Mexico and Nafta

Mexico's decision to let the peso plummet about 30 percent this week roiled bond and stock markets and hurt Mexico's credibility with international investors.

Critics of Nafta, the free-trade accord between the U.S., Mexico and Canada, chimed in with the proposition that the peso's fall would turn bilateral trade against the U.S., thereby vindicating their opposition to open trade.

Much of the criticism is unwarranted. President Ernesto Zedillo, who took office only three weeks ago, had little choice; as foreign reserves dwindled, he could no longer afford to spend billions propping up the value of the peso.

And though his decision angered many foreigners, whose investments plummeted in value along with the peso, Mexican economic policy remains sound.

If Zedillo manages the economy well, this week's misfortunes need not impair long-term growth. Finally, there is no substance to the notion that the falling peso vitiates the benefits of Nafta.

Letting the peso float -- despite government promises to the contrary -- comes as no great surprise. Mexico has run trade deficits for years, which raised fears that the peso would eventually have to fall to balance the books.

But government policy has kept the peso stable as a good way to fight inflation and reassure foreigners that their investments would be safe.

His strategy was to count on steady inflows of foreign investment to raise the productivity of domestic industry. Over time, exports would rise and eliminate the trade imbalance.

The strategy, though plausible, was cut short because Mexico ran out of reserves. Investors, fearful of devaluation, fled the peso. That left Zedillo a choice between defending it by raising interest rates, thereby throwing his economy into recession, or devaluing so that Mexico could close the trade deficit by exporting more and importing less. Zedillo made the proper choice.

Still, for the medicine to work, the Zedillo administration will have to tighten its budget and postpone promised new social spending. That, along with the likelihood of temporarily slower growth rates, is worrisome at a time of continued political instability.

There are reasons that foreign investors will not be permanently disaffected. Mexican market reforms, for instance, are on track; they have already brought inflation from 160 percent to under 10 percent and balanced the federal budget.

What investors will watch carefully is what Zedillo does from here on. If, for example, domestic businesses take advantage of the depreciated currency -- which makes foreign imports more expensive -- to raise wages and prices, then the benefit of depreciation will go for naught.

Nafta critics point to the fact that Zedillo is counting on a lower peso to price U.S. exports out of the Mexican market and lower the cost of Mexican goods to U.S. consumers. That, they say, will eliminate the U.S. bilateral trade surplus and eliminate U.S. jobs.

But the argument makes little sense. The purpose of trade is not to raise employment -- which the Federal Reserve now controls -- or rack up surpluses. Its purpose is to steer workers into high-productivity jobs: into computer and software production and out of textiles. The U.S. comes out ahead under Nafta no matter what happens to the bilateral trade balance.

The specter of a new government pledging one policy one week and doing something completely different the next is not pretty. And Mexican consumers will suffer from higher prices of foreign goods. But the alternative -- prolonged recession -- would have been worse. Mexico can survive this week's turmoil and prosper.

-- The New York Times