PERSPECTIVE ON MEXICO : Miracle Workers’ Comeuppance : The peso was overdue for adjustment, but the Zedillo technocrats’ overconfidence turned a nudge into a free fall.

As the Mexican peso plummeted over the past week, U.S. activists who had opposed the North American Free Trade Agreement alternated between crying “foul” and boasting “I told you so.” Congress, after all, had been sold NAFTA based on the allure of rising exports to our southern neighbor; a cheapened peso now threatens to slow the U.S. export boom, make Mexican workers even more competitive and further threaten American wages and jobs.

But it is not just the United States suffering from peso shock. A key element in maintaining support for NAFTA in Mexico was the connection of trade liberalization to the peso’s stability. The reason was straightforward: The Mexican inflation-fighting “miracle” of the past six years was based on the coupling of unilateral reductions in trade barriers with a relatively fixed currency, which insured that imports could act as a sort of ceiling on domestic price hikes. The results were nothing short of spectacular: a decline in inflation from nearly 160% in 1987 to less than 10% this year. Many small and medium-size Mexican industrialists who felt battered by the increased international competition nonetheless welcomed the return to macroeconomic stability.

Devaluation, however, was always a real possibility. Between 1987 and 1993, exports grew by around 50% while imports quadrupled. Trade and current account deficits skyrocketed to levels not seen since before the 1982 debt crisis, and the peso was more overvalued than it had been in 1981. The government’s technocrats dismissed worries about the peso’s sustainability, arguing that the demand for Mexican currency was driven by investors eager to crowd into the newly stable economy. But the vast bulk of “investment” involved the return of flight capital and purchases in the Mexican stock market, and the sudden collapse in the dollar value of these assets is likely to chase many skittish investors right back out.

This complicates a Mexican political scene already staggered by the effects of the renewed fighting in Chiapas. The almost 40% decline in the peso will soon translate into higher prices, and the clamor for compensating wages will feed the inflationary spiral. Exorbitant interest rates, jacked upward to reflect the new currency risk, will stifle domestic investors’ plans. As the economy slows and the government is forced to tighten its purse-strings, the promises of the last electoral season--that in 1995, economic prosperity would finally trickle down to the poor--are likely to be broken.

Why did newly inaugurated President Ernesto Zedillo chose a course seemingly designed to alienate the wealthy, frustrate the poor and reduce the purchasing power of Mexico’s growing middle class? He decided to loosen the government’s reins on the sorely overvalued peso, hoping for a soft landing, a nudge downward that could be blamed squarely on the Zapatista rebellion. But when the peso went into a free fall, investors felt betrayed by the government, not Subcomandante Marcos, and their run toward the dollar pushed the peso to unexpected lows.

Zedillo’s miscalculation was partly rooted in the excessive confidence of the technocrats: Having managed both an end to inflation and a history-defying free-trade pact with the United States, they valued textbook economic theory over political wisdom. The miscalculation also reflects the new president’s attempt to both embrace and break free of the legacy of his mentor, former President Carlos Salinas de Gortari: Zedillo wanted to begin his administration with a bold charge in a new direction, just as Salinas did in 1988; unlike Salinas, Zedillo chose a policy destined to weaken his hand.

The political fallout is just beginning. One poll last week reported that 89% of the public sees little or no hope of economic improvement in the coming year. The head of Mexico’s major business federation has called on Zedillo to develop a new economic plan, signaling the erosion of support for a government that Salinas taught business to love.

What should the United States do? The Clinton Administration has reactivated a $6-billion credit line, which gives the Mexican government additional monies to support the peso. There is little else to do now but wait--and begin to worry about other Latin American reformers, such as Argentina and Peru, that have taken a similar policy tack with regard to unilateral trade liberalization, overvalued currency and the pursuit of free-trade pacts with the United States.

As the second act of the Mexican “miracle” unfolds, its missteps of recent weeks are warnings for Latin America’s future.