Treasury Policy Is Wrong on Mexico : Aim for Long-Term Stability, Not Immediate Debt Payment

At a critical juncture in Mexico’s precarious effort at economic and political consolidation, our Treasury’s debt strategy amounts to nothing short of a U.S. foreign-policy disaster in our relationship with Mexico. The Treasury clings to a strategy of recovering maximum interest payments. For now, Mexico ought to hang on to every penny that it has in reserve. Yet our Treasury proposes a depletion of Mexican coffers to muster debt service on a scale and timetable that are bound to set off another wave of capital flight. This policy, in effect, is provoking a bank run on Mexico.

Over the past few years Mexico has implemented a draconian adjustment plan. Unlike the United States, it has balanced its budget. The non-interest budget has been shifted from a deficit of 6% in 1980-82 to a surplus of 6% today. Taxes are up, and subsidies are down. Inflation has been reduced from near 300% levels to only 20%. Restructuring of state enterprises has led to the sale or closing of more than 400 firms, and more are to come. Therewas a lot of fat and meat, but now Mexico is coming close to the bone.

Of course, the immediate price of all these adjustments has been awesome: The real wage is only half what it was in the early 1980s, and per-capita income has fallen by 15%. Public-sector infrastructure investment has fallen to half the level of the early ‘80s. And, with no growth in the economy, the rapidly rising labor force has not found legitimate employment; in consequence, the underground economy and migration to the United States have mushroomed.

All of this adjusting has been the down payment on a return to stability and high growth that Mexico has known in the past, before oil made the country rich too fast. Mexican policy-makers have been at work trying to bring back these conditions by budget cutting and modernization. They are doing pretty unusual things, from import liberalization and deregulation to putting rich people into jail for not paying taxes.

Unfortunately, major adjustment programs like the one that Mexico has been pursuing are extremely vulnerable to populism. Austerity is pervasive, and the recovery of employment is painfully slow. All the costs are up front, and the benefits --growth, financial stability, confidence--come only in time. Hence the outcry for public-sector spending programs and a reversal of reforms. The opposition has an easy time calling on the government to roll back austerity and modernization and to pursue growth the old way by public spending and increased real wages. Populism has added appeal because Mexico collaborated with the creditors and demonstrated its continued willingness to make large interest payments abroad. This lays the government open to the charge of destroying living standards at home for the benefit of bankers abroad--not an inconsequential charge against a government that is trying to establish political legitimacy in the aftermath of hotly contested elections.

At issue now is the extent of Mexican debt service this year and in the near future, not unconditional debt forgiveness. Mexico has asked to reduce debt service to one-third, with the remainder deferred or reduced under one of the widely discussed schemes of debt reduction or credit enhancement. The Treasury wants Mexico to pay on a scale no longer feasible. The fall in oil prices and the dramatic import liberalization have eaten up a $10-billion trade surplus that used to cover interest payments.

Rather than giving Mexico time to consolidate, our Treasury is recommending even more adjustment. Mexico is told to devalue the peso again, in the middle of a stabilization program of wage agreements centered on a policy of no further devaluation and real wage cutting. Devaluation would be an open provocation to labor, forcing them to break the agreements and support opposition leader Cuauhtemoc Cardenas in a general strike. Our Treasury also advises Mexico to finance interest payments by attracting back flight capital through a policy of high interest rates above the 40% real interest already in place. The money might come back, but investment and growth would certainly not return.

At issue, then, is a question of priorities: What matters more, a couple of years of Mexican stability--enough to restore economic and political confidence and with that a reflow of capital--or the immediate payment of interest? The Salinas government cannot and should not adopt devaluation and even higher interest policies, but by our attitude it may well be forced into confrontation and moratorium.

Our Treasury has no idea of how to handle Mexico’s creditors, and responds by shoving all the problems onto the debtor’s back. Mexico has been the bright spot, and now the Treasury in its incompetence is forcing it to join the ranks of Argentina, Brazil, Peru and Venezuela, where populism is winning the day. The Treasury has stayed away from initiatives on debt to avoid setting precedents. But this is the time to single out countries like Mexico that do adjust and show that they can count on our support to tide them over at a critical juncture. Countries that liberalize imports at our urging, and thus help us export more, should be able to count on flexible and timely help to sustain their reform. If that assurance cannot be given, why would countries risk the difficult route of adjustment rather than give in to easy populism?

The Mexico issue today has nothing to do with pervasive Third World debt relief or doing good for the poor. This is hard-nosed self-interest, because Mexico today is a U.S. national-security issue. Our bungling on Mexico is rapidly reversing the good will created by the early meeting of George Bush and Carlos Salinas de Gortari in Houston last fall. President Bush must take over before our insensitivity destabilizes Mexico’s economic program, and with it political stability on our frontier.