For many investors and businesses unfamiliar with emerging countries in Latin America, secondary cities are often a non-starter for running a business. When it comes to establishing an operation or investing in some sort of real estate development, infrastructure project or other asset, many companies prefer to play it safe and stay in the largest and most established markets. But those who skim beneath the surface will see that secondary markets are offering ample opportunities with promising yields, while Latin America's largest cities are increasingly saturated and expensive.
Latin America is the most urbanized region of the world with nearly 80 percent of the population (and growing) living in urban areas. Over 260 million people in Latin America currently live in cities, and another 60 million will by 2025. The reasons are simple: better public services, better health care, better connectivity and - most importantly - better job prospects. This is no surprise considering the astonishing disparity between the region's most modern urban centers and the vast impoverished hinterland.
"Since these cities are not obvious choices for investment, they have to try harder..."
Yet there have been important shifts in the last two decades relating to where urban migration is happening. In the 1980s and 1990s much of the urban growth was concentrated in Latin America's largest megacities: São Paulo, Rio de Janeiro, Mexico City, Bogotá, Buenos Aires, and Caracas. But as recent reports by the McKinsey Global Institute and the UN point out, migration to the largest cities (particularly those with more than 5 million people) is slowing, and migration to secondary cities is accelerating. McKinsey estimates that approximately 40 percent of Latin American regional GDP growth by 2025 will happen in secondary or mid-sized cities. São Paulo and Rio have dropped from above the national average in GDP among Brazil's cities to below in the last few decades. Mexico City, meanwhile, has been outpaced by 45 mid-sized cities in Mexico.
What is driving this trend? The biggest cities are experiencing what McKinsey calls diseconomies of scale. Their inability to accommodate rapidly growing populations has led to severe traffic congestion, air pollution, and police forces that are too stretched thin to deter crime and violence. Burdensome regulatory systems too often stifle innovation and grassroots business expansion, which plays into the hands of monopolies and others who are well connected and already established. Because of these issues, megacities in developing countries are often unable to generate sufficient meaningful employment for their ever-expanding populations.
Many problems also stem from jurisdictional ambiguity. The unchecked growth of megacities has swallowed up suburban municipalities, which creates bureaucratic hurdles in delivering public goods. Bogotá demonstrates a compelling example of this: with the city growing into its suburbs, these municipalities are often unable to resolve who is responsible for providing utilities to peripheral shantytowns, or who will clean up the river that forms the outer boundary of the city, or who will finance the last leg of Transmilenio so that it reaches the airport.
To be sure, megacities are doing some amazing things to overcome these hurdles. But the secondary markets are replicating these ideas and in many cases doing them better and faster because they are smaller with more nimble bureaucracies and less saturated consumer markets. Since these cities are not obvious choices for investment, they have to try harder; so many have created pro-investment agencies that assist new companies in navigating administrative processes, identifying their target market, and hiring workers. Because there is less interference between the academic, public, and private sectors, many universities in secondary markets are able to be more hands-on and effective in helping to tackle practical urban issues.
Lower operating costs in secondary markets can offer real benefits to companies looking to establish themselves in emerging markets. Utilities are often lower because the providers usually aren't as strained as they are in the megacities. Traffic is much more manageable, which imposes a lower time cost on residents. Buying or leasing a property can be anywhere from 15 to 50 percent cheaper in secondary markets; top offices in Medellín are renting at USD$20 to 25 a square meter a month while comparable buildings in Bogotá will cost USD$40- to 45 square meters a month.
Below are some examples of secondary markets in Latin America that have been pro-active in luring investment and stimulating their domestic business clusters:
Monterrey, Mexico has established a technology cluster, Tecnologico de Monterrey, that has become a world-class institution. The campus has expanded throughout the country, linking academia to more than 80 tech enterprises. It is a big reason why Monterrey has Mexico's lowest share of population living below the poverty line, and why its per capita GDP has grown 40 percent faster than the country average between 1999 and 2009.
Guadalajara, Mexico holds the title of "Mexico's Silicon Valley" thanks to a high proportion of IT firms who came in after the passage of the North American Free Trade Agreement. Today it stands as a high-tech industrial hub in Latin America.
San José, Costa Rica is often overlooked by vacationers who bolt straight to the beaches. But businesses have much to gain in this city thanks to its vast Free Trade regime that gives tax incentives for high value-added activities such as manufacturing, services, and scientific research. Companies such as Intel and HP have established major operational hubs in San Jose. It also doesn't hurt that the beaches are nearby.
Medellín, Colombia has earned respect from municipal leaders all over the world thanks to a holistic approach to urban redevelopment that features new lower-middle income housing, downtown reinvestment, elevators in the hilly shantytowns, a network of libraries and parks, and its business incubator cluster adjacent to the University of Antioquia.
Cali, Colombia is becoming a leader in Latin America for medical education and Pan-American sporting events. The Mio, modeled after Bogotá's Transmilenio, is considered to be one of Latin America's most efficient mass transportation systems.
Bucaramanga, Colombia is a fast growing city that is the center of Colombia's oil and gas industry. It boasts the country's most educated populace and lowest unemployment rate.
Quito, Ecuador is often bypassed for its larger Andean neighbor cities, Lima and Bogotá, due to its smaller population. However, Ecuador's budding capital boasts a growing middle class, good security, great parks, and world class hiking and climbing within the vicinity.
Valparaiso/Viña del Mar, Chile is located just 70 km west of Santiago on the Pacific Ocean, this metropolitan area consists of two of Chile's most important cities and is known for providing a high quality of life. Its robust economy is based around a bustling port and logistical sector.
Curitiba, Brazil is known for its innovative urban planning and the world's first Bus Rapid Transit system that is now being replicated in all continents. Approximately 54 percent of all journeys are made on public transport (about 2.4 million passengers a day).
Florianopolis, Brazil is one of Brazil' up-and-coming tech hubs, and it consistently ranks as one of the best places in Latin America to live. It is a prime vacation destination and is known as Brazil's Silicon Valley.
Of course, not everything is rosy in Latin America's secondary markets. There is some risk, as these cities aren't as established and companies will need to do more due diligence. Finding local providers could be a bit trickier, as could finding an office or storefront to operate thanks to a lower supply and lower availability of space. But decision-makers should remember that once upon a time the more established markets represented a similar risk, and those who got in early were able to take advantage of the opportunities. Scott Figler lives and works in Bogota, Colombia where he heads up the research division for Jones Lang LaSalle's North Latin America operation. His market reports can be found here.