Mexico is poised for a significant economic upswing - A gateway to a prosperous nation.

Mexico is poised for a significant economic upswing - A gateway to a prosperous nation. 

When you think of Mexico? What is the first thing that comes to your mind?  Did you know it is the 13th largest country in the world and the 2nd largest economy in Latin America? Through general misconceptions and understandings, Mexico is often seen as a poor country where people go to spend time at the beach. It is rarely looked at as an economic powerhouse. 

Consider Mexico as a dormant giant, steadily amassing wealth due to its unique geographical location between the United States and Canada. This strategic advantage is a catalyst for its economic growth. The US and Mexico, with their 1,954-mile-long border, 54 border crossings, and four time zones, have fostered a robust trade relationship. While this relationship is mutually beneficial, it has recently tilted in Mexico's favour, propelling its economic growth.

Mexico GDP per Capita on the rise

GDP per capita is essential for understanding a country's economic health. However, it is also necessary to consider the GDP per capita in individual states or regions. While Mexico’s overall GDP is concentrated in its northern areas that share a border with the US, this growth will likely spread across the country over the next several years. 

It's worth noting that the economic statistics from 2023 reveal not only the expected growth in the north but also a significant surge in the south, particularly in Oaxaca and Tabasco. This sudden development can be attributed to nearshoring, a concept that Mexico has successfully implemented. Nearshoring, the practice of transferring a business operation to a nearby country, is gaining traction as American, European, and Asian companies are relocating their operations to Mexico. This trend has directly led to a substantial influx of foreign investment, making 2023 a pivotal year for Mexico with 18% year-on-year growth.

Mexico is one of the Fastest Growing countries in the G20

Why is this shift happening, and will it continue? The global political landscape is volatile and likely to remain so. Escalating tensions between the United States and China, coupled with rising trade wars and tariffs, have diminished the appeal of manufacturing goods in China for American and European firms. As a result, these firms are redirecting their attention just across the southern border. While Mexico is unlikely to surpass China as the leading global exporter,  the country's massive growth opportunities are undeniable. In early 2024, Mexico surpassed China as the leading source of imports for the US, a fact that has drawn more attention to Mexico and is expected to fuel further investment. Mexico continues to be ranked as one of the G20's fastest-growing economies, with increased wages. 

However, it's crucial to acknowledge the existing challenges. Mexico grapples with deep inequality, with a small fraction of the population holding a significant portion of wealth. This disparity, coupled with a high poverty rate, poses a significant hurdle for a country aspiring to achieve prosperity.

This is allowed to persist due to one of the nation's most famous but illicit industries. Mexico has long had a reputation for illegal activity, especially around the drug industry, being home to many cartels. High levels of crime and homicide don't usually correlate with business investment. As such, these issues have halted Mexico's economic growth, giving rise to a large informal sector to go with it.

While Mexico's unofficial economy, largely driven by criminal activity, is a significant issue, it's not the focus of our discussion today. Let's instead explore the reasons why Mexico is on the path to becoming a developed and affluent nation. Since the colonial era, Mexico's economy has been marked by resource extraction.

As we saw before, Mexico is a vast country home to a wealth of natural resources. Its large stores of silver and other minerals have led to significant mining investments. However, the most crucial event in the development of Mexico's economy came with the discovery of large oil fields in the early 20th century. The discovery of the Cerro Azul field in 1916 was significant, as while people knew that there was oil in the Gulf of Mexico, no one knew just how much.

Mexico’s Massive Oil and Gas Reserves

At the time of discovery, this oil field was the most productive in the world, producing over 260,000 barrels of oil per day at its peak. The discovery of these and other fields propelled Mexico to become one of the world's leading oil producers in the early 20th century, which profoundly impacted its economic development over the next few decades. Exporting oil has allowed the nation to generate significant revenue, especially during high oil prices.

While private companies initially undertook development and drilling, this was a source of contention for the Mexican government, and they soon moved to nationalize the industry. Pemex, the state-owned oil company, was created in 1938, and this meant that the exploration, extraction, and sales of natural gas and petrol have gone through the state ever since. This has had many advantages.

Pemex's revenues have been a significant source of government income, historically around 30-40% of total fiscal revenues. Following the worldwide Great Depression of the late 1920s and 1930s, Mexico's economy had begun to grow steadily. By 1950, Mexico seemed poised for an economic takeoff, which would take place in a period known as the Mexican Economic Miracle.

At this time, more and more workers were flowing into cities, manufacturing was increasing as a share of GDP, agricultural production was declining, and education was spreading throughout the country as literacy rates rapidly increased. Between 1950 and 1981, real GDP in Mexico grew by 6.5% a year, and despite a high population growth rate, real GDP per working-age person grew by 3.6%. In this boom period, the government began to invest heavily in things that would improve the lives of its citizens, such as healthcare, education, and infrastructure. Hopes for more growth were boosted again as further discoveries of oil fields in 1977 increased Mexico's proven oil reserves by 151%.

With this discovery, the government further expanded its public expenditure, meaning that the demand for elementary school education was fully satisfied for the first time in the country's history. However, at the beginning of the 1980s, things need to be corrected for Mexico. Its use of oil revenues, which had been a blessing for so long, quickly became a curse.

In the times of high oil prices in the 1970s, Mexico had been generating high export revenues on the international market. It used this to borrow heavily to fund its public sector expansion program. Accordingly, foreign sector debt went from $4.3 billion in 1970 to $58.9 billion in 1982. However, a rapid fall in the price of oil around the end of the 70s caused by a surplus of oil on the global market meant that Mexico's export revenues dropped significantly. At the same time, spending remained relatively similar, causing a public deficit of 17.6%. Mexico and other oil-exporting Latin nations could no longer meet their debt payments, and finally, in 1982, the Mexican government defaulted on its loan payments, thus starting the 1982 debt crisis.

What resulted was ten years of stagnation, high inflation, and low growth, often referred to as the lost decade. Following the crash, oil prices picked up again. Mexico benefited greatly from the commodity supercycle of the late 90s and early 2000s, where most commodities experienced double-digit annual real price growth. With this, their economy began to recover. Today, oil is still a crucial element of the Mexican economy, accounting for around 20% of government revenues. However, moving away from oil as a source of economic growth and income has long been a desired goal of the Mexican government. Since the 1990s, this has taken shape in a few different areas.

The North American Free Trade Agreement (NAFTA)

Firstly, with trade. In 1994, Mexico entered the North American Free Trade Agreement, or NAFTA, with Canada and the United States. This agreement essentially allowed Mexico and Canada to trade freely with the US, reduced tariffs on most goods and services, and eliminated many barriers to cross-border investment. Reducing these barriers has allowed Mexico's exports to boom.

As a share of GDP, they have more than doubled to 41% from 1994 to 2021. In the same period, the value of Mexico's constant dollar exports rose more than fourfold to $465 billion, a pace that compares favourably with countries such as Thailand and Malaysia. In this period, Mexico has also significantly diversified its exports, as the focus has moved away from agricultural goods and oil towards more labour-intensive manufactured goods like electronics and auto parts, which have seen significant growth. Following the crisis of the 1980s, Mexico had very high levels of government debt.

However, the subsequent trade surpluses from NAFTA have accumulated large foreign exchange reserves and reduced this total figure. And aside from increasing government revenues, trade has had some beneficial knock-on effects on the Mexican economy. Even though the USMCA agreement has now replaced NAFTA, the reductions of tariffs and trade barriers, as well as Mexico's proximity to the world's largest economy, have led to a surge in investment, FDI precisely, and these flows are estimated to be around 60% higher than they would be without the agreement.

The manufacturing industry, in particular, has benefited from FDI by expanding and modernizing its operations, and many American companies have moved parts of their operation across the border to establish production centres and lower costs. The stimulation of investment from NAFTA has also led to the creation of many new jobs, providing a viable source of income for many Mexicans, helping to draw more and more workers into formal employment, away from their previous jobs, providing them with pensions and job security that they lacked before. These jobs also tend to be in industries that often require higher skill levels than traditional agricultural or low-skilled jobs, and increased demand for higher-skilled jobs means that workers are encouraged to seek higher education and vocational training, equipping the local workforce with better skills and increasing their earning potential.

The Nearshoring Boom in Here to Stay in Mexico

The practice of nearshoring is not just limited to companies from the United States but also ones from Europe and China. Chinese firms are beginning to invest billions of dollars in Mexico due to rising shipping costs and increased trade wars for fear of losing their primary market in the US. In 2023, most of this added spending was reinvestment by companies already in Mexico. This suggests that the nearshoring phenomenon is just in its infancy, and Mexico will continue to grow as a manufacturing power. Further requirements placed by the USMCA also require a certain percentage of goods to be made in North America for them to be tariff-free, for example, 75% on automobiles.

This has led to a rise in assembly plants nationwide where a Made in Mexico sticker can be attached to lower costs. Such an influx of investment in these areas will likely have a significant multiplier effect across the economy as spending increases in infrastructure and telecommunications. Despite the general optimism around Mexico's economy, there has been a fear that Mexico still needs to include a few crucial ingredients to propel itself to the status of a developed nation fully.

Mexico's GDP per capita grew by 0.7% from 1980 to 2019. To put that into perspective, it's considerably below similar countries that started from comparable income levels. Over the same period, Chile averaged 3% growth, and South Korea 5.3%. Low productivity gains explain this gap, which has remained relatively stagnant since the 1980s.

An expanding labour force primarily drove Mexico's economic growth during this period. Yet this progress has been offset by poor total factor productivity gains, such as how efficiently inputs are used to create an output. Productivity is the primary driver of growth in most advanced and emerging economies and needs to be improved in Mexico.

Their rapidly expanding workforce has meant that there has been a growing pool of working-age individuals in the economy, meaning that they are increasing their inputs rather than using them more efficiently. However, this boom in the workforce is expected to end by around 2030, and its fertility rate of 1.9 children per woman is far below the number of children needed to keep the population stable from generation to generation. Another area detracting from Mexico's productivity and growth is its level of education.

Mexico currently has one of the lowest rates of educational attainment and enrolment in the OECD countries. While this steadily increases, it's still a factor holding it back. Higher levels of education improve the skills of the workforce, which can lead to more efficient use of existing technologies and greater output, ultimately meaning higher wages. More specifically, enhancing educational outcomes for Mexico could help address some structural challenges that hinder productivity growth, such as inequality in education access and quality between urban and rural areas.

Most modern developed economies typically have formal businesses registered with the government. Still, the informal economy in Mexico is comprised mainly of tiny companies that are not taxed or regulated, accounting for a staggering 24% of its GDP and 55% of employment. Workers in this sector need more benefits, such as healthcare and pensions. Because informal firms are off the books, they typically cannot borrow from banks, so their growth is limited, and government tax collection is also significantly lower. This is tied to poor access to loans and credit, which severely limits Mexico's growth.

Despite extensive banking reforms following the financial crash in the 1990s, the country's financial sector remains notable for its low levels of credit extended to firms and households. In the 21st century, domestic credit to the private sector as a share of GDP averaged just 24%, compared with 99% in Chile, 51% in Brazil, and 131% in Korea. Such a low rate of credit hampers production, capital formation, and innovation, which ultimately generates economic growth. Where does this leave Mexico to grow from here? The country clearly has a lot of potential to become a developed nation.

America accounts for 80% of Mexico's exports, meaning that changes in this trading relationship in the future stand to significantly affect the Mexican economy and jobs. This is particularly relevant in 2024, as Mexico and the USA have elections, meaning that these outcomes could significantly alter the two countries' relationships and, ultimately, their entire economies. However, Mexico's proximity to the world's largest economy makes it a different case from Germany, as it further benefits from de-globalization and moves away from China.

Trade and manufacturing will undoubtedly play a huge role in Mexican growth. Unlike some of the European economies we've covered, Mexico also has a very young demographic that is continuing to grow, meaning that more and more people will be entering the workforce. They will also not be troubled by large welfare payments on healthcare and pensions like in European countries. The growth of the country is expected to continue to rise and grow over the next couple of years as nearshoring becomes a more significant phenomenon, but what it needs to make sure is that it effectively uses the inflow of investment and capital to build the long-term capacity of its economy.