583 June 4,1987 FOR MEXICO'S AILING ECONOMY TIME RUNS SHORT INTRODUCTION CesarAlbondi as and his brother, Jorge, own a small tailor shop in the Mexican port city o Veracnu. he Albondigas brothers wish to be

manufacturing souvenir T-shirts A er waiting seven months, he borrows 50 drthday present for the loan officer. His loan is disbursed the following week The brothers then are told by the local union chief th at the union will select six of their ten employees for them. Two o the employees turn out to be relatives of the union boss. They and electrical service are mysteriously cut OB and his cloth supplier in Monterrey informs him that there will be a delay of uncertain duration in his next shipment. when the bank calls in the Albondigas brothers' loan early, they close up their little factory and make plans to emigrate illegally to the United Stat es tho to se f 1 to tourists and sailors. Cesar applies or a bu s iness loan at the state-owned bank show up for work only on lf uesdays and Thursdays. when Cesarw them, his telephone pesos fiom a moneylender to buy a The economic tribulations and frustrations of Cesar and Jor e Albondigas (fictional exico is the "sick n ames and characters in an all too typical1 real situation) are ti e tribulations and frustrations of Mexico. In starkly persona r terms, they explain why, des ite an abundance hi! of natural resources and a hard working and entrepreneurial people man" of N orth America. Yet just a decade ago it was viewed as a model for other This is the fourth in a series of Heritage studies on Mexico. It was preceded by Backerounder No. 581 Mexico's Many Faces May 19,1987 Backerounder No. 575 Mexico: The Key Players April 4,1987). and Backpounder No. 573 Keys to Understanding Mexico: Challenges to the Ruling PRI April 7,1987 Future papers will examine other aspects of Mexican policy and development. developing countries. Today, Mexico is crushed by a $105 billion foreign d e bt, an annual inflation rate of 114 percent, continuing capital flight, and a declining current account balance. Even with world oil prices edging up from last years lows, it is clear that there is little hope for a long-term economic turnaround during th e remainder of this decade without sweeping economic and political reforms Deadly Combination. These reforms will have to address the aternalistic olitical system that is the fundamental cause of Mexicos economic ills discovere B by the Albondigas brothers , a deadly combination of statism and institutionalized corruption stifles individual initiative. The system fosters corru tion by concentrating control of vast financial resources .in the hands of a relative handfu P of officials accountable only to thems elves. It is not surprising that the popular view is that the overnment has forgotten the common man and instead misdirects investment and wastes i illions of pesos on unproductive enterprises.

Under pressure from the United States and international financ ial institutions, the Mexican government has enacted some structural and sectoral economic reforms. Yet these have been largely cosmetic. Without genuine reforms that allow economic growth and eater pluralism, Mexicos problems wll mount until radicals exp l oit them politically running short ECONOMIC STRENGTHS For iG exico and its needed genuine and fundamental economic liberalization, time is Mexico is rich in human and material resources. Its citizens through the years have contributed significantly to the worlds of art, literature, and international business. With a population of 80 million (the globes eleventh most populous country it is im ressive that the adult literacy rate is 74 percent, one of the highest in the developing worlcf Mexicans moreover, h a ve demonstrated a remarkable capabili for resilience and private initiative In contrast to man other developing countries, Mexico is rich in natural resources and industrial capacity. de nations estimated oil deposits of 49 billion barrels make it the wor lds fourth largest in terms of petroleum productionand fifth in terms of reserves.

Mexico also ranks seventh in the world in natural gas reserves, has roved coal deposits of 643 million metric tons (compared to 490 billion metric tons in the Pr .S and is o ne of the worlds lar est silver producers. The country also contains important deposits of copper as demonstrated by their stunning response to the 19 I! 5 Mexico City earthquake zinc, lead uorspar, and iron ore.

Agriculture, comprisin 9 percent of the co untrys gross domestic product GDP is Mexicos largest industria P sector. Mexico ranks tenth in the world in terms o i GDP developing worlds total manu H acturing output. In absolute terms, the value of Mexicos originating from manufacturin and alone accou n ts for more than 10 percent of the industnal output is twice that of South Korea and more than five times that of Israels ECONOMIC WEAKNESSES Despite Mexicos economic strengths and enormous potential, the economy in recent years has found itself in a cris i s so serious that only periodic infusions of external financing 1. The Wall Street Journal, October 15,1985 2. James H. Street, Mexicos Development Crisis, Current Historv, March 1987, p. 101 2have kept it from collapsing. Last year, GDP fell 3.5 percent. The peso, which five years a o was trading at 24 to the dollar, has spffered such severe devaluations that today one 8s. dollar buys more than 1,OOO pesos. Mexico's external debt has tripled in less than a decade. Servicing the debt now consumes 16 percen t of GDP. While the debt soars at least $6 billion to 7 billion per year is lost in ca ita1 flight, as Mexicans secretly move than they would if kept at home in Mexico. Meanwhile the current 114 percent inflation rate means that real per ca ita income is d e clining steadily, while nearly half of the labor assets abroad where they are presumed to be s B er or to earn a better real rate of return force is unemployed or un B eremployed Falling Output. Last year was particularly bleak for the Mexican economy. In addition to the sharp fall in the eso's value, a 'cultural production slipped by an estimateq2.9 fncreasing numbers of Mexico's entrepreneurial class sought better opportunities elsewhere as ynprecedented numbers of middle-class Mexicans attempted to slip into.the U.S. illegally.

Mexico's rapid population growth--a demographic factor which, if coupled with a vibrant economy, could be a great resource--contributes to economic destabilization.

Although its current annual population rowth rate of 2.9 percent has declined from the Mexican population is expected to be 110 million, growing to 182 million by 2050 ercent, industrial pro B uction was o fr 5 percent, and domestic commerce declined 3.3 ercent clip of the 1960s, Mexico sti f 1 has one of the fastest growinf gopulations in the wor P d. Nearly 60 percent of Mexicans are under age

20. By the turn o t e centuv, the This burgeoning population means that one million Mexicans annually enter the Mexican labor market. To provide jobs for them, the GDP needs t o expand at 7 to 8 ercent. Last year's decline in GDP dims employment prospects for young Mexicans here has been only a minimal increase in new jobs. A notable exception is the free market-oriented Maquiladora program, whose paroll jumped about 25 ercent last THE BURGEONING PUBLIC SECTOR year, adding about 50,000 new jobs and now employng a quarter million J exicans.

The Mexican overnment is publicly committed to a mixed economy. Its policies however, contra c ict this. Following the 1982 nationalization o f Mexico's private banks government ownership of the means of production grew to 55 percent, leaving only 45 percent in private hands. More important perhaps than state ownership of key industries is a pervasive, yet subtle, control that the government ex erts over the private sector through a system of complicated regulations, corruption, and an alliance with organized labor. This is what suffocates the entrepreneurial efforts of the likes of the Albondigas brothers.

The state owns more than 909 enterprise s, including banks, hotels, factories, ship ing and air lines, and major utilities. Last year, to qualify for a $12 billion internationa P rescue 3. The Washmeton Post, February 8,1987, p. H2 4. Banco Naaonal de Mexico, Review of the Economic Situation in Mexico, November 1986, pp. 440,442,448 0 5. Information from FAIR (Federation for American Immigration Reform Washington, D.C 6. The World Bank, World DeveloDment Report. 1984 (New York Oxford University Press, 1984 p. 193 7. U.S. Department of Commerce F oreign Economic Trends and Their Implications for the United'States Mexico,"

November, 1986, p. 13 3-the size of its bloated and corrupt bureaucracy. So far a reshuffling of state employees. Mexico also has made a state-owned enterprises to satisfy its int ernational reforms d is February, for instance, the government offered to the public 34 percent of the stock in two major Mexican national banks. Most of these shares, however, were sold beforehand at bargain prices to insidgrs and supporters of the rulin g political party, the Institutional Revolutionary Party or PRI An office manager for a small Mmian company discovered that, after the company moved to new quarters, mail deliveries stopped and the missing mail could not be found One day, out of exasperati on, the office managergave the new postman 5,OOOpesos and askd him to try tofind the miss

maiL He was back in a day or two with it. Now once a month, the postman s given 5,OOOpesos and a bottle of tequila, and the compariy has no more mailproblems that it is accepted as a necessary part of any transaction, from parking a car to winning high p o litical office. Bribes grease the wheels of Mexico's ponderous government bureaucracy. Americans interested in investing in Mexico often give up rather than wade throu the swam of corruption. For example, after the U.S. Foreign Corrupt Practices in Mexico insisted that they lost$usiness to European and Japanese competitors who were not subject to similar restraints and sectoral economic reform as those who benefit from graft strongly oppose changes that might jeopardize their privileged status Institutiona l ized Corruption. Corruption in Mexico is so institutionalized Act o P 1978 prohi f ited U.S. companies from paying bribes abroad, American subsidiaries Corruption, of course, also impedes structural State ownership of the 'ant oil industry, PEMEX, and oth e r enterprises has enabled federal senator and director general of PEMEX during the late 1970s, was accused of embezzling $34 million on the purchase of two oil tankers. According to Alan Ridin of The New York Times, former president Luis Echeverria, in of f ice from 1970 to 197 is believed to have stolen between $300 million and $1 billion during his term in office, while his successor, Jose Lopez Portillo became one of the richest men in the world at the expense of his fellow citizens, misappropriating betw e en $1 billion and $3 billion THE PRIVATE SECTOR corrupt officials to steal bi 'Lf ions of pesos from the state. Jorge Dim Serrano, a Mexican Roadblocks to Private Investment Despite Mexico's serious need for venture capital to spur economic growth, govern m ent policies seem designed to discourage domestic and foreign direct investment. The spate of 8. The New York Tima February 23,1987 9. William Stockton, "Bribes Are Called a Way of Life for the Mexicans," The New York Times October 25,1986, p. 3 10. Alan R idmg, Distant Neivhbors (New York Alfred A. Knopf, 1985 pp. 131-133 11. Riding, PD. cit p. 123 4nationalizations in the 1970s and early 1980s, combined with the government's rhetorical hostility toward businessmen, spawned uncertainty and slowed pnvate in vestment. In this period, instead of putting their money into productive investments in their own country wary Mexicans sent some $50 billion abroad, much of it going into U.S. real estate and bank accounts.

According to the U.S. Commerce Department, Mexic o in theory" welcomes foreign direct investment, yet, in reality foreign investqent as a whole has been subject to increasing government scrutiny and regulation To be sure, the current administration of President Miguel de la Madrid has sought to promote f oreign investment by stating that it will be "flexible" in administerin the restrictive Foreign Investment Law. Actually the de and otherwise. The impediments to business are more subtle--corruption and bureaucratic obstacles la Madrid government is now o fi cially encouraging foreign investment, both in rhetoric Whims of Officials. In theory, foreigners are allowed to own up to 100 percent of a Mexican company's shares at the discretion of the forei investment authorities. In fact be restricted mainly to t he free zone or Eaauiladora pro am. Foreigners In fact, P ew foreign investors are willing to ris P large sums in a direct investment inflow to lJ exico between 1982 to buy shares in Mexican businesses, as long as t e purchases do the share ca ita1 of the enterprise and total forei investment to the interpretive whims of officials. Current agreements de la Madrid's successor, a point su ported by a decline The Maquiladora Program In 1965, the Mexican government launched a pro am to create jobs and spur eco n omic development alon the northern zone that borders f e U.S. Called 'I Maauiladorzf roubhly meaning 'I ands on"--it has sought to attract subassembly operations to the components, and machinery free o P Mexican duties, provided that most of the roduction is earner. The U.S. General Accounting Office predicts that the Maauila P ora exchange program by regon. Plants participating in the rogram are allowed to import raw materials exported. A few Maauiiadora plants recently have been allowed to sell up to 0 p ercent of their output in Mexico.

The Maquiladora program has become one of the most important sectors of the Mexican economy, second only to exports of oil and petroleum as a forei 1995 could com rise 1,500 factories employing one million workers." The mo dernization and growth oft K e Maauiladora, program, however, is constrained by the inadequate infrastructure, as well aS a shortage of skilled labor, especially in high technology operations f 12. U.S. Department of Commerce, International Trade Admitrat i on, Overseas Business Reports series Investing in Mexico December 1985, p. 3 13. United Nations, Foreien Direct Investment in Latin America: Recent Trends. ProsDects an d Policv Issues, August 1986, p. 3 14. U.S. General Accounting Office, Commerce Debart m ent Conference on Mexico's Maauiladora Proeram December 10,1986, pp. 6-7 15. Ibid p. 8 5Exponential Success. The Maauiladora program has been phenomenally successful--in some Mexican cities growth has been exponential. Chihuahua, for example, doubled Maau iladora employment in 19

85. Although there has been harassment of Maauiladoras by Mexican unions, the relatively large number of women employed has probabry ke t this to a minimum, as few women belon to Mexican unions. The Mexican government R as piladora s are Mexicos second largest source of foreign exchange MEXICOS ROAD TO STATISM also adopted a more or less laissez- f aire policy toward the industry, mpp likely because the The powerful government influence in every facet of the Mexican economy--as well as its olitics, culture, and society--is rooted in the national desire for a stron central independence from S ain in 18

21. The violence and wides read suffering brought about molding a consensus favoring consolidation of po!itidpower in a single entity. After various incarnations, the political movement Institutional Revolutionary Party (PRI emerged as that entity aut K ority after decades of weak governments and concomitant instability B ollowing by the Mexican Rev0 P ution of 1910 to 1920 deep1 sha ed l ow Mexicans view politics by The PRIs system of institutionalized authoritarianism worked well for a number of years. It provided stability and impetus to move Mexico from a largely agrarian pre-capitalist society to a modem industrialized state. Howeve r , instead of adapting to a chanpng economy and society in response to Mexicos development, the PRI became ossified, resisting the changes necessary for continuing stability Blessing and Curse. The discovery of massive oil de osits in the Gulf of Mexico in the extraordinary bonanza of wealth, the oil also raised false expectations and masked the severe mismanagement and antibusiness policies of President Luis Echeverria (1970-1976).

His administration made the huge government bureaucrav even more interventi onist by brin ng in young, university-educated specialists, or gechmcos Echeverria assumed that of a statist economic system could be rectified throu& technical expertise 1970s proved to be a blessing and a curse. While provi B ing modern Mexico with an m a r El et forces had little bearing on a nations econom and believed that the inefficiencies reduction in private investment. A r eading player in the United Nations debate over the 1970, public s ending accounted for 26 percent of B DP; when Echeverria lef t office in Echeverrias policies and hostili to the business community led to a significant New International Economic Order, Echeverria expropriated private lands on a massive scale and frightened away foreign investors by adopting a strongly pro-Cuban an ti-Western fore

policy. At the same time, the government began heavy borrowin abroad to finance its own growth and development rojects in every economic sector. fn 1976 it was 3 s percent and by 1982 more than 50 percent of GDP Fear of Default. The techni cos , moreover, were not able to manage the states development roects. There was administrative confusion, squandenng of resources, and heavy capital kgkt of the borrowed funds. The Mexican economy, which had been relatively stable during the 1960s, sunk i nto recession. Fearing that Mexico might default on what was then a com arativel minor external public debt of $27 billion, the U.S. joined extraordinaxy financial rescue effort with the International S6 onetary und (IMF) and the World Bank in 1976 in an 1 6. Council of the Americas, Washinaton Rewrt , February 1987, p. 1 6The e loitation of Mexico's oil discoveries allowed President Lopez Portillo 1976-13 t o avoid the austerity measures that, regardless of their value, were prescribed by the I undermined t he Mexican economy. A massive infusion of petrodollars a; owed the Lopez Portillo government to launch a national development propam, dwarfin4 that of his state-owned industrial seaports, steel mills, automobile plants; and other factories. All were prote c ted by high tarrffs under the gove'ment's strict im ort substitution policy which erected high levies and other bamers to imports ostensi t ly to force development of domestic-oriented industries He thus also avoided addressinF the structural and sectoral roblems that redecessor. This rogram, largely the creation of Mexico s current President, Miguel de la Ladrid, who was t i en Minister of Planning and Budget, called for construction of Consumer Buying Binge. Determined to make the national development pr o gram a success before the expiration of his presidential term, Lopez Portillo accelerated the rojects. This led to poor planning, considerable inefficiency, and widespread corruption Pn the meantime, Mexicans went on a gigantic consumer buying spree fuele d by the state's infusion of billions into the income flow and an overvalued peso. Because the rudimentary Mexican industrial sector was unable to meet consumer demands, imports of smuy#ed goods soared. The result: petrodollars flowed out almost as fast as they flowed in.

With Mexico's 1982 debt standine at more than $80 billion (three times that of the "crisis" of Administration launched another rescue effort to prevent a default economic debacle Portillo sought a private sector scapegoat. He accused the p rivate banking community of undermining the economy by sendin too many dollars abroad. Using this lame accusation investment holdings To halt the dollar exodus and stabilize the peso, the Mexican .i government imposed exchange controls. These actions shoc k ed the international financial community. Predictably, new investment in Mexico, foreign and domestic, dried up that the true causes of his nation's and corruption, President Lopez as an excuse, on September 1,1982 e nationalized the banking system along w ith all of its DE LA MADRID'S POLICIES Mipel de la Madrid assumed the presidency in December 1982 bearing the burden of executing the strict austerity lan that comprised the conditions of a new $3.9 billion IMF loan. These measures were B esigned to reduc e inflation, cut imports and the public sector rebuild reserves, and produce trade and current account surpluses complied with the austerity measures, the fall in oil prices in 1984 contraction, steady devaluation of the peso, and unchecked dollar outflow.

Yet another bailout for Mexico--this one consisting of 12 billion in new loans over 18 months--was put together by U.S. Treasury Secretary James Baker last summer. The latest rescue called for private U.S. banks to rovide roughly half of new lendin with t he bailout unless Mexico agreed to major structural economic reforms Token Steps Toward Reform. De la Madrid agreed to the conditions of the new loan promising to reduce the government deficit, privatize or dismantle parastatals, decontrol prices, reduce s ubsidies, allow the peso to float, cut the size of the government other half to be furnished by multilaterals. Ti! e bankers were reluctant to contn 8 ute to the 17. For example, although Mexico's export earnings increased substantially during the late 19 7 0s and early 198Os, the balance of payments current accouIlt showed a deficit in 1981 and 1982, and there was only a temporary increase in monetary reserves. Street, p cit p. 102 7bureaucra and join the General eement on Tariffs and Trade (GATT). Mexico's entry into IT ostensibl obligate 7 it to reduce protectionism and force its industries to become more efficient by Y acing competition in the international marketplace.

The results so far have been mixed. In fact, evidence suggests that the latest loan ba ilout, coupled with a rise in oil prices and a decline in international interest rates, is being used as a windfall to allow continuation of the PRI's disastrous statist policies. Only token step toward structural and sectoral reforms have been taken so f a r. Other keforms, such as retrenchment of the bureaucracy, have sim ly involved a reshuffling of government workers with no real reduction in total personnef No significant government ministries have been abolished, there has been no repeal of the law req u iring majority Mexican ownership of enterprises, and returning the banks to the private sector has been a sham Ignoring the Evidence. Even though de la Madrid ma be sincere about privatizing and its leftist allies in the labor movement and academia. Many influential Mexicans reportedly agree with leftist political scientist Froylan Lopez Narvaez' sentiments that 1118 reforms do not help the econom and are contrary to the socialistic aims of the nation.

Other Mexicans, of course, and most all economists in nations lendin to Mexico disagree with this. They cite overwhelming historical evidence that the free mar et reforms are the only prescription that can aid the ailing economy.

Although the government-owned Acero steel plant in Monterrey has been shut beca use of unprofitability, the government has sold only relatively minor state assets such as a hotel chain, a bottle company, a bicycle factory, and a few other small enterprises. Even the actual number of parastatals is uncertain. One U.S. Commerce De artm e nt report in fact leadin Mexican financial newspaper that, whilqghlexico had 849 parastatals in November parastatals, the sale of state-owned enterprises has been 4 ercely resisted by the ruling PRI f a indicates that the number of parastatals may not hav e been cut at al lp The report cites a 1982, B e number was up to 971 last November.

De la Madrid recently said that his goal was to gt in half the state-owned entities.

Some of this, however, will not be by privatization. Even the Mexican government .admits that about 50 state-owned enterprises simply will be merged with others, while other sources sq that many of the other parastatqs scheduled to be sold or dissolved exist only on aper. The six ma'or state companies, whic h together account for more than 20 percent of tE e public sector de f! cit, are not being considered for divestment 18. Robert M. Press Mexicans split on issue of economic reform The Christian Science Monitor, September 11,1986 p. 12 19. U.S. Department o f Commerce Foreign Economic Trends and Their Implications for the United States Mexico,"

November 1986, p. 13 20. Mexico City XEW Television Network, March 27,1987 FBIS Latin America, April 2,1987, p. M2 21. Larry Rohter, "Divestment Efforts in Mexico Deba ted," The New York Times, April 14,1987, p. D10 22. These are Conasupo (distributer of basic necessities to low-income groups the federal electricity monopoly, and the state sugar, steel, railway, and fertilizer monopolies 8MEXICOS ECONOMIC FUTURE Despite entrenched PRI op osition to reforms, Mexicos private sector appears to be responding cautiously to the re I axation of government controls forced by international loan revealed by x; ture PRI actions. The governments 1987 budget promses to fuel moderate c onditionali Whether these changes are to be permanent or merely tactical will only be economic owth by giving businesses access to 20 percent more credit, in real terms, than in 1986 e American government to convert $1 into equity in joint ventures to bui l d hotels in major Mexican tourist areas Company has negotiated a deal with the Mexican million (16 percent of Mexicos debt to the U.8. company Over the past year, forei n corn anies have swapped about $1 billion of Mexicos external debt for equity, an fiR a furt er $700 million is being processed. Mexican investors are also being allowed to buy public sector forei n debt with dollars and convert it at a discount to peso investments. Demand for debtfequity swaps is re ortedly so great .that the Although war y of the concept at first, the Mexican overnment now views debt/equity swaps as a means oArepatriating the $30 billion to 50 billion believed held abroad b Mexican nationals. Another encouraging sign is the announcement last week that e Mexican government w ill sell its mono oly sharsin Mexicana airlines as part of the Mexican Finance Ministry has set a limit of $100 rmllion per mont K on such conversions continuing effort to slim down the pub P ic sector ti B Lingering Economic stock market rallied in disbu r sements from CONCLUSION Without fundamental reforms, Western lenders may either tire of bailing out Mexico or not have the resources to do so. This certainly is the mesa e of the recent decision b Mexican governments recent overtures to the private sector appear promising, they may be only a tactic to spur some growth as the 1988 national election a proaches. There is fear its monetary reins on the public sector and disregard its promised structural reforms K Citicorp to begin planning for write-offs of it s Third World f oan portfolio. Although t e among economists that, once Mexico receives a new infusion of IF oreign loans, it will relax 23. The Wall Street Journal, March 19,1987 24. Financial Times, March 3,19

87. See also Morris B. Goldman, ed., DebtEau itv Conversion: A Stratear for Easine Third World Dek(Washington, D.C.: The Heritage Foundation, 1987 25. Financial Times, May 27,1982, p. 28 26. International Countrv Risk Gui&, February 1987, p. 20 9There also is a possibility that pessimistic, or reali stic, Mexican investors will put their share of the new loan dollars into paper assets rather than productive ones, thus continuing the capital flight. Without confidence in Mexico's future, investors will be unwilling to risk their capital internally.

Mexico has the resources to become a lasting "success story" for the developing world.

Whether it becomes so is ultimately a uestion of whether Mexico's leaders have the ownership of Mexico's economy political sense and courage to begin a Rn damental dismantling of state control and Timothy F. Ashby, Ph.D.

Deputy Director Arthur Spitzer Institute for Hemispheric Development 10-