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Stabilization, efficiency and the development of a North American Free Trade Agreement.

The 1980s were a difficult decade for Mexico. On one hand, macroeconomic instability, fundamentally caused by iii-conceived policies that favoured consumption over saving, and unexpected external shocks, such as increasing real interest rates and the collapse of many commodity prices, engulfed the country in a vicious cycle of high inflation and low output.

On the other hand, oversized and outdated government structures inhibited efficient economic performance. The public sector became more and more involved in the national economy. State enterprises, many of which had no incentive for efficient operation, multiplied themselves. Protectionist trade policies delayed industrial modernization. Regulatory obstacles caused supply bottlenecks, increased production costs unnecessarily, and propitiated corruption. All in all, microeconomic inefficiency put most Mexican industries out of international competition.

Clearly, the prospects for growth could not improve by doing more of the same. An overhaul of the economy was necessary in order to create the necessary competitiveness for a stable and sustained recovery.

The new Mexican economic model is based on two basic principles that provide internal consistency to the program: (1) Policies are designed to consolidate macroeconomic stability; and (2) efficient resource allocation is promoted through microeconomic policies that facilitate market guidance.


Macro policy is designed to assure sustained price stability, which means domestic inflation rates similar to those of the principal trading partners of the country. After several years of rising inflation rates and with the economy on the brink of hyperinflation, the Mexican government sponsored a comprehensive antiinflationary program, known as the Pacto.

Pacto rests on strong macroeconomic foundations: strict fiscal discipline, which has produced the largest budget surplus in Mexico's modern history; successful renegotiation of foreign debt, which has eliminated the problem of overhang; and an open trade regime, which has allowed an effective arbitrage of international prices.


The second pillar of the Mexican program is microeconomic modernization. Low inflation is a necessary condition for growth, but it is also crucial to complement the macroeconomic stabilization program with a strategy to achieve microeconomic efficiency, in order to increase productivity and improve overall market performance.

All over the world, regardless of the ideoIogical origins of government systems, economies are being reformed and adapted to market rules of global competition and interdependence. In this spirit, the Mexican government has based its microeconomic policies on the following strategies: open trade and foreign investment regimes, deregulation, technological innovation and export promotion.

Trade Policy: Opening Up the Economy

Trade policy has evolved from a discretionary system based on import permits and quotas to a general system based, fundamentally, on tariffs. Trade reforms have radically transformed price formation mechanisms in Mexico. From a closed economy, in which domestic prices were basically independent of international arbitrage, we became one of the most open economies in the world, in which protection-based rents have been eliminated by the effective influence of international prices on the domestic economy.

Today, in fact, import permits regulate less than 2 percent of all tariff items. The rest of the schedule has been liberalized. Furthermore, the structure of protection has been rationalized; today, the maximum import tariff is 20 percent and the average weighted tariff is less than 10 percent.

Due to trade reforms, productive resources have been reallocated towards those sectors with higher returns. Firms have access to industrial inputs at international prices and levels of quality, and they have also rationalized their production lines. All this has resulted in a more efficient economy, one which no longer biases economic decisions in favor of the importable goods sector at the expense of the exportable goods sector. The outward orientation of the economy explains why Mexican nonoil exports, in dollar terms, have quadrupled in the past nine years. Mexico ranks today among the first twenty exporting countries that are members of the GAT[

Foreign Investment

Along with trade policy, foreign investment is another key element for internationalizing the economy. Foreign investment is often concomitant with the adoption of new technologies, innovative market strategies, and efficient management techniques. It can be combined with private domestic savings to provide a healthy financial base for many private sector projects. It is a source of domestic employment, not only through direct jobs but also by indirect employment effects, and it substantially enhances the export capacity of the economy.

Foreign investors demand a competitive tax system and a clear and consistent regulatory framework. Mexico has moved rapidly in both areas to make them compatible with these demands. On one hand, tax rates today are competitive with those in the United States. On the other, the new regulatory framework, published in 1989, allows for up to 100 percent foreign ownership in areas that cover more than two-thirds of Mexico's GDP. Together, these two policies explain why foreign investment during 1991 reached $9 billion and set a new historical record.


The objective of Mexico's deregulation program is to eliminate barriers to entry, reducing the cost of doing business and enhancing the efficiency of the economy. As long as an economy remains overregulated, it cannot reap the full benefits of trade liberalization.

One crucial sector for export promotion that has been substantially deregulated, for example, is transportation. It is estimated that the annual consumer loss in Mexico due to the previous licensing requirements in the freight trucking sector amounted to about 0.5 percent of GDP. Today, the trucking sector has been completely deregulated, rates have declined up to 30 percent, and free competition is benefitting producers and consumers alike.

Other areas that have been deregulated are petrochemicals, telecommunications, fish-farming, agricultural exports and domestic commerce.

Technological Innovation

Today, the role of technology is crucial in the formation of competitive advantage. Outdated production strategies, due to technological weakness, have been recently identified as a fundamental cause of loss of productivity. This is true not only in countries like Mexico, but in advanced nations as well. Technologies, however, need not be pathbreaking in every sector of an economy; for Mexico, a labor abundant country, this strategy would be too costly. Instead, Mexico needs "appropriate" technologies, which means technologies suited to the comparative advantage of each sector and of the economy in general.

Deregulation of the transfer of technology facilitates necessary technological change, by letting companies freely choose their own technology at the most appropriate contractual terms. Concomitantly, adequate protection to intellectual property rights is considered as a priority, because this is the only way to propitiate investments permanently. In 1991, the Mexican Congress approved a new law that modified the legal framework that protects industrial property, in order to offer a similar protection to that given in advanced nations.

Export Promotion

In an open trade regime, resource allocation benefits the exportable goods sector and production plans are rationalized so that industries can fury exploit their economies of scale and are able to specialize. This, in itself, provides a solid support for the expansion of exports. In today's increasingly competitive and interdependent world, nonetheless, an effective export promotion strategy also requires adequate and permanent external market access.

In Mexico, our participation in multilateral and bilateral trade negotiations is designed to guarantee such access. Our negotiations aim for reciprocity; proper recognition for unilateral trade liberalization is essential so Mexican exporters can develop multiannual investment projects. On the multilateral front, the facts are clear enough. Mexico is one of the few countries that has consolidated the entire tariff structure; our present tariffs, moreover, are well below the consolidated level that we have committed to the GATt. On the bilateral front, a crucial issue is multinational trade areas. Given the global tendency, Mexico intends to enter into bilateral agreements that ensure export niches in foreign markets based on the Mexican economy's comparative advantages.

In this context, trade relations with North America have a special significance. Presently, over two-thirds of Mexico's foreign trade and investment flows involve the United States and Canada. However, North American trade relations can improve substantially. Currently, tariff and nontariff barriers, uncertainty in the application of the Generalized System of Preferences and unilateral measures affect each other's markets access. Mexico is not benefitting totally from the larger American market and the United States and Canada are not reaping the benefits derived from the high propensity of Mexican consumers to buy North American goods.


The establishment of a North American Free Trade Zone would solve these and other problems by guaranteeing free market access to all trilateral trade. This is why the governments have initiated negotiations of a comprehensive agreement. There are seven reasons that explain why a Trilateral Free Trade Agreement will be beneficial to the whole region.

1. The complementary nature of our economies will allow the full exploitation of the comparative advantages of each country, as well as more efficient allocation of resources within the region. Each country will be able to concentrate in the production of goods that it can produce more efficiently. A free trade zone will allow our countries to complement our mutual factor endowments, such as natural resources, capital, and labor. Other sources of complementarity are technological know-how and, due to climatological differences, complementary seasonal production patterns of agricultural goods.

2. Geographical proximity will promote free trade. Our exchanges face very low transportation and communications costs; ports in the Pacific and the Atlantic coasts, linked railroads and highways, telecommunications, pipelines and air transportation greatly facilitate the flow of goods between the three countries.

3. Market size is another reason for a Trilateral Free Trade Agreement. Together, our countries represent a market of over 360 million consumers, with a purchasing power of about 6 trillion dollars per year.

4. Economies of scale and scope as well as greater specialization argue for free trade. Access to larger markets will allow producers to reduce average costs per unit of output and obtain a better pricequality ratio for final goods to consumers.

5. An augmented market will create many new business opportunities: new investments for plant expansion and modernization; greater specialization; new products for new markets; increased marketing expertise; increased merger and acquisition activity; and more decisions based on the principle of comparative advantage.

6. Job creation and wider product availability should also result. Free trade will improve regional welfare, because it will not only create job and investment opportunities, but it will also expand the availability of goods to consumers and producers.

7. Regional competition can be met better by free trade. The formation of trade blocks in a world of growing interdependence is a challenge that Canada, United States and Mexico should face together. The creation of a large regional market, greater specialization in industries and increased regional efficiency will allow us to be in a better position to compete successfully with other blocks, such as Europe 1992 and the emerging Pacific Basin conglomerate.

In sum, free trade will create new jobs in the whole region, promote domestic and foreign investment, and facilitate the transfer of technology.


The first issue is related to market access. We are trying to articulate a program to remove barriers in order to guarantee the free flow of goods among the three countries. In order to accomplish this, we are working in some specific aspects, such as duties, other institutional barriers to trade and specific sectoral problems that require ad hoc analyses.

The elimination of trade barriers shall be gradual, in order to achieve the balance that will ensure competitiveness and, simultaneously, prevent traumatic shocks to sectors. Through this formula, we will be able to ensure an effective linkage of the three economies.

The goods that will flow freely in North America must meet certain rules of origin. Hence, we are conducting negotiations with the twofold purpose of avoiding circumventions of goods from third countries and, simultaneously, recognizing that shared production processes are one of the main sources of international competitiveness. Of course, it is not possible to establish a single criterion of origin. The heterogeneity of productive processes make a detailed analysis necessary.

The second topic is related to the rules of trade, including safeguards, subsidies and unfair competition. The purpose of the agreement is to increase the competitiveness of the three countries, but competitiveness would be unattainable in a distorted environment.

The full exercise of sovereignty demands that countries retain the right to impose restrictions in case of exceptional circumstances. In order to guarantee that the application of safeguards will not become a new form of protectionism, it is necessary to formulate clear rules, establish strict temporality and avoid specific discriminations.

Competition is an incentive for productivity. In order to stimulate it, it is necessary to eliminate subsidies to exports, harmonize incentives and improve and homogenize antidumping legislation.

Likewise, issues relative to standards are also part of this topic, because these provisions must not become the pretexts to erect new barriers to trade.

The third topic addresses services. The increased flow of goods among the three countries will necessarily entail greater participation of the tertiary sector in foreign trade activities. The growing importance of freight, insurance, financing, consulting and marketing, among other services, is evident in today's world economy.

In this regard, the negotiation must ensure the whole region's competitiveness. Hence, the liberalization program must be gradual. In order for Mexico to benefit from competitiveness in areas where we have advantages, the full spectrum of services must be included, whether labor or capital intensive.

The fourth topic relates to investment, a key issue in any export-oriented project. Mexico has begun a new era of national and foreign investment promotion, with strict compliance of our constitution, since we are well aware of the intense competition to attract capital that, by definition, is a scarce resource.

With regard to investment policy, Mexico will retain its inalienable right to set its own rules according to the principles of our constitution. Based on this sovereign right, we shall continue to promote investments, setting clear rules of general application, and not discriminating between countries.

The fifth topic addresses the area of intellectual property. The new laws encourage technological innovation, through provisions protecting inventors, especially Mexicans who in the past have had to go abroad to patent their discoveries or innovations. In addition, the new laws promote the transfer of technology and, therefore, greater competitiveness and investment.

The sixth and last topic in the negotiations refers to dispute settlement mechanisms that, in view of the intensity of our relationship, will eventually be necessary. The mechanisms that we will negotiate will have clear rules, will expedite procedures and unbiased instances to provide solutions to problems, and will assure, most of all, that legality will always prevail over arbitrariness.

Dispute settlement mechanisms must include consultation formulas that will help reconcile differences in an amicable way, as well as arbitration procedures, in which decisions will be compulsory for both parties.


In recent years we have witnessed a broad process of change and transformation that has modified the traditional way to perceive relations between nations. President Salinas has stated that "the lesson of our era has been to join efforts to create competitiveness, and that competitiveness is never fixed in the profile of nations; it is forged by the development of talents and promotion of social creativity; it is consolidated through internationalization and not through solitude."

Serious and consistent policies, a strategic 1ocation, a productive labor force and overall comparative advantages make Mexico a competitive economy by international standards. They also make the prospect of a North American Free Trade Zone feasible and potentially profitable to Mexican, Canadian and U.S. investors.

The end result of a successful trilateral negotiation will be increased employment and prosperity in our nations, and a broader participation of our economic agents in world markets. It will also imply a stronger and more competitive North America, with a brighter vision of the future.

Together, Canada, United States and Mexico can begin an era of economic cooperation and mutual development, in which creativity and enterpreneurship will catalyze new trade and investment relations. It is in this context that I see a potential to form a great new partnership for growth.

* Jaime serra Puehe is Secretary of Trade and Industry, Mexico.

This article reviews the nature of the Mexican stabilization and structural adjustment programs, their theoretical foundation, and their implication for stable, long-term growth. This review leads to the conclusion that, due to economic reforms, Mexico, Canada and the United States can use free trade to increase joint output and aggregate welfare.
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Author:Serra Puche, Jaime
Publication:Business Economics
Date:Apr 1, 1992
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