Download Mexico: Latin America`s Uncertain Bright Spot

ISSUES IN INTERNATIONAL
POLITICAL ECONOMY
March 2002, Number 27
MEXICO: LATIN AMERICA’S UNCERTAIN BRIGHT SPOT
Sidney Weintraub
The three major economic rating agencies have accorded
investment grade status to Mexican government
obligations, thereby making this paper eligible for
inclusion in many pension funds. The ratings are a
testament to Mexico’s solid macroeconomic management.
When projected revenue declines, Francisco Gil-Díaz, the
finance minister, does not hesitate to cut budgeted
expenditures. In recent years, the Mexican peso has
appreciated against the dollar—which, in large part, is a
reflection of the conservative management of monetary
policy by the Bank of Mexico. The ratings from Standard
& Poor’s, Moody’s, and Fitch, however, are based more
on a snapshot—the macroeconomic solidity of the
moment— than a sophisticated analysis of the future.
By most reckonings, 2001 was not a good year for
Mexico. Gross domestic product GDP), which had grown
solidly for the previous five years (i.e., after recovery from
the disastrous economic decline in 1995), fell in 2001 by
0.3 percent. The main reason for the economic decline
was the drop in exports to the United States, which had its
own economic slowdown. The United States is the
destination for 85 to 90 percent of Mexico’s exports. This,
however, was not the only reason for export problems.
Industrial productivity declined in most sectors last year
and unit labor costs rose. The high value of the peso in
relation to the dollar was surely a drag on exports. GDP
growth is expected to grow this year by only about 1
percent.
If these were the only economic indicators, a dynamic
analysis might lead to the judgment that the problems of
2001 were merely a temporary hiatus in Mexico’s
successful march to a more prosperous future. Foreign
direct investment is holding up (the total in 2001 was $25
billion, which includes the CitiBank purchase of
Banamex) which implies that long-term investors have
reached this conclusion. Other features must be taken into
account, however. Perhaps the most important is that
Mexico’s export growth rate of some 20 a percent year in
recent years is unlikely to be sustained in the future,
particularly if the United States does not grow as rapidly
as it did in the halcyon years of the latter 1990s. Evergrowing exports to the United States in those years were
the main engine for Mexico’s economic growth, but this
engine is likely to slow.
There were other disappointing developments in Mexico
last year. The tax reform proposed by the government—
whose central feature was to raise the value-added tax on
food and medicines to 15 percent, thereby making the
VAT rate uniform—failed miserably. Some reform was
achieved in the income tax, but this was counterbalanced
by a complicated luxury tax that most Mexican economic
analysts hope can be discarded quickly. Other structural
reforms have gone nowhere. These include making the
labor market more flexible, simplifying investment in
electricity generation, opening natural gas exploration to
private investors, reforming the telecommunications
structure, and altering the judicial system, especially as it
applies to mercantile law. The electricity rate structure for
consumers was altered in early 2002 and this change
raised the cost to middle-class ratepayers by 25 to 50
percent.
Mexico’s net domestic savings rate remains low, in the
neighborhood of 17 percent, and tax collections as a
percent of GDP are about 11 to 12 percent, low even by
Latin American standards. This throws a heavy burden on
Pemex, which picks up much of the revenue shortfall,
thereby shortchanging its ability to invest in oil and gas
exploration and exploitation. Because Pemex is the only
source for investment in the oil industry in Mexico, this
translates into inadequate investment in this vital sector.
Polls indicate that the popularity of President Vicente
Fox is declining steadily; it is now below 50 percent and
William E. Simon Chair in Political Economy  Center for Strategic and International Studies
1800 K Street, N.W.  Washington, D.C. 20006  Tel: (202) 775-3292  Fax: (202) 775-3199  www.csis.org
seems to slide further in each successive poll. The
economy is in the doldrums and this diminishes the
president’s popularity.
Many Mexicans lost jobs last year and, in addition, there
was a 300,000-person shortfall in job creation for the one
million new entrants in the labor force. Fox and his team
were seen as inept negotiators with the legislature on
taxes and the budget. Democracy, including an
independent legislature dominated by the opposition, is a
relatively new phenomenon in Mexico and the political
class is still learning how to deal with this.
Some of the problems of 2001 and early 2002 may be
manageable in the months and years ahead. The
Institutional Revolutionary Party has just chosen a new
leader, Roberto Madrazo, and he may show a willingness
to negotiate structural issues with the government. The
peso, which is probably overvalued, may decline in value
during the coming months; the peso is not being propped
up by active intervention or high interest rates. Mexico
needs considerable investment in infrastructure and funds
for this should be available from the international
development institutions. The learning curve for dealing
with an opposition-led legislature may speed up.
Other issues, however, require more complex solutions.
These include the main structural impediments to growth,
raising the low savings rate and thereby reducing the
large reliance on capital inflows, and dealing with the
growing lawlessness in many Mexican cities. Efforts to
deal with these matters have not succeeded in the past,
including when the PRI ran both the executive and the
legislature. The capacity to deal with these structural
issues is really at the heart of Mexico’s economic future.
If the export engine is slowing, supplementary measures
are needed.
The mood in Mexico is one of disillusion. President Fox
is not meeting the expectations aroused by candidate Fox.
The problems are not necessarily his entire making, but
his watch is a historic one after 71 years of PRI
domination. This mood of disappointment, especially
from middle-class voters who supported Fox, was the
dominant impression I took away after a recent visit to
Mexico. Mexico has a solid macroeconomic foundation,
and this impresses Wall Street and foreign investors, but
makes little impression on those Mexicans who expected
more tangible progress under a new, non-PRI
administration.
confrontational atmosphere between the congress and the
presidency would help alter the mood of helplessness,
which informed Mexicans now take for granted when it
comes to innovation in public affairs. Fox’s cabinet,
which has been replete with internal quarrels, does not
have a good reputation in Mexico and some changes will
probably occur—although not in the economic sphere.
What is needed most of all, however, are structural
reforms that will convince Mexicans and foreigners alike
that Mexico is prepared to confront its problems head on.
The nature of these reforms has already been cited.
What role can the United States have in helping to turn
around what I found to be current pessimistic mood in
Mexico? The most important action is to run the U.S.
economy well because the growth in U.S. GDP is the key
determinant of Mexico’s exports. In this respect, keeping
one number in mind is useful: exports to the United
States comprise 30 percent of Mexico’s GDP.
The two countries (three, if Canada is included) are in the
ninth year of an integration process that has come a long
way since NAFTA was first proposed, and the
relationship has been transformed beyond anyone’s
expectations a decade ago. The integration process,
however, still has a long way to go—in facilitating trade,
promoting investment, intensifying official and informal
contacts, and stimulating knowledge of each other’s
cultures. Bringing the two countries even closer in the
years ahead requires a prosperous and self-confident
Mexico, and not a country that looks to its neighbor to
the north as an escape valve for its impoverished
population. This kind of economic advance will not come
without structural changes—and these are needed sooner
rather than later if the Fox administration is to be a
successful one.
CSIS does not take specific policy positions.
Accordingly, all views, positions, and conclusions
expressed in this publication should be understood
to be solely those of the author.
© 2002 by the Center for Strategic and
International Studies.
The year 2001 was only the first of a six-year term, and
there is plenty of time to turn around negative
impressions. A U.S. recovery, even if modest, will help,
and a sustained U.S. recovery will help even more. A less
William E. Simon Chair in Political Economy  Center for Strategic and International Studies
1800 K Street, N.W.  Washington, D.C. 20006  Tel: (202) 775-3292  Fax: (202) 775-3199  www.csis.org