Abstract
Mexico is the world’s 12th largest economy in terms of Gross Domestic Product ($1.657 trillion), growing at an average rate of 3.8% annually. With a 47.7 million labor force, Mexico has GDP per capita of $15, 100 which is the 81st highest in the world. Mexico’s leading industry include food and beverages, tobacco and cigarette production, chemicals, iron and steel manufacturing, petroleum, mining, textiles, clothing, manufacture of motor vehicles, consumer durables, and an active tourism sector. Ninety percent of Mexico’s trade is under free trade agreements with countries from the whole North America, most of Central America, the European Free Trade Area and Japan (The CIA Factbook, n.d.).
Mexico’s growth is attributed to its signing of the North American Free Trade Agreement (NAFTA). Mexico, along with the United States and Canada, has created a trilateral trade block that came into force on January 1, 1994. One of the effects of NAFTA on the economy of Mexico is the change in the Foreign Direct Investments (FDI) made. Foreign direct investments are defined as investments that are made into a country for the establishment of production facilities or business ventures.
This study examines the econometric relationship between FDI and Mexico’s economic growth, as measured through its Gross Domestic Product (GDP). Using regression analysis, the study was able to determine that FDI is a significant contributor to GDP growth. Other factors however, could influence growth and this could be examined in future studies.
Introduction
Mexico is the world’s 12th largest economy in terms of Gross Domestic Product ($1.657 trillion), growing at an average rate of 3.8% annually. With a 47.7 million labor force, Mexico has GDP per capita of $15, 100 which is the 81st highest in the world. Mexico’s leading industry include food and beverages, tobacco and cigarette production, chemicals, iron and steel manufacturing, petroleum, mining, textiles, clothing, manufacture of motor vehicles, consumer durables, and an active tourism sector. Ninety percent of Mexico’s trade is under free trade agreements with countries from the whole North America, most of Central America, the European Free Trade Area and Japan. Mexico is the 14th largest exporter in the world in terms of value (at US$ 292 billion), exporting consumer goods, processed foods, coffee, LCD screens and other electronic devices, cotton, automobiles, and aircraft engines. Mexico trades most with the Germany (1.7% of total exports), Canada (6% of total exports) and the United States of America (76.5% of total exports). In terms of imports, Mexico imports goods and services from Japan (4.1% of total), South Korea (5.4%), Chile (9.3%), China (5.4%), Brazil (31.4%) and the United States (at 55.5%)! In fact, according to the US Department of State website, not only is the United States of America the largest trade partner of Mexico, it’s also the largest foreign investor. Mexico trades with America with a lot of “intermediary” goods, or those that require finishing or further processing. The result of this mutual dependence is a free-flowing trade market and an improvement in competitiveness of both countries.
Mexico’s economic growth is believed to be influenced by the establishment of the North American Free Trade Agreement (NAFTA). Mexico, along with the United States and Canada, has created a trilateral trade block that came into force on January 1, 1994. The goal of the NAFTA is to promote trade and investments between the three member countries through several mechanisms that include removal of tariffs for export and import of goods, elimination of non-tariff trade barriers, improved intellectual property rights protection (Hanson, 2007). One of the effects of NAFTA on the economy of Mexico is the change in the Foreign Direct Investments (FDI) made. Foreign direct investments are defined as investments that are made into a country for the establishment of production facilities or business ventures. These include the expansion of existing operations, transfer of operations from one country to the host country, or the purchase of a local company by a foreign company (Cuevas, et al. 2005). FDI does not include passive investments such as stocks, bonds or other forms of securities. Starting in 1994, Mexico’s economy has experienced very high growth and the country has become a mature economy in terms of foreign investment and trade. This growth coincides with the ratification and implementation of the provisions of the NAFTA leading to many widely published scholarly works on the effect of NAFTA for Mexico, the US and Canada. Villareal (2010) in a paper for the CRS Report for Congress stated that since January 1994, since the implementation of the North American Free Trade Agreement (NAFTA), the relationship between the United States and Mexico has improved greatly. Significant issues such as health, environment, domestic and border issues and most importantly policy, trade and investment issues are determined by both countries under the NAFTA framework. More importantly, there is focus on the welfare of Mexico as a trade partner and participant of NAFTA, which was discussed in the 111th United States Congress. The effect of NAFTA on the Mexican economy is manifested clearly through the economic development of the country, as reflected in the country’s Gross Domestic Product (GDP). Mexico, from a difficult and poor economy in the 1980s, has emerged as a developed economy that employs highly skilled labourers enjoying better wages and living a higher state of economic being.
These effects are seen in Mexico’s many industries. According to Waldrich (2008), the impact of the FDI on Mexico’s manufacturing industry is significant. Mexico’s industrial productivity and wages have increased significantly in the first 10 years, according to Waldrich, due particularly to the increase in FDI as a result of the implementation of the NAFTA. The NAFTA has made Mexico a destination for foreign investments, manufacturing and exports. The measurement of the country’s Total Factor Productivity (TFP) is positive and has not affected the wage levels of the country negatively. The increase in FDI comes from the US pouring investments into Mexico due to NAFTA, with other countries having very little documented effect on the increase in FDI. This paper attempts to quantify the effect of increased FDI on the country’s economic standing, as expressed in GDP growth.
Statistical Data
The data used for this analysis comes from the following sources:
- The World Bank (http://data.worldbank.org/country/mexico#cp_fin)
- USDA Economic Research Service (http://www.ers.usda.gov/topics/international-markets-trade/countries-regions/nafta,-canada-mexico/mexico-trade-fdi.aspx#.UgGezI35DiA)
- Index Mundi (http://www.indexmundi.com/facts/mexico/foreign-direct-investment)
Time series data (from 1970 to 2011) on Mexico’s net FDI (inbound and expressed in US$ millions) and GDP (expressed in US$ millions) were acquired and analysed statistically. Relevant information was derived from scholarly articles published online for this analysis. Currently, there are more than 100 scholarly articles, discussions, and published work related to the topic. The benchmark for the definition and measurement of Foreign Direct Investments is provided by the Organization for Economic Cooperation and Development (OECD). OECD’s definition includes all transactions between the host country and the investing country or company within a reference period (normally a year). Like other forms of investments, direct investments are affected by macroeconomic factors such as the foreign exchange rate between the host and investing country or company, relative prices of other investments, and others. The FDI is an accumulation of flows and the changes in one sector over the other may lead to a negative value for foreign direct investments (consider for example loan payments from the host country to an external debtor). Thus the direction of the FDI as exhibited by its numerical value provides information on what the FDI is and where it is directed or heading to. Scholarly work on the effect of FDI on economic progress indicates that FDIs translate to transfer of critical technology that spurs domestic economic growth. Studies also support findings indicating that the stronger the human capital stock of a host country, the better the transference of technology, thus the higher the pace of economic development. However there clearly is much more to FDI, especially when framed under a trade scenario that focuses on improving investment relationships across international borders.
Regression Estimate
A statistical model shall be developed to determine the contribution of FDI into Mexico’s GDP. There will be two parts of the analysis. The first is a trend analysis showing the time series data for both metrics, shown from 1970 to 2011 and highlighting the comparison of FDI to the total GDP of the country. The second part of the analysis is a regression analysis. The regression analysis will be utilized in the determination of the correlation between the contributions of FDI to the country’s GDP. The comparison shall include time series data in US Dollars. These two comparative analyses would indicate the improvements on Mexico’s economy as a result of the infusion of capital. The use of the country’s GDP and FDI comparison indicates resource conversion, wherein the higher FDI numbers should translate to high GDP growth. For the regression analysis, the econometric equation shall be:
GDP = FDI + Constant
Where:
- GDP is Mexico’s annual GDP measured in US Dollars
- FDI is the corresponding FDI for the year, as calculated above
- A constant or error term
Results
A comparison of the FDI received by Mexico and its GDP is shown the diagram below. The growth of FDI seems to be progressing at a steady rate whereas GDP’s fluctuations are more erratic. This indicates that there are other factors other than FDI that contribute to GDP movement in Mexico. To ascertain how much of the movement in GDP is correlated to FDI movement, the regression analysis is conducted.
Figure 1 Comparison of FDI and GDP per year
A scatter plot diagram indicates the correlation between the two. No visible correlation indicates that FDI is not a good predictor of GDP. The scatter plot diagram below however, indicates otherwise. There seems to be a positive relationship between FDI and GDP. As FDI increases, GDP also increases. This is also shown in the linear trend line formed, which is the same regression results.
Figure 2 Scatter Plot Diagram GDP and FDI
The regression results are:
GDP = 0.3098FDI + 1073.4, R² = 0.8399
The regression results show that FDI positively affects GDP. One unit change in FDI (say 1 million US$ increase in FDI) increases Mexico’s GDP by 0.3089 US$ million. The relevancy or goodness of fit of this equation is at 83.99% (as shown in the R-square metric).
The T-stat shows that the degree of freedom (df) is 1 for the regression equation. At a df of 1, the critical t-stat based on statistical tables is 2.920. We will say that the variable is significant if it its absolute value is greater than the calculated t-stat value. Based on the results, FDI has a t-statistic that is greater than 2.920. Therefore FDI is a significant explanatory variable.
Figure 3 Regression Results
Conclusion
The regression analysis proves that FDI is a significant explanatory variable for GDP growth. However, it is not the only variable that contributes to GDP. There are other factors that could improve the econometric equation such as the value of Mexico’s exports (net exports) and the US’s GDP due to the close relationship between the economies of both countries. However, FDI is a good starting base and helps explain how Mexico has transformed itself into a sustainable and thriving economy.
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