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The real threat of U.S. withdrawal from NAFTA forced López Obrador, a longtime critic of the agreement, to become a supporter. Here, Mexico's top port, Lazaro Cardenas. (Photo: API Lazaro Cardenas)
Christopher Wilson, Deputy Director of the Mexico Institute at the Wilson Center. 
Thursday, July 26, 2018
Perspectives

AMLO’s Economic Policy and NAFTA


Is López Obrador willing to live within the constraints of macroeconomic stability?

BY CHRISTOPHER WILSON

Andrés Manuel López Obrador was elected to do three things. First, his supporters voted to reject the status quo and take power away from the PRI (and to a lesser extent the Mexican political class more generally). Second, he promised to govern in an austere and honest fashion, intolerant of the corrupt practices that infect politics and public administration in Mexico. Finally, AMLO campaigned on a message of inclusive development, which puts the poor first and seeks to bridge regional and class-based divides. Each has important economic implications, and though with his landslide election victory López Obrador has accomplished the first task—no small feat—the other two may prove even more difficult.

The break with the status quo that AMLO represents has two important consequences.

First, he will take office with a mandate to reshape the Mexican political economy, especially given his overwhelming electoral victory and the Morena-led coalition’s control of both houses of Congress. Having been opposed by much of the Mexican private sector, López Obrador is beholden to very few interest groups, further freeing him to pursue major reforms. Though empowered by his constituents, AMLO is perhaps more constrained by markets than most Mexican presidents. Both the PRI and the PAN has built up a track record of macroeconomic discipline and a respect for the autonomy of the central bank. This gave past Mexican administrations a degree of credibility with investors that AMLO will have to earn.

So far, López Obrador and his transition team have sent all the right signals. He took time out of his victory speeches on election night to telegraph his intention to keep a balanced budget and maintain the central bank’s independence. He has appointed a qualified economic team that, though lacking in the immediate name recognition and market confidence that some more high profile Mexican economists could have brought, is more than capable of offering AMLO sound economic advice and management. It will of course be up to the president himself to pay heed to his advisors, a relatively easy task during periods of economic growth, but a much harder one in the event of a negative shock such as a U.S. recession or the cancellation of NAFTA.

NAFTA: NEW POSITION

The incoming administration will face two major economic challenges. The first is related to NAFTA and trade relations with the United States. Mexico depends heavily on its access to the U.S. market, sending approximately 80 percent of its exports to the United States. Though Mexico has one of the most extensive networks of free trade partners in the world, it has for years come up short in its efforts to diversify trade and, in particular, to reduce dependence on the U.S. market. This is natural given the economic weight of its neighbor, but it left Mexico vulnerable to the economic nationalism of President Trump. Negotiations to modernize and rebalance NAFTA have been underway for almost a year, but the most contentious issues remain unresolved, meaning the AMLO team will play an important role in resolving this critical issue.

The real threat of U.S. withdrawal from the agreement forced López Obrador, a longtime critic of the agreement, to become a supporter of NAFTA, which Mexicans generally accept is critically important for their economic well-being. During the campaign, his economic advisors sought to protect their candidate from claims that he represents a danger for the Mexican economy by voicing not only general support for NAFTA but specific support for the work of the current negotiating team and virtually all (barring the issue of including wages in the agreement) of their positions on specific issues. From the Mexican side, one should expect significant continuity in terms of the NAFTA negotiations. This of course only goes so far in mitigating NAFTA risk, which is predominately based on the potential that the United States may withdraw from the agreement.

MORE EXPENSES, BUT NO TAX HIKE

The second, more fundamental challenge is the simultaneous completion of AMLO’s seemingly contradictory promises to increase social and infrastructure spending without raising taxes or growing the country’s debt. To do so, AMLO has promised to find major savings by stopping corruption and by applying an austere approach to governance.

He has promised to sell the presidential plane, eliminate pensions for former presidents, cut benefits for senior officials, limit official travel, and hire fewer high-level administrators. Though this will certainly save the government some money, these should largely be understood as symbolic gestures. Corruption does in fact cost the Mexican economy significantly, with estimates ranging from 2-9 percent of GDP, but it seems quite unlikely that endemic corruption could be halted quickly or that the resulting economic growth would immediately translate into higher tax revenue. There are, without doubt, efficiency gains to be found in government spending, but the spending promises embedded in the AMLO economic plan, if even mostly implemented, would be sure to dwarf any hard-won savings.

AMLO has promised a return to greater government involvement in driving economic growth, and his list of campaign pledges reflects this. Among López Obrador’s promises with fiscal implications are a doubling of government paid pensions for the elderly; financial assistance for the disabled; holding real energy (gasoline, natural gas, electricity) prices steady; modernizing existing refineries and building one to two new ones; building a high speed rail line for tourists in the Yucatán Peninsula; building another commercial rail line across the isthmus of Tehuantepec; creating an extensive scholarship program; agricultural subsidies and price guarantees; programs to support entrepreneurs; and more generalized infrastructure spending. Just the non-infrastructure components of this plan are likely to cost about one percent of GDP per year.

Fortunately for AMLO, he is inheriting a healthy if slow-growing economy. GDP growth has been in the range of 1.4-3.6 percent during the Peña Nieto administration. Mexico’s total debt/GDP ratio rose to 50 percent by 2016 but has since fallen to between 47 and 48 percent, with the government running a primary budgetary surplus over the past two years. The central bank holds sufficient dollar reserves, and real interest rates have already been pushed high by the bank to contain exchange rate-driven inflation. NAFTA-related risk drove this trend, but, barring a negative NAFTA shock, Mexico seems well positioned to manage future inflationary pressures by simply maintaining its already high rates.

Mexico’s solid fiscal and macroeconomic position give López Obrador a limited amount of space to implement his desired economic policies before running into credit risk or budgetary constraints. Despite the fact that anti-corruption policies and administrative austerity will not adequately finance social and infrastructure spending goals, it appears that AMLO’s team will have the opportunity to responsibly meet some (but not all) of its economic objectives. The key question then becomes, is López Obrador willing to live within the constraints of macroeconomic stability? The signals for now point to a positive response, but the proof will come in watching whether and how he handles tough trade-offs as the budget is created this fall and again in the coming years.

Christopher Wilson is the Deputy Director of the Mexico Institute at the Wilson Center. This article is excerpted from the new report Changing the Guard in Mexico: AMLO’s Opportunities and Challenges from the Mexico Institute at the Wilson Center. Republished with permission.

 

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