The Butterfly Effect - EconVue Mexico Report

Chicago and Mexico are inextricably intertwined on multiple levels. The Midwest has structural similarities to the Mexican economy, especially in terms of the dominance of its manufacturing sector. Chicago has the largest Mexican-American population in the country outside of Los Angeles, more than three quarters of a million people. We even share a connection in the natural world. This is the season when a kaleidoscope of Monarch butterflies swarm through Chicago, on their way to spend the winter in Mexico.

Recently however, manufacturing has taken a hit in both the Midwest and in Mexico. The latest Chicago Purchasing Manager's Index fell to 47.1 in September from 50.4 in August, and is now in contraction territory. Despite a slight uptick in September, the IHS Markit Mexico Manufacturing PMI was 49.0 in August, the lowest reading in the survey’s nearly 8 1/2 year history. There is hope for both regions however, as supply chains shift away from China, providing new investment and employment opportunities.

Sometimes however, well-intentioned micro-level policies get in the way of positive macro trends. We recently studied the possible ramifications of a new tax plan currently under review in Mexico. If adopted, new regulations would erode the deductibility of interest payments on business loans. This is a trend that began in the US last year, spurred by the OECD and the G20 as part of a quest to close global tax loopholes for multinational corporations.

This evolving experiment has the effect of making financing investment more expensive, and could have particularly negative effects in developing economies, which traditionally have depended on tax incentives to attract investment. In Mexico’s case, there is an added twist. Deductions are calculated net of inflation, which is higher there than in most OECD countries, now 3.5%. Uncertainty about how these regulations will be applied will certainly weigh on investment decisions.

In economics, fluctuations in interest and exchange rates are hard to predict, but forecasting taxes and their intended and unintended effects is even more complex.  Compliance issues cloud the picture as well. To try to understand how these new regulations could affect Mexico, we gathered expert opinions and data from investors, businesses, economists, and tax policy specialists in Mexico, the US and Europe. We conclude that the impact of this under-the-radar taxation scheme could counterbalance the positive effects of the upcoming USMCA.

In addition to the many people who helped us with this report, I want to especially thank EconVue intern Raphael Cohen-Fuentes from the University of Chicago. He made invaluable contributions to our research, and tirelessly and expertly translated key documents as well as the Spanish version of this report. 

When a butterfly flaps its wings in Europe, can it cause a tornado in Mexico? We shall see if Chaos Theory is correct. In the meantime, if you would like to follow the migration of monarch butterflies across North America this autumn, Journey North has a live map here.