17/08/12 Can Mexico Overtake Brazil By 2022?

- Forbes

Kenneth Rapoza, Contributor

C ove ring Brazil, R ussia, India & C hina.

I NV ES T I NG | 8/11/2012 @ 12:52PM | 5,402 vie ws

Can Mexico Overtake Brazil By

2022?
For decades, Brazilians said and
believed, for the most part (menos
os tucanos) that they were living in
the country of the future: o pais do
futuro. That was Brazils rallying
cry. But after nearly seven years of
a commodity led economic boom,
Brazil has moved into the future.
Its own future. Brazil is not the
country it once was. But nowadays, Brazil or Mexico? For Nomura Securities in New
o pais do futuro is giving way to York, "el pais del futuro" is Mexico.

el pais del futuro.

And that country, as Nomura Securities in New York sees it, is Mexico.

El Futuro

Most investors dont look too far into the future. A quarter away is a lifetime
for some fund managers. But there are plenty of mutual funds and corporate
investors who need to have a vision of what the world will look like in 10 years
so they can put their money to work now, when the world doesnt quite look
that way. Getting the future right is how companys and investors succeed.

These days, investors are in love with Mexico. Over the last few years, its
become known as a drug infested, cheap labor market for the U.S. thats lost
ground to China. While Brazil, the most powerful and largest economy south
of Texas, was seen as safer, more mature, more diverse economically, and a
benefactor of the China boom.

That might change. In some respects, it already is changing.

Tony Volpon, managing director of Nomura Securities and Benito Berber,

Nomuras senior Latin America strategist, have been considering this for
some time. Volpons from Brazil. He knows the country intimately. His take?
Mexicos economy might even be bigger than Brazils within 10 years.

Both had a conference call with Nomuras investing clients on Thursday to

outline how Mexico might overtake Brazil in the years ahead.

Brazil x Mexico

Brazil and Mexico grew similarly throughout the 1990s and up until 2004.
After that, the Brazilian economy boomed. Looking back, the real game
changer for Brazil was the coming of China into the world economy. The
massive commodity demand that came from China was a blessing to Brazil,
the worlds leading exporter of iron ore, sugar, coffee, orange juice and a
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major exporter of soybeans after the U.S. The election of Luiz Inacio Lula da
Silva in 2003 nearly killed the Brazilian real, pushing the forex to about four
to one at the start of the commodity bull cycle. It was nearly impossible to
compete with Brazil on price and the country captured that market quickly. To
this day, Brazil is a haven for all types of agricultural investment be it in
sugarcane for sugars sake, or for ethanol, or just in owning crop land for
cotton and soybeans.

Brazil had, and still has, a natural

competitive advantage and attracted
billions in foreign direct investment
because of it, into sugarcane ethanol,
Brazils newfound oil wealth, and even
human capital.

Plus, Brazil had very low credit demand in

Avenida Paulista in Sao Paulo. the early 2000s. It was under 30 percent
of GDP and rose to 50 percent of GDP as
the country got richer, labor markets
improved and investment capital poured in. Brazil started on the road to
affluence, and Brazilians were feeling it, taking on debts against future
income.

On the Mexican side meanwhile, Chinas accession to the World Trade

Organization put Mexico in third place in terms of percentage of U.S. imports.
China became number one. Canada was number two. Thats changing, says
Berber. Mexico is now producing more cars for the U.S. market than Canada.

I would argue that the spread between Mexico and Canada will start to close,
says Berber. Mexico is producing more cars for the U.S. And China share of
U.S. imports is stabilizing while Mexicos share is rising gradually. On the
investment side, a lot of investment into Mexico was interrupted by the 2008
crisis, but that is also recovering.

What will influence growth in these countries over the next 10 years?

From a total factor productivity standpoint, a guide post used by economists

to measure capital investment in an economy, Brazil grew 1.2 percent over the
last 8 years ending 2010, while Mexico grew just 0.1 percent.

Mexico was reforming at the time, basically privatizing the banking sector and
floating the exchange rate. Growth remained elusive. Not so in Brazil.
Moreover, growth in the U.S. real estate market took a lot of labor out of
Mexico and moved it into the U.S. That is expected to reverse, helping
Mexicos human capital, keeping wages stable to low as supply improves.

If you compare the two countries, you can see that in the last 10 years up to
2010, Brazils contribution of capital has been high and will go higher,
Volpon says. We do see human capital contribution falling because the
country virtually has full employment. Thats good news in one sense, bad
news in the other sense, because the lack of available labor actually means
you are going to see lower growth.

The two sectors that are growing in Brazil are commodities and services, but
they dont require a lot of technology like manufacturing does. Commodities,
with the exception of petroleum, do not incorporate technological change as
rapidly. That means less investment and could mean slower employment
growth. Brazil is also becoming more of a service economy, so productivity
overall will fall because services and raw commodities are not areas requiring
massive investment and productivity, especially in the services sector. As a
result, Brazilian economic growth should oscillate around 3 percent for the
next decade. Not bad.
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In Mexico, there are two sets of things that will support growth. The first has
to do with external factors. As labor costs rise in China, more countries are
moving to Mexcio inmanufacturing. Thats labor intensive and capital
intensive. Also, the type of manufacturing Mexico is attracting is the value-
added type; high end, like aerospace for example, which of course is very high
cost and human capital intensive. As the U.S. manufacturing sector
strengthens, that will also lend support to stable growth in Mexico because the
linkages between the two economies are strong due to the North American
Free Trade Agreement, or NAFTA.

In terms of labor, the construction sector and services sector in the U.S. are
not doing well, so that implies that a lot of migrant workers are coming back to
Mexico. And those that would like to go to the U.S. are staying in Mexico,
Berber says, adding that the country is still dependent on structural reforms of
the new government if it is to make their call correct.

Forecasting medium to long term growth can be a dangerous excercise.

But giving the arguments on productivity between the two economies, the
Mexican economy could overtake Brazil as early as 2022 to 2030.

Our call is predicated on the approval of labor reform by the Mexican

congress, Berber says. It is very difficult to fire people in Mexico, so that
makes it harder to hire people. Labor, fiscal and energy reform are all
important. Energy is dominated by the state, but the new government has
been very adamant about the private sector being involved in the energy
sector. If that happens, that could boost total production in the Mexican
economy.

Over the last decade, there has been a

commodity focused, populist p0litics
that has dominated the region. While
many countries have differed in their
statist approach, it has all been
variations of the same team with a
much-needed emphasis on social
services and income distribution,
sometimes coupled with a more
closed economy. This was especially
true in Brazil.

If Mexico begins to grow at a higher rate with market friendly types of policies,
then investors may see a reversal of the populist Latin American leadership
and a return, perhaps, to a more U.S. friendly one, Volpon says.

There is no real consensus about what should be done about the slower
growth in Brazil, says Volpon. Brazils economy is seen growing at just 2
percent this year, below the 2.7 percent last year and below the 4 percent
target set by the government in January.

Volpon concludes that some economists say Brazil has to return to a reform
agenda. They complain about the tax burden and infrastructure and a
government that seems to argue that the big problem is a lack of demand. This
lack of consensus means that very little will get done. I dont think there is a
lack of demand, but more of an issue of supply to meet that demand. There is
a frustrated growth. Meanwhile Mexico might overtake it, he says.

Well, Mexico overtaking Brazil? At least its not Argentina. But that could
ultimately lead to a rethinking of economic policy in a Brazil that will unlikely
take falling to No. 2 without a fight.

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This article is available online at:
http://www.forbes.com/sites/kenrapoza/2012/08/11/can-mexico-overtake-brazil-by-2022/

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