Mexico Resurgent: Riding the Reform Wave

Over the years Mexico and Brazil have been seen as counter cyclical in terms of each other’s economic performance. When Brazil has done well, Mexico has faltered, while the opposite is true on those occasions when Mexican growth and economic prosperity have risen at the same time as Brazil’s have fallen. This perception is very much in play today as markets, media and analysts look at both economies and conclude that Brazil’s stature as a BRICS star has faded, while Mexico’s is on the ascent — even though it was never part of the BRICS and has an unenviable average growth rate of 2.4% over the past 12 years. Putting aside the short-term, superficial nature of these perceptions, there are marked differences in how the two governments are currently approaching their development strategies. While Brazil’s structural reforms are mired in bureaucratic uncertainties and regulatory haphazardness, Mexico’s new government has embarked on a truly remarkable set of reforms which, if completed, will place its economic prospects among those at the top of the list of emerging markets offering the right incentives for growth, investment and heightened prosperity.

Mexico’s structural reforms

The reforms Mexico’s new President, Enrique Peña Nieto, has introduced in the first year of his presidency have earned him praise from international media and political commentators. His bold reform proposals coupled with the political agreement his Institutional Revolutionary Party (PRI) signed with the two main opposition parties, his stance on security, and his general mastery of political deal-making have reinforced international investors’ interest in Mexico. Indeed, against the backdrop of an economic upturn, the announced changes had very promising implications for business, with clear prospects for a reduction in monopolistic barriers, greater opportunities for more foreign investment, and a raft of measures aimed at boosting the annual economic growth rate to 5–6% in the coming years.

When Mr. Peña Nieto won the Mexican presidential election in July 2012, his promises of change elicited controversy and scepticism. After all, the PRI had ruled Mexico autocratically for 71 years and gained a reputation for running the country with little regard for democracy, the spread of corruption, or the flourishing of monopolies. Despite spending 12 years in opposition, many people were not convinced that the party had renewed itself: indeed, there was concern that Peña Nieto’s victory heralded the return of political ​“dinosaurs” at the helm of the country and rule by presidential fiat.

To the surprise of many, Mr. Peña Nieto’s first twelve months in power have been marked by tangible progress and the push for much awaited change in critical and long-neglected areas of public policy. The first step Mr. Peña Nieto took towards enabling substantive reforms was negotiating the ​“Pact for Mexico” with the two main opposition parties, the PAN and the PRD. The pact represents a significant political victory for the President: the agreement, signed as he came into office in December 2012, is designed to guarantee political support for a joint policy agenda in various areas of reform such as education reform, economic deregulation, and modernisation of the energy sector. With the agreement in place, opposition parties were much less likely to block proposed reforms and interests groups found it more challenging to lobby for changes than to derail the reform agenda.

So far, Mr. Peña Nieto and his government are off to a promising start: after helping pass a labour reform in November 2012 and passing an education reform in February 2013, Mr. Peña Nieto obtained a telecoms reform, which passed this spring, and a competition policy reform that will make it much more difficult for the traditional conglomerate monopolies to continue their oligopolistic practices.

In November, Congress passed a financial and fiscal reform package that, although small in terms of additional revenues for the Treasury, sets the stage for further tax reform in the coming years. There was strong opposition to new taxes by the private sector, but the government stood its ground and the package was approved overwhelmingly by the legislature. Even more surprisingly, Congress easily passed the new proposed budget for 2014 with almost all the government’s demands intact.

The real prize, however, and the biggest legislative battle will come with energy and political-electoral reforms. The blueprint for the first wave of reforms is instructive both from a political and business perspective: understanding how the new administration designed and promoted these initial reforms offers clues about the potential scope of the more significant—and likely more controversial reforms yet to come. 

Labour and education reform: reducing the informal economy, increasing productivity, breaking the unions

The labour reform that Mr. Peña Nieto’s senators and representatives helped pass in November 2012 was designed to make the formal economy more competitive and reduce the informal economy by raising the number of formal jobs, increasing the country’s tax take, and boosting labour productivity. While wages in Mexico are low, labor productivity gains lag the OECD average. By making work contracts more flexible and specifying that productivity rather than seniority should be the main criterion for determining an employee’s suitability and eligibility for a position, the new legislation aims to make the workforce more competitive.

Tax evasion in the formal economy and tax avoidance in the informal sector are costing the government an estimated $50 billion in revenue a year and this means Mexico has one of the lowest tax intakes among OECD countries. By making it easier for companies to hire and fire workers, the new law encourages firms to create more jobs, which in turn should increase Mexico’s tax take.

The education reform, passed by Congress in February 2013, has major implications for the future of Mexico’s economy. Mexico’s dismal education system has long acted as a brake on economic development. Mexican students’ test scores are amongst the lowest of the OECD’s Program for International Student Assessment (PISA).

The primary obstacle to improvements in education has been the tight control wielded by the National Union of Education Workers (SNTE) over education policy, staffing, and funding. Indeed, the SNTE was in control of all teachers’ hiring and firing; the union repeatedly blocked any attempts to administer any evaluations of teachers’ performance; and all too often teaching posts became hereditary or could be bought from union power brokers. The might of the SNTE was such that the government still has no official records of the number of teachers in Mexico.

To the surprise of many, Mexican prosecutors arrested the longstanding leader of the SNTE, Elba Esther Gordillo, in February on charges of embezzling $150 million of union funds. Gordillo has traditionally been the main obstacle to any educational reforms and her arrest dealt a political blow to the union just as the government introduced its education reform in Congress. The ambitious education reform purports to upend the entire education system by setting out clear merit-based guidelines, implementing mechanisms for evaluating and improving teacher performance, and improving school quality and the student environment.

Liberalising the telecommunications sector: breaking up the monopolies

Perhaps one of the most exciting of Peña Nieto’s reforms is the telecommunications reform, which the lower house passed in March 2013 and the Senate approved several months ago.

Mexico’s telecom market has long been dominated by two main players: Carlos Slim’s América Móvil, with 80% of landlines and 70% of mobile phone and broadband connections; and Emilio Azcárraga’s Televisa, which has 70% of the national free-to-air market and half of pay-TV subscribers. In 2012 the OECD estimated that the lack of competition in telecoms cost Mexico’s economy $25 billion a year, due to high prices for broadband and calls from fixed lines to mobile phones. The reform, which Mexico’s finance minister says will increase the economy’s annual growth rate by 1%, intends to increase competitiveness in the sector by allowing greater foreign ownership and introducing new competitors into the market. 

Mr. Peña Nieto’s government will set up an independent regulator with the authority to assign licenses and charge stiff penalties to firms that control over 50% of their markets. This should force Televisa and América Móvil to divest, creating more opportunities for both domestic and foreign investors. The reform allows 100% foreign ownership of telecom companies (it is currently limited to 49%), and up to 49% foreign ownership of broadcast media networks. The new regulator can also implement asymmetric connection fees (charging market leaders higher interconnection rates than their smaller rivals). The reform also creates two new national television networks by holding an auction from which Televisa and its smaller competitor, TV Azteca, will be barred. Finally, the new legislation forces content providers to offer their programs to all cable-TV firms, and cable-TV firms would have to carry the shows of all content providers.

The telecoms reform creates opportunities even for the current dominant players, as both América Móvil and Televisa have been aiming for a slice of the other’s market. While facing potential losses from increased competition and price cuts, they both stand to profit from increasing their shares in markets now closed to them.

Energy and political reforms: unlocking Mexico’s latent potential

The most highly anticipated of Peña Nieto’s reforms are the energy and electoral reforms, which he is likely to try to push through before the 2015 mid-term elections. The energy reform seeks to realise the vast and largely untapped potential of Mexico’s oil and gas reserves. Pemex, the state-owned oil and gas monopoly, hands over most of its profits in taxes to the state. This prevents the company from investing in new technology or optimising production, which has led to a gradual decline in oil production since 2004 and forced Mexico to begin importing petrol and natural gas from the United States.

While Mr. Peña Nieto has ruled out privatising Pemex, many hope that the energy reform will, on the one hand, allow private investors to enter into risk-sharing contracts with Pemex for deep water exploration (half of Mexico’s oil is in unexplored deep waters), shale gas, and refining; and, on the other hand, allow Pemex to reinvest more of its profits as the government weans itself off oil revenue and relies on a greater tax intake. This is why the administration argues that any changes in the energy sector must go hand in hand with fiscal changes already on the books. Mr. Peña Nieto’s reforms have the potential to open up attractive new business opportunities and spur greater foreign investment in Mexico. If the new administration can build on its early reforms and open up the energy sector to private investment while restructuring its public finances, Mexico is sure to attract more attention from international investors and become a top investment destination.

A third reform debate, this time over changing the rules and institutions of the Mexican political system, is in full swing. Recent proposals by the opposition PAN and PRD parties have highlighted rival but complementary plans for addressing what are seen by some as the most problematic weaknesses of democracy in the country. As a central element of the Pacto por Mexico, political reform will definitely occur, and its implications for Mexico’s political balance will be profoundly felt.

Over the past three decades, piecemeal political reforms in Mexico have played a role in the gradual transformation from a closed authoritarian system to an evolving democracy. The true significance of many of these reforms was not apparent at the time, but they have played important roles on the path to democratisation. The creation of the Instituto Federal Electoral (IFE) stands out as perhaps the most important of these but other reforms have proven to be highly significant in the long term.

The most recent attempts to reform Mexico’s political system came during the final two years of Felipe Calderon’s presidency. The PAN government at that time proposed a series of changes including allowing independent candidates (that is, candidates not belonging to an established political party), and re-election. While the reelection proposal was rebuffed, the initiative for independent candidates was approved by the Mexican congress in the Fall of 2011, and will play a role in the forthcoming congressional elections in 2015. In the current debate over political reform, a number of intriguing elements appear, such as the issue of allowing coalition government and removing the President’s immunity from prosecution during his/​her time in office. But the major emphasis will be placed on three issues. At the heart of the new proposals for political reform, we find the re-election issue re-emerging. Long-identified as a serious impediment to increasing accountability by elected officials, and seen as a handicap for the development of real policy expertise in the legislature, it appears that the major political parties are ready to overturn the constitutional prohibition on the re-election of mayors, deputies and senators. Although they are not willing to contemplate the re-election of governors or the President at present, this will nonetheless be a watershed moment in Mexican political history, overturning a system instituted to avoid the establishment of immovable dictators after the revolution. The ban on re-election is deeply engrained in Mexican culture and is still a popular prohibition in the eyes of a majority of the Mexican electorate. But the opposition PAN and PRD parties have put the issue front and center in the current political reform debate.

The second major change concerns the nation’s electoral institutions, the IFE and the TRIFE (the Federal Elections Tribunal or court). The opposition proposals call for the strengthening of these institutions to give them truly national power, not only over federal elections but also over state elections. This would mean the abolition of state-level electoral institutions, and the creation of a single National Elections Institute (INE). The issue is seen as crucial by the opposition parties after decades of electoral fraud and interference in state and municipal elections by governors and local political powers. At the time of writing this analysis, it seems that a deal has been struck to create the new INE but allow state electoral authorities to continue for an indefinite period of time. The third major area of political changes concerns campaign financing and spending during the electoral cycle. Since the scandals of the 2012 Federal elections, when the PRI was accused of breaking electoral rules by giving out supermarket cash cards to generate support in cities and towns, the opposition parties have been insisting on stricter rules concerning this kind of practice. The PAN is proposing stronger punishments for individuals and parties who surpass campaign spending limits and the PRD would also like to see the cancellation of any election where parties violate spending rules and limits. Stricter rules are also being proposed to address federal government spending on advertising and media exposure for its own programs during election times. This issue has been hotly debated over the past two presidencies with both the Fox and Calderon administrations coming under fire over their spending on advertising social programmes in election years.

What are the chances of such a reform at this time? Two factors suggest that the reforms put forward by the opposition parties will achieve at least partial success. The first is quite simple: the Pacto por Mexico , the political mechanism that has been crucial in securing the impressive economic reforms to date, includes these elements as part of its list of 95 policy priorities. Given the importance of the Pacto for the government’s legislative agenda, it should be willing to concede these points in order to maintain Congressional cooperation with the PAN and PRD. The second reason is that the PAN is conditioning its support of energy reforms on a commitment by the PRI to allow political reform to take place. Although recent concessions by the PRI to the opposition parties on issues of fiscal reform showed that a negotiated consensus emerged on that front, the PAN’s support for energy reform continues to depend on the PRI compromising on political reform.

And so the stage is now set for the first year of the Pena Nieto administration to conclude with an impressive array of reforms already under its belt. What’s more, these reforms will fundamentally alter Mexico’s economic and political landscape, hopefully bringing higher levels of growth, more reliable income for the government, and clearer and more progressive rules for strengthening democracy.