The Heritage Foundation

Backgrounder Update #172

January 20, 1992

January 20, 1992 | Backgrounder Update on

Privatization in Mexico: Much Better, But Still Not Enough

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PRIVATIZATION IN MEXICO: MUCH BETTER, BUT STILL NOT ENOUGH

(Updating Backgrounder No. 797, "Rivatization in Mexico: Good, But Not Enough," November 15, 1990.) Mexico's program of privatization is an integral part of its drive toward modernization and economic structural reform. Sold to the private sector by the administration of President Carlos Salinas do Gortari have been Mexico's telephone system and steel industries, roads and bridges, and nine of the eighteen com- mercial banks. Salinas, moreover, has approved privatization of the social security system and the state- owned communal farms. Because of the scope and success of the Salinas privatization program, it deserved- ly has earned an outstanding reputation worldwide. Despite thew significant strides in privatization, mare remains to be done. The potentially rich but ineffi- cient state-owned oil and electricity sectors of the Mexican economy continue to barrow from the. World Bank and other international financial institutions to modernize and invest in now technologies. This not only has run up a huge foreign debt, but has reduced incentives for the oil and electricity industries to operate efficiently. Salinas refuses to privadze these industries because dieir state-owned status is mandated by the Mexican Constitution, and because they are considered as too "strategically" important to the sovereignty and national security of Mexico to be operated by the private sector This rationale is unfoundecL Thew sectors of the Mexican economy should be privatized precisely be, cause they an so critical to the nation's well-being and potential for modernization. Micy are performing poorly now because they are ran by inefficient bureaucracies. Privatizing them would make them more effi- cient and productive, thereby strengthening Mexico's economic sovereignty. The Salinas admini tration has authorized the privatization or "disincarporation" of some 351 statr- owned enterprises since 1988. Of this total, 165 have been privatized already and 132 remain up for sale. So far the total number of state. enterprises privatized since 1982 is 864. By 1994, when Salinas leaves of- fice, this number should rise to 960.7lius, the total number of state-run companies in Mexico will have declined from 1,155 in 1982 to 195 in 1994. BaWm Swel, and TelephoneL The Mexican government last year concluded the sale of Telefonas de Mexico CM.N=, the telephone company. to a consortium group headed by corporate magnate Carlos Slim. 71m enterprise was sold for $4 billion. Also last year, the goverment sold nine commercial bank&- including Banco Naclonal do Mexico (BANAMEX) and Banco de Comercio (BANCOMER), the two largest banks in die country-to private financial investment groups. Overall prices have averaged almost three times their book value. no total amount of revenue raised by these sales has been $7 billion. Other important include the December 1991 sale of the costly and vastly ineftient sted holdings, Akw Horms do Mexico SA. (AHMSA) and Siderurgica Lazaro Cardenas L45 Truchas (SICARTSA). They were sold to investor groups for a total price of $1.5 billion. Other sales include ft bi9blY state sub-

sidized fertilizer enterprise, Fertilizantes Memicanos (FERTIMEX), over 60 sugar farms known as in- genios, and the insurance conglomerate Aseguradores Maxicanos (ASENEEX), which is expected to be sold for $500 million. In addition, the government has authorized a "contracting out" method of privatization for the construc- tion of highways and bridges. It plans this year to explore whether highways could be owned privately or operated by private toll companies. Further, the government has engaged private firms to produce, manage, and distribute potable water to the population. This is expqcted to benefit-Guadalajara, Mexico City, Monterrey, Torreon, and other urban areas suffering from a lack of potable water. Private Pension Plans. An important breakthrough in Salinas's privatization efforts is a March 1991' proposal to let private investor groups compete with the public social security system for the mangement of workers' pensions. According to the proposal, which is still under debate in the Chamber of Deputies, private businesses would be given the option to choose between private financial organizations or the ineffi- cient Mexican Social Security Institute to manage retirement pensions. The businesses would finance the pensions with tax-deductible wage hikes of 2 percent every two years until 1996. A very similar plan was adopted in Chile during the 1980s and has been very successful. In another bold move, Salinas in May 1991 ordered the privatization of all seaport facilities. The govern- ment dismantled the corruption-ridden union stronghold in Veracruz, Mexico's main maritime port. Similar- ly, over fifty airport customs unions will be privatized. The official reason: poor service and corruption. But perhaps the most daring measure taken by Salinas is his plan to reform Mexico's inefficient state-rah agricultural system, called the ejido. Salinas declared in an address to the nation on November 1, 1991, that the legal framework of the ejido system needed to be modified. A week later Salinas submitted a proposal to the Chamber of Deputies to change Article 27 of the Constitution. Under Article 27, the land has been owned by the state, and not by private farmers, who are merely granted the right to cultivate it. The proposed modifications to the Constitution will allow ejido farmers to till the land as they see fit, as well as to sell it, buy it, or rent it. The Salinas reforms also are designed to encourage voluntary joint ventures (called "associations of par- ticipation!) between the ejido farmers and private investors. This type of joint project is already underway in the region of Vaquerias, in the northern state of Nuevo Leon. It has been a tremendous success in inject- ing badly needed capital and new working equipment into a previously impoverished area. Also, farmers' profits have tripled in less than a year. Fundamental Reform. Despite its success, the proposed agrarian reform has sparked an unprecedented debate in public and political circles. Public officials explicitly deny that the modification of the Constitu- tion implies privatization. Rather, government officials refer to it as "agrarian modernization." In fact, how- ever, the Salinas agrarian reform plan constitutes the most basic form of privatization: assigning to the people transferable private property rights and complete control over landholdings. This initiative is tile most fundamental market-based economic reform of the Salinas administration. It marks an end to govern- ment-mandated land redistribution and the advent of institutional security to landholders through private property rights. Because. of the changes in the Constitution, a future s on cannot reverse Salinas's agrarian reforms. This will give future private investors much-needed confidence because the government will be prohibited from seizing their property. Salinas's aggressive privatization program has had positive economic and financial results. Mexico recorded an impressive growth rate of 4.2 percent in 199 1. Inflation has dropped to 18.8 percent from a staggering 159 percent in 1987. And the value of f6reign investment flowing into Mexico reached $8 bil- lion in 1991, which is an all-time high.

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The performance of privatized companies has been very good. For instance, the notoriously inefficient airline, AEROMEXICO, which was sold in 1988, has been transformed into one of the most productive and efficient airlines in the world. With 36 percent of the original operations personnel, it now handles 25 percent more flights per day. In 1990 the company was first place worldwide in on-time flight departures and arrivals. Attractive to Investprs. Privatization also has spurred private investment in the Mexican economy. Some 98 percent of privatized assets have been sold to Mexican buyers. Private capital investment in the Mexican economy has increased from 56 percent of total investment in 1981 to 75 percent in 1990. As a result, the Mexican economy grew 4.2 percent in 1991. Moreover, it unleashed a growth rate of 129 per- cent in the Mexican stock market in 199 1. This makes it the most attractive overall investment option in the world right now. Privatization also has eased Mexico's massive domestic debt. So far privatization has yielded revenues in excess of $13 billion; another $4 billion are expected from future sales. The huge revenues obtained in 1991 were used almost entirely to retire 26 percent of Mexico's outstanding internal debt. All in all, federal subsidies as a percentage of the grdss domestic product (GDP) declined from 9 per- cent in 1981 to 4 percent today. Public sector spending as percentage of GDP was 16 percent in 1981, but will decline to around 5 percent by 1994. As a result of these new revenues, 1991 was the first year in the country's contemporary history that Mexico had a budget surplus. It was around $3 billion, or 0.4 percent of GDP. Another surplus of $6 bil- lion, or 0.8 percent of GDP, is projected for 1992. These surpluses will help bring down the inflation rate from 18 percent in 1991 to an expected 9.7 percent for 1992. If this happens, it would be the first time in over two decades that Mexico has reached a single-digit inflation rate. Despite all this progress, the Salinas government still refuses to privatize the so-called "strategic sectors" of the economy-oil, petrochemicals, and railroads. The Mexican president continues to invoke Articles 25 and 26 of the Mexican Constitution, which endow the government with the right to administer economic af- fairs. These legal provisions, however, are incompatible with the free market aims implicit in Salinas's carn- paign of privatization. Articles 27 and 28 give the Chamber of Deputies the exclusive right to determine which sector counts as "strategic," and this constitutes a blank check for expropriation of any property deemed to fit that category. The "strategic" sectors of the economy perform poorly. They were responsible in 1991 for $2.9 billion worth of new foreign debt. This does not include emergency credits of approximate- ly $6.5 billion approved by the U.S. Export-Irnport Bank to modernize PEMEX's (Petroleros Mexicanos) outdated technologies. The burden of covering losses incurred by the inefficient performance of the oil, petrochemical and other "strategic" industries has been transferred to consumers in the form of sudden sharp price increases and new maintenance surcharges. Political Obstacles. Furthermore, the argument that complete state ownership of these sectors is irm versible because they are strategic is unconvincing. Other strategic sectors of the economy, such as telecom- munications, highways, airlines, and potable water distribution, have been privatized. Why not railroads, electricity and oil? The obstacles are not economic, but political: the outdated and mistaken belief that privatization of these areas would threaten national sovereignty. Despite the controversy surrounding the privatization of oil and other "strategic" industries, the prospects are good that these, too, someday will be sold to private investors. Salinas's agrarian reforms suggest that Mexico is beginning to respect private property rights more than ever before. Further, if as expected, Mexico joins America and Canada in a free trade area agreement, Mexico will be forced to sell off un- profitable state-run enterprises to compete with its more economically advanced neighbors. Privatization is a key ingredient in Salinas's plan to modernize Mexico's economy and promote economic growth. But to accomplish these goals, the President must expand his privatization program. He must aHow private investors to purchase all or parts of the oil, electricity, petrochemical and other "strategic"- industries. Only then will the corruption, waste and inefficiency that now run rampant in these

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industries be eliminated. He can do this by urging the Congress to modify the provisions of the Constitu- tion that prohibit the privatization of these industries. Salinas should tell the Mexican people that privatization does not represent "crony capitalism," but "popular capitalism." It spreads the wealth among the people by creating economic growth and taking property out of the hands of bureaucrats and putting it in the hands of private individuals. If the oil and other remaining state-owned industries are privatized, the nation's patrimony will not be sold off, but be given back to the people. Intemational Acclaim. Argentina, Brazil, Colombia, Venezuela, and other Latin American countries are copying Mexico's privatization program. Thus, Mexico already has won prominent international acclaim. However, it could win more. If the program is expanded to include the "strategic" industries, Mexico will surpass its already enviable reputation as the site of one of the world's most exciting free market revolu- tions. It also will take a critical step toward reaching its self-proclaimed goal of becoming an advanced, First World country.

Roberto Salinas Academic Director Center for Free Enterprise Research Mexico City, Mexico

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