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Credit Mexico for Staying the Right Course

The country could have followed Venezuela's path back toward protectionism and state control

ONCE again confounding its skeptics, Mexico is showing increasingly strong signs of rebounding from the financial crisis that shook its economy earlier this year. Thanks to the stiff economic discipline being administered under President Ernesto Zedillo's recovery plan, Mexico's large trade deficit is turning around, the peso has stabilized, inflation is dropping, and investment is returning more quickly than expected.

International financial observers have offered praise for this progress. But it should not be forgotten that while Mexico is choosing to follow the right path, it is also a difficult path. Mexico is redoubling efforts to modernize its economy and also imposing tough short-term hardships to get its financial house in order. This course shouldn't be taken for granted.

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All one has to do is look a little further south - to a country like Venezuela - to see what might have been. After a brief economic boom earlier this decade, Venezuela was hit by a severe downturn from which it has yet to recover. High interest rates and political turmoil in 1993 precipitated a crisis that caused foreign investment to flee. Unfortunately, Venezuela's populist, but protectionist, response only made the situation worse. Investment continues to slump badly; inflation and interest rates remain sky-high. Analysts project Venezuela's economy will shrink for a third consecutive year.

A surprising turnaround

The picture for Mexico is much different. Despite the severity of the recent crisis, indicators point to a surprisingly strong turnaround - and renewed growth by year's end.

Why is Mexico on the road to recovery while Venezuela stagnates? Both have vast natural resources and had similar economic profiles going into the 1980s - large public sectors and a dependence on oil exports. Both resorted to protectionism and nationalization in times of crisis.

For Mexico, the point of departure came after the 1982 debt crisis, which precipitated a period of protracted economic stagnation. At that time, Mexico imposed many of the same policies Venezuela follows today - nationalizing banks, imposing capital controls, and keeping itself closed behind stiff trade barriers. The result was years of negative per capita growth.

Learning a hard lesson, Mexico rejected the state-managed model and opened itself to free markets and liberalized trade. Now most of Mexico' s economy has been privatized. It has a diversified, competitive export sector. Where oil was once the primary export, it now represents only 10 percent of exports - and manufactured products have surged to account for 79 percent.

The success of its export sector reflects Mexico's efforts to hold fast to its program of modernization rather than return to the protectionism of the past. When the recent crisis hit, the Zedillo administration maintained its determined commitment to free-market policies.

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The results have been clear, and positive. New trade figures show a strong correction in Mexico's previous trade imbalance. A 32.1 percent surge in exports and a more moderate 7.5 percent decline in imports has resulted in a trade surplus of $3.7 billion for the first seven months of 1995.

Other key indicators are also improving quickly. Stringent fiscal and monetary measures have created a public sector surplus and rapid decline in interest and inflation rates, which skyrocketed earlier this year. The peso has restabilized at about six to the dollar, and Mexico's stock market is up more than two-thirds after hitting rock-bottom last February. Almost 90 percent of Mexico's troublesome tesobono (treasury bond) short-term debt has been retired, and both the government and private sector have been able to reenter the capital markets sooner than expected.

Another key sign of economic turnaround is continuing investor confidence. The American Chamber of Commerce found in a recent survey that capital investment in Mexico by member firms is expected to actually increase in 1995 by 5.1 percent, in spite of the crisis.

Some of this will flow into new privatization and investment openings - in telecommunications, satellite operations, power generation, rail transport, secondary petrochemicals, and ports - resulting from President Zedillo's economic plan.

Continuing direct investment also reflects an important trend in US-Mexican trade: the growth of production partnerships. Production sharing - where manufacturing is divided up to take advantage of local efficiencies - is an increasingly significant business strategy for improving global competitiveness.

One of the primary goals of the North American Free Trade Agreement is to encourage expansion of business partnerships among North American firms, to more successfully counter the fierce competition of imports from the Far East and Europe.

So far, evidence shows this strategy is bearing fruit. A July 1995 study published by the US International Trade Commission reports that nearly half of Mexico's exports to the United States now come from production partnerships, and that "having US materials processed or US components assembled in Mexico increases the competitiveness of US producers of labor-intensive articles with Asian producers in the US market."

This is a positive trend for US businesses and workers. Goods produced with Mexico as the partner contain a much higher portion of US-made content than products from other countries. This means retaining US jobs that might otherwise have been lost.

Mexico as global test case

Over the last decade, Mexico has been an important test case for the free market/free trade model of development. This model was envied and largely adopted by developing economies throughout Latin America and the world. But the alternative of protectionism and closed doors continues to lurk in the shadows.

Last December, unfortunately, Mexico also became a test case for the dangers of economic integration in the new world of volatile international capital markets. Capital that flowed in quickly showed a disturbing predilection to flow out even more quickly when spooked by signs of political and economic trouble.

Fortunately, Mexico chose a path out of crisis based on steadfast adherence to free markets - while also pressing ahead with important legal, judicial, and political reforms. This commitment, with help from the US-led international financial package, has laid the foundation for a remarkably quick rebound.

Mexico's recovery remains very much in the US interest. Alternatives to continued economic partnership and integration, wisely, have not been seen as realistic options by either country. That is a partnership we should continue to cheer.

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