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The Mexican reform process : improving long-run perspectives and mastering short-run turbulences

  • Langhammer, Rolf J.
  • Schweickert, Rainer

Mexico's recent financial crisis, culminating in December 1994, threatens the positive effects of the substantial reforms that the country has implemented since 1985 by opening its real sector: first trade has been liberalized unilaterally, then Mexico has joined the GATT, the Uruguay Round, the NAFTA and recently the OECD and thus has committed itself to internationally binding rules and liberalization schedules. Furthermore, foreign direct investment has been invited to formerly closed sectors. With these reforms, Mexico has succeeded in establishing a solid base for a sustainable take-off. However, both the legacies of past distortions and the effects of its exchange-rate based stabilization policy have prevented Mexico from fully harvesting the fruits of its reform efforts. Capital productivity still warrants improvement, investment und domestic savings ratios are lower than in Asia and in the Latin American "success story" Chile. In merchandise trade, non-traditional exports and import-competing domestic industries have suffered from real appreciation. FDI flows to Mexico rose after adjustment programmes were implemented. However, absolute increases cannot obscure the fact that Mexico's position in US foreign direct investment (the major source of FDI inflows) only recovered to levels already achieved prior to the debt crisis in 1982. German and particularly Japanese investment remained below this level and even declined in relative terms. Furthermore, there are structural vulnerabilities: Mexico's industrial exports and inward foreign investment heavily concentrate on the motor vehicle industry, which exposes the country to short-term fluctuations in consumer demand for cars, particularly in the United States. In total, even before the December 1994 crisis, Mexico was not as attractive a host to FDI as newly industrializing countries in Asia or transformation economies in Europe. Both external factors (increase in US interest rates) and political events (regional upheavals, the assassination of the presidential candidate, elections) led to the outbreak of the financial crisis in December 1994. Yet, the Mexican exchange-rate-based stabilization strategy can be regarded as the real cause of the crisis. This strategy entailed high risks and was also implemented in an inconsistent way: the so-called Pacto agreements failed to provide sufficiently restrictive monetary and wage policies, the fiscal surplus was achieved by cutting public investment rather than taxing consumption, and factor market deregulation was delayed. 1995 forecasts of high inflation and negative GDP growth show that Mexico has entered the "bust" phase of exchange-rate-based stabilization strategies. The only short-run option is to continue the present float of the Peso and to establish the credibility of the money supply target. In the medium run, Chile's passive crawl with wide bands provides a blueprint for a low-risk exchange rate management. Without re-establishing the credibility of monetary policies, the gains from real sector reforms will not materialize. Yet, even with credibility, Mexico has to remove several bottlenecks, e.g., in human capital and infrastructure before it can fully reap the gains from previous reforms.

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Paper provided by Kiel Institute for the World Economy (IfW) in its series Kiel Discussion Papers with number 255.

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Date of creation: 1995
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Handle: RePEc:zbw:ifwkdp:255
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  1. Teolis, David P. & von Furstenberg, George M., 1993. "Reducing real exchange rate variability and drift: Mexico on the way to North American monetary union?," The North American Journal of Economics and Finance, Elsevier, vol. 4(2), pages 253-269.
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  3. Gerard Adams, F. & Alanis, Mario & del Rio, Abel Beltran, 1992. "The Mexico-United States free trade and investment area proposal: A macroeconometric evaluation of impacts on Mexico," Journal of Policy Modeling, Elsevier, vol. 14(1), pages 99-119, February.
  4. Rainer Schweickert, 1995. "Searching for credible exchange rate regimes in the former Soviet Union," Intereconomics: Review of European Economic Policy, Springer, vol. 30(3), pages 126-132, May.
  5. von Furstenberg, George M. & Teolis, David P., 1993. "Growth and income distribution benefits of north american monetary union for Mexico," The North American Journal of Economics and Finance, Elsevier, vol. 4(1), pages 127-143.
  6. Leonardo Leiderman & Carmen Reinhart & Guillermo Calvo, 1992. "Capital Inflows and Real Exchange Rate Appreciation in Latin America; The Role of External Factors," IMF Working Papers 92/62, International Monetary Fund.
  7. Schweickert, Rainer & Nunnenkamp, Peter & Hiemenz, Ulrich, 1992. "Stabilisierung durch feste Wechselkurse: Fehlschlag in Entwicklungsländern - Erfolgsrezept für Osteuropa?," Kiel Discussion Papers 181, Kiel Institute for the World Economy (IfW).
  8. Brown, D.K. & Deardorff, A.V. & Stern, R.M., 1991. "A North American Free Trade Agreement: Analytical Issues and A Computational Assessment," Working Papers 289, Research Seminar in International Economics, University of Michigan.
  9. Burgess, Robin & Stern, Nicholas, 1993. "Taxation and Development," Journal of Economic Literature, American Economic Association, vol. 31(2), pages 762-830, June.
  10. Schweickert, Rainer, 1995. "Searching for credible exchange rate regimes in the former Soviet Union," Open Access Publications from Kiel Institute for the World Economy 1651, Kiel Institute for the World Economy (IfW).
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