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Mexico Boom Obscures Harm Done to Small Firms by Drug Warfare

Victor Hugo Barragan saw sales plummet 40 percent in the first nine months of 2010 at his homemade-ice-cream shop in Guadalupe, Mexico. A grenade blast that injured 14 people in the town’s central square in October - - the first drug-trafficking attack on the general public ever in this Monterrey suburb -- made a bad year even worse.

Days later, a police officer and elderly bystander died from narcotics-gang gunfire near the same spot, as Bloomberg Markets magazine reports in its January issue.

“People are afraid to come down here,” Barragan, 30, says. The Barragan family has been selling ice cream for 15 years in front of the tree-lined plaza bookended by Guadalupe’s cathedral and the municipal palace’s 100-year-old clock tower.

“Look at it,” Barragan says. “The plaza is empty. This is the worst year that I’ve seen here.”

So far, the violence that has gripped northern Mexico since 2006 has done little to deter large companies, which can afford their own security forces, from building new factories. But many small businesses in regions plagued by drug-cartel killings are suffering or shutting down amid extortion and kidnappings by crime gangs.

Mexico’s small and medium-sized businesses -- those that employ 250 workers or fewer -- account for 52 percent of the economy and 72 percent of formal employment, according to Mexico’s Economy Ministry.

Homicides Rise

American companies say they choose Monterrey for investment because it’s a two-hour drive from the U.S. border, and its universities provide a highly skilled workforce. The country’s third-largest metropolitan area, with 3.6 million people, is part of the state of Nuevo Leon.

The annual homicide rate in the Monterrey region has risen 97 percent since 2006, to 954 in 2010, as of Oct. 30.

“If Monterrey falls to the level of other border cities, it would be catastrophic for the Mexican economy, not just Monterrey itself,” says Scott Wine, chief executive officer of Polaris Industries Inc. The Medina, Minnesota-based maker of all-terrain vehicles and snowmobiles is building a 435,000- square-foot (40,000-square-meter) factory near the city that will employ about 500 people.

In cities across northern Mexico, soldiers often clash with drug traffickers armed with grenades and machine guns in convoys of pickup trucks. In Monterrey, local police patrols are so weak that common criminals feel emboldened, says Juan Ernesto Sandoval, president of the city’s chamber of commerce.

Closing Early

Many small businesses close early to avoid robberies, and owners dress like employees to avoid abduction, he says.

“Businesses are opening at their own risk because, unfortunately, the police aren’t capable of guaranteeing security,” Sandoval says. “This is very serious.”

By the numbers, Mexico’s economy seems little fazed with the drug violence that has claimed about 30,000 lives since Mexican President Felipe Calderon declared war on organized crime four years ago. The central bank estimates that the economy grew as much as 5 percent in 2010.

More than 850,000 jobs were created in the first 10 months of 2010. Mexico’s IPC index of the 35 largest stocks reached a record high of 36,543.40 on Nov. 8, and foreign investment in the first half of 2010 increased by 28 percent from a year earlier. The peso gained 7.1 percent against the dollar in 2010, and the benchmark interbank interest rate dropped to a seven- year low of 4.83 percent on Nov. 3.

Paying Ransom

Mexico would be growing faster if small businesses didn’t have to pay crime gangs ransom or protection money, says Alonso Cervera, an economist at Credit Suisse Group AG in Mexico City. The cost of violence to Mexico’s economy is difficult to calculate because much of it is tied to lost opportunity, Cervera says.

Retailer cash that goes to gangs would otherwise be invested to expand and hire employees, he says. The Finance Ministry estimates that organized crime shaves 1.2 percentage points annually from gross domestic product growth.

Cervera says that number falls short because it’s based on just violence between drug gangs and police, not damage to innocent bystanders and shopkeepers.

“The issue of extortions and kidnapping should not be underestimated,” Cervera says. “Focusing only on the inter- cartel killings is misleading. It’s only part of the problem.”

The effects of the violence are beginning to crop up in statistics, he says. Gross fixed investment was flat in Mexico in the first half of 2010 compared with the same period in 2009. That contrasts with increases of 17 percent in Brazil and 19 percent in Chile in 2010 as of Nov. 8.

Security Measures

The number of tourists visiting northern Mexico dropped 8.5 percent in the first eight months of 2010.

The large Mexican companies that operate small convenience stores nationwide are spending money to protect their outlets. Fomento Economico Mexicano SAB, owner of Mexico’s largest convenience store chain, outfits its Oxxo stores with surveillance cameras and trains employees on security, says Chief Executive Officer Jose Antonio Fernandez. It keeps no more than $40 in store cash registers, to deter robberies.

The Monterrey-based company, which has a market value of $20 billion and controls Latin America’s largest Coca-Cola Co. bottler, has pressured authorities to detain criminals caught on in-store video, Fernandez says. The measures have helped cut the number of thefts by 50 percent in its Tijuana stores and are making progress in Monterrey, he says.

‘More Serious’

Family-run stores that don’t have the money or the political clout of Oxxo should join together to combat crime, Fernandez says.

Nuevo Leon authorities were caught off guard by the magnitude of the drug-related violence and didn’t move quickly enough to quell it, Fernandez says. That’s changing.

“Now that we’ve realized the problem is much more serious than what we thought, we’re reacting,” he says.

Foreign investors, meanwhile, remain bullish on Mexico. Christopher Palmer, who manages $6 billion as head of global emerging markets at Gartmore Investment Management Ltd. in London, is overweight in Mexican stocks. He says he’s confident the government can beat back the drug cartels.

“The more-organized companies that can afford sophisticated security are going to do better,” Palmer says. “It does shift the burden to the relatively unprotected.”

Investment Rises

Foreign companies and investors are watching closely how President Calderon deals with crime gangs in Monterrey, the industrial hub of northern Mexico. In the state of Nuevo Leon, where Monterrey is the capital city, foreign investment rose to $1.8 billion in the first 10 months of the year, topping the total for each of the previous two years.

Along with Polaris, Easton-Bell Sports Inc. is constructing a $50 million plant to make football helmets and Lego A/S is spending $100 million to expand a toy factory.

Violence related to organized crime claimed 10,035 lives in Mexico in 2010 through Oct. 30, according to a tally by Mexico City’s Reforma newspaper. The border state of Chihuahua, where Ciudad Juarez is the largest city, led the country with 2,797 deaths. Nuevo Leon had the sixth-worst record among 31 states and Mexico City, with 524 deaths this year.

Calderon is trying to fight organized crime by creating a unified police force for each state to replace municipal law enforcement. Leaders of the Institutional Revolutionary Party, the largest party in the lower house of Congress, have said they oppose Calderon’s plan.

Corrupt Police

The move is needed to clean up corrupt local police departments that have allowed crime gangs to flourish, says Juan Miguel Alcantara, executive secretary of the National Public Security System. Calderon says improved law enforcement is necessary to protect lives and boost Mexico’s economy and employment.

City patrolmen lack training and decent wages to be effective, Alcantara says. Local officers in more than 60 percent of city police forces earn about 4,000 pesos ($324) a month, he says. Mexican factory workers, on average, make more than twice that, or 9,980 pesos a month, according to government labor statistics.

In cities in northern Mexico, as many as 70 percent of officers have failed confidence-control tests, Alcantara says.

“No officer making 4,000 pesos is going to risk his life,” he says.

Eliminating Extortion

In San Pedro Garza Garcia, population 122,000, a suburb of Monterrey that’s the richest municipality in Mexico, Mayor Mauricio Fernandez has eliminated gang extortion of shopkeepers with a $70 million public project. The community pays patrolmen three times more than most Mexican cities do, installs cameras that read license plates and recognize faces and purchases squad cars and motorcycles.

By eliminating extortion, retailers and other small businesses hold on to more revenue, Fernandez says.

Officers earn base pay of 12,000 pesos a month and undergo scores of exams, including polygraph and drug tests, Fernandez says. The local patrols have gained the confidence of residents and store owners, who in turn are assisting with the city’s security.

“When people are afraid of their police, which many times in Mexico that’s the case, they don’t report crimes,” Fernandez says. “Here in San Pedro, they do trust the police and they report.”

Fernandez’s chief bodyguard, Carlos Reyes, was gunned down on Nov. 4, shortly after the mayor gave a speech in his city. Police have made no arrests.

State Control

The government of Nuevo Leon recognizes that the health of its economy depends on improving security and is committed to working with Calderon, says Javier Trevino, the state’s secretary general. The state plans to be the first to adopt Calderon’s program to unify municipal law enforcement under state control, Trevino says.

“It’s an issue of professionalizing and dignifying the police,” he says.

With broken police forces and courts, Monterrey organized crime will increase, says the Nuevo Leon chapter of a Mexican business group known as Coparmex. That will create a breeding ground for more criminals, the group says. Its leaders no longer make statements as individuals on concern over safety.

“Of course, there’s a risk the violence could reach levels even greater than what exist in the state,” the group says. “This is why it’s urgent to take pertinent actions to attack the problem in a serious and committed manner.”

‘We’ll Survive’

Combating drug crime is essential for small businesses to return to profitability so they can hire more workers, the group says.

Barragan, the ice-cream shop owner, says he saves up during good times to weather the economic downturns that have plagued Mexico. He’s hoping those savings will outlast the crime wave.

“If we’ve lived through so many crises before,” he says, “we’ll survive this one, too.”

To contact the reporters on this story: Thomas Black in Monterrey at tblack@bloomberg.net;

Jonathan Roeder at jroeder@bloomberg.net

To contact the editor responsible for this story: Jonathan Neumann at jneumann2@bloomberg.net.

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