Mexican lessons for Chile
Recent statements from Felipe Larraín, who will be Chile's finance minister from 11 March, when President-elect Sebastián Piñera is inaugurated, show that the assumptions that underpinned the Washington Consensus are still influential.
Larraín and Piñera both appear to believe that the state has become too bloated after 20 years of centre-left Concertación governments in Chile and needs some heavy pruning. Piñera claims that the outgoing President Michelle Bachelet is bequeathing him a fiscal deficit of 4.5% of GDP. Dealing with this, Piñera says, will make 2010 a tough year.
What Piñera ignores is that the economy is in much better shape because the Bachelet government decided to spend the savings it had accumulated in the good times to prevent a bad time becoming a disaster.
What happened in Mexico, where fiscal orthodoxy triumphed, and real GDP contracted 6.5% year-on-year in 2009, should serve as a cautionary tale. To be fair, Mexico's room for fiscal manoeuvre in 2009 was limited by more than economic dogma. Oil production, still a state monopoly after a decade of avowedly right wing governments, continued to fall heavily. As oil provides the government with about 35% of its total revenues, the finance ministry could not afford to gamble on a fiscal stimulus.
What is alarming about Mexico is how even an avowedly pro-business government, which has now been in power for a decade, has failed to do what it proposed to unleash the potential of the Mexican economy. Key indicators show that the country has, on several measures, actually become poorer and weaker since the Partido Acción Nacional came to power.
The rightwing argument, in Mexico, is that the government's decision to give priority to maintaining fiscal stability instead of stimulating the economy will pay off in the long run, though it obviously had damaging short-run effects. We do not believe this argument is sustainable.
What has happened in Mexico has, obviously, huge implications for Chile and Piñera. The Right argues that investment and productivity are the keys to a successful economy. On both scores Mexico's economy has done poorly in recent years. In 2009, private sector investment in Mexico was feeble and Foreign Direct Investment (FDI) fell by 41% according to the latest report by the UN Conference on Trade and Development (Unctad). Unctad said that FDI came to US$13bn in 2009, down from US$21bn in 2008.
Mexico's productivity growth is one of the lowest in the region. According to
the national statistics agency, Inegi, the country's manufacturing productivity
has risen by 23% since 2003, but productivity in Korea increased by 60% in the
same period.
To be fair, FDI has picked up so far in 2010. Not only will the
US$6.7bn take-over of Femsa, a Mexican drinks company, by Heineken, a Dutch
based beer company, boost the overall figure, but two major multinationals have
also committed themselves to Mexico. Nestlé, a Swiss-based confectionery
company, has committed to investing US$400m over the next three years while
HSBC, a UK-based back, will invest US$700m. This is equivalent to a 30% increase
in the bank's capital in Mexico.
What the government and its supporters claim happened in 2009 is not supported by the statistics. Even with the ostensibly hair-shirted approach, the fiscal deficit in 2009 was still M$274.5bn (US$21.1bn) according to the finance ministry. This meant that the deficit was equivalent to 2.3% of GDP. Spending in 2009 set a new record of M$3.09 trillion (US$238.32bn), up 2.2% on 2008. The government increased spending to blunt the effect of the global economic slowdown: even so the economy still contracted a hefty 6.5% in 2009.
The government increased spending by M$218bn (US$16.8bn) in 2009 over 2008. What is worrying is that current spending made up just over two-thirds of this increase, while capital spending went up by just M$76.7bn. There was a 6.5% fall in total government revenues to M$2.81 trillion (US$216.6bn). This fall was the result of a 21% drop in oil revenues and an 11.5% fall in non-oil revenues. Oil revenues fell because of a 38% drop in average export prices (compared with 2008); a 7% fall in production; and a 13% fall in export volumes.
Since 2000, when the supposedly rightwing and hostile-to-big-government Partido Acción Nacional (PAN) came to power, government spending has increased by 64.5% in real (i.e. inflation-adjusted) terms. The government's share of GDP has increased in this period from 22.5% of GDP to 26.1%.
Even more of a concern, is that if oil revenues are stripped out of government revenues, non-oil revenues only just get into double figures in terms of GDP. The PAN government has long proposed fiscal reforms but it has failed to achieve them.
The parallel in Chile is clear, where each year the taxes and profits from the state-owned Corporación del Cobre are equivalent to all other corporate tax revenues paid in Chile. What is worrying in Mexico is that the public debt is starting to rise at double digit rates. In 2009 public debt increased by 10% and now totals US$233.9bn. To be fair the bulk of the debt is peso-denominated at the equivalent of US$188bn. Foreign debt at the end of 2009 stood at just US$46.2bn. Central bank reserves are more than twice the level of the foreign debt.
Larraín's idea that the government should look at borrowing more in pesos is a good one. He argues that such a move should lead to a fall in the peso against the US dollar. We're not so sure that his reasoning is right, though. Larraín said that issuing domestic debt would have been a better policy choice than the outgoing government's decision to repatriate US$7bn by raiding the “rainy day" copper funds. The Bachelet government used the US$7bn to stave off the worst effects of the global economic downturn. Larraín claimed that the repatriation has depressed the dollar exchange rate.