Home Mail Articles Stats/current Supplements Subscriptions Links


The following article appeared in Left Business Observer #68, March 1995. It was written by Doug Henwood, editor and publisher. It retains its copyright and may not be reprinted or redistributed in any form - print, electronic, facsimile, anything - without the permission of LBO.


The Contract with Mexico

It's a good thing that Mexico's economy is so fundamentally sound, otherwise the present bailout would probably cost $100 billion or more, instead of only 50.

Mexico is not fundamentally sound, of course, but saying so is a requirement for renewal of punditry licenses. And that's by a very conventional definition of soundness. With low growth rates and real investment such a low share of GDP, Mexico's profile resembles a sclerotic rich country more than it does one in the early or middle stages of hyperdevelopment. Instead of enjoying the boom that was promised after the years of harsh "adjustment" - endless rounds of austerity and debt restructurings that culminated in the North American Free Trade Agreement (NAFTA) - Mexico faces another deep recession, and Mexicans face a real income cut of up to 40% over the next year, after the halving of real incomes in the 1980s.

Despite some recovery from the late 1980s, real (inflation-adjusted) per capita GDP is still 9% below 1981's peak, and real per capita investment 28% lower. The 1995 crisis promises to knock both these figures for a loop. This is not what booms, even orthodox booms that can leave the ordinary population in the dust, look like.

The contrast with countries that really are booming is sharp. As was pointed out in LBO #64, while in South Korea, investment levels were approaching 35% of GDP, well up from the 1970s, Mexico's were hovering just above 20%, below the level of the 1970s. That's ignoring the fact that Mexican income distribution is far more unequal than Korea's (the richest fifth of Mexicans claim almost 14 times as much income as the poorest fifth; in Korea, the figure is "only" six times; the U.S. falls about midway between these two countries).

Despite this fundamental weakness, investors came to believe their own propaganda about Mexico's fundamental soundness. Hot to catch a piece of the next economic miracle, plungers poured $85 billion into Mexico from 1991 through mid-1994, almost 80% of it in the form of portfolio investment (paper assets like stocks and bonds), and only 20% in the form of direct investment (real things). The surprise isn't that the bubble burst, but that it swelled to such sublime proportions.

The disaster is rich with political ironies. Ernesto Zedillo was elected by voters who weren't deeply fond of his platform or party, but thought he represented stability. The opposition leftish candidate, Cuauhtémoc Cárdenas, made some weakly appealing sounds - cautiously critical of free trade, fiscal orthodoxy, and the corrupt and undemocratic political culture of the PRI - but a vote for him was a lurch into the unknown. For a country suffering from a dozen years of crisis and austerity, Zedillo represented the comforts of the familiar, of "competence, not ideology," as the incompetent Mike Dukakis once put it. Now of course Zedillo looks utterly incompetent in the face of the country's worst economic crisis since the debt melodrama broke out in 1982, and the worst political crisis since his party took power in 1929.

Six months ago, Mexican economic officials were a dream team, celebrated by journalists, academics, development bankers, and investment bankers alike. Now, they are once again being treated with the contempt typically reserved Third World officials. The former president, Carlos Salinas, was once canonized in U.S. media, so much so that Dow Jones & Co. put him on their board of directors. Now he is humiliated, under suspicion for tolerating (at least) drug trafficking and political assassinations. This produces the delicious irony that when our leading business paper writes about him, sentences like this appear: "Carlos Salinas, who is a board member of Dow Jones & Co., publisher of The Wall Street Journal, hasn't been charged with any wrongdoing." Yet. At least he has the comfort of his rumored billions stashed who knows where, a fortune provided him by grateful cronies who prospered enormously during the bubble.

What happened?

Let's savor the official line for a moment, in the form of the utterances of the Under Secretary of the Treasury for International Affairs - on leave from Salinas' alma mater, Harvard - Lawrence "Africa Is Vastly Underpolluted" Summers. "Ultimately," Summers declared, "it was Mexico's own choices which prompted Mexico's present difficulties." Forget those "optimistic voices in economic and market circles"; forget the repeated seals of approval from the World Bank, the IMF, and the U.S. government. Like our own poor, Mexico's problems are the just the result of some bad life choices.

After several years of receiving the blessings of everyone that mattered, the Mexicans are now bumblers, deaf to wise advice from the north. And the Administration has retrospectively discovered its own prescience, and Mexico's incompetence. In testimony before the House Committee on International Relations, Summers said that "while many commentators and analysts predicted an imminent resumption of capital inflows" after the troubles of early- and mid-1994 interrupted them, "U.S. officials became increasingly concerned. Treasury and Federal Reserve officials at a range of levels warned their Mexican counterparts that Mexican policy could well prove unsustainable. Unfortunately, the Mexicans ignored those warnings" If only they'd told us.

Summers makes the argument of fundamental soundness in devious ways. In Senate Banking Committee testimony, he enthused about how "the dollar value of annual Mexican exports had nearly doubled from 1980 to 1993" - forgetting to mention that they'd nearly tripled between 1960 and 1973, and that they increased nearly 17-fold between 1970 and 1983. Further, Summers kvelled, "real annual GDP growth averaged 3.0% between 1989 and 1994 compared to an average of 0.1% between 1982 and 1988" - comparing the modest recovery of recent years with the worst of the debt crisis, and neglecting to say that growth averaged 7.5% a year in the 1960s and 6.6% in the 1970s, a period Summers et al. dismiss as one of hopelessly backward economic policies.

Summers, as well as his boss Robert Rubin - the former co-chair of Goldman Sachs, which was by far the leading hawker of Mexican securities in the early 1990s - and Fed chair Alan Greenspan, have all made it clear that more than portfolio losses and increased immigration are at stake. Nothing less than the prestige of capitalism is on the line. Summers' rhetoric is truly expansive. "When people talk about this period in history," he told a Brookings Institution audience, "they talk about the capitalist revolution sweeping in the world. They witness a growing awareness worldwide that states cannot direct economic activity, but must rely on private markets and competition to find the way forward. [Bailouts excepted. - Ed.] People will continue to speak with tremendous optimism about this period. They will marvel at how, if this capitalist revolution continues, this will have been the era during which 3 billion people got on a rapid escalator to modernity. When the history books are written that change will rank with the industrial revolution, and with the renaissance, in terms of its significance to human affairs. Because the Mexican model has been so widely watched, and so widely emulated, and is so salient in the minds of investors, what happens in Mexico has implications that go far beyond Mexico, or even Latin America."

Or as the Washington Post put it, reporting on a speech by Summers' boss, "Rubin warned that because Mexico had been regarded as the star pupil of the [sic] free-market economic development, its collapse might have prompted officials throughout the developing world to repudiate the liberal approach U.S. policymakers and academic economists have promoted so zealously for the past two decades." Perish the thought.

As for those carpers who say NAFTA has something to do with the Mexican meltdown, Summers has an answer for them too: "I think the NAFTA critics have the argument precisely backwards. Without NAFTA, Mexico's problems would be much worse, both for Mexico and the United States. NAFTA ensures that Mexico can never again close its borders to American products. NAFTA ensures that Mexico must continue to provide safeguards for our investors. NAFTA bolsters investor confidence, helping to contain Mexico's difficulties. In short, NAFTA is what ultimately will protect the capitalist revolution underway in Mexico."

NAFTA can't be "blamed" for the crisis in the narrow sense; it was part of a broad project of integration of Mexico into the U.S. economy as a sweatshop that needs to export like mad to pay off its debts. Integration only makes sense if Mexican incomes remain a fraction of ours; the fantasy of strong Mexican demand for U.S. products was part of the NAFTA sales pitch, not an economic reality. But Summers couldn't very well say that. Nor could he admit the bolstering of investor confidence was part of the problem.

Coping with windfalls

The problem of how to cope with a surge in capital inflows - a fate that capital-starved countries can't imagine has any harmful side - has preoccupied officialdom recently. The recently published Per Jacobsson Lecture, an annual talk sponsored by a foundation housed at the IMF, by the Spanish banker and economist Guillermo de la Dehesa, is devoted to that very issue. Mexico, data presented in Dehesa's talk shows, was the largest recipient of private capital flows in the Third World, nosing out China, whose economy is almost twice as large as Mexico's, and dwarfing South Korea, an economy of comparable size, by more than two-to-one. All together, the flood of capital into the Third World totaled $380 billion between 1990 and 1993, with almost half of it accounted for by the top 5 countries (Mexico, China, Argentina, Korea, and Indonesia).

It is important, however, to put that flood into perspective. Official estimates of capital flight from the so-called developing world during the 1970s and 1980s are around $300 billion, meaning that the capital flood brought in only a bit more - less, if inflation is taken into account - than was drained from the poorer countries during the decades of heavy borrowing and the resulting debt crisis.

Why would the equivalent of money falling from the sky be a problem? A country that experiences a surge of external investment can find its equilibrium disturbed. An inflow of funds means a sudden demand for assets with no comparable change in supply. This forces up prices in the target country, and can drive up the country's currency as well. This upward pressure on prices can drive up domestic inflation, and the pressure on the currency can price exports out of global markets.

Therefore the monetary and fiscal authorities have to offset the pressures of the inflow by tightening policy. De la Dehesa: "[A]nother efficient response to capital flows shocks is the establishment of factor market flexibility, both for labor and capital. In a situation of equilibrium nominal wages, exchange rate appreciation will result in too high a wage level. Wage flexibility will be needed not only to restore the balance but to avoid any negative impact on employment." This requires translation. Were de la Dehesa's idiom English rather than mumbo-jumbo, these sentences would read: "To respond to capital flows, markets for labor and capital must be minimally regulated, to assure that wages and interest rates adjust quickly to circumstances. If wages are right to begin with (which they probably are, if markets are unregulated), then capital surges can drive them up above desirable levels; therefore, the appropriate response should be policies to drive down wages - to preserve jobs."

Capital outflow? Cut wages to make the country more attractive to investors. Capital inflow? Cut wages to make the country's products more attractive to foreign buyers. A nice symmetry, really. Or, as de la Dehesa concludes, "in a world environment of freedom of capital movements, developing countries will be subject to severe economic discipline by potential investors."

Discipline

The surge into Mexico drove up the peso's value beyond rational levels, so some devaluation was in order. But the moment the devaluation was announced on December 20, panicky capital fled the country. Instead of floating gently southwards, the peso sank like a stone.

Capital began exiting Mexico well before the peso's collapse. The Mexico Fund, a basket of Mexican stocks packaged for trading on the New York Stock Exchange that is an excellent proxy for foreign (mainly U.S.) interest in the country, lost 20% of its value between its January 1994 peak (the first month of the Zapatista revolution) and Zedillio's inauguration. The peso didn't, suggesting that the Bank of Mexico spent its reserves supporting the currency, which is a kind way of saying that the Bank accommodated fleeing investors with overvalued pesos, exchanging dollars for pesos at a rate they must have known was unsustainably wrong. Central banks can be quite generous in a pinch.

In early 1994, as the Mexico Fund was peaking, the central bank had $26 billion in foreign exchange reserves, presumably the residue of the flood of capital into the country. On the eve of the U.S. bailout package, Mexico was down to its last $2 billion in reserves, as good as none, meaning that over $20 billion was squandered maintaining the peso's comforting but falsely high value.

The solution

Clinton, of course, originally tried to get Congress to approve some sort of rescue program, but Congress would have none of it. Instead, he quickly cobbled together an alternative - proving that when money talks, the hell with Congress. The package includes $20 billion from an obscure Treasury entity called the Exchange Stabilization Fund (ESF); $10 billion from European central banks; $17.8 billion from the IMF (more than twice the total it lent all countries in 1994); and $2.5 billion each from the World Bank and the Inter-American Development Bank - some $50 billion, plus a few spare billion here and there from miscellaneous sources like Canada.

As with IMF loans, the full $20 billion in the U.S. portion of the deal will not be disbursed all at once, but in stages (tranches) that will be released only if Mexico meets the required condition of putting its economy through the wringer. The reports required by the U.S. government, stricter than usual IMF practice, include quicker, more detailed, and presumably more accurate reports on basic economic indicators (not entirely unwelcome, since Mexican data has been late, spotty, and of doubtful accuracy). To assure repayment, the Mexican national oil company, Pemex, will be required to tell foreign customers to deposit their payments in a special U.S. bank account, which will be seized by the Federal Reserve Bank of New York and turned over to the U.S. Treasury in the event of default. Pemex will also have to ask Yankee permission to sell oil currently delivered to U.S. customers to non-U.S. buyers. Despite these pledges, it's not clear whether the oil revenues are already pledged, formally or not, to cover other obligations. If oil revenues already pay a significant portion of the country's foreign bills, who loses if these are irrevocably pledged to Washington? But the hidden agenda, collateral aside, is to take a few steps towards the old American dream of appropriating Mexican oil reserves.

Who pays?

Populist agitators have presented the bailout as a gift to Mexico, but it is no gift at all. The scheme is the latest in a series of such packages, the modern prototype of which was the New York City bailout of 1975, extends through the various schemes for handling Third World debt during the 1980s, and is now being applied to the busted city of Washington, D.C. In a nutshell, the packages protect creditors who are facing default by some official entity; the creditors emerge essentially whole, but the debtor is forced to adopt policies highly pleasing to capital, such as budget cuts, the sale of public assets at favorable rates, the extension of tax breaks and other goodies to business interests in the name of economic "development," and often an explicit first claim on some portion of public revenues.

Mexico will pay dearly for its rescue. Fees and interest payments will be high, and terms will get stiffer the more the country draws on Uncle Sam's generosity. Washington will charge Mexico an interest rate of 2.25 to 3.75 percentage points higher than that prevailing on 91-day U.S. Treasury bills, or 8-9.5%, well above the 5.5% the IMF now charges its borrowers.

Any country facing a withdrawal of capital can expect a slump, but Washington has commanded that the Mexican government assure it be a deep one. Government spending will shrink, taxes will be raised (there's no tax cut in the Contract with Mexico), meaning that the country will move towards a budget surplus as the economy collapses. Deficit spending, which has powered the U.S. and other First World economies for years, is verboten to Mexico. The Bank of Mexico will shrink, not merely restrain, the supply of money and credit, even though the domestic banking system is imploding. This is the 100% orthodox approach to economic crisis, and it's a wonder to hear Democrats channeling Andrew Mellon, the 1920s Republican Treasury Secretary whose prescription for the Great Depression, "liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate," stood as the embodiment of old-style stupidity during the liberal-Keynesian era of the 1950s and 1960s. The Democrats, once an occasional vehicle of debtors, are now wholly in creditors' hands.

Mexicans face a deep recession - after a decade of depression and only a weak recovery in the early 1990s. This is extraordinarily bad news for a country where half the population lives under the official poverty line, and a fifth lives in "extreme poverty." During the 1980s, real wages fell by half, and it looks like they could fall 20% or more by the end of this year. It is hard to imagine how Mexico as a society or Mexicans as people can take it. To be kicked in the face only moments after you begin getting off the ground has to be deeply demoralizing.

The consequences for Mexico are already hellish, and will get worse. Some 250,000 jobs have already disappeared in the last three months, with another 500,000 likely to go in the next three, according to official Mexican projections.

NAFTA was supposed to lead to a boom in U.S. exports to Mexico; now, the further impoverishment of Mexico makes that unlikely, and the peso devaluation makes Mexican workers look 50% cheaper to multinational firms than they did last year. That instant cheapening is bad news to both U.S. workers and Caribbean countries, who fear fresh competition from Mexico, especially in textiles and apparel.

A different set of hellish measures is also being taken in order to please foreign investors: the silent murder of thousands of Chiapans. Despite public protestations of peaceful intent, Mexican government forces - led in part by graduates of the U.S. School of the Americas, which has trained a generation of death squads and coup-makers - are surrounding the rebels and their supporters, hoping disease and hunger will do them in silently, making attention-getting bombing runs unnecessary.

Will it work?

The official line is that this is a short-term crisis of confidence and liquidity, and the bailout will kill these two troublesome birds with a single stone. It had better; there just isn't enough money in the package otherwise.

Mexico faces $70-80 billion in interest payments and maturing principal this year, or more than twice Mexico's 1994 exports. Even if every centavo of Mexican export earnings were attached (which leaves aside the question of how essential imports will be paid for), the country would come up at least $35 billion short. Here's the math: $70-80 billion in obligations - a $40-50 billion rescue package + $30-35 billion in exports - $50-something billion in imports = big time insolvency.

The more fundamental questions to a political economist are: how can a country ever achieve some thing like prosperity if its own government is forced to engineer a second bout of depression to please its foreign creditors; how can the social and political structure of Mexico take such an onslaught; and how can Mexicans survive as human beings with their world crashing down around them? But this is just the kind of carping that Larry Summers would dismiss out of hand. Everything must be sacrificed to preserve the value of money and the beauty of the economic model. As Summers himself once said in his infamous World Bank memo that advised the dumping of toxic waste in poor countries - because they're poor, they have so much less to lose than do the overprivileged - the logic is impeccable.


Home Mail Articles Stats/current Supplements Subscriptions Links