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Mexico’s Reforms: The Good, the Bad, and the Ugly

Monday, December 16, 2013

Mexico’s Congress has delivered an energy reform plan that could alter Mexico’s economic outlook for decades to come, but its populist tax policies and profligate spending threaten the steady growth the country has achieved in recent years.

The Mexican Congress has exceeded expectations and produced a reform package that could revitalize the country’s crucial energy sector, allaying concerns about the energy plans President Enrique Peña Nieto had earlier presented.

This hopeful development is the most important achievement under the Pacto por Mexico (Pact for Mexico) — an agreement among the leaders of the country’s three major political parties and the presidency to work together on shared priorities. That agreement also led to a fiscal reform plan that fell short of the critical goal of modernizing Mexico’s tax structure, and to an education package whose real impact depends entirely on how it is implemented by the president. Indeed, it remains to be seen whether Peña Nieto’s reform plans are overwhelmed by the powerful populists in his party who have a vested interest in the status quo.

The good news is what finally happened on energy reform. Mexico’s Senate delivered a much-improved plan that, if implemented robustly, could alter Mexico’s economic outlook for decades to come. When the leftist Party of the Democratic Revolution (PRD) decided to boycott the negotiations because of its implacable opposition to change, the ruling Institutional Revolutionary Party (PRI) and the center-right National Action Party (PAN) agreed on significant changes to the original reform that far exceed the president’s original plan for restructuring Mexico’s poorly managed energy sector.

The reforms will ferret out corruption from the state-run oil company PEMEX and reduce the influence of the notorious industry labor union.

The revised language adopts best practices from other state-owned oil companies that make them both profitable and accountable to their people. The most important features will ferret out corruption from the state-run oil company PEMEX and reduce the influence of the notorious industry labor union by eliminating its representation on the company’s board.

PEMEX will also be opened to private and foreign investment, and the company’s operations and financial management will be more efficient. For example, a key provision will reduce the amount of revenue that PEMEX funnels into the government’s budget from more than 80 percent of PEMEX’s revenues to no more than 4.7 percent. This is one of the cornerstones of the reform, because it will allow PEMEX to invest what it needs in exploration and operations in order to become profitable.

The creation of a “Mexican Petroleum Fund” will channel adequate money to a sustainable pension fund for PEMEX employees, provide a reliable source of funding for infrastructure (30 percent of revenues), and invest in PEMEX’s human capital (10 percent of revenues) to encourage postgraduate education and specialization for the company’s workers.

While privatization of Mexico’s oil industry was not seriously considered, the steps taken last week by Mexico’s Congress are ambitious and groundbreaking. Similarly, the prospect of allowing private companies to be involved in the distribution of electricity could help Mexico’s Federal Electricity Commission (CFE) become more profitable and less dependent on the government for its operations.

Unfortunately, the fiscal reform adopted earlier this fall is a step in the wrong direction. Beyond overtaxing the wealthy to compensate for social programs, the new tax regime will have a disproportionate negative impact on the productive, salaried middle class. It will not allow the government to raise enough revenue to balance the budget after paying for new spending — the equivalent of 4 percent of GDP — that was adopted to counteract sluggish growth of about 1 percent this year. Populist tax policies and profligate spending threaten the steady growth that Mexico achieved in recent years.

Populist tax policies and profligate spending threaten the steady growth that Mexico achieved in recent years.

The performance of Mexico’s public education might be described as just plain ugly. Mexico’s student performance ranks among the worst of the OECD countries. Education reform adopted earlier this year, while viewed by many as the first step toward overhauling a key engine of growth, does not tackle inefficiency and corruption. In particular, it limits the impact of teacher evaluations. There is reason to doubt that the government will have the political will to challenge the status quo in applying the new reforms against stiff resistance by the teachers’ union.

As the year began, there was much hope that the reforms presented by Peña Nieto could sustain Mexico’s progress for a generation to come. At year’s end, the very busy reform agenda has produced mixed results, and much will depend on how these new rules of the game are applied. And that is where Peña Nieto will prove his commitment to reform.

Roger Noriega is a visiting fellow at the American Enterprise Institute and managing director of Vision Americas LLC, which represents U.S. and foreign clients. Felipe Trigos is a research analyst at Vision Americas LLC.

FURTHER READING: Noriega also writes “Latins Rally to Restore Human Rights Panel,” “Post-Chávez Crisis an Opportunity for Venezuela,” “Venezuela Headed for Chaos,” and “Mexico's Reform Agenda at Risk.” Michael Barone says “Mexico Becomes a Stable, Politically Diverse Neighbor” and “Mass Migration from Mexico May Be History.” Stuart James makes “The Case for Mexico.”

Image by Dianna Ingram / Bergman Group

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