Business

Overview

Mexico is a middle-income country with a developing economy that is closely linked to the much larger economy of the United States. Mexico’s economy ranks as “mostly free” in the 2006 Index of Economic Freedom (a joint publication of the Wall Street Journal and the Heritage Foundation). From the 1940s through the late 1960s, successive governments followed an economic strategy of import substitution and fiscal and monetary restraint intended to promote growth while holding inflation in check. During the 1970s, populist governments abandoned fiscal discipline and oversaw a massive expansion of consumer subsidies and state ownership of productive sectors. Unsustainable public-sector spending backed by over-reliance on oil export revenues and abundant international credit contributed to chronically high inflation and wild fluctuations in economic performance. As a result, the economy experienced spurts of rapid growth followed by sharp depressions in 1976 and 1982. The mid- to late 1980s were years of economic austerity and stagnant growth during which Mexico was able to balance its national accounts while combating high inflation. Gross domestic product (GDP) grew at an average rate of just 0.1 percent per year between 1983 and 1988. During these years, monetary policy was severely restricted and public-sector spending sharply curtailed.

The late 1980s and early 1990s saw far-reaching market-oriented structural reforms, including privatization of hundreds of state-owned enterprises, liberalization of foreign investment laws, deregulation of the financial services sector, and across-the-board reductions in tariffs and nontariff trade barriers. These reforms, which culminated in the ratification of the North American Free Trade Agreement (NAFTA) in 1994, attracted an influx of US$148 billion in foreign direct investment (FDI) during the next decade. From 1988 to 1994, GDP growth averaged 2.6 percent, sustained by exports and an influx of foreign capital. However, the collapse of the peso in December 1994 and the ensuing economic crisis erased most of the real wage gains from the previous years. In response to the 1994 crisis, Mexico passed legislation granting greater independence to its central bank. Growth resumed in the late 1990s, but the recovery was cut short by the spillover effects of the 2001 recession in the United States. Since 2002 a worldwide commodity price boom, a U.S. economic recovery, and sound macroeconomic policies have helped boost economic growth while allowing inflation to remain in the single digits. ((OT))

The economy is hampered by structural weaknesses that limit Mexico’s potential for future growth and job creation. Mexico’s workers are generally low skilled and have less schooling than workers in advanced industrial economies. This deficit in human capital manifests itself in terms of stagnant labor productivity and real wages, as well through the existence of a large “informal” labor sector that deprives the education, health care, and social security systems of crucial tax revenues. Income distribution remains highly unequal; about half of Mexico’s population lives in poverty.

Despite recent reforms, public policy continues to impose artificial restraints on the economy’s competitiveness and growth potential: rigid labor and commercial codes discourage hiring and inhibit informal workers from transitioning into the formal economy; the lucrative energy sector, which remains state-owned, suffers from numerous inefficiencies and undercapitalization; and the federal government relies heavily on the oil industry for revenues, which consequentlyrenders public budgets vulnerable to cyclical fluctuations in hydrocarbon prices. While the liberalizing reforms associated with NAFTA have been a boon to northern and central Mexico’s manufacturing centers, few new jobs have materialized for the predominantly agricultural states in the south and southwest. This uneven development pattern has failed to slow large-scale wage migration to the United States. As global competition for capital investment has increased—particularly from low-cost manufacturing in Asia—Mexico’s status as a premier export hub for the North American market has eroded.

Gross Domestic Product (GDP)

GDP stood at US$699.5 billion dollars in 2005 (US$1.07 trillion in terms of purchasing power parity), representing a per capita GDP of approximately US$6,500 (US$10,500 in terms of purchasing power parity)—the highest in Latin America. In early 2006, Mexico was entering the third consecutive year of economic expansion with predicted annual GDP growth of approximately 3.5 percent. Economic output in 2005 was divided among the sectors as follows: services, 69.5 percent; industry, 26.5 percent; and agriculture, 4 percent.

Government Budget and Public Finance

During 2005, federal government expenditures were US$184 billion (equivalent to 26 percent of gross domestic product), slightly outpacing revenues of US$181 billion. The public sector typically relies on profits from the state-owned hydrocarbons sector for a quarter of its revenues. Federal tax revenue is derived from several sources: corporate and individual income taxes, a nationwide value-added tax, and excise taxes on the mining industry. State and local governments rely heavily on federal government revenue transfers for their budgets.

Inflation

Inflation has trended generally downward since the late 1980s (when it exceeded 150 percent), thanks to a commitment by successive governments and the independent central bank to anti-inflationary fiscal and monetary policies. During the first quarter of 2006, core inflation stood at an annualized rate of approximately 3 percent.

Agriculture, Forestry, and Fishing: In 2005 agriculture accounted for only 4 percent of gross domestic product but employed 18 percent of the labor force. Agricultural practices range from traditional techniques, such as slash-and-burn cultivation of indigenous plants for family subsistence, to the use of advanced technology and marketing in large-scale, capital-intensive export agriculture. The staple food crops are maize, wheat, sorghum, barley, rice, beans, and potatoes. The principal cash crops are coffee, cotton, sugarcane, fruit, and vegetables. Other important agricultural goods include beef, poultry, dairy products, and wood products. Agricultural exports, valued at US$5.77 billion in 2004, are primarily destined for the United States. Forestry production is geared toward the exploitation of domestic fuelwood, sawlogs for construction, and pulpwood for processing in domestic paper mills. Mexico’s coastal fishing grounds offer a rich variety of fish and other seafood. The Pacific coast accounts for nearly three-quarters of Mexico’s total catch, producing mainly lobster, shrimp, croaker, albacore, skipjack, and anchovies. Mexico’s Gulf and Caribbean waters produce shrimp, jewfish, croaker, snapper, mackerel, snook, and mullet. In 2003 the total catch exceeded 1.5 million metric tons.

Non-fuel Mining and Minerals

Mexico has abundant mineral resources and has historically led the world in the production of silver. During 2004 silver production exceeded 3 million tons.

Other significant mining products in 2004 were iron (6.9 million tons), sulphur (1.1 million tons), fluorite (0.84 million tons), sodium sulphate (0.61 million tons), zinc (0.38 million tons), copper (0.35 million tons), and manganese (0.14 million tons). Mexico also possesses substantial deposits of mercury, bismuth, antimony, cadmium, phosphates, and uranium.

Industry and Manufacturing

Manufacturing is the economy’s leading export sector, accounting for 84 percent of total export revenues (US$158 billion in 2004) and about a quarter of gross domestic product. About a quarter of Mexico’s labor force is engaged in some type of industrial or manufacturing activity. The manufacturing sector was transformed by the liberalizing reforms of the late 1980s and early 1990s, which privatized hundreds of state enterprises and greatly expanded opportunities for foreign direct and portfolio investment. Manufacturing attracts about half of all foreign direct investment in Mexico, two-thirds of which is concentrated in the maquiladora sector, comprising more than 2,000 businesses employing 1.13 million workers in 2004. Overall manufacturing output in 2004 was dominated by three activities: food, drink, and tobacco (29.5 percent); metals, machinery, and equipment (28.9 percent); and chemicals, petrochemicals, rubber, and plastics (14.9 percent). Other major components of manufacturing output included textiles, clothing, and leather goods (6.3 percent); metals (5.2 percent; and paper products (3.5 percent). Principal industrial centers are located in and around the Mexico City metropolitan area, Monterrey, and Guadalajara.

Energy

Mexico is the world’s sixth largest oil producer, extracting an average of 3.4 million barrels per day of crude oil in 2005. As of January 2005, Mexico had 14.6 billion barrels of crude oil reserves—the third largest reserves in the Western Hemisphere—mostly located in the Cantarell fields in the Gulf of Mexico. About half of Mexico’s crude oil production is consumed domestically, while the other half is exported—mainly to the United States. Over the past two decades, the oil sector’s share of total export revenues has fallen sharply as the economy has diversified and as an increasing share of production has been dedicated to meeting domestic demand. Crude oil exports accounted for 12 percent of total export revenues in 2004 versus 61 percent in 1985. Although production has remained relatively constant in recent years, few new oil reserves have been discovered. Mexico’s state oil corporation, Petróleos de Mexico (Pemex), operates an extensive pipeline network consisting of approximately 453 pipelines spanning 4,700 kilometers.

In addition to crude oil, Mexico has 420 billion cubic meters of proven natural gas reserves. Since the late 1980s, Mexican demand for natural gas has outpaced production, which stood at 37 billion cubic meters in 2004. Mexico also has 1.3 billion tons of recoverable coal reserves. During 2003 it produced 11.9 million short tons of coal while consuming 20.4 million short tons. Most coal consumption is used for electricity generation, while the remainder is used for steelmaking. Mexico has a single nuclear power plant, the 1,400-megawatt Laguna Verde plant near Veracruz.

Mexico generated 209.2 billion kilowatt-hours of electric power in 2003: 83 percent by conventional thermal sources, 9 percent by hydroelectricity, 5 percent by nuclear power, and 3 percent by renewable sources. The bulk of conventional thermal capacity in the national electricity grid consumes fuel oil, followed by coal and natural gas. The country consumed 193.9billion kilowatt-hours of electric power in 2003. Demand is expected to grow by 6 percent per year during the next decade.

Banking and Finance

Banking and finance is the most advanced component of the services sector, attracting about 25 percent of total foreign investment. Mexico has a central bank and six types of banking institutions: public development banks, public credit institutions, private commercial banks, private investment banks, savings and loans associations and mortgage banks. Other components of the financial system include securities market institutions, development trust funds, insurance companies, credit unions, factoring companies, mutual funds, and bonded warehouses. Since 1994 Mexico’s central bank (Banco de México) has been largely autonomous. The bank is governed by a five-member board composed of a chairperson or “governor” and four “subdirectors.” The governor serves a six-year term; subdirectors serve eight-year terms and are appointed on a staggered basis. All members are appointed by the president but once confirmed may not be removed except in cases of gross misconduct or incapacitation as outlined in the Central Bank Law.

Services

Services (including financial services) make up the largest segment of the Mexican economy, accounting for 69.5 percent of gross domestic product (GDP) in 2005 and employing about 60 percent of the national workforce. In recent years, major transnational retailers have expanded their presence in the country. Merchandise counterfeiting and intellectual property rights crimes are pervasive within the informal retail sector, threatening the profitability of the formal retail sector. The tourism sector, which caters primarily to U.S. travelers, accounts for about 8 percent of GDP. Mexico is the primary foreign destination for U.S. travelers, receiving 11.6 million U.S. visitors in 2004.

Labor: During 2005, the labor force was estimated at 34.5 million (out of a total population of 106.2 million). Approximately 1 million new workers enter the labor force annually; however, the Mexican economy typically creates only about half as many new jobs. The Mexican labor market is characterized by the existence of a large informal sector in which workers are mostly unskilled, do not pay taxes, and do not receive benefits, and a formal sector in which jobs generally require more skills, and working conditions and benefits are regulated by strict labor laws. The informal sector is estimated to make up between 40 and 65 percent of the total labor force. During 2005 Mexico reported a low unemployment rate of approximately 4 percent; however, real wages have stagnated during the past decade, and 25 percent of the workforce is believed to be underemployed. In 2003 the labor force was distributed by occupation as follows: services, 58 percent; industry, 24 percent; and agriculture, 18 percent.

Foreign Economic Relations

Mexico’s extensive trade linkages to the United States dominate its foreign economic relations. During 2004 the leading markets for Mexican products in terms of percentage of total exports were the United States, 87.5 percent; Canada, 1.8 percent; Japan, 1.1 percent; and Spain, 1.0 percent. Mexico’s leading suppliers in terms of percentage of total imports were the United States, 56.3 percent; China, 3.8 percent; Germany, 3.6 percent; and South Korea, 3.0 percent. Since the early 1990s, Mexico’s foreign economic relations have emphasized active participation in the World Trade Organization (WTO) and the negotiation of free-trade agreements (FTAs)—most notably the North American Free Trade Agreement(NAFTA) with Canada and the United States in 1993. Mexico has entered into regional and bilateral FTAs involving more than 40 countries.

Trade Balance

Since the late 1990s, the overall merchandise trade balance has been slightly negative, largely as a result of growing deficits with the European Union and Asia (mainly China). During 2005 Mexico’s total merchandise imports were valued at US$223.7 billion versus US$213.7 billion in exports Mexico’s trade deficit with the rest of the world is largely offset by a trade surplus with the United States. This surplus has grown steadily since the late 1990s, driven initially by the boom in manufacturing exports and, more recently, by high world oil prices. During 2004, Mexico’s trade surplus with the United States stood at US$53.7 billion.

Balance of Payments

In recent years, Mexico has overcome a historical pattern of unsustainable high current account deficits. Since the late 1990s, the current account deficit has shrunk to sustainable levels of generally less than 3 percent of gross domestic product (GDP). Current transfers—made up largely of wage remittances from Mexicans living in the United States—have become an important contributor to Mexico’s external accounts, providing capital inflows estimated to be as much as 2.5 percent of GDP. In 2005 Mexico’s current account deficit was estimated at US$9 billion.

External Debt

Total external debt was US$145 billion in 2005. At 21 percent of gross domestic product (GDP), Mexico’s external debt-to-GDP ratio is one of the lowest in Latin America. The debt-service ratio (the ratio of debt service to export earnings) has declined from 25.5 percent in 2001 to an estimated 15.8 percent in 2005.

Foreign Investment

Mexico is the second largest host of foreign direct investment (FDI) in Latin America after Brazil. During the 10-year period following the ratification of the North American Free Trade Agreement (1994–2004), Mexico attracted a cumulative US$148 billion in FDI, about 50 percent of which was invested in manufacturing and another 25 percent directed toward the financial services sector. Net portfolio investment has been rising since 2002; by mid-2005, foreign holdings of government bonds totaled approximately US$10 billion, while foreign investment in the Mexican stock market exceeded US$85 billion.

Foreign Aid

The World Bank provides expertise and financial support to Mexico. Presently, the bank is financing 32 projects in the country, with an average annual commitment of up to US$1.7 billion. The World Bank’s 2005–2008 Country Assistance Strategy (CAS) for Mexico projects loans totaling about US$4.8 billion during the strategy’s four-year timeline and is designed to support the government’s commitment to fighting poverty and inequality.

Currency and Exchange Rate

Mexico’s currency is the peso (MXN). In July 2006, the exchange rate was approximately US$1=MXN11.

Fiscal Year

Calendar year.

Source: Library of Congress – Federal Research Division Country Profile