Previously, Mexico attempted to keep its distance from the United States. Since the resolution of the 1980s’ debt crisis, however, Mexico has instead embraced the advantages of its large neighbor. There are signs that this strategy may be starting to pay off.
That the Mexican economy is very closely tied to its northern neighbor is not news. Lately, this “not-news” has been both good and bad: bad because disappointing growth in the United States has translated into disappointing growth in Mexico; good because Mexico still has an advantage over other emerging economies. Similar economies that are more closely tied to Europe have had to cope with European stagnation, and many other resource-dependent economies—including other countries in Latin America—have felt the recent Chinese slowdown. In contrast, the United States has remained a relatively stable source of economic growth for Mexico.
Since the 1990s, Mexico has traded that cycle for coordination with the US business cycle.
Before the 1990s, Mexico attempted to keep its distance from its neighbor. That was perhaps understandable given the past history of the two countries. But the attempt to “go it alone” in economic growth yielded little beyond some financial crises and an infamous political business cycle. Since the resolution of the 1980s’ debt crisis, Mexico has instead embraced the advantages of its large neighbor. There are some signs that this strategy may be starting to pay off.
The close connection between the two most populous North American economies can be seen starkly in figure 1. Although the common business cycle originates in the United States, Mexican GDP is more volatile than US GDP. It fell more during the two US recessions since 1995 and grew faster during the post 2008–09 recovery. This reflects Mexico’s integration with the US manufacturing sector, which itself is more cyclical than the rest of the US economy.
The common cycle is new. Before the 1990s, the government ramped up spending in the year before each election, and the new president (Mexican presidents serve only one term of six years) then would spend two or three years tamping down spending and trying to get the budget under control. This resulted in a six-year boom-bust cycle patterned after the presidential term, which was completely unconnected to business cycles in the United States.1 Since the 1990s, Mexico has traded that cycle for coordination with the US business cycle.
This makes it seem like Mexico’s relationship with the United States is a choice. In reality, it is a fact of geography that post–World War II Mexican policymakers attempted to ignore for several decades. But Mexicans have finally realized that their fate—like that of the other North American Free Trade Agreement (NAFTA) partner, Canada—is closely connected to that of the United States.
This eventually resulted in Mexico’s adopting a “take your medicine” approach to economic policymaking. Even before the 1994 peso crash (and the US-organized rescue), Mexico had taken a number of steps to move away from its earlier attempt to decouple from the global economy (and the United States). After the passage of NAFTA, Mexican authorities generally attempted to follow the Washington Consensus, although domestic political opposition has slowed reform. This approach stressed liberalizing financial and product markets, making labor markets more flexible, and adopting floating exchange rates. As part of the approach, Mexican authorities considered the country’s proximity to the United States as an opportunity rather than a curse. They began pushing back against the entrenched interests that preferred an isolated, less dynamic country that protected some of its citizens—unionized workers and politically connected businesses, for example—against outside competition.2
Vietnam and India—neither of which has the geographical advantage of Mexico—have seen growth take off (not to even mention China). What is the secret sauce that allowed those countries—with surely just as many fundamental issues as Mexico—to reach such high rates of growth?
Figure 2 shows the disappointing results of Mexico’s reform attempts so far. Mexico is not alone, as Latin American economies in general have done poorly compared with East Asia. Mexicans might wonder why they haven’t seen better results. Vietnam and India—neither of which has the geographical advantage of Mexico—have seen growth take off (not to even mention China). What is the secret sauce that allowed those countries—with surely just as many fundamental issues as Mexico—to reach such high rates of growth? The answer is not clear.
Despite such concerns, Mexican policymakers continue to believe that market-friendly structural changes are the key to long-term prosperity. In 2012, Mexico’s political leaders doubled down. The main political parties agreed on an ambitious framework for modernizing the Mexican economy (the Pacto de México), and Congress has indeed passed a number of broad reforms in areas such as education and telecom.3
Mexican authorities have also adopted responsible monetary and exchange rate policy. Before the reforming spirit took hold in response to the 1980s’ debt crisis, Mexico attempted to maintain a fixed exchange rate. That was to the advantage of Mexican consumers (especially those wealthy enough to afford imported goods), but high inflation in Mexico created a series of currency crises. The 1994 crisis was the last straw. Mexico let the peso float in early 1995. Not long before, the government had given the Bank of Mexico autonomy and a single mandate of keeping inflation in check.
Mexico’s flexible exchange rate helped to mitigate the impact of the US financial crisis and recession. As economists predicted, some of the impact of lower demand in the United States was absorbed by improved Mexican competitiveness as the exchange rate depreciated.
The results of the new monetary policy speak for themselves (figure 3). The exchange rate became more volatile, and the trend has been toward depreciation, as the average dollar/peso rate has more than doubled. But the inflation rate has become less volatile—and much lower. Even better, Mexico’s flexible exchange rate helped to mitigate the impact of the US financial crisis and recession. As economists predicted, some of the impact of lower demand in the United States was absorbed by improved Mexican competitiveness as the exchange rate depreciated.
So it would be wrong to say that the Mexican authorities’ willingness to stick to the path of reform has been fruitless. The turn to an independent monetary policy has been a huge success in eliminating the previous pattern of exchange rate crises and in keeping inflation under control. With luck, the harder-to-implement structural reforms will succeed as well.
Mexico’s GDP growth accelerated a bit in the first quarter, to 0.8 percent for the quarter. That kept up Mexico’s record of consistent economic growth (between 2 and 3 percent) since the second quarter of 2014. It’s an enviable record given the volatility of global financial markets and the changing risks in the global economy over that period. Mexican growth continued at moderate rates even as US growth slowed in Q4 and Q1—although some may say that this supports the hypothesis that US GDP figures suffer from seasonality problems.4 At the same time, Mexico’s inflation remains restrained (also between 2 and 3 percent per year).
The one-two punch of lower oil prices in 2014–15 plus the recent slowdown in US manufacturing has been a formidable drag on the Mexican economy.
Mexicans would, of course, prefer to see higher growth. The one-two punch of lower oil prices in 2014–15 plus the recent slowdown in US manufacturing has been a formidable drag on the Mexican economy. Domestic demand has remained strong enough to keep GDP growing, although the Q1 figures show slower growth in domestic demand as well. Absent a pickup in US growth (and, even better, global growth), Mexico’s economy will eventually slow even more.
Mexico’s long-term problems remain. Productivity growth is slow: The Bank of Mexico estimates that output per worker in manufacturing was virtually unchanged over the past three years. And Mexico’s headlines are still all too often dominated by violence, whether related to teachers’ unions (as happened in June in Oaxaca5) or drug cartels. But the Mexican economy remains vibrant, and Mexican authorities remain committed to market-based reforms.