Nearshore Americas

Mexico’s Competitive Edge Continues to Erode

Mexico's Competitive Edge Continues to Erode

With a global recession well underway, many countries are bolstering their FDI attraction capabilities and setting out recovery plans for which plenty of capital will be needed. Job creation will be vital following the widespread job losses suffered in 2020, and with concerns over long-distance travel, many North American companies with outsourced operations in Asia are looking towards Latin America for Nearshore locations. Opportunity, it seems, is knocking at the door of regional market powers like Mexico and Colombia.

But in Mexico, the political environment is causing investors to stop and think. In the last two years, the Morena government of President Andrés Manuel Lopez Obrador has taken a series of actions that signal a definitive change in attitude toward foreign private interests in the country. The perception is that business in Mexico no longer offers the certainty it once did.

“The changes that the federal government has made since it arrived are undoubtedly impacting the country’s competitivity rankings,” says Ricardo Castro-Garza, Principal at law firm Baker & McKenzie and professor of labor law at Universidad de Monterrey.


The Fall of ProMexico

The arrival of the AMLO government began an apparent reversal to the pro-business, pro-investment sentiment shown under the previous president, Enrique Peña Nieto. The dismantling of ProMexico, an investment promotion agency (IPA) given high importance under the former administration was an indication of Mexico’s shift.

Just months into its term, the government closed all 46 ProMexico offices in locations including New York, Tokyo, London, Madrid and Shanghai. The reason given was that the agency offices “don’t do anything” and that the savings made on office rental costs and salaries could be used more efficiently in accordance with the government’s austerity stance.

Diane Limouzineau said she found it hard to find data on Mexico

With no IPA, foreign investment opportunities for Mexico may have been lost. Diane Limouzineau, Director of New Markets and Strategy at TDCX, a major global BPO that recently chose Bogota, Colombia as the location for its new Americas office, said that the company needs accessible information to understand a country’s market proposition and build a case for investment. “When I started looking for a new destination in the region in 2019, I could very easily get in touch with IPAs from other countries,” she said. “In Mexico, there was nowhere obvious to start. In the end, I had to reach out to the consulate in New York City. They explained that there was no Mexican investment agency which meant information couldn’t be quickly gathered for a market survey. On the other hand, having an IPA as well organized and efficient as ProColombia for instance, clearly facilitated TDCX’s decision to invest and launch operations in Colombia,” Limouzineau said.

The decision to close ProMexico was symbolic as well as economic, indicating a clean break with the globalized strategies of the former government in favor of populist perspective. According to Alan Stevenson, US Commercial Director of OCO Global, an international trade and investment consultancy, the closure of ProMexico put Mexico in an isolated position in regards to FDI.

OCO Global was hired by the World Bank to review national IPAs

“In 2013, we were hired by the World Bank to carry out a competitive assessment of the world’s national IPAs,” Stevenson explained. “Back then, there were only four countries in the world that didn’t have a national IPA. Since then Norway and the U.S. – two of the four – have created their own agencies. Mexico is now one of the very few countries that don’t have an agency dedicated to attracting investment,” he said.

A drop off in global FDI flows following the pandemic means that across the board countries across have seen a dip in investment projects. But rates in Mexico have almost halved, Stevenson noted. “Over the last four or five years, Mexico typically had 450 – 500 projects each year. In 2020 there were only 270,” he said.

Outsourcing: Using a Sledgehammer to Crack a Nut?

In the renewable energy market, Mexico’s Chamber of Deputies recently passed the president’s reform bill that benefits the state-run electricity company CFE over the private players that gained entry to the market after the 2014 Energy Reform. Similar actions like the restriction of bidding rounds in the oil and gas industry, and changes to gas importation authorizations that affect competition between national oil company PEMEX and private retailers, have also been passed. JP Morgan is reported to be exiting Mexico while the world’s major credit agencies have repeated concerns over the country’s attractiveness and the potentially negative consequences on its sovereign rating. The feeling between the public and private industry was not helped by President Lopez Obrador accusing those lawyers defending private foreign interests in the CFE case of committing treason against the country.

Now, changes look set to be made to laws governing the country’s outsourcing industry, which grew 73 percent between 2008 and 2018 and is responsible for 25 percent of employment in the country’s capital city.

“The government is taking a 1970s approach to business instead of understanding the interconnectedness of modern business landscape,” said Bernardo Del Rio

In Mexico, IT companies are often structured as groups that include both an operating and service company. The operating company generates profits, while the service company provides services to the operating company and employs the personnel providing those services.

The government alleges that this outsourcing system breaks laws relating to the benefits employees of companies should receive, including the profit-sharing distribution system that obliges companies to pay a percentage of their profits to employees and helps companies avoid paying higher tax rates. The accusation is that because the operating company is not directly employing workers, the profits it generates do not have to be shared.

The outsourcing draft bill would ban companies from subtracting another company that offers the same core business service under the bill’s ‘specialization’ section, would force companies to pay 10% of profits to employees and turn the breaking of these laws into a criminal conviction, seriously upping the ante. However, the changes will have little to no impact on companies exporting IT services, experts believe.

A Blanket Application

Bernardo Del Rio said the government should adapt its proposed changes

There are obvious and inhibitory problems for normal business practices in Mexico if the bill is passed in its current state, says Bernardo Del Rio, Partner at law firm JA Del Rio. The first is that under the current profit-sharing scheme, a 10 percent profit-sharing tariff would generate huge bills for the employer. “This is particularly true for companies in capital-intensive industries. Imagine an electricity generator that requires US$200 million in investment. If 10 percent profit-sharing goes to five employees, that’s a lot of money,” he says.

Similarly, the specialization change would mean that companies would struggle to find high-quality services during particular periods of the year. “In Mexico it is very common for one company to hire another with the same core business to fulfil one specific part of that business service or for certain periods in the year. Therefore, service providers will have to think about reorganizing their businesses and specialize each one in order to continue to render those services, depending on how the final legislation is passed,” explained Luz Monserrat, Colin Campos a Tax Partner at JA Del Rio.

“These are the kind of changes that the government needs to tweak,” Del Rio said. “A tech company may contract another tech company – an independent, not an outsourcer – and under the specialization rule they would still be hit. The government is taking a 1970s approach to business instead of understanding the interconnectedness of modern business landscape.”

Luis Armendariz is concerned that FDI will be affected

Undoubtedly, there are some unsavory actors that use the insourcing and outsourcing modalities to stretch the meaning of law and get away with malpractice that leaves employees bereft of benefits. But the private sector says that the various aspects of the law have not been properly considered and its blanket application will harm many law abiding stakeholders. “The intention to eliminate abusive practices is correct and the business organizations in the country are in favor of that. But not complete prohibition,” says Luis Armendariz, Partner at CAAM Legal, a commercial law firm specializing in cross-border business advisory. “This change may make foreign companies wonder why this outsourcing practice, that is already in place and used by companies in the US and Canada, and the benefits of which are recognized by the ILO, will be taken away.”

Peter Appleby

Peter is former Managing Editor of Nearshore Americas. Hailing from Liverpool, UK, he is now based in Mexico City. He has several years’ experience covering the business and energy markets in Mexico and the greater Latin American region. If you’d like to share any tips or story ideas, please reach out to him here.