Economic Policy Reform in Mexico. A Case Study for Developing Countries

229 Pages·1981·2.678 MB·English

by  Leopoldo Solís (Auth.)

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PERGAMON ON INTERNATIONAL
POLICY
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Economic Policy
Reform in Mexico
A Case Study for
Developing Countries
Leopoldo Soifs
Pergamon Press
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Copyright © 1981 Pergamon Press Inc.
Library of Congress Cataloging in Publication Data
Solîs M Leopoldo.
Economic policy reform in Mexico.
(Pergamon policy studies on international develop-
ment)
Includes index.
1. Mexico—Economic policy—1970- I. Title.
II. Series.
HC135.S6383 1981 338.972 80-26937
ISBN 0-08-026330-5
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Printed in the United States of America
Preface
This is an essay in political economy that tries to assess the
recent economic developments in Mexico, especially the attempt
at economic reform in the early 1970s. At the beginning of the
present decade, Mexican politicians and economic policymakers
realized that the traditional goals of per-capita income growth
and price and balance-of-payments stability were no longer
sufficient. Therefore, a new objective was added, namely,
improvement in income distribution and, perhaps of more in-
terest, stepping up the economic activity of the State. Thus,
an effort was made to begin to translate the concept of equal-
ity into economic reality. I was fortunate enough to witness
this process - sometimes quite closely - as head of the
Economic Programming Directorate of the Secretariat of the
Presidency during 1971-75.
When Luis Echeverria became President of Mexico in 1970,
the country was ripe for change. Ever since Cardenas' presi-
dency in the 1930s, Mexico had enjoyed a good deal of political
stability and economic growth. Cardenas' policies, especially
his social and economic reforms, becomes the centerpiece of the
Mexican revolution and, at the end of his administration, the
main institutional features of modern Mexico took shape. The
early 1940s marked the beginning of the phase of "national
unity" and an end to the ideological and class struggles of
previous years. The 1960s saw the end of that stage of Mexican
history. For the first time during this decade, Mexico
achieved continuous price stability; and this stability, plus
sustained economic growth, became known as Stabilizing Devel-
opment. The concept was in many ways an a posteriori ration-
alization of the chain of economic events that followed the
1954 devaluation and the subsequent short-lived inflationary
spurt. Politically, the Stabilizing Development period meant a
coalition - sometimes called the "developmental alliance" - of
ix
x PREFACE
the beneficiaries of economic progress, namely, organized
labor, government bureaucracy, and private entrepreneurs.
At the end of the 1960s, the economic policies of Stabil-
izing Development became subjected to mounting criticism. The
main issue was income distribution. It became clear that the
families in the lower half of the income scale were relatively
worse off, regardless of the evidence of production indicators.
The general political dissatisfaction of the middle class
(despite or perhaps because of the fact that it received many
benefits through the Stabilizing Development period) was
dramatically expressed in the 1968 student riots. The police
repression of the movement turned the Diaz Ordaz administration
into a lame-duck government, incapable of taking initiatives in
matters of national importance. Observers of Mexican affairs
commented that the political development of the nation lagged
behind its economic growth, that political institutions had
become stale and social mobility frozen. At this moment,
incumbent President Luis Echeverria issued a call to the
country in his Inauguration speech of December 1970, asking all
Mexicans to support him in his efforts to provide Mexico with a
more equitable and just society.
The first chapter of this book examines the period of
Stabilizing Development in order to provide the reader with a
framework necessary for judging the environment in which the
attempts at economic reform were undertaken. The chapter is a
piece of applied economics that tries to assess the now too
frequent attacks against that phase of economic policy. The
following three chapters discuss the economic policy objectives
of Echeverria1 s administration, the attempt at tax reform and
the change in the structure and practices of public spending.
The final chapter evaluates the experience and draws some
inferences about the nature of decision making in economic
policy and the constraints faced by a government that wants to
use economic policy as an instrument for the promotion of
social welfare.
The style varies in the different sections of the book.
The first chapter shows the detachment from the subject matter
expected of an economist. The following three chapters de-
scribe events in which I took part and are therefore written
from a far more personal point of view. The concluding chapter
contains afterthoughts arrived at within the intellectual
environment of Princeton University, which is so conducive to
serene and reflective thinking.
I have included intact some staff papers prepared in the
rush of the moment. Those papers were written quickly, usually
in a few hours1 time, and therefore contain some faulty anal-
yses, and their style is rough. I decided to manicure them in
order to give the reader a fresh and honest view of the pres-
sures, satisfactions, and frustrations of an economic advisor.
PREFACE xi
I wish to express my thanks to Sir W. Arthur Lewis, John
P. Lewis, Albert Hirschman, Arnold Harberger, Larry Sjaastad,
and Carlos Bazdresch for their valuable suggestions and com-
ments. I also want to thank Jerry Kavanagh, who patiently
typed several drafts of the book; Doris Garvey, who carefully
converted Spanish-English and Czech-English into American-
English; and Jirina Rybaczek from Czechoslovakia, who trans-
lated all included documents and whose editorial help made it
possible for me to finish the book much earlier than I ex-
pected. The standard disclaimers apply.
1
Stabilizing Development
ECONOMIC GROWTH AND PRICE STABILITY
Mexico has had a long history of political and economic in-
stability. Although political stability was assured with the
merging of the revolutionary groups and forces into one po-
litical party in 1929 (PNR, later PRM and now PRI), economic
order in the form of price and balance-of-payments stability
came into being much later, nearly three decades afterwards.
The peso devaluation of 1954 that fixed the exchange rate at
the old rate of 12.50 pesos to a dollar, was a traumatic event
indeed. Policymakers of that time comment to this day that the
labor unions1 response, triggered by the devaluation, shook up
the whole party structure.(1) A wage increase was granted to
appease the workers because it became evident that the economic
growth with price instability was unacceptable to them. The
share of wages and salaries in national income had actually
decreased during the 1940s,(2) and policies had to be devised
to prevent labor from bearing the whole burden of growth, i.e.,
to prevent labor's income share from going down further. The
prevailing explanation of the time was that prices lead, wages
lag, real wages go down. Inflation had to be stopped. This
was in fact achieved in 1956-57 and, since 1958, economic
variables have shown quite a different pattern of behavior.
The 1958 recession of the U. S. economy, however, depressed the
early years of the price stability period, and some analysts
argued that the stabilization policies of the time were driving
the country to stagnation.(3) Private investment slowed down
and a sharp and critical exchange of comments between the
public and private sectors took place, showing that a recession
eroded the amity between entrepreneurs and the government. The
ascent of Castro in Cuba also affected the private sector's
1
2 ECONOMIC POLICY REFORM IN MEXICO
prevailing mood. In that context, the 1960s started and, with
them, Stabilizing Development. We are fortunate enough to have
a yardstick for judging the economic policies that followed in
the 1960s. At the 1969 Annual Meeting of the World Bank and
the International Monetary Fund, Antonio Ortiz Mena, Secretary
of Treasury from 1958 to 1970, presented a comparative analysis
of the 1950-58 period, which he called the inflation-devalua-
tion cycle, and the 1959-67 period, which he called Stabilizing
Development.(4) The document contains a useful conceptual
framework that merits a detailed description.
Ortiz Mena states that during the inflation-devaluation
phase, in a cyclical upswing of investment, spending outpaced
voluntary savings, increases in the price level closed the
savings-investment gap, and subsequent changes in factor shares
led to the worsening of income distribution. Stabilizing
Development was intended to raise voluntary savings, improve
the allocation of savings, and increase the stock of capital
per worker. Tax policies were geared to foster the reinvest-
ment of profits, and subsidies were selectively extended to
favor the most productive projects. Profit reinvestment
promotion, we are told, meant convincing investors that future
capital gains - not taxed currently - were more attractive than
current dividends that would be taxed.(5) Tax practices were
adjusted in such a way as to support the processes of capital
deepening; capital was also to be spread out in the productive
absorption of the growing labor force.
Debt policies were designed to tap both domestic and
foreign savings. Foreign and domestic debts were quite low at
the beginning of the 1960s. The central bank's reserve re-
quirement mechanism was used to channel domestic savings into
financing government deficits and complementing foreign funds
in order to achieve levels of borrowing that would be, on the
one hand, non-inflationary and, on the other, sufficient to
promote development. To that end, government spending was
budgeted at levels that would avoid excessive issues of high-
powered money. In order to increase domestic voluntary
savings, in the form of additional flows of financial inter-
mediation channeled by financial institutions, and to induce a
stream of capital inflow, real interest rates were set at
levels sufficiently above those prevailing in the U. S. market.
Interest was kept tax-free or taxed at very low, flat rates,
and an array of fixed-income securities was permanently pegged
at nominal prices. Such financial issues were in fact free of
risk and, as time passed with the exchange rate unaltered,
foreign exchange risk as perceived by investors and reflected
in international rate differences gradually diminished.
In the external sector, Stabilizing Development had,
according to Ortiz Mena, two aims: to keep the foreign ex-
change rate of the peso fixed and to borrow abroad to com-
pensate for insufficient foreign exchange coming from exports
STABILIZING DEVELOPMENT 3
and for insufficient public investment coming from tax col-
lections.
The analysis of Stabilizing Development showed that the
GDP in real terms grew 6.5 percent annually in 1959-67 - having
been 5.6 in 1951-58 - which was at a faster rate than during
any previous period in Mexican history. The price deflator of
the GDP rose only 3.6 percent a year while, in the 1950s, it
had been 7.5 percent. Inflationary expectations gradually
diminished. The ratio of price changes to real GDP changes
fell from 1.34 in 1951-58 to 0.55 in 1959-67. The other
objectives of Stabilizing Development (besides more rapid
growth and a slowing down of the rate of price change) were
achieved to a certain extent: a rise in the savings ratio,
increases in factor productivity, an improvement of real wages
and an expansion of the wage-share in national income, and a
stable foreign exchange rate. The record shown in Tables 1.1
and 1.2, however, merits some additional comments. In order to
raise the savings/income ratio, policies focused on domestic
price stability and on improving the competitive position of
Mexican financial institutions vis-a-vis the U. S. financial
market by introducing high nominal interest rates on Mexican
financial paper. A higher proportion of domestic savings was
diverted to banks, and especially to other financial insti-
tutions - mainly financieras (investment banks) - and these
resources were complemented by a much more active use of
foreign funds, mainly in the form of long-term loans to of-
ficial institutions, which also passed through Mexican fi-
nancial intermediaries. Total savings, which averaged 0.13
percent of the GDP in 1951-58, increased to 0.21 percent in
1959-67. Foreign loans and domestic credit accommodated the
government's financial needs without forcing inflationary
monetary expansion. Public spending was kept at levels that
required no inflationary financing and made it possible to keep
the exchange rate unchanged. International capital flows
became increasingly free of foreign exchange risk. The use of
foreign savings made up for the insufficient inflow of commod-
ity export earnings and for low revenues from tax collections.
Consequently, the public sector was forced to supply energy and
other essential public services at low prices and was able to
do so without severe supply restrictions.
As a complement to a higher savings ratio, the government
intended to raise the private productivity of capital. In this
context, the official attitude favored external economies, the
channeling of investment into activities of high productivity
(thereby increasing product per unit of labor input) and a
fuller use of plant capacity.
Public spending, especially in the capital account, was
directed toward increasing the profitability of private in-
vestment. In general, however, private expenditures were
favored by a system of tax benefits, exemptions, and subsidies,
4 ECONOMIC POLICY REFORM IN MEXICO
which were used to promote the reinvestment of profits by the
private sector but which made fiscal policy ineffective in
increasing tax revenues.
This chapter will examine the economic record of the
1960s, with separate sections devoted to the following issues:
import substitution and growth of manufacturing, stagnation in
agriculture, boom in financial intermediation, tax reform
attempts, and distribution inequality. The final section will
deal with the evolution of economic policy and will offer some
conclusions on domestic and foreign equilibrium.
Before turning to the economic analysis of the 1960s,
however, we may ask what was the political meaning of the
period of Stabilizing Development. We may suggest that the
objectives of stability and growth were supported both by the
entrepreneurial class and by organized labor, who mainly
appropriated the benefits of growth. The middle class, al-
though belonging to the beneficiaries,(6) lacked as well as
anybody else channels for overt political participation. More
importantly, however, the position of the lower classes
worsened relatively. Budget constraints on public sector
spending meant that the sectors and social groups unable to
apply political pressure, especially those outside the modern
or commercial segments of the economy, were by-passed by public
spending; and their efforts to be subsidized or otherwise
supported, and thereby to improve their income and wealth
position, were thwarted. This was to have important political
and economic repercussions in the latter part of the 1960s,
which will be discussed in the final assessment of the overall
characteristics of the decade.
IMPORT SUBSTITUTION AND THE GROWTH OF MANUFACTURING
During the 1960s, economic growth was fairly steady, averaging
7 percent annually, varying from a low of 4.7 percent in 1962
to a high of 11.7 percent in 1964, the last year of the Lopez
Mateos administration.(7) Income per capita exceeded a level
of U.S. $700 in 1970. The structure of the spending components
of the GDP showed some changes: there was a relative decrease
of private consumption and exports; government consumption
increased; and gross fixed investment gained nearly three
percentage points, reaching 19.0 percent of the GDP in 1970 - a
figure well above the 12.8 percent achieved 20 years earlier.
The structure of output changed somewhat, with agriculture and
cattle raising declining from 15.9 to 11.6 percent of the GDP,
and industry increasing to 34.4 percent of the total (see Table
1.3).
In manufacturing, the production of consumer goods con-
tinued losing importance in the aggregate, but at a slower rate