Public and private investment in Mexico, 1950-90: an empirical analysis.

AuthorRamirez, Miguel D.
  1. Introduction

    During most of the post-World War II era, public investment was the driving force behind the general strategy known as Import Substitution Industrialization (ISI) in Latin America.(1) Policymakers in countries such as Mexico and Brazil recognized that investment played a crucial role not only as a component of final aggregate demand, but also in terms of determining the size of a country's capital stock, and thus, its future source of growth and employment opportunities. It was also generally believed that private investors would be reluctant to channel needed resources to key industrial projects because of the region's lack of social and economic infrastructure, as well as the absence of fully developed markets for equity, insurance, and information. Government investments in infrastructure and basic industry, with their attendant positive spillover effects, were viewed as necessary by policymakers for achieving optimal rates of investment and growth.

    However, with the onset and aftermath of the debt crisis in 1982, most countries of the region, particularly Mexico and Chile, have radically changed their overall development strategy. Instead of concentrating on inward-directed growth, under the auspices of state-directed investments, the new growth model is outward-oriented in nature, and more importantly, heavily reliant on market forces as evidenced by the ongoing deregulation of product and factor markets and the privatization of most state-owned enterprises.(2) The unprecedented streamlining of the public sector in countries such as Mexico can, in part, be traced to the limited external and internal resources available to governments of the region during the 1980s, but, more importantly, it is also the result of past inefficiencies and failures generated by the public sector's attempt to undertake too many investments in state-owned enterprises producing goods in which the private sector had (and has) a comparative advantage (e.g., steel, chemicals, trucks and buses, cellulose products, food processing, sugar, fertilizers, textiles, banking and tourism services, etc.).(3)

    Nevertheless, in their justified efforts to diminish the government's excessive involvement in economic affairs, policymakers seem to have forgotten that the withdrawal of the state from the economy should not endanger those minimum essential duties that it must perform for the optimal functioning of a market economy, namely, the provision of essential social and economic infrastructure.(4) Having said this, the application of severe economic adjustment measures in many countries of the region, notably Mexico, has led to across-the-board cuts in public spending that have generated unprecedented reductions in the level of public investment in the nation's railways, highways and roads, bridges, sewerage systems, modern power plants, dams, airport fields, and port facilities. These investments, as a number of researchers have recently shown [1; 2; 3; 4; 5; 6; 9; 11; 30; 34; 35; 40; 41; 46; 50; 52; 53], usually complement, rather than crowd out private investment, and their continued and future neglect may well undermine the efficiency gains promised by the country's ongoing liberalization and privatization process.

    In light of these developments, this paper examines the still controversial question of whether public investment complements or displaces private capital formation in one of the larger countries of the region: Mexico. The choice of Mexico to test the hypothesis of complementarity or substitutability between public and private investment spending is warranted for two reasons. First, it is one of the more industrialized, and from the standpoint of the U.S., strategically important countries of the region--other than Chile--that has implemented far-reaching market-oriented policies; and secondly, it is one of the few countries of the region for which there are reliable time-series data on public and private investment for a number of years.

    The paper is organized as follows. First, it gives a brief overview of the role of the Mexican state in the investment process during the post-World War II period. Next, it develops a conceptual framework of analysis for including the public capital stock as an argument in a standard neoclassical production function, thereby generating a set of testable hypotheses. The third section presents a modified flexible accelerator model that not only explicitly incorporates the impact of public investment expenditures, but also circumvents some of the investment data problems one finds when dealing with developing nations such as Mexico. Statistical estimates of various specifications of the modified accelerator model are then presented in the fourth section. This section also attempts to determine whether there is a long-term relationship between the relevant regressors by performing Engle-Granger Cointegration (EG) tests on the various regression specifications. It therefore goes beyond other empirical discussions of the complementarity hypothesis--both for developed and developing nations--by testing whether the residuals of the relevant cointegrating regression equations are stationary, thus addressing the important question of spurious correlation. Lastly, pairwise Granger causality tests are performed to determine the direction of correlation between public and private investment expenditures. The last section summarizes the paper's major findings.

  2. The State's Changing Role in the Investment Process

    During most of the post-World War II period, the Mexican state played a pivotal role in the investment process. It is no exaggeration to say that during the heyday of the ISI strategy pervading most of Latin America, it was the driving force behind the rapid economic growth the country experienced. Table I below shows that during the fifties and sixties the state's share of overall investment averaged between .46 and .66, and as the yearly data indicate, it even exceeded 70 percent during the populist administration of Adolfo Lopez Mateos (1958-64). With the election of conservative president Gustavo Diaz Ordaz (1964-70), the government placed greater reliance on the private sector and its role in the investment process diminished accordingly, reaching a record low of .27 in 1971.(5)

    Table 1. Mexico: Participation of the State in the Process of Capital Formation, 1950-91 (as a percentage of total gross fixed capital formation) Year Coefficient Year Coefficient Year Coefficient Year Coefficient 1950 .58 1960 .65 1970 .35 1980 .43 1951 .64 1961 .58 1971 .27 1981 .45 1952 .64 1962 .57 1972 .34 1982 .44 1953 .63 1963 .55 1973 .39 1983 .39 1954 .61 1964 .55 1974 .37 1984 .37 1955 .66 1965 .30 1975 .43 1985 .36 1956 .72 1966 .31 1976 .41 1986 .34 1957 .70 1967 .36 1977 .41 1987 .30 1958 .70 1968 .36 1978 .46 1988 .28 1959 .68 1969 .36 1979 .45 1989 .27 1990 .26 1991(*) .23 Period Average Coefficient of Participation 1950-59 .66 1960-69 .46 1970-79 .39 1980-85 .41 1986-90 .29 *Preliminary data. Source: Computed from NAFINSA, La Economia Mexicana en Cifras [36, Tables 3.1 and 3.2, pp. 68-70; and NAFINSA, op. cit., [1992]. The government's pro-business policies, however, would be short-lived, especially in light of the country's deteriorating social indicators which generated mounting political pressure from key sectors of society, primarily urban labor, peasants and students, to confront and resolve them. Beginning in 1972, the Echeverria administration (1970-76), in an effort to diminish both social tensions and maintain the rate of economic growth, embarked upon an ambitious populist program which increased the state's expenditures on collective consumption goods while, at the same time, raising the rate of economic growth and profits via increased real spending in the capital goods sector. This explains the dramatic rise in the state's coefficient of participation of 16 percentage points between 1971 and 1975.(6)

    However, the country's inefficient and regressive tax system was not up to the task of financing this dramatic increase in real government spending, so, by the end of the Echeverria term the country was caught in the vicious circle of rising public-sector deficits, excessive money growth, accelerating inflation, rapid capital flight, and mounting foreign debt. Had it not been for the discovery of vast deposits of oil and gas reserves in 1976-77, the country would have had to adopt many of the market-oriented measures that it eventually implemented under the administrations of Miguel de la Madrid (1982-88) and Carlos Salinas de Gortari (1988-1994).(7) As it turned out, these badly needed reforms of the country's fiscal and productive apparatus, as well as the export-import sector, were postponed during the petroleum-led boom of the 1977-81 period (this accounts for the increase in the state's coefficient of participation from .41 in 1977 to .45 in 1981.

    The onset of the debt crisis in 1982, and its immediate aftermath, however, left the Mexican government with no choice but to alter radically its overall development strategy. Under the auspices of the IMF and World Bank, and in close consultation with the country's key economic grupos, it began a process which has culminated in the unprecedented opening of the Mexican economy to foreign competition and investment, as well as the total withdrawal of the state from key sectors of the economy.(8) Table I shows clearly this trend, particularly after the election of Carlos Salinas de Gortari.

    In a market economy, where private investment is the driving force of economic growth, these are welcome developments, but, there is danger in too much of a good thing. The across-the-board cuts in government spending called for by expenditure-reducing policies tend to fall most heavily on central government capital expenditures because the negative effects are not evident to the public immediately. However, what is politically...

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