Capital, Please!
Entrepreneurs' battles to secure capital in Latin America show the challenges that face the region in its economic development
Twenty South Koreans supervise about 1,000 Mexicans in the state of Guanajuato, Mexico in three sock factories. All of the three factories are owned by the same South Korean. Fifty-five hour work weeks for all, hours long commutes for many. It is mechanic and physically taxing work on an assembly line. Some stuff socks in packages at a torrid pace while others work the design printing machines. The outside heat combined with heat from the machines creates a sauna-like feeling in the massive rooms. The Mexican workers make 400 dollars a month, have chances for performance bonuses, plus they receive one free meal a day and commute assistance. “They are lucky to have this work, actually. It is stable and pays more than double the minimum-wage,” says the head Korean manager.
The twenty Korean supervisors and managers are mostly in their fifties and sixties. They themselves were low-level workers in sock factories in South Korea in the 1970s, 1980s and 1990s. They learned to work the machines and the factory processes. Foreign companies developed manufacturing centers in South Korea to take advantage of its low-wages, political stability, and open investment climate. Not only did the South Koreans gain low-wage jobs, they also gained business and technological know-how in the sectors they worked. Armed with this knowledge, South Koreans began to start their own manufacturing businesses.
As South Korea became one of the wealthiest nations in the world through its export-driven economy and wages rose, many low-wage jobs left for lower-wage countries like China, Southeast Asia and Mexico. Most younger South Koreans work in white-collar jobs and are highly educated. Some of the former Korean manufacturers and employees, however, created or managed manufacturing businesses in these lower-wage parts of the world. The head Korean manager of the Mexican sock factory makes over 4,000 dollars monthly, over 10 times the base wage of his Mexican workers. The Korean owner of the factories makes even more. The experience of having foreign investment and factories in manufacturing decades ago has paid off handsomely for those Koreans still in manufacturing.
Spurred on by economic liberalization efforts first in the 1980s and then by the North American Free Agreement in the 1990s (NAFTA), Mexico has been a low-wage manufacturer for international firms for nearly three-decades. After three-decades or so of manufacturing experience, Korean firms were starting to export to other nations and develop strong brand recognition. Mexico, however, has not developed any international technology or manufacturing firms like LG, Samsung, or Hyundai. Moreover, the Korean-owned sock factory sells almost exclusively within Mexico and is one of the largest sock factories within Mexico. In other words, foreigners are taking home significant profits in a significant business sector. Why has Korea been able to do what Mexico has not? In another thirty years, will Koreans still be supervising Mexican sock production in Mexico or will Mexicans be the owners and managers of the factories in their own country?
A clue may come from Cartagena, Colombia, a city with a tiny manufacturing base in a country with little history of manufacturing. On a 2018 visit to a small family business that makes embroidered clothing using heavy equipment, the owner discussed the challenges of starting a manufacturing business where no one has ever manufactured beyond handmade, household goods. Pointing to three industrial-sized embroidery machines he owns, he says that “when I bought these machines, they were the first of their kind in this city. To buy them I had to go to Medellin [on the other side of the country]. Furthermore, I had to bring someone from Medellin here to train us. There was literally no one to learn from here. The process of bringing the equipment and a trainer here was very expensive. Furthermore, even with training we had a lot to learn given we had never used a machine like this.”
The advantage that this small business owner has, however, is access to capital. Thanks to a private foundation in the city that provides micro-credit to over 2,000 small businesses, the owner was able to buy the equipment and hire the trainers he needed to expand. The foundation gives loans to businesses that lack the long financial history required by traditional banks. Given the lack of local clothing manufacturing in the city, he has contracts for custom uniforms with local baseball and soccer teams, the city government and schools. His capital access and entrance into a niche market overcame the lack of manufacturing knowledge in Cartagena.
When asked why he went through the private foundation microcredit arm rather than a traditional bank, he said that banks have requirements he could not satisfy. He did not have a past credit history nor proof he had turned a profit for multiple years. The foundation with whom he worked inspected his then starting business, came to terms with him on a loan, and provided follow up consults on the progress of his business. This small business owner, however, is lucky he has a foundation from which he can borrow. As of 2017 it was estimated that 6 million Colombians desired microcredit for their small businesses but lacked access.
While Mexicans are benefiting from learning the business and technology of manufacturing, and thus have a substantial leg-up on their counterparts from Cartagena, they too are hamstrung by a serious lack of credit. A 2016 report estimated that 56 million Mexican adults, or 71 percent, did not participate in formal financial institutions. This means they did not have bank accounts, credit cards, or formal loans. Without a financial history, this means that many Mexicans cannot prove their credit-worthiness to obtain a loan.
The problem is regional. In many countries in Latin America, the level of informality is at 50 percent. The informal economy effectively shuts out massive numbers of citizens from the formal credit market as they lack conditions for a loan. Moreover, microcredit in Mexico, like the type the Cartagena manufacturer accessed, is some of the most expensive in Latin America at 74.7 percent annually in 2015. This compares to 38.4 to 42 percent annually offered by the foundation for the Cartagena business owner (still very high by North American standards). However, over six million Colombians who need microcredit lack access. As such, it is not possible to generalize beyond the specific examples in Cartagena regarding Colombian access to microcredit.
Lack of access to capital was cited by an American businessmen who frequently does business in Mexico as a major impediment to the development of a manufacturing sector. “Banks and the government don’t make it a priority to help develop these types of small and medium sized manufacturers,” he said. A Mexican-American businessman with investments across the world stated that “businessmen like Carlos Slim [one of the world’s richest people; he owns the telecom behemoth Telmex] who control the majority of major sectors of the economy don’t have an interest in developing a Mexican middle class. They eat up many smaller Mexican companies or deny them entry to the market.”
On a 2018 visit to Mexico City we visited a year-old small printing business. Their typical products are banners, customized photos and wedding invitations, among others. For the majority of the seed money, family members contributed. Ownership shares were divided according to the percentage of capital invested. “Given high interest rates, we really wanted to limit our exposure to loans,” they say. Luckily for their business, they do not need too much heavy equipment yet. However, as they likely expand and need more complex equipment that can handle greater order sizes or new products, it is possible that loans will be necessary. The ability of informal means like family financing to deliver will be tested.
The owner of this printing business, Salena, also worries whether her business will fall victim to the same trends her parents’ businesses did in the last twenty years. Each parent owned a mattress and furniture business which both experienced multiple years of profits. Larger chains, however, entered these markets and drove out smaller competitors by offering payment plans and lower prices. Both ultimately went out of businesses. Salena’s family’s economic outlook has been difficult for years. In the United States, one might go to Costco for these customized products. The fear is in Mexico this will happen in Salena’s industry, too, like it already has in other industries.
Will Mexico and other Latin American nations reproduce the Korean miracle? Why were Koreans making socks thirty years ago while now they supervise sock factories in Mexico while Korean firms have the best technology in the world? Capital and internal investment appear to be greater barriers than a lack of knowledge. In addition to the sock factory we saw where Mexicans are gaining manufacturing knowledge, international automakers and other high-value products are manufactured throughout Mexico’s central and northern regions. Mexicans are obtaining crucial industrial knowledge just as Koreans did decades ago.
Latin America’s problem with capital is also seen in the dearth of private and public investment in nations. Latin American national economies spend a tiny amount on research and development (R and D) compared to European, North American and East Asian nations. Brazil is the only nation in the region that spends over 1 percent of GDP on R and D while South Korea is tied for first place globally at 4.3 percent of GDP. Likewise, the public sector is underfunded due to low tax collections (of which corruption and tax evasion plays a part) which limits investment in education and infrastructure.
Low education hurts innovation. A recent study of four Andean nations showed they have only one-fourth the number of engineers, per capita, that advanced nations have. Likewise, poor infrastructure hurts productivity. As Rafael de la Cruz of the Inter-American Development Bank states, a typical cargo truck in the United States drives 100,000 kilometers in a year while in Latin America the same truck drives 50,000 kilometers. The lower flow of capital causes a decrease in productivity.
There are, of course, significant historical forces that have prevented the industrialization of Latin America. The late Uruguayan writer Eduardo Galeano argued in the second part of his masterpiece The Open Veins of Latin America that European and U.S. industries, aided by their national governments, thwarted nascent and promising Latin American industries in the 1800s by forcing Latin American nations to open their economies to cheap industrial products before their domestically made products were competitive. Galeano also highlighted how Latin American nations, from independence onward, were constantly in debt to foreign banks which constrained their investment in domestic infrastructure and industry. Foreign debt issues continue to hamper the ability of many nations in the region to invest in infrastructure and human talent.
Equally challenging are the internal racial, ethnic and socio-economic divisions in many Latin American nations between the vast underclasses and the wealthy which overlaps with the divisions between indigenous, mestizo and light-skinned elites that often look abroad for schooling and investment. This in turn drains the nation of capital and educated professionals. And then there is the extreme violence in Latin America which does not help economic growth. The list of problems is long, but as entrepreneurs with access to capital and industrial knowledge show, industry can and will grow. But absent capital, the knowhow, individual hard work and innovation will not get off the ground. Absent individual hard work and innovation, there is only so far a nation can grow economically and improve the lives of as many citizens as possible.
