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special issue: federations and the economic crisis
Mexico tries new remedies for downturn
In addition to infrastructure and stimulus spending, Mexico considers a flat tax
REUTERS/Ho New
Mexico’s President Felipe Calderon is seen on two screens as he announces a new 2009 economic stimulus package in Mexico City. Calderon unveiled sweeping cuts to energy prices to soothe the impact of the global economic crisis on consumers and businesses.
By Armando Chacón
To combat the economic crisis, Mexico has to deal with a depressed global market for its exports as well as significant reductions in direct investment, financial resources and remittances from Mexicans living abroad. According to Guillermo Ortiz, governor of the Bank of Mexico, “Mexico will be the most severely hit country in Latin America.”
Mexico did not take part to any significant extent in the risky financial investments that kicked off the crisis in the United States and Europe. But it has to deal with the after-effects of the financial crisis that caused other countries’ economies to shrink and resulted in foreign investors pulling their capital out of Mexico and elsewhere.
However, unlike in other recent crises, there will be no international financial institutions standing in line to offer Mexico a bailout in exchange for fundamental reforms. The Organization for Economic Co-operation and Development (OECD) warns that the support Mexico will receive from abroad will not offset the losses suffered by the Mexican economy. Once the crisis starts to ease, Mexico will be facing a very different reality.
The only possible outcome of this crisis, given the net-worth losses suffered by American families, companies and the government, is a noticeable long-term reduction in consumption and indebtedness. This, of course, will have a significant negative effect on the Mexican economy.
The result of this is likely to be a dwindling demand for all categories of consumer goods, especially exports to the United States. Since the North American Free Trade Agreement (NAFTA) was signed, the share of Mexico’s international trade has risen from 25 per cent of GDP to around 60 per cent in 2008. Exports to the United States, mostly durable goods such as automobiles and appliances, account for 80 percent of the total.
Mexican government responds
By the end of the second quarter, Mexican exports shrank by 30 per cent of GDP. According to Grupo de Economistas y Asociados (GEA), on the basis of data from the Federal Reserve Bank of Saint Louis, sectors such as assembly and manufacturing of cars, trucks, household appliances and airplanes are expected to take more than a decade to return to 2008 levels and they may take longer if the economic recovery is slower than forecast.
In spite of the appeal to avoid the undesired effects of the crisis by bailing out companies in distress, it is critical to determine if this is possible and at what cost. After the understandable initial drive to save companies, the argument that some are “too big to fail” is losing strength as soon it becomes clear that bailouts are a costly proposition. After each bailout, the policy makers face a harder time selling the idea of a new one to the public. Mexicans are growing increasingly reluctant to collectively cover the losses incurred by questionable actions of individual companies and executives.
The case of General Motors is a good example of this drop in public support for bailing out companies. In late March, a Presidential Commission reviewing the case began casting doubt on the likelihood and the merits of such continued support from the public purse.
The Mexican government has won some praise for its management of the economic crisis. According to Ángel Gurría, secretary-general of the OECD, “Mexico did what it had to do and it did it well. Maintaining balanced budgets, it made good use of oil surpluses and distributed them among states and municipalities.” Gurria went on to warn, however, about the urgent need to implement fundamental reforms that would pave the way for private sector investments which have so far been constrained by legislation when they are needed most.
Stimulus outcome uncertain
During the last seven months, the federal government committed around US$ 27 billion to counter-cyclical stimulus measures. Around 80 per cent of that amount has been earmarked to support investment in infrastructure. The rest has been distributed to small and medium-sized businesses, development banks, mass transportation projects, lines of credit to the automobile industry and employment-support programs. The major recipients of this aid were listed in the bill approved by Congress. While the success of this measure to provide the desired economic stimulus is uncertain, the effect on the budget is clear.
While the effectiveness of the measures to offset the prolonged contraction is questionable, economic performance figures for the first quarter of 2009 are not very promising. The GDP growth rate fell by 9.3 per cent during the first six months of 2009, as opposed to a positive growth rate of two per cent for all of 2008. During the first quarter, Mexico’s GDP fell by 8.2 per cent. In the second quarter, it fell by 10.4 percent, reflecting the effects of the outbreak of the H1N1 influenza pandemic, which stagnated tourism and services by up to 90 per cent – an estimated cost of more than half a percentage point of the GDP.
In addition, counter-cyclical stimulus initiatives face the pressing limits of deteriorated public finances. In the first quarter of 2009, tax revenues fell by approximately 9.5 per cent coupled with a decline both in production and in oil export prices. Also in the first quarter, public spending increased by approximately 24 per cent as a result of the stimulus measures and plans to advance public security and combat drug trafficking. The Treasury initially announced a budget “gap” of around US$ 300 billion for 2009. Later assessments doubled that gap.
Resources depleted
So far, Mexico’s states have not suffered from a reduction in federal revenues thanks to the federal government’s oil stabilization fund and contingency provisions in the federal revenue sharing mechanisms. However, these resources have run out and the impact on local budgets is imminent. The central government does not have the resources to increase its funding to the states. And the tax base of the states is limited to property taxes and a few other small taxes, such as hotel and motor vehicle taxes. This leaves the states with little else but to improve efficiency or implement austerity measures in their budgets.
In spite of its great impact on Mexico’s economy, the crisis does not alter the fundamentals of the country’s agenda for change. It simply makes change much more urgent. In this sense, the priority must be to attract investments and maintain fiscal balance to guarantee macroeconomic stability.
In the face of the budget crisis, the debate about the need to increase tax revenues is gaining momentum. However, trying to close the fiscal gap by raising business and personal tax rates would be a disincentive to investment at the worst possible time. So the goal is to increase the total amount of taxes collected without increasing the tax rates. Given the polarization that has resulted in railing against the elimination of exemptions and preferential regimes built into the value-added tax, there are few alternatives left. One of the most promising is expediting the ongoing transition from the current income tax towards a full-fledged flat tax. Moving forward on this, now that some initial concerns about implementation have been resolved, could bring about a major stimulus by reducing the tax rate and allowing instant depreciation of all investments in assets and inventory.
Foreign investment falls
In 2008, direct foreign investment fell from the previous year’s level by 20 per cent and an even sharper fall is expected in 2009. Apart from setting up a more competitive tax system, it is crucial that regulations allow opportunities that are presently closed to national or foreign investment. The legal possibilities for some types of investments opened by the recent energy reform must be leveraged. To that end, legislation should be passed and regulatory decrees issued to generate favourable conditions and attract potential investors.
It is also essential to lift barriers to competition and investment in key sectors. Foreign investment in the operation of telecommunications networks and the authorization of correspondent banks that foster competition and penetration of banking services in certain sectors and geographic areas are issues still in the pipeline of Congress.
“Despite its big network of trade agreements, Mexico’s international trade still faces significant barriers given the complexity of the tariff system,” said Mexico’s Secretary of the Economy, Gerardo Ruiz. The simplification and unilateral reduction of tariffs is a priority for Mexico to recover its appeal as an investment market with a freer flow of inputs and finished products from a more diversified portfolio of countries. The prospect of an appreciation of the Chinese Yuan coupled with a weak Mexican Peso bring about sizable opportunities for Mexican exports if trade policy lives up to the challenge of a more open and efficient border. 
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