Why Mexico is a key player in the global value chain
On April 20, 2016, Pirelli, the fifth largest tire manufacturer worldwide, announced an additional investment of US$200 million in Mexico, over the next three years. Two weeks before, Ford Motor Co. confirmed an investment of $1.6 billion to build a new factory in Mexico. And the giant biopharmaceutical firm AstraZeneca just opened a Global Technology Center (GTC) in Mexico, with a $12-million investment, to match the company’s GTC in India, to serve the Americas markets with more flexibility.
In 2015, foreign direct investment (FDI) in Mexico rose 25 percent, reaching $28 billion, mainly because of AT&T’s $2-billion acquisition of Mexican wireless operators Iusacell and Unefon, and the $2.15-billion purchase of Vitro’s glass container business by the US Company Owens-Illinois Inc.
Why do so many global companies continue to land in Mexico, despite the country’s negative image in the international media, due to the drug war? Why is Mexico considered by investors as a country worth looking at?
The NAFTA region represents a potential market of about $20 trillion, greater than the economic output of the 28 countries in the European Union.
Search for “Mexico’s advantages” on the Internet, and many articles include the five, seven or 10 reasons why investing in this emerging country makes sense, among them geographic location, free trade agreements, young population, cheap labor, market size and, more recently, structural reforms.
Beyond all these real advantages, Mexico also has demonstrated its great ability as a country to become one of the world’s leading car producers and a powerful export machine. How was this possible? There are some specific aspects have helped Mexico to become a key player in the global value chains.
Too Big to Ignore
One is the importance for Mexico of being part of the North American Free Trade Agreement (NAFTA). The NAFTA region represents a potential market of about $20 trillion, greater than the economic output of the 28 countries in the European Union, according to the CIA World Factbook 2015. One important factor for site selection is this market size. Most of the global manufacturing companies established in the Mexican territory are looking for access to the US market.
Costs are also important. With the reduction of import tariffs, NAFTA has lowered the import prices from the three country members, thereby contributing to a productivity increase in the region. In terms of international transportation, the possibility to deliver directly to the customer in a more flexible way, with less inventory, has pushed logistics costs and uncertainty down.
NAFTA has also provided impartial legal mechanisms for dispute resolutions, reducing the risk costs of doing business. Another important reason is that the NAFTA has made possible the alignment of main macroeconomic variables among the three country members, such as inflation and interest rates, giving greater long-term economic certainty to investors. That is why, according to AlixPartners Manufacturing Outsourcing Cost Index, Mexico is now among the least expensive countries for the manufacture of US-bound products.
According to the Boston Consulting Group, in 2015, manufacturing costs in Mexico were 4 percent lower than in China.
Another aspect considered by investors is the ability of Mexico to integrate successfully the country’s production capacity to regional production chains of high-added-value industries, such as automotive and aerospace. For instance, vehicles made in North America have a great number of parts, sourced from Canada, Mexico or the United States, driving costs down. Cheaper labor costs in Mexico have encouraged global automakers to expand their production in the country to increase profitability. According to the Boston Consulting Group, in 2015, manufacturing costs in Mexico were 4 percent lower than in China.
But if costs were the only factor to attract new automotive companies, most of these global companies probably would have gone to cheaper regions, such as Central America.
Why then is Mexico the fourth largest exporter and seventh largest vehicle manufacturer in the world? Why is the aerospace industry is growing more and more important in the country? One of the answers is that the wide network of free trade agreements with 45 countries, besides NAFTA, facilitates foreign trade and also the arrival of global suppliers participating in just-in-time and just-in-sequence production processes, converting the country into a very attractive platform for large anchor companies.
With energy reforms and the loss of the government monopoly, Mexico expects to lower the cost of electricity, which now is almost five dollars higher per megawatt than the cost in the US.
According to data from the National Industrial Auto parts association (INA), there are about 2,500 auto parts suppliers in Mexico from Tier 1, Tier 2 and Tier 3 levels of production, organized in local clusters whose main mission is to develop efficiency and specialization to reinforce high quality standards in vertical production chains.
The existence of world-class industrial parks has also been a major factor to make possible exponential economic development surrounding major assemblers. This is the case with the Mazda and Honda plants in Guanajuato, the Nissan plant in Aguascalientes, the Volkswagen and Audi plants in Puebla, the GM plants in Guanajuato and San Luis Potosí, as well as the Kia plant in Nuevo León, among others.
According to the Mexican Federation of the Aerospace Industry (FEMIA), in the aerospace industry, there are more than 300 suppliers in Mexico, participating in manufacturing, aircraft maintenance, repair, overhaul, engineering and design, with capacity to produce aircraft components, composite airframes and micro-tolerance turbine parts.
Knowledge and Reforms
Investors assess as well the capacity of Mexico’s workforce to provide the managerial and technical skills, as a strategic support for the several manufacturing industries operating in the country. During the past decade, state governments have made important efforts to create training schools and technical and specialized universities — such as the aerospace university in Queretaro — to meet the demand of human resources at automotive and aerospace companies in Mexico. According to the World Economic Forum, Mexico is among the 10 top countries in engineers produced annually, with almost 144,000 graduates in 2015. In addition, Mexican workers are well known for being very productive compared to other countries, in terms of talent management, turnover, cost of human resources and the cost of human capital (Saratoga Study, PricewaterhouseCoopers 2014).
According to the World Economic Forum, Mexico is among the 10 top countries in engineers produced annually, with almost 144,000 graduates in 2015.
Complementing the above competitive advantages, the Mexican government has been able to pass long-awaited structural reforms in education, communications, finance, energy, fiscal policy and elections rules, with the expectation of boosting economic growth in the coming years.
With the energy reform, which considers the end of the Federal Electricity Commission’s monopoly and the participation of the private sector, Mexico expects to lower the cost of electricity, which now is almost five dollars higher per megawatt than the cost in the US. At the same time, the government seeks to increase the supply of natural gas through a more efficient pipeline system. These initiatives will give Mexico the opportunity to offer to foreign investors a significant energy-cost advantage over most other exporting economies. Cheaper Mexican energy will likewise help local firms to become globally competitive. Now the challenge is to implement all these reforms in the mid-term.
No doubt, Mexico is an attractive country for investments. With 118 million inhabitants, and a GDP of about $1.37 trillion in 2015, the country is one of the largest emerging economies in Latin America and in the world. However, for Mexico to strengthen the country’s position as a rising star of global manufacturing, it is still necessary to improve the business environment, with more transparency and efficiency in institutions to better enforce regulations and procedures. That will be our main challenge in the near future.
Dr. Claudia Avila Connelly is the executive director of the Mexican Association of Industrial Parks (AMPIP), with 28 years’ experience in international business promotion in both the private and public sectors.