Foreign investment in Mexico after economic reform

Introduction Since the mid-1980s the Mexican economy has undergone a process of deep economic reform designed to shift away from the more inward-oriented development model that Mexico had followed until then. The main purpose of these reforms was to privilege market mechanisms in economic activities, which meant reducing the state's direct and indirect involvement in the economy. Some of these economic reforms have been completed, some are still in process, and still others - those that encountered opposition - have not yet, or have only just, been implemented. Economic liberalization had varying effects on the behavior of economic actors and therefore on the evolution of various economic sectors and the Mexican economy as a whole. Liberalizing reforms were intended to have a strong impact on the investment process. Under the previous development model - import-substitution industrialization (ISI); the state played a fundamental role in directing investment; the reforms sought to shift that role by placing greater emphasis on domestic and foreign private investment, while at the same time orienting investment more toward exports and tradable activities and less toward non-tradable sectors. The expectation was that, as the reform process took its course and obstacles to free market operations were reduced, investment decisions would increasingly be based on market signals, thus increasing both efficiency in the use of the factors of production and the potential for economic growth. Mexico's liberalization process began in 1982, when collapsing petroleum prices and rising international interest rates highlighted the economy's vulnerability and the waning effectiveness of an importan import-substitution model characterized by high levels of protectionism and strong state participation. Those developments prompted the Mexican government to try to modulate the impact of international economic shocks, and they also paved the way for vigorous attempts to modify the country's development pattern. Liberalizing reforms sought to convert the private sector into the axis of economic growth, ideally making it able to operate competitively (without subsidies); in world markets. The main elements of this reform process included opening the domestic market to foreign trade, attracting foreign investment, deregulating the economy, privatizing public enterprises, signing the North American Free Trade Agreement (NAFTA);, and liberalizing financial markets. (1); The reforms'goals have been bolstered by a governmental commitment to continue stringent monetary and fiscal policies while eliminating preferential lending. These efforts, particularly by the late 1980s, transformed a nearly closed economy into one that is highly open to foreign participation in trade and investment. State involvement in the economy was curtailed sharply, as shown by the downsizing of the public sector and the substitution of market forces for state intervention in determining key variables such as interest rates, nominal exchange rates, and prices of basic inputs. In addition to their broad sweep and the speed with which they were implemented, the reforms displayed two other interesting features. The first is that they were largely accepted by key economic and political players. That is, the shift toward trade liberalization, the elimination of subsidies, and an expanded role for market forces in allocating funds did not encounter strong opposition from those who had benefited from the prior system of protection and subsidies, or from the workers and labor unions who were affected by productive restructuring and new conditions in the labor market. Even the currency crisis that erupted in December 1994 did not provoke a rejection of the new development model. In fact, in dealing with the crisis, the administration of President Ernesto Zedillo (1994-2000); reaffirmed its commitment to the reform process and to orthodox management of fiscal and monetary policy. Moreover Vicente Fox (2000-2006); - Mexico's first ever elected Presidential candidate not nominated by the Partido Revolucionario Institucional (PRI); - has stated his intention to extend the reform process. The second feature concerns the reforms' impact on economic growth. From 1983 to 1988, the Mexican economy was stagnant; from 1989 to 1994, per capita gross domestic product (GDP); grew by only 0.8 percent a year on average; and in 1995, more than ten years after the reform process was launched, per capita GDP dropped 9 percent in real terms, its largest decline in sixty years. The consensus among observers is that Mexico received an international financial aid package and achieved a speedy, though moderate, economic recovery in 1996-2000 largely thanks to the NAFTA, the productive apparatus's focus on foreign markets, and appropriate fiscal policy-all central results of the economic reform process. Despite the recovery, however, Mexico's economy has yet to show the high and sustained growth rates required to generate sufficient jobs to curb national unemployment and underemployment. Moreover, in 2001 Mexico's GDP once again stalled, falling 0.1%. The key role that capital formation plays in creating and expanding productive capacities, incorporating technology, and raising productivity makes it a fundamental factor in macroeconomic development. Yet despite its importance, there is little information available on the sectoral performance of capital formation in the Mexican economy. (2); In fact, empirical studies of investment in specific sectors have lagged behind the theoretical advances of recent years. Against this background, this chapter analyzes the effect that Mexico's liberalizing reforms have had on fixed capital formation at the aggregate level and in the industrial sector. (3); The period under study begins with the aftermath of the 1982 economic crisis and continues to 2000 and - when data was available - to 2001. The following four sections review, respectively, the behavior of aggregate investment and its relationship to the growth process; (4); trends and performance of foreign direct investment (FDI);, including the activities of in-bond processing plants (maquiladoras);; the behavior and determining factors of investment in manufacturing; and the impact of investment patterns on the manufacturing industry's structure and export performance. (1); Mexico's reforms are well documented; for an overview, see Aspe 1993; Lustig 1998; Ros 1991. (2); The available data on capital formation tend to be highly aggregated. (3); Commodity-producing sectors and public utility services are not included in this study. For a general overview of investment in these fields, see Máttar 2000. For the telecommunications sector, see Escobar de Medécigo 1999; on the electrical power sector, Rodríguez 1999; on highways and ports, Scheinvar 1999; and on the petroleum sector, Torres 1999. (4); The section on the behavior of aggregate investment partially draws on Máttar 2000 and the ones on investment in manufacturing, and its impact on the industry's structure and export performance are based on Moreno-Brid 1999.