The economy: Mexico's labyrinth of uncertainty

Robert J. Shiller, Professor of Economics, Yale University Project Syndicate

What makes countries grow is perhaps the most fascinating issue in economics, and one of tremendous political-indeed, geopolitical-importance as well. The case of Mexico -- neither an economic tiger like China or Singapore nor a sluggard like many African and Carribean countries -- may be especially instructive.

On a recent trip to Mexico I spoke to many Mexicans about the state of their economy and about their hopes for the future. I asked about their long-term expectations, and about their thoughts concerning Mexico's economic prospects in the decades ahead. What I heard suggested that the dominant feeling for most Mexicans is one of a great uncertainty about their future-perhaps the very uncertainty at the root of our imperfect knowledge about growth in general.

Mexicans seem to believe that they could be living at close to U.S. living standards in another few decades. But they find it equally likely that their living standards might drop even lower than they are today. This mixture of optimism and fear applies to everyone, Mexican businesses and Mexican families alike.

People do have strong reasons to be optimistic. The 1994 North American Free Trade Agreement (NAFTA) between Mexico, the U.S., and Canada helped Mexico's economy recover quickly from the 1994- 1995 peso crisis. Indeed, NAFTA membership has proven to be so popular that Mexico's government has forged many other free trade agreements, including one with the EU in 2000.

So Mexico's current economic slowdown appears to reflect nothing more than weak global conditions. In fact, the economy has shown signs of recovery recently. If these are sustained, Mexico should soon find itself on a solid upward path.

Once again, Mexicans can thank NAFTA for the quick recovery. True, NAFTA is only an economic-not a political -- union, and no symbolic gesture like the creation of a common currency is contemplated. But the obvious advantages of economic integration with the prosperous U.S. are no less important to Mexico's economic stability and development than accession to the EU is for countries like Poland, Latvia, or Slovakia.

Indeed, the most important benefit of NAFTA for Mexico is that it represents a long-term commitment among the three member countries to work together. With over 20 million Mexicans in the U.S. already, and with Hispanic voters so potent a political force that President George W. Bush makes a show of speaking Spanish, that commitment appears genuine.

But alongside those strong grounds for optimism are significant worries. As Pedro Aspe, a much-admired former finance minister, emphasized to me, NAFTA did give a sudden boost to Mexico's economy at the outset. Labor productivity soared, as Mexicans were forced to adapt to the rules of the U.S. economy in order to compete. But that improvement appears to have been only a so-called "impact effect." Mexican productivity growth has since fallen back to its levels in the 1980s.

Mexicans also point to their economy's disappointing growth on a per capita basis since 1982. Twenty years is a long time to have almost no economic growth. It was also a time when many Mexicans were abandoning their economy and leaving to work in the U.S. The situation would have been even worse had this safety valve not been in place.

Meanwhile, China, a country with more than 10 times Mexico's population, managed to grow spectacularly in this period. Why, Mexicans ask, should their country's growth have been so disappointing-and this just as they were establishing free-market institutions, privatizing assets, and developing a more robust democracy?

China's one-child policy must have been an advantage for its per capita GDP growth, allowing more time to be spent on business activities rather than childrearing. But Mexico has recently also shown a sharp decline in population growth rates, as Mexican women opt for more birth control and smaller families.

Mexicans' obsession with China is no accident. China's much lower labor costs mean that Mexican jobs and income levels are directly at risk. Mexican autoworkers earn three times as much as Chinese autoworkers. So Mexico's auto industry must make huge advances in productivity if it is to maintain the same wage level in the future.

Part of Mexico's problem is due to suffering two major financial crises since 1982: the less-developed-country debt crisis of the early 1980's and the peso crisis of 1994-1995. Both were random hits generated by sudden shifts in investor confidence; both represented big setbacks that required years to recover from fully. Worse, no one can be sure that such setbacks will not occur again. Confidence crises beget the risk of further confidence crises.

More political and legal change is needed if confidence is to have a more solid footing. For example, corruption in all economic sectors -- as well as government and labor unions- impedes growth by destroying trust. This means that personal and family connections mean a lot more in Mexican business than they do elsewhere, which prevents people from moving freely through the economy to exploit their personal talents.

Mexicans generally do not want to go to college abroad because they would miss opportunities to form the necessary bonds with other Mexicans. But if corruption were reduced and social trust strengthened, such inhibitions would become irrelevant, and investor confidence would rise.

Moreover, though Mexico elected its first president, Vicente Fox, from an opposition party after 71 years of one-party rule, this new democratic government appears ineffective. No party has a majority in the Chamber of Deputies. Political bickering seems to take priority over action. Disaffection with an ineffective government might lead voters to acquiesce in a more authoritarian government.

Little wonder, then, that Mexicans express fundamental uncertainty about where their country is heading. That uncertainty will be a major factor in how Mexico's economy does or does not develop.

The writer is author, most recently, of The New Financial Order: Risk in the 21st Century, Princeton, 2003.