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Volume 59 / Social Sciences


ROBERT E. LOONEY, Professor of National Security Affairs, Naval Postgraduate School

SCHOLARLY PUBLICATION ON the Mexican economy has flourished over the last several years. On a macroeconomic level, analysis of three main events dominates the literature. Surprisingly, works on the 1982 debt crisis continue to appear. A few of these recent works benefit from the fact that the authors were not involved directly in the events of the time, and thus can provide a somewhat more objective perspective than some previous authors (item #bi 98000474#).

The second body of literature focuses on the economic policy shift in the late 1980s—a much more proactive neoliberal reform process under the "Washington Consensus" guidelines (item #bi 98000531#). Arguably, these reforms turned the economy around, improving expectations and launching Mexico to the forefront of emerging market nations. Finally, toward the end of 1994, the peso crisis and a deep recession caught most by surprise (items #bi 97015462# and #bi 97014685#).

Clearly, Mexico is used as a case study for economic policy reform, given the different results of its various reform attempts. However, most writing on the Mexican economy contains a bias either in support of or against a particular policy. Supporters of the current reform process note the benefits of trade liberalization, including the economy's ability to rebound from a severe recession. Those who oppose the efforts of former President Carlos Salinas de Gortari to modernize Mexico underline the country's tremendous fall in purchasing power, deteriorating income distribution (items #bi 98000518# and #bi 98000474#), and failure to sustain a minimum economic growth rate.

The type of economic development model Mexico should follow has been the topic of an ongoing debate in recent years. Those seeking significant changes in economic policy criticize the tremendous cost that the modernization process has incurred (items #bi 98000514# and #bi 98000545#), and claim that Mexico must change current policies in order to achieve a sustained growth rate (item #bi 97014685#). This forecast is based on an extrapolation from the 1990s. The other side of the debate highlights the benefits of recent reforms (item #bi 98000539#) and minimizes discussion of the costs.

Valid arguments exist on both sides of the debate. Although the transformation of the Mexican economy may have been necessary, few estimated accurately its tremendous social costs. Nevertheless, most of these costs are now in the past and should provide the economy with the necessary platform for future economic growth. The depth of the 1995 recession can be explained only in terms of the structural changes that occurred (item #bi 99008532#). But at the same time, the speed of the recovery would not have been possible without the improvement in the fundamentals brought about by these same changes. This double irony highlights Mexico's path through the reform process.

Another body of literature focuses on the ongoing reform process and the manner in which it has begun to impact the development of key sectors and industries. For example, although trade liberalization was achieved quickly once tariffs were reduced and NAFTA negotiated (item #bi 98013814#), the effects on the economy continue to transform firms, entrepreneurial spirit, and labor relations throughout the country. Given that different sectors have absorbed these changes at their own pace, recovery and expansion success varies across sectors. Similarly, on a regional level, certain sections of the country are advancing rapidly (item #bi 98000481#), while others continue to lag behind (item #bi 98011261#).

To understand how far Mexico has advanced economically, it is useful to compare the policy response to the peso crisis of 1982 to that of 1994 (item #bi 98000549#). In 1982, the government responded by nationalizing the banks, introducing exchange controls, requiring permits for virtually all imported goods, and forcing the conversion of dollar deposits into pesos. In general terms, the response was to increase government intervention and controls, given the inherent mistrust of the market's ability to attain stability. Although the government's initial policy was restrictive, it did not remain so for very long. The result was a zero percent growth record on average for most of the decade, no voluntary international financial lending for seven years, no stability (owing to a continuous 50-plus percent inflation rate), and a high fiscal deficit.

In 1995, the government responded to the crisis with an orthodox market policy response: floating the exchange rate, not introducing any trade barriers, continuing with privatization, and carrying out restrictive economic policy. This time, the budget remained balanced. In contrast to 1982, voluntary financial lending resumed within the first six months of 1995 and the recession, although quite deep, did not last nearly as long.

Although the modern sectors of the economy—especially manufacturing—were quick to register a recovery, the more traditional sectors have shown a worrisome lag. The two main causes may be rooted in the previous adjustments, made when the economy was first subject to trade liberalization, and in the effects of income distribution. The manufacturing sector was the first to carry out large-scale efforts to increase productivity and efficiency and to become competitive vis-à-vis the global economy. Thus, once the domestic economy collapsed, the sector was able to switch markets rapidly through a strong increase in exports. Yet, the traditional, small-scale retail sector did little to adjust to a more competitive economy and found the road to recovery extremely difficult.

Many other examples demonstrating the costs of the transition from a closed, inefficient economy to an open, market-oriented system are documented in recent writings. A good example is the banking sector, which was once owned and operated by the government. During the 1980s, the government operated a huge fiscal deficit, crowding out virtually all credit opportunities available to the private sector. By the mid-1980s, the government had set a 100 percent marginal reserve requirement to finance its deficit, which had reached almost 17 percent of GDP, and the banks therefore needed no credit risk analysis to allocate credit.

When the banks were finally privatized (item #bi 99008515#), the government eliminated its deficit, so the recently purchased banks had credit that could be channeled into the economy. The new owners, who lacked banking experience and had no credit risk analysis mechanisms in place, distributed this credit as fast as possible, mainly due to the high price they had paid for the banks. At the same time, the previously inefficient business sector was undergoing a transformation and becoming much more competitive, and ultimately, some firms defaulted on their loans. As a result, the banks were making unrecoverable loans and their nonperforming asset portfolio increased rapidly.

In short, although the reform process was necessary, little attention was paid to implementation costs. This lack of vision caused a brutal banking crisis, a high level of net job loss, a severe decline in purchasing power for the majority of the population, and an all-around decrease in welfare. Increased poverty and inequality have been documented extensively: despite a 35 percent average income expansion during the first phases of liberalization, the condition of the poorest 15 percent of the population deteriorated significantly, while the incomes of the richest individuals increased disproportionately (item #bi 99008537#). One could conclude that the deterioration in income distribution and the lack of poverty reduction since the beginning of the intensive economic transformation process are not mere coincidence, but that liberalization measures provided better opportunities to those were initially in a better position, while excluding the disadvantaged and shifting most of the policy costs to them.

The next HLAS survey of the Mexican economy undoubtedly will include accounts of how the government deals with the challenge of efficiency in the wake of lingering reform dislocation and deteriorating income distribution.

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