MexECON Blog

Six Lessons Mexico Could Teach the Europeans

We live in interesting times, and much of the conventional wisdom of the past no longer seems to hold.  One idea that seems to have been proven wrong is that the large, rich, well-developed countries of the West are always more stable and better governed that the so-called "emerging markets."  In fact, it now looks like many less-developed countries, including Mexico, have a thing or two to teach the developed countries, particularly the Europeans.

If you objectively compare Mexico's recent economic performance to that of Europe, the idea makes a lot of sense.  Mexican gross domestic product (GDP) has been growing unusually fast - 4.5% year-over-year in the third quarter - and the expansion is now very broad-based.  Mexico's trade balance has shown a surplus in five of the last thirteen months, after years of perennial deficits.  Industrial production is on the upswing, unemployment is falling gradually, and now personal consumption and investment have replaced trade as the main source of economic growth.

Just as important, Mexican stability indicators are enviable.  Consumer inflation is approximately 3.0%, in part because the Mexican government has kept its fiscal deficits modest and Banco de México has prioritized keeping a lid on prices.  The banking sector is relatively healthy, and capital inflows are strong.

In this context, here are several lessons that the Europeans could learn from Mexico:

1) Less-developed countries need a flexible exchange rate.  Over the last couple of decades, the Mexican peso has periodically lost significant value.  While this has often been traumatic, as after the Tequila Crisis of 1995, it also helped the Mexican economy regain its export competitiveness in relatively short order.  Whatever the pretensions of poorer European countries such as Greece and Portugal, their economies, in many respects, are just as uncompetitive as Mexico's.  They are essentially "less-developed countries," and as such, they need a currency that can depreciate in order to make up for their inefficiencies and facilitate exports.

2) Geography and free-trade deals are not enough to ensure prosperity.  Close geographic proximity and free-trade regimes with highly-developed rich countries are clearly not sufficient to ensure that a less-developed country will become prosperous and stable.  After all, Mexico has always been right next door to the highly-developed, rich United States.  And after the implementation of NAFTA in 1995, it gained tariff-free access to the U.S. market for a wide range of products.  And yet, the country still suffered relatively slow growth and a volatile economy until the recent past.  For the less-developed European countries, therefore, close proximity and free trade with countries such as Germany and France are no substitute for policies that support domestic innovation, competitiveness, and stability.

3) Fiscal discipline has to be a top priority.  For years, Mexico's tax revenues have hovered only slightly above 20% of GDP, versus 30% or so in the United States and 40%, 50%, or more in many European countries.  Despite the minimal tax take, however, Mexico has maintained tiny fiscal deficits of about 2% or 3% of GDP.  In other words, the Mexican government has learned to live within its means.  This wisdom was born of the painful experience of capital flight and financial crises in the past, when international investors lost faith in Mexico.  Now, much of Europe is learning the same lesson.  If tax evasion and narrow tax bases are big problems for countries such as Greece, Portugal, Spain, and Italy, the answer is to spend less, not borrow more.

4) High debts eventually scare off foreign capital.  In recent years, Mexico's net central government debt has been kept to a modest 35% of GDP or so, compared with towering levels of 100% or more in many European countries.  For large, sophisticated, advanced countries with reserve currencies (such as the United States), debt levels can get quite high before investors begin to get nervous.  Not so for less-developed countries.  In the early years of the Euro, many less-developed EU countries were temporarily treated like large, sophisticated, advanced countries, but now the truth is out:  Greece, Portugal, Spain, Italy, etc. are not so stable after all.  No one wants to buy their debt.  And no one would want to buy their debt unless it was much, much smaller than it is today.

5) Low labor costs can be essential to growth.  One little-noticed change in global economics since 2005 has been the relative rise in Chinese labor costs.  Indeed, wage rates in China have skyrocketed.  In contrast, Mexican labor costs have been well contained, and businesses have responded by "near-sourcing" more production for the U.S. market to Mexico from Asia.  Sadly, once the less-developed countries on Europe's periphery joined the Euro Zone, their wage rates also started to climb toward those of Germany, even though their productivity was not rising fast enough to make up for the higher costs.  With higher costs and limited productivity gains, economic growth was not nearly strong enough to generate the tax revenues needed to pay for those countries' high spending.

6) Unified policymaking is essential.  Even though Mexico has undergone significant economic and financial crises in recent decades, its government has generally responded forcefully.  Among other important measures, it has adopted free-trade agreements with dozens of countries, let its currency float freely, allowed foreigners to invest in banks and many other industries, and adopted healthy fiscal and monetary policies.  Mexico still has much work to do, such as de-monopolizing the economy, deregulating, opening up the energy sector to private investment, and fighting corruption, but its reforms over the last couple of decades should be applauded.  In contrast, the Europeans seem to have no mechanism to overcome the deep political differences among themselves.  This probably should be no surprise.  The impetus for the European Union was to short-circuit the Europeans' perennial political differences that led to two world wars and millions of deaths in the 20th century.  Those political differences are long-lived and deep, and the EU experiment simply has not gone far enough to end them.  The truly worst-case scenario for Europe now is that the whole EU edifice could come crashing down, leaving the various countries to once again look out only for themselves and quite possibly leading to a new period of European wars at some point in the future (if it happened in the past, it could happen again).  If the Europeans can't overcome their differences and can't emulate the positive policy responses that even lowly Mexico has been able to achieve in response to its crises, then we will all see even more volatility, angst, and risk out of Europe.

Patrick Fearon, CFA
Vice President, Fund Management

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