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HoustonBusiness A Perspective on the Houston Economy FEDERAL RESERVE BANK OF DALLAS • HOUSTON BRANCH • Trade, Manufacturing Put Mexico Back on Track in 2004 The 2001 recession was led by manufacturing in both the United States and Mexico, and slower recovery in Mexico was largely because of Mexico’s greater dependence on industrial production. A decade after the Tequila Crisis of December 1994, the Mexican economy presents a macroeconomic landscape that has been fundamentally improved. An independent central bank brings new transparency and accountability to the conduct of monetary policy, with a stated objective of targeting inflation. The fiscal deficit has been held under 2 percent of gross domestic product (GDP) every year since the 1994 – 95 crisis. The exchange rate floats successfully, with accumulated foreign exchange reserves reaching nearly $65 billion in December. Markets for government debt attract investors at low rates, and government securities now have a duration of up to 20 years. The success of Mexican macroeconomic policy can be seen in the course of recent history. Together with the North American Free Trade MARCH 2005 Agreement and the opening of Mexican markets to trade, it contributed to the rapid recuperation of the Mexican economy after 1994 – 95. And it was essential in limiting the 2001 Mexican downturn to a mild recession, a landmark in a country where every downturn of the prior 30 years had been accompanied by a financial crisis. Macro stability has also brought into focus the growing synchronization of the U.S. and Mexican economies, primarily the product of strengthening trade ties between the two countries. The 2001 recession was led by manufacturing in both the United States and Mexico, and slower recovery in Mexico was largely because of Mexico’s greater dependence on industrial production. In 2004, however, Mexico finally caught up with the United States, as both countries saw GDP grow at a 4.4 percent annual rate. It was the best year for both countries in this round of expansion. This article examines Mexico’s economic performance in 2004 and discusses its economic and political outlook. Figure 1 Mexican Economy Growing Since Summer 2003 sion. Also, both tary policy nine times in 2004, economies were pushing short-term interest Index, January 2000 = 100 buffered by rates from 6 percent to 9 per115 strong consumpcent in an effort to maintain tion throughout inflation within the targeted 110 the downturn rates of 3 percent and 4.5 perand recovery. cent. 105 Although fixed investment fell External Sector 100 9 percent in 2001 Mexican trade reached 2 ), the (Figure $385.8 billion in 2004, up from Dallas Fed coincident index 95 INEGI Global Economic Activity Index decline was much $335.3 billion a year earlier. less severe than Mexico’s No. 1 trading partner 90 the 34 percent continues to be the United 2000 2001 2002 2003 2004 drop in 1995. InStates by far, representing 72 SOURCES: Instituto Nacional de Estadística Geografía e Informática; vestment began percent of total trade. Asia folFederal Reserve Bank of Dallas. to recover again lows with 13 percent and in mid-2003 and Europe with 8 percent. U.S.– strengthened in Mexico trade seems to be back 2004; in the third quarter, it on track, rising at annual rates Mexico Takes Off reached its best quarterly perof 13.5 percent since January Economic activity in Mexico formance since 2000, at an 8.5 2004. intensified in the summer of percent annual rate. Trade has been supported 2003. Figure 1 shows two Because the 2001 recession by sustained increases in the economy-wide measures of was not driven by financial real exchange rate, a roughly Mexican economic activity: a crises, a stable peso and low 25 percent devaluation since coincident economic indicator rates of inflation allowed doMarch 2002. The peso was produced by the Federal Remestic consumption to support among the few currencies in serve Bank of Dallas and an the Mexican economy during the world to depreciate against index of global economic activthe downturn. In 2004, private the dollar in 2004, as the dollar ity produced by Mexico’s chief consumption averaged 8.4 perfell by 5.4 percent in 2004 statistical agency. The two indicent annual growth through the against a broadly weighted cators point to growth in 2004 index of foreign currencies.2 first three quarters, with durof 5.6 and 5.2 percent, respecThe maquiladora industry ables, nondurables and services tively, while the expansion in was the largest generator of all sharing in these increases. GDP was 4.4 percent.1 foreign exchange for Mexico, As job growth improves in 2005, The most strongly growing earning $19.1 billion. This was growing employment and sectors last year were industrial followed by remittances from income seem likely to keep activity; transportation, wareconsumption strong. housing and communications; Inflation in wholesale and retail trade; and Mexico reached a financial services. Within the Figure 2 30-year low of 4 industrial sector, growth was Consumption Fueled the Economy percent in 2003, strongest in construction, manReal Index, 2000:Q1 = 100* but rebounded in ufacturing, and electric, gas, 120 2004 to 5.2 perand water utilities. Together cent. The reasons these sectors accounted for 115 Private consumption for higher prices nearly 80 percent of Mexico’s Fixed investment range from global overall growth in 2004. 110 pressures on com105 modities prices to Consumption and Investment mad cow disease There are numerous paral100 to a weaker peso. lels between recent economic As a result of risevents in the United States and 95 ing prices, the Mexico, including a downturn Banco de México in domestic investment as a 90 2000 2001 2002 2003 2004 tightened monekey feature of the 2001 reces* Seasonally adjusted. SOURCE: Instituto Nacional de Estadística Geografía e Informática. 2 Figure 3 Retail and Wholesale Trade Improve eral building for imports are from the United housing, schools, States, and 91 percent of MexIndex, January 2000 = 100* offices and hospiico’s imports are industrial 125 tals accounted goods. The maquiladora plays 120 Retail trade for 44.4 percent a big role in these numbers; Wholesale trade 115 of construction goods to be assembled are 110 in December; exported by the United States, transportation and assembled final products 105 projects for 21.3 return to the United States as 100 percent; and oil domestic imports.4 95 The revival of U.S. manufacand petrochemi90 turing began in the summer of cal projects for 85 2003, attributable to a resump10.5 percent. The tion of U.S. investment and remaining 23.8 80 2000 2001 2002 2003 2004 strong export growth that percent was * Seasonally adjusted. accompanied global expansion divided among SOURCE: Instituto Nacional de Estadística Geografía e Informática. and a weaker dollar. Mexican water and sewage, manufacturing responded on electricity, televirtually the same schedule communications (Figure 4 ). and other projects. Mexicans working abroad at Like the U.S. decline in Construction activity was $16.6 billion, oil at $15.6 billion manufacturing, the industrial concentrated in the Federal and tourism at $5 billion. Marecession was long and deep in District (22.2 percent), Nuevo quiladora earnings passed oil Mexico. The decline began in León (9.4) and Tabasco (6.1). in 1998 to become No. 1, and late 2000. Mexican manufacturThe states of Campeche, Jalisco, 2004 marked the first year reing employment fell by more Veracruz, Baja California, Tamittances passed oil to assume than 500,000, or 12 percent, in maulipas, Sonora, México and the No. 2 position.3 Mexico’s 2001. Losses continued with a Chihuahua were all in the 3 to international reserves stood at 2.1 percent decline in 2002 4 percent range. Together these historic highs near $65 billion before stabilizing in 2003. The states accounted for well over at the end of 2004. turnaround in jobs began last two-thirds of December conyear, adding back more than struction. Sectoral Gains 60,000 Mexican factory jobs. As consumption, investment Manufacturing and The good news from Mexiand trade improved in 2004, the Maquiladoras can manufacturing is that for they drove improvement in Much of the credit for jumpthe 2001 – 04 period, labor propredictable sectors — retail and starting the Mexican economy ductivity grew at a 4.2 percent wholesale trade, construction goes to the revival of U.S. manannual rate (Figure 5 ). Real and especially manufacturing. ufacturing. The Retail trade increased by industrial linkages 7 percent in 2004, and wholebetween the two sale trade increased by 5 perFigure 4 countries are deep, cent. Retail gains were wideManufacturing Sector Rebounds and trade has bespread, shared by auto dealers, Index, January 2000 = 100* come the chief furniture and home appliance 116 vehicle to transmit stores, clothing and shoe 114 112 economic developstores, and department stores. Mexico industrial production 110 U.S. industrial production ments between In wholesale trade, the strong108 countries. Today, est sectors were oil and energy, 106 91 percent of Mexiconstruction materials, metallic 104 can exports go to manufacturing materials and 102 100 the United States, general inputs to manufactur98 and 82 percent of ing (Figure 3 ). 96 Mexico’s exports Mexico’s construction sector 94 are industrial prodgrew 12.5 percent during 2004, 92 ucts. Similarly, 62 continuing an upward trend 90 2000 2001 2002 2003 2004 percent of Mexican that began in July 2003. Gen*Seasonally adjusted. 3 SOURCES: Instituto Nacional de Estadística Geografía e Informática; Federal Reserve Board of Governors. Figure 5 Manufacturing Productivity Rises and chemicals. Along the Index, January 2000 = 100* Thousands* Texas – Mexico 4,600 120 border, Ciudad 4,400 115 Juárez has added 4,200 9,600 jobs; Rey110 nosa, 9,000; and 4,000 Nuevo Laredo, 3,800 105 3,100. Altogether, 3,600 the six major 100 Employment Productivity border cities 3,400 between Texas 95 3,200 and Mexico add3,000 90 ed more than 2000 2001 2002 2003 2004 21,000 maquila* Seasonally adjusted. dora jobs, conSOURCE: Instituto Nacional de Estadística Geografía e Informática. tributing 28 percent of the nationwide wages matched a decade-long maquiladora job gains in 2004.6 trend by increasing at a 2.4 percent annual rate. Reforms and Politics The maquiladora industry is If Mexico’s macroeconomic a vital component of Mexico’s picture has improved greatly industrial sector, big enough to over the past decade, there is have its own implications for ample room for continued the Mexican economy. It genergains from reform. According ates half of Mexico’s exports, to most estimates, Mexico’s accounts for $19 billion in forcurrent 4 percent growth is eign exchange and provides bumping against the ceiling of 30 percent of Mexico’s manuits potential growth rate. To facturing employment. As with grow faster — to improve the the rest of Mexican manufacturpotential growth rate to 6 pering, the 2001 recession was difcent or higher — changes are ficult for the maquiladoras. needed in Mexico’s basic instiFrom the industry peak in Octutional fabric. More specifitober 2000 to the trough in July cally, the Organization for 2003, the industry lost 290,000 Economic Cooperation and jobs, a 21 percent decline. ReDevelopment recently pubcent research points to the U.S. lished a list of what it regards business cycle as the chief culas the main challenges for prit in this downturn, although Mexico to reach 6 percent many low-wage jobs in sectors growth: like apparel, toys and leather are unlikely to return.5 • Remain committed to Maquiladora payroll employmacroeconomic stability. ment has been increasing since • Put public revenue and late last summer, again matchexpenditure on a more ing closely trends in the U.S. solid and predictable industrial sector. During 2004, footing. maquiladoras added back • Ensure that resources for 75,000 jobs, or 26 percent of education and training those lost to the downturn. are used more effectively. Among the sectors leading this • Raise and improve the upward trend are electronics, stock of infrastructure transportation, services, textiles capital. 4 • Pursue labor market reforms. • Ease regulatory measures and other impediments, including failings of the judicial system and high perceived levels of corruption.7 The past year brought little or no progress in advancing a series of widely proposed structural reforms to the Mexican economy. The need for the reforms is recognized, but the political will is lacking. Tax reform is high on virtually every agenda because Mexico’s tax system in 2002 yielded revenues equal to only 18.8 percent of GDP, compared with 26.9 percent in the United States and 34.2 percent in Canada. Further, oil continues to deliver close to one-third of public sector revenue, an unreliable source given the volatility of oil prices. The additional revenues must be committed to basic infrastructure and education. Energy reform is needed to bring down high electricity prices and infuse much-needed capital into oil and natural gas exploration and production. Mexico’s labor market ranks among the world’s most rigid, imposing high nonwage costs on employers. And Mexico ranks low on most measures of governmental effectiveness, regulatory quality, rule of law and control of corruption. Not only are reforms needed, but also the timing of such reforms is crucial for Mexico’s future economic growth.8 The Fox administration has been unable to move reforms forward without a majority in Congress. Figure 6 shows the division of votes among Mexico’s three major parties in recent years. Last year was the final opportunity to move reforms forward before the next Figure 6 Mexican Electoral Results, 1991–2003 Percent of total votes 70 PRI 60 PAN 58.5 48.6 50 38.0 40 38.3* 36.9 30 20 25.0 25.9 25.0 16.8 18.7 16.1 10 7.9 0 1991 1994 1997 2000 * Includes alliance with Green Ecological Party of Mexico. SOURCE: Instituto Federal Electoral. presidential election in 2006 because political parties have now turned their focus inward to select candidates. The 2003 midterm elections may point to the return of the Institutional Revolutionary Party (PRI) after a six-year break in its 70 years of rule. Or the Party of the Democratic Revolution (PRD) could ride the popularity of Mexico City’s mayor into the Mexican White House, becoming the first socialist party to rule the country. Or perhaps the National Action Party (PAN), which now rules the country, can score another victory. Given the current division of voting sentiment among the public, it is a battle that promises to leave deep political scars. It is virtually certain Mexico will operate without significant fiscal, labor or energy reforms through 2006. The opportunity to pass such reforms in the next administration will depend on the 2006 electoral outcome, as well as on the intensity of the political conflict that follows the election itself. Economic Outlook Private analysts currently are predicting only slightly slower growth of Mexican GDP in 2005 — in the PRD range of 3.5 to 4 percent. This outlook is based largely on the 37.3* strong growth prospects for 30.7 the United States, where 17.6 GDP is expected to hit 4 percent. At the same time, 2003 these same analysts regard the growing U.S. fiscal and trade deficit as a risk to U.S. expansion, and in turn to Mexico. Also, an unanticipated acceleration of inflation could put both countries’ economies at risk. Growing political uncertainty as the 2006 election approaches could also begin to slow growth, if consumers, businesses or foreign investors hold back on spending to await the outcome of the elections. — Jesus Cañas Roberto Coronado Robert W. Gilmer Cañas and Coronado are assistant economists and Gilmer is a vice president at the Federal Reserve Bank of Dallas. Notes 1 2 3 For more information behind the methodology of the Mexican index of coincident economic indicators, see “Business Cycle Coordination Along the Texas – Mexico Border,” by Keith R. Phillips and Jesus Cañas, Federal Reserve Bank of Dallas, Working Paper no. 0502, July 2004, available at www.dallasfed.org. According to the Federal Reserve Bank of Atlanta trade-weighted dollar index, available at www.frbatlanta.org/ econ_rd/dol_index/di_index.cfm. For more information on remittances, see “Workers’ Remittances to Mexico,” by Roberto Coronado, Federal Reserve Bank of Dallas, El Paso Branch 5 4 5 6 7 8 Business Frontier, Issue 1, 2004, available at www.dallasfed.org. “U.S. – Mexico Trade: Are We Still Connected?” by Jesus Cañas and Roberto Coronado, Federal Reserve Bank of Dallas, El Paso Branch Business Frontier, Issue 3, 2004, available at www.dallasfed.org. “Maquiladora Downturn: Structural Change or Cyclical Factors?” by Jesus Cañas, Roberto Coronado and Robert W. Gilmer, Federal Reserve Bank of Dallas, El Paso Branch Business Frontier, Issue 2, 2004, available at www.dallasfed.org. Texas –Mexico border cities are Ciudad Juárez, Reynosa, Matamoros, Nuevo Laredo, Piedras Negras and Ciudad Acuña. Economic Survey of Mexico, 2003, Policy Brief, Organization for Economic Cooperation and Development, Nov. 24, 2003. Chile and Mexico, like other countries in Latin America, experienced severe economic crises in the early 1980s, but each underwent a different recovery path. In 1980, Mexico’s per capita income was almost double that of Chile; however, after two decades, Chile has erased this gap and returned to its output trend. Mexico, on the other hand, has not yet recovered, and its output continues about 30 percent below its trend. A recent study by the Federal Reserve Bank of Minneapolis and the Central Bank of Chile attributes such differences to early privatization, banking and corporate law reforms taken by the Chilean government. See “A Decade Lost and Found: Mexico and Chile in the 1980s,” by Raphael Bergoeing, Patrick J. Kehoe, Timothy J. Kehoe and Raimundo Soto, Federal Reserve Bank of Minneapolis, Staff Report no. 292, September 2001. Houston A ll indicators point to continued strength in the Houston economy. The Houston Purchasing Managers Index remained over 60 for the 12th consecutive month, with sales, production and employment all registering nice gains. A value over 50 indicates expansion in the local economy. Labor markets continue to strengthen, with 12-month growth in employment now at 1.7 percent, and the unemployment rate fell from 6.1 percent to 5.5 percent during the same period. Retail Sales and Autos Retail sales are mixed in Houston. At opposite ends of the spectrum, discount and upscale stores reported solid results in January and February, while department stores barely met plan. Furniture stores and small independent retailers were operating below expectations. Overall sales are probably up marginally. New car and truck sales in Houston started the year out right, with January sales up 7 percent over January 2004. It was the second consecutive month of 12-month increases — the first time this has happened since late 2001. Real Estate Existing home sales continued to set records in January, with new highs for the month for properties sold, value of transactions and median sales price. Sales are expected to slow in 2005 due to higher interest rates and a growing oversupply of apartments. More jobs and expanding income should keep the market healthy, BeigeBook February 2005 however, and shift the focus from starter homes to more upscale properties. Absorption and occupancy are growing again for Houston office space, although rents are still falling. The central business district and Galleria are leading the improvement. Retail absorption is healthy, with rents and occupancy flat. Industrial occupancy rose during the past year, but flattened out in the fourth quarter. Oil Services and Machinery The domestic rig count moved up by more than 20 rigs in recent weeks, with much of the improvement in Texas. Oil service respondents were not bashful about using the “boom” word, comparing current conditions to 1978. They were quick to add, however, that they were anxious to avoid the hangover experienced at that last party. Capacity is becoming an issue. Some customers are contracting upfront for rigs and services for multiple jobs to ensure availability. People are the main constraint, however, because of shortages of drilling crews and workers with key skills. Prices and margins are such that service companies are now sharing fully in the high commodity prices producers have enjoyed for some time. Refining Refiners have begun their spring turnarounds. A refinery fire and a series of operating problems have kept Gulf Coast refineries at capacity utilization near 90 percent. Refiner margins have moderated from high levels in recent weeks because product prices have not kept up with rising crude price. Inventories of heating oil improved counterseasonally, and gasoline inventories were in excellent shape for February. Chemicals Virtually every segment of the petrochemical industry is doing extremely well based on revenue, pricing and profits. Strong product demand is the chief factor giving strength to the industry. Several years of poor demand resulted in reduced capacity for a number of products, and current strong demand is outstripping remaining capacity. Chlor-alkali, olefins, plastics and aromatics are all projecting record profits in 2005. Among the aromatics, benzene is expected to see a return to record prices in coming weeks as the turnaround season continues for refineries. Propylene prices are up due to strong demand, with some signs of prebuying by customers to avoid future price hikes. Polyethylene prices fell back by 2 cents per pound as feedstock prices slipped, and demand eased, especially export-related demand. For more information or copies of this publication, contact Bill Gilmer at (713) 652-1546 or bill.gilmer@dal.frb.org, or write Bill Gilmer, Houston Branch, Federal Reserve Bank of Dallas, P.O. Box 2578, Houston, TX 77252. This publication is also available on the Internet at www.dallasfed.org. The views expressed are those of the authors and do not necessarily reflect the positions of the Federal Reserve Bank of Dallas or the Federal Reserve System..
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