Many of these firms were attracted by Mercosur, the regional trading bloc led by Argentina and Brazil. With the Argentine economy in a tailspin, Mercosur’s prospects suddenly look very bleak, and foreign investment in Brazil has quickly declined. Without these funds Brazil’s external deficit has become unsustainable, and the country’s currency–the real–has weakened significantly, trading at 38 cents U.S., down from 56 cents at the end of 2000. Since a large fraction of Brazil’s debt is in U.S. dollars, the depreciation of the real also increases the value of the debt, worsening the country’s finances.
Now, as the Argentine crisis deepens, many eyes are turning toward Mexico. For decades Mexico was the Latin American country most prone to instability and currency debacles. Many Latin Americans still remember the devastation that the last Mexican crisis–the so-called Tequila Crisis of December 1994–wrought throughout the region. After the peso was devalued, international capital flows into all of Latin America stopped abruptly. Without international financing, authorities in the region were forced to raise interest rates dramatically; at the same time, they implemented deep financial cuts. Economic growth declined sharply, as did wages and employment. And, partially as a result of the Tequila Crisis, in 1995 Latin America had the worst economic performance in years.
This time, however, things appear to be different in Mexico. During President Ernesto Zedillo’s administration, a serious effort was made to create a sturdy economic structure. In particular, the peso was allowed to float freely in response to market forces. By giving up any effort to artificially control the exchange rate, Mexican authorities eliminated a major source of instability. Also, exports have grown at an impressive pace, and the banking sector, a source of perennial vulnerability, has been strengthened significantly. In fact, large international financial institutions have recently acquired Mexico’s two largest banks.
More important, perhaps, almost seven years after the implementation of NAFTA the Mexican economy has become increasingly linked to the U.S. economy. More and more, Mexico is becoming a genuine “Northern” country, with declining ties–financial and otherwise–to the rest of Latin America. Currently, more than 80 percent of Mexico’s exports go to the United States, and less than 5 percent go to its neighbors to the south. All of this suggests that Mexico is unlikely to be a major victim of contagion stemming from Argentina. Indeed, the international financial market seems to agree with this notion, and Mexico’s cost of borrowing internationally has remained stable and low.
In spite of vast economic improvements, Mexico still has some vulnerable spots. Chief among them is a stubborn fiscal deficit, which in reality is almost three times larger than the official figures. Tackling this imbalance–which exceeds 3 percent of gross domestic product–is a must. To this end Finance Minister Francisco Gil Diaz has proposed a massive fiscal reform. Congress’s action on this legislation during the next few months will determine whether Mexico can consolidate its economic stability.
Whatever happens, Mexico’s recent success in largely avoiding contagion provides an important lesson. If emerging nations are given the opportunity to expand their exports, they will build a robust and resilient economy capable of withstanding the vagaries of the international financial marketplace. Encouraging freer trade–mostly by eliminating the advanced nations’ protectionist practices–appears to be an effective recipe for reducing international instability. In that regard the U.S. Congress should support wholeheartedly President George W. Bush’s efforts to create, sooner rather than later, a Free Trade Area of the Americas that would stretch from Alaska to Tierra del Fuego. If this becomes a reality, crises will be fewer and less severe, and the hemisphere will be more stable and prosperous.
