Germany and Mexico: Past, Present, Future

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Germany and Mexico: Past, Present, Future
Prof. Dr. Dr.h.c. Wolfgang Michalski, Managing Director, WM International SARL

Paper prepared for the 1st Bilateral German-Mexican Business Summit, held on 27th June 2011 in Dresden / Germany

Formal German-Mexican economic relations have a long history. They started with the signature of a “Treaty of Commerce and Navigation” between Mexico and the Free and Hanseatic City of Hamburg in 1823. A first major wave of German immigration in the order of about 80,000 occurred between 1857, the year of the first global economic and financial crisis, and 1910, the beginning of the Mexican Revolution. Siemens provided the first electric street lightening for the Paseo de la Reforma as early as 1894 and completed the construction of an electric power plant in Mexico City in 1898.

After the interruption of transatlantic economic relations as a consequence of the Second World War, Volkswagen started selling the beetle in Mexico in 1954 and its assembly in 1961. Today Volkswagen is employing more than 16,000 people directly in its Puebla plant and provides jobs for an estimated additional 50,000 directly and indirectly elsewhere. Apart from Volkswagen, there are about 1,200 German enterprises with operations in Mexico, including nearly all big German players.

The most important enabling conditions for Mexico’s success to establish itself as a dynamic emerging economy and as an attractive market and location for foreign companies must be seen in the profound reform and structural change process since the early 1980’s. There are three dimensions to it: policies, institutions, and process. As concerns the general policy environment, Mexico has matured over the last decade to a pluralistic democracy with a strict separation of the three constitutional powers: the government, the parliament and the senate, and an independent jurisdiction. Property rights, including the protection of investment and of intellectual property, are guaranteed by the Constitution.

In economic policy Mexico has made considerable progress, too. In particular improvements in the macro-economic policy framework and reforms in the financial system have contributed to reduce volatility of overall economic performance. Equally important, President Calderon has committed his government in his third State of the Union in September 2009 to launch a wide-ranging regulatory reform process in order to increase the competitiveness of the country and facilitate economic and social development. The result today is the elimination or fusion of more than 9,000 rules, standards, laws or programmes due to deficiencies, contradictions, duplications or over-regulations. In the Ease of Doing Business Index 2011 of the World Bank Mexico now ranks far ahead of other emerging countries such as Brazil, China, India, Russia or Turkey. Furthermore it is interesting to note that Mexico – according to the World Bank – is an easier place to do business than even a number of EU-countries including the Czech Republic, Hungary, Italy, Poland and Spain.

In terms of economic openness Mexico has made significant headway already since the 1980’s. Of particular importance in this context was continued liberalisation of trade and international financial flows. Outstanding institutional advances in international economic cooperation were: Mexico joining the GATT in 1986, APEC in 1993 and the OECD in 1994. The most important specific move in the trade area was the NAFTA, the free trade agreement with the United States and Canada which also came into force in 1994. Today with a total of 12 free trade agreements Mexico covers no less than 44 countries world-wide. This is more than Brazil, India or China and even more than the United States.

Although most of the free trade agreements include some provisions on FDI, these arrangements are supplemented by 23 bilateral investment treaties. As regards Germany in particular, Mexico concluded an initial investment agreement in 1998 and a wide-ranging economic partnership agreement with the European Union in the year 2000 with further amendments on trade in services, FDI and intellectual property rights in 2001. Since 2008 Mexico is a strategic partner of the EU. Before addressing the issues of trade and investment more specifically, it is worthwhile to throw a glance st the enormous progress which Mexico made since the middle of the 1980’s.

Between 1986 and 1996 real economic growth was in average 2.5 % per year. From 1997 to 2007 it reached 3.2 % annually. For the three years from 2010 to 2012 the OECD forecast is 4.6 % and this despite the weak recovery in the United States. The average increase in consumer prices between 1986 and 1996 amounted to no less than 36 %. It remained at double digit rates although at lower level until the end of the century. Since then the average increase was 4.7 %, and the forecast by the OECD for 2011 and 2012 is 4.3 and 3.7 %. Official unemployment is between 4 and 5 %. The real social problem is that even today a significant share of the population still lives in poverty.

The current account balance which showed a deficit of between 4 and 6 % of GDP in the earlier period has come down to between 1 and 2 %. At the same time – a sign of the increasing openness of the Mexican economy – the import penetration went up from 12 to 28 % which is nearly three times higher than that of Italy and twice as high as that of the United Kingdom. Mexico’s external debt to GDP rate, standing at 20%, is one of the lowest in Latin America. Finally with a pre-crisis budget deficit of 2.5 % of GDP which may again be reached after fiscal consolidation by 2012, and a total public debt rate over GDP in the order of 37 %, Mexico is one of the very few OECD countries which would even without any accounting tricks meet the Maastricht criteria.

This record is without doubt remarkable, but it does not mean that Mexico could not do even better– in particular in the long-run. The most serious issue is the fight against organised crime. In addition to absorbing a high amount of government resources, the related violence tends increasingly – probably unjustified as Mexico as a whole is concerned – to deter foreign direct investment. According to Agustin Carstens, the President of the Mexican central bank, this may reduce the GDP of the country by about 1 % annually.

In the economic and social policy realm the two principle avenues for further improvement – apart from reducing poverty - would include on the one hand all measures which would contribute to further level-up the potential growth rate and on the other all measures which further enhance the capacity of the economy to absorb external shocks. Reducing the still wide-spread rigidities in product and labour markets would serve both purposes. The same holds true for further enhancing competition in main network industries such as telecommunications, transport, electricity, gas and water.

Although illiteracy has declined sharply and stands at 1.9 % for people aged between 15 and 29, a major contribution to increasing the growth potential of the Mexican economy in the longer term could be expected from a still better performance of the education system from a qualitative perspective. Other challenges in this context are a strengthening of the innovation capacity of the economy and an accelerated improvement of critical infrastructures. The exposure and resilience to external shocks could be reduced by further efforts to make the public budget less dependent on oil revenues and by greater diversification of external economic relations.

This brings us back to the issues of trade and foreign direct investment. More than 80 % of Mexican exports go to the United States. The European Union is Mexico’s second important client with around 4.5 %, followed by Canada with slightly more than 3.5 %. Germany the biggest market in the EU accounts directly for no more than 1.4 % of Mexican exports. Clearly, this prompts immediately two questions both for the European Union as a whole and for Germany in particular: are Mexican suppliers not sufficiently competitive, or do they perhaps not make sufficient efforts. The response is difficult.

But there is a third question, and this is related to the reliability of the statistics. Mexican exports shipped to Spain because of non-existent language barriers, but finally consumed or used in Germany, count as Spanish imports. A comparable problem arises when Mexican products, finally consumed in Germany, enter the EU with the services of a Dutch or Belgian importer via Rotterdam or Antwerp. Furthermore, even EU imports from Mexico may be much higher than the official trade statistics make us believe. Quite a few Mexican exports to Europe are channelled through the United States and, to the extent that they are not officially declared as transit, would in the EU statistics show up as US imports.

Available data on the regional distribution of Mexican imports may be slightly more trustworthy than the export statistics, although most of the shortcomings related to export reporting are in principle relevant for the import statistics, too. Looking, however, at rough orders of magnitude, there are at least two statements which can be made with a certain degree of confidence. First, the share of the United Sates as a supplier is much smaller than as a client, - probably in the order of 50 %. And second, Asian countries, in particular China, South Korea and Japan, play a much greater role, - with direct imports of roughly 25 %.

Unfortunately, available statistics on foreign direct investment in Mexico and especially according to the country of origin are not much better than trade statistics. At least it seems somewhat improbable that over the five year period from 2003 to 2007 Dutch FDI in Mexico reached 13.5 billion US$ and German FDI not even 1.9. Who would believe that companies from the Virgin Islands have invested nearly twice as much as German enterprises in the same period? The 2009 statistics are no less surprising. Germany is at par with Luxemburg at 1 % of FDI in Mexico, but Virgin Islands are at 7 %. It seems fairly obvious that these figures show the origin of financial flows, but have very little in common with the origin of FDI.

Of course, I do not want to give the impression that it is in particular German FDI that is channelled through the Virgin Islands. But I am pretty sure that some of the FDI flows from Luxemburg, the Netherlands, Switzerland or even the United States and Canada may be de facto of German origin. There is no doubt, therefore, that bilateral trade and FDI statistics cannot serve as a basis for any decision on the establishment or enforcement of business relations between Mexico and Germany, although the presumption is that both exports and imports and in particular FDI may be even higher than the figures mentioned so far.

A much better guide is the evaluation of the macro-economic environment and its dynamics which I have described already earlier. And if this perspective is attractive - including in a longer-term -, there is still the need to complement the big picture with an in-depths analysis of a number of more specific issues. Many of these depend on the particular sectors or even products and services the company is operating in. Others are of a more general nature. The latter include the market outlook both domestically and internationally, supply chain issues on the output as well as on the input side; access to finance and interest levels; availability of qualified labour, direct and indirect labour costs and labour laws; taxation, red tape and regulatory burdens; and this represents only an illustrative selection.

As it is not possible to review all these criteria, some of which are highly activity specific, I will restrict myself to a very few of a more general significance. A first factor to look at, is labour costs. According to the AlixPartners consultancy which publishes a ranking of low labour cost countries annually, Mexico comes out as number one before India and Vietnam as well as several places before China where labour costs are clearly on the increase. A second aspect is taxation. The Mexican corporate tax rate is 28 %. This is 3 percentage points higher than in China, but 6 respectively 8 percentage points lower than in Brazil or India. In addition, Mexico requires only six tax payments per year which reduces administrative costs. Taking labour costs and overall taxation together, the Federation of Danish Industries ranks Mexico clearly first.

A third criterion is regulatory burdens. The number of procedures and days required to open a business in Mexico is 8 and 13. In India the respective numbers are 13 and 30, and in Brazil 16 and 120. Also the number of procedures and days required to obtain a construction permit are significantly lower in Mexico than those in Brazil, China or India. Another and fourth dimension is labour laws. Here Mexico could still make further progress in terms of reducing market rigidities. Nevertheless, if one compares worker termination costs in weeks of salary compensation, Mexico is with 52 weeks at the same level as Chile, slightly more favourable than India with 56 weeks and far ahead of China where the official redundancy compensation corresponds to 91 weeks.

All this is, however, only one side of the coin. The other is the market. Today already Mexico is a one trillion economy with a population of 112 million. Business as usual estimates put Mexico at 1.4 trillion in 2015. Other available projections such as those by PriceWaterhouseCooper or the HSBC take a 2050 perspective. Regardless all the uncertainties surrounding the numerical long-term GDP or growth rate estimates, they all suggest that Mexico may by the middle of the century belong to the ten biggest economies of the world. In one of these projections the question comes up whether due to the positive population dividend Mexico may in 2050 even be at par with Germany.

But it is not only the potential dynamics of domestic demand that make Mexico an attractive location for investment. There is little doubt that the United States, even after they have been overtaken by China in terms of GDP, will remain the richest country of the world. Investors in Mexico have easy access to the US market both in terms of trade openness and in terms of geographic proximity. In the long-run, however, it is not only NAFTA that counts. Alongside Brazil, Argentina, Chile and Venezuela may become increasingly interesting export destinations, too. And of course for all Mexican companies, both foreign and domestic, there are not only the Americas and perhaps Asia, but also Europe.

Up to now only a few genuine Mexican companies have extended their activities to the other side of the Atlantic. The first was CEMEX who started its operations in Spain in 1992 and is today present in around 15 other European countries, including Germany. Two further outstanding examples are: first, Grupo Alfa, in particular with its subsidiary Nemak, with plants in Germany and five other European countries; and second, Mexichem operating not only in the United Kingdom, but after its acquisition of INEOS indirectly also in eight other European countries, again including Germany. All three examples, however, represent what the Boston Consulting Group calls the “Global Challengers”, the heavy weights or the rising stars.

What would be desirable, and not only from a European and in particular German perspective, is an increasing engagement in trade, joint ventures, technology cooperation and outbound investment of at least medium-sized Mexican companies. One good example is Corporación EG from Monterrey who took over Ruhrpumpen GmbH; and there may be about 15 or 20 others with activities in Germany. But compared to 1,200 enterprises, fully or partly owned by German investors and operating in Mexico, this is certainly extremely unbalanced. A one-way road in international economic relations is seldom a sound and sustainable basis.

So, I hope very much that at the forthcoming German Mexican Business Summit, taking place in Querétaro / Mexico on 12th September this year, there will be someone to forcefully explain the general business opportunities for Mexican companies in Germany, as I have tried to do mainly in the other direction today here.

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