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MEXICO'S ECONOMIC CRISIS.
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Background, causes & effects of 1994 peso crisis. Politics, global aspects, prices, employment, balance of payments, land reform. Charts.... More...
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Paper Abstract:
Background, causes & effects of 1994 peso crisis. Politics, global aspects, prices, employment, balance of payments, land reform. Charts.
Paper Introduction:
MEXICO’S ECONOMIC CRISIS
Introduction
This research examines the economic crisis in Mexico. A brief history of the crisis, a review of the statistics reflecting the current status of the country’s economy, and potential solutions are presented.
Brief History
The most traumatic economic event afflicting Mexico over the past five years has been the peso crisis that struck in 1994. The events that led to the peso crisis, however, began to emerge in the 1980s. Therefore, this brief history of the crisis begins with these earlier developments and proceeds through the peso crisis of 1994 and its aftermath.
A major economic development in Mexico prior to 1990 was the emergence of the
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Thus far in the mid- and late-199 s, oilrevenues have been disappointing for Mexico. Between 1979 and 1982, the estimate ofcapital flight from Mexico precipitated by residents of the country wasUS$3 billion (Dornbusch & Fischer, 1986). (1995, Summer). The majority of Mexican agriculture consists of small land plots,with 58 percent of Mexico's farms smaller than 12 acres in size. As a consequence of the debt crisis accompanies by capital flight, theMexican government resorted to "inflationary finance"-printing money(Dornbusch & Fischer, 1986). In the 199 s, Mexico's political and economic leadership found that,frequently, the world simply does not work as economists postulate that itwill. In the absence of meaningful agrarian land reform, however, it isdifficult to justify a claim to a democratic political structure. Journal of Economic Perspectives, 1 , 87-1 3. Hope for the future of theMexican economy depends substantially on an improvement in world oilprices. Further, the Constitution had beenchanged to allow foreign corporations to own up to a 49 percent investmentin these joint ventures (Caron, 1994). An aidpackage from the United States government was required. The roles of the state and the marketin establishing property rights. Naim, M. Mexico's trade balance-net exports (exports minus imports) followed apattern for the 199 -1996 period similar to that of the country's balanceof payments ("Emerging Market Indicators: Mexico," 1995). The peso appears to be stabilizing, but at a level far higher thanthe trading level that prevailed prior to the late-1994 financial crash.Chart 4Change in Mexican Balance of Payments: 199 -1996________________________________________________________________US$ (billions) + 1 - 1 - 2 - 3 - 4 - 5 199 1991 1992 1993 1994 1995 1996 [Source: "Emerging Market Indicators: Mexico" 1998; 1995]________________________________________________________________ Solutions Mexico's new economic system proved to be all but "powerless in theface of external factors beyond its control" (Naim, 1995, p. The Constitution has beenamended further to allow groups of small farmers to agree to produce on acontract basis for larger firms. While Mexico'strade deficits over the period were somewhat less than the country'scurrent account deficit, the pattern was nearly identical to that for thecurrent account deficit illustrated in Chart 4.Chart 3Change in Mexican Unemployment: 199 -1996________________________________________________________________% of Labor Force + 1 + 8 + 6 + 4 + 2 - 2 199 1991 1992 1993 1994 1995 1996 [Source: "Emerging Market Indicators: Mexico" 1998; 1995]________________________________________________________________ The Mexican peso has taken a beating in the wake of the late-1994financial crash in the country. The events that led tothe peso crisis, however, began to emerge in the 198 s. The UnitedStates Congress, however, refused to approve the rescue package. Mancur Olson (1996), writing in the Journal of EconomicPerspectives, defined the economic logic that must underlie the initiativesof government in efforts to create and effective market economy. By May 1998, the trading level had increased further to8.68 pesos to one United States dollar ("Emerging Market Indicators,"1998). The initial aidpackage put together, which in principle did not imply any disbursementobligation on the part of the United States government, was to becollateralized with the receipts of Mexican oil exports and was contingenton Mexico's adoption of harsh economic reforms. As the data presented in Chart 3 [see page 7] indicate, unemploymentin Mexico was affected adversely in the year following the financial crash,although the increase in Mexican unemployment was not as severe as were theeffects of the crash on Mexican GDP and consumer prices in Mexico.Chart 2Change in Mexican Consumer Prices: 199 -1996________________________________________________________________% Change + 4 + 3 + 2 + 1 - 1 - 2 199 1991 1992 1993 1994 1995 1996 [Source: "Emerging Market Indicators: Mexico" 1998; 1995]________________________________________________________________ As the data presented in Chart 4 [see page 8] indicate, Mexico'sbalance of payments was affected positively in the year following thefinancial crash. While this decision calmed markets andgave Mexico a brief respite, the action forced the IMF to extend anassistance package seven times bigger than the normal limit and to commitone-fifth of its liquid resources to save the emerging capital market andits foreign in Mexico (Naim, 1995). (1995, 3 September). Olson, M., Jr. (1998, 9 May). But Mexico's new economic system showed itself to be powerlessin the face of external factors beyond its control" (Naim, 1995, p. Federal Reserve Board to raise interest rates or for the Mexicans to devalue their peso (p. The Mexican government in the 199 s is encouraging joint venturesbetween ejido farms combined into larger land holdings and Mexicancorporations through the Vaquero Program. This agreement by the IMFwas for a period of 18 months extending through the end of 1987.Simultaneously, Mexico agreed to join the GATT (General Agreement onTariffs and Trade). In turn, the Mexican peso experienced a hugedepreciation in real terms from 1982 to 1986-28 percent. 3 ). In July 1986, the International Monetary Fund (IMF) agreed to provideadditional credit to Mexico in the amount that the country would lose as aconsequence of falling world crude oil prices. Conclusion Mexico, to paraphrase Rapaczynaki (1996) has attempted to create amodern political and social structure without first building a strong andeffective economy, the participants in which, will demand the changes inthe political and social structures that they want. The Mexican financial collapse of late-1994, indeed, took the world bysurprise. Thus,Mexico will be forced to face this issue squarely in the future. National Catholic Reporter, 3 , 19. Big bills left on the sidewalk: Whysome nations are rich and others poor. Through this program, theejidatarios supply labor and land, and Mexican corporations providecapital, technical advice, and market access. B. In the early-199 s, the Mexican governmentinitiated policies to reverse some of the land reform implemented decadesearlier. Adecline in world oil prices, therefore, compromises the future of theeconomic performance of Mexico. The reason for this apparent anomaly was the financialrescue package for Mexico that was structured by the United States (Naim,1995). Economist,336, 124. Joining the GATT committed Mexico to theimplementation of tariff reductions and to the introduction of policiesthat would lead a more open economy (Dornbusch & Fischer, 1986). (1994, 7 January). Olson(1996), however, possessed the acumen to point-out that economic logic isnot the only logic that is at work in any country or globally, and that ifsocial logic does not also underlie such initiatives they likely willstumble at best and fail at worst. Foreign Policy, 112-13 . Economist, 347,1 6. Earlydata for 1996, as indicated in the chart, reflects the beginning of arecovery for Mexican GDP.Chart 1Change in Mexican GDP: 199 -1996________________________________________________________________% Change + 6 + 4 + 2 - 2 - 4 - 6 199 1991 1992 1993 1994 1995 1996 [Source: "Emerging Market Indicators: Mexico" 1998; 1995]________________________________________________________________ As the data presented in Chart 2 [see following page] indicate,consumer prices in Mexico skyrocketed in the year following the financialcrash. Emerging market indicators: Mexico. Furthermore, theassistance would have made money for the United States government, as theMexicans would have had to pay steep fees for using the loan guarantees. All it took to reduce the interest of investors in the benefits of international diversification was for the U.S. Third World debt.Science, 234, 836-841. Mexico had attracted a "lot of acclaim for its economic reformsof the proceeding years, largely following the US-backed model for economicdevelopment. President Clinton then acted on his own initiative to assemble analternative rescue package that did not require congressional approval andthat relied heavily on funds supplied by the United States ExchangeStabilization Fund and by the IMF. Another issue that came back to haunt the Mexican government in the199 s was land reform. Journal of Economic Perspectives,1 , 3-24. Economic indicators.Review of the Economic Situation of Mexico, 9, 3-61. The government of Mexican President Salinas renegotiated the country'shuge foreign debt, initiated economic reforms that boosted the country'sprestige with the OECD countries, and negotiated entry into the NorthAmerican Free Trade Agreement (NAFTA) with Canada and the United States.Naim (1995) observed that: "Mexico soon became a main beneficiary of theunprecedented surge in private capital flow, a favorite son among the'emerging markets.' Between 199 and 1994, Mexico became the world'ssecond-largest recipient of foreign private investment, after China" (p.112). A large proportionof the foreign borrowing in which Mexico engaged in the late-197 s andearly-198 s "was wasteful or unjustified in that it primarily financedconsumption and government budget deficits rather than investment"(Dornbusch & Fischer, 1986). (1996, Spring). The ejidofarmers also were given the right to sell the land, rent the land, or usethe land for collateral against loans. References Banco Nacional de Mexico. (1986, 14 November). In essence, the constitutionalchanges allow Mexican farmers to be returned to the status of tenantfarmers. Arefusal to extend this financial support, President Bill Clinton suggested,would throw Mexico into a major political and economic tailspin, whichwould harm the economy of the United States (Naim, 1995). (1997, February). Dornbusch, R., & Fischer, S. 126). Mexican land reform to unite smallfarmers and big business. The peso was trading at the level of 3.34pesos to one United States dollar in May 1994. 112). A restriction on the size of combined farm land holdings remains;however, Mexican corporations now are permitted to own farm land, which hadbeen prohibited in the past. The land problem, together with the issue of the Mayan rebellion inChiapas state also remain to be solved in Mexico's future. As a result some retrenchment in emerging nations for the rest of the decade can be expected (p. In the absence of that rescue package, it is difficult to speculateon just how devastating the effects on the Mexican economy and Mexicansociety might have been. Mexico's larger story. Economic Status The Mexican financial crash in late-1994 had dramatic effects on fourof the country's macroeconomic measures-GDP, consumer prices, unemployment,and balance of payments. Lastly, the constitutional changepermitted these farmers to combine their holdings into larger tracts ofland. As a consequence, real wage levels decreases by 4 percent (Dornbusch &Fischer, 1986). Mexico's economic performance is tied closely to the world price ofcrude oil. Investment poured into these nations, allowing their leaders to pursue economic reforms. Therefore, thisbrief history of the crisis begins with these earlier developments andproceeds through the peso crisis of 1994 and its aftermath. This realcurrency depreciation caused real wage levels in Mexico to plunge, which,in turn, prompted multinational corporations (MNCs) to attempt to establishbases of production in the country to exploit the low real wage levels(Dornbusch & Fischer, 1986). Mexico's Economic Crisis Introduction This research examines the economic crisis in Mexico. Dutch tulips and emerging markets.Foreign Affairs, 74, 28-44. A substantial proportion of the increase inMexico's external debt during this period was linked to an exodus ofcapital by residents of Mexico. (1995, July-August). The Mexican crisis showed that the prospect of high yields rather than prudence motivated this internationalization. Krugman, P. (1996, Spring). Emerging market indicators: Mexico. The explanation was that investors had realized the benefits of diversifying the risk in their portfolios by spreading them internationally, and emerging markets provided the opportunity to do so. But the crisis in Mexico has pointed out some shortcomings in the so-called "Washington consensus." Excessive optimism led to excessive speculation for which Mexico was not ready, and the attack on the peso ensued. Within the context of Olson's line ofreasoning, Paul Krugman (1995), writing in Foreign Affairs, observed that: The world appeared to be at the start of a new era in international capitalism in 199 , as communism was defunct and most of the world's developing nations seemed committed to free markets as the way to economic development. The effects of the crash on these four variablesare illustrated in Charts 1 through 4, which may be found on the next fewpages. According to Naim (1995), the Mexican financial crash exposed themotivations underlying the internationalization of investment portfolios.Within this context, Naim (1995) added that: The voracious appetite in the United States and other industrialized countries for investments in emerging markets was initially interpreted as a reaction to opportunities created by economic reforms. As the data presented in Chart 1 [on the following page] indicate,Mexico's GDP plummeted in the year following the financial crash. Foreign corporations are not permitted to ownMexican farm land (Caron, 1994). A failure to implement effective agrarian land reform also is a majorbarrier to economic development. Largely, that top-downapproach to the creation of the Mexican state and Mexican society appearsto be at the root of Mexico's problems. A brief historyof the crisis, a review of the statistics reflecting the current status ofthe country's economy, and potential solutions are presented. Early data for 1996 reflects a continued increase in Mexicanconsumer prices, although the rate of increase appears to be moderating tosome extent. Investors were looking abroad for the high returns that they were not getting at home, given the bearishness of financial markets in the United States, Japan, and Europe. Rapaczynski, A. Caron, J. Prior land reform efforts in Mexico havebeen high profile governmental efforts, but they have been both incompleteand high in rhetoric. By January 1995, thetrading level had risen to 5.76 pesos to one United States dollar, and byJanuary 1996, the trading level had risen to 7.54 pesos to the UnitedStates dollar. In 1992, the constitution was amendedto eliminate the right to be granted land by the state upon request and togive title to the farmers currently working the ejido land. In thefirst-half of the 199 s, Mexico began a program designed to reverse theprocess of traditional land reform. From 1982 to 1986, the Mexican government reduced expenditures andraised taxes to be able to pay the interest on the country's external debt. To build a strong economy,however, Mexico must effect meaningful land reform in order to bring allresidents of the country into a meaningful level of participation in theeconomy. 112). Brief History The most traumatic economic event afflicting Mexico over the past fiveyears has been the peso crisis that struck in 1994. A major economic development in Mexico prior to 199 was the emergenceof the country's huge external debt in the early 198 s. Revenues from the petroleum sector contribute 6 percent of thecountry's export earnings and finance approximately one-half of the fundingfor central government activities (Banco Nacional de Mexico, 1997). Both economicand political imperatives underlie the need for agrarian land reform inMexico.
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