A Tale of Two Economies, One Flourishing, the Other Moribund

The Mexican economy is rapidly growing, but few Mexicans are benefiting. There are two economies in Mexico: a strong, industrial, exporting sector and a weak, inefficient, domestic-oriented sector still suffering from the government’s decision, in 1985, to liberalize import restrictions. Indeed, all that is well in the Mexican economy is related to the North American Free Trade Agreement.

The boom in the Mexican economy is a novelty for Mexicans under age 18, half the population: They have never experienced anything like it. Fundamentally, surging economic growth means something else as well: For the first time in more than 30 years, the Mexican economy has a sound foundation.

Ever since the ‘60s, the economy had been floundering. In the ‘70s, the chief cause was government expropriation of companies it deemed to be “strategic.” The Echeverria and Lopez Portillo administrations, in effect, built a fictitious economy, one totally dependent upon government favors and regulations. Since then, excessive government borrowing and sheer incompetence have checked economic growth. The economy barely succeeded in not further diminishing the welfare of the average Mexican.

The recent economic recovery, with a growth rate above 7% this year, showcases the new strength of such restructured industries as automobiles, auto parts, steel, cement, chemicals, fertilizers, electronics and pharmaceuticals. This modernized side of the economy, however, employs less than one-third of all working Mexicans. The companies, both Mexican and foreign, pay extraordinary wages relative to those received by most Mexicans; their productivity rates rival those anywhere in the world, and they demand ever higher levels of training and education.

The remainder of Mexican workers struggle to make ends meet. Most of the businesses, usually small and medium-sized low-tech manufacturers, that employ them have failed to adjust to the new economic circumstances. Unable to compete with U.S. or Asian imports, they rely more and more on a shrinking domestic market. But they still employ around 60% of the industrial work force.

Two things happened when the economy crashed in 1995, following the devaluation of the peso. On the one hand, the government, which avoided bankruptcy only because of the U.S. bailout, addressed the country’s economic problems head-on and succeeded in restabilizing the economy, as a whole, in short order. Even so, there were casualties.

The older part of the economy, having lost its protection from imports and facing ever more import competition as a result of NAFTA, was hanging on largely because of old supplier relationships. Many of these businesses continued to sell to each other, regardless of quality, in those sectors not immediately affected by imports. For example, manufacturers of radios collapsed overnight, but pencil and food producers, though their markets were shrinking, stayed afloat.

The crash of 1995 delivered the coup de grace to these businesses. They couldn’t service old debts, which kept growing. In a matter of days, interest rates skyrocketed from around 17% to more than 160%. Having failed to develop export relationships, they could not capitalize on export opportunities then available. Finally, the economic depression dried up their domestic markets. The older economy became moribund.

The other effect of the ’95 crash was that the government had no choice but to adopt a series of policies that greatly diminished its ability to make independent decisions. First, it changed its exchange-rate policy: The government would no longer fix the peso’s exchange rate, but let its currency float. That policy recently passed a tough test. While Asian currencies were falling, throwing their economies into crisis, the peso, though it drifted downward, did not precipitate a similar reaction in Mexico.

The government’s attempts to save the Mexican banking system from bankruptcy were less successful. Three years after the crash, the banks still cannot fulfill their primary purpose: to fuel the growth of the economy.

The bottom line is that the Mexican economy is growing despite itself. Domestic economic and political institutions are weak. The political parties do not exert leadership. The banks do not provide credit. The police does not reduce crime. The judiciary does not settle disputes. Only a handful of institutions serve their purpose. The new Federal Electoral Institute, for one, has shown that elections need not be stolen and that they can be credible. In the economy, it is NAFTA that has become the key institution.

Of course, NAFTA is only an agreement to trade goods and establish rules of investment. But from the Mexican side, NAFTA is much more. The reason why the Salinas administration first proposed to negotiate an economic agreement with the United States was essentially political. Former President Carlos Salinas de Gortari wanted to anchor the reforms he had set in motion to something that would make them permanent. Given the personalistic and un-institutionalized nature of Mexican politics, nothing inside Mexico could accomplish this. Only the United States could offer such a guaranty.

The unfolding of history since NAFTA was inaugurated, early in 1994, has confirmed, over and over, the wisdom of both governments in fighting for such an arrangement. Both nations have benefited greatly, even though many unskilled American and Mexican workers have lost out. One measure of success, the easy one, can be found in the sheer volume of trade between the two nations. Total bilateral trade will exceed $180 billion this year. It was less than $35 billion in 1987.

Much more important than the numbers is that the Mexican economy has stuck to the course outlined in NAFTA, despite the temptation that, when the crash struck in 1995, many people and politicians in Mexico, if not most, would have willingly changed course and taken Mexico back into the economic and political doldrums of a protected economy and an authoritarian political system.

But the Mexican economy still has a long way to go. In stark contrast with most Asian nations, and fortunately for its stability, the banks in Mexico have played no part in the making of the current economic boom. But without a working, efficient and competitive banking system, the reach of the economy’s growth will continue to be limited, and most Mexicans will remain left out.