The Pandemic and Its Impact on Mexico’s Economy and Foreign Trade

Interview with José Luis de la Cruz, Director of the Institute for Industrial Development and Economic Growth (IDIC)

By: Susana Sáenz

The Pandemic and Its Impact on Mexico’s Economy and Foreign Trade
Among the factors we can use to try to weigh up the economic outcome of the pandemic is what we remember from past crises, as well as trends in global value chains, like the current economic war between the United States and China, or the recent coming into force of the USMCA. Talking to Comercio Exterior, IDIC Director José Luis de la Cruz, author of the book México frente a su crisis, presents an array of topics that make us think about the course to follow.

What do you think about how the Mexican economy is behaving in this complex global situation?

With information until April, a downturn of close to 20% pa was seen in the Mexican economy, the worst since monthly records exist, that is, since 1993. It is also of a higher magnitude than the one registered in the early eighties, which marks the beginning of the period known as the “lost decade.” So, considering the 30 years of uninterrupted economic growth of the so‑called “stabilizing development” (1940-1970), we will have to go back to the 1929 Great Depression to find a crisis of similar proportions to the one that, based on available data, is emerging in the country.

 

What are the differences between the current crisis and the one in 1929? At the time, the crisis was triggered by a stock market crash, followed by a prolonged slowdown of economic activity. Today’s crisis originated in a public health problem that we had not seen in over 100 years. Hence, the usual monetary and fiscal policies will not be sufficient to tackle the problem.

 

 

For some analysts, economic activity will follow a V‑shaped curve; more cautious ones say it will be more of a U shape, and pessimists even talk about an L shape. How long will this crisis be?

Historically, Mexico takes up to two to four years to overcome a crisis and go back to the previous level of economic activity. This time, however, it will face an even more adverse situation. The United States, usually an engine for the growth of the Mexican economy and particularly important in episodes such as the 1995 crisis, is going through a deep recession—the biggest in the past 50 years. The health emergency is ongoing and the recent infection spike has slowed down or reverted the lifting of lockdown measures in numerous American cities. This uncertain situation will affect the northern neighbor much more, as well as its foreign trade dynamic, and thus, will have a negative impact on the recovery of Mexico’s economy.

 

Even with the coming into force of the USMCA, I believe Mexico will need three to five years to overcome the crisis. Let’s see if the country’s economic policy is able to chart a faster route to recovery.

 

 

 

In order to establish a reference framework, what would you say was good in the country’s industry performance in 2019, the year before the pandemic?

Clearly, the Mexican economy started 2020 with signs of weakness: in 2019, the economy fell 0.3%, and in December of that year, industrial production already accumulated 15 consecutive setbacks. The downward trend was notorious. In a broader timeframe, the average industry growth in the last 18 years is 0.5%: a very limited expansion, despite the fact that we export many manufacturing products. The problem is that, without an industrial policy, the value added internally to Mexican exports is very low. The weak production chains of the export sector, along with the rest of the industrial fabric, limit the industrial dynamics of the country. The outlook does not look encouraging in other production sectors either: the construction sector shows very weak performance, and the extractive sector is suffering from the very significant drop in oil and gas production.

 

 

What other elements should be taken into account to have a better picture of the country’s current economic situation?

In this complex world panorama, there’s a set of key variables that show an acceptable evolution for the Mexican economy. There’s price stability; exchanges rates have resisted internal and external attacks; and depreciation seen in the first few weeks of the health emergency was contained. Public finances showed good results in the year’s first quarter, although since April, government income lost momentum. Its ultimate test will come from the second quarter of the year. The evolution of these variables will affect the performance of relevant activities for the economic course of the country; among others, retail trade (because of the livelihood it provides to thousands of Mexican families), wholesale trade (important indicator of the country’s business dynamics), transportation, and other services such as education, health and professional.

 

How have things evolved in other parts of the world? Is there evidence of successful economic recovery strategies?

The biggest success is seen in Asia. China, for example, has seen two months of growth in its industrial sector. After the sharp falls in January and February, it managed to halt the decline in March, and in April and May it registered growth rates averaging 4.3%.

 

South Korea also managed to contain and overcome the moderate setbacks of its economic activity. In other countries of Chinese influence, like Taiwan and Hong Kong, economic evolution shows mixed results, but there are already signs of stabilization. Driven by the strength of its industry, Germany is likely to be the first European economy to recover, and it will do so together with France, with which it established an industrial policy alliance to reactivate their economies. On the American continent, Canada managed to stabilize its economy and is on the path towards growth. It should be noted, however, that the uncertain evolution of the pandemic will test the strength of economic recovery in all countries.

 

 

How will the beginning of the USMCA impact the evolution of the Mexican economy?

The impact of the USMCA on the Mexican economy will be much clearer over the next two years. We need to give company investments and projects time to mature in anticipation of the new trade regulations coming into force. This applies to all trade agreements. And in the particular case of the USMCA, we should also take into account that many of the tariff reductions for intraregional trade were already considered in NAFTA, the previous trade agreement. Therefore, the effects of the new agreement will hardly materialize in the short term.

 

Another element to consider is the recession the three North American trade partners are going through, mainly Mexico and the United States. Ongoing investments and projects, and those scheduled for the next few months will most probably need to be adapted to the new recessive environment. There is caution among investors, because the recent evolution of the pandemic makes it difficult to establish when economic activities will return to normal.

 

Another factor that will come into play in the evolution of the USMCA is the upcoming US presidential election, since we know that the new agreement is a President Trump project and that investors will act with greater caution in the event of a change in administration. Not because the agreement is in danger—I don’t think it is—but until now, we don’t know what Joe Biden could incorporate into the trilateral agreement, should he become president. This possibility will surely result in a waiting period in the investment decisions of companies. And finally, I would add another element, which Alejandro Werner, director of the International Monetary Fund, pointed out: Mexico must work to shore up confidence and certainty among investors. If this endeavor is not successful, the USMCA will contribute little to the reactivation of the Mexican economy.

 

 

From your thoughts in your book México frente a su crisis: el reto de la cuarta transformación, what do you consider to be the most salient aspects of a comprehensive and virtuous response to the ongoing economic crisis?

The first thing is to have a great national agreement. The government does not have sufficient financial resources to take charge, on its own, of the much‑needed recovery of the Mexican economy, the preservation of jobs and the business fabric. So, a great national agreement is essential.

 

That great national impact must ensure that investment and public spending have a positive impact on the value added internally to goods and services produced in the country, i.e. promote what’s made in Mexico. The objective of raising productivity and competitiveness should also be part of this national agreement and be in line with the preservation of employment and social welfare. In the execution of this great national agreement, the development bank plays a leading role, but it must assume a more active role in financing the production sector, especially small and medium-sized enterprises. Finally, it is essential that public investment in infrastructure be increased and that the construction sector be given decisive support, because it is one of the most dynamic engines available to reverse the Mexican economy recession.

 

 

How will the health emergency and the measures taken to restrict mobility in public spaces impact on the digitization and automation of companies in the country?

In principle, Mexico must be aware that the fourth industrial revolution, in a way, is well underway. It is hardly in a position to exercise any kind of thought leadership because most of that breakthrough has already occurred. Therefore, it has to democratize the technological revolution, make available to the vast majority of companies the advances of the fourth industrial revolution, the technification, digitization, the use of telecommunications, the processes taken to the cloud, including advances in robotics, mechatronics, microelectronics, to name a few.

 

And of course, the educational system, which needs to head towards higher quality processes in the teaching of mathematics, physics, science and technology, for children and young people to be ready to adapt to the fourth industrial revolution, especially to have the ability to influence technological processes that will ensue.

 

 

How will internationally highly segmented value chains, such as automotive and aerospace, evolve?

The USMCA will create a new reference framework for the automotive industry in North America. Regional content rules, and work and wages regulations in the new agreement clearly do represent a substantial change in its production dynamic. With the impulse of NAFTA, Mexico consolidated itself as a very dynamic automobile and auto parts production and export platform, with the United States as a very relevant destination market. There is now some uncertainty regarding the destination of the new production investments of the North American automotive industry: will they still come to Mexico or will some portion be redirected to the United States or Canada. Surely, these decisions are already on the table for directors of the automotive companies with interests in the region, and I believe there is a good chance investments will reach Mexico and contribute to the recovery of its economy. As for aeronautics, it’s a relatively new industry in the country, but with very positive progress. In order to keep up its vitality, Mexico must step up its efforts to create an environment to attract more investments. We must remember that in this recessive environment, some projects will be scaled down, especially those related to tourism and air traffic, two activities that are highly affected by the pandemic and mobility‑restricting measures.

 

 

A commercial war was being waged by the world’s biggest economies before the pandemic even started. Phase one of an agreement between the United States and China had already been signed, but tensions increased after the COVID-19 outbreak. How will the health crisis impact the international situation?

The geopolitical and geoeconomic war between the United States and China will not change, and it will continue to intervene in President Trump’s foreign policy. With the election around the corner and a possible change in administration, this policy could incorporate some changes, but not substantial ones, because at the end of the day and beyond President Trump, the United States aims to win back part of the manufacturing processes that went to China.

 

A reelection of President Trump would exacerbate this confrontation. Mexico, the United States and Canada would then seek to replace part of the intermediate parts, machinery, equipment and final consumer goods that are imported today from China, with regional production. The Chinese would probably then decide to establish part of their production in North America, especially in Mexico, to try to overcome the restrictions that this trade war would impose on them.

 

 

China has a very important presence in global value chains. How will this crisis affect global production dynamics, and international trade and investment flows?

That’s a very relevant point because today, China produces 1 out of every 4 dollars of added value in manufacturing, i.e. 25% of world manufacturing products are produced in China, and obviously this implies there is high dependence on what is manufactured there. If Trump is re-elected, we will surely witness a change in that international architecture, because the president will press for that to happen. And surely, in a second term, he could end up reconfiguring the World Trade Organization and other international regulatory bodies to exercise increased pressure on China.

 

In conclusion, what can we expect from the second half of the year? Resilience has been said to be key for recovery.

The capacity for the Mexican economy to recover is seen in the different crises it has faced in the last 40 years. What’s important in this new situation is to not only recover the previous economic activity level, but to also undertake a true transformation process enabling economic growth greater than 4% and maintain it. The way to this is to recover our capacity for development, for investment, and the only mechanism that has proven to enable this in the last 40 years is industry. Industrial development is at the root of Korea’s, China’s, Indonesia’s, and Singapore’s takeoff. Mexico would have to go down this path, substantially increase its production capacities, and take them to a new level of growth and social development for the next 15 years.