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MEXICO: AN ECONOMIC ANALYSIS.
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Impact of trade, economic theories, per capita gross domestic product, effects of labor conditions, NAFTA, 1994 peso crisis, financial structure.... More...
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Paper Abstract:
Impact of trade, economic theories, per capita gross domestic product, effects of labor conditions, NAFTA, 1994 peso crisis, financial structure.
Paper Introduction:
MEXICO: AN ECONOMIC ANALYSIS
Introduction
This research analyzes specific issues related to the economy of Mexico. The issues discussed are (1) per capita gross domestic product (GDP) differentials between Mexico and the United States, (2) the effects of labor on the per capita GDP differential, (3) the North American Free Trade Agreement (NAFTA), (4) the 1994 peso crisis, and (5) the role of the financial structure and system in the peso crisis.
International Trade As An Explanation for Differentials in Per Capita Gross Domestic Product in Mexico and the United States
The basic model of international trade is structured around the concept of comparative advantage. The theory of comparative advantage holds that mutually advantageous trade between countries will alw
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Duesterberg, T. 112). Dornbusch, R., & Fischer, S. A substantial proportion of theincrease in Mexico's external debt during this period was linked to anexodus of capital by residents of Mexico. Economic Record, 16, 36-43. Drache, D., & Gertler, M. One reason, therefore, for the continuingincome disparity in countries such as Mexico, therefore, is that theglobalization of trade is working to the advantage of skilled labor to thedetriment of unskilled labor. A refusal to extend this financialsupport, President Bill Clinton suggested, would throw Mexico into a majorpolitical and economic tailspin, which would harm the economy of the UnitedStates (Naim, 1995). The initial aid package put together, which inprinciple did not imply any disbursement obligation on the part of theUnited States government, was to be collateralized with the receipts ofMexican oil exports and was contingent on Mexico's adoption of harsheconomic reforms. The peso was trading at the level of 3.34pesos to one United States dollar in May 1994. (1994, March). The roles of the state and the marketin establishing property rights. New Brunswick, NewJersey: Transaction Books. New York: McGraw-Hill Book Company. Economics. The contention of thehypothesis is that, in the context of development, both economic and socialforces produce tendencies towards disequilibrium, and that the assumptionin economic theory that disequilibrium situations tend toward equilibriumis false. (1996). (6th ed.). One important problem within the context of this policy dilemmaappears to be the mistaken assumption that global corporations are seekingto gain advantages through the exploitation of unskilled labor indeveloping countries. How trade affects jobs. In the 199 s, it is recognized that both supply anddemand factors are at work in the determination of relative prices whichestablish a basis for a mutually advantageous exchange between countries.In spite of significant changes in economic thought since the eighteenthcentury, the theory of comparative advantage still stands as an example ofsound economic reasoning. (1991). 837). F. NAFTA as social dumping. 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. In 1992, negotiators from Canada, Mexico, and the United Statesfinished work on the NAFTA, and late in that year the Presidents of Mexicoand the United States and the Prime Minister of Canada signed the NAFTA.The agreement was ultimately ratified by the legislative branches ofgovernment in all three countries, to become effective on 1 January 1994.Under the NAFTA, virtually all trade barriers between the three countrieswill be eliminated by 2 3, creating a single, unified North Americanmarket of 36 million persons. As a consequence, the Mexican pesoexperienced a huge depreciation in real terms from 1982 to 1986-28 percent. (6th ed.). World development report, 1997. A tariff is an import tax. Many smaller economies in the twentieth century have not been capable offinancing economic development at the level or at the rate desired solelythrough the use of domestic resources (Thirlwall, 1991, pp. The obstacles to economic growth and development in many smallercountries being brought into regional free trade arrangements are dualism,cumulative causation, and the problem of population (Thirlwall, 1991).Dualism is defined as economic and social division in an economy, such asdifferences in the level of technology between sectors or regions,differences in the degree of geographic development, and differences insocial customs and attitudes between indigenous and an imported socialsystem. Vanston, N. Initially, the theory was based on labor-cost differentials. Between 1979 and 1982, theestimate of capital flight from Mexico precipitated by residents of thecountry was US$3 billion (Dornbusch & Fischer, 1986). 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, p. As Olson (1996) observed,governments must apply social logic as well as economic logic indeveloping and implementing their policies and initiatives. Most tradebarriers are imposed by national governments, although they are most oftenimposed at the insistence of or with the support of domestic industry andlabor organizations. Olson, M., Jr. Thus, the rationale of extant international economicpolices is becoming irrelevant. The issues discussed are (1) per capita gross domestic product(GDP) differentials between Mexico and the United States, (2) the effectsof labor on the per capita GDP differential, (3) the North American FreeTrade Agreement (NAFTA), (4) the 1994 peso crisis, and (5) the role of thefinancial structure and system in the peso crisis. Ratification meant only that the NAFTA backers persuaded (byconvincing argument, by political threat, or by whatever means) thenecessary majority in each house of Congress to vote to affirm theagreement. 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. New York: McGraw-Hill,Inc. 3 ). 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). New York: John Wiley & Sons,Inc. From 1982 to 1986, the Mexican government reduced expenditures andraised taxes to be able to pay the interest on the country's external debt. This real currency depreciation caused real wage levels in Mexico toplunge, which, in turn, prompted multinational corporations (MNCs) toattempt to establish bases of production in the country to exploit the lowreal wage levels (Dornbusch & Fischer, 1986). The reasoning behind the theory ofcomparative advantage is that no single country can have comparativeadvantage in all commodities. Friedman, S. Krugman, P. Animplicit condition in this scenario is that the immigrating low-skilledlabor will be paid wages lower than those being earned by the resident low-skilled labor prior to the immigration, and that income transfers will notbe made to the immigrating low-skilled labor to raise their income to thelevel of the resident low-skilled labor. 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. The major formal barriers to international trade aretariffs and quotas. 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). Challenge, 35,27-32. (1997). In order to generatefinancial capital through the process of net investment, however, either anumber of different or a combination of policies must be pursued. (1997). Indeed, the highest levelof economic growth in Mexico is found in the maquiladoras-special zonesalong the Mexican border with the United States where American and Canadianfirms establish manufacturing facilities whose output is not distributedwithin Mexico, and where such firms avoid both American and Canadian laborlaws and most Mexican taxes (Banco Nacional de Mexico, 1997). 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). Economist, 347,1 6. (1995, August-September). Mexico had attracted a "lot of acclaim for its economicreforms of the proceeding years, largely following the US-backed model foreconomic development. M. It is preferable, thus, to find afeasible means of using a country's human capital within its own economy.Because of the political and social problems involved, free trade holdsadvantages over both free capital movement and free immigration, and freecapital movement holds advantages over free immigration (Thirlwall, 1991). The validity of the counter arguments will be assessed by thefunctioning of the American economy under the NAFTA. A quota also seeks to restrictthe flow of goods into a country. (4th ed.). Rethinking international tradetheory: A methodological appraisal. Overall percapita GDP (gross domestic product) in Mexico (including the maquiladoras)in 1996, as an example, was US$ 3,1 , while that in the maquiladoras wasUS$ 5,9 . Rather, in the contemporary international economicenvironment, most global corporations appear to be attempting to replaceskilled labor in the developed countries with skilled labor in thedeveloping countries. (Eds.).(1991). Unemployment in Mexico was affectedadversely in the year following the financial crash, although the increasein Mexican unemployment was not as severe as were the effects of the crashon Mexican GDP and consumer prices in Mexico. The world economy. In the interveningperiod, the disagreement will remain (Friedman, 1992). A country will highlevels of skilled labor will gain from increased trade; however, a countrywith high levels of unskilled labor will experience losses for skilledlabor in the wake of free trade. Second, firms tendto migrate within the boundaries of the free trade region. Peso Crisis of 1994 In the 199 s, Mexico's political and economic leadership found that,frequently, the world simply does not work as economist postulate that itwill. 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. An aid package from the United Statesgovernment was required. (1986, November 14). Opponents of the free trade agreement contendedthat American jobs and industries would be lost, workers would loseprotections built into American labor law, and American environmentalstandards would be weakened through the implementation of the NAFTA. Mexico's GDP plummeted in the year following thefinancial crash. 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. Early data for 1996 reflected a continuedincrease in Mexican consumer prices, although the rate of increase appearedto be moderating to some extent. Furthermore, the assistance would have made money forthe United States government, as the Mexicans would have had to pay steepfees for using the loan guarantees. Economist,336, 124. It does so through a direct restrictionon the number of items which may be imported, however, as opposed to anattempt to price the goods out of the market (Walther, 1997). W. The Cobb-Douglas production function is anequilibrium model. Washington Quarterly, 16, 115-128. Chiswick, A. Mexico's new economic system proved to be all but "powerless in theface of external factors beyond its control" when the peso crash occurredin 1994 (Naim, 1995, p. 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). Walther, T. Macroeconomics. The political fight in the United States over the NAFTA ratificationwas bitter and divisive. World Bank. Consumer prices in Mexico skyrocketed in the yearfollowing the financial crash. In regional free trade arrangements, two phenomena tend to occur.First, labor tends to migrate within the boundaries of the free traderegion. Gordon, R. Mexico's larger story. The theory is based on anassumption that different countries have different quantities of thefactors of production-land, raw materials, labor, and capital. 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. Barriers to trade are obstacles which preventgoods and services from moving freely between countries. Mexico: an economic analysis Introduction This research analyzes specific issues related to the economy ofMexico. Montreal: McGill-Queen'sUniversity Press, 3-25. (1992). Barriers to trade. Benvignati, A. This firmmigration tends to be characterized by the immigration of employers fromhigh-labor cost economies to lower-labor cost economies. The specific factor-price equalization theory holds that, underabsolutely free international trade, not only the prices of tradedproducts, but also the prices of the factors of production, will beequalized among the trading countries (Walther, 1997). A history of economic theoryand method. The narrow and broad arguments for free trade.American Economic Review, 83, 36 -373. Financial resources are usually derived from two very general areas:domestic resources and external resources. Largely, that top-downapproach to the creation of the Mexican state and Mexican society appearsto be at the root of Mexico's problems. The function attempt toexplain the relative constancy of the shares of capital and labor innational income (Gordon, 1995). Thirlwall, A. Federal Reserve Board to raise interest rates or for the Mexicans to devalue their peso (p. 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. The Stolper-Samuelson theory predicts that removing trade barrierswill have different effects in different countries. Financial Structure and System A major economic development in Mexico prior to 199 was the emergenceof the country's huge external debt in the early 198 s. Growth & development. Early data for 1996 reflected the beginning of a recoveryfor Mexican GDP. The hypothesis of cumulative causation attempts to account for thepersistence of spatial differences in a wide variety of developmentalindices between countries and between regions within a single country onthe basis of the existence of geographic dualism. Third world debt.Science, 234, 836-841. Journal of Economic Perspectives,1 , 3-24. e greater application of capital as opposed to laborthat is used in the economy of the United States in relation to the capital-labor ratio that has prevailed in Mexico is held to explain thedifferentials in the per capita GDP levels in each country which favor theUnited States. The United States Congress, however, refused toapprove the rescue package. (1992). Because it is held that international trade increases the scope oflabor specialization, and achieves economies of scale through theenlargement of markets, most economic theory holds that international tradeshould be free of artificial restrictions. Bensel, T., & Elmsie, B. 839). The dilemma of immigration. The world-economy and the nation-state: The new international order. The basic premise of thefinancing of development from domestic resources is found in the concept ofnet investment: consume less than is produced. Such anoutcome would narrow the income spread between skilled and unskilled laborin such developing countries (Ekelund & Hebert, 1996). In Drache, D., & Gertler, M. (1995, July-August). Naim, M. Byrns, R. The new era of global competition. The most recent experience ofmany developing countries has not conformed to the various internationaleconomic theoretical predictions, however, and the validity of many of theessential policies upon which international economic development is beingbased are being called into question (World Bank, 1997). T. Journal of Economic Perspectives, 1 , 87-1 3. (1992, October). New York: OxfordUniversity Press. (1995). (1995, September 3 ). Review of World Economics, 128, 248-264. Glenview,Illinois: Scott, Foresman and Company. Mexico's balance of payments was affected positively in the yearfollowing the financial crash. 126). All it took to reduce the interest of investors in the benefits of international diversification was for the U.S. It is designed to restrictthe flow of goods into a country, by causing them to be too expensive tocompete with domestically produced goods. Emerging market indicators: Mexico. The assumption is that the social forces in developingcountries, if not countered, will continue to deprive micro-enterprises inboth urban and rural areas (Thirlwall, 1991. B., & Hebert, R. Clague, D., & Greenaway, D. (1993, Summer). This labor migration tends to be characterized by the immigrationof lower-income workers into higher income economies. (4th ed.). J. Big bills left on the sidewalk: Whysome nations are rich and others poor. Global competitiveness and UnitedStates-EC trade relations. Almost immediately, the Canadian government indicatedthat any free trade agreement between Mexico and the United States wouldaffect Canada, and, thus, Canada should be a party in any free tradediscussions between Mexico and the United States (Krugman, 1993). Ekelund, R. By May 1998, the trading level had increased further to8.68 pesos to one United States dollar ("Emerging Market Indicators,"1998). 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.117). As a consequence of the debt crisis accompanies by capital flight, theMexican government resorted to "inflationary finance"-printing money(Dornbusch & Fischer, 1986, p. 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. The Cobb-Douglas production assumes that the substitution of labor andcapital is technically feasible within an economy. That the NAFTA wasratified in the United States Congress was not an affirmation that theproponents of the agreement were correct and the position of the opponentswas in error. Krugman, P. Economic indicators.Review of the Economic Situation of Mexico, 9, 3-61. New York:HarperCollins Publishers. In effect,the Heckscher-Ohlin theory explains why the theory of comparative advantageis valid. (1996, Spring). 11 -132). M. P. In the absence of that rescue package, it isdifficult to speculate on just how devastating the effects on the Mexicaneconomy and Mexican society might have been. 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. But Mexico's new economic system showed itself to bepowerless in the face of external factors beyond its control" (Naim, 1995,p. The NAFTA Early in 199 , the governments of both Mexico and the United Statesbegan to speak openly and favorably toward the idea of free trade betweenthe two countries. The peso appears to be stabilizing, but at a level far higher thanthe trading level that prevailed prior to the late-1994 financial crash. One suggested solution to the problem of surplus human capital is theimplementation of policies that permit the free movement of human capitalacross national borders. 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. Investment poured into these nations, allowing their leaders to pursue economic reforms. Rapaczynski, A. Thesepolicies are related to the type of monetary and fiscal programs pursued bythe countries concerned, the ability of the leaders of a country tostimulate domestic savings, and the ability of the monetary and fiscalmanagers within a country to control the level of domestic price inflation. 112). The theory of comparative advantageholds that mutually advantageous trade between countries will always beavailable, because trade patterns will be based on relative prices, asopposed to absolute prices, which is based on the theory of absoluteadvantage, wherein mutually advantageous trade between countries might notalways be possible (Walther, 1997). (1993). Emerging market indicators: Mexico. 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. (1998, May 9). The reason for this apparent anomaly wasthe financial rescue package for Mexico that was structured by the UnitedStates (Naim, 1995). Labor The Heckscher-Ohlin theory holds that a country will tend to exportthe commodities that use relatively more of the factors of production whichare relatively more abundant in that country. The Mexican financial collapse of late-1994, indeed, took the worldby surprise. Bycontrast, proponents portrayed the NAFTA as the white knight that wouldlead to American economy to unprecedented growth. (1993). The Mexican crisis showed that the prospect of high yields rather than prudence motivated this internationalization. (1995, Summer). References Banco Nacional de Mexico. The Mexican peso has taken a beating in the wake of the late-1994financial crash in the country. (1997). As a result some retrenchment in emerging nations for the rest of the decade can be expected (p. Dutch tulips and emerging markets.Foreign Affairs, 74, 28-44. Chiswick (1993) contended that the immigration of low-skilled laborinto a country need not harm the low-income labor already resident in thereceiving country if a benign income transfer system subsidises any incomelosses suffered by the resident low-skilled labor while simultaneouslymaintaining the level of income for resident high-skilled labor. 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. International Trade As An Explanation for Differentials in Per Capita Gross Domestic Product in Mexico and the United States The basic model of international trade is structured around theconcept of comparative advantage. The NAFTA permits American and Canadian firms in large number torelocate their production facilities in Mexico to take advantage of lowercosts of production-primarily lower labor costs. (1991). OECDObserver, 11-14. (1996, Spring). While this solution is sound, it a difficult oneupon which to gain widespread agreement. 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. Incidence theory, specific-factors and the augmented Heckscher-Ohlin model. London: TheMacmillan Press, Ltd. Foreign Policy, 112-13 . T., & Stone, G. As a consequence, real wage levels decreased by 4 percent (Dornbusch &Fischer, 1986). (1997, February). For most developing countries, thistheory posited that skilled labor income would suffer to a greater extentthat would unskilled labor income in the wake of freer trade.
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