Legal and economic development in Mexico -- El Camino Mexicano de la Transformacion Economica by Pedro Aspe Armella / Migration Impacts of Trade and Foreign Investment edited by Sergio Diaz-Briquets and Sidney Weintraub / and others

FROM THE early 1930s until the early 1380s, Mexico, like 1 any other developing countries, encouraged investment in domestic manufacturing (import substitution), kept agricultural prices down, and expanded the size of its public sector enterprises while attempting, at the same time, to stimulate savings and investment through taxation and credit allocated by the public sector. Restrictions on trade, particularly tariffs and quantitative controls on competing imports, were used to promote domestic production at the expense of export activities.(1) The prevailing view was that a shortage of domestic physical capital was the key impediment to development. Import-substituting industries grew behind protective walls made up of subsidies on the one hand and tariffs on the other in a milieu where many other determinants of the rate of economic growth, such as investment in human capital and the role of microeconomic incentives, were completely ignored by policymakers. This protection of import-substitution industries allowed domestic prices and costs to far exceed international prices and created little incentive for efficiency. However, although these protected industries produced substitutes of goods formerly imported, they usually depended on the import of raw materials and technology to do so. Consequently, the demand for imports grew rapidly as these firms imported capital goods to accelerate investment. The anti-export bias, combined with the import-substitution program, caused foreign exchange to become scarce, and this, in turn, created a structural barrier to the investment in expensive first-rate technology. Nevertheless, within this environment protected from international trade, firms could still survive by investing in second-rate technologies.

This approach to development came to an end in Mexico during the international debt crisis of 1982. Specifically, rising world interest rates and falling oil prices, coupled with the inability of the public sector to react due to its huge fiscal deficits, dealt a final blow to the statist policies Mexico had followed for many decades. At this point, Mexican policymakers realized that internal markets and import substitution alone were not enough to assure economic growth sustainable into the future.(2) The demise of the import-substitution model left Mexico with no other option for economic growth than to break with its earlier policies of protection and state regulation. After some initial modest efforts at liberalization (1983/1984), Mexico began a much more impressive liberalization attempt in July 1985. Its aims were to expand the tradables sector, to open the economy up to international competition, and to encourage efficiency in both exporting and import-competing activities. Through these reforms, Mexico was able to transform i economy from one that was largely closed to one of the most open in Latin America.(3)

The policy alternatives and reform path followed by the Mexican government at different stages of the liberalization program are brilliantly described by Mexican Finance Minister Pedro Aspe Armella in his latest book, entitled El Camino Mexicano de la Transformacion Economica (1993). Pedro Aspe, as a member of an iconoclastic group of Latin American leaders that came to power in the early 1980s, brought a new philosophy to the Mexican public sector. As Finance Minister in the Salinas administration, he also designed an outward-oriented, private-sector-led development strategy. This approach to reform, deepened and strengthened under the presidency of Carlos Salinas de Gortari (who took office in December 1988), contributed to a growing confidence in the Mexican economy, as was demonstrated by sizable inflows of capital and the signing of North American Free Trade Agreement (NAFTA) with the United States and Canada. As a result, the macroeconomic situation has stabilized, leading, at least so far, to a modest recovery in growth.(4)

The key elements in Mexico's reform have been, specifically: fiscal austerity, the opening of the economy, and a changing role for the state within society. The Mexican privatization program has to be viewed as a consequence of a re-evaluation and redefinition of the role of the state. As such, it has been conceived by Aspe not only as the sale of enterprises but also as a way to allow the private sector to participate in activities which had traditionally been reserved exclusively for the public sector. These activities include banking, the construction and operation of roads, airports, water treatment plants, garbage collection and disposal, railway transport, petrochemicals, fertilizers, and many others. In addition, privatization was intended as a mechanism by which to eliminate subsidies and bring market prices more in line with opportunity costs. As a consequence, the Mexican privatization plan is one of the most comprehensive ever implemented by any country. For example, whereas there were 1,155 public enterprises in 1982, there were only 220 by June 1392, just 10 years later. Obviously, this had important implications for the government budget. Transfers to public enterprises were reduced from 3.5% of the gross domestic product (GDP) in 1983 to 1% in 1990. From 1984 to mid-1992, the receipts from privatizations came to $21.9 billion (IMF, 1994: 78-79). As stated, this shift of ownership to private hands has also included the sale of Mexican commercial banks, a process completed in the first half of 1992 as part of the financial reform program. It is also noteworthy that the Salinas administration has resisted the temptation to use the proceeds of these privatizations for current public expenditures. Some of the government statistics presented by Aspe show that most of the process were used for reducing debt, both external and domestic (Aspe and Sigmund, 1984). As a result, the macroeconomic environment that has emerged seems to be relatively stable, supported by a restructuring of Mexico's foreign debt that has not only reduced annual transfers abroad by about $4 billion but has also relieved pressure on the exchange rate (Aspe and Sigmund, 1984). More importantly, the increase in confidence in tandem with the rest of the reform program enabled domestic interest rates to fall by 20 percentage points, while inflation was reduced from 20% (in 1991) and 11.8% (in 1992) to single-digit levels in 1993 (pp. 65-69). In short, the privatization program has produced a threefold set of financial gains: (1) revenues of $21.3 billion, (2) a decrease in government net transfers to state enterprises, and (3 the additional tax revenues (35% of profits) collected from the privatized enterprises (see Miller, 1989).

The fiscal adjustment has also been remarkable. Aspe's description of events further shows that the efficiency of the tax system has been substantially improved. A major tax reform in 1987 expanded the tax base, simplified the tax system, reduced marginal rates, and modernized tax administration. Personal and corporate tax rates have been brought in line with international levels; therefore, one of the main fiscal conditions for a supply-side resurgence has been addressed. At least as important as the revenue-raising objectives of reform were those of reducing the distortionary effects of the tax system and improving equity. As a result, Mexico has acquired an internationally competitive tax system which enhances the efficient allocation of resources (see Gil, 1992: 59-98).

Austerity measures have also been introduced within the government expenditure accounts. Public spending was brought down from 35% of GDP in 1981 to 20% in 1990 (IMF, 1992). These large cuts increased the efficiency of government operations by eliminating most of the dubious, large projects that had been initiated in the late 1970s (IMF, 1992). However, the expenditure on social sectors suffered excessive reduction during the 1982-88 period, particularly if one takes into account the fact that some 25% of the Mexican population still lives below the poverty line of $350 a year (World Bank, 1993). These levels of poverty are clearly unsustainable for any country that hopes to achieve institutional stability. The Salinas administration has recently attempted to deal with this situation, fighting poverty primarily through the use of well-defined economic instruments. Aspe describes how the Programa Nacional de Soldaridad (PRONASOL), initiated in 1988, targets the areas of health, education, nutrition, housing, employment, infrastructure, plus other projects aimed directly at the poor in disadvantaged areas (see pp. 13-61). The PRONASOL budget has tripled since its inception: from $500 million in 1989 to more than $1.5 billion in 1992 (pp. 57-59). To this effort must be added food subsidies targeted to both urban and rural areas. It has been estimated that the poverty programs will probably see their budgets increased by 30-40% prior to the presidential election scheduled for August 1994 (EIU, 1994).

Aspe acknowledges the government concern with poverty when he states that:

the experience of the past 25 years in developed countries shows, however, that unequal distribution of income and wealth did not translate into an accelerated and sustainable economic growth but, as shown in recent studies, the countries with the worst distribution of income have experienced a slower economic growth on average and have also been more vulnerable to external economic shocks. . . . he adds later that] Mexico can be considered as one of he cases where a regressive distribution of income has been associated with poor performance in terms of economic growth (pp. 57-58).

According to Aspe, political support for the unprecedented stabilization effort and reform process has played an important role (see Chapter 1). This political support could only be forthcoming by means of a broad societal coalition. In fact, the Salinas administration has forged and periodically renewed important coalitions under a pact, Pacto de Soliaridad Economica, which was originally negotiated among the main political parties, labor unions, and business leaders in 1987. Despite its effectiveness, the Pacto, now in its seventh phase (October 1992 to December 1993), has begun to witness various signs of social conflict, including most notably the uprising in Chiapas and the assassination of a presidential candidate (Donaldo Colosio) as well as a spate of kidnappings of several prominent and well-known business leaders. Policymakers urgently need to draw lessons from this latest phase of the social pact and ponder their possible implications for economic stability.

A detailed analysis of the society and its pressures would seem to suggest that perhaps the Pacto needs to be extended to encompass those groups that have thus far been left outside the current power structure. These groups -- composed mainly of campesinos in marginal regions, leaders of unions and industry who feel threatened by the economic opening as well as disenchanted intellectuals -- have frequently resorted to extra-legal means of confrontation, viewing such acts as their only way to resolve disputes or draw attention to their needs. These unfortunate events indicate, among their other lessons, that one of Mexico's more pressing needs is for some kind of legal reform that will provide clear, predictable, and accessible mechanisms by which those with grievances can seek to redress grievances. A close examination of Mexico's legal environment shows that, at present, resolving disputes through the courts is a lengthy, costly, and unpredictable process due mostly to: (a) abuse of judicial procedures now employed for the resolution of civil and commercial disputes, (b) a lack of confidence in the state court system, (c) a huge backlog of civil and commercial cases, and (d) an arcane system for the administration of the courts (for more details, see Sunstein, 1993). In order to avoid social conflict and promote economic development at the same time, courts must be empowered to play a vital role in ensuring that laws, regulations, and private agreements are applied in a manner both predictable and coherent. Most importantly, it is necessary to build consensus among the judiciary (and also within the executive and legislative branches of government at both federal and state levels) regarding the relevance and importance of judicial reform.(5) In this improved context, the Mexican Constitution would establish the general legal framework for development of the private sector and protection of foreign investment.

For example, the Salinas administration has started a profound transformation of the agricultural sector. The system, created after the Mexican Revolution of 1910-17 focused upon the communal ownership of land and heavy government intervention in setting prices, both input and output, to the extent that the latter failed to reflect relative scarcities (Otero, 1989). The system was further distorted by the government's control of agricultural marketing and subsidized credit. In November 1991, the government announced the end of the land redistribution program initiated after the revolution and proposed a modification of the constitution to allow -- but not require -- the sale and leasing of ejidos, or communal lands. Under this new system, farmers were allowed to own land individually with all the rights that this entails. In early 1992, the constitution was amended, and the government issued a new agrarian law, thus creating the legal framework for privatizing ejido lands and ensuring rural property rights. The old law theoretically provided every Mexican with the right to land but established restrictions on land use and farm size. Ejido lands could neither be pledged as collateral for credit nor rented or exploited through sharecropping or other tenancy arrangements. These constraints on collateral limited the amount of credit that small farms could receive and thus hampered investment in the agricultural sector. The 1992 amendment, on the other hand, should foster the emergence of a land market, which could, in turn, work to improve productivity and encourage private agricultural investment.

The constitutional reforms sponsored by the Salinas administration firmly defined private property rights to land by abolishing the constitutional obligation to distribute land, while permitting investment, both foreign and domestic, in agriculture. Under the new system, the ejiditarios will have security of tenure and the option of either remaining on communal property or becoming individual proprietors. The agricultural reforms instituted by the Salinas administration have moved toward increasing the reliance on market forces. However, moving towards a market system without addressing the fact that thousands of farmers do not hold formal title to the land they work and consider their own is a recipe for provoking social upheaval. A market system must be founded on the existence of formalized instruments for the exchange of assets such as land. However, a multitude of Mexican families on small farms have not had access to land registries which might have formalized their property rights. This has created the potential For abuse by land speculators strongly supported by local party officials who, under a market system, have expropriated the land from powerless farmers whose property rights are informal at best (Otero, 1989). Expropriation of land at random as well as land speculation have been common in various parts of Mexico, particularly in those places, such as in Chiapas state, where unrest is endemic and outbreaks of violence have occurred (EIU, 1994). These events represent a social threat to the economic reform process in Mexico. Therefore, institutional changes, beginning with a program of effective land titling, must take place soon if private ownership of communally-held land is to become a reality. This would require that a national network of property registries be established at the very beginning stages of the reform process in order to ensure that clear titles are provided to the informal owner/occupiers of the land. In this situation, NAFTA will have far-reaching effects on Mexican agriculture. The transition from the current highly protected system of agriculture to one that is more open could provoke even more disruption and social upheaval if the government does not adopt effective remedial measures in advance of the transition (The Economist, 1993:7).

Internal political and social forces pushed by NAFTA requirements have also been forcing Mexico to reconsider many of its legal institutions. A new role has emerged for the private sector, which together with a vast increase in the international transaction of goods and services, makes it. necessary to define and enforce rights and obligations in areas where gaps still exist. The Salinas government has been a prolific producer of new statutes and regulations affecting important areas of the economy. But much more needs to be done. Specifically, the introduction of legal institutions compatible with a market economy and improvements in the administration of justice ought to be considered as two of the most necessary complements to economic reform. Even though Aspe provides an outstanding inside account of the many political and economic constraints faced by the Salinas administration throughout the reform period, he overlooks any real discussion of the main links between the legal and economic aspects of Mexico's recent history in this study.

Aspe recognizes the fact that an improved regulatory framework and increased confidence have stimulated foreign investment. Deregulation has been extended to industry and transportation, where Mexico's old interventionist industrial policies have been dismantled. Those public enterprises that still remain in public hands are being reformed, including the government monopoly in charge of oil production. But key sectors of the economy, such as financial markets, need regulatory definition. Once again, Aspe remains silent regarding the country's lack of an effective framework to oversee and ensure that financial institutions are backed by an adequate supply of capital. In this situation, the high risk inherent in the portfolio of Mexican banks (a function of the corporate governance that still prevails among the principal domestic business conglomerates) could cause a domestic financial collapse of enormous proportions (The Economist, 1993:78-73). At the same time, many of those large conglomerates are also majority shareholders holding seats on bank boards, which places them in the position of being able to lend to themselves. This leads to a lack of diversification in bank portfolios which the government is unable to detect much less regulate, thus posing a danger to the economy as a whole.

As already mentioned, economic growth has been modest so far. However, in order to make this economic growth strong enough to improve the distribution of income, the social transformation of Mexico should go beyond the purely economic dimension described by Aspe. In the overall social context, legal reform is imperative. Because the core elements of a statutory framework for private business have been in place for many decades,(6) only two more steps need to be taken: (1) federal corporate, commercial, and related laws need to be significantly updated so as to reflect present economic and social realities and (2) there needs to be a coordination of reforms between the federal and state levels of government. For example, because Mexico's present corporate and commercial legal framework impedes access to important forms of credit, it fails to meet the needs of small, medium, and large enterprises. Furthermore, firms do not believe they have access to an impartial, efficient judicial system that can be depended upon to enforce their legal rights. This adds to the time and expense involved in pursuing and enforcing legal rights and contractual obligations and, for this reason, increases the cost of capital invested in long-term projects (see Buscaglia Jr., 1993). In most cases, even when a lender holds a security interest in property owned by a borrower, the slowness of Mexican procedures for repossession of collateral and the existence of dysfunctional courts make it impractical to engage in lending secured by such property except in very exceptional circumstances. Consequently, given the current environment, loans to new enterprises for investment in dynamic areas of the economy are likely to be less desirable assets in the portfolio of financial institutions. This hampers, in turn, the viability of technological improvement (Buscaglia Jr., 1993).

In a related area, laws that define the different forms of business associations are not flexible enough to accommodate the allocation of risks by the parties to an agreement, nor are they reasonably specific so that the rights of parties are sufficiently clear to allow them to assess, in different scenarios, the risks and benefits of participating in a given business. In other words, Mexico's laws respecting the activities of firms have not kept pace with the growing role of the private sector and the increasing role of foreign direct investment which is anticipated as a result of the NAFTA. Additional factors that discourage investment and thus hamper economic growth also occur in situations in which the rights of minority shareholders lack clear definition, even in cases that involve large, well-known, and publicly-held companies. Aspe's work does not analyze or propose much-needed reform of any of these legal matters which have a direct bearing on Mexico's economic stability over the long term.

The failure to recognize that economic and legal development go hand in hand has been widespread among social scientists. For example, increasing the productivity of workers requires much more than the sustained investment in human capital mentioned by Aspe. It also requires the establishment of a transparent, flexible labor market in which firms can exercise considerable discretion in organizing their human resources. Analysis of Mexico's system of labor laws would suggest that its labor market is both restrictive and over-regulated (Porter, 1990). Recent research with a focus upon migration patterns reveals a linkage between a regulatory environment in which firms have but a limited ability to absorb additional workers due to significant costs of dismissal and the increase of emigration. In this regard, most studies conclude that there is no viable alternative to labor market flexibility and economic development that would reduce the flow of Mexican workers into the United States to any significant extent (see Dornbusch, 1988: 231-284).

This also seems to be the main conclusion reached by many of the studies in the volume edited by Sergio Diaz-Briquets and Sidney Weintraub, which is entitled Migration Impact of Trade and Foreign Investment: Mexico and the Caribbean Basin Countries(1991). Diaz-Briquets and Weintraub display n rich statistical and economic analysis which demonstrates how much the external environment affects and is responsible for Mexican development. According to their analysis, the United States needs to resist macroeconomic policies which could slow growth in both Mexico and the United States itself. Thus, stable economic growth in both countries would serve to balance the flows of migratory labor. Additionally, the book forecasts that the importance of Mexico as a source of immigration into the United States may decline in coming decades relative to other countries in the region due to its comparatively more auspicious economic prospects. However, consideration of Mexico's legal framework does not seem to enter into any of their conclusions even though many of the aforementioned aspects of its law and legal system have been seen to play a direct role in the migratory patterns observed in developing countries.(7)

A much richer analysis is provided From an unexpected source. Alexander Monto's The Roots of Mexican Labor Migration is a study in social anthropology that purports to explain the largest circulation of migrants in the world as a consequence of the institutions, formal and informal, that prevail in Mexican society. By asking why migrants make the journey across the border, Monto begins to address many of the legal bottlenecks mentioned in this essay.

Stimulating growth of the Mexican private sector will involve much more than simply maintaining an appropriate macroeconomic policy and launching NAFTA. It will also entail removing some important obstacles to growth. In the case of Mexico, despite a long tradition of private property rights, the legal system does not meet the needs of modern business. Many laws are outdated. The legal sector must focus, among its main strategies, on modernizing the legal framework governing commerce and on improving the mechanism for resolving disputes. Not only has the amount of time and expense involved in enforcing legal rights and contractual obligations become unpredictable, but it has also added transaction costs to the cost of doing business and discouraged actors from entering into arrangements that require long-term investment .

In order to promote stability within Mexican society, improvements in the distribution of income and wealth must be addressed by more than just the government's use of public spending. The legal framework and the administration of justice must also provide the requisite much-needed access to the courts and make enforcement of property rights predictable. Some of the legal mechanisms recommended in this essay would also help ameliorate the unsustainable social conflicts observed in Mexico.

NOTES

1. Prior to import liberalization, several programs were introduced in order to promote exports, of which the most substantial was the maquiladora system. Under this program, components and raw materials needed for operating a maquiladora can be imported duty-free. The finished product is then exported to the United States, with De manufacturer paying tariffs only on the value added in Mexico. In 1991, the maquilas accounted for nearly 16% of employment in manufacturing, while generating exports of over $4 billion (see Krueger, 1988).

2. For a description of this process, see Buscaglia, Jr. (1993).

3. Mexico joined GATT (General Agreement on Tariffs and Trade) in 1986, which added to the credibility of its reform program.

4. Economic growth slowed from roughly 4% between 1989 and the first half of 1991 to around 2.8% in the second half of 1991 and to 2.6% in 132. At present, the rate of growth rate has slowed even more: to approximately 2% during the first quarter of 1994. Some reasons that may explain the decline in growth are explained below (for more details, see the IMF, 1994).

5. Mexico is a federal Republic composed of 31 states and a Federal District. However, the federal government clearly dominates the system. While the Constitution provides that states are "free and sovereign in all that concerns their internal government," the constitutional division oF powers is weighted heavily in favor of the federal government, which is authorized, under certain circumstances, to intervene directly in state affairs. The states are also substantially dependent on the Federal Government for revenues. According to the Constitution, the powers of the federal government are divided into three independent branches: the executive, the legislative, and the judicial. However, they are not evenly balanced. The executive branch functions as the real center of political power. The Congress, composed of the Chamber of Deputies and the Senate, traditionally approves proposals submitted by the president and rarely takes independent action on its own. Though the judiciary enjoys more independence than the Legislature, it too is subordinate to the executive.

6. The essential statutes are provided in the following pieces of legislation: the Code of Commerce of 1870; the General Law on Sociedades Mercantiles of 1934; the Law on Negotiable Instruments and Credit Transactions of 1934; and the Law of Bankruptcy of 1942.

7. For a legal analysis of labor migration, see Bouvier (1992).

REFERENCES

ASPE, P. and P. SIGMUND (eds.) (1984) The Political Economy of Income Distribution in Mexico. New York, NY: Holmes and Meier.

BOUVIER, L. (1992) "Immigration, Population Changes, and Legal Reform," pp. 37-61 in Simcox (ed.) US-Mexico Immigration. Lexington, MA: Praeger Publishers.

BUSCAGLIA, E. (1993) "Law, Technological Progress, and Economic Development" (Hoover Institution Paper in Intentional Studies I-93-5). Stanford, CA: Stanford University International Studies Program.

DORNBUSCH, R. (1988) "Mexico." Economic Policy (October): 231-284.

(The) Economist (1993) Survey of Mexico. No. 326 (12 February): 7.

(The) Economist Intelligence Unit (EIU) (1994) Mexico Country Report (First Quarter). London, England: The Economist Ltd.

GIL, F. (1984) "The Incidence of Taxes in Mexico: A Before and After Comparison," pp. 59-98 in P. Aspe and P. Sigmund (eds.) The Political Economy of Income Distribution in Mexico. New York, NY: Holmes and Meier.

International Monetary Fund (IMF) (1994) IMF Government Statistics. Washington, DC: IMF.

_____ (1992) IMF Government Statistics. Washington, DC: IMF.

KRUEGER, A. (1988) Foreign Trade Regimes and Economic Development: Liberalization Attempts and Consequences. Cambridge, England: Cambridge University Press.

MILLER, V. (1989) Bond Maturity and Inflation Uncertainty: The Case of Mexico. Ph.D. dissertation, Massachusetts Institute of Technology.

OTERO, G. (1989) "Agrarian Reform in Mexico: Capitalism and the State," pp. 82-103 in W. Thiesenhusen (ed.) Searching for Agrarian Reform in Latin America. Winchester, MA: Unwin Hyman Press.

PORTER, M. (1990) The Competitive Advantage of Nations. New York, NY: The Free Press.

SUNSTEIN, C. (1993) "The Constitutional Transition In Latin America,' pp. 103-123 in Stotzky (ed.) Transition to Democracy in Latin America: The Role of the Judiciary. Boulder, CO: Westview Press.

The World Bank (1993) "World Development Indicators" (World Development Report). Washington, DC: Oxford University Press.

Edgardo Buscaglia, Jr. is a Professor of Law and Economics at Washington College. He is the co-founder of the Latin American Law and Economics Association and the Argentine Law and Economics Association. He serves as a consultant for The World Bank and has published numerous articles dealing with law and economics in general, and Argentina in particular. His current research interests include law and economics of development and the political economy of technological innovation.

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