By Peter G Hall, Vice President and Chief Economist
It looks like trouble is on the way. Who would have known? For multiple reasons, Mexico has been something of a market darling, and I have said as much in the past. Canada’s relationship with Mexico has blossomed and grown in recent years as a key player in our move to more integrative trade, and as a result there is a lot of interest here in Mexico’s welfare: on speaking tours, I am invariably asked questions on Mexico, and my commentaries on the Mexican economy are close to the top of the ‘most popular’ list. That engaged curiosity is doubtless turning into great concern. What lies ahead for Mexico?
The turn of events is a shocker in light of Mexico’s considerable successes. Over two decades ago now, it was a significant win for Mexico when it inked a free trade deal with the U.S. and Canada. It breathed new life into the Maquiladora program, and spurred a wave of foreign direct investment into Mexico that has become a key economic mainstay, now hovering steadily at the $25-$30 billion mark annually and establishing Mexico as a manufacturing powerhouse. All the while, Mexico has impressed with its abundant labour supply, skills training and competitive wages. Steady post-recession performance has been aided by these features, by its proximity and strong linkages to the U.S. market and by an increasingly aggressive industrial reform program. Is the solid run now over?
Trouble was brewing in mid-2014 when commodity prices began their steady plunge. Mexico’s public finances depend critically on oil revenues, and a clever hedging program shielded the public purse from the initial impacts. However, that has now run out, and cuts – among them, substantial reductions of gasoline subsidies – are highly unpopular and leading to unrest. Also, slumping world prices arrived just as the energy reforms were hitting their stride. A cash-poor global industry has generally had to hold off on an aggressive expansion into Mexico. With little hope for an imminent price rebound, prospects for an investment surge anything like what triple-digit world prices would have offered are likely well off into the longer-term horizon.
To make matters worse, the President has experienced a stunning fall from grace. From enjoying a surge of electoral popularity in 2012 – a 61 per cent favourability rating – a series of missteps, culminating in the disastrous pre-election visit by then-candidate Trump, saw his rating plunge to just 23 per cent, making him the least popular president ever.
At the same time, the U.S. election outcome has handed Mexico a massive diplomatic challenge. Multiple disparaging statements were made about Mexico through the course of the election, punctuated by more alarming threats to build a border wall, slap a 35 per cent tariff on all U.S.-bound Mexican goods, repatriate illegal immigrants, control remittances, and if those measures weren’t enough, to tear up NAFTA. Will rhetoric become reality?
At the time of writing, no concrete policy actions had been announced. The ‘Day 1’ plan of the incoming administration held no big Mexico elements. What we have at the moment is bluster, a bevy of appointments and an unpredictable volley of tweets – which themselves have affected markets, and possibly investment plans. Recent auto sector announcements suggest a tilt away from Mexico, putting all significant U.S.-led investment projects in Mexico on watch that they are under surveillance. While this is no doubt putting investment plans on hold, business logic suggests this will be temporary. First, the high integration of business between the U.S. and Mexico will be difficult to unravel quickly. Second, if it does unravel, it will be very costly not just for Mexico but for the U.S. itself. The Woodrow Wilson Center estimates that trade with Mexico supports some 5 million U.S. jobs. Texas is particularly exposed to trade with Mexico. Third, nixing Mexico’s prosperity will only add to the considerable illegal immigration problem. Fourth, a roll-back threatens to re-boot illicit business. Fifth, a foreign investment vacuum is an open invitation to other foreign suitors that the U.S. might find unpalatable so close to home.
The bottom line? Solace for Mexico is that economic logic is on its side. Hopefully, that will be enough to ensure that U.S. tough-talk is truly about getting a better deal – one that upgrades current arrangements – and ultimately proves to be a win-win.
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