A decade's prosperity may fall by wayside in Mexico.

At a private dinner just over a year into his presidency, Carlos Salinas stunned 10 of Mexico's top industrialists by announcing his intention to dismantle trade and investment barriers protecting their companies from U.S. rivals.

"The initial reaction was one of panic," said Eugenio Clariond, chairman of steelmaker Grupo IMSA SA, who attended the March 1990 dinner in the industrial city of Monterrey. "How in the world were we going to compete with the U.S.?"

Competing with the U.S. turned out to be easy. The North American Free Trade Agreement that took effect less than four years after the Monterrey dinner led to a tripling of Mexico's non-oil exports, to $150 billion, and a 27 percent rise in gross domestic product. Mexico has catapulted past Spain to become the world's biggest Spanish-speaking economy. Clariond's company this year expects to double sales from pre-Nafta levels to $3 billion, of which half will be in the U.S.

Now, with costs rising and lower-wage countries such as China luring away investment, Mexico may have squandered the opportunity of a decade of prosperity afforded by Nafta. By many accounts, it has failed to spend on education, cut bureaucracy, boost energy production or create a more skilled labor force.

"Mexico's comparative advantages under Nafta are eroding, because of rigidity against change, because of lack of reforms, because other countries are signing their own free Wade agreements," said Serra Puche, a Yale University-trained economist who now runs a consulting company in Mexico City.

The nation's $600 billion economy has languished this year as a recovery takes hold in the U.S., the buyer of 85 percent of Mexican exports. In October, Mexico halved its 2003 economic growth forecast to 1.5 percent, the country is running a trade deficit for a sixth year.

President Vicente Fox's efforts to push through legislation to open electricity and oil production to foreign investment, ease laws on hiring and firing workers, and boost tax collection have stalled in Congress because of opposition from the Institutional Revolutionary Party, which ruled for 71 years before Fox's election in 2000.

"The challenge was for Mexico to move to the next level and it hasn't happened," said Riordan Roett, who directs the Western Hemisphere Program at Johns Hopkins University. "They are looking at three more years of stagnation. Mexico is losing ground."

Mexico's biggest glassmaker, Vitro SA, turns off factory lights during peak electricity consumption hours to reduce costs. Power for construction and automobile glass plants is more expensive than ever, says Chief Executive Federico Sada.

Petroleos Mexicanos, the state oil monopoly, says it lacks the funds to develop the nation's natural gas fields and instead relies on imports that cost more than twice as much as domestic gas to meet demand from generators and factories. The Energy Ministry says the country needs to invest $50 billion over the next 10 years to avoid power shortages.

Companies also pay four times more per local telephone call in Mexico than their counterparts in Brazil, according to the Yankee Group.

Credit shortage

Protected by import tariffs of as much as 27 percent, many of Mexico's top industrialists had prospered under a government policy to substitute foreign-made goods with local products. In the 1980s, Vitro had 29 business divisions. Steelmaker IMSA also milled wheat flour and manufactured men's clothes, baby strollers and furniture.

To prepare for free trade and boost efficiency, Vitro, Cemex, IMSA and other industrial groups sacked workers and invested in technology. In the early 1980s, as much as 30 percent of the glass produced by Vitro had imperfections compared with 5 percent now.

After the country devalued the peso in 1994, causing the banks to collapse and seek a federal bailout, the new Wade links and a U.S.-arranged $50 billion credit line helped restore investors' confidence. Expanding foreign commerce helped Fox become the first opposition candidate to unseat the PRI from the presidency since 1929.

"The banking system, which had been a problem through the 1980s and up through the mid-1990s, has been put in very solid shape," said Citigroup Vice Chairman William Rhodes, who led a committee of banks that rescheduled Mexico's $48 billion of defaulted loans in the 1980s.

Fox's government has trimmed the budget deficit to a third of what it was when he took office, helping push down benchmark lending rates to historic lows. Annual inflation this year fell to a record 4 percent from a high of 180 percent in 1988.

The country, however, now finds itself caught in between two economic dynamics.

A failure to invest in education, transportation, health and other infrastructure is slowing Mexico's advance from dependence on low-wage manufacturing exports.

Mexico spends about 14 percent of its per capita gross domestic product on educating each high school student, compared with 23 percent in the U.S., according to the World Bank.

And thanks to growing competition from China, it is losing the low-wage business as well.

It is in places such as Ciudad Juarez, an industrial center across the border from El Paso, Texas, that the challenges facing Mexico are most apparent. There, Diego Arosemena, a mechanic and would-be line worker in his 30s, has first-hand experience of the country's declining competitiveness.

Arosemena has searched in vain for a job at one of the maquiladoras. The factories, most of them owned by U.S. companies, have shed 275,000 jobs, or 20 percent of their workforces, since October 2000, because of declining U.S. demand and rising competition from China.

Mexico's labor costs climbed about 50 percent in dollar terms as the peso held at about 9.5 per dollar between 1999 and 2002 and inflation accelerated faster than in the United States. Mexican maquiladora workers now are paid about $50 to $75 per week, a third more than their counterparts earn in China.

The economy isn't growing fast enough to generate sufficient jobs to employ the 900,000 Mexicans entering the workforce each year.

"If throughout the next year we don't see any progress in the reforms and if demand in the U.S. doesn't pick up, the outlook for Mexico may start to change," said Roberto Sanchez-Dahl, who manages emerging-market fixed-income investments for Federated Investors Inc.