U.S. Should Help Mexico Ease Its Dependency on Oil Revenue : Debt Relief, Greater Interdependence Would Aid Both Nations in Long Run

The recent drop in oil prices that began in the Persian Gulf hit Mexican shores like a tidal wave, confounding policy-makers, upsetting financial negotiations, and revealing once and for all what insiders had known for months--that Mexico cannot both service its debt and remain politically and economically viable. New borrowing will only postpone the day of reckoning.

At a time when new sources of capital and entrepreneurship are needed in Mexico, potential investors face an extraordinary combination of short-term economic and political risk.

As it has become clear that Mexico can’t grow by depending so heavily on oil, there is now greater attention to promising growth opportunities that have long existed but were ignored or impeded by policies that viewed oil as a way to liberate Mexico from its reliance on the United States.

The opportunities are evident in the presently flourishing maquiladoras, border industries that import goods and then re-export assembled products, but the economic potential of Mexico goes well beyond that.

Mexico must concentrate on industries that take advantage of its labor pool, resources and location. Those industries must be able to manufacture not only for the domestic Mexican market but for export to the United States as well.

Access to Wider Market

The United States would benefit by retaining those segments of such industries that require greater skills, capital and research and development. If such cooperation between Mexico and the United States is accompanied by gradual reduction in the two countries’ trade barriers, both would enjoy greater access to a wider market.

Both Mexican and U.S. business executives are aware of the opportunities. And labor, both here and in Mexico, recognizes that enhancing Mexico’s industrial base in cooperation with the United States is preferable to mass migration out of Mexico into the United States and the flight of certain labor-intensive industries to Asia.

But the debt crisis is an obstacle to realizing the potential for U.S.-Mexico cooperation on trade and development. The crisis requires more than a patchwork approach and calls for statesmanship at the highest level of both countries.

The U.S. government needs a more coherent policy that brings together the disparate policy-makers in Congress, the Treasury Department, State Department, Federal Reserve Board and the White House and that recognizes that long-term opportunities lie beyond current difficulties.

The rapid fall in oil prices has now highlighted fundamental flaws in Mexico’s development model.

Dangerously Dependent

As early as the mid-1970s, it was apparent to many that Mexican growth was dangerously dependent on imports. The Mexican development model relied too heavily on capital, which is in scarce supply, and not enough on labor, which is in abundance.

It took more than a 2% growth in output to produce a 1% increase in employment, even as the number of job seekers increased more than 3.5% annually. As labor shifted from the countryside to the cities, most of the employment growth took place in low-productivity jobs, creating an underclass of street vendors, domestics and other low-skilled workers.

For the most part, Mexican industry is capital-intensive, produces at high costs and low volumes, and serves a small, protected market of upper middle class and elite consumers.

A decade ago, there was a call for restructuring, but the oil boom came along and made imports at least temporarily cheap. As a result, the economy marched forward from 1976 to 1981 on the same flawed model without fundamental reforms.

By 1981, imports were growing at three times the rate of output, while employment lagged, and the need for foreign exchange went well beyond oil revenues. The cost of imports and a flight of capital out of the country to avoid devaluation led to unprecedented borrowing. Mexico was thus set for a crisis well before rising real interest rates and a slumping oil market triggered the 1982 flight from pesos. Since then, the government has imposed stringent belt-tightening, slowed growth to a crawl, cut back imports and restructured debt payments. Debt default by Mexico offers no solution to its problems. The economy continues to operate on its flawed growth model. Mexico’s non-oil businesses still rely heavily on imports to keep functioning. Debt default would only lead to a drying-up of trade credits and to worldwide commercial distrust that would make long-term solutions difficult, if not impossible. Mexico’s oil-based growth strategy had led to even greater international dependence than ever--and far more vulnerability to the uncertainties of the oil market than it would have been to trade and investment links with the United States and other countries. By the end of 1985, the $14-billion estimate for Mexican energy exports last year had fallen by about $2 billion. The prospects for 1986, at an estimated price of $18 per barrel of oil (which might be optimistic) and an average of 1.4 million barrels per day would be about $10 billion. This would not even cover debt-service payments, much less support increased levels of imports necessary for a resumption of growth and structural economic change.

The debt problem requires some combination of the following three approaches: a shift from the present debt structure to a greater degree of risk-sharing by creditors, with debt payments linked to international oil prices and Mexico’s trade position; an increase in net borrowing; a cap on interest payments or reduction of principal. Unless oil prices go up again dramatically, the second option no longer offers a long-term solution.

U.S. Must Take Steps

Some combination of the first and third option is inevitable if Mexico is to avoid defaulting on its loans. However, to make such a solution possible, the U.S. government will have to take steps to assure that major bank lenders do not become insolvent in the process and jeopardize the financial system.

The political situation in Mexico is as disquieting as the financial one. Debt-imposed austerity has cut back real wages by one-third, eating up all of the gains of the oil boom. Furthermore, Mexico’s six-year presidential administrations have customarily pursued a cycle of expenditures that tends to start slowly and accelerate in the third and fourth years.

This is the fourth year of the administration of Miguel de la Madrid. The usual upswing in spending that is needed for patronage and to cement political support has been truncated by the austerity program and is now threatened even more by the oil slump.

The result has been a drastic increase in the political infighting among challengers inside and outside of de la Madrid’s party (the dominant PRI) at the very time when policy coherence is required. Conditions are not helped by the appearance of indecisiveness on de la Madrid’s part.

But de la Madrid’s cautious approach indicates he understands the problem’s complexities; there is certainly good reason not to shoot from the hip.

Ever since Treasury Secretary James Baker III announced a new initiative on world debt, the United States has demonstrated a willingness to view the debt problem in political as well as economic terms. It has recognized that the issues cannot be resolved by market forces alone.

Once there is a reasonable, coherent approach to Mexico’s debt crisis, the financial markets will begin to adjust and resume their role in furnishing the financing for trade and investment. Until that point, however, the situation will not just remain at a stalemate. It will deteriorate both economically and politically.

For this reason, short-run decisions at the highest level in both countries must be linked with longer-term strategies that will open up a new era of managed interdependence between the United States and Mexico.