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Economic Forecasts

Unending Drug War Slows Mexican Economy

With bullets flying, U.S. firms are reluctant to establish a new presence south of the border.

Look for the drug war to limit foreign investment in Mexico over the next few years. As battles between cartels and government forces escalate, fights among the cartels themselves grow deadlier. Cities with little history of organized crime are now caught in the crossfire. The result is that foreign firms that don’t yet have a presence in Mexico will postpone investment, probably until after President Felipe Calderón leaves office in 2012. That delay will crimp productivity for years to come.

Monterrey provides one of the starkest examples. The hub of Mexican heavy industry for more than a century, Monterrey hosts dozens of U.S. companies. As recently as a few years ago, Fortune magazine ranked it the best city in Latin America in which to do business. Today, it is ground zero of a turf war between Los Zetas and three rival cartels aligned against them. “We just closed our exchange program with Monterrey Tech because a couple of our students were killed in a crossfire,” says John Doggett, a senior lecturer at the University of Texas at Austin’s McCombs School of Business.

The violence exacts a more immediate toll by slowing Mexico’s economic growth, particularly along the border with the U.S. Retail sales are plummeting -- the prospect of catching a stray bullet is a powerful deterrent to would-be shoppers. Likewise, real estate values in such communities as Tijuana, Ciudad Juárez and Nuevo Laredo are crashing as residents seek safer places to live.

Potentially worse is the impact on tourism, one of Mexico’s leading sources of foreign revenue. The cartels have carried out assassinations in such major resort cities as Acapulco and Cancún, hundreds of miles from the border. Efforts by the Mexican government to beef up security in such communities have yielded mixed results. “If you go down there and see [soldiers and police officers] with flak jackets and AK-47s, it makes you feel safer, but it doesn’t make you feel like you’re on vacation,” says Doggett.

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While much of the violence is retaliatory, the cartels are also playing a shrewd political game. They’re sending the message that would-be presidential candidates have a choice: Cut a deal with the cartels or put Mexico through another six years of chaos. Mexico’s constitution limits the president to a single six-year term. Less than two years remain until voters go to the polls to choose Calderón’s successor.

But the violence won’t scare off the U.S. corporations already in Mexico. If anything, such companies are likely to add to their stake in Mexico’s economy. Chinese wages are nearing parity with Mexican pay. Lengthy ocean shipping times from China plus persistently high fuel costs make transport by truck and rail from Mexico look cheap. The result is that Mexico is increasingly competitive with China for manufacturing investment. Chrysler is plowing $550 million into its plant in Toluca, outside Mexico City. Even in Ciudad Juárez, firms such as Delphi, Johnson Controls and Emerson Electric are thriving.

That’s not to say that such firms don’t have big concerns about the risk to their employees. A recent study by the American Chamber of Commerce of Mexico says that its members now invest 3% of their operating costs on security. That may well increase. Several of the cartels are now expanding their range of criminal activities, branching out from drug trafficking to such fields as credit card fraud, cargo and merchandise theft, extortion and kidnapping.

“You’re much more cautious when you make decisions” about investing, says Albert Zapanta, president and CEO of the U.S.-Mexico Chamber of Commerce. “You do your due diligence.” Zapanta expects that the result will be that firms operating in Mexico will hunt for safer locales within the country, rather than abandoning it altogether. Querétaro in central Mexico, for example, is already drawing massive investment as a hub of air frame manufacturing. Other central Mexican cities such as San Luis Potosí and Léon are also likely to benefit.