Pursuing Lasting Progress in Emerging Markets

On Mexico’s Shores

Having lived and worked in Latin America for much of the 90’s, I am saddened by the widespread violence and turmoil that the drug trade has wrought in Mexico. The fallout from drug-related violence has devastated the Mexican tourism industry, and the country as a whole. Setting aside the challenging problems associated with the drug trade, Mexico's economy may yet claim a better future if a nascent trend continues: the “re-shoring” of manufacturing capacity. There is a growing body of evidence that Mexico is well positioned to gain market share in manufacturing industries that shifted to China over the past two decades. There are three drivers behind this trend: 1) the narrowing wage differential between Mexico and rival Asian manufacturing countries, 2) continued high global transportation costs, and 3) relative competitiveness of the peso versus the yuan.

As pointed out in a recent article in The Economist, sustained economic growth in China over the past two decades has led to higher wages there. Pay for factory workers in China increased almost 70% between 2005 and 2010.1 Mexican manufacturing wages have increased only a fraction of that, up less than 1% between 2005 and 2009.2 As such, the competitive balance between manufacturing capacities in China and Mexico has begun to shift: while Mexican wages are on average still higher than that of China, the gap is narrowing. Furthermore, for many product categories, labor is a decreasing percentage of total manufacturing costs; rather, transportation and inventory-related costs constitute a large share of end-market prices.3 Rising fuel costs mean that it is more expensive to transport products from Asian manufacturing sites to their end-use destination. Inventory costs add an additional burden: one recent study suggests that a business that decides to import from China must carry substantial inventories – 100 days or more in some instances.4 This encumbrance can be reduced when the goods are manufactured nearer to the consumer, and Mexico’s proximity to the U.S. provides its manufacturing sector a growing advantage given trends in inventory and transportation costs.

Another factor driving the re-shoring trend is the relative cheapness of the peso, especially when compared to the yuan. The yuan has appreciated 21% vs. the U.S. dollar since it de-pegged in 2005. The peso, by contrast, has depreciated 27% vs. the U.S. dollar over the same period of time. Put another way: the yuan has appreciated an eye-opening 60% versus the peso over the past six years (see nearby charts). Much of the yuan’s movement is warranted, as China has enjoyed both higher productivity gains and lower rates of inflation than Mexico. However, the net result is that these gains in the currency have slowly eroded China’s competitiveness, particularly in low-value-added manufacturing industries. Mexico may experience more re-shoring as a consequence of these currency movements, particularly if such trends continue.

[Mexican Peso and Chinese Yuan vs. US Dollar, 2000-2011 YTD]
Chart begins on 7/29/05 and ends on 10/18/11. Past performance does not guarantee future results.
[Mexican Peso vs. Chinese Yuan, 2000-2011 YTD]
Chart begins on 7/29/05 and ends on 10/18/11. Past performance does not guarantee future results.

Perhaps the strongest evidence that Mexico can gain share in industries seeking to re-shore to North America is visible in the country’s industrial production statistics (visible in the chart nearby). Production dipped in 2008 – as it did nearly everywhere around the world during the global financial crisis – but has since regained most of its lost ground, and is holding steady amid the tepid global recovery. New data was released last week, and though it was a bit lower than expected – 3.1% growth versus 3.4% forecast – it is still quite solid by global standards.

[Mexico Industrial Production, 2000-2011 YTD]
Chart begins on 7/29/05 and ends on 10/18/11. Past performance does not guarantee future results.

Before Mexico can attract substantial foreign direct investment to support the re-shoring trend, it must get a handle on the lawlessness and destruction wrought by the drug trade – a tall order, by all counts. However, Mexico’s outlook is nonetheless encouraging because it appears to be holding steady despite its internal strife; if it can alleviate its problems, there is reason to believe that the trends mentioned above will only accelerate. Industries are already on the move: three large aerospace manufacturers have reallocated production to Mexico over the past couple of years. The auto sector – which accounts for approximately 25% of total manufacturing in the country – also stands to benefit as production ramps up on some particularly well-received models like the new Fiat 500.

Whatever happens, investors must exercise caution when approaching Mexico. The country’s fiscal position appears to be eroding, and this may induce greater dependence on inflows of foreign capital to cover the deficit; and this in turn may make the peso more volatile. However, with scant few safe havens left and as the flights to quality and liquidity continue across the financial markets, I am optimistic that industrial production in Mexico will be a bright spot in the emerging markets in the coming years.

Kate Jaquet

The views and information discussed in this commentary are as of the date of publication, are subject to change, and may not reflect the writer’s current views. The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding a particular investment or markets in general. Such information does not constitute a recommendation to buy or sell specific securities or investment vehicles. It should not be assumed that any investment will be profitable or will equal the performance of the portfolios or any securities or any sectors mentioned herein.

The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Seafarer does not accept any liability for losses either direct or consequential caused by the use of this information.

  1. The Economist, “Moving back to America,” 12 May 2011.
  2. U.S. Bureau of Labor Statistics, “International Comparison of Hourly Compensation Costs,”, 8 March 2011.
  3. Coyle, Langley, & Gibson, Supply Chain Management: A Logistics Perspective, Penn State University, 8th Edition, 2009
  4. The Economist, “Moving back to America,” 12 May 2011.