Democracy Lab

Mexico on the Brink

Mexican society is reeling from an epidemic of organized crime. But now it faces another challenge: taking its economy to the next level.

Note: This article is an abridged version of the Legatum Institute's longer case study, "Mexico on the Brink."

Adrián Cadena picked us up on the Ciudad Juárez side of the Paso del Norte U.S.-Mexico bridge and brought us to his neighborhood of Villas de Salvárcar. Here, in a tragic case of mistaken identity, Cadena's son was gunned down along with 14 friends while celebrating a birthday in one of their homes. Cadena showed us that next to a memorial for the slain youth was a new park, replete with basketball courts, football and soccer fields, as well as a theatre space. Here, he and other parents have poured their grief, energy, and money to help improve the lives of the young people still living here. The road to Villas de Salvárcar is lined with factories upon factories producing everything from flat-screen TVs to wind turbines to beer, with more people arriving to work. This juxtaposition of grave security threats and economic awakening illustrates not just the contradictions of Ciudad Juárez, but of Mexico itself. Both the violence and the growth reflect the fundamental changes that the economy and society have undergone over the past three decades.

Arguably the most overlooked aspect of Mexico's coming of age is the role played by global supply chains in manufacturing. This is why U.S. President Barack Obama's visit to Mexico today, Feb. 19, is expected to focus on the economic ties between the United States, Mexico, and Canada, as part of President Obama's goal of streamlining regional trade. Mexico's combination of competitively priced labor, proximity to the United States and Canada, and market-friendly regulation has led to an unprecedented degree of integration between the three countries' economies, powering the growth of Mexico's middle-class.

Mexico's remaining challenges are undeniable. Organized crime still makes life terrifying for millions on a daily basis; public services remain inadequate to create an innovative workforce; the national oil monopoly is still corrupt, poorly managed, and lacking in modern technology. And yet, Mexico really does have a shot at joining the elite club of rich, democratic nations.

Since the early 1980s, the most dramatic changes have been in the economy's basic structure. Beforehand, the Institutional Revolutionary Party's (PRI) one-party rule meant that Mexico's markets were largely closed to the world, protected by high tariffs, numerous quotas and subsidies, and the anti-competitive dominance of hundreds of state-owned enterprises. This all began to change in 1982, when declining oil prices paired with escalating interest rates on money borrowed in foreign currencies forced Mexico to halt payments on some $80 billion in foreign debt.

The ensuing financial crisis forced the single-party government to shift course. Then-President Miguel de la Madrid began by cutting patronage spending, reducing subsidies, and signing the General Agreement on Tariffs and Trade, which lowered trade barriers. But the opening of the economy also opened the political system to interests that had no stake in preserving a bloated, bureaucratic government and corrupt state-owned enterprises. De la Madrid's successor, Carlos Salinas, privatized hundreds of state-owned enterprises ranging from mining, to telecommunications, to steel and airlines. He also re-privatized the banking sector. Mexico's public enterprises shed half a million jobs.

To bring in foreign investment, Salinas negotiated the NAFTA with the United States and Canada, removing all tariffs barriers to regional trade and tying Mexico to the economies of the United States and Canada, fundamentally altering the nature of trade and investment. Even with a financial meltdown (the 1994 Peso Crisis), the government did not regress to protectionist policies; instead it opened Mexico's economy even further by continuing to privatize state-owned companies and allowing foreign ownership in a growing number of sectors. The combination of a depreciated currency and access to the world's largest consumer market (the United States) spurred an economic rebound.

These dramatic shifts created losers as well as winners. Mexico's rural areas and small-scale farmers were hit the hardest. The rise of large-scale, capital-intensive farming in Mexico and competition from U.S. agribusiness drove some 2 million Mexicans either into Mexico's burgeoning cities, or north to the United States. But many others benefitted: manufacturing employment grew by over one million; the service sector expanded far more, gaining some 10 million employees through the decade; consumers enjoyed expanded choices and lower prices for everything from food to clothing to cars.

Fast forward to today. Mexico has signed free trade agreements with some 40 nations. The ratio of total trade (imports plus exports) to GDP is in excess of 60 percent. Moreover, unlike many other open economies in Latin America, Mexico's exports are mostly manufactures, leaving the economy less susceptible to price swings in commodities.

This rising tide has expanded Mexico's middle class. We traditionally think of Mexico as a country of haves and have-nots, yet between these extremes is a growing, vibrant middle. Mexico's National Council of Evaluation of Social Development Policy estimates that 55 percent of Mexicans no longer live in poverty, taking into account access to basic services such as healthcare, education, housing and food, as well as income. Today, over half of Mexican households own cars, one-third own computers, and nearly all have cell phones and TVs, while the majority live in houses or apartments that they own.

Earlier, the primary route to a middle-class income was employment in a state agency or enterprise; now, the opportunities largely lie in private sector jobs. The number of women in the workforce has more than doubled over the past three decades to 45 percent. Parents are investing more in smaller families: The average years spent in school have doubled from a mere four years in 1980, to 8.5 years in 2012, and enrollment in universities has also tripled over this period.

The macroeconomic impact of the growth of the middle class can be seen in the public's willingness (and ability) to spend on consumer goods. Indeed, over the past six years of turbulence in the global economy, private consumption has been one of the most stable components of Mexico's GDP growth. Household investment in education has played a role in powering growth, too. The ongoing investment in human capital may prove decisive in allowing Mexico to escape the "middle-income trap," a common phenomenon among developing economies in which the growth rate slows before living standards reach the level of the highly industrialized countries of Europe, North America, and East Asia.

The economic middle has also begun to flex its political power. It was pivotal in voting out the long-ruling PRI in 2000. Middle-class voters are no longer in any one party's pocket, and theories abound about how their growth will affect future politics. Most scholars see them as the rock on which a stable, responsive democracy can be built.

The role of global supply chains in manufacturing has become a pivotal element powering Mexico's growth. In the 20 years since NAFTA was signed, trade between Mexico and the United States has increased five-fold to half a trillion dollars' worth of goods flowing back and forth each year. More important, Mexican supply chains are becoming ever more integrated with U.S. companies and factories. For nearly half of U.S. states, Mexico is the first or second most important export destination.

The nature of this trade has changed. Components, as opposed to finished goods, have come to dominate the exchange. For every U.S. product labeled "made in Mexico," an average of 40 percent of the value was added by American workers. One of the most integrated sectors is automobiles, as production and assembly routinely span the borders. More than one quarter of each U.S.-made car comes from abroad, with the largest percentage of value-added coming from Mexico.

The question is: What's holding Mexico back? While the World Economic Forum's Global Competitiveness reports offer evidence that Mexico is improving in terms of business sophistication and innovation, Mexico falls in personal safety. Other reports echo these security concerns. The 2012 Legatum Prosperity Index ranks Mexico near the bottom of the pack in its ability to provide national and personal security -- a reality that reduces this upper-middle-income country's overall prosperity ranking to a disappointing 59th (behind Sri Lanka, Belarus, and Saudi Arabia). Freedom House's Freedom in the World report also cites Mexico's inability to control violence as part of the reason for the country's "partly free" classification.

With some 80,000 killed and tens of thousands more Mexicans missing due to drug-related violence during Felipe Calderón's presidential term (2006-2012), the threat is all too clear. The violence extends past the country's well-known homicide rates to include extortion, kidnapping, human trafficking, and robbery. These crimes loom large in the consciousness of average Mexicans. According to a 2012 study by Latinobarómetro (a non-profit polling firm), more than 40 percent of Mexicans claimed that family members had been victims of crime in the past year. The impact reverberates through Mexican society, undermining civil liberties and slowing the pace of investment.

The collateral damage is most obvious in the country's justice system. The number of convictions is shockingly small. México Evalúa, a Mexican public policy think tank, reports that only two out of every 10 murders ends with a conviction. Meanwhile, the Mexican Institute for Competitiveness estimates that the conviction rate for all crimes is closer to 2 percent, creating little deterrence to a life of crime.

To address these deep-seated problems, Mexico pushed through a comprehensive judicial reform in 2008, with a 2016 implementation deadline. The legislation (if enabled) will fundamentally change the justice system, moving from written to oral trials, strengthening due process and the assumption of innocence until proven guilty. Preliminary findings from jurisdictions already implementing the system confirm that it is both quicker and more efficient in resolving cases, and that it allows prosecutors to prioritize severe offences. The bad news, though, is that implementation has been slow, as roughly one-third of Mexico's states have yet to begin the transition process.

And while the Mexican economy has opened and diversified, it is still hobbled by institutional weaknesses. Among the most important is the lack of competition, not only in highly visible industries (notably telecommunications), but in industries as varied as glass, cement, corn flour, soft drinks, sugar, and bread. One cause of the market concentration that has impaired competition, ironically, was the economic opening of the 1980s: The privatization process was opaque, and those close to the ruling-PRI were offered lucrative deals, creating several of the monopolies and duopolies that dominate sectors of Mexico's economy today.

The Mexican government has taken some initial steps toward fostering greater competition. In 2007, the Supreme Court struck down the notorious Televisa law, which would have ensured the continuation of the telecommunications duopoly. In 2013, Mexico's Congress followed suit, passing a telecommunication reform that should begin to chip away at the power of Mexico's media and telecom moguls.

Another barrier to competition and innovation is access to credit. Consumer credit (i.e., home mortgages, car loans, and credit cards) has entered the popular lexicon, a total transformation from just a few decades ago. However, according to the World Bank's Ease of Doing Business Index, credit lags on the business side, ranking 40th, behind little-admired economies including Ukraine and Guatemala. Inferior physical infrastructure is also a drag on Mexico's potential. Less than 40 percent of Mexico's roads are paved; ports and airports have not kept pace with the growing population and economy.

Economic inequality is another pervasive challenge. Despite the emergence of a middle class over the past decade, it is still a country with both extreme poverty and fantastic wealth. Arguably as important, economic mobility is low. The Espinosa Yglesias Study Center estimates that among those born in the bottom 20 percent of the income distribution, half will remain there. Those who do escape generally make it up just one rung, from subsistence to struggling working class. Mexico's weak public education system exacerbates this inequality, not just in terms of income, but opportunity. Mexico's students fill the lower rungs among OECD countries on standardized tests in reading, math, and science. This combination of substantial poverty and low mobility affects everything from teen pregnancy, to crime, to political stability, to growth.

All told, Mexico is doing better than many analysts expected, but is still not reaching its potential pace of advancement. While the recent 3 to 4 percent GDP growth is welcome news, it is below the rate the country needs to move up the global economic ranks -- and more important, to break out of the "middle-income trap" that leaves few resources available to improve the quality of life for the have-nots. Opening the economy to the global winds was necessary, but not sufficient to assure long-term development.

Mexico is now at a crossroads. It could continue down a path of growth and social change to become a leading democracy with an energetic middle class. Or it could become bogged down by its many challenges: violence, interest-group politics, and the corrupting call of crony capitalism. Much rides on the outcome, especially for many of Mexico's 112 million citizens who do not yet enjoy the living standards of other OECD countries. But in an ever more integrated global economy, what happens to Mexico's matters to the rest of the world and, in particular, to the United States.

John Moore/Getty Images

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