The trouble with Mexico's economy

Mexico's contentious and close election finally seems settled. On Dec. 1, Felipe Calderón, of the pro-market National Party (PAN), will become that country's new president. His main opponent, the left-leaning Andrés Manuel López Obrador, has not conceded, but he seems to accept that he will not be the official president.

American investors should welcome this result. With it, they have avoided a potential disruption to Mexican development and possibly a drift toward a less enthusiastic embrace of the North American Free Trade Agreement (NAFTA).

But that is about the best that can be said about this result. Mexican politics remain too divisive to implement the fundamental reforms that might truly develop Mexico into a full trading partner, relieve immigration strains, and realize the country's economic potential. With attention focused on China, India, Brazil, and a few other emerging economies, it is easy for US investors to overlook Mexico. That would be a mistake.

Along with Canada and the US, Mexico is a member of NAFTA, still the largest free-trade area in the world. Mexico is America's second-largest trading partner after Canada. Mexican assembly operations along the border are still an important partner for many of the largest US manufacturers. Mexico is a major supplier of oil to the American econo- my. It is also far and away the major source of immigration, both legal and illegal. Mexican policy is indeed important to American finance and the US economy.

Lackluster growth

Mexico's election was fought almost entirely on economic grounds. After a rapid real per capita growth rate of 3.5 percent a year between 1960 and 1980, the economy has remained stubbornly resistant to growth since. Between 1980 and 2005, per capita real growth amounted to a mere 0.7 percent a year and has picked up only marginally to 1.2 percent in the past 10 years.

The lack of growth and jobs has driven many Mexicans north to the US. An estimated 10 percent of the nation's population has made the move. So it is no surprise that voters demanded growth strategies from each candidate.

In meeting this demand, Mr. López Obrador and his left-leaning Party of the Democratic Revolution (PRD) eschewed the anti-American rhetoric typical of the Mexican left. On the contrary, he emphasized closer ties to the US, pushing the notion that NAFTA should structure itself more like the European Union (EU).

In particular, he argued for the kinds of competitiveness funds used in the EU to transfer development monies from more prosperous members to less-developed members. Obviously, in the context of NAFTA, such a device would shift funds from the US to Mexico.

Mr. Calderón and his right- leaning PAN stressed a route to growth through deregulation, free trade, and less government intrusion into business, including a continued full participation in NAFTA. He wants Mexico to model its NAFTA role on the US-Canadian relationship. As part of that effort, he promoted the idea of extending the NAFTA-associated North American Development Bank from its current focus on development along the border into a regional engine of economic development.

Interestingly, the Institutional Revolutionary Party (PRI) that ruled Mexico consistently for 70 years before the 2000 election, also took a pro-American, pro-NAFTA line. During the campaign, the PRI candidates actually criticized the outgoing PAN president, Vicente Fox, for failing to forge better relations with the US. The general similarities in these positions suggest that Mexico will hold to a fairly consistent line of developing within NAFTA a position that should encourage investment in Mexico.

Poor prospects for bold reform

Less encouraging, however, is the relative squeamishness all candidates showed in addressing the structural problems that have held Mexico's economy back for 20 years. There was little talk of the inflexibilities in Mexico's labor market that are widely seen as an impediment to employment growth and economic development generally.

Nor did the candidates explore options to make industry more efficient, especially the notoriously backward oil sector. Few spoke of reorganizing state-owned enterprises; none spoke of outright privatization.

This reticence to pursue substantive change suggests that the new government will do little to address Mexico's fundamental, structural economic and industry problems. New political realities make reform even more difficult. In the lower house of Mexico's congress, the PRD and PAN gained seats, while the PRI lost them.

In this mixed political milieu, President Calderón would have to compromise even if he were inclined to make bold moves. Making any reform even less likely, the leaders of three parties, including Obrador's PRD, announced recently the formation of a coalition to block the new president.

Investors on both sides of the border may have dodged a bullet with Calderón's victory. But the result leaves little hope that the country will make the aggressive changes needed to accelerate economic growth and allow Mexico to become either an engine of growth or a fully contributing partner in NAFTA. Neither do the results suggest a turn to growth that might discourage migration to the US. And that's something people on both sides of the border – not just investors – will be watching carefully.

Milton Ezrati is senior economic strategist at Lord Abbett, a money management firm.

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