Bullish on Mexico
Jude Wanniski and David Goldman
May 15, 1989


In a visit to Mexico City last week, we heard the same evaluation of the Salinas administration from leading industrialists, young lawyers and professionals, and several taxi drivers: Unprecedented changes in the country's political structure are underway, on a scale that no one could have predicted six months ago. Some see in Mexico's 40% "underemployment" rate a portent of social chaos; we see 40% unutilized capacity. The proper resolution of Mexico's present economic crisis could unleash hidden economic potential, propelling Mexico on a growth path comparable to that of the Asian "tigers."

Past presidents L6pez Portillo and Miguel de la Madrid gave Mexicans good cause for cynicism about the country's leaders and political institutions. After only seven months of Salinas, though, Mexicans have begun to believe that the unthinkable is now possible. Tough action against corrupt union officials and drug traffickers, as well as tax-avoiding financiers, added to Salinas' credibility. But more is involved than high-profile headbashing; Mexico is shaking off the political habits of a half century.

The transformation is visible on the street. Salinas had just settled a national teachers strike when we arrived; army trucks ferried passengers stranded by a bus strike. Musicians' union dissidents unfurled giant banners along the capital's main boulevard, protesting mafia-like control of their union. But there is surprisingly little rancor in these actions, despite the pressing economic conditions. Ordinary Mexicans are groping for a role in the great events now underway.

The strategy of President Carlos Salinas de Gortari and his closest aides, Finance Minister Pedro Aspe and Commerce Minister Jaime Serra Puche, recalls Patton's quip that he was too weak to defend, and therefore had to attack. They are gambling that debt relief will take the pressure off Mexico's stagnant economy and prevent further deterioration of the peso's value. Conventional thinking would consider their position hopeless: the Citibank-led bank creditors' committee and the devaluationists at Treasury want to make Mexico swallow more of the same economic poison. Meanwhile, the disgruntled "traditionalists" of the Institutional Revolutionary Party (PRI), e.g. Interior Minister Fernando Gutierrez Barrios, expect that Dr. Aspe's failure in the debt negotiations will enable them to restore their grip on the party.

Two factors convince us that Salinas will confound the odds against him. The first is the profound change in Mexico's national mood. A half-century after President Lazaro Cardenas nationalized Mexico's oil-fields, Mexico remains trapped in chains of its own forging: the protectionist state apparatus designed to defend the revolution-torn country against easy picking by its powerful northern neighbor. President Salinas has shown his constituents that he .has the audacity to lead Mexico into the 21st century. If he offers the required policies, they will support him.

The second factor is the Bush Administration's new willingness to put Mexico's long-term economic growth prospects ahead of the narrowly-defined interests of the creditor banks. As we reported, Washington leaned on the IMF last month to lend $3.5 billion to Mexico without a currency devaluation, the first abandonment of Keynesian doctrine since the debt crisis broke out. Mexico is well attuned to the change in Washington's outlook. A May 11 Wall Street Journal editorial defending Mexico's position against the Citibank strategy appeared the next day in full translation on the front page of Mexico's leading daily, Excelsior, for example.

Much of the tough talk by Mexican officials is intended to get the Bush Administration's attention. Rumors were everywhere during our visit that Mexico would run out of reserves and stop debt payments in July. Friends of Salinas warned darkly that Mexico's reserves had fallen to only $3-4 billion, and that a payments stop would be inevitable. The same theme played across the front pages of the country's newspapers. Reserves are closer to $7 billion in fact, a fall from $16 billion a year ago. There is no real danger during July; if necessary, Washington will probably provide a bridge loan. The time frame for a deal on the debt problem does not close in July, but in November or December.

The impasse in the debt negotiations stems from a fallacy inherent to the Brady Plan, in which the banks are supposed to forgive part of their debt in return for guarantees on the remainder. But Western taxpayers (through the IMF) are not prepared to guarantee, say, $280 billion of Latin America's $350 billion of outstanding bank debt, especially given the debtors' current economic woes. The banks, meanwhile, demand payment terms that would ensure further economic decline, promoting a vicious circle.

A growth strategy is prerequisite to breaking the vicious circle that began in September 1976 when U.S. economists of the Bergsten variety persuaded Mexico to devalue the peso to spur exports. (The correct solution to Mexico's stagflation at the time was to reduce inflation-swollen tax rates.) The peso had been 12 to the dollar for 24 years and was devalued to 20 per dollar, igniting more inflation, tax-bracket creep and capital flight. The peso is now at 2300 to the dollar! Imagine the mindlessness of Treasury Undersecretary David Mulford and his sidekick, Bergsten-protege Charles Dallara, demanding yet another peso devaluation!! Had they succeeded, it could have been the last straw for the patient Mexican citizenry, at the least dissipating the confidence Salinas has been slowly accumulating and at worst civil unrest and a massive flight of people and capital.

Instead, the Salinas economic team has bought time, although its energies are still consumed by the debt issue, with no signs it has a clear growth strategy. Yet with growth restored, the IMF could agree to underwrite a symbolic fraction of outstanding debt, and banks could agree to forgive the 20% or so envisaged by the Brady Plan, because Mexico's effective debt burden will be diminished by increasing ability to pay. We advised the industrialists we met with that the $100 billion Mexican debt would seem relatively small if economic growth rates could be kicked into double digits, which we could easily imagine with supply-side policy changes. Debt forgiveness by the creditor banks, backed by IMF guarantees of the remaining principle, seems wholly unrealistic without clear prospects that the Mexico economy is poised for growth.

Our discussions centered on the Polyconomics-Price Waterhouse "Mexico Project." We found that our views on the matter had already circulated widely among Mexico's political and business elite. The supply-side solution has already become a credible policy-alternative. Some top-level business leaders and political professionals are already enthusiastic converts. Skepticism remains among top officials (trained at Harvard, Yale, and MIT), about reducing marginal tax rates while the government is gasping for revenues. But a learning process has begun (for us as well as our Mexican discussion partners). Over the June-December period in which we plan to conduct our study, we foresee close cooperation in data-gathering and analysis from Mexican public and private-sector institutions. The seeds are being sown for Mexico's supply-side revolution. Given the vast resources of the country's people, currently smothered under layers of policy forced on them by the IMF and Washington over the years, we came away excited by the prospects for change.