Many Mexicans believe that their country has gone through a period of “neoliberal” free-market reform and that it hasn’t worked. This misconception deprives them of an economic alternative and vision for the future.
In fact, neoliberal reforms and free trade in Mexico were frequently fake. The so-called neoliberalism was crony capitalism dressed up using the language of free markets. Managed trade with many exceptions and red tape has often been touted as wild capitalism. In Mexico, elite control of the economy through government was simply replaced by elite control through crony capitalism—the handing off of state assets, monopolies, and protection from foreign competition and other rent-seeking opportunities to friends, supporters, and relatives of the regime. Rather than releasing entrepreneurial drive, it protected privilege. Yet governments in Latin America and international institutions like the International Monetary Fund and the World Bank praised Mexico for its “free-market” reforms.
Even though Mexico divested itself of state enterprises and opened up the market through privatization, this has often been illusory. The old elites simply took the “privatized” assets and continued their control of the economy under crony capitalism. This is the very opposite of free markets, with the rich and the powerful suppressing the freedom and opportunity of others. The so-called neoliberal reforms did not touch special interests. They ignored problems such as crony capitalism, a heavy regulatory burden, subsidies, corruption, and unequal distribution of the gains of growth, both socially and geographically. This is why there has been an aversion to free markets in Mexico. People think that Mexico experienced free markets, and inequality subsequently increased, when in reality, the Mexican people have not really experienced free markets and free trade.
In the 1980s, the Mexican economy was dominated by state-owned enterprises: telephone companies, banks, bus companies, railways, fertilizers, even a yogurt company. Given the fact that most of the companies were in the red, the government resorted to printing money, or getting the country into debt. Many companies were privatized in the late 1980s, except for the oil and electricity sectors for ideological reasons. If this privatization had not taken place, Mexico could well have entered into a period of hyperinflation.
Many of the privatizations were not sold to the highest bidder, though, but were instead handed to government cronies. Loyalty to the people in power was rewarded. The most famous case is the telephone company Telmex, which was sold on credit. Even after privatization, the company enjoyed a monopoly market. After 1994, under the North American Free Trade Agreement, foreign companies were allowed in. AT&T and MCI came to Mexico, but they had to partner with local companies because they could not hold more than 49 percent of a Mexican subsidiary. So, for many years, AT&T had to connect with Telmex and pay Telmex a connection fee, and it could only offer long distance calls, not local calls. In this way, AT&T was handcuffed, with limited ways to invest more in the Mexican market. Thus the opening to foreign direct investment (FDI) was cosmetic, and a former public monopoly became a protected private monopoly. The Mexican people suffered with higher prices for telephone services, so Telmex got extra rents from the Mexican people, with an increase in inequality. Yet there is hope. In 2013, a reform was enacted that seems very promising and has opened the telecommunications sector to more FDI. Already, Virgin Mobile has arrived in Mexico, and AT&T is planning more investment.
From the 1940s until the 1980s, Mexico followed the model of import substitution industrialization: It created tariff and non-tariff barriers, and used import permits, to shield local producers from foreign competition. The results were predictably disappointing. It forced mature foreign companies to produce in Mexico, usually at a higher price than abroad. It created infant industries that never matured. There was no innovation, no care for quality. It created the most horrendous inequality, with the local market being too small for companies to have economies of scale, and thus it did not create a lot of employment. Poverty belts surrounded every city in Mexico. Import substitution industrialization started generating macroeconomic disequilibrium, and created the conditions for the 1982 crisis.
Given the severity of this crisis, Mexico had to start opening up its economy. In 1986, Mexico entered into the GATT, and in 1994, the North American Free Trade Agreement. These two actions started opening Mexico up to foreign trade. Exports started increasing to unprecedented levels, and the maquiladora industry gained momentum. Mexico also signed other trade agreements with Europe, Israel, Japan, and some South American countries. But even though Mexico has signed various trade agreements since 1994, these have been gradual, and have left many exceptions in place in order to protect certain groups from foreign completion. Tariffs from countries outside of the trade agreements have been very high. For instance, tariffs applied to some Chinese goods can reach 500 percent. There is a high level of variability in the tariff rates. The customs system is complex and constantly changing. This is the result of protecting groups from foreign competition, thus increasing inequality. It weakens the rule of law, and increases the level of unpredictability.
The poster child for protectionism in Mexico is the automobile industry. The first auto assembly plant in Mexico was established in 1925 by Ford. By 1940, there were several international auto companies. But 1940 is when import substitution industrialization got started in order to force foreign companies to assemble cars locally under the presidency of Miguel Aleman. In the 1960s, import substitution was deepened, forcing auto manufacturers to have 60 percent Mexican content. This regulation had unintended consequences: Volvo, Mercedes, and others simply abandoned the country. They could not produce 60 percent of content locally given that the market was too small for economies of scale. During the period of import substitution, cars assembled in Mexico were lagging behind by about 8 years, quality was low, there was not much variety, and Mexico never exported, except in 1982 when a Volkswagen dealer sold Fidel Castro 12 Westphalia vans. Cars made in Mexico were sold at more than double the price of cars made in the USA. Since Mexico entered the NAFTA agreement, the car market has been slowly liberalized. Indeed, it has experienced dynamic changes, becoming an exporter of cars. In fact, Mexico is the 4th largest exporter of cars in the world, as well as the largest exporter of trucks and auto parts. That is the miracle of liberalization, something never accomplished during the import substitution industrialization period.
With the NAFTA agreement started a period a gradual liberalization, first with the new cars, and then with some used cars. The final liberalization for used cars will take place in 2019. The fact that the liberalization for used cars has been very gradual has created its own unintended consequences. Used cars in Mexico are still more expensive than used cars in the US. AMDA (the Mexican cars distributors association) has lobbied to create non-tariff barriers in order to make US cars more expensive in the Mexican market. They don’t want prices of used vehicles to go down. This lack of liberalization of the used car market in Mexico has impacted low income households, thus increasing inequality. People thought that with free trade, they would be able to go to the US and buy a car, and import it into Mexico easily, but this has not been the case, thus creating a lot of disenchantment with “free trade.” The protection given to the distributors’ network has also impacted tourism negatively. American tourists need to get a permit to bring a car beyond the border cities, thus opening the door to arbitrary actions from customs officials, a source of corruption. Even though Mexico has great touristic assets, it has not been living up to its potential because of the protection given to Mexican car distributors. Thus, the protectionism of the distribution network transfers resources from low income families to the car distributors’ network.
Since Mexico has started abandoning import substitution industrialization, it has entered into a new dynamic. There are companies which have focused on the export market (like the maquiladora industry) that have won prices in quality. The maquiladora industry has evolved from simple operations to more complex assembly like cars, TVs, auto parts, computers, and aeronautics.
On the other hand, there are other industries which are not linked to world markets and which are still asking for protection from foreign competition.
Mexican agriculture has evolved to become an exporter of agricultural goods that 20 years ago were not known in Mexican markets. Mexico has become an exporter of berries, eggplants, cucumbers, leeks, peppers, and asparagus to the US and the world. Mexico is also a top exporter of tequila. But there is still a part of agriculture that is not mechanized, that does not export and that has low productivity levels.
The mining sector is also a mixed bag. There are some states that are friendly to mining and appreciate the benefits of this sector. Regulations have been streamlined and have increased investment. Mexico has attracted substantial mining investment, although still below its potential. On the other hand, in other states there is distrust and harassment by radical groups trying to make money with frivolous accusations and inflammatory declarations against (mostly Canadian) mining companies.
Opening a business in Mexico has become relatively easier in recent years, but there is still much room for improvement: administrative requirements, bureaucracy costs, extra payments, and favoritism are still a challenge.
Another challenge for Mexico is the respect for contracts and legitimately acquired property. It can take a lot of time and effort to get a contract enforced in the court system. Property registration has not been very efficient, which opens the door to multiple claims on the same property.
The union system is still a drag on competitiveness as well. There is no democracy in unions: If the company is unionized, new workers have to belong to the union. Membership dues are discounted automatically from paychecks and given to the union. The unions have not actually been helping Mexican workers, but they have been a source of enrichment for union leaders.
In the maquila industry, the unions are not so powerful, given the high turnover rate. In the public sector, though, the unions create rigidities. In the education system, there is no line between the Ministry of Education and the teachers union. The unions distribute jobs in education, thus creating barriers to the best-educated who are not connected with the union bosses.
The level of English language skills of Mexicans is very deficient even though the country is close to the US, and the unions have not allowed competent US teachers to teach in Mexico’s public schools.
The unions in the state-owned oil and electricity companies have been a source of corruption, nepotism, selling jobs, and exchange of favours.
In 2013, Mexico passed laws that will open the hydrocarbons and electricity sectors to foreign and local private investment. This is a revolutionary change. In the 1930s, Lazaro Cardenas expropriated the oil and gas. The expropriation had serious consequences for the legal system: Cardenas appointed judges who agreed with his policy, thus weakening the independent judiciary. Even with the expropriation, foreign direct investment was not forbidden; foreign companies could still associate themselves with Pemex, the national oil company.
However, the greatest blow came in the 1960s with the Lopez Mateos administration. During its term, FDI in the oil sector was completely forbidden. The expropriation and lack of competition created corruption at unprecedented levels, and the oil union became so powerful that even the jobs at Pemex were sold. During the 1990s, as demand for gasoline increased and new cars required higher quality gasoline, Pemex associated with Shell to open a refinery in Houston in order to refine Mexican crude there to satisfy Mexican demand. That was the biggest irony: Mexico sought energy independence with a nationalist rhetoric, and in fact it became more dependent on partners abroad. The same thing with natural gas: Mexico has huge reserves in the north, but it had to import gas from the US to satisfy demand, with a price 3 or more times higher than in the US. Oil production has been decreasing in the last decade: Without new discoveries, Mexico would have been a net importer of crude oil in a few years.
During his presidency, Felipe Calderon tried to open up the country to FDI, but he achieved only very moderate change. Congress approved service contracts with Pemex, but that did not attract a lot of investment given that during companies could not benefit from the rise in oil prices when it occurred.
Foreign companies will soon be able to partner with Pemex under profit-sharing contracts. This will increase exploration in the deep waters of the Gulf of Mexico and in places in the impoverished south like Chiapas. In the medium and long run, it will increase production and reserves.
A great opportunity is the shale gas reserves which are located mostly in the north of Mexico, in the region from Ciudad Juarez to Ojinaga in the state of Chihuahua. Other concerned regions are in Coahuila, Nuevo Leon, Tamaulipas, and Veracruz. It is a great opportunity to transform marginalized regions into more prosperous ones. It will provide revenue for farmers in the form of access fees. The cost of energy will decrease for households and enterprises, and the costs of electricity and of refining will be impacted.
The only danger is that various groups are disseminating hysterical information about fracking in an attempt to scare the public. If they win the media battle, they can create paralysis and a race to the bottom, and no politician will be willing to defend shale gas. One group, El Barzon, that in the past used to harass Canadian mining companies, has now started a virulent campaign against fracking. Environmental consulting and law firms stand to benefit from creating a litigious environment in the shale gas industry. Gas companies, and society in general, have to wake up and realize the economic benefits of shale gas before the radical groups win the media battle like they did it in Quebec.
As for the electricity market, in the late 1800s, foreign companies started building hydropower in Mexico. One of the most important hydro projects was the Boquilla dam in northern Mexico, built with Canadian capital. During the time of import substitution industrialization, there was wave of economic nationalism. Electricity generation companies were nationalized in 1960s, which ended the tradition of building hydro power. After the 1960s, the government company started building thermoelectric plants which used coal and oil as fuel, thus creating more pollution. During the past 20 years, electricity demand has exceeded supply, but the government could not build new generations plants due to budget constraints. There were efforts to open up the electricity sector to foreign investment, but they were blocked for ideological reasons. Fortunately, after many years of impasse, the Mexican Congress approved a reform that opened up the electricity sector to foreign companies. Now foreign companies will be able to produce electricity and sell it in bulk to the national electricity company.
Even before the Congress authorized foreign direct investment in electricity, there was a silent revolution in electricity generation, by wind energy. There are wind farms in the states of Nuevo Leon, Tamaulipas, Jalisco, Oaxaca, Chiapas, and Baja California. Some of the companies present are Iberdrola, Fenosa, and mining companies like Penoles and Grupo Mexico.
Even though Mexico has competitive problems and inequality issues, the recent reforms in electricity and hydrocarbons will have a positive impact in the economy as a whole. It will decrease the price of inputs for industry, agriculture, and households. It will also send a positive message that the Mexican economy is going through a profound transformational period, not a cosmetic one.
* Miguel Ángel Cervantes is a researcher at the Fraser Institute.