Mexico
Overview of Foreign Direct Investment in Mexico
This past weekend, political and business leaders from around the world converged at the World Economic Forum in Davos, Switzerland. Among attendants was Mexican president, Felipe Calderón, and finance minister, Ernesto Cordero. While topics at the forum ranged from global sustainability to microfinance, Calderón used the opportunity to emphasize the lucrative business opportunities available in Mexico, undeterred by the escalating security situation. “We explained that Mexico is a safe destination for investment”, Calderon told reporters, and as proof of this attractiveness, pointed to the 53% increase of foreign direct investment (FDI) to Mexico in 2010, the largest increase in a decade.
Calderón isn’t the only one to herald the return of foreign investment to Mexico in recent months. In the oft-cited A.T. Kearney FDI Confidence Index, a regular survey of senior executives at large companies, Mexico was raised to from 19th to 8th in the world for investment attractiveness in 2010. The outlook of the executives in the survey is telling as these companies generate more than $2 trillion dollars in annual global revenue.
Foreign direct investment plays an important role in globalized economies, especially export-oriented ones like Mexico. Foreign direct investment is a catchall category that refers to longer-term, cross-border business activity and joint ventures. For example, when a Canadian mining company decides to open a mine in Mexico for extraction, as Goldcorp has recently done in Zacatecas, this is considered FDI. Direct investment excludes the shorter-term purchase of shares called ‘foreign portfolio investment’, which can be more speculative and has a less direct impact on job creation. FDI is important because it provides capital for powerful industries to grow, foreign currency to make international purchases, and drives new job creation. Over the last decade, FDI in Mexico has accounted for as much as 5% of all economic production per year.
A careful look at the characteristics of FDI in a country can reveal interesting dynamics about that country’s economy. What does foreign direct investment during the last decade tell us about Mexico’s economy? What does this perspective contribute about the future of Mexico’s economy in the new decade?
Primary Investors in Mexico
In looking at overall investment, it is no surprise to see that Mexico’s northerly neighbor is the largest source of FDI. With the North American Free Trade Agreement linking the two countries together, bilateral trade between the U.S. and Mexico is vital to both economies. The U.S. is Mexico’s largest trading partner, receiving 80% of their exports, and Mexico is the U.S.’s third largest trading partner behind Canada (1st) and China (2nd) [2].
The largest investors in Mexico in 2009 were USA (44%), Spain (18%), Holland (13%), and Canada (10%). 2009 closely mirrored the largest investing countries over the past decade. Averaged over 2000-2009, the largest ten FDI sources to Mexico are USA, Spain, Holland, Canada, UK, Switzerland, Germany, Japan, Italy, and Sweden.
It might be surprising to see that both Spain and the Netherlands are larger investors in Mexico than Canada, the third member of NAFTA. Spain's investment is explained largely by the large presence of Spanish banks in Mexico, such as Santander and BBVA.
FDI also conveys an important aspect of how the global financial crisis impacted Mexico. The global crisis negatively impacted Mexico in three distinct, but equally potent, ways: the fall in consumer demand in the U.S. for Mexican exports, the drop in migrant incomes in the U.S. and subsequent decline of remittances to Mexico, and the global drop in the price of oil. This crisis is most easily seen in the sharp contraction of the growth rate of Mexico’s economy. GDP growth decreased from 5.1% in 2007 to 1.3% in 2008, and then falling to -6.5% in 2009.
The global financial crisis also affected FDI to Mexico, as investors scrambled to cover their losses. From 2007-2009, Mexico experienced an overall 50% decrease in foreign investment totaling $14.6 billion dollars. The greatest change was from 2008 – 2009 when FDI decreased 41%.
However, the changes in investment were not uniform across source countries. Interestingly, the largest relative withdrawal of investment was by the smallest absolute investors. These years suggest an inverse relationship between the overall size of direct investment and the percentage decrease in FDI during a crisis. Looking at the figure below, the largest decreases in FDI came from Germany, Italy, and Sweden – all countries ranking among the smallest investors in Mexico.
This trend reflects a few things. One is definitional; Because FDI encompasses investments that are long-term, the larger the investment, the more difficult it is to liquidate. Direct investments often involve a lot physical equipment, such as manufacturing machinery and mining equipment, that is expensive to move, or investments of time, such as worker training, that involve significant costs to replicate in different locations. The larger the investment, the more costly it is to abandon these investments and move locations.
Secondly, FDI often reflects what economists call ‘economies of scale’, the fact that as the size of production or economic activity increases, efficiency increases and marginal costs of operation decrease. These economies of scale create benefits to commitment, encouraging companies to ‘weather the storm’ by temporarily reducing jobs rather than shifting production locations. Financial ties between the U.S. and Mexico are deep and widespread, so it makes sense the U.S. decrease would be the smallest negative change.
But economies of scale appear on both sides of the investment flow. Bi-national investment involves higher than average transaction costs because companies need to adapt to local market conditions, laws, and political climates. In this way, the process of investment can also develop economies of scale. The more money a country as a whole invests in another country, the more people and resources there will be to collect information on the country, monitor changes, and make smart investments. The smaller investors, such as Italy, Sweden and Germany might be making riskier investments because of poor information and as a result withdraw their investments more quickly.
However, there are three countries that buck this trend: France, Japan, and Holland. All of these countries invested more money in 2009 than in 2008. Why is this? Well, looking at the data, all three of these countries made significant, sharp withdrawals of investment from 2007-2008. It is likely the case that investors were too quick to react in 2008, pulling out more money than they needed to, and than reinvested as the relative risk of investing in Mexico became clearer. Holland and Japan, for example, when considering the whole crisis, overall reduced their investment by 67% and 44% respectively, rather than having increased their investment levels as the 2009 data suggests.
Manufacturing drives FDI in Mexico
Foreign investment is particularly important to Mexico because of the ‘maquiladora’ sector, or manufacturing plants that assemble goods for export. These manufactured exports are critical to Mexico’s position in the global economy. With 12 free trade agreements signed with 44 countries, Mexico is one of the most trade-liberalized countries in the world. More than 90% of Mexican trade flows under free trade agreements. As an example of their market strength, when considering U.S. imports of textiles and apparel, Mexico ranks as the third largest supplier behind Vietnam and India.
It is revealing to look at which economic sectors foreign investors most prefer in Mexico. The order of investment can be seen in the adjacent doughnut graph. Manufacturing is the clearly preferred sector, receiving 30% of FDI. Considering the historical importance of Mexico’s gold and silver industries, it might be surprising to see that financial services rank second (20%), ahead of mining and extractive industries (19%). Agricultural falls last claiming less than 1% of FDI.
In relation to foreign investors, Mexico has alternated between vitriolic hostility and open-arms embracement over the past century. Following the national civil war one hundred years ago, foreign ownership of businesses was effectively banned due to sentiments that foreign interests had widened income gaps and made Mexico a pawn to international interests. Before the civil war in 1910, foreign ownership of businesses in Mexico reached two-thirds of all investment [6].
In 1973, due to internal economic pressure, the government finally passed a law to permit and attract foreign investment. The “Law to Promote Mexican Investment and Regulate Foreign Investment” maintained government ownership of certain sectors, namely exploration of petroleum, railroad operations, and five other categories. However, the law opened the door to foreign participation in business through percentage limits on foreign ownership of most other types of businesses, ranging from 30% to 49%. Pressures to further relax the restrictions resulted in a 1988 regulation change to allow foreign majority ownership in limited categories. It wasn’t until 1993, with the passage of the “Foreign Investment Law”, that the ability for foreigners to own majority shares in Mexican companies became the norm rather than the exception.
This history helps explain, for example, why extraction and processing of oil, carried out by Mexico’s largest company Pemex, receives no FDI. It also helps explain why transportation, such as railroads, and high-energy production, such as nuclear energy activities, do not appear on the list. Economic nationalism is still strong in Mexico and is not likely to disappear soon.
In the graph below, you can see how FDI in Mexico has changed over the last 10 years. One-year spikes tend to reflect significant acquisitions or purchases. Notable spikes include the spike in financial services in 2001 when the American financial company Citigroup acquired the Mexican banking giant BBVA. While 2010 is not widely available yet, quarterly reports show a significant jump in manufacturing investments, largely because of Holland’s Heinekin purchase of the Mexican beer conglomerate Femsa Cerveza [5]. During the third quarter of 2010, manufacturing investments accounted for over 60% of direct investment. Easily visible is the across the board decrease in investment after 2007.
The one sector that increased in FDI over this period was mining and extraction. This also conveys an interesting aspect of financial crises. As the financial markets tumbled, investors turned towards gold and silver as stores of value, preferable over riskier stocks and mutual funds. This jump in demand created a gold and silver boom in Mexico, causing several companies such as Goldcorp to increase their investments and expand production.
We can do the same sort of comparisons as in the analysis above, looking at the relative changes by sector during the global financial crisis. Was FDI withdrawn uniformly across all sectors? Interestingly, no. The sectors where direct investment was concentrated - commerce, manufacturing, and financial services - experienced the smallest relative decreases. The two largest sectors, manufacturing and financial services, experienced decreases ranging from 30 – 40%, while the two smallest FDI recipients, Agriculture and Electricity/Water, experienced decreases between 75 – 80%.
Again, why these changes? The same line of logic as above again helps explain the dynamic. The sectors where FDI is concentrated are those that are most strongly linked to the U.S. economy: finance and manufacturing. In these large sectors, high levels of investment build economies of scale, producing smart investments and commitment.
If there is one lesson to be drawn from examining foreign direct investment in Mexico, it is that stronger international trade agreements and coordination produce longer-term business partnerships. Active business coordination, like those between the U.S., encourages deep investments that withstand the year-to-year vagaries of financial markets. As the U.S. emerges out of the worst economic recession since the Great Depression, so to will Mexico. Already, there are signs of significant positive economic growth. As Calderón pointed out in Davos, FDI to Mexico has risen again, promising job creation, rising exports, and renewed growth for Mexico in the new decade.