Mexico's Paradox

By Ken Stier / Monterrey

Back when Mexico was still a colony of Madrid, Monterrey was frontier--much like America's Wild West, more than 200 years later--settled by a rugged cast of characters, including unmoored Jews and some in trouble with the Spanish crown, whose present-day descendants are fiercely proud of their heritage and the modern metropolis they developed. Monterrey is the most important business center in the country after Mexico City. It's as if San Antonio, Texas, went on to become Pittsburgh, Pa., skipping the Rust Belt phase. This city of nearly 4 million, often confused by Americans with its California namesake, is, after all, still in its ascendancy, and--like Texas, its closest American kin--it has tall ambitions that may prove critical to how Mexico as a whole develops. Or maybe not.

Monterrey is home to many of Mexico's largest companies, some now in the vanguard of going global. They benefited from their proximity to the U.S. and from imitating its business culture. (The Dallas Cowboys count about 1,400 Monterrey fans as season-ticket holders.) They also bulked up on Mexico's earlier import-substitution policies, which positioned them well for the challenges and opportunities when the North American Free Trade Agreement (NAFTA) came into force in January 1994. The lion's share of $200 billion of foreign investment that has rolled in since then--two-thirds from the U.S.--went to the north, both to maquiladora assembly operations in border towns and to Monterrey and nearby Saltillo, also known as Little Detroit for the sizable auto investments there, especially by the U.S.'s Big Three. Thirty percent of Mexico's GDP comes from manufactured exports, 80% of that auto related, and the U.S. accounts for 60% of that.

Yet Monterrey may be getting less competitive, as is Mexico itself. The country needs tax enforcement, regulatory reform, a deregulated oil industry and agricultural reform--in the U.S. also--if it is to maximize the potential that NAFTA offers. If not, the U.S. can expect an even larger flood of new arrivals, to whom a fence installed by Congress may as well be made of cardboard.

Grupo Industrial Saltillo, with eight business units, shows the link and how NAFTA's market access is accelerating this corporation's global evolution. More than half its roughly $1 billion in sales last year went to the U.S., Canada, Japan and Australia, and 84% was auto parts. That will expand when a $136 million engine factory, a joint venture with Caterpillar, opens next year. Saltillo's building-products division, on the other hand, is 90% dependent on the domestic market. Within five years, this proportion is projected to be evenly split between domestic and foreign sales, a feat that may not prove feasible for other business units, which would then be more likely to be sold off. "Mexico is a country in transition, and much of that change has been forced by NAFTA," says Robert Bryant, Saltillo's executive vice president of corporate strategy and business development. "In a protected economy, conglomerates made a lot of sense because there were synergies across business units. Well, in a worldwide economy where you have to be globally competitive in each of your business units, those domestic synergies aren't as relevant."

Mexico's predicament is that its economy needs to generate a million jobs a year for roughly the next two decades--in order to handle its demographic bulge--but lately has been producing about half that. A balance of at least 400,000 is heading across the border, and there is no end in sight. The bitterly contested July elections--narrowly won (by a margin of 0.6%) by Felipe Calderon against the populist Andres Manuel Lopez Obrador--were largely fought over economic policies, as are, at least in part, the recent battles in Oaxaca. The campaign exposed a yawning chasm between those benefiting from the status quo and those falling further behind: almost 48% of Mexicans continue to live in poverty. The election was also a referendum on NAFTA, which has strengthened Calderon's political base in the north. But in the south, NAFTA is the source of a steep decline in jobs partly because of a surge in U.S.-taxpayer-subsidized agricultural sales--without a commensurate jump in manufacturing employment.

In essence, Mexico has blown a big lead in industrial competitiveness, especially in relation to China. Mexico had a long head start in industrializing, and the plan was just to keep staying ahead of the value-added-production curve. But China has leapfrogged in front, and now there is a 50% overlap in Mexico's and China's exports. As a consequence, the maquila operations along the border have bled 800,000 jobs in recent years. Infrastructure investment has dropped off so much in Mexico that for relatively light goods, it is just as cheap for the U.S. to import from China as from southern Mexico. And although a Mexican wage earner is paid three times as much as his Chinese counterpart, high domestic prices undercut, and nearly level out, his purchasing power. (Conversely, high domestic prices also push up those wages, further undermining Mexican firms' competitiveness.) "For Latin America, China is an incredible opportunity as a driver of commodity prices, but for Mexico it is strong competition," says Sergio Kurczyn, an economist with Banamex, owned by Citigroup. "If I am not optimistic about structural reform, I can't be optimistic about competing with China."

He is referring to the broad reform agenda--fiscal, labor, energy and competition--that outgoing President Vicente Fox unveiled but then failed to deliver on. Although more politically adroit, Calderon inherits a far more acrimonious political environment, in which Lopez Obrador still insists he is the legitimate President. This surely will complicate Calderon's dealings with the public-sector unions and with sensitive symbols like the national oil company, Pemex, which desperately needs foreign investment, now outlawed. "Mexico needs to think outside the sovereignty box," says Raul Rodriguez, former CEO of the North American Development Bank, but Mexico's nationalization of Rockefeller's Standard Oil company holdings in 1938 is still commemorated every March 18 as National Expropriation Day.

Pemex is now the government's cash cow, providing about 30% of federal revenues, a dependence that has torpedoed fiscal reform. Nonoil tax collection, as a percentage of GDP, is about 10%--about the same as in Haiti. Lopez Obrador's economic team calculated that an additional 2% to 3 % of GDP could be recouped with more rigorous tax collection, which would mean cracking down on rampant tax evasion--roughly at 50%--and the widespread abuse of legal but economically unjustified tax exemptions. "All businesses should pay tax without exemptions," says Jose Luis Barraza, president of the Consejo Coordinador Empresarial, a leading business group. But for Calderon to do this on the scale needed would seem to mean taking on the powerful business interests that dominate his party (and hamstrung Fox), which played a decisive role in electing him in his razor-thin win.

There are a few Monterrey-headquartered firms making their way into the world-class league, like Vitro, which manufactures glass. Another is Cemex, the cement behemoth, with $15.3 billion in sales last year--the world's largest producer of ready-mix concrete. It recently made a $12.8 billion bid for Rinker Group of Australia that would be the largest acquisition ever by a Mexican firm and would strengthen Cemex's already leading position in the U.S. market. Such success puts the city on a trajectory pulling further and further ahead of much of the rest of the country. Mexican states in the north are growing twice as fast as those in the south and already contribute three times as much GDP on a per capita basis.

But critics say some of this success is due not to globalization but to the local political clout these large firms wield, yielding favorable government treatment--everything from default forgiveness on bank loans to airbrushing competition regulations. Their heft makes them effective bullies. After Fox took office in 2000, promising a new era, several younger Cemex execs decided to take him at his word and struck out on their own, competing against their former employer by importing cheaper cement from Russia. Their boat got tied up in every port, and after months of harassment, they took their business to Africa. Oligopolistic pricing is so pronounced in some sectors--like telecom, dominated by Carlos Slim, one of the world's richest men--that it is hurting Mexico's competitiveness. "The key to being successful in business in Mexico is to have little competition. I guess everyone in the world wants this, but the problem is that the state cannot foster that if you want to be a successful country," says Adolfo Hellmund, a former economic adviser to Lopez Obrador who used to work at ALFA, another Monterrey firm. "They are our Rockefellers and Carnegies. We are now the country of the robber barons."

Still, Monterrey's entrepreneurial spirit may prove critical for the country. It is at the hub of Mexico's most ambitious push to forge government, business and university partnerships that can generate new companies, based not on natural resources but on cutting-edge technologies. The city's "Monterrey Tech"--perhaps Latin America's premier business and engineering school--is a central link in this effort, which is supported by $1 billion of annual federal spending on scientific and technological research and focused on building up Ciudad del Conocimiento (Knowledge City), mandated to germinate new business clusters in biotechnology and information technologies. Monterrey has more than 30 colleges, with some 150,000 students enriching the mix, but it's not Boston yet. Still, when Michigan-headquartered Whirlpool, which in recent years has been pumping in an additional $100 million a year to its expanding production facilities here, decided to establish an R&D center in Monterrey recently, it found it could easily source almost all the engineers it needed locally.

The biggest challenge, though, is stimulating the critical creative spark. "We need to change the paradigm of people's thinking," says Antonio Dieck, Tech's business school (EGADE) dean. But for all of Monterrey's impressive start, not all the necessary pieces are yet in place. The venture-capital industry is in its infancy, there is no Mexican NASDAQ (although a draft bill to create one recently surfaced), and minority-shareholder rights need to be strengthened. More important, the Mexican business culture does not carry much appetite for risk in its DNA or an appreciation for failure. As a result, at least for the time being, a government-supported business incubator for its most promising start-ups has also migrated across the border--to Silicon Valley.