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MONTERREY, Mexico (Reuters) - Mario Ramos thought it was a bad joke when he received an anonymous email at the start of this year demanding $15,000 a month to keep his industrial tubing business operating in Monterrey, Mexico's richest city and a symbol of progress in Latin America.
Sitting in his air-conditioned office looking across at sparkling office blocks dotting the mountains on that morning in January, he casually deleted the email as spam.
Six days later, the phone rang and a thickset voice demanded the money. Ramos panicked, hung up and drove to his in-laws' house. It was already late and he had little idea what to do. Then, just after midnight, masked gunmen burst onto his premises, set fire to one of his trucks, shot up his office windows and sprayed a nearby wall with the letter "Z" in black paint, the calling card of Mexico's feared Zetas drug cartel.
"They were asking for money I could never afford," said Ramos by telephone from San Antonio, Texas, where he fled with his family the next day. "I should have taken the threat more seriously, but it was such a shock. I couldn't quite believe this could happen in Monterrey."
In just four years, Monterrey, a manufacturing city of 4 million people 140 miles from the Texan border, has gone from being a model for developing economies to a symbol of Mexico's drug war chaos, sucked down into a dark spiral of gangland killings, violent crime and growing lawlessness.
Since President Felipe Calderon launched an army-led war on the cartels in late 2006, grenade attacks, beheadings, firefights and drive-by killings have surged.
That has shattered this city's international image as a boomtown where captains of industry built steel, cement and beer giants in the desert in less than a century -- Mexico's version of Dallas or Houston.
By engulfing Monterrey, home to some of Latin America's biggest companies and where annual income per capita is double the Mexican average at $17,000, the violence shows just how serious the security crisis has become in Mexico, the world's seventh-largest oil exporter and a major U.S. trade partner.
Almost 40,000 people have died across the country since late 2006, and in Monterrey, the violence has escalated to a level that questions the government's ability to maintain order and ensure the viability of a region that is at the heart of Mexico's ambitions to become a leading world economy.
Already drug killings have spread to Mexico's second city Guadalajara and while Mexico City has so far escaped serious drug violence, the capital does have a large illegal narcotics market. If the cartels were to declare war on its streets, Monterrey's experience shows that Mexico's long-neglected police and judiciary are not equipped to handle it.
"If we can't deal with the problem in Monterrey, with all the resources and the people we have here, then that is a serious concern for the rest of Mexico," said Javier Astaburuaga, chief financial officer at top Latin American drinks maker FEMSA, which helped to spark the city's industrialization in the early 1900s.
Lorenzo Zambrano, the chief executive of one of the world's largest cement companies Cemex, is equally concerned. "The trend is worrying," said Zambrano, whose grandfather helped found the Monterrey-based company that has become of a symbol of Mexico's global ambitions.
"But we won't let Monterrey fall."
That is what residents want to hear. Calderon has made two high-profile visits since September, swooping in by helicopter to offer his support and sending in more federal police to the city.
But the day-to-day reality is a violence that is out of control. Just over 600 people have died in drug war killings in and around Monterrey so far this year, a sharp escalation from the 620 drug war murders in all of 2010.
The dead include local mayors and an undetermined number of innocent civilians, including a housewife caught in cross-fire while driving through the city, a just-married systems engineer shot dead by soldiers on his way to work and a young design student shot by a gunman in the middle of the afternoon on one of Monterrey's busiest shopping streets.
Almost every resident now has a story of someone they know who spent a horrifying evening face-down on a bedroom floor while gunmen fought battles in the streets outside.
More than a thousand people have disappeared across Nuevo Leon state, of which Monterrey is the capital, since 2007, according to the U.N.-backed human rights group CADHAC, which says they were forcibly recruited by the Gulf and Zetas gangs.
Human Rights Watch has documented more than a dozen forced disappearances over the same period that it says were carried out by soldiers, marines and police working for the cartels.
On the surface, Monterrey, which generates 8 percent of gross domestic product with 4 percent of Mexico's population, is still a city featured in shiny business magazines.
Executives can still touch down at its marble and glass airport terminals and take its sleek highways to posh hotels and business conferences, admiring the impressive vista of Saddle Mountain that dominates the skyline to the south of the city. On Sundays, barbecue smoke and brassy Norteno music emanate from houses across the city.
Known for its private universities, large middle class, modern subway network and 1,800 foreign-run factories, Monterrey was even chosen to host a United Nations conference on development in 2002, attended by some 50 world leaders.
Like the Catalans of Spain, Monterrey residents liked to think of themselves as apart from the rest of their country -- efficient, reliable and led by decent political leaders.
But turn on the television news, flick through the local newspapers or chance to hear the intermittent sound of gunfire in the city's streets and it quickly becomes clear that there's a battle being waged for Monterrey between the powerful Gulf cartel and its former enforcers, the Zetas. And they know no bounds.
On New Year's Eve, gunmen hanged a woman from a road bridge. They've dumped severed heads outside kindergartens and killed traffic police as they helped children cross the road. In a matter of minutes, they can shut down large parts of the city by hijacking vehicles at gunpoint to block highways with trucks and buses to allow hitmen to escape the army. Police, once considered Mexico's best, have been infiltrated by both gangs.
On two consecutive days in April, a record 30 people were killed in shootouts, mainly hitmen and police, but also a student who was run down by a fatally wounded police officer trying to escape gunmen.
Jaime Rodriguez, the mayor of Garcia municipality in the Monterrey area, survived two attempts on his life in March, saved only by his armored vehicle. "I couldn't stop shaking," said Rodriguez, speaking days after the second attack and with soldiers now as his bodyguards. "After they tried to kill me the first time, I got home and downed half a bottle of tequila. After the second, I finished it."
Some of the city's jobless have joined the chaos after seeing the impunity that drug gangs enjoy. They are trying their luck at all types of crime, robbing drivers at gunpoint at traffic lights, bursting into restaurants to steal clients' cash and holding up car dealerships, banks and even the offices of a local zoo for as little as $500 a time.
Gunmen stole a record 4,607 vehicles in Nuevo Leon in the first four months of this year, almost double the number stolen in all of 2004 and more than in Mexico City, which has five times the population, the Mexican Insurers Association says.
Kidnapping, almost unheard of before 2007, is now more of a concern to business people in Monterrey than it is in Mexico City, where kidnap-for-ransom has long been a scourge, according to a recent study by consultancy KPMG.
Both the Gulf gang and the Zetas, led by a former elite Mexican soldier who calls himself "The Executioner," want not just the smuggling routes to the United States, but control of Monterrey as a place to live, launder money and prey on private companies for extortion, U.S. and Mexican experts say.
"Monterrey is a strategic point in Mexico for trafficking. It's a kind a crossroads on the northeastern corridor and it is very lucrative territory," said a U.S. official at the Bureau of Alcohol, Tobacco, Firearms and Explosives in Mexico City.
The cartels are ferociously well-armed, mainly with weapons from the United States. But, more alarmingly, since late 2009 just prior to the Zetas' breakaway from the Gulf gang, Zeta henchmen have been bringing in weapons -- fully automatic M-16s and military explosives -- from Central America, the ATF says.
"These were legitimate military sales to foreign governments during the 1980s and 90s, and those guns are walking out the back door and finding their way to northern Mexico," the official said. "Not only the guns, but military grade explosives: Claymore mines, C-4 (plastic explosives) as well as grenades."
To the alarm of many investors, the violence is undermining economic growth in the region, as some businesses put investment on hold, companies' security costs rise, restaurants shutter, tourists cancel visits, and students are scared off.
Business leaders worry Monterrey is losing investment to Texas, to other parts of Mexico and to the rest of Latin America, while failing to capitalize on the advantages that rising Chinese labor costs bring to a region that already produces about 11 percent of all Mexico's manufactured goods.
"Business people come to me almost every day with horror stories about how they're being extorted, how they've been robbed, how their employees have been abducted, things you just can't imagine," said Guillermo Dillon, the head of Nuevo Leon's industry chamber CAINTRA that counts 5,000 companies as its members. "Of course all this is having an impact on the economy," he said.
Mexico is rebounding strongly from a steep recession in 2009, helped by a bounce in exports to the United States. Investment has also risen and Monterrey, with a skilled workforce and location close to the border, is reaping the benefits.
Nuevo Leon state government forecasts the economy will grow 5 percent this year and expects more than $2 billion in foreign investment this year, similar to 2009, although slightly less than in 2010, when Heineken bought Femsa's brewing division.
Deputy state minister for foreign investment, Andres Franco Abascal, said 12 manufacturers ranging from China to Germany confirmed $498 million in investment in the first quarter of this year.
But if not for the drugs war, things would be even better.
Business leaders including Dillon estimate the violence will shave 1 to 2 percentage points off economic growth this year, holding back the local economy. It grew 6.5 percent last year and 7.2 percent in 2006, prior to the global recession and before the violence took hold.
Having grown at almost double the rate of Mexico as a whole between 2005 and 2007, Monterrey's economy is likely to expand this year at about the same 5 percent pace as the national economy.
Economists also warn that the damage done by the drugs war to the economy could get worse.
"A lot of companies are still in wait-and-see mode, they are still here, still doing business," said Jorge Garza, an economist at the University of Monterrey. "But if security continues to deteriorate and they start pulling out, then we could be looking at a much more serious impact."
The "wait-and-see" mood is pervasive among the 680 assembly-for-export "maquiladora" plants operating in the state. A quarter of those factories have their expansion plans on hold for a second year running, meaning fewer new product lines churning out laptops and car parts, and ultimately fewer jobs being created, said Emilio Cadena, head of an industry group that represents Nuevo Leon's maquiladoras.
"The big question is: how much faster would we be growing if it were not for the violence?" Cadena asked.
Helicopter maker Eurocopter this year ditched plans to invest $550 million in Nuevo Leon to build its second plant in Latin America, instead choosing the central state of Queretaro, which has so far been unscathed by drug violence.
A survey of major businesses operating in the country this year by the American Chamber of Commerce in Mexico found that Nuevo Leon is now considered one of the four most dangerous states in Mexico. It used to be considered the safest.
State Governor Rodrigo Medina conceded last year that some foreign investors had been put off by the violence.
"We have to recognize (violence) could have affected the decision-making of the investor ... I've come across some cases (of investors freezing plans to set up in Monterrey)," Medina said in a Reuters interview last October. His aides declined recent requests to elaborate.
Even if manufacturing is showing some resilience, security costs are growing, while moving goods up to the U.S. border and to neighboring states is getting riskier.
Small and medium-sized companies operating in and around Monterrey are spending 5 percent of cash flow on security, a cost that was negligible just five years ago, while firms selling GPSs, alarms, locks and cameras in Monterrey have seen a 20 percent jump in annual profits in three years, according to Monterrey's commerce, retail and tourism chamber.
"If you look at the figures, companies are still investing, but there's a lot of evidence that the money is being diverted into security, not into research and development," said Rafael Amiel, a Peruvian economist who comes to Monterrey once a year to attend a conference for U.S.-based forecaster IHS Global Insight. "This is money that's going into barbed wire fences, not solar panels and that is going to hurt competitiveness in the long term," he added.
Drug war lawlessness in the neighboring states of Tamaulipas and Coahuila is also weighing on regional business.
One Monterrey-based businessman supplying piping to drinking water plants in Coahuila said it is common to see black-clad, masked Zeta hitmen stopping cars on the highway west out of Monterrey, even with the army patrolling nearby.
"I try to stay calm every time, it is terrifying, but what choice do I have? I can't afford a helicopter," he said, locked in his office, having been robbed at gunpoint by Gulf cartel hitmen who burst in on him last year.
The route from Monterrey to Nuevo Laredo, Tamaulipas and across into Laredo, Texas is a crossing used by 2.5 million trucks every year, or some 40 percent of U.S.-Mexican cross-border trade. It used to be safe at any time but can now only be traveled in daylight hours for fear of attacks by Zeta gunmen.
The Zetas have taken to supplementing their drug smuggling income with robberies of trucks carrying everything from copper pipes to car parts, U.S. and Mexican security officials say.
Many manufacturers here work on a "just-in-time" basis to avoid a build-up in inventories and storage costs, and are increasingly frustrated by the delays in crossing the border.
Tough safety checks by U.S. customs agents and the sheer size of truck trade already mean long waits, so crossing at night had for long been a way of avoiding the bottlenecks.
"Either you have to pay the bad guys something for the right to travel at night and not be robbed, or you go by day and pay extra storage in Nuevo Laredo, which drives up our costs," said one Monterrey-based trucking company owner moving auto parts, who declined to be named due to safety concerns.
"We've got trucks idle waiting for longer at the border and we're spending time and energy on safety logistics, which was never a factor before."
Rising premiums for insurance against robbery of goods can eat up over half of companies' profit margins, truckers say.
Worse for some is the damage to Monterrey's image. Never a big tourist town, far from any white beaches and lacking the Aztec ruins of central Mexico, the city was building a reputation as a place for Americans to seek medical treatment at a third of the cost of the United States.
With 15 million Americans expected to seek healthcare abroad by 2016, up from 750,000 in 2007, according to consultancy Deloitte, Monterrey was going beyond the cheap dental care Mexican border towns offer Americans, providing operations ranging from gastric bypasses to heart surgery.
Even as recently as early 2010, when drug killings had increased noticeably, Monterrey's private hospital group Christus Muguerza was receiving about 70 foreign patients a week, mainly from the United States, some paying thousands of dollars a time. "Business is practically zero now," said Eduardo Garcia, a doctor who helps oversee medical policy at the University of Monterrey, which is linked to Christus Muguerza.
Four hospital groups including Christus Muguerza invested several million dollars in expanding and modernizing their capacity for so-called medical tourists between 2007 and 2008, while the prestigious Tec University's Zambrano Hellion Medical Center is under construction and is billed as offering "innovative medical care to Mexico and to the world."
One Monterrey-based company, Nurses Now International, was training Mexican nurses in English to better serve visiting U.S. patients, but is now focusing its efforts at hospitals in beach resorts that have been spared the drug violence.
Perhaps hardest of all for city leaders to stomach is the exodus of some 2,500 students, some 20 percent of the student body, studying at the Tec University, considered one of Latin America's top schools for engineering and business and at the heart of Monterrey's industrial success. According to the university's former rector Rafael Rangel, undergraduates started packing their bags last year after two students were shot dead accidentally by soldiers who mistook them for hitmen in a firefight outside the campus.
The Tec's fame as Mexico's answer to the Massachusetts Institute of Technology means that more than half its students are from other Mexican cities or from abroad, and while many have transferred to other Tec campuses within Mexico, Monterrey is losing talented youngsters.
"Yes (the insecurity) has hit the institution, it's hit us more than the economic crisis," Rangel said at an event to mark his retirement in late April.
That has forced the university to lay off about 300 staff, also having a knock-on effect on the hundreds of shops and rental agencies that depend on the student population.
Professors consulted by Reuters say there are also concerns that student numbers could fall by another 10 percent at the start of the new academic year in August. The university declined to comment.
Some residents, who are known as "regiomontanos" for the mountainous region they live in, have already seen enough, sparking concerns of a brain drain.
Wealthy small and medium-sized business owners are taking their money and ideas north of the border to set up shop in Texas. With anything upward of $100,000 to invest in a U.S.-based business, Mexicans can obtain a fast-track U.S. investor visa for themselves and their families.
Demand at the U.S. consulate in Monterrey for the "E" visas is surging: the number of investor visas issued by the consulate almost doubled to 390 between July 2010 and the end of March this year, compared to the prior nine-month period.
Those who haven't already left can't deny they are worried. "I'm thinking 'I'm OK, nothing's happened to me,' but if it does, I know I'll have to consider it," said a businessman with a mid-sized food exporting business who declined to be named for security reasons.
In the meantime, he has switched his SUV for a low profile sedan and he stays out of the limelight, avoiding the local paparazzi that rely on the business elite to fill local gossip rags. "I definitely don't want my photo in the society pages these days," he said.
Many who knew Monterrey as one of Latin America's safest cities wonder how things got so bad so fast.
Part of the answer lies in the drugged up eyes of 18-year-old gang member Alan, who spends his days bored and jobless wandering the city streets, and his nights getting high on glue and marijuana with his friends on the dirty concrete stairways of his parents' apartment block.
With his arms elaborately tattooed with the name of his gang, "Los Vatos Locos" (The Crazy Guys), Alan is part of Monterrey's rarely mentioned underclass that the Gulf and Zetas cartels have seized on to recruit dealers, smugglers and hitmen to fuel their bitter war.
Though drug violence is more associated with the infamous border towns of Tijuana and Ciudad Juarez, Monterrey has also seen a surge in gangs over the past decade after neglecting its poorer citizens, who see little future other than joining the cartels.
"School bored me. Now's there no work," Alan said, his face partly hidden under a tilted baseball cap.
Alan is not a hitman, but he soon could be.
On the street corners of Monterrey's poorest barrios and the region's neglected rural towns, the cartels recruit dropouts like Alan, often as young as 12 or 13, to sell drugs or diversify into other crimes like carjacking and burglaries, paying handsomely with "gifts" such as SUVs, cash or drugs.
That is a lifestyle that Monterrey's urban poor can only dream of on the factory wages paying $350 a month.
But the gifts come with strings attached.
If anyone decides they want out, they have to pay back the gifts -- an impossible task. So they keep going.
They are pushed into worse crimes until the street corner gangster becomes a fully-fledged cartel henchman, willing to torture a rival gang member, throw grenades at civilians or open fire in a crowded street.
"You get pushed into it because there's no work and you dropped out," said 26-year-old former gang member and addict Sergio Alvino, who sold crack for about $10 a hit for the cartels before finding a way out with the help of a Catholic shelter. "It is the perfect preparation for a career with the cartels, even if it is likely to be a short one," he said.
Monterrey's politicians and captains of industry are only now waking up to the reality that the city has huge pockets of poverty and about a third of all Nuevo Leon's residents live on $5.25 a day or less. Poor families barely get by on about $600 a month.
Despite a steady fall in the number of poor in Nuevo Leon, Coahuila and Tamaulipas between 1970 and 2000 as Mexico benefited from an oil and manufacturing boom, poverty on the border today is as high as it was a decade ago, according to government data. With a median age of roughly 27 years, Mexico should be at a huge advantage as developed nations struggle with aging populations. Over the last decade, Mexico's rate of jobless young has doubled to about 10 percent, according to a United Nations study.
Being poor does not make you a criminal, and certainly not a hitman. "But without a job, without your self esteem, you are easy prey for the cartels," said Catholic mother superior Guillermina Burciaga, who has worked for more than a decade with street gangs in Monterrey, seeking to help many leave drugs and the gangs behind.
Jaime Rodriguez, the mayor of Garcia municipality in Monterrey who survived two attempts on his life, is even more candid. "Ask yourself who is doing all this killing. It is our young people. We have failed our young," he said.
More chillingly, when the cartels find they can't entice youngsters into the gangs with money, they abduct them and force them into the business, the CADHAC human rights group and U.S. anti-drug officials say.
CADHAC has logged 36 cases of forced disappearances in Nuevo Leon since 2007 but says the real figure is more than 1,000, as few victims' families come forward out of fear and state officials don't take them seriously.
"The crime of forced disappearances doesn't exist in the penal code and the government is in denial. The few parents who come forward are met by ridicule from authorities," said Carlos Trevino, a lawyer for CADHAC.
"The prosecutor's office says to the mothers: 'I'm sure your son's just out partying, he'll be home soon," he added. The state attorney general's office denied such accusations and said many cases are under investigation. But many law-abiding Monterrey residents have fallen into the habit of assuming that anyone who goes missing is a criminal, inhibiting proper investigation. "People want to be rid of this situation, so you see a lot of comments in chat rooms such as: 'kill them all' or 'that's one less bad guy,' but that is no way to deal with the problem," said CADHAC investigator Maria del Mar Alvarez.
Victims' families interviewed by CADHAC reported two cases of mass kidnappings of 40 to 50 young Mexicans during raids on working class districts in Monterrey in July 2010 and a string of individual cases over the past four years, often of men aged between 18 and 20 years old.
"I don't let my boys play on the street at night anymore because they are kidnapping the youngsters," housewife Berta Luna said in a poor area of the Guadalupe municipality in Monterrey. CADHAC believes the youngsters are taken to other states within Mexico to work as hitmen, to smuggle drugs or to pack marijuana in safe houses.
For Monterrey, the biggest lesson of the drugs war is that, despite its entrepreneurial flare, it faces the same institutional crisis as the rest of the country. The drug war has ripped the skin off the illusion that it is different.
Its municipal and state police services have been infiltrated. Officials acknowledge its justice system fails to resolve most crimes. Its youngsters are caught up in the country's dysfunctional education system. Huge inequalities between rich and poor have created a festering underclass that is cannon fodder for the cartels.
If Monterrey could make even a little headway on these challenges, it could lead Mexico once again.
The signs that it is about to do so are mixed.
Monterrey's business elite appears determined to help. Both Cemex's Zambrano and FEMSA's Astaburuaga say they are taking a central role to support the state government by putting resources into social programs to help youngsters, backing campaigns that urge citizens to denounce more crimes and putting some of their executives into government.
The number two official in the state government, Javier Trevino, is a long-time Cemex man who joined the newly-elected administration in late 2009.
Jorge Domene, security spokesman for Nuevo Leon, reels off a list of achievements, including progress on firing hundreds of police officers suspected of working for the cartels over the past year, rolling police checkpoints across Monterrey, more collaboration with the military, and efforts to modernize the police with military personnel.
In the San Pedro Garza Garcia municipality, part of Monterrey and the richest in Mexico, Mayor Mauricio Fernandez, himself a wealthy businessman, is investing $65 million in security equipment, more modern police buildings and 2,000 cameras to monitor every street corner in the area.
But Nuevo Leon's efforts to reform its justice system have slipped badly after being the first state to introduce U.S.-style oral trials in 2004, making little progress adopting open court hearings where prosecutors and defense attorneys present their cases before a panel of judges.
A plan to build a new high security prison in Nuevo Leon has stalled and the CAINTRA business chamber feels the state government is slipping behind on flushing out corrupt cops.
Twelve of Nuevo Leon's rural towns are without any local police as cops have quit after brutal drug gang attacks.
U.S. officials admit privately that Monterrey's best hope is to contain the violence and get it off the front pages.
And there is still a lot of denial.
"Is there a problem? Yes there is, but it is a problem between the cartels, not against society," said Mayor Fernandez in his office, adorned with paintings, in San Pedro.
Unlike in Mexico City, wealthier residents seem reluctant to protest against the government, seeing it as vulgar.
"That's for a different class of people, no?" said Lorena, a young mother who declined to give her last name, struggling to explain why there is not more public outrage in Monterrey.
Many of the Monterrey diaspora admit they would like to go home. They are strangers in Texas, they miss friends. The enchiladas north of the border are terrible, they say.
But many, like businessman Ramos, say they are too afraid to return. "I don't see much progress. They've got to do something about the Zetas. They are the ones robbing Monterrey of its future."
Additional reporting by Tim Gaynor in Phoenix; Editing by Kieran Murray and Claudia Parsons