NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Mexico's Problems: Don't Blame NAFTA

"Trade liberalization has done its part, providing extraordinary growth in exports and producing a surge in foreign investment... kinks in the supply chain caused exports to fall, dragging down the economy in the process."

Over the last few years Mexico's economy, and most notably its exports, have stagnated. It's tempting to deduce from this that Mexico's aggressive moves to lower barriers to trade and investment -- its participation in the North American Free Trade Agreement (NAFTA) chief among them -- produced the opposite of their intended effect, extinguishing rather than igniting growth.

But in NAFTA and Mexico's Less-Than-Stellar Performance (NBER Working Paper No. 10289), authors Aaron Tornell, Frank Westermann, and Lorenza Martinez argue that trade liberalization has done its part, providing extraordinary growth in exports and producing a surge in foreign investment. The problem with Mexico, they assert, is that while it has excelled in thinking globally, it has failed to act locally. Most notably, they suggest, Mexico's inability to reform domestic lending and contracting practices in the wake of the financial or "Tequila" crisis of the mid-1990s has produced a protracted credit crunch, one that initially did damage mainly to non-export companies but is now hurting the once high-flying export-oriented firms that depend on them for goods and services.

Tornell and his co-authors see constraints on credit as the main explanation for the fact that, from the first quarter of 2001 through the second quarter of 2003, growth in Mexico has been practically at a stand-still and non-oil exports have fallen an average of one percent a year. "We argue that Mexico's less-than-stellar growth is not due to liberalization...and that in all likelihood, growth would have been slower without liberalization and NAFTA," the authors write. "In fact, in the wake of the crisis, exports experienced extraordinary growth and (economic conditions) recovered quite quickly."

Indeed, Mexico's emergence from its financial crisis -- a crisis characterized by a huge currency devaluation and a massive amount of bad loans -- had been touted in many quarters as one of the great economic success stories of the late 20th century. So what took the wind out of its sails?

Tornell, Westermann, and Martinez observe that in the post-crisis world, Mexico rode back into the realm of relative economic health largely on the backs of its export-oriented industries. And a key reason these firms were able to do so well is that they had access to international financial markets and were the main recipients of foreign direct investment. So, with the peso plunging to historical lows, export companies were able to use that external finance to buy goods, services, and other "inputs" from non-export oriented Mexican companies at what the authors note were "fire sale prices." But while the export-oriented firms rapidly rebounded, for those not in the export sector -- companies that don't usually attract foreign investment -- things got bad and then things got worse, to the point that many went from having fire sales to no sales at all.

Eventually, the non-export or "nontradeables" sector was unable to adequately supply export-oriented businesses with "inputs" such as freight services, repairs, or the critical materials needed to keep a textile or chemical plant operating at capacity, for example. And these kinks in the supply chain caused exports to fall, dragging down the economy in the process. "This is the bottleneck effect, which implies that sustainable growth cannot be supported only by export growth," the authors state. "This effect is key to understanding Mexico's recent performance."

Tornell, Westermann, and Martinez acknowledge that a U.S. recession and competition from China have played a part in Mexico's troubles. But they contend that what has really hurt Mexico is the fact that the credit crunch has depressed investment in non-export companies. Constraints on credit are to be expected in the wake of the kind of currency devaluations that affected Mexico in the mid-1990s. But the authors observe that "a distinctive fact about Mexico ... is that in the wake of the Tequila crisis, Mexico's credit crunch was both more severe and more protracted than a typical" developing country emerging from a similar situation.

In fact, the credit crunch never really ended. The authors note that the amount of real domestic credit fell by "an astounding 58 percent between 1994 and 2002." For non-export companies, available credit has fallen by 72 percent.

Tornell, Westermann, and Martinez believe that the credit crunch which has now trickled up, so to speak, to dampen exports is largely if not entirely of Mexico's making and not a result of its greater exposure to global markets. They contend that after the crisis Mexico failed to enact the reforms that eventually would have eased the credit crunch and give non-export companies access to the capital they needed to keep abreast of the demands from the export sector.

For example, after the crisis it became so obvious that Mexican authorities would do little if anything to borrowers who defaulted on their debts -- such as allowing creditors to take collateral used to secure a loan -- that the country developed what many Mexicans called the "cultura de no pago" or a culture of nonpayment. Even borrowers who could have made good on their debts decided "why pay if there are no consequences for nonpayment"?

Meanwhile, banks had other incentives not to lend. They were still making profits thanks to government compensation for loans that went sour during the financial crisis. In order to jump-start credit growth, in 2000 the government instituted reforms to give banks a greater ability to enforce loan contracts. However, it remains unclear whether they will have much practical effect on the economy.

-- Matthew Davis


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