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Mexican Economy Shrugs Off Narco War

On America’s southern border lies Mexico, a nation under siege as a violent battle rages between rival drug gangs for control of the supply of cocaine and other drugs into the United States.

cancun mexico
Hisham Ibrahim | Getty Images
cancun mexico

On Thursday, authorities arrested 16 police officers suspected of protecting four members of the notorious Los Zetas who are linked the massacres of at least 126 people in San Fernando.

It is an all too familiar story in Mexico, where over 30,000 people are believed to have died in 2010 as the drug war raged on despite the government’s efforts to boost police numbers and crack down on corruption.

The drug war has been cited as a reason why Mexico’s economy has been unable to match the growth rates of other major emerging markets in recent years, despite its proximity to the world’s biggest economy, the US.

Over the last decade UBS says growth has averaged less than 2 percent whilst the BRIC nations have shined, but last year Mexico began to play catch up.

“The buzz that has surrounded the BRICs (Brazil, Russia, India, China) and other fast-growing emerging economies in recent years has largely passed Mexico by, and arguably for good reason” said Rafael De La Fuente, an economist at UBS in a research note.

Despite the drug war, Mexico’s economy took off last year with growth of 5.5 percent and UBS is predicting 2011 growth will hit 4.8 percent.

De La Fuente says this growth is not being mirrored by inflationary pressures.

“This surge in growth is happening in the absence of significant macroeconomic constraints: inflation pressures remain subdued; fiscal and external accounts are healthy, and the peso, despite its sharp appreciation in recent months, remains competitive,” he said.

Following loss of market share to China on the sale of manufactured goods to the US but UBS note that whilst China continues to dominate sales of manufactured good to America, Mexico is beginning to take market share off other Asian exporters.

“Mexico appears to be taking market share from other Asian exporters as well as developed market players, especially Canada.," De La Fuente said.

“The second thing to note is that this is not exclusively an auto story.

While autos are indeed Mexico's most important export manufacturing sector, and the one where it enjoys the clearest competitive advantages, Mexico is also capturing market share in electronics, and has even managed to halt the slide in low value added sectors such as textiles,” he said.

Mexico benefits from lower labor costs, a relatively competitive Peso and its ability to get goods to the US market easily by road.

“As far as the rise in violence is concerned, it appears to have negatively impacted manufacturing activity in the hardest-hit states, but there is evidence to suggest that some of this manufacturing activity has migrated to lower-violence states in central and southern Mexico that have the necessary infrastructure to supply the US,” De La Fuente said.

One of the problems holding back the Mexican economy is its failure to create enough value added jobs that would boost earnings and therefore domestic demand.

“While the economy has generated more than one million formal sector jobs since the trough of the recession, they have been largely in low value-added, low-paying sectors.

Growth in better-paying manufacturing employment should therefore support a recovery in consumption that has so far proved elusive, giving increased lift to other sectors –particularly services -- in the process,” said De La Fuente.

UBS does not believe Mexico’s economy is about to enter a new sustained period of higher growth.

“Its dearth of investment in key industries, its fiscal overdependence on oil, the prevalence of monopolistic practices, the increase in violence are all too real and likely limit Mexico’s potential growth rate in our view to somewhere in the vicinity of 3 percent going forward, pedestrian by the standard of many emerging markets,” said De La Fuente.