail, which in turn depend on;

The price of oil, as this is the essential input for fuel used by these means of transportation;

Import duties charged on goods, according to their origin.

Shipping lead times, especially under just-in-time criteria;

Origin and destination of cargo flows

Source: Taken from Samuels J.M. (2008): The Freight Railroad Renaissance.

NORTH AMERICA: Railroad network

Even a cursory inspection of the railroad network in North America reveals that the demographic and economic center of gravity of the region rests of the US Midwest and East Coast. This is the heartland where most of the cargo flows originate and are received.

II.2. Logistics

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Transportation cost from China to the East Coast of the US are more than 2.5 times the cost for deliveries from Mexico.

In addition, merchandise imported from China must pay MFN duties whereas goods from Mexico enter duty-free under NAFTA rules.

Rising differentials as the price of oil increases

II.2. Logistics

Source: SAI, based on information from Rubin, J. (2008): Will Soaring Transport Costs Reverse Globalization?.

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Consistency of macroeconomic policies in North America has been an important by-product of NAFTA that reduces risk, and thus reinforces the region’s competitiveness.

Today, the three NAFTA economies show substantial convergence on key indicators: inflation, interest rates and foreign exchange stability.

II.3. Macroeconomic Convergence

Source: SAI, based on data taken from INEGI and Banco de México.

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A. Investors vote “with their feet”…

II.4. Openess to Capital Flows

Source: Adapted from The Economist, (October 12, 2013)

Absence of controls to capital flows is an additional competitive advantage recognized both by international investors and business concerns. This is particularly apparent in BRICS and in Latin America.

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II. Structural reforms underway

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Measuring Labor Skills

I. Structural Reforms: EDUCATION

Source: SAI, based on data taken from JOBS: The World Development Report 2013, The World Bank.

PISA tests* provide a broad, but internationally comparable indirect yardstick to measure specific skills acquired through education.

These tests focus on three major areas:

Reading skills

Mathematical skills; and

Science skills,

Grades in these areas tend to be highly correlated, so any of them can be used to explore effects on labor productivity.

Years of schooling is another variable linked to productivity.

* PISA stands for Programme for International Student Assessment, is a worldwide study conducted by the OECD.

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The average number of schooling years is positively related to labor productivitity, but the relationship is relatively weak: the quantity of education matters, but not that much.

The quality of education, as measured by the PISA tests, appears to be a much more significant factor in raising productivity. Therefore, efforts to improve this quality (especially in emerging economies) are clearly justified.

With this in mind, early these year a comprehensive reform to Mexico’s education laws was approved by Congress, and by a majority of state legislatures.

Source: SAI, based on data taken from JOBS: The World Development Report 2013, The World Bank.

Correlation Coefficient: 0.4349R2 Coefficient (Linear): 0.1891

Correlation Coefficient: 0.7006

R2 Coefficient (Linear): 0.4909

III.1. Structural Reforms: EDUCATION

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Notwithstanding strong opposition from teachers’ unions, two key changes introduced:

Mandatory, national evaluation of both teachers and students, at all pre-college levels, federally administered;

Centralization of all labor relations with teachers, to be administered by the federal government.

Statistically, the long-term payoff of improving the quality of education is quite significant: a 1% increase in PISA grades appears to improve value-added per worker between 6% (Mathematics) and 7% (Reading), while raising the average years of schooling appears to have a much smaller benefit.

Source: SAI estmation, based on data taken from JOBS: The World Development Report 2013, The World Bank.

Reading Science MathematicsCoefficient: -8.882 -26.794 -24.032 -22.879Std. Error: 4.051 4.013 3.935 3.656t-Statistic: -2.193 -6.677 -6.107 -6.258

Coefficient: 2.847 6.738 6.139 5.889Std. Error: 0.881 0.872 0.856 0.795

t-Statistic*: 3.230 7.725 7.148 7.400

Multiple: 0.185 0.565 0.528 0.544Adjusted: 0.167 0.555 0.518 0.534

* Significant at a confidence level of at least 1% .

PISA Grades:Regressors:

Years of Schooling

Estimated Coefficient

R-Squared

Intercept

Logarithmic Estimation Results:

III.1. Structural Reforms: EDUCATION

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Mexico’s telecoms are dominanted by a single private monopoly, which controls over 2/3 of most telecom markets, where services are overpriced and investment is scarce.

Corrective regulatory measures have been judicially challenged and effectively blocked by “temporary” injunctions stay in place for years.

However, under extensive reforms already approved this year:

“Temporary” injunctions will no longer apply

A new, constitutionally charted regulatory agency has been created, with expanded powers to, among other things:• Establish assymetrical regulation to the

dominant operator;

• Licenses now open 100% to foreigners in non-broadcasting sevices;

• Separation between infrastruture providers and sellers of retail telecom services

III.3. Structural Reforms: TELECOMMUNICATIONS

Source: OECD

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Source: International Monetary Fund.

Comparative costs of natural gas

III.2. Structural Reforms: ENERGY

A key competitive advantage for the US as a manufacturing hub rests in its dramatically expanded availability of economically-priced energy resources, especially natural gas, of which the US is rapidly growing as a net exporter.

Located nextdoor to Texas, Mexico shares many of the geological features of the most energy rich region of the US, and has a strong potential to replicate its success story.

However, today Mexico has one of the most restrictive regimes for the development and exploitation of the country’s energy resources: such activities can only be done by PEMEX, a state monopoly.

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Source: Energy Information Administration, Office of Oil & Gas, Natural Gas Division, Gas Transportation System.

I. Structural Reforms: ENERGY

The removal of these constitutionally-established restrictions, a highly sensitive issue as many consider these a pillar of national sovereignty, is currently been debated in the Mexican Congress, with a better-than-even prospect of being approved.

In the short to medium term, this reform would open construction and operation of natural gas pipelines by private firms, both foreign and national.

In turn, this should dramatically improve the availability of low-priced natural gas imported into Mexico from the US.

Later on, the new pipeline can distribute gas extracted from Mexican fields, developed and exploited by private firms under profit and risk sharing arrangements.

US gas pipeline network

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III.2. Structural Reforms: ENERGY

In the longer term, these arangements should open to private concerns the development of deep-water oilfields in Mexico’s exclusive economic zone, thereby reinforcing North American competitive advantage in energy.

Experts anticipate that, if the proposed reform is approved, private investment in Mexico’s oil and gas sector may equal over 3% of the country’s GDP over the next 6 years, and may surpass public investment 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).

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IV. Concluding remarks

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1. No single NAFTA partner can single-handedly sustain the region’s competitive edge, but they all have an excellent chance of doing so by preserving and expanding the benefits created by their path-breaking free trade agreement reached 20 years ago.

2. Largely as a result of NAFTA, Mexico already offers a substantial contribution to North America´s global competitiveness given its abundant and labor force, its logistic advantage vis a vis Asia in the region’s supply chain, and its openess to international capital flows.

3. This contribution is especially significant in manufacturing, but can also become quite important in other major sectors of the region’s economy, such as energy and telecommunications.

4. Last, but never least, competitiveness is something acheived by firms, rather than by countries. This is why events like this conference are so important: they bring together business executives and advisors who can translate potential opportunities into concrete business undertakings.

IV. Concluding remarks