More than twenty years ago, Ross Perot warned that removing trade barriers with Mexico would create a “giant sucking sound,” as jobs left the United States for its southern neighbor. Today, the sound you hear in Mexico is a giant exhale.
That’s the sigh of relief after the United States, Canada and Mexico reached a new North American Free Trade Agreement. Mexico heavily relies on NAFTA, which has been in place since 1994, and was vulnerable after President Trump criticized the trade pact and threatened withdraw.
The uncertainty over NAFTA was cloud hanging over Mexico’s new president, Andres Manuel Lopez Obrador, who took office on Dec. 1 after his landslide victory a few months earlier. There is still some anxiety over the proposed agreement because it needs congressional approval. Congressional Democrats, who will lead the House next year, say the deal doesn’t go far enough to protect workers and the environment. Still, no one wants to see NAFTA scrapped because it would harm the economies of all three countries.
Mexico is the poster child for the benefits of free trade. NAFTA was an unusual deal in that it involved two highly developed economies and a developing one in Mexico. Since 1994, Mexico’s gross domestic product, a measure of output in goods and services, has more than doubled to $1.15 trillion. The economy has been driven by exports, as foreign investors built factories across northern and central Mexico to supply the North American market.
Last year, Mexico exported nearly $410 billion worth of goods, about 80 percent to the U.S. and Canada. The largest export is vehicles, followed by electric equipment and machinery, including computers. The auto industry is a big winner in the revamped trade deal, which is being called the U.S.-Mexico-Canada Agreement, or USMCA, simply by averting a major disruption to it supply chain.
NAFTA’s impact on Mexico has gone well beyond economics. The deal signaled a new era of openness for Mexicans, increasing their willingness to venture out into the world to forge new ties. Mexico has embraced free trade, striking deals with Europe, South America and parts of Asia.
The nation has also liberalized foreign investment in some national sectors previously forbidden or heavily capped to foreign ownership. Under Lopez Obrador’s predecessor, Enrique Pena Nieto, the Mexican government reformed the energy sector four years ago to allow private operators into its territorial waters for the first time. Until then, state-owned Pemex had sole exploration and production rights.
But a drastic decline in oil production in the last 15 years led the government to invite foreign investment to boost production. Oil is a significant source of revenue for the government.
The international industry has moved into the country and achieved quick results. In July 2017, the first offshore exploration well drilled by the private sector in Mexico’s history discovered oil. Energy reform is expected to continue to attract new capital and provide local jobs and government revenues.
As foreign oil firms develop the areas they have won at government auctions, they could bring in more than $100 billion in investment to the country. Much of the foreign investment after NAFTA was to take advantage of Mexico’s lower wages to manufacture goods for export. But financials flows into the country are shifting from labor arbitrage to infrastructure and consumer-driven investments. Despite all the political rhetoric about building walls, U.S. investors remain big fans of Mexico, accounting for nearly half of the foreign direct investment last year.
To attract investment to economically underdeveloped areas in the southern states, Mexico created Special Economic Zones in 2016. Companies setting up in these areas receive various incentives, trade facilities, duty-free customs benefits, infrastructure development prerogatives and regulatory and administrative benefits.
Investors are making big bets on Mexico despite concerns about Lopez Obrador, a leftist who once criticized free-market policies. He has come around on USMCA because It provides stability and certainty as he tries to stimulate the economy.
While Mexico has successfully integrated into the world economy with NAFTA and other trade agreements, it still struggles with slow economic growth.
GDP has increased about 2 percent annually in recent years in Latin America’s second largest economy. Structural reforms are needed to address tax, labor and social insurance rules that stifle productivity and undermine economic progress.
The lack of growth has generated poverty, crime, violence and migration. How Lopez Obrador tackles these stubborn issues will be closely watched by foreign investors. But now that the dust has settled on NAFTA, there is increased optimism about Mexico’s future.
Raimundo Diaz is head of Americas at TMF Group, a professional services firm based in the Netherlands. TMF Group provides accounting, payroll, HR and other corporate services, with a focus on companies expanding internationally.
