Mexico Feels US Manufacturings Pain

October 3, 2005
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GRAND RAPIDS — The impact of Hurricane Katrina and her cohort Rita will be felt throughout the global economy in the months to come.

Katrina and Rita were major shocks both to the U.S. manufacturing sector and to the inflation side. Behemoth Katrina delivered a double blow to the U.S. economy by pushing up energy prices and destroying infrastructure.

Globally, its impact will be transmitted primarily through a temporary spike in global consumer price inflation, which will put a squeeze on household purchasing power through the end of the year, according to Alfredo Thorne, managing director and head of Latin American Economic & Policy Research at JP Morgan Chase Bank/Bank One. Thorne delivered an economic overview of Mexico at Western Michigan University’s downtown campus Wednesday.

When America hurts, Mexico feels its pain.

“Both of us across the border are extremely linked in the sense that Mexico is a manufacturing hub for the U.S., as is China on the other side of the Atlantic,” Thorne said. “Mexico is growing less because U.S. manufacturing growth is slowing down.”

Mexico has strong exposure to the U.S. automotive industry and “that patient is not healthy at all,” as Thorne put it.

“Three large U.S. auto companies that account for most of the output in Mexico are having trouble,” he said “When your companies get into trouble, ours do too. We probably get into more trouble because we are suppliers.”

Mexico’s automotive production collapsed by more than 30 percent in July because GM car-buying incentives liquidated some of the inventory rather than producing additional cars, he noted. He said Mexico is now diversifying to reduce its dependence on automakers.

Mexico’s maquila industry, on the other hand, is doing pretty well, Thorne said. The maquila sector includes thousands of plants that assemble a variety of finished or semi-finished durable goods to be exported and sold predominantly in the United States. The maquila sector constitutes a significant portion of America’s offshore industry.

“They don’t sell to anyone anywhere else except the U.S. This sector is linked 100 percent to the U.S. economy.”

In the fourth quarter, manufacturing in Mexico should start to feel the negative effect of Katrina, the deceleration in U.S. manufacturing output and the effect of high gasoline prices on auto production. Less growth is expected for the remainder of 2005, but JP Morgan Chase analysts expect most of those drags on economic growth will fade in the early months of next year.

Mexico suffered in the mid-’90s when the U.S. Federal Reserve tightened monetary policy, but the country has become much more resilient since then and has reduced its vulnerability to external shocks, Thorne said. Mexico has changed, and it has changed for good, he said.

“Mexico now has a flexible exchange regime,” Thorne said. “The exchange rate is an instrument that actually absorbs shock; it’s a way of controlling for pressures that otherwise couldn’t have been controlled.”

He said that means Mexico should be able to absorb the “shock” of Federal Reserve tightening without much problem.

On top of that, Thorne pointed out, Mexico’s current account deficits have narrowed. The country’s current account balance has a slight deficit, unlike when the Fed tightened in the early and late 1990s.

Too, Mexico has substantially reduced its reliance on foreign borrowing, and thus its vulnerability. The main danger posed by large foreign capital inflow is that it has the potential to destabilize a country’s macroeconomic management and result in the loss of local control over economic decision-making.

Thorne said that unlike previous periods of Fed tightening, Mexico currently has a large international reserve buffer. Furthermore, Mexico has developed local capital markets, which assures there will be no major sell-off in the debt market, he said.

“That means most of the debt is funded domestically, not externally, so we rely less on the external market,” he explained.

JP Morgan Chase analysts see “dramatic improvement” in efficiency and cost adjustment among Mexico’s manufacturing firms. After falling off in the 2001 recession, manufacturing labor productivity has boomed. To analysts, the drop in manufacturing unit labor cost in Mexico implies improved labor cost competitiveness.

The combination of higher labor productivity and reduced labor costs has helped restore companies’ profit margins and competitive advantage, they say.    

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