1. U.S.-Mexico Economic Update: Where are we headed? Roberto Coronado Assistant Vice President in Charge and Sr. Economist May 17, 2013 The views expressed in this presentation are strictly those of the author and do not necessarily reflect the positions of the Federal Reserve Bank of Dallas or of the Federal Reserve System. Any secondary distribution of this material is strictly prohibited. May be quoted with appropriate attribution to the author.

2. Today’s agenda  U.S. economic update  Mexico’s economic update  Trade between the U.S. and Mexico  Texas-Mexico border economy in transition  Future of manufacturing in Mexico  Concluding remarks

3. U.S. recovery continues to be modest

4. What do we mean by a sluggish recovery?

5. GDP growth: two steps forward, one step backward

6. Payroll employment continues to improve

7. Unemployment rate is coming down

8. U.S. manufacturing recovery gaining momentum

9. Is manufacturing picking up?

10. Vehicle sales continue to improve

11. What about the rest of the economy  Housing has bottomed down. Recovery gaining momentum.  Consumer spending has picked up. However, consumer sentiment still low.  Inflation in the comfort zone.  The big elephant in the room: Uncertainty

12. Mexico’s recovery has moderated

13. Mexico’s economy is moderating

14. Expansion is broad-based

15. What is driving the strong recovery? 1.External sector – Mexico tapped into the strong growth of emerging economies, around 20% of its exports go to EM – U.S exports have also grown, specially autos 2.Internal sector – Formal employment posted strong gains – Healthy banking system – Jobs + Lending = Strong consumption 3.Capital flows – FDI bouncing back after the “Great recession” – Portfolio investment taking the lead

16. Non-U.S. Mexico’s exports in the lead

17. What is driving the strong recovery? 1.External sector – Mexico tapped into the strong growth of emerging economies, around 20% of its exports go to EM – U.S exports have also grown, specially autos 2.Internal sector – Formal employment posted strong gains – Healthy banking system – Jobs + Lending = Strong consumption 3.Capital flows – FDI bouncing back after the “Great recession” – Portfolio investment taking the lead

18. Growth in Mexico’s formal employment

19. Lending has returned to pre-crisis levels

20. Retail sales

21. What is driving the strong recovery? 1.External sector – Mexico tapped into the strong growth of emerging economies, around 20% of its exports go to EM – U.S exports have also grown, specially autos 2.Internal sector – Formal employment posted strong gains – Healthy banking system – Jobs + Lending = Strong consumption 3.Capital flows – FDI bouncing back after the “Great recession” – Portfolio investment taking the lead

22. Capital inflows making a strong comeback: portfolio investment taking the lead

23. Outlook for the Mexican economy 2013 GDP Forecast (%) 2014 GDP Forecast (%) Banxico (4/13)3.43.9 Banamex (3/13)3.63.8 Bancomer (5/13)3.1 IMF (4/13)3.4 Blue Chip (5/13)3.44.1 UTEP BRMP (Q1/13)3.53.9

24. Trade is the main catalyst for U.S.- Mexico economic integration

25. Title in here World trade now exceeds pre-crisis peak…

26. Title in here …but still below 1992-2007 trend

27. U.S.-Mexico trade Source: Census Bureau/Haver Analytics

28. U.S.-Mexico trade Source: Census Bureau/Haver Analytics

29. U.S.-Mexico trade Mexico is the third most important trading partner for the U.S. In 2012, Total trade with Canada almost reached $616 billion, with China $536 and with Mexico $493 For Arizona, California, New Mexico and Texas, Mexico is a key trading partner: Arizona ---- $6.3 billion (34%) California ---- $26.3 billion (16%) New Mexico ---- $0.6 billion (21%) Texas ---- $94.8 billion (36%)

30. How are the U.S.—Mexican industrial sectors linked? 18% of U.S. exports go to Mexico 72% of U.S. exports to Mexico are industrial products 8% of U.S. imports are from Mexico 90% of these imports are industrial Maquiladoras are a major vehicle for this cross-border movement of industrial goods

31. U.S.-Mexico total trade by sector Sector 1996 (Billions) 2012 (Billions) % change Petroleum7.960.6667% Road Vehicles19.673.4274% Electrical Machinery20.950.0139% Telecommunications9.538.8308% Office /Automatic Data Processing5.630.4443% General Industrial Machinery4.724.2415% Power-Generated Machinery4.818.2279% Total Trade U.S.-Mexico131.1494.0277% Source: U.S. Census Bureau

32. Trade by port of entry Source: U.S. Department of Commerce Bureau of the Census, Foreign Trade Division Texas ports2012 $ Billions2012 % of Texas total Brownsville-Cameron15.393.73% Del Rio4.141.00% Eagle Pass21.655.25% Laredo168.7940.91% Hidalgo/Pharr26.846.51% Rio Grande City0.270.07% Progreso0.380.09% Roma0.050.01% El Paso66.8516.20% Presidio0.500.12% Texas412.57

33. Texas–Mexico border synchronization Laredo-Nuevo Laredo El Paso-Ciudad Juarez Mc Allen-Reynosa Brownsville-Matamoros Notes: Charts show nonfarm employment annual growth rates (left-axis) for U.S. border cities and maquiladora value-added annual growth rates (right-axis) for Mexican border cities, for the period 2000-2006. Sources: U.S. Bureau of Labor Statistics and Instituto Nacional de Estadistica Geografia e Informatica.

34. Piedras Negras- Eagle Pass Notes: Charts show nonfarm employment annual growth rates (left-axis) for U.S. border cities and maquiladora value-added annual growth rates (right-axis) for Mexican border cities, for the period 2000-2006. Sources: U.S. Bureau of Labor Statistics and Instituto Nacional de Estadistica Geografia e Informatica.

35. Maquiladoras impact by border city 10 percent increase in maquiladora output leads to an increase in the adjacent U.S. city as follows: − 2.8 percent increase in total employment in El Paso − 4.6 percent increase in total employment in Laredo − 2.2 percent increase in total employment in Brownsville − 6.6 percent increase in total employment in McAllen − 3.9 percent increase in total employment in Eagle Pass

36. Title in here Maquiladoras are quite important for Texas border cities Estimation method: IVEl PasoDel Rio Eagle PassLaredoMcAllenBrownsville City Level 2.77*-1.233.90*4.626.58*2.21 Construction 0.20-1.470.993.194.04*1.29* Manufacturing -1.28-6.851.631.021.640.66 Transportation 5.30*2.1611.4*7.21*6.63*4.6* Wholesale 0.4333.9230.881.964.01*0.84 Retail 1.31-6.464.06*0.663.21*1.34* FIRE 2.12*-4.343.99*8.23*4.63*0.64 Services 1.84*n.a. 5.93*7.38*3.89* Notes: This table shows elasticity estimates. That is the table shows the percentage increase in local employment from a 10 percent increase in maquiladora production for each Texas Border Cities. * indicates significant at the 10% level. Source: J. Cañas, R. Coronado, R. Gilmer, E. Saucedo (2011) “The Impact of Maquiladoras on U.S. Border Cities”, Federal Reserve Bank of Dallas, working paper.

37. Texas-Mexico border economy in transition

38. Border economy in transition Employment migrating from manufacturing to services Per capita income closing gap with national levels 1990 Mfg. 2011 Mfg. 1990 Services 2011 Services El Paso20%6%73%85% Laredo4%1%86%91% McAllen14%3%74%87% Brownsville16%4%76%88% Eagle Pass17%4%72%81% Source: Bureau of Economic Analysis

39. Per capita income in El Paso and other Texas border cities, 1969-2010 (As a share of the US level)

40. Percentage-point contribution to border-city earnings growth by selected industries, 2001-2010 BrownsvilleEl PasoLaredoMcAllenUS Manufacturing-6.9-10.3-0.8-4.4-7.3 Health Care8.82.75.311.24.6 Retail-0.3-1.2 0.2-1.6 Cross-Border Trade6.57.81.55.65.2 Transportation0.10.3-2.50.7-0.2 Services6.06.52.74.85.1 Federal Civilian0.41.11.30.10.3 Total Earnings5.04.44.96.82.7 Source: Crossroads Issue 2: July 2012 ; Federal Reserve Bank of Dallas, El Paso Branch

41. Future of manufacturing in Mexico

42. Future of Mexico’s manufacturing Mexico has undergone a severe transformation in manufacturing and exports since 2001. Today, Mexico is a key player in global manufacturing. However, there are plenty of challenges ahead.

43. China’s manufacturing wages are growing faster than Mexico, but… Index, 2002=100 Source: Bureau of Labor Statistics and author’s calculations

44. Mexico’s manufacturing compensation still higher than China $/hour Source: Bureau of Labor Statistics and author’s calculations

45. But manufacturing productivity is growing in Mexico Source: INEGI and author’s calculations

46. Mexico auto exports

47. Mexico gains ground in North America light vehicle production Source: Thomas H. Klier, Federal Reserve Bank of Chicago, with data from Ward’s Automotive Group.

48. Mexico becomes largest source country of U.S. motor vehicle parts Source: Thomas H. Klier, Federal Reserve Bank of Chicago, with data from International Trade Commission. Mexico

49. Mexico is closing the gap with China Source: U.S. Census Bureau 2013* Year to date

50. Exchange rate

51. Exchange rate forecast 2013 Forecast2014 Forecast Banxico (4/13)12.19 Scotiabank (4/13)12.4412.51 Banamex (5/13)12.1211.99 Blue Chip (5/13)12.3012.27 UTEP BRMP (Q1/13)12.5612.75

52. Concluding remarks The U.S. economy is coming out of the worst recession in decades, slow recovery. The shape of Mexico’s recovery going forward depends on the U.S. industrial sector. Strong domestic market has fueled Mexico’s recovery. Mexico now plays a critical role in the North American auto sector. The U.S. auto sector is expected to continue to grow and this should be good news to the trade flows between the U.S. and Mexico.

53. U.S.-Mexico Economic Update: Where are we headed? The views expressed in this presentation are strictly those of the author and do not necessarily reflect the positions of the Federal Reserve Bank of Dallas or of the Federal Reserve System. Any secondary distribution of this material is strictly prohibited. May be quoted with appropriate attribution to the author. Roberto Coronado roberto.coronado@dal.frb.org 915.521.5235