The new economy and the opportunities for Mexico
Mexico needs to invest more in the creation of industries of the future and in the development of greater productive and innovation capacities, and to do so urgently to capitalize on the opportunities that a more regionalized and greener global economy offers. In an interview with Comercio Exterior, Kevin Gallagher puts out this call and backs it up with a rigorous analysis of the international situation; of the dispute for world leadership in which China and the US are engaged, and of the impact that the technological revolution and the pandemic are having on the performance of international flows of goods and investment. Time is of the essence.
Por: Guillermo Máynez

Will the instability associated with the increasing rivalry between the US and China be the defining aspect of the international scenario in the coming years?


I hope not. Although the loss of economic leadership by the US and its increasing obsession with China have deteriorated the international environment, it is up to key and developing economies, such as that of Mexico, to form a common front to reconstruct the multilateral system and ensure that the tensions between the two superpowers are settled within their institutions. We need a renewed multilateral system, that is stable and capable of ensuring healthy competition in the markets, but also closer cooperation that channels international efforts toward the achievement of wider development objectives.


Given the complexity of the international context, do the bases exist to expect a significant exit of productive processes from Asia and their relocation in North America, particularly in Mexico?


Some of the most important value chains were established in Asia because China overtook Mexico as an export platform toward the US and Europe, which is still surprising. China has been investing in innovation for many years, in special economic zones and in other efforts aimed at the construction of an environment ripe for the arrival of global firms and the strengthening of China’s capacities for production and export. In research I carried out with Enrique Dussel of the UNAM’s Economics Faculty, we became aware of the dynamic growth of Chinese exports to the US, and the subsequent displacing of Mexican exports to that market. The geopolitical environment and the rising salaries in China offer a new opportunity for Mexico. The USMCA contains some useful clauses to recover and expand Mexico’s presence in external markets, but if the country does not invest the necessary amounts it could irretrievably lose that opportunity. It must be taken into account however that business prospects in a market with the rhythm of growth and size of China in particular, and of Asia in a wider sense, constituted, at the time, another powerful incentive for foreign firms to set up shop in that continent. The incentive is still there, many companies will maintain their operations in Asia to take advantage of that and we will eventually be able to see a significant shift in the dynamic of the global economy, when China and other countries pull back into their domestic markets in the face of growing hostility from the US.



Will the hostility that currently characterizes the relationship between China and the US change significantly under a Biden administration?


Trump’s erratic economic policies and his inadequate handling of the pandemic revealed the risks of a global production model that is excessively segmented; as a result, we can expect a correction in order to bring the manufacturing of certain goods back to the US. At least one segment of the coalition supporting Biden is committed to a recovery of US industry, more than that expressed by Trump, and it is probable that Biden will try to forge a new bilateral relationship, guiding it above all by diplomatic channels. If that is the case, Mexico will have the opportunity to improve its place within US value chains, giving priority to effectiveness and innovation, and leaving salary costs and the geographical proximity more in the background.

If Biden achieves his ambitious economic plans, Mexico will have to accompany him on his shift toward the substitution of fossil fuels. If that is the case, Mexico’s oil and gas exports to the US will see a substantial decline and that will obligate Mexico to reconfigure its productive infrastructure so that clean and dynamic energy generation predominates. Trump abandoned that transformation and Mexico followed him. Biden, in contrast, must accelerate it, if he wants to compete with China and Europe, which have been making the decisions and carrying out the correct investments for more than a decade.


In September of this year, in a panel at the Center for Strategic and International Studies, you recommended that Latin American countries negotiate more ‘Asian-style trade agreements.’ Could you elaborate on that?


In investment and trade agreements promoted by the US the interests of those activities and companies in which the US has clear comparative advantages have prevailed, that is, in the financial and pharmaceutical industries and others that are capital- and knowledge-intensive. The bias that can be observed in those types of trade agreements limits the development of strong financial and health systems, and the advancement of knowledge-based industries. In contrast, Asian-style investment and trade agreements offer a wider margin for maneuver to implement public policies that channel efforts and investments toward providing a boost to newer and more dynamic sectors. This to a large extent explains why Asia has become a powerhouse of manufacturing and knowledge.


In the context of Covid-19 and the evolution of global trade, we can identify three important trends: the regionalization of productive processes, the automation of production and the predominance of the availability of infrastructure and a specialized labor force as decisive factors for the location of multinational companies. In a world with these characteristics, what future awaits Latin America in general, and Mexico in particular?


This could be the last opportunity for Latin America to transit to a higher level of development. While it is true that Mexico’s strategic insertion into the production chains of North America makes it one of the countries with the biggest impact in the region, it is also true that it faces the challenge of channeling large-scale investments to strengthen its productive and innovative capacities. In this context, Mexico and the rest of the countries of Latin America have shown a highly deficient performance over the last 30 years. Investments do not surpass 20 percent of GDP and to a great extent come from foreign companies that, due to their scarce links with the rest of the production chain, tend to displace local industry. During that same period, productive investment in Asian countries has performed better and oscillated between 30-40 percent of GDP.

Within the current context of the world economy, investments in innovation, technology and industrial capacity are decisive for a country’s development. Given the lesser importance of oil and gas in the productive processes of the greatest impact, as well as the displacement of cheap labor as a decisive factor in the international competitiveness of emerging economies, Mexico, in my opinion, has no other option but to invest intensively in green and dynamic industries, as well as in creating a highly trained workforce.

You have written about the different types of development of Mexico and China, noting the subtle differences between the Chinese model of ‘learning via production’ and the Mexican model of ‘learning by trading.’ What lessons can we learn from these comparisons?


México has applied industrial and trade policies that, on top of everything else, inhibit the development of vibrant and diversified industries. Its monetary policy, for example, favors imports by maintaining a frequently over-valued exchange rate parity. NAFTA, for its part, promoted the establishment of foreign companies in the country and the creation of a platform for manufacturing exports of little added value at home, given the scarce investment in national production capacity and the formation of human capital. China has done the opposite in each sector, with competitive exchange rates, wider trade agreements and large-scale public investment in infrastructure and national industries, and the contrasting results speak volumes. If Mexico wants to take advantage of the opportunities brought by the new global context it is obliged to emulate the kind of policies implemented in Asia.


Shared production in North America is one of the most important legacies of NAFTA that, in general terms, is consolidated with the entry into force of the trade deal’s successor, the USMCA. What are the main areas of opportunity in this region in the years to come?


The world’s main car manufacturers have installed themselves in North America and have integrated a very solid sector. Evidently, the transportation of vehicles and aerospace products is costly, and which shows the importance of moving production closer to consumer markets. The region is drawing up a plan of regional infrastructure, of highways, railroads and air routes, that stimulates the demand for ecological vehicles and transportation systems like the ones now being developed in Europe and Asia. If the three countries could unite to develop a plan of that kind and the region worked together to modernize infrastructure and companies, a more adequate environment could be created for private investment and regional economic growth. However, due to political reasons, North America continues to stick to models of relatively lower impact and the region is in danger of remaining at the margin of the development that we are seeing in Asia and Europe.


The tension that prevails in the China-US bilateral relationship has limited the trade exchange between both countries, particularly regarding hi-tech products, where China is losing presence in the US market. What course of action would you recommend the Mexican government and private sector follow to take advantage of this situation?


For Mexico this is a real opportunity, without a doubt, given that the US will try to block Chinese technology. But the opportunity will not materialize on its own, we need to work on it. First of all, the North American Development Bank should be strengthened and a regional planning agency should be established that could support it with the design and financing of infrastructure and innovation, as well as aligning trade and investment to that plan. The three countries [Mexico, the US and Canada] urgently need large-scale investment. Until now the private sector has been reluctant to provide it. But as the case of China shows us, private initiative is activated when the government deploys large-scale investment, and which is a factor that all Asian countries share.


What recommendations would you make to the Mexican government to drive economic recovery and combat the economic consequences of the pandemic?


Mexico needs a major fiscal stimulus that, in the first instance, guarantees access to medical services for all of the population and provides economic backing to the people and companies that are most exposed to the noxious effects of the lockdown. It also needs a large support package to improve infrastructure and promote investment in innovation and the development of the industries of the future. Interest rates are currently very low and Mexico also has important development banks that could be strengthened in order to actively participate in the construction of a better and more dynamic productive capacity.


Some analysts foresee a new energy panorama dominated by renewables, in which China would control the production of various raw materials and crucial manufacturing processes. What impact would that have on global alliances?


It is too soon to concede those markets to one specific country. As a result of mistaken policies, the US and North America in general are way behind in the digital and energy technology of the future. If North America worked together to innovate and create the bases for sustainable infrastructure, the size of our markets would strengthen our international competitiveness in these strategic sectors. That is the central challenge.


You have written about the relationship between free trade and the environment. Are there synergies between the two, or are they following a zero-sum game?


Trade and investment treaties have not aligned with environmental goals, and that has proved very costly for two reasons. Firstly, and as I mentioned before, the rules of trade and investment favor the interests of traditional industries, some of which are close to obsolescence, and have put the brakes on the development of clean technologies and activities. To that is added the high cost we pay for environmental degradation, of between four and five percentage points of GDP per year, according to conservative estimates.


You have also written on the regulation of cross-border capital flows. The pressure to more effectively combat cross-border crime and money laundering appear to indicate a need for new laws of governance of those flows. What are your expectations in this theme for the coming decades?


This is an area in which Mexico has a lot of experience and, to a certain extent, leadership. Both Mexico and Latin America, in general, are very exposed to economic cycles of sudden bust and boom. When interest rates are low, demand for Mexican imports in the US grows, and short-term capital flows to Mexico increase. These movements cause an appreciation of the Mexican peso against the US dollar, and which causes the sensation among investors that they have more solid collateral, and as a result they contract more credit. As a result, not only does that initial impulse slow down (via the exchange rate mechanism), but it creates a US dollar-denominated debt bubble when interest rates go up again. Unfortunately, the exchange rate adjusts very quickly, and which increases the country’s financial fragility. Over the last decade, Mexico has incorporated some interesting mechanisms of currency coverage, but it has failed in the instrumentation of policies that channel long-term financing into the industries of the future, such as those used in countries like South Korea, China, Chile and Colombia. Mexico put a lot of attention in the original NAFTA on reserving the right to apply those regulations, but it has not exercised them, unlike South Korea, which has done so within the framework of its own free trade agreement with the US. It is one thing to procure the space to apply responsible policies and another to take advantage of that space.