Going Global

Then Again, Maybe the Government Can Screw Up the Economy

I've argued elsewhere in this blog that one of the great virtues of the global integration of commerce is that it provides some protection against a government's ability to screw up the economy whatever direction the prevailing political winds may be blowing.  It seems I may have gone too far, however, in suggesting that the democratic attitudes of the individuals who make up the consumer market in Venezuela are sufficient to mitigate the political risk to business in that country resulting from the socialist policies of the current regime.

As Hugo Chavez expands his efforts to nationalize the economy, his policies are beginning to take a real toll on the economy that I fear will get much worse.  Even in my earlier post suggesting that things might not be so bad for international trade in general, I did allow as his policies presented real risk for companies in industries directly connected to public infrastructure.  Consistent with that, Chavez's immediate efforts are in fact directed at the oil industry and public utilities.   

Also, to be fair, to this point there have been no nationalizations strictly by government fiat as the administration has negotiated buy outs of private interests that it seeks to control.  For example, the government recently bought out the interests of US power company CMS for $106 million and acquired the interests of Verizon in the country's telecom system for $572 million.  The buyout prices were described by unnamed economists in a recent Reuters story as "tough but fair".

Unfortunately the implementation of the Chavez political agenda is beginning to have serious down stream effects on the economy which could wind up crippling the country.  Inflation is already approaching 20% annually -- an extremely high figure by current global standards.  That kind of volatile pricing environment leads to inefficiencies in the price regulation mechanism.   It also discourages incoming trade as it is difficult to maintain a rational price policy when prices begin to move at such a rapid rate compared with the originating markets.  The result of these impacts is shortages in basic goods and services, something that is already beginning to show up in Venezuelan marketplaces.

A second impact beginning to emerge is a brain drain as the best talent begins to flea nationalized, or more to the point politicized, industries.  As reported in a stroy in today's Wall Street Journal (subcription required for on-line access; story on page A11 of the print edition), this is already having a measurable impact on the oil industry where the loss of key management and technical talent is leading to an increase in costs and a decrease in productivity.   This is obviously not a good trend in the industry on which Venezuela most depends as its economic driver.

It is at the intersection of the oil industry and Chavez's nationalization campaign where the ultimate death blow to the economy may be dealt.  While the government has been successful thus far at negotiating buy outs of foreign interests in lesser industries where the payouts have been in the 9 figures, the regime is having more difficulty coming to terms on a "fair" (and affordable) price for foreign interests in its oil operations owned by companies such as Exxon Mobil.  Already stretched by billions spent on social services, it is not at all clear that the government will be able to afford the cost of a negotiated buy out of these oil interests.   The result is likely to be payments that nearly bankrupt the treasury and which fuel inflation to crippling levels or a government seizure at less than fair prices or at no price at all.   Either outcome will be ugly.

The saddest part of all this is that Venezuela is a country which has the potential to be the leading economy in South America.   Nationalization was a disruptive agenda to pursue when economies and markets were predominantly national in scope.  With the global realities of today's integrated international economies, I am afraid that the nationalization of whole industries, particularly in a smaller country which does not have a sufficiently broad local market to support self-sustained growth and development, will be suicidal.

Venezuela -- Hotbed of Democracy AND Capitalism

In yesterday's post I discussed the Latinobarometro survey results, the seeming incongruity of Venezuela's high ranking in the democracy index while electing a socialist president by a sizable majority, and what that and similar international events say about any correlation between democracy and capitalism.  Well, it turns out that at least in Venezuela there is apparently a high correlation between pro-democracy attitudes and capitalist success.

Waiting for me when I got home last night was the December 25 issue of Fortune magazine which contains the Investor's Guide 2007 (am I the only person who wonders why, having come out on December 14th, it's not the December 14th issue, and is that determination made by the same people who begin sending "urgent" renewal notices a mere two months after renewing my annual subscription?).  Anyway, one of the features was the "Global Scorecard" for 2006, including a list of the best performing world stock exchanges (p. 189 in the print edition).  Is it just coincidence that the best performing stock market for the past year was the Caracas stock exchange with the index delivering a total return of 150%?

Many people might say that using stock market performance as an indicator of capitalist activity is like using the customer traffic report at a gambling casino, but the fact is that absent fraudulent manipulation, market performance is driven by supply and demand, and the upward performance of an exchange index such as the one in Caracas is a good indicator that for the period in question more dollars (or in this case Bolivars) were seeking to invest in the companies that make up the index than were seeking to exit the market.  Indeed, the reason I track some of the leading stock exchange indexes in the right hand column of this blog is that they are indicators of the capital investment environment for local businesses.

So democracy at 70%, the market up 150%.  Who would have thought? -- Hugo Chavez, good for democracy, good for business.  What's not to like?

Political Attitudes and Political Risk in Latin America

A significant hesitation among many small businesses contemplating an international business strategy is the concern that political attitudes in many countries are either unknown and unknowable risks or what is known sounds risky for business.  Larger companies, although certainly wary of political risk, tend to have the size and diversification necessary to take on comparatively larger risks, but for a small business, political risk in a significant market can be a "bet the company" proposition.

For companies interested in assessing markets in Latin America, the December 9 issue of The Economist publishes the data from the annual survey of political attitudes undertaken by Latinobarometro in an article entitled "The Democracy Dividend" (page 45-46 in the print edition).  The survey contains data from each country on attitudes toward democracy, critical political issues, the effectiveness of the political process generally, and institutions that make up the political fabric.

Some of the data may at some level seem counterintuitive.   For example, Hugo Chavez's Venezuela ranks fifth on positive attitudes toward democracy with 70% of the people saying that democracy is preferable to any other type of government.   Similarly, Venezuela is second in the percentage of people saying that they are satisfied with the way democracy is working in their country.  Interesting results for a country which reelected by a significant majority a president who is largely vilified in the U.S. as being the communist Castro's socialist compadre to the south.  Perhaps we should consider whether a democratically elected socialist in Latin America is any better or worse for business than one elected in say Germany.   

I was wondering whether there might be some positive correlation between a commitment to democracy and the business environment in a particular country.  Uruguay, Costa Rica and Argentina top the rankings of countries where democracy is viewed most favorably, and certainly each of those countries present fairly stable business prospects at least from the point of view of political risk -- economic swings might be a different matter.   But just when there seems to be some connection here, one notices that our largest Latin American trading partner, Mexico, is in the bottom half of the list with only 54% saying that democracy is the preferred form of government, and Brazil, the other most significant market, ranks even lower at only 46%.  Couple those results with what has evolved in China and one might question whether capitalistic market development and democratic political attitudes are as interdependent as generally thought in the Euro-American orientation to political economy.

As I study the data in light of these questions, I am thinking that perhaps the most important findings in the Latinobarometro results is the narrow band in which people define themselves on the political spectrum between left and right.   On a scale from 1 to 10, with 1 being the furthest left and 10 being the furthest right, the countries ranged from Uruguay which had an average perception rating of about 4.7 to the Central American countries ranked as a group with an average perception rating of about 5.7.  Indeed, to display much dispersion at all, The Economist published the results of this 1 to 10 information on a chart with a scale from 4.5 to 6.0.   Whatever is going on in the governments of the individual countries, the people in those countries, at least on average, see themselves as pretty centrist -- which I think is a good place for any country to be when it comes to doing business.

I've mused elsewhere in this blog whether one of the results of the global integration of markets isn't to put a damper on the influence that political extremes can have on the economic environment in any given country, contrasting in one post, for example, the political instability in Mexico with the historically stable economy.  Political risk is a worthwhile consideration, particularly if you are doing business with the government or engaged in a critical infrastructure industry where nationalization is a concern, but for most businesses, a far greater question is the perceptions of the individuals who make up your market of suppliers and customers.  On that score, markets in Latin America are looking up.

Politics and the Economy -- Two Different Animals in Mexico

By some accounts the state of politics in Mexico is in crisis.  Mr. Calderon won the recent presidential election by the thinest of margins and with only a plurality of the vote cast.  Mr. Obrador has been tying up Mexico City with sit-ins and slow downs and is threatening to establish and preside over a parallel shadow government of the Left.  If all one read was the political news,  you would have to conclude that Mexico was not a particularly good place for business investment.

But while politics dominates the news, the business climate in Mexico tells quite a different story.  In Rich Karlgaard's Digital Rules column in the October 16 issue of Forbes he has a blurb entitled "Time to Invest in Mexico?" [a subscription is required to access the on-line edition -- the column appears on page 31 of the print edition currently on the newsstand].  He points out that Mexico had 3.5% GDP growth this past year with a 4% rate projected ahead.  Inflation is at 3%.   Strong increases in consumer credit reflect increased economic activity and consumer confidence.   The Mexican stock market is undervalued as a percent of GDP.

On a similar note, I saw in a recent blurb from Motley Fool that the investment letter service recently had a favorable write up of Mexican cement goliath Cemex, which I understand to be the first non-U.S. stock that the newsletter has recommended recently. 

Obviously the business news paints a very different picture of Mexico from the political news as a place to invest and do business.  This makes me wonder whether the integration of markets and globalization of business has rendered irrelevant the infighting of national politics which seems to have become a blood sport in so many countries around the world -- at least for countries willing to remain engaged in international commerce. 

Two Mexicos and Trade -- The Left Had Best Be Careful What They Wish For

On the eve of the certification of Filipe Calderon as the new president of Mexico by the electoral court following its discounting of the opposition's fraud claims last week, Andes Manuel Lopez Obrador, who lost the election by less than 1% of the vote, is continuing his call for disruptive action.   Obrador is calling for a rally in Mexico City in September 16 and continues to proclaim his  intent to establish a rival parallel government.   While I continue to believe that the people of Mexico will see the wisdom in unity and accept the court affirmed election results as constitutionally mandated if not altogether agreeable, Obrador's continued call for an alternative government at this late hour at least raises the question of what would happen if his calls were followed to one logical conclusion, i.e. a separation between the parts of the country in which he finds his base of power from those parts of the country which saw Calderon as the better choice.

Calderon's Mexico would be in the industrialized north.   Following Calderon's pro-NAFTA policies, the north would be able to leverage its geographic proximity to the U.S. to further its economic development and continue its progress in creating a more stable market environment with moderate inflation and reasonable interest rates.  Obrador's Mexico would be comprised of the less developed south and would include a disproportionate share of Mexico's impoverished people.  Left to pursue policies more along the lines of Castro's Cuba or Chavez's Venezuela, I would be afraid that South Mexico would be deprived of much of the economic engine necessary to lift his people out of poverty.  In the most extreme case, if Mexico City were to become part of the leftist south, I could see many of the headquarters of important Mexican companies fleeing to a new northern capital, perhaps in Monterrey, further aggravating the chasm between Mexico's "haves" and "have-nots".

Obrador would do better by his supporters, I think, if he were to work tirelessly  as a voice of opposition within the existing government structures.  Otherwise he may have his political victory and be called "el presidente", but he will have set back the prospects of his supporters achieving better economic conditions for themselves by several decades with less hope in sight than exists today under the present imperfect but improving system.

Hope Is Not a Strategy -- It's Time to Engage Cuba in Robust International Trade

When Fidel Castro underwent serious surgery two weeks ago, the U.S.'s policy toward Cuba was back on the front page.  What has been striking in the reactions is the degree to which they shed light on our long standing policy toward Cuba -- impose an economic boycott and hope something changes.  The hopes that things might change were on high alert with Castro's surgery and temporary disappearance from the public eye.  For a post discussing some of the reactions in the press and from public officials such as Senator Mel Martinez, see the article from the Miami Herald featured in a post on the always excellent The Latin Americanist blog.

In training sales and marketing people to develop actionable business development plans, one of our mantras was always "Hope is not a strategy."  I think the same should apply to U.S. policy toward Cuba.  We have been pursuing the economic embargo / isolation / punishment tact for 40 years with absolutely no results.  I think the more than four decades of failure explain why the tone of reactions to recent events sound only of hopes instead of action.

I have advocated elsewhere in this blog that robust international trade can produce the sorts of economic interdependencies and cultural integration that may be one of the greatest chances we have for peace to supplant chaos in the modern "flat" world we inhabit where one country can't avoid the impacts of problems on the other side of the globe to say nothing of problems a few miles off its shore.  Cuba is no exception -- indeed it may be the perfect place for a change in policy in this direction to work.

In the days of the delicate balance of power between the U.S. and the Soviet Union, it may have made political sense to isolate Cuba to contain the impact that a Soviet satellite state might have so near to our borders.   But the threat of Soviet missiles in Cuba is long gone and no longer relevant.  Indeed, our continued economic isolation of Cuba has impelled them into the arms of China in seeking a significant global trading partner, setting up the conditions for the Soviet threat to be replaced at some point by the Chinese threat as China continues its march toward being the world's "other" superpower.

Likewise, one can hardly argue that the one party communist regime that rules Cuba necessitates a policy of economic isolation.  In this limited respect, China is of course no different, and yet our policy from Nixon's historic visit to the extension of membership in the WTO and the granting of permanent normal trade relations has been one of affirmative economic engagement, seeking to create greater ties that might diffuse any threat that China might otherwise present.  For more discussion on this, see some of the excellent blogs on China such as the China Law Blog and the Angry Chinese Blogger. 

We are waiting and hoping for a democratic revolution in Cuba, but it seems clear that democracies only take root in countries that have developed a sufficient middle class such that there are enough people with sufficient stake in political outcomes to care and sufficient resources to take action.  By isolating Cuba economically for so many years, we have consistently denied the people the one avenue of robust economic activity that might have permitted the development of these necessary conditions for democracy.  And so the Cubans remain seemingly apathetic subjects of the communist dictatorship and we continue our policy of hoping that something might change.

China certainly appears to be a model as to how economic development and empowerment of a consumer class is creating pressure on its traditionally closed government to open up its policies in many areas.  With many fewer people to bring up into middle class status, the process could conceivably move much more quickly in a country such as Cuba.  It's time that the U.S. lifted the economic embargo and engaged Cuba in trade, providing its people the opportunity to develop a market and grow not only their economic freedom, but their political freedom along with it.

An Informal Poll of Mexican Taxi Drivers Indicates Positive Results from Last Week's Elections

I just returned from a week in Mexico and thought it would make sense to post a bookend to the earlier piece on the elections in Mexico.  We were staying about a 25 minute cab ride from el centro, so I had numerous opportunities to engage the taxi drivers in conversation -- and like taxi drivers the world over, in Mexico they are more than accommodating if you ask them to share their wisdom and insight.  I asked each one their opinion about the presidential election and each of them had a passionate response one way or the other (although it was generally not as passionate as their opinions on who would win the world cup).  The poll was not scientific, but it was certainly random -- at least as to what taxi we happened to get into.

I would say it was split just about right down the middle between taxi drivers supporting Calderon and those supporting Obrador -- a fair reflection of the 0.58% margin of victory announced for Calderon on Wednesday.  The legitimacy of that result is being challenged with Obrador's PRD camp backing up its formal appeals to the Federal Election Tribunal with calls for protest marches challenging the ballot count -- there will be tense days ahead as Mexico faces a constitutional test of its electoral process ala Bush v. Gore in 2000.   The Tribunal has until September 6 to validate the election results.

The most remarkable reaction stemming from my taxi conversations, however, is that while the driver's were clearly passionate in their choice of candidate, they all seemed confident that the system would play out as intended rather than cynical that their choice made any difference, as might have been the case even 10 years ago.   So while the next president remains in question, the people of Mexico are clearly winners in that they seem to have taken control of the electoral process -- and that, I think, is a very positive development.

(Note: To follow the continuing story of the election process as it unfolds, as well as other stories on Latin American politics, business and culture, keep an eye on The Latin Americanist blog which is certainly among the best english language blogs I've found focusing on Latin America).

Elections in Mexico -- No Matter Who Wins, There Are Positive Signs for Development

I'm heading down to Mexico on Monday and I'll be very interested to hear what people are saying about the results of the presidential elections being held tomorrow.   No matter which candidate wins, the election has the potential to continue the historic shift in Mexican politics that has taken place over the past 10 years along with the country's continued march to being a fully developed economy.

In my own experience traveling around the world, there is an inextricable link between a country's political climate and its place on the continuum of economic development.  Generally speaking, in developed economies, there is a vibrant middle class with a vested interest in political outcomes and that vested interest is reflected in the dynamism of the political process and debate.  Conversely, in countries with much less developed economies, wealth is so concentrated in the hands of the entitled class, that the economic and ruling elite are one and the same and there is very little real vibrancy infused in the political process.

When I first began doing business in Mexico, NAFTA was just coming into reality and the PRI was still entrenched in its 70 year reign of political dominance.  The country was working its way through the effects of "The Devaluation".   The tone of government seemed paternalistic and the average person, although clearly feeling the impact of government policy, seemed cynical about their ability affect that policy one way or the other. 

When the PRI was unseated from the presidency by Vicente Fox and PAN, I believe it was a symptom of the sea change in political empowerment that comes with economic development.  Whatever the outcome, the elections this year continues that trend.  The polls have been shifting continuously throughout the campaign, making this the first election when any one of the three major candidates -- Felipe Calderon of PAN, Andres Manual Lopez Obrador of PRD and Roberto Madrazo of PRI -- have a chance to win.

Perhaps the biggest story is the heated battle between the two front runners, Calderon of the incumbent Fox's PAN party and Lopez Obrador of the left wing PRD.  Lopez Obrador is running on the strength of the 30% of the population who have not yet been pulled along by the strides in economic development over the past 10 years and still constitute a sizable population of the disenfranchised and disadvantaged .  The PAN is painting Lopez Obrador as a Castro-esque leftist who would bring to Mexico an anti-American agenda similar to that of Hugo Chavez in Venezuela.  Acknowledging the impact of both the geographic proximity to the US and the importance of trade with the US on Mexico's economy, Lopez Obrador has denied that such an agenda is practical -- although the terms in which he has denied its feasibility makes one think that in the perfect world, that would be his leaning.  (Another interesting angle on the ties between Mexico and the US is the impact that the 10 million Mexican citizens living in the US may have on the election since they are entitled to vote).

It remains until tomorrow to be seen whether Lopez Obrador and PRD can unseat PAN, or whether PRI can regain power in an improbable come from behind victory.  I tend to think that Lopez Obrador's recognition of the practical constraints of being so closely tied economically with the US will moderate his agenda regarding business relations between the countries if he prevails, although he would certainly pursue a much more restrictive policy concerning foreign investment in certain industrial sectors such as banking that have been opening up over the past 6 years.   Of course if Calderon prevails, then I think Mexico's stance toward free trade will continue to be very bullish.

But i do think that perhaps the most important aspect of this election is the clear investment that the people seem to have in the outcome.  One gets a sense that the average Mexican firmly believes that they can impact government policy -- a sure sign that a majority feel that they own a personal economic stake in the country's future.

Mexico and Offshore Operations -- An Alternative Worth Considering

I was at a conference recently where a number of business people spoke about their decisions to move some of their manufacturing offshore in order to stay competitive in their manufacturing costs and be able to retain the business of customers who were weighing alternative sources of supply from abroad.  Admittedly the focus of the conference was India and China (see my earlier post on this), but in follow up conversations it became clear that those had really been the only two alternatives that were seriously examined.  In all the understandable hype about the hot markets of these booming Asian economies, no one seriously analyzed whether there was an option closer to home -- namely the United States' second largest trading partner, Mexico.

While all three countries have advantages and disadvantages and a final decision where to invest capital requires a careful analysis unique to the particular company and business situation, there are two key reasons why Mexico should at least make the list of countries to look at --

1. With the rapid economic growth in India and China, the wage differential is narrowing.  As noted elsewhere in this blog, there is a strong feeling among many business leaders that while low hourly wages may be a reason to set up shop halfway around the world, in the long run, it shouldn't be the only reason; and
2. Low wage rates are only one factor and, in some industries, may not even be the primary driver of total manufacturing costs.

As I see it, there are at least three major components that need to be analyzed.

• Base manufacturing costs;
• Expanded manufacturing costs; and
• Remote management costs.

Base manufacturing costs begins with hourly wage rates.   Although higher than China or India, at an average hourly manufacturing wage of $2.50 / hour, Mexico is certainly attractive.   A second key, however, is productivity.   Are there government requirements or cultural elements that dictate the number of workers that must be hired to run a particular machine or production line?   Are the  workers familiar with and comfortable working in a 5S or lean manufacturing environment?   How good is the inherent commitment to quality and consistency and how does that affect waste and rejects?   My own experience is that all of these questions is likely to get a more positive answer in Mexico than in most operations in China or India.  I don't know if it really translates from making hamburgers to base manufacturing, but one interesting study of international advantages and disadvantages which included a productivity measure is the "Big Mac" index study performed by the University of Chicago -- India ranked lowest in productivity (Big Macs per hour of work produced at otherwise similar McDonald's restaurants) out of the 27 countries included in the study. 

In calculating expanded manufacturing costs, one must look not only at the in-plant cost of production, but also at costs such as sourcing raw materials and re-importing finished product.  Where are the raw materials coming from?   What are the transportation options and how well developed is the infrastructure necessary to get them from the source to the plant?   Similarly, what are the logistics for shipping the finished product to the final market?   Are there any free trade agreements which affect the cost of importing raw materials to the plant site and re-importing the finished product?   Again, with a closer proximity to the home base, a relatively well developed infrastructure, and membership in NAFTA, Mexico offers some intrinsic advantages.  (For another perapective on the continued competitiveness of Maquiladoras plants in the current global environment, follow this link to an article from the University of Texas).

Finally, any foreign operation is going to have remote management costs which are all too often underestimated in the business plan.  The foreign operation will have to be visited with some regularity to train the production supervisors on what is required, and, as importantly, to assure acculturation and compliance with the outsourcing company's expectations for quality.  And of course there is problem management, because there will always be unforeseen fires to put out.   As I told one colleague, I always slept sounder over operations in Mexico than ones in Asia if only because I knew that if the yogurt hit the fan, I could be there in a matter of hours and operate in the same time zone instead of having to take a couple of days to travel half a world away.