Mexico: the economic emergence of the United States' neighbor to the south.

• Author: Leithe, Joni

What happens to the Mexican economy affects more than just the border states; it impacts the entire U.S. labor market, substantial financial investments, and the physical environment.

Author's note: The economic information in this article is a summary of the work of Nora Lustig, Brookings Institution, and John Adams, Jr., Norwest Bank. Further information on Mexico's economic reforms can be found in their publications cited at the end of this article. Part II of this article, to appear in the February 1998 issue of Government Finance Review, will focus on developments among Mexico's state and local governments.

Beyond the attention-grabbing headlines of the past few years, lies a story of profound change in Mexico - a transformation of an economy and political system. Like much of Latin America, Mexico has been remaking itself during the 1980s and 90s from an inward-looking, highly regulated economy and one-party political system to a free trade, laissez-faire economic regime and pluralistic political system. As the Mexican economy underwent the dramatic changes from a closed economy to an open one, it reduced its dependence on oil exports and recovered from a massive foreign debt overhang and high inflation rates. The country also has seen some movement to decentralize government functions from the national to state and local governments and to strengthen their abilities to provide services.

What happens in Mexico has always been important to the United States, affecting the physical environment and labor markets of not only the southern border states, but reaching as well the entire U.S. labor market through immigration. The size of the Mexican-born population living in the United States was estimated recently at about 7.2 million; approximately two-thirds are legal residents and one-third unauthorized residents.(1)

Mexico has long been America's third largest trading partner, after Canada and Japan. With the opening of the Mexican economy to foreign trade and investment, of which a substantial portion has been U.S. investment, the U.S. now has a direct financial stake in Mexico's economy. Between the implementation of NAFTA in January 1994, and the first half of 1997, American exports to Mexico increased more than one-third and imports from Mexico jumped by 80 percent. Mexico's large (97 million), young (80 percent under age 40), and rapidly growing population (a 25 percent increase over the past 20 years) make it a prime and growing market for U.S. exports.

Changes in Economy

From 1950 to 1970, the Mexican economy industrialized, modernized, and performed remarkably well, generating per capita annual growth rates of 3 to 4 percent with annual inflation rates held to about 3 percent. The government followed an import-substitution industrialization model, which created an economic environment protected by trade barriers. Under this policy, the proportion of imports subject to licensing requirements increased from 28 percent in 1956 to about 70 percent, on average, in the 1970s.

In the early 1970s the Mexican economy slowed, as seen in Exhibit 1, as did most other countries' economies in response to the oil shock of 1973, when the world's oil-producing nations dramatically increased oil prices. (Mexico was not yet an oil producing nation.) In order to counteract the recession and rising social tensions, the government increased state intervention in the economy and public expenditures, resulting in a rising fiscal deficit that was financed by borrowing in the world capital markets.

The discovery of oil reserves, announced in December 1976, led the...