Latin America’s Moment

This is a guest post by Greg Mendoza, an MA student at The Fletcher School, Tufts University. He previously was an intern in the Latin America Studies program at the Council on Foreign Relations. Last year, Mexico passed a historic energy reform to end over seventy years of exclusive state control of the energy sector. Some analysts estimate drastic changes in the sector—with upwards of twenty billion dollars in foreign direct investment a year that could boost GDP 2 percent annually by 2025. On August 11, President Peña Nieto signed into law the secondary legislation that dealt with issues ranging from the distribution of oil rents to the reorganization of the electricity sector. One important but less discussed aspect for the nation’s future will be the Mexican Fund for Stabilization and Development, designed to help the Ministry of Finance mitigate the negative effects of volatile energy prices. Oil and commodity price fluctuations have buffeted Latin American economies for decades. Governments exacerbated the damage by maintaining procyclical fiscal regimes—increasing spending during booms and slashing budgets when prices fell. These policies are dangerous for states such as Mexico given that last year oil revenues accounted for sixty-six billion dollars, or one-third of the government’s annual budget. The new Mexican Fund for Stabilization and Development will manage government energy revenues. Controlled by the Bank of Mexico, the country’s independent central bank, the fund will disburse an estimated sixty-three billion dollars to the federal budget (based on current receipts from Pemex). Assuming additional revenues, some of the monies will be saved while others will be allocated to programs such as the universal pension system and local development projects. A technical committee that consists of the Ministers of Finance and Energy, the Governor of the Central Bank, and four independent parties will recommend to congress the amounts given to each of these programs. This structure contrasts with Mexico’s previous Oil Revenues Stabilization Fund. The previous fund could never save enough revenue to make a difference in downturns because of the balanced budget rule, which annually withdrew money from the old oil fund when there was a budget deficit. Under the new law, the technical committee limits transfers to the federal budget at 4.7 percent of GDP, and bigger outlays for economic emergencies require a two-thirds vote in the Mexican lower house. In creating this new fund, Mexico hopes to replicate the success of other sovereign wealth funds. Chile’s Economic and Social Stabilization Fund is the best known in Latin America, credited with bailing the country out in the wake of the 2008 world financial crisis. With copper representing 20 percent of the country’s GDP, the fund saves surplus copper revenues during booms, and spends the reserves during economic downturns. The central bank manages the fund and is valued at almost $16 billion, a large sum for a country whose GDP was $277 billion in 2013. The government’s adherence to saving copper surpluses proved successful in 2008, when funds were quickly transferred to the federal budget to mitigate the effects of the Great Recession. The success of Mexico’s new stabilization fund will depend on whether the new fiscal rules work. Saving money for a rainy day is not easy. Oil bounty could also push up the currency (the dreaded resource curse) hitting Mexico’s robust manufacturing sector, which represents three-fourths of its exports. However, the new stabilization fund addresses these concerns and removes the old restrictions on its savings, limits monetary transfers to the federal budget, and is managed by the independent central bank to minimize political interference. The new rules should insulate the economy from the negative effects of oil revenue variability and provide resources for future development. The fund’s success will be determined by the upcoming implementation, and although there are still challenges institutionalizing these reforms, the new laws are a positive first step in modernizing Mexico’s energy sector.

With the World Cup over, Brazilians are turning to their next big event—October’s presidential elections. While President Dilma Rousseff still leads in the polls, her margins continue to shrink. A recent Datafolha poll puts Rousseff and Aecio Neves—her leading challenger—as statistically tied in a hypothetical second round. Potentially adding to Rousseff’s vulnerabilities is Brazil’s electricity sector, which, though opened to private investment in the 1990s, remains dominated by the state through its stake in Electrobras. The combination of weather dependent sourcing, underinvestment, and rising demand has led the system to the brink of capacity. And political history shows that disruptions aren’t looked upon kindly by voters—as José Serra surely remembers, when power rationing helped Rousseff’s predecessor Lula finally get to Planalto. The current shortages are a result of several factors. One is the lack of rainfall. Two-thirds of Brazil’s power depends on hydro. After a disappointing December-March rainy season, reservoirs are at near-record lows. A second problem is the lack of connections. New power line construction has been repeatedly delayed. As a result, many plants and wind farms stand idle, unconnected to the grid. Other generating and transmission projects are also behind schedule. These supply constraints are also exacerbated by growing demand. In 2013, consumption rose over 5 percent compared to the previous year, and electric power consumption shows no signs of abating in the near future. This reflects increasing wealth—as incomes rise, so too does electricity use. It is also spurred by government policies—electorally friendly 20 percent residential price cuts in 2012 boosted usage (Electrobras’ share price plunged in the wake of the announcement). The government has tried to compensate by importing natural gas to fuel existing power plants and diversifying its mix away from hydro through new fossil fuel plants. Still, the current lack of spare capacity—estimated at just 2 percent—has led to power outages. Last February, as many as 6 million consumers and industrial users in eleven states lost power. In addition, several companies have struggled since the outage, including those serving Sao Paulo and Rio de Janeiro.  And studies by Rio de Janeiro-based energy consultancy PSR puts the risk of further blackouts at roughly 20 percent. But even if the lights stay on through the October election, the next administration will face difficult choices. The sector’s current high costs will likely require both government financial support and consumer price hikes, feeding inflation. Shortages will dissuade investment in energy intensive industries—including steel and petrochemicals—and hinder economic growth more broadly. And the problem of increasing supply to keep pace with demand will only continue. While 2014 may bring more rain, what Brazil really needs is vast investments in electricity infrastructure to underpin a more promising economic future.

This is a guest post by Stephanie Leutert, who is beginning an MA in Global Affairs at Yale University in the fall. She previously was my research associate in the Latin America Studies program at the Council on Foreign Relations. Mexican manufacturing is perhaps best symbolized by the infamous maquiladoras in the border region. Yet, in states from Chihuahua to the Yucatán, Mexican engineers are changing the narrative. Alongside more established auto and medical equipment manufacturing, Mexico is growing its aerospace industry, attracting investment, creating jobs, and changing its economic identity. But many challenges remain if the benefits are to be felt widely. For now, Mexico’s aerospace industry is the world’s fourteenth largest. Some 287 aerospace companies operate in eighteen states, with five major clusters in Baja California (59 companies), Sonora (45 companies), Querétaro (33 companies), Nuevo León (32 companies), and Chihuahua (32 companies). And the sector is growing exponentially. From 2009 to 2012, Mexico’s aerospace industry received more foreign direct investment than any other aerospace sector in the world—boosting its exports to $5.5 billion in 2013. Driving the sector’s explosion is its integral role in the North American aerospace production platform. “The United States is the market, Mexico is the low cost manufacturing, and Canada is the partner for production,” explained Marcelo López Sánchez, the secretary of sustainable development for Querétaro. In the sector’s continental supply chains, “aircraft are designed in Canada, set up in Mexico, and final production takes place in the United States.” This role—along with Mexico’s macroeconomic stability, low wages, few if any tariffs for exports to the United States and Canada, protection of intellectual property rights, and growing number of aerospace engineers—have propelled the sector onto the global map. Mexico’s federal and state governments have also cleared the way—offering companies enticing tax incentives, cutting through bureaucratic red tape, and signing bilateral aviation agreements with forty countries to waive the inspections of pieces and parts before they are packed for export. Still, Mexico’s aerospace industry employs only about 43,000 Mexicans, a tiny portion of the country’s 50 million strong workforce and even small within the advanced manufacturing sector. But the real importance lies in the spillover effects. Every $1 million invested in engineering intensive manufacturing is estimated to create an average of four jobs. And every one high tech manufacturing job supports at least two jobs elsewhere (though some estimates are as high as fifteen jobs)—both directly (in the companies that supply the aerospace industry) and indirectly (in construction, transportation, and other service industries). However, for Mexico to reap the full benefits of its aerospace clusters, the sector will need to continue building out its local companies and employee base. The majority of aerospace companies operating in Mexico are foreign, limiting the economic effects for host regions. This stands in contrast to other advanced manufacturing industries where Mexican companies have a much larger presence. In Querétaro alone, Mexican companies make up almost a third of the state’s automobile manufacturing, and expanding into the burgeoning aerospace industry would appear to be a logical next step. But the transition has been slow. Part of the problem, according to Luis Lizcano, director general of the Mexican Federation of Aerospace Industry (FEMIA), is the different business model. “In the automotive industry, [production] is high volume, low mix, in aerospace it is low volume, high mix.” A company may get an order for 250 parts, many of which are different—and all must be of the highest quality. “It requires a different mindset.” For those companies already shifting mindsets and moving into aerospace, there is also the challenge of becoming certified. Compared to other advanced manufacturing industries, aerospace certifications are stricter and more expensive, and navigating the process can be tough for companies just entering the sector. “You have to be technically savvy to understand the industry and the certifications,” says Lizcano. To provide support, state governments have taken the lead—counseling Mexican companies on how to obtain the appropriate certifications necessary to break into global supply chains. But none of this matters without the human talent necessary for aerospace manufacturing. Mexico graduates an impressive number of engineers, but given the aerospace industry’s recent arrival, most are specialized in other sectors. Some communities are working hard to change this. In 2006, Bombardier arrived in Querétaro after the state agreed to build a National Aeronautics University to train aerospace engineers. Today, the university provides two-thirds of Bombardier’s workforce for its Querétaro plant and sets up specialized training programs when needed. Other universities and technical programs are also popping up across the country, and are increasingly partnering with schools in the United States. The goal for workers, says Lizcano, is to have a “higher knowledge base, higher skills, and then higher value added per job,” making the sector more competitive and hopefully pushing up wages. Today, Mexico’s aerospace industry employees continue to earn low salaries by international standards. An operational worker (the majority of the sector’s employees) earns an average of US$1,000 a month, and a technical job brings in about US$1,500 a month—limiting the upsides for families and communities. Fully addressing any of these challenges will take time, even given the current efforts among industry leaders and policymakers. Yet, the industry is already a powerful symbol of the country’s expanding economic identity. As the domestic suppliers and workforce continue to develop, Mexico’s aerospace sector has the potential to change the country’s economic narrative and ultimately its reality.