IN today's global economy, markets react quickly to financial crisis - and often overreact. For small countries that have opened their markets to foreign capital, missteps in management can bring rapid and potentially catastrophic consequences, as investors pull back from losses and increased risks, actual or perceived.
Mexico, whose Dec. 20 devaluation has mushroomed into a severe financial crisis, is still struggling to find secure footing. Latin American nations who took Mexico's reforming economy as their model this week saw their currency and stock markets hit by the aftershocks, whether or not justified by local conditions.
The crisis vividly shows the dangers as well as benefits of financial interdependence. Mexico has made tremendous strides in dramatically reducing budget deficits and inflation, opening markets to competition, and convincing Mexicans they were on the road to prosperity. But some costly mistakes in exchange-rate policy have suddenly made the nation's future beholden to thousands of foreign investors. The middle class slips downward, being asked to accept wage restraints as prices surge and interest rates soar to restore investor confidence. Dissatisfaction with slow political reform is compounded by disillusionment over the supposed economic prowess of their leaders. Many say they are unwilling to take it anymore.
Restoring investor confidence is essential. And President Clinton's offer to extend and expand US credit helped halt the plunge of the peso and stock markets. Clinton himself is under fire as members of his own party call for the repeal of NAFTA.
But what is at stake here is not only what he correctly calls US strategic interest in Mexico's stability. It is also the stability of an entire region that has shifted from autocracy and statist, protectionist economics toward US-promoted democracy and free, open markets - boosting public expectations in the process. If these countries are hit hard as a consequence, public support for governments could deflate as rapidly as dashed hopes of prosperity. To avoid this, all involved should carefully learn the lessons of Mexico's crisis.