Drug Trafficking, Violence and Mexico’s Economic Future

In June 2010, in the days leading up to Mexico’s state elections, Rodolfo Torre, a leading gubernatorial candidate from the northern state of Tamaulipas, was assassinated. He had campaigned against Mexico’s drug-related violence. Shortly thereafter, in July, drug criminals used a car bomb for the first time in the history of Mexico’s drug war and killed four people in Ciudad Juárez. In August, the bodies of 72 migrants were found in northern Mexico. They had been shot after refusing to work for a drug gang. Days later, a prosecutor and police officer investigating the crime disappeared.

Headlines such as these have become commonplace in today’s news stories. Yet the reasons behind this escalating violence and its broader impacts on Mexican society are not fully understood because public attention is consumed by the shocking nature of the crimes. Since the scale of the human tragedy has already been well-examined, this article focuses instead on the source of increasing drug-related violence in Mexico; its economic impact, including direct and indirect costs; and the response of the global business community.

Mexico produces and distributes marijuana, cocaine, heroin, and methamphetamine to most of the world. Its largest market, the U.S., sources 90% of its cocaine from Mexico. Drug trafficking is a lucrative activity for the Mexican cartels, generating estimated annual revenues of US$35 billion to US$45 billion for Mexico, with a profit margin of approximately 80%. For this reason, many cartels are fighting for the profits involved in producing and distributing drugs. Currently, seven powerful drug-trafficking organizations occupy different regions of Mexico — La Familia Michoacán, the Gulf Cartel, Los Zetas, the Beltrán-Leyva Organization, the Sinaloa Cartel, the Tijuana Cartel, and the Juárez Cartel.

Mexico’s drug trade and these cartels have existed for many decades. However, the violence related to the country’s drug trade has increased dramatically since President Felipe Calderón took office in December 2006. While previous administrations did not confront the drug trade aggressively, Calderón launched a total war, believing the increasing power of Mexico’s drug cartels poses a serious threat to the country’s security.

Almost immediately after taking office in 2006, Calderón deployed 36,000 national troops to nine states to destroy crops, collect intelligence, interrogate suspects, and confiscate contraband. He has also initiated a variety of public security and judicial reforms. For example, the Mexican government is working to improve the effectiveness of its federal police force, planning to hire 8,000 additional police investigators during 2010, while at the same time trying to purge the force of corruption. In August 2010, nearly 10% of the federal police were fired for failing lie detector, drug, or other tests that form the “trust control exams” designed to identify officers with ties to organized crime.

In addition, Plataforma México, a recent reform related to information management, aims to create real-time interconnectivity within Mexico’s police force by developing a national crime database to facilitate tracking drug criminals. Some of the judicial reforms include the introduction of oral trials, plea bargaining, and alternative case-resolution methods, as well as the possibility of engaging anonymous judges for drug-related prosecutions in order to increase the efficiency and safety of the judicial process. More importantly, the government is taking the punishment of convicted drug criminals seriously and has increased extraditions to the U.S.

Recognizing that the drug trade is not only Mexico’s problem, the U.S. has also pledged to help the country through the Mérida Initiative, an agreement under which the U.S. will provide support to Mexico and other Central American countries in their fight against drugs. Specifically, the U.S. has allocated US$1.5 billion over a three-year period to eliminate corruption within these countries’ government institutions by funding training for police forces, security-development programs, and purchases for equipment used in the war against drugs.

New Alliances, More Violence

Despite the efforts of Calderón’s administration and the increased cooperation between Mexico and the U.S., drug-related violence in Mexico continues to rise. An estimated 7,000 people died in Mexico in 2009 as a result of the drug war — significantly more than the 1,300 people who are believed to have died in 2005 before the war began. There were also an estimated 1,200 kidnappings in 2009. Paradoxically, Mexico’s strong stance against the cartels seems to be contributing to increased drug-related violence. While the efforts of Calderón’s administration have, indeed, weakened the cartels, the capture of key leaders has upset their dynamics as members fight for powerful and profitable leadership positions.

The Mexican government’s war against drugs has also affected the distribution of power among the cartels as they fight to gain the rights to their now-weaker competitors’ drug routes. This fighting is so extreme that it has resulted in alliances between certain cartels in order to defeat others. For instance, La nueva federación is an alliance that was formed recently between La Familia Michoacán, the Gulf Cartel, and the Sinaloa Cartel.

Another likely explanation for the increase in drug-related violence is that the drug cartels are attempting to force the government to back down by terrorizing the public. As a result, violence has now spilled beyond the cartels, embroiling Mexico’s public and creating an insecure environment within Mexico, especially for businesses. The cartels now use various forms of violence against corporations — from kidnappings to theft to extortion — as a means of gaining power and profit. Pemex, the state-owned petroleum company, has been a repeated target of the cartels. In 2010, the company experienced multiple kidnappings and theft by the cartels and corrupt employees. Reuters estimates that Pemex loses “US$750 million of fuel and oil from its pipelines each year” along with “valuable spare parts and equipment.”

The drug cartels challenge the viability of safe and secure business environments not only for large companies such as Pemex but also for small business owners and average citizens. In July 2010, gunmen ambushed a birthday party in the Mexican state of Coahuila, killing 17 people and injuring many more. Some sources believe these mass killings were the result of the innkeeper’s not paying the extortion fees that had been demanded of him. Clearly, the carnage of Mexico’s drug war is now affecting all strata of society — from impoverished migrants to the wealthiest elite and from neighborhood businesses to Mexico’s largest firms.

In August 2010, the far-reaching impact of Mexico’s drug-related violence prompted Calderón to open debate on legalizing drugs. While there are differing opinions among Mexican politicians, many influential figures — including current Partido de la Revolución Democrática leader Jesús Ortega and former presidents Ernesto Zedillo and Vicente Fox — believe the government’s strong stance against drugs is not working and that legalization must be explored. Their main argument is that by eliminating the black market for drugs in Mexico, the price of drugs will decrease, along with the profits and power of the cartels. Calderón has been quick to respond that the price of drugs is not determined by the market in Mexico, but by the market in the U.S., where the Mexican cartels sell the majority of their drugs. Thus, unless the U.S. also legalizes drugs, Calderón has said “it would be absurd” for Mexico to do so. He is strongly opposed to creating an environment that facilitates drug use and addiction.

In addition, he and some members of his administration oppose legalization due to the cartels’ pervasive influence in Mexican society. Even if drug production, distribution, and use were legalized, the cartels would likely increase other criminal activities, such as extortion and kidnapping, as a means of maintaining or boosting their earnings. Therefore, it is unlikely that legalization would affect the current levels of violence and corruption in the near future.

The attitudes of business leaders with operations in Mexico reflect the deteriorating conditions and suggest that insecurity has significant economic consequences. For the past two years, American Chamber Mexico (AmCham) has conducted a survey of its members — foreign and national managers — to gauge their sentiment regarding corporate and personal security: 75% say their businesses have been affected by the country’s insecurity. While their principal concerns have consistently been employee security and executive protection, other results show divergent perceptions of key issues. Nearly 60% of the respondents felt less secure on a personal level in 2009 than in 2008; but the same respondents were equally divided as to whether their respective companies were more, less, or equally secure across the same period.

Of the third of the respondents who viewed their companies as being less secure than the year before, the most commonly noted contributing factors were the strengthening of organized crime activity, impunity in the judicial process, and activities associated with drug trafficking. Among those who felt their companies were more secure, 25% credited the work of the Mexican authorities, while 75% attributed the improvement to the results of efforts within their own companies. Whether respondents felt their companies were better or worse off in 2009 than in 2008, there appears to be a consensus that the government is not succeeding in its efforts to provide a more secure environment.

The Role of the Private Sector

As these survey results suggest, because the government is not capable of providing adequate security, the private sector has been playing a more prominent role in this arena. The market for private security in Mexico equals 1% of GDP, or $8 billion. In response to this significant market opportunity, there are now over 10,000 private security firms compared to 6,000 15 years ago. Only 10% of these firms are professionalized, meaning they invest in training, infrastructure, technology, and analysis. Private security employs a workforce of 500,000, equal to nearly 85% of the public security sector excluding the military.

The most common goods and services provided by Mexican private security firms are bodyguards, electronic devices, and armored cars. The April 2010 Mexico Security Expo, a conference that showcases a wide range of the industry’s products and services, was 20% larger than the previous year’s. A conference spokeswoman illustrated the growing need for security services: “Sadly, the violence generated by organized crime has made Mexico one of the best markets for multinationals specializing in security.” In a move that reflects this sentiment, the Spanish security firm Prosegur augmented its presence in Mexico with its acquisition of a local security firm in 2009. Prosegur has seen its revenues there grow from US$1 million in 2007 to an expected US$17 million in 2010.

As previously noted, vehicle armoring is a principal offering of the security industry, and it is not surprising that the growth of the market is most visible in this subsector. In Latin America, the armoring market has increased by 850% in the last eight years, and Mexico is now the second largest market after Brazil. Since 2008, the number of armored cars has increased by 25% in Mexico City and by 60% in the rest of the country. This market is expected to grow by 20% in 2011. Businesses have responded to this need: There are now 70 registered providers of armoring, compared to only three 15 years ago.

Car manufacturers are also producing armored cars targeted toward this market. The extent to which the profile of the typical armored car owner has changed demonstrates the broad societal impact of insecurity. In 2008, CEOs of large companies were the principal users. Two years later, executives two or three levels lower in the hierarchy, as well as their family members, are using armored vehicles. The CEO of International Armoring Corp., an American firm that has seen a great increase in its shipments to Mexico and U.S. border cities, confirms that his client base is shifting: “[These cars] are made to blend in…. They are no longer only for heads of state. Our customers at the borders are normal executives who are concerned for their safety.” Even more tellingly, the 40% growth of the market for used armored vehicles and the introduction of armored versions of mainstream, affordable brands such as Chrysler and Volkswagen suggest that the need for this protection has spread beyond the elite.

Confronting this troubled security situation is undoubtedly costly to the Mexican government and society. Kroll estimates the direct cost of insecurity to the government, businesses, and citizens to be US$65 billion, or 8% of GDP. While the magnitude of this figure is notable on its own, when put in the context of other key economic data, it is even more striking. Also, according to Kroll’s figures, this amount represents 75% of the total income and sales taxes collected by the Mexican government, 2.5 times the inflow of remittances to the country, and 3.5 times the amount of foreign direct investments. It is twice the size of Mexico’s oil exports.

Violence and insecurity clearly come with negative economic consequences, even beyond the staggering direct costs. As former president Vicente Fox (2000-2006) commented recently on his website, “the magnitude of the damage [of the violence associated with the fight against organized crime] has also extended to the perception and image of the country, economic activity, particularly in tourism and foreign direct investment, as well as the formidable opportunity cost that we are paying in resources, people, and time that have to be sacrificed at the expense of other strategic areas.” President Calderón has voiced a similar sentiment, stating, “the insecurity, in general, and the information that derives from it send, not only to Mexico but to the world, a sign of violence that worsens the image of our country.”

Beyond the perception, though, it is difficult to quantify the economic impact. International tourism revenue, the third largest source of dollar inflows, fell 15% in 2009, the first decline in a decade. This cannot be attributed solely to a fear of violence, however, as that year saw the global economic crisis as well as the swine flu outbreak in Mexico, both of which discouraged tourism. While authorities maintain that tourist areas remain safe for visitors, there have been incidents of violence in formerly popular destinations such as Acapulco, Puerto Vallarta, and Taxco.

It is also commonly believed that the insecurity is negatively impacting foreign direct investment, particularly as violence is increasing in Monterrey, one of the country’s principal industrial cities. Local business leaders there say that some foreign investments have been put on hold due to security concerns, but they are reluctant to give specific examples. Of course, it is impossible to identify all of the investments that would have been made had the security atmosphere been more favorable, but 27% of AmCham survey respondents indicated they had reconsidered investments in Mexico due to security issues. This figure represents the views of managers who already have ties to Mexico.

It is likely that negative publicity would have an even greater influence on those making the decision whether to begin investing in Mexico. However, capital continues to flow into the country. In fact, foreign direct investment is experiencing an impressive recovery from the economic crisis and is expected to reach 2006 levels of US$20 billion in 2010. As the director of the Economic Commission for Latin America and the Caribbean (Comisión Económica para América Latína y el Caribe) recently noted: “What is important for an investor in regards to security has to do with legal security and country risk. In both aspects, Mexico has advanced a lot, and this is the type of security that affects the investor.”

This positive trend, however, should not be over-emphasized. While some progress has been made in Calderón’s fight against organized crime with the arrests and killings of key traffickers, four years into the struggle the violence is worsening, with no end in sight. An increasing proportion of AmCham respondents do not expect to see improvements in the security context within the next five years. While the private security industry is benefiting from its increased relevance, this crisis is imposing significant financial, social, cultural, and psychological costs on Mexico. Adding to the difficulty of gauging these costs, specifically in economic terms, is the reluctance of key stakeholders to speak openly and frankly about the topic.

Executives are understandably unwilling to discuss in detail the full extent of their security concerns and, even more so, their precautions, as such candor could make them less effective. Security consultants are similarly mum on specifics because discretion is key to the services they provide. Stakeholders with sufficient interests in the country — whether they are investors, government officials, or well-connected citizens — may be hesitant to contribute to negative perceptions of Mexico.

This results in starkly mixed messages: Near-daily headlines tell of torture, shoot-outs, kidnappings, and murders that should scare off tourists and investors. At the same time, some maintain that insecurity is highly regional, limited primarily to those involved in the drug trade, and is not a significant business concern. Like most such dichotomies, the truth lies somewhere in the middle — for now. The fight for security in Mexico has the potential to move the country toward one of those extremes; overcoming the drug violence, therefore, is of utmost importance to the country’s future.

This article was written by Devon Duff and Jen Rygler, members of the Lauder Class of 2012.

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