Given Mexico’s location on the doorstep of the world’s largest economy, its low unit labour costs, and its openness to trade and investment, the country has become a manufacturing hub serving the US and other markets. Since the North American Free Trade Agreement (NAFTA) was implemented in 1994, the country has become deeply integrated into North American supply chains, becoming a leading exporter of both components and finished products in the auto, aeronautics and electronics segments. This saw large foreign direct investment (FDI) inflows into the Mexican manufacturing sector as foreign firms established and expanded their operations in the country. In earlier years, such operations often took the form of maquiladoras, or relatively low-value-added assembly plants in border areas. Since the turn of the century, however, Mexico has begun to climb through value chains, with increased domestic content in evidence in its exports.
Alejandro Díaz de León, deputy governor of Banco de México and the former director-general of state development bank and export credit agency Banco Nacional de Comercio Exterior, told OBG, “The greatest macroeconomic priority is how we can develop global value chains to improve opportunities for Mexican companies. With the implementation of structural reforms, the role of state-backed development banks is even more crucial, especially given the low penetration of financing in the Mexican marketplace.”
These positive developments mean that more proceeds from the country’s exports are retained domestically, while increased skill levels among the local labour force have been able both to attract higher wages and engage in progressively more skill-intensive activities. These developments have had a positive spill-over effect on the domestic manufacturing ecosystem, through backward linkages, as exporting firms come to rely more on local suppliers for inputs. FDI has also become more prevalent in non-border areas, with the development of high-tech manufacturing clusters in new areas such as Mexico’s central corridor and plans for developments in the south.
By The Numbers
According to the IMF’s 2016 Article IV consultation, 2013 saw a record for direct investment in Mexico, with a total of $46.9bn; however, this fell back sharply to $26.9bn in 2014 before recovering to $32.1bn in 2015. It moderated to $28.7bn in 2016.
In spite of uncertainty surrounding the policies of the newly elected US President Donald Trump, in the fourth quarter of 2016 FDI rose to $5.28bn, up 17.1% on the same period in 2015, according to a February 2017 media report. The IMF projects inflows will recover to $32.3bn in 2017 and $36.4bn in 2018.
According to the UN Conference on Trade and Development (UNCTAD) “World Investment Report 2016”, the recovery in inward FDI in 2015 – the most recent full year for which UNCTAD had data – was driven by auto manufacturing, which accounted for some $6bn, following the announcement of $26bn in greenfield projects in the sector over the 2012-14 period.
UNCTAD also pointed to a turnaround in FDI inflows in Mexico’s mining sector, from a net investment of $2bn in 2014 to a net divestment of $29m in 2015. This was attributed to continued weak commodities prices, as well as the sector’s adjustment to the new fiscal framework that came into effect at the beginning of 2015 (see Mining chapter).
UNCTAD highlighted a steep rise in cross-border mergers and acquisitions activity in 2015, led by a small number of mega-deals. These included the $2.5bn purchase of Grupo Iusacell by the US-based AT&T, finalised in early 2015, and the May 2015, $2.15bn purchase of Vitro SAB, a glass and plastic bottling manufacturer, by US-based Owens-Illinois. This trend continued with the mid-2016 announcement of the acquisition of pharma firm Rimsa by Israel’s Teva Pharmaceuticals for $2.3bn; however, by late 2016 the deal was in doubt as Teva alleged cases of fraud at its Mexican subsidiary and had gone to court seeking a retroactive discount.
The US and Spain are consistently the top sources of FDI in Mexico, accounting for 52.2% and 26.1% of total inflows, respectively, in 2015, according to UNCTAD. By sector, manufacturing is by far the most important, attracting 50% of all inward FDI flows in 2015, whereas no other sector comprised more than 10%. Just five states together accounted for over half of all FDI inflows in 2015: Ciudad de México (16.4%), Nuevo León (11.7%), Estado de México (8.8%), Jalisco (8.3%) and Chihuahua (7.7%).
While the recent recovery in FDI inflows is encouraging, Mexico still receives proportionally less FDI as a share of GDP than other large economies in the region, such as Chile (8.4% of GDP in gross FDI inflows in 2015), Colombia (4%) and Brazil (3.7%), albeit with the exception of Argentina. However, looking at stocks of FDI paints a slightly different picture, with Mexico’s 36.7% of GDP in 2015 lagging behind Chile (86.7%) and Colombia (50.2%), but comfortably surpassing Brazil (27.9%), according to UNCTAD figures. Unlike some of its commodity-rich Latin American peers, Mexico has not experienced significant FDI inflows to its primary sector. This is largely due to the fact that its most significant commodity export, oil, was the preserve of a state monopoly until 2013.
According to the OECD’s FDI Regulatory Restrictiveness Index (FDI Index), most sectors of the Mexican economy still remain relatively more closed to inward investment than the average in advanced countries. The FDI Index measures legal restrictions on FDI across 22 economic sectors, taking into account foreign equity limitations and other operational restrictions. Sectors are evaluated on a scale of 0 to 1, with 0 being completely open and 1 being closed. The top-five open segments in Mexico are radio and television broadcasting, aviation, maritime transport, general transport and media. Recent telecoms reforms now see restrictiveness in the sector, rated 0.1, as being on par with the OECD average of 0.092, but despite the reduction in restrictiveness in media, which is rated 0.525, the sector is still significantly more restrictive than the OECD average of 0.159. The five most restricted sectors are architecture, hotels and restaurants, communications, electricity generation and electricity distribution.
Mexico uses a range of federal- and state-level incentives to attract investment. For example, importers can claim tax refunds on goods that are re-exported, while the Manufacturing, Maquiladora and Export Services (IMMEX) programme allows for the temporary import of goods in the manufacturing sector without exposure to taxes and duties, as long as they are used to generate exports. Under certain conditions, eligible IMMEX-participating firms are also allowed a significant reduction in the payment of income tax. Affiliated industries reported a profit of MXN288.8trn ($17.4trn) since its establishment in 2006.
There also preferential tariffs available in certain sectors, such as through the Ministry of Economy’s Sectoral Promotion Programme. In addition, eligible companies can claim a tax credit of 30% on total spending on research and development activities. Outside of the cities of Mexico City, Monterrey and Guadalajara, a tax incentive known as an immediate deduction is available for foreign investors for expenditure on locally sourced, labour-intensive, non-polluting inputs.
In The Zone
In order to attract FDI to less-developed states, which may not have previously been on the radar of potential investors, in June 2016 the government implemented a federal law to create four special economic zones (SEZs) to redress this imbalance. The four new SEZs are to be clearly demarcated geographical areas designated with the express intent of attracting FDI. They are to benefit from improved infrastructure, reduced regulations and targeted tax incentives calibrated to take into account the extent to which firms integrate into the local economy, through supply chains, for example. The first SEZ, adjacent to Lázaro Cárdenas Port, on the Pacific coast on the border with the states of Michoacán and Guerrero, was to become operational in 2018. Three further SEZs are to follow at the Isthmus of Tehuantepec, incorporating parts of the states of Veracruz and Oaxaca; Puerto Chiapas, which is in the state of Chiapas, bordering Guatemala; and at the Mexican Gulf port of Coatzacoalcos, in Campeche. The aim is to have one anchor firm operating in each SEZ by 2018, and initial investors have been identified.
Given the geographic distance of southern states from the US border, the strategic location of the SEZs beside existing ports seems prudent, but it will be important to ensure investment in port facilities to ensure their capacity is sufficient to meet the extra demand that the success of the SEZs would create. One challenge that will need to be overcome is that of land ownership regulations in the designated areas, about half of which is reportedly not in the hands of the federal government, but of subnational governments and private landowners. Another challenge, particularly if the government is to meet its target of attracting higher-value-added processes rather than maquiladora-type activities to the SEZs, will be to invest in education and training so the labour force in the surrounding areas is equipped with the necessary skills.
Mexico’s attractiveness as a destination for FDI will be reinforced by the weakening peso, which further improves the country’s cost competitiveness in manufacturing, and by advances in the implementation of key structural reforms. The IMF is relatively bullish that inward FDI flows will continue to grow in the medium term, to $36.4bn in 2018 and $39.1bn in 2019. In early 2017, however, there was a large degree of uncertainty with respect to the trade and investment policies of the US, particularly with President Donald Trump stating in February 2017 that he was looking at revamping NAFTA, which could have profound implications for Mexico.
While there is as yet little concrete data to support the proposition that overall FDI flows will take a significant hit as a result of a change in US policy, several high-profile announcements by US firms – notably Carrier Corporation in November 2016 and Ford Motor in January 2017– that they would scale down or cancel planned investments in their Mexican manufacturing operations have given rise to concerns that this vein of inward investment could be scaled back.
A deceleration in greenfield investment projects was already under way before the November 2016 US presidential election and pointed to a tapering of foreign investment in manufacturing plants in the coming years, dropping from $34.1bn in 2013 to $32.8bn in 2014 and $25.6bn in 2015, according to UNCTAD figures. However, Walmart announced in December 2016 that it would invest a further $1.3bn in its already extensive Mexican operations over the coming three years, while Citibank stated in October 2016 that it would invest $1bn through to 2020. What is certainly likely over the medium term, irrespective of proposed US policy changes, is a rebalancing of FDI inflows towards services and energy, and away from manufacturing.