Understanding the Risks of Doing Business in Mexico
During the first six months of 2019, Mexico overtook Canada as the U.S.’ largest trading partner, with more than $309 billion in goods. In many ways, now is a great time to do business with Mexico. Before one makes the decision to do so, however, he or she should understand a bit of the history and context of our relationship and be fully cognizant of the associated risks. The opportunities for investment are plentiful, but so are the potential hazards. With sound mitigation of those risks, now can be a great time to engage with our southern neighbors.
THE CONTEXT OF OUR RELATIONSHIP
Much of Mexico’s National identity is defined by her resistance to domination by foreign powers and popular revolutions. Even though much of her early history was focused on resistance to European powers, the relationship with the U.S.—“El Norte”—is paramount. From a US perspective, we tend to think of the conflicts in 1836 as Texas’ fight for Independence and the war in 1846-1848 as the Mexican-American War. Mexicans see those events as an illegal occupation and then annexation of their territory and finally, as a U.S. invasion. Some of the most revered heroes in Mexican history are the six “child heroes” from their military academy who died defending the Chapultepec Castle from the U.S. invaders in September of 1847. Five of these heroes were cadets and one was a young lieutenant in the Mexican Army. They refused to surrender to the U.S. Soldiers and died defending their honor. One—Juan Escutia—reportedly leaped to his death wrapped in the Mexican flag rather than surrender. The memory of the child heroes is celebrated with parades and speeches at official events at all levels of government every year and the image of Mexican children giving their lives to defend their country’s honor against an invasion from the north plays large in Mexican national identity. A second “invasion” by the U.S. Army was the Punitive Expedition in 1916, led by then Brigadier General John “Black Jack” Pershing to capture or kill Pancho Villa.
The Mexican revolutionary leader (or bandit, depending on your perspective) had been leading raids into U.S. territory culminating in an attack on Columbus, New Mexico that killed 16 U.S. citizens. The Army pursued Villa (without the approval of the Mexican government) and the deeper that it got into Mexico, effectively violating Mexican sovereignty, the more resistance increased. Pershing’s hunt for Villa led to protests and a short skirmish with the Mexican Army, and the U.S. forces withdrew back to U.S. territory. They did not find Villa but instead damaged Mexico’s self-esteem, giving Mexico another reason to resent the U.S.
The military relationship between our two countries has not always been negative. During World War II, the Mexican Air Force’s 201st Fighter Squadron (The “Aztec Eagles”) fought very successfully under U.S. command in the Philippines.
During the emergency response in the wake of Hurricane Katrina, the Mexican Army legally entered into US territory and provided significant humanitarian relief to U.S. citizens. In addition to other assistance, the Mexicans cooked more than 7,000 meals a day for the victims of Hurricane Katrina. More recently, the Mexican security forces and intelligence services have been cooperating very closely with the U.S. military and law enforcement agencies in their fight against the Transnational Criminal Organizations (TCOs), commonly referred to as drug cartels. Most of our current cooperation is “behind the scenes.” The average U.S. and Mexican citizen does not know how closely we are working together to enhance each country’s security. Given that backdrop, I believe that any dealings with Mexican government entities or Mexican businesses must first be built on a firm foundation of mutual respect, and certainly that foundation must respect Mexican law, culture, and sovereignty.
The current governmental system in Mexico was created in the aftermath of the 1910 revolution. Its constitution of 1917 mandates a presidential system similar to the one in the U.S., with two bodies in the legislature and an independent judiciary system. Even so, Mexican politics were dominated by a single party, The Institutional Revolutionary Party (PRI) for more than 70 years. Mexican presidents serve for a single six year term, or sexenio, and they cannot be re-elected. From 1929-2000, PRI won every presidential election, and the serving president (in effect) designated who his successor was to be. Mexico’s major opposition, the National Action Party (PAN) won its first presidential election in 2000, and from that date until 2018, both PAN and PRI alternated in winning the presidency.
The third major party in Mexico, the Party of the Democratic Revolution (PRD) is an off-shoot of PRI. Its candidate in both the 2006 and 2012 elections was Andres Manuel Lopez Obrador (or “AMLO”). In both cases, he ran a strong campaign but lost to first the PAN and then the PRI candidate.
For the 2018 election, AMLO changed his tactics, moderating his usual fiery rhetoric (his platform was more moderate and less left-leaning than it had been in the past), and he established an entirely new political party, The National Regeneration Movement, or MORENA. AMLO promised to “return the Army to the barracks,” or get them out of a law enforcement role, reduce the levels of violence, and defeat the corruption that besmirched all three of the other parties. In our own national election in 2016, then-candidate Donald Trump said a number of things about Mexico and Mexicans that probably played well with his U.S. base and helped him get elected, but offended nearly every one of our neighbors to the south. The President of Mexico at the time, Enrique Pena Nieto, publicly defended Mexico’s honor and his abysmal approval rating (12% at the time) improved, if only moderately. AMLO’s campaign was overwhelmingly successful. He won the presidency with a record 53% of the vote, but just as importantly, the MORENA party won majorities in both houses of the legislature. The mandate from the people was clear. They wanted a significant change of direction, to reduce the levels of violence, and to end corruption.
AMLO was inaugurated on the 1st of December 2018, and in his first year, he has governed consistently with his campaign promises. AMLO rolled back many of the trappings of the office of the president (such as disbanding the presidential guard and capping government salaries) and has taken steps to fight corruption. Regarding the return of the Army to the barracks, he seemed to realize even before he was inaugurated that the military plays an indispensable role in fighting the “Narcos.” In many region/states, the military was the only force capable of fighting and defeating the TCOs. AMLO announced the creation of a “National Guard,” which would have many law enforcement responsibilities. The speed at which he did so was impressive, but it was not built from scratch. The Mexican government formed the National Guard from the ranks of the Federal Police, Navy (and Marines), and mostly the Army. Though there are still many details to resolve, the National Guard has already seen significant action against the TCOs.
The creation of the National Guard reflects AMLO’s inward-looking focus…one could call it “Mexico First.” As such, he has reverted to a non-interventionist foreign policy posture and has sought a less forward-leaning role than his predecessor in both regional and international leadership. The inward orientation has also been focused on the economy. Though results have been somewhat mixed, Mexico’s consumer prices rose an annual 2.99% in early September, the lowest inflation rate in three years. Mexico’s unemployment rate has been consistently less than 4% and retail sales have been exceeding expectations. The economy has contracted throughout 2019, not yet reaching projected growth rates. Maybe most importantly, AMLO has been pushing PEMEX (the nationally-owned oil company) to increase both oil and gas production. AMLO has also embraced the U.S.-Mexico-Canada Agreement (USMCA), the pending follow-on agreement to the North American Free Trade Agreement (NAFTA), because it is likely to have an even greater impact on Mexico’s economy than NAFTA had.
THE MEXICO-US TRADE AGREEMENTS: NAFTA AND THE USMCA
NAFTA, was initially proposed by President Reagan and eventually enacted under President Clinton’s leadership. The agreement—the first of its kind—has been generally positive for all three countries. Total North American trade was valued at $1.1 trillion in 2016, and NAFTA was the driver of the creation of a North American trade corridor, which is a system of highways and railroads geared toward boosting the international commerce of all three member nations. As an example of scale, about 16,000 trucks cross the U.S.-Mexico border every day at Laredo, Texas, which is only one of our 48 land Ports of Entry on the border with Mexico. Just as importantly, NAFTA guaranteed the protection of intellectual property in all three countries. The lack of those protections is currently a major obstacle in the U.S.-China trade relationship. Few Americans realize this, but about 40% of the products made in Mexico come from U.S. sources. In particular, automobile manufacturing is tied to both sides of our southern border, with multiple crossings of parts and assemblies in the manufacture of a single car or truck. NAFTA also eliminated many tariffs and decreased protectionism in all three countries. Lastly, there has been an undeniable net increase of manufacturing jobs in both Mexico and Canada. Despite the political rhetoric that NAFTA cost the U.S. many thousands of manufacturing jobs, most of the loss was due to increased automation and competition with China rather than our trade agreement with Mexico and Canada. Since Ross Perot ran against Bill Clinton and George HW Bush in the 1992 U.S. presidential election, no U.S. politician rallied around the need to change NAFTA until Donald Trump ran for president in 2016. NAFTA will stay in place and govern our trade relationship with both Mexico and Canada until a follow-on agreement is ratified in Congress as well as the Canadian and Mexican legislatures.
That follow-on agreement is the USMCA. At this point (late December 2019), both Republican and Democrat members of Congress have signaled bipartisan support for approving the USMCA, so it looks like it will be ratified in 2020. Despite much of the talk, the USMCA retains much of NAFTA, and is “modernized” by provisions of the now-defunct Trans-Pacific Partnership (TPP) agreement. According to Bruce Heyman, the U.S. Ambassador to Canada under the Obama Administration, the USMCA is a “rare win-win-win” for all three countries. The USMCA will have a profound impact on the automobile industry. While NAFTA requires that 62.5% of the parts that go into cars here must be manufactured in North America, that figure will increase to 75% under the USMCA. Auto executives surveyed in a year ago believed that it would increase North American vehicle manufacturing and provide a net improvement for both workers and consumers, but they also realize that they’ll need to find efficiencies. Under the USMCA, automakers must build 40 percent of their cars in facilities where assembly workers earn at least $16 an hour. This wage limitation is not a challenge for the U.S. or Canada but will have a significant impact on wages in Mexico. Mexico has also revamped its product safety regulatory framework to ensure that it is consistent with U.S. law. As a result of the USMCA, one can expect continued strong support for low tariffs on the Mexican side and continued support for their export-oriented programs, which give advantages to U.S. companies that operate near the U.S.-Mexico border and bring in goods from the U.S. for further processing in Mexican facilities. The USMCA also mandates stronger country of origin requirements for textile production within the free trade zone, which is designed to bolster American textile manufacturing. Some of the modernization adopted from the former TPP agreement include streamlined customs procedures and provisions on digital commerce. U.S. investors and companies who understand and prepare for these coming changes will be in a better competitive spot than those that don’t. Suggested changes to the USMCA appear to be on the road to approval in all three countries. Our thriving trade relationship with both Mexico and Canada is likely to become even stronger.
Understanding the Significant Threats: TCOs and Corruption
Though one might be tempted to call the Mexican-based TCOs “drug cartels,” that would be too simple a moniker. After their peak in the 1980s, Colombian drug cartels were displaced by the Mexican organizations. The Mexican TCOs do in fact grow/manufacture, smuggle, and sell illegal drugs, but their central reason for existence is to make money, anyway they can. They smuggle people (both migrant workers and criminals), they kidnap and ransom victims, they steal fuel, smuggle weapons and ammunition, and extort both business and governmental leaders. The Mexican TCOs currently have a presence in every major U.S. city to represent their interests in every component of the illegal drug trade. The Mexican TCOs used to concentrate on moving marijuana, but have recently retooled their efforts to concentrate on heroin, meth-amphetamines, cocaine, and fentanyl. Chinese firms are also complicit in this business, since nearly all of the precursors for fentanyl made in Mexico originate in China. It may be true that fentanyl has important uses in anesthesiology in operating rooms around the world, but as an illicit drug, it is an opiate that is 50-100 times as powerful as heroin and it currently accounts for a significant percentage of opiate overdoses and deaths in the U.S. (which for several years have outnumbered deaths due to car accidents).
The U.S. Department of Justice reports that Mexican TCOs bring in between $18 and $39 billion dollars in profit every year. Those funds enable the TCOs to buy military grade arms and ammunition which compete with (and in some cases outgun) Mexican security forces. In addition to outfitting their troops with military grade munitions, the TCOs reward innovation and ingenuity. They tend to be agile and employ drones, for example, to monitor the U.S. border and leverage social media to enhance U.S. heroin sales.
If nothing else, the Mexican TCOs are very violent. Most of that violence occurs in areas where rival TCOs are competing for dominance, and much of that area is on the U.S.-Mexico border. They regularly employ terrorist methods: car bombs, ambushes, and beheadings are all typical tactics. The U.S. Department of State currently lists Mexico as a “Level 2” area (exercise caution), but five states are assessed at Level 4 (do not travel there), and 11 are at Level 3 (reconsider travel). Those travel warnings concern more than half of Mexico’s 32 states. In 2018, Mexico had the highest number of murders in its history (an average of 91 deaths a day) and that ominous statistic will likely be higher in 2019. With respect to the drug part of their business, there will probably always be TCOs as long as the demand for illegal drugs on the U.S. side of the border is high. To date, most U.S. citizens caught in TCO violence are either involved in the drug trade, or just happen to be at the wrong place and time. Unlike the violence in 1980s Colombia, U.S. citizens are generally not targeted. Tourist areas are generally safe as is Mexico City (Acapulco is an exception). President Trump is considering declaring the Mexican TCOs as Foreign Terrorist Organizations, or FTOs. On one hand, the threat of labeling TCOs as FTOs could propel AMLO into taking more action against the TCOs, as the threat of imposing barriers to Mexican goods convinced the Government of Mexico to do more to curb illegal migration to the U.S. According to some experts, however, there would be no real benefit in doing so, since we already have all the tools necessary to extradite and prosecute TCO leaders under the 1999 Kingpin Act. Conversely, such a declaration would put us at odds with the Government of Mexico and surely drive up insurance rates for U.S. businesses operating in Mexico.
Corruption, the abuse of public power for private benefit, is rampant throughout Latin America and in 2018, Mexico ranked 138th our of 180 countries in Transparency International’s Corruption Perceptions Index (CPI), which tied it with Russia, Iran, and Papua New Guinea. Corruption grew under 70 years of PRI governance, then it changed face under the last 20 years of PAN and PRI leadership. Both the PAN and PRI parties forced an increase in privatization, with the goal of reducing or defeating corruption. If anything, it has made the situation worse. AMLO said in his inauguration speech that privatization was synonymous with corruption—signaling an obvious move back toward state control. Only time will tell if AMLO is successful in his fight against corruption, but with majorities in both houses of the Mexican legislature, there is reason to be hopeful. A basic assumption (though clearly a generalization) is that the local police are more corrupt than the federal police, and the federal police are more corrupt than the military. There are plenty of exceptions to that generalization, but it is safe to say that the risk of corruption increases in proportion to how far away from Mexico City one travels. Non-U.S. competitors that are conducting business in Mexico do not need to comply with the Foreign Corrupt Practices Act, which may put U.S. businesses at a relative disadvantage in Mexico. While most industrialized nations have anti-corruption laws, U.S. anti-corruption laws are strictly enforced. The fight against corruption in Mexico will be a long one, but there’s reason for hope: Chile, formerly one of the most corrupt countries in Latin America, enacted a comprehensive series of anti-corruption measures and completely turned around its reputation. Chile now ranks 27th on the CPI list, which is only slightly behind the United States at 22nd. For the foreseeable future, the dual threats of criminality and corruption are potentiality always part of the environment in Mexico.
I believe that the time is right to both invest and do business in Mexico. With a new Mexican President who is tackling corruption and with the likely ratification of the USMCA, there are plenty of opportunities and reasons to be optimistic. If American businesses treat their counterparts with respect and continue to be aware of the TCOs, I believe that there is abundant opportunity for successful trade to benefit all. There are plenty of good people on both sides of the border fighting these heinous criminals, but this will be a long fight. My recommendation is clearly to engage in Mexico, but I also recommend U.S. businesses continue to be aware of the hazards and don’t take unnecessary risks.
The U.S. Embassy in Mexico has a very active section that is geared toward helping American firms to do business in Mexico.
One can learn more at https://mx.usembassy.gov/business/getting-started-mexico/