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backLATINtalk May, 2011

Surprise South of the Border?

It’s an economic adage well known to Canadians: the US sneezes, and we catch pneumonia. We don’t suffer alone – this delicate constitution also afflicts the only other nation to share a long stretch of US border. It’s only natural to expect that Mexico was ravaged by the US-led recession, and that it has shared the frustrating convalescence that followed. How is the Mexican economy doing?

To say that Mexico was pummelled by recession is an understatement. Following meagre 1.5% growth in 2008, the economy was slammed with a 6.1% drop in output, one of the worst drubbings suffered by any emerging market. Exports led the decline, tumbling 14% after barely increasing in 2008. The shock rattled the domestic economy, as consumer spending fell 5.7%, investment dropped 11% and the unemployment rate rose to 6%. Clearly, recession proved the adage to be true.

Domestic demand has been slow to recover. Consumer spending rose by 4.7% in 2010, but growth was a drag on overall GDP, and consumer confidence remains 15% below its previous peak. Rising by just 1.8%, investment weighed even further on performance. The government sector offered only a modest boost. All told, domestic growth in 2010 suggested that the adage was alive and well.

If so, trade performance should also have been tepid. Here’s where the adage breaks down. Exports surged by 24.5% last year, enough to lift them 7% above the pre-recession peak. Mexico’s industrial production is consistently outpacing US industrial growth, and quite unlike the latter, is now ahead of pre-recession levels and maintaining strong momentum – a testament to Mexico’s efforts to attract key investments. Mexico’s auto sector is again cranking out the same number of vehicles produced prior to the recession, in spite of the lack of recovery in US auto sales – a considerable achievement.

Current success stands in contrast with Mexico’s well-known structural concerns. Labour force rigidities are a constraint on employment growth. Educational constraints threaten growth of the skills needed to further manufacturing growth. Private investment is weak, hampered by the difficulty of accessing capital. Competition is limited in key markets. And the sizable hidden economy together with well-publicized security concerns put further limitations on growth. Together, these factors contribute to relatively weak long-term potential growth, estimated at just 2.5% annually.

Compared with other emerging markets, potential growth this weak puts Mexico close to the bottom of the class. Effective reforms could change the picture radically. After all, labour force growth – a key pillar of potential – alone is 1.5-2% annually. Add in trend investment and reasonable productivity growth, and it’s not hard to imagine sustainable growth at the 4% level, or even more.

Canadian exporters have benefited from Mexico’s recent success. Pre-recession export growth to Mexico averaged 13% annually, and hit 15% last year, making Mexico a key part of Canada’s recent trade diversification trend. Bilateral trade has shrugged off the recession, and is now well ahead of previous peaks. Investment flows are expected to follow, suggesting a shared bright future.

The bottom line? Mexico has surprised even itself with a robust export-led rebound that has been a big plus for Canada. Sustaining that momentum will be even better for both countries.

Source: Export Development Canada - GAI

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