Mexican Economy After Global Financial Crisis Economics Essay

 From a colonial economy based largely on mining, especially silver, in the twentieth century, the economy has diversified to include strong agriculture, petroleum, and industry sectors. Strong growth from 1940-80 interrupted by series of economic crises, caused in part by massive over borrowing.1980s marked by inflation and lowering standard of living. Austerity measures and introduction of free-market policies led to a period of growth from 1990-94. Membership in North American Free Trade Agreement (NAFTA) in 1993 led to hopes of continued economic growth. However, growing trade deficit and overvalued exchange rate in 1994 financed by sale of short-term bonds and foreign- exchange reserves. Series of political shocks and devaluation of new peso in late 1994 caused investor panic. Inflation soared, and massive foreign intervention was required to stabilize situation. Although overall economy remains fundamentally strong, lack of confidence makes short-term prospects for strong growth unlikely.

Introduction

Mexico has a population of slightly over 100 million people making it the most Populous Spanish-speaking country in the world and the third most populous country in the Western Hemisphere. Based on a gross domestic product (GDP) of $1.167 trillion in 2011 (about six percent of U.S. GDP), Economic conditions in Mexico are important to the United States because of the close trade and investment interactions, and because of other social and political issues that could be affected by economic conditions, such as immigration.

The economy contains rapidly developing modern industrial and service sectors, with increasing private ownership. Recent administrations have expanded competition in ports, railroads, telecommunications, electricity generation, natural gas distribution and airports, with the aim of upgrading infrastructure. As an export-oriented economy, more than 90% of Mexican trade is under free trade agreements (FTAs) with more than 40 countries, including the European Union, Japan, Israel, and much of Central and South America. The most influential FTA is the North American Free Trade Agreement (NAFTA), which came into effect in 1994, and was signed in 1992 by the governments of the United States, Canada and Mexico. In 2006, trade with Mexico’s two northern partners accounted for almost 90% of its exports and 55% of its imports. Recently, the Congress of the Union approved important tax, pension and judicial reforms, and reform to the oil industry is currently being debated.

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The Mexican economy is both complex and very much in transition. There are at least 3 transitions that are worth noting. The first is the economy’s transition from an agricultural economy to an industrial one. In 1940, agriculture accounted for 19 percent of GDP and employed 65 percent of the labor force. However, in 1999 agriculture accounted for 5 percent of GDP and employed 23 percent of the labor force. In contrast, manufacturing and services accounted for 88 percent of GDP in 1999 and employed approximately 70 percent of the labor force. The most important catalyst for such a dramatic change is Mexico’s involvement in World War II in the early 1940s. As a member of the Allies, Mexico began supplying its fellow Allies with war equipment and supplies and, because of the decreased availability of consumer goods from other nations, supplied its own population with consumer goods as well. Since then, both government and private citizens have furthered Mexico’s industrial develop.

1994 Crisis and Recovery

The collapse of the new peso in December 1994 and the ensuing economic crisis caused the economy to contract by an estimated 7 percent during 1995. Investment and consumption both fell sharply, the latter by some 10 percent. Agriculture, livestock, and fishing contracted by 4 percent; mining by 1 percent; manufacturing by 6 percent; construction by 22 percent; and transport, storage, and communications by 2 percent. The only sector to register positive growth was utilities, which expanded by 3 percent.

By 1996 Mexican government and independent analysts saw signs that the country had begun to emerge from its economic recession. The economy contracted by a modest 1 percent during the first quarter of 1996. The Mexican government reported strong growth of 7 percent for the second quarter, and the Union Bank of Switzerland forecast economic growth of 4 percent for all of 1996

Mexican Economy after Global Financial Crisis (2008)

The Mexican economy experienced the most serious decline in economic growth in Latin America after the global financial crisis began in 2008. Mexico’s dependence on manufacturing exports and strong ties to the U.S. economy have made the country very vulnerable to external events and changing economic conditions in the United States. Public sector revenues declined as a result of the crisis, and a number of estimates indicate that Mexico’s gross domestic product (GDP) contracted by 6.6% in 2009. Though GDP is expected to grow in 2010, some economists predict that Mexico’s economy will not return to its pre-crisis level for some time. Although Mexico has done much to modify its economic policy over the last 20 years through trade liberalization, privatization efforts, and a floating exchange rate regime, these policies have not been enough to protect Mexico from fluctuations in the U.S. economy. Many analysts argue that structural weaknesses in the Mexican economy have prevented the country from experiencing higher levels of growth and decreasing its dependence on the U.S. economy.

GDP

The Gross Domestic Product per capita in Mexico was last recorded at 11,55,206 million US dollars in 2011, when adjusted by purchasing power parity. It is equivalent to 70% of the world’s average and it is recorded by the World Bank.

Purchasing Power parity GDP is gross domestic product converted to international dollars using purchasing power parity rates. Using PPP basis is more useful when comparing generalized differences in living standards between nations because PPP takes into account the relative cost of living and the inflation rates of the countries, rather than using just exchange rates which may distort the real differences in income.

http://www.tradingeconomics.com/charts/mexico-gdp-per-capita-ppp.png?s=mexnygdppcapppcd

Mexico’s GDP per Capital is only $15,000 as compared with the U.S. of $49,000 per Capita.

People in Mexico are working for $2/hr. They have a sub industrial economy where many grow their own food because they cannot afford to buy food, because over 50% of the households do not earn enough money to buy food. They have to grow their own food in this subsistence life style because there are no jobs. Thus, since they are not looking for jobs, because there are no jobs, they are not reported as being unemployed. That does not mean that they do not want a job, they are coming to the U.S. to find work to support their families.

Mexican GDP expanded by 3.9% in real terms in 2011, as compared to 5.5% in 2010. This slackening was primarily due to lower growth in goods and services exports, which increased by 6.7% in real terms (21.7% in 2010) in the face of the slowdown in the world economy and the United States in particular. The rate of import growth also moderated to 6.8%, from 20.5% in 2010. The current account deficit widened slightly to 0.8% of GDP (0.3% in 2010) as the services and income balances turned more sharply negative

Mexico will grow over 3.5% in 2012 thanks to its competitiveness and stability. Mexico’s current GDP growth exceeds the levels seen before the 2009 recession, despite the US recovery not being especially intense. This is due to:

Gains in competitiveness

A domestic scenario of stability with stable inflation and favourable financing conditions that boost domestic demand

.

Inflation

The inflation in Mexico was recorded at 3.57 % in December 2012. Inflation rate in Mexico is reported by Banco De Mexico. Historically, from 1974 until 2012, Mexico inflation rate averaged 27.88% reaching an all-time high of 179.7% in February 1988 and a record low of 2.91% in November, 2005. In Mexico, the inflation rate measures a broad rise or fall in prices that consumers pay for a standard basket of goods.

http://www.aboutinflation.com/_/rsrc/1320230293452/inflation-rate-historical/mexico-inflation-rate-historical-chart/Mexico_Inflation_Rate_Historical_1970_2011.png

Mexico defaulted on its external debt in 1982, and experienced several years of inflation. On 1 January 1993, the Bank of Mexico introduced a new currency, the Nuevo peso which was equal to 1,000 old pesos. Since the Mexico Peso Crisis of 1994 the value of the Mexico peso has plummeted by almost 60%. The government contends that the devaluation was necessary to decrease the account deficit.

Current Scenario

The more volatile prices drop surprisingly and reduce the inflation outlook for 2012:

The fall of corn and wheat prices will moderate food inflation, although the effect will not be as abrupt as the rises were, because of the negative effect of the drought on supply

The slack in the economy offsets the increase in imported goods prices

The current rise in oil prices is only temporary, this means that electricity tariffs will help slow down consumer prices

The probability of inflation remaining within the Central Bank’s target range at the end of 2012 is estimated at 80%, with a 20% probability of it being above 4%.

The probability that inflation will reach end 2012 and 2013 at around 3% (between 2.9% and 3.2%) is of 2% and 20%, respectively. However, it remains on course to convergence, with a probability of 40% that it will settle at a level of between 3.2% and 3.5% in December 2013.

Inflation should fall moderately to levels of between 3% and 4% in 2013.

Unemployment

Unemployment Rate in Mexico decreased to 4.47 percent in December of 2012 from 5.12 percent in November of 2012. Unemployment Rate in Mexico is reported by the National Institute of Statistics In Geography. Historically, from 1994 until 2012, Mexico Unemployment Rate averaged 3.68 Percent reaching an all-time high of 5.93 Percent in May of 2009 and a record low of 2.22 Percent in March of 1997. In Mexico, the unemployment rate measures the number of people actively looking for a job as a percentage of the labour force

Mexico Unemployment Rate

Unemployment in Mexico is becoming more and more troubling, despite the decrease in the rate. Young Mexicans are the segment of the population that is most affected, suffering unemployment rates twice as high as those among adults. Even worse, better-educated professionals have the highest unemployment rate. Government efforts to raise educational levels in order to promote economic development have failed. Some people blame the neo-liberal economic model, claiming it puts too high a priority on price stability, limits investment, restricts wage growth, and makes conditions even more precarious for the unemployed – a situation that has forced the government to permit indiscriminate growth in the informal, underground economy. Still other critics cite increased emigration to the United States as proof of Mexico’s inability to generate the jobs that people demand

In recent months, the Mexican government has announced new labor policy initiatives that are tied to its educational initiatives. The first policy is the National Occupational and Work Survey, which will enable the government to collect detailed data about the changing dynamics of Mexico’s labor market. The survey will enable the government to create parameters for measuring Mexico’s performance against international standards. The second new initiative is the Mexican Observatory of Labor. Using the Internet, this tool will enable the government to track key indicators about 53 professional careers and more than 1,500 job categories. Among other services, the Observatory will also provide advice about career selection and labor market forecasts, sector by sector, for people who look for jobs at employment offices, job fairs and elsewhere.

Effect of Global Financial Crisis (2008) on Employment

Mexico’s labour market conditions deteriorated during the crisis, and unemployment rose to its highest level since 2000. As a result, private consumption and retail sales fell significantly. The unemployment rate in the last quarter of 2009 was by far the highest figure in the past decade. The unemployment problem is more severe in urban areas; with the unemployment rate in large cities reaching 7.6% while that in small communities was only 3.7%.Government data on unemployment may not reflect deeper employment effects because the data include jobs in the informal sector, which are oftentimes very low-paying jobs that have no health or retirement benefits.

The economic crisis has resulted in a shortage of opportunities in the formal economy in Mexico. Mexico’s job market has a large informal sector, and the crisis may have caused a growing trend towards informality and self-employment. The formal sector of the economy contracted after the downturn while the number of jobs in the informal market increased. Informal sector jobs nearly doubled in the third quarter of 2009 when compared to the same period in 2008. One report estimates that 39.3% of the Mexican workforce is in the informal sector and that if workers classified as formal but who receive no health coverage were included, the informality figure would rise to 45.3%.Growth in the informal sector of the economy can present a social problem for the government because workers in the informal sector do not receive the same social benefits as workers in the formal sector. Informal employment tends to be concentrated among poor workers who may not have the ability to save for retirement or for a house, or have health insurance.

Mexico Balance of Trade

Mexico reported a trade deficit equivalent to 806 Million USD in August of 2011. Mexico is the biggest exporter and importer in Latin America. Mexican trade is fully integrated with that of its North American partners. Close to 86% of Mexican exports and 50% of its imports are traded with The United States and Canada. 

U.S.-Mexico: Trade and Investment

The United States is Mexico’s largest trading partner and largest foreign investor. Mexico is the third largest U.S. trading partner after Canada and China, and is the U.S. second largest foreign supplier of petroleum

Much of the U.S. trade with Mexico is in intermediate inputs, which are used to finish U.S. products. The deep integration of the U.S. and Mexican economies has resulted in a cross-border production system that enhances the competitiveness of both countries. To put this in perspective, Mexico and the U.S. do as much business in just over a month as Mexico does with all 27 countries of the European Union combined in a year.

In 2009, U.S. goods exports to Mexico were $129 billion and U.S. goods imports from Mexico were $177 billion.

Since NAFTA implementation in 1994, U.S. exports to Mexico have nearly tripled and Mexican exports to the United States have more than quadrupled.

Roughly 80% of Mexico’s total global exports of $230 billion go to the U.S.

More than half of Mexico’s total global imports of $234 billion come from the U.S. and are valued at $129 billion dollars.

In 2009, the U.S. provided up to 80% of all inputs for Mexico’s maquiladora manufacturing and assembly firms, and 90% of all exports from Mexico’s maquiladoras returned to the U.S., translating to over $114 billion in bilateral trade.

Nearly 80% of Mexico’s agricultural imports come from the U.S. with an annual growth rate of almost 9% per year since the beginning of NAFTA.

The U.S. is the largest foreign investor in Mexico, accounting for over 50% of all reported foreign direct investment.

Monetary Policy

Mexico’s monetary policy was revised following the 1994-95 financial crises, when officials decided that maintaining general price stability was the best way to contribute to the sustained growth of employment and economic activity. As a result, Banco de México has as its primary objective maintaining stability in the purchasing power of the peso. It sets an inflation target, which requires it to establish corresponding quantitative targets for the growth of the monetary base and for the expansion of net domestic credit.

The central bank also monitors the evolution of several economic indicators, such as the exchange rate, differences between observed and projected inflation, the results of surveys on the public and specialists’ inflation expectations, revisions on collective employment contracts, producer prices, and the balances of the current and capital accounts.

A debate continues over whether Mexico should switch to a US-style interest rate-targeting system. Government officials in favour of a change say that the new system would give them more control over interest rates, which are becoming more important as consumer credit levels rise.

Until 2008, Mexico used a unique system, amongst the OECD countries, to control inflation in a mechanism known as the corto, a mechanism that allowed the central bank to influence market interest rates by leaving the banking system short of its daily demand for money by a predetermined amount. If the central bank wanted to push interest rates higher, it increased the corto. If it wished to lower interest rates, it decreased the corto.

The minutes from the last monetary policy meeting reflect intense debate on the

Appropriateness of a lending rate cut. The lending rate was maintained unchanged at 4.5%, and a less accommodative tone was adopted. The debate on the need to reduce the rate will continue into the forthcoming meetings. Therefore, the rates are likely to be cut in the future.

Monetary Policy Strategy over the Last Years:

(1995-1996) Containment of inflationary pressures from crisis. Reestablishing orderly market conditions.

(1997-1998) Monetary Policy becomes nominal anchor. Use of “Corto”

Fiscal Policy

With slow growth and high inequality Mexico needs investments in infrastructure, education and social policies. Mexico has increased spending in all of these areas. This was easily financed thanks to fiscal reforms in 2007 and 2009 as well as high oil prices in recent years. Oil revenues, which account for around one third of budgetary receipts, are highly volatile, especially due to price movements, and the prospects for production are uncertain, even though less so than in previous years. Mexico has the lowest tax revenues as a share of GDP in the OECD and much of Latin America, even when oil-related revenues are included. The government should improve the efficiency of its public spending. Mexico spends significant sums on energy subsidies, which are in large part captured by higher-income groups. Moreover, these subsidies are not in line with Mexico’s ambitious goals to reduce greenhouse gas (GHG) emissions. These subsidies should be gradually withdrawn in line with the government’s goals. Extending cash benefits to the poor instead would be much more efficient to fight poverty and help citizens and the economy as a whole to buffer income shocks. Agricultural spending should be re-structured to finance more investment in public goods and less support for producers, which has proven ineffective in increasing agricultural productivity. Broadening the tax base by withdrawing some of the most distortive tax expenditures would make an important contribution to strengthen revenues. This would also help make the tax system simpler, thus reducing compliance costs as well as opportunities for tax avoidance and evasion. Efforts to enhance tax enforcement should continue.

Tax Reforms

The proposed tax reform seeks to increase revenues from all sources, in order to minimize distortions in any one sector and favors consumption taxes:

Excise taxes: new excise on telecommunication services; increases in revenues from tobacco, beer, alcoholic beverages, and games and lotteries.

Income taxes: limitation to tax consolidation, increase in the corporate rate and individuals in high income brackets, increase in IDE rate and reduction in the exempt level of monthly cash deposits.

Consumption taxes: new contribution of 2% on sales of all goods and services, except for exports. The contribution has a cash base, and it applies to all

Conclusion

Prudent Polices have allowed Mexico to continue strengthening its macroeconomic position despite global tensions, Growth is holding up, supported by sound policy management and improved international competitiveness.

In the absence of significant fiscal, financial and external imbalances, the role of the exchange rate as a shock absorber has helped to shore up stability. After several years under a free-floating foreign exchange regime, predictable fiscal policy and stable prices, Mexicans have learned to deal with exchange rate fluctuations.

While a number of supply shocks led inflation to breach the target ceiling, core inflation is expected to remain well contained as a result of moderate wage demands, renewed peso appreciation pressures and a low for longer monetary policy stance in the U.S, Mexico’s largest trading partner. Enhance credibility has made it easier for the central bank to affect the term structure of interest rates, anchor inflation expectations and limit second round effects.

Despite robust macroeconomic performance in recent years, Mexico’s trend growth remains around 3.5%, one of the lowest rates in the region. The main challenge would be to increase it.