Short-Term Problems, Long-Term Potential : Mexico clamps on program of economic austerity

The price of restoring investor confidence in the battered Mexican economy has again gone up sharply--and this time the costs will be borne most heavily by the Mexican people. The government of President Ernesto Zedillo last week announced a tough new austerity program, which the financial community has received as just the harsh medicine the Mexican economy needs if it is to recover for the long term. But in the short run it will mean recession and unemployment.

Under the new austerity plan, announced Thursday by Finance Minister Guillermo Ortiz, government spending will be slashed and electricity and gasoline prices will rise sharply. This is sure to push the Mexican economy further into recession. But the government will also draw on international credits to help bolster its banks and provide aid to the poor. The minimum wage will go up 10% in April, hardly enough to keep up with an inflation rate projected at 42% for this year.

The dose of economic austerity was needed to stabilize the peso, which has been dropping since it was first devalued last December, as well as to foster U.S. support for the international aid package that Washington crafted for Mexico. At least as far as the peso is concerned, the new program seemed to have the intended effect almost immediately, with the currency’s value rising slightly Friday to 6.28 to the dollar after five straight days of record lows.

U.S. Treasury Secretary Robert Rubin had it about right when he told the Senate Banking Committee on Friday, “We should recognize the political courage in taking these steps.” Indeed, the political and social disruptions likely to follow the onerous austerity plan will test President Zedillo, not to mention hard-pressed Mexican citizens. Unlike the government’s initial austerity measures, announced in January, the new steps do not include an agreement of cooperation from labor and business leaders. This is an apparent rupture of Mexico’s longstanding pacto, as the system of negotiating economic targets and policies among government, labor and business is called. And that could portend more political infighting in Mexico, already reeling from the economic crisis and from political scandals.

But if the political problems do not get out of hand--and so far Zedillo is handling those too with remarkable courage--the corrective economic policies should help buttress an economy that is fundamentally sound but is suffering from over-dependence on foreign capital. Too much of that foreign capital is controlled by investors seeking short-term gains rather than long-term growth. While that is understandable from an investor’s point of view, what Mexico needs is long-term investment as its economy evolves in partnership with its North American Free Trade Agreement co-signatories--Canada and the United States. The long view must be kept by decision makers both in Washington and California over the next couple of years as this country experiences a predicted drop in bilateral trade and a possible increase in illegal immigration across our southern border.

In hindsight, it is easy to argue that Mexico’s economic problems might have been handled differently.

Federal Reserve Board Chairman Alan Greenspan acknowledged this before the Senate Banking Committee, saying that Mexico’s financial problems were “allowed to fester” far too long. “But that is water under the bridge,” he added. “Having gotten to where we are, I see no other credible alternatives to what is being done.” Greenspan is right. This bitter medicine is necessary. And so is a lot of patience.