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Can NAFTA Change Mexico?

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THE RISKS OF FREE TRADE

Many Mexicans have welcomed NAFTA as an undisguised blessing, whatever its effects on the United States. In the government and among the general population the agreement is seen as a ready course to modernization. President Carlos Salinas de Gortari's policies have consciously supported this impression. His administration has determinedly pursued NAFTA as part of a dual strategy. Economically, the trade agreement was to provide Mexico's ailing economy with the foreign capital injections it has long required for sustainable growth. Politically, an expanding Mexican economy-one linked to the United States-would help lay the foundations for an eventual and controlled democratic transition.

Overlooked, however, has been the fact that NAFTA itself entails great risks. No country has ever attempted to develop an export manufacturing base by opening its borders so quickly and indiscriminately to more efficient and lower-cost producers. No nation today, not even the United States, has so willingly sacrificed an industrial policy or an equivalent form of managed trade. By unilaterally renouncing these advantages, Mexico will lose far more jobs in the next few years than it will create. Old industries and agricultural producers will die, be swallowed up or join with foreign ventures, long before the new jobs arrive.

Mexico is not a modern country. True, over the past half-century it has witnessed dramatic change. An inward-looking, illiterate and agrarian land has become an urban, partly industrialized nation with a growing middle class and a nascent civil society. But Mexico's underlying problems persist. It retains a largely corrupt and unchallenged state that possesses only the merest trappings of the rule of law. The enduring obstacles to Mexico's modernization-its repeated failure to transfer power democratically or to remedy the ancestral injustice of its society-remain and will require Mexico to continue to change itself, with or without a trade accord.

Any Mexican government's performance, as well as the virtues of a new relationship with the United States, must be measured against this background. Under certain conditions, NAFTA provides an opportunity to build a more prosperous, democratic and equitable nation. But NAFTA alone will not modernize Mexico. In the short term especially, the accord as it stands may only exacerbate the country's already stark disparities and dislocations. Rather than speeding and facilitating Mexico's long-awaited and much-hoped-for democratic transition, the near-term effect may be to slow the momentum for political reform. This must not happen.

WAITING FOR DEMOCRACY

Whatever political advances may have occurred under President Salinas, Mexico has yet to devise a system to transfer power democratically. The 1994 presidential succession promises to be as traditional a ritual as ever. The outgoing president will choose his successor, and then do everything necessary at the polls to secure his election. This system worked adequately for more than a half-century. But it dealt only with half the problem of modern government-order-leaving the other half-democratic representation-unresolved.

This quasi-magical procedure functioned properly only so long as everyone accepted its rules. But by the mid-1980s parts of the political establishment began to wonder whether they might not do better outside the system. In the 1988 election former Governor Cuauhtémoc Cárdenas, son of Mexico's most revered president this century, and former Institutional Revolutionary Party Chairman Porfiro Muñoz Ledo broke with the PRI and ran for office on their own, faring much better than they would have otherwise. Muñoz Ledo was elected senator for Mexico City, and Cárdenas, in the opinion of many Mexicans, won the presidency.

Since then, despite two electoral reform laws under Salinas, Mexico's democratic transition has not come to pass. The opposition and Mexicans generally, according to polls, believe that the 1994 elections will again be a sham. The umbilical cord between party and government has not been severed. This was demonstrated by the "shakedown dinner" at which the PRI, in the presence of President Salinas, attempted to extract campaign contributions of $25 million each from 30 of Mexico's richest business leaders. But this time, the PRI's central problem of appointing a candidate and securing the election and accession of a new president will be further aggravated by Mexico's economic doldrums and social deterioration. Salinas seems unable to satisfy either of the two desires of his middle class constituency: a democratic and orderly transfer of power and a growing economy with low inflation and a stable exchange rate. The only solution, as Carlos Ramírez, the most widely read columnist in Mexico, has put it, lies in the de facto exclusion of the presidency from the electoral arena, ensuring that, come what may, the next president will be the PRI candidate.

Part of the problem is that Mexico's opposition has yet to become a viable alternative to the status quo. The National Action Party (PAN) lacks strong national leadership and a nationwide presence; Cárdenas and his Party of the Democratic Revolution are still perceived as too radical, divided and inexperienced to take office. Yet both probably maintain sufficient strength to prevent the PRI from tampering with next year's election without incurring exorbitant costs. Thus, in addition to winning the election more or less cleanly, the PRI candidate will also have to convince his rivals of their defeat and his victory. Mexican politicians and pundits across the spectrum believe that the 1988 crisis must not be repeated. It would be terribly costly to carry into office another PRI candidate whose victory at the polls was disputed by adversaries representing half the electorate.

The need to manage a difficult succession makes a political solution more likely. Instead of emphasizing continuity in economic policy, Salinas will more likely choose a successor who can both win and persuade the opposition he won. Manuel Camacho, the mayor of Mexico City, and Luis Donaldo Colosio, the Minister of Social Development, look best placed to accomplish this task, although Finance Minister Pedro Aspe and Education Minister Ernesto Zedillo cannot be overlooked. The appointment of either Camacho or Colosio would enhance the possibility of what many are calling for privately: a pact among the PRI, PAN and Cárdenas to set ground rules for the campaign, the election itself and some sort of post-election national reconciliation. Camacho best understands the need for such an arrangement, but has aroused suspicions among the business community that he is a closet populist who places negotiation above a firm hand. Colosio, meanwhile, is experiencing difficulties in gaining national support.

While the PAN seems to pose no serious challenge in the presidential race, Cárdenas' situation is more complex. Conventional wisdom holds that he has squandered the popular support garnered in 1988 but that he will still fare better than the nine percent his party obtained in the 1991 midterm elections. Polls give him strong recognition ratings-over 60 percent-higher than any other contender. But he also has high negatives. A poll for the daily Excelsior showed 35 percent of those questioned felt Cárdenas should run again, while 44 percent said he should not.

Cárdenas' fate will ultimately be determined by the state of the economy, the extent of social inequities and the eventual divisions within the PRI. Also critical will be his ability to focus the campaign on his strong suits-democratization, social justice and the fight against corruption-and at least to neutralize his weaknesses-the lack of a detailed economic alternative and the fear that he represents instability.

MEXICO'S FLAGGING ECONOMY

Mexico's lacerating social and economic inequality stems partly from the antidemocratic nature of its politics. High levels of postwar economic growth, progress in education and health, and the emergence of a significant middle class have not remedied Mexico's atrociously lopsided income distribution. If 40 years of growth did not help, then a decade of economic stagnation in the 1980s only made matters worse. A recently published survey found that the richest ten percent of Mexicans, those who earned 32.8 percent of national income in 1984, saw their share jump to 37.9 percent by 1989. Conversely, the share of the poorest 40 percent shrank from 14.3 percent to 12.9 percent. The 1990 census, moreover, revealed that 63.2 percent of the nation's inhabitants made no more than twice the minimum wage-$200 per month-while price levels approached those in the United States. The long absence of free elections, of an emancipated labor movement and of the rule of law has helped keep the fruits of any economic expansion in the hands of a minority.

Much of the problem has been Mexico's inability to hurdle an apparently immovable obstacle to its economic growth: the need for substantial foreign capital injections. Since 1972 Mexico has been unable to overcome this external constraint on growth, except during the ephemeral convergence of exceptional circumstances-high oil prices, cheap and abundant lending, wholesale privatization or high yields in the stock market. The costs of attracting foreign capital-higher interest rates and reduced domestic spending-have become a severe burden and have engendered boom-bust cycles in the economy. Either the economy does not grow or, if it does, immense current account deficits spring up, requiring equivalent magnitudes of capital to finance them. The outcome of each cycle has been a currency devaluation, like those in 1976, 1982 and 1987, or an economic downturn with equally devastating consequences.

The Salinas administration sought to break these frustrating cycles and to achieve high growth-five to six percent a year-with a moderate external imbalance. Trade liberalization, privatizations and reduced restrictions on foreign investment were means to this end. After an initial, prudent economic expansion, however, the trade balance began to deteriorate drastically, rising from $4.3 billion in 1990 to more than $20 billion in 1992. Imports have risen by approximately 25 percent annually since 1988. At the same time, exports have stagnated, growing less than one percent in 1991 and 1.5 percent in 1992. This imbalance was made largely inevitable by the rapid opening to foreign trade, an appreciating real exchange rate and the remarkable propensity of the Mexican middle class to consume imported goods. By 1992 the overall current account deficit had reached $23 billion, or seven percent of GDP-Mexico's highest level ever.

Consequently, the Salinas administration was forced to throw the economy into a virtual recession, as the foreign capital imbalance prevented faster growth. After expanding in 1990 at 4.5 percent, economic growth slowed to 3.5 percent in 1991 and 2.6 percent in 1992. Government figures forecast slightly lower levels for both 1993 and 1994. Mexico's per-capita growth has thus once again fallen dangerously close to zero.

Moreover, Salinas was forced to make a series of bold moves to attract enough foreign capital to finance even these reduced and more realistic growth rates. He thus pursued a free trade agreement with the United States, the privatization of the Mexican banking system and a policy of encouraging powerful local investors to transform the Mexico City stock exchange, or Bolsa, into a magnet for money from abroad. These steps paid off. There has not been, and probably will not be, a major devaluation of the currency, and Mexico has built up an unprecedented $20 billion of reserves.

But there were costs. Yields on the Bolsa had to stay astronomically high (over 60 percent in dollars in 1991), and when they declined or stagnated, as they have since mid-1992, interest rate differentials between the United States and Mexico had to rise to stabilize portfolio or speculative investment (estimated at approximately 70 percent of the total). Direct foreign investment remains dismally low, as in the 1980s, ranging from 1.5 percent to 1.8 percent of GDP. And overall investment, despite the unprecedented inflow of funds, has not budged, remaining at a disappointing 19 percent of GDP. The dire need for foreign capital drove domestic real interest rates to nearly 15 percent in dollars by mid-1993; lending rates reached 30 percent. Besides, the capital these moves attracted was not ideal. Two-thirds was speculative, and the rest was concentrated not in the creation of new wealth but in services, largely tourism, and in foreign purchases of existing Mexican assets.

In the end, the course Salinas set is more responsible than that of his predecessors, but it still has not achieved the long-sought goal of high growth combined with manageable external accounts. The economic downturn, together with the effects of the previous decade of stagnation, has contributed to rising unemployment and social decay. Manufacturing employment, flat even while the economy was growing, has now fallen: in an index in which the year 1980 equaled 100, it never rose above 87 under Salinas, and by early 1993 it was down to nearly 80. By 1993 tens of thousands of factory workers, bank employees and retail store clerks had lost their jobs. Although a number of new jobs have been created, many more have been lost as a result of the economic downturn and the growing, and so far irresistible, competition from abroad.

Many in the United States nonetheless believe that economic integration and NAFTA have moved jobs on a "fast track" to a modernizing Mexico. In fact, the country's disparities are deepening. Ever more dispossessed accompany the growing number of Mexican "yuppies." The loud "sucking noise" of American jobs going south that U.S. presidential candidate Ross Perot ominously announced last fall is, from the Mexican side of the border, singularly difficult to hear.

IS NAFTA THE ANSWER?

The Salinas regime's strategy in the face of these myriad economic and political difficulties was simple and singleminded: free trade with the United States. To hold a clean election and at the same time to secure the victory of Salinas' hand-picked candidate, the economy had to deliver high growth and create near the million jobs per year necessary to absorb population increases and facilitate social spending.

The only way to attract the foreign capital necessary to stabilize the exchange rate and to fund the ensuing current account deficit was to provide hesitant potential investors with guarantees of continuity of economic policy and access to the U.S. market through an ironclad agreement with Washington. NAFTA, it was hoped, would satisfy both requirements. The sustained economic growth generated by NAFTA would narrow income differentials by creating jobs. President Salinas' antipoverty program, known as Solidaridad, would ease the transition from past stagnation to NAFTA-fueled high growth. As the fruits of growth trickled down and discontent no longer threatened economic policy, Mexico would gradually evolve into a democracy.

More than a complement to the modernization policies embarked upon since 1985, NAFTA was seen as a silver bullet to neutralize the obstacles those policies engendered. When more capital than expected was needed and greater reluctance to invest was encountered, NAFTA would make up the difference. It would also relieve pressure from abroad to accelerate political reform, as U.S. supporters of NAFTA toned down their criticisms of human rights violations and electoral fraud in Mexico to avoid imperiling free trade. Investment from abroad would enable the economy to grow while introducing new technology and greater efficiency and modernizing Mexican society. Most Mexicans' traditional identification of modernity with the United States would be reinforced; their traditional resentment of the United States over past injuries and present asymmetries would be softened.

While it was hoped that NAFTA would address many of these problems, it has not defused the end-of-term crisis that Mexico's succession process has traditionally generated. Granted, the government's expectations, however inaccurate or overblown, touched a receptive chord among large sectors of the population. Polls repeatedly indicate strong support for NAFTA, as well as unfounded reasons for it: a recent survey found that 45.8 percent of those interviewed believed NAFTA would make it easier for Mexicans to get jobs in the United States. Similarly, it has created illusions in the United States that it would help stem Mexican immigration. Most immigration scholars in both countries expect NAFTA and the economic policies it will encourage in Mexico to stimulate migratory flows in the short run, as displaced peasants and laid-off employees take advantage of large wage differentials and head north.

But the dichotomy between the short and long term runs through the debate on NAFTA's advantages and drawbacks. Economic integration between the United States and Mexico, already under way for years, is surely better served by a legal framework to rationalize and administer it. And Mexican economic development and living standards-if not national autonomy or cultural identity-will benefit in the long run from more investment and trade with the United States. The problem lies in the interim: How will the adjustment costs of NAFTA be distributed among the three partners and among different regions and sectors of the population within each country? How should the agreement address these questions?

NAFTA either ignores these problems or leaves their solution to the market. The trade pact presupposes that the amount of money needed to bring together economies and societies as distinct as Mexico, the United States and Canada is not overwhelming and that market forces alone will provide it. In fact the United States will have to retrain tens of thousands of workers and cushion the shock to innumerable communities and factories. Canada is already losing jobs and markets, while Mexico confronts its balance-of-payments difficulties. The three countries will also have to tackle environmental problems and infrastructure deficiencies, along the border and inside Mexico, together with major regional disruptions and a costly process of harmonization.

NAFTA'S HIDDEN COSTS

As the Europeans have learned, bringing together advanced and backward economies is an expensive proposition. Since the disparities between Mexico and its neighbors are greater than any comparable differences in Western Europe, odds are that the North American experience will be more costly. The three governments hope whatever must be done will be accomplished by private investment: low wages and solid business opportunities will attract private capital to Mexico, paying for infrastructure, environmental cleanup, the trade gap and debt service. But private money is unlikely to prove sufficient; nor will it flow to Mexico as freely as expected. For now NAFTA incorporates no contingency provision-no special funds and no special taxes.

Moreover, Mexico's regulatory situation was largely excluded from NAFTA, with the exception of those areas where strong American interests are involved: foreign investment, intellectual property and the textile industry. But if Mexico profoundly differs from its neighbors in any way besides overall wealth, it is in the absence of the rule of law and the regulatory framework that characterize developed market economies. The Mexican judicial branch is totally subservient to the executive; regulatory agencies have no independence whatsoever; corruption is egregious. By omitting both supranational mechanisms for enforcement of norms and rights-on the environment, labor, consumer protection, due process-and any demand for the overhaul of Mexico's political and legal system, NAFTA's signatories ignored a fundamental facet of the Mexican reality.

Finally, NAFTA does not address the issue of whether Mexico has-or should have-the same type of market economy as that espoused by United States. Is Mexico more like the United States, where nearly everything is left to the private sector and the relatively free workings of the market? Or are Mexican traditions closer to those of the European social market economy model, with greater emphasis on state involvement and more stringent regulations and constraints on the market? Will NAFTA be an association of like-minded partners, like Europe before Britain joined, or will Mexico always play the role of former British Prime Minister Margaret Thatcher, defending seemingly eccentric customs and preferences? In the initial euphoria of negotiations, these matters were all shunted aside, dismissed as irrelevant or to be taken up at a later time. That time may have suddenly arrived.

NAFTA NEEDS REFORM

In the same way that the Clinton administration decided that a series of so-called supplemental agreements would serve U.S. interests, a number of changes would render NAFTA far more beneficial to Mexico as well. Various proposals have been placed on the table to transfer resources from NAFTA-winners to NAFTA-losers: border transaction taxes, a windfall profit tax, a North American development bank, a European-style regional fund scheme and a deeper reduction in Mexico's debt, among others.

These proposals are viable because their proponents come from the two wealthier nations, who would have to foot most of the bill. Moving forward with NAFTA without provisions along these lines would mean missing an excellent opportunity to attack the key obstacle to Mexico's development. A long-term program, including social conditionality and accountability-whereby local authorities and nongovernmental organizations receive and supervise part of the funding-would work wonders for Mexico's balance of payments, the reconstruction of infrastructure and the redistribution of resources.

NAFTA should also be designed to contribute to political change in Mexico. It should only go into effect with a preamble like that issued in 1978 by the European Community at the start of negotiations to include Spain, Portugal and Greece: "The heads of state and government solemnly declare that respect for and maintenance of representative democracy and human rights in each member state are essential elements of the European communities." The application of the European precedent would entail a crucial test: submitting Mexico's August 1994 presidential elections to international monitoring by the United Nations and the Organization of American States. U.S. or Canadian congressional certification of the elections should be explicitly excluded; the multilateral nature of the exercise should be firmly proclaimed.

Support exists in Mexico for the idea. PAN has often called for international observers, and grass-roots groups have invited contingents from abroad. Cárdenas met with former President Jimmy Carter in May to explore the possibility of Carter's participation in Mexican election monitoring. Ratification of NAFTA and its entry into law could be postponed until the elections, as may occur anyway. Or NAFTA could be ratified, but its entry into law conditioned on free, fair and internationally monitored elections in 1994.

Finally, there is a necessary social facet to the new U.S.-Mexican relationship. Money of the right sort will not flow to Mexico in adequate volumes, nor can it be put to good use, unless a series of deep changes are carried out in social policy and structure. These policy changes must extend to unions and the environment and include efforts to reduce income disparities through tax reform and higher social spending, as well as measures to strengthen civil society. These are the famously debated labor and environmental chapters of NAFTA-side agreements with teeth, that is, commissions independent from the three governments with the resources and power to impose sanctions.

Beyond the side agreements, though, the bilateral relationship must empower Mexican society to achieve its own aims and fight its own battles. Mexico's social inequities can only be redressed through major efforts in education, health, housing and combating poverty. This enterprise, in turn, can only be achieved through significant tax reform. Other than improvements in collection, little has been achieved on this score; the adjustment in Mexican public finances over the past decade occurred entirely on the spending side. According to the Organization for Economic Cooperation and Development, total tax revenues over GDP stagnated from 1980 (17 percent) through 1991 (16.8 percent), remaining at a level well below not only that of Europe and the United States but also that of most successful developing nations.

There are, of course, other additions to the trade pact that would be beneficial to Mexico, such as beginning immigration negotiations on temporary domestic service workers. And there are issues of concern to the United States--and to many Mexicans-that can be partially approached through democratization: the authentic establishment of the rule of law, improved drug enforcement and an end to corruption.

CHANGE WITH OR WITHOUT NAFTA

The question in the final analysis is whether a free trade agreement without these improvements is still in both countries' interests and, conversely, what consequences NAFTA's rejection or postponement would have for Mexico. As with the rest of the NAFTA debate, hyperbole has contaminated the discussion of what these options would imply: a collapse of the Mexican economy, a reversal of the structural reforms, a run on the currency, a dramatic drying up of investment, a deep-rooted nationalist backlash.

Except for short-term pressure on the peso-manageable in many ways, including the Federal Reserve's intervention in exchange markets-should the agreement not be approved by the U.S. Congress by January 1, 1994, these catastrophic scenarios are unlikely. They are mainly a scare tactic to expedite passage. The Mexican economy is already in recession. Adopting NAFTA on time might set off a rush of short-term financing, but raising the long-term volume of direct foreign investment is an arduous task, especially given the global economic slowdown. The economic reforms undertaken in Mexico over the past few years were largely inevitable; with logical, and necessary, rectifications and adjustments, they are here to stay.

NAFTA's rejection would lead to a nationalist backlash only if the Mexican people felt strongly enough about it. But while polls show they support NAFTA, Mexicans are increasingly skeptical and vastly uninformed about the accord. Undoubtedly, some would engage in "gringo-bashing," but outside the immediate circle surrounding Salinas and the largest Mexican conglomerates, NAFTA's postponement may be either regretted or hailed but would not mean the end of the world.

Indeed, the most severe consequences of postponement may well be political. President Salinas bet the store on NAFTA, and if passage is his triumph, rejection or delay is his defeat. There was no need to frame the issue in those terms, but now that Salinas has, damage to his prestige and power may be unavoidable. That this complicates the succession is beyond dispute, although it is already clear that Salinas will have to choose the PRI candidate without knowing the outcome of the NAFTA debate. It is equally evident that quick approval of NAFTA would strengthen Salinas' hand in the succession; its postponement or rejection would weaken him. But whether it would weaken Mexico is highly dubious.

The broader issue is which process for transferring power will help to address Mexico's deep-rooted dilemmas. The case has been made that the most desirable outcome can, under present conditions, only be secured through the traditional authoritarian process; a NAFTA-induced crisis would favor supposed "nationalist-populist" options, either within the PRI itself or in the Cárdenas camp. But others argue, more persuasively, that if postponement of NAFTA forced an opening of the political system and a clean election in 1994, the process itself would guarantee the outcome: whoever was elected-even a closet populist from the PRI, Cárdenas or an inexperienced PAN candidate-would have to govern in the center, because that is where the votes are. Instead of the perfect outcome resulting from an increasingly unstable process, a reformed democratic process would ensure an acceptable outcome for everyone.

In the end, this is the central issue Mexicans and their neighbors to the north must face. The country has enjoyed unparalleled stability for more than seventy years, but the levers and gears that maintained it are worn out. There are two risks to choose from: sticking with the old system until it breaks down, seriously and irreparably; or taking the leap into a new system, knowing full well that both the transition period and the new order itself will not be free of dangers. Had everything neatly fallen into place-the economy buzzing along at six percent, jobs and social spending up, corruption and drugs under control, NAFTA approved on time and with minimal damage-a painless and risk-free, gradual and perfectly managed transition might have been feasible. But in the real world, everything does not always break the right way; many of the things that could have gone wrong did. In view of the options, the best choice for Mexico is evident: change at last. It is not without perils, but it offers the chance of finally making Mexico the country its people have always deserved, and never possessed.

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