Economic Survey of Mexico 2005: Economic performance and Key challenges

Mexico’s performance has improved, but not by enough

The recovery from the slowdown that started in 2001 seems to be soundly established, with GDP expanding at about its potential rate. The OECD expects that 2006 will mark the third consecutive year that GDP will grow by 4% or more. The recovery was broad-based and both exports and production of non-tradeables are rising briskly with the usual risks related to the evolution of the world economy.. It is significant that neither the slowdown nor the recovery were steep, and that there were no signs of serious instability in either financial or foreign exchange markets. Inflation continues to drift downwards, albeit erratically, towards the Central Bank’s target of 3% with a variability interval of plus or minus 1%. The stability-oriented fiscal and monetary policies put in place after the 1995 peso crisis are thus bearing fruit, and much of the unexpectedly higher oil revenues in the last couple of years have been spent sensibly, or saved. But although a sustained 4% growth rate of GDP seems out of reach for most OECD countries, in the Mexican case it is barely enough to keep per capita living standards rising at the same rate as the OECD average. Convergence towards these much higher living standards would require faster actual growth for many years and hence a rise in potential growth.

Mexico’s challenges and the constraints it faces

Raising potential growth will require some combination of faster growth in the quality of labour inputs, more and better physical capital endowments, better ways of combining inputs of both, and more advanced technology. Achieving some of these can be left to markets, provided that the markets function well. In this respect, the reforms of the past three decades are helping: tariff and quota reductions have put domestic firms under competitive pressure to innovate and cut costs, and the reforms of the financial sector have greatly improved its potential intermediation role. There are other reforms that would have little fiscal cost and could also help.. These include further liberalising the labour market and some product market sectors, notably electricity and other network industries. However, no political party has a majority in Congress, and sub-national governments play an active political role. It has therefore proved extremely difficult to reach agreement on some reforms despite continued efforts by the federal government. These delays are unfortunate and risk discouraging foreigners from investing more heavily in the country. On the other hand, some of the pathways to prosperity have to be both mapped out and financed by the public sector. Primary and (at least) lower secondary education, basic health services, transport infrastructure, a minimal social safety net, and the rule of law, can only be provided for by government. Mexico needs more of all of these, and of better quality. Moving ahead quickly over the medium term on all fronts, rather than a piecemeal approach, would create synergies. But core fiscal resources are too limited for this, and oil-related revenues are too unpredictable. Tax reforms that would help ease the fiscal constraints have become snarled up in the political process. Mexico badly needs a fiscal framework that will allow its development needs to be financed in an adequate, stable and predictable fashion by the different levels of government. In the discussion of these crucial reforms, all parties involved should focus on objective elements rather than on narrow political interests. Comprehensive reforms across all these areas are the only means to ensuring that labour productivity can rise fast enough to close the gap in living standards.

Labour is plentiful but its productivity is low

There is no shortage of labour in Mexico, but its productivity is low. Labour force growth has averaged 2½ per cent over the past 15 years. The Mexican population older than 12 years nearly doubled between 1990 and 2004. Most people enter the labour market in their mid-teens, there is no unemployment insurance and pensions are low; pressures to find work are therefore high. But labour productivity is about a third of the OECD average. Although this opens ample opportunity for catch-up, productivity growth, except in the manufacturing sector, has been mediocre, despite the reform programmes of the past two decades. The evidence suggests that:
Levels of human capital are very low. Educational attainment is not only the lowest among OECD countries as shown by OECD and national surveys but, unlike in most other OECD countries, younger workers have only a little more schooling than the older workers. Adult training is still scarce;
There is large scope to increase productivity by addressing areas where reforms have been timid or lacking to date, including the labour market and some key network industries;
Even when reforms are legislated, implementation can be patchy. The legal system offers many possibilities for long-drawn out appeals, and it can often be circumvented altogether by interference from pressure groups or plain corruption;
The conclusion is therefore that action needs to be taken in several areas both to enhance productivity directly, and to release synergies that will augment the benefits of previous reforms.

Mastering faster growth

Fiscal management has been successful in recent years, and the backdrop of an inflation-targeting monetary policy has helped anchor expectations that macroeconomic stability is here to stay. In addition, the financial sector has gone through an important transformation and a broader and deeper domestic capital market has developed. This will enable the Mexican authorities to turn more of their attention to long-term priorities, which are where the important policy challenges increasingly lie. Faster growth of living standards will require reforms to the tax system so as to finance the appropriate level of current spending and long-term investment needs. Fiscal relations between the different levels of government need to be re-thought so as to ensure a more effective and more equitable use of revenues. Part of higher oil revenues should be earmarked for financing some important multi-year but finite programmes. Major reforms to education, the labour market, the electricity industry, other network sectors and ways of doing business are also desirable, and will help spur investment in Mexico’s future by both domestic and foreign firms. It is important that reforms be assessed and judged by legislators on their intrinsic merits rather than through the prism of short-term political considerations.