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• • • Hoover or Roosevelt All issues in your presidency have now been overtaken by a single overriding problem: the question whether to be Hoover or to be Roosevelt. To administer scarcity or to coordinate dynamism. It is true that you do not face a sudden crash. It is also true that just as the economic downturn in the United States has pushed Mexico down, so recovery in the United States will eventually bring Mexico up. These qualifications, however, provide no reason for complacency. The consequences of the present economic decline may irreversibly tarnish your administration. They may they prevent you from keeping your promise to ensure high growth. They may also starve your social initiatives and poison your political ones. Moreover, the helpless dependence on rescue through a quick American recovery reveals a dependence on the United States so extreme as to cast doubt on the feasibility of any strong national project in Mexico. A surrender to Hooverism -- the idea that Mexico must stoically undergo the interruption of growth -- would be a tragedy for you as well as for your country. All of your instincts and skills go toward action and production. You are not cut out to serve as a trustee of stagnation, and that is not the role the Mexican people assigned to you when they elected you. Can you, however, become a Roosevelt? By becoming a Roosevelt I mean using the fight against recession to achieve a dramatic broadening of economic opportunity and empowerment. In this letter, I argue that there is a way to turn the present setback into a breakthrough. This way is not radical in its methods. It does not affront the established macroeconomic orthodoxy about sound management of monetary and fiscal policy. It is, however, unconventional. It requires imagination in conception and boldness in execution. Like any serious, transformative program, it will provoke disagreement and conflict. However, it can also help trigger the organization and alignment of social constituencies and political groupings capable of sustaining it. Faced with the choice between passive resignation and active resistance to it, the temptation may be great to hedge your bets and split the difference. It is a bad escape: it will irritate without overcoming, and tantalize without satisfying. I argue here for a course of decisive action. Constraints on economic reactivation Three circumstances, together, define the special character of economic slowdown in Mexico now. These same circumstances also shape your possible response. The first circumstance is the extreme dependence of the Mexican economy, especially of Mexico's foreign trade, on the economy of the United States. To moderate this dependence should be one of your goals. Moderated or not, it is likely to remain overwhelming in the immediate future. The second circumstance is the unvailability to you of the traditional forms of expansionary monetary and fiscal policy. Monetary policy lies in the hands of an independent Central Bank that remains focused, under its inflation targeting regime, on monetary stability to the near exclusion of any concern with growth. (I shall have more to say below about the nature and implications of this orientation.) The room for expansionary fiscal policy, in the conventional sense, is drastically restricted by the need you recognized early to increase the abysmal tax take of the Mexican government. Moreover, given the views prevailing at the Bank of Mexico, any failure to raise more money in tax without also spending less money would likely cause the Central Bank to adopt an even more restrictive monetary policy. To recognize these facts is no license to embrace as a good the commitment to fiscal austerity and monetary restraint in the midst of a severe recession. Do not fool yourself. This not economic orthodoxy. It is the pseudo-orthodoxy the rich countries now try to impose on the poor countries, and the strong on the weak. It is one thing for you to find your hands tied. It is another thing to commemorate their being tied as a token of virtue. Your job is to find a way to untie them. The third circumstance is more removed from the agenda of economic policy and the discourse of the business press. However, it imposes what is by far the most important constraint on the prospects of the country. A vast part of the economically active population continues to lack the barest access to the resources and opportunities of production -- technical or professional education, credit, and the prospect of a decent job in an organization run on the basis of merit. The production system remains thin in its ability to substitute imports and to export products made with Mexican components. As a result, in an economic downturn such as the one that is now beginning to take place in Mexico, a frightening series of events have occurred, almost unnoticed. They are characteristic of the performance of the Mexican economy in a downturn, but no less destructive for being predictable. As the economic slowdown has deepened, unit costs have gone up and productivity has gone down. Productivity growth in the industrial sector -- the single most important predictor of the future of the Mexican economy and of the evolution of the real wage -- has now fallen below 2%. And, in the first quarter of 2001, as the growth rate of imports of both capital goods and intermediate goods fell precipitously, the import of consumption goods grew by almost 30%. The appreciation of the peso, supported by substantial inflows of capital from abroad, and by the confidence-mongering of the Central Bank, has subsidized the consumption of the comparatively well off. The problem of restrictive monetary policy The single-minded pursuit of monetary stability to the detriment of any commitment to rekindle economic growth in a country in which tens of millions of people remain desperately poor might well be condemned as perverse. The international and Mexican business press salute this orientation as a demonstration of orthodoxy. The truth, however, is that it is not first-world orthodoxy to maintain a restrictive monetary policy in the face of a dangerous recession. It is an abuse of inflation-targeting procedures to apply them without regard to a rapid decline of real economic activity. This policy may be ineffective, even for the narrow purpose of minimizing inflationary pressures. As domestic production and imports of capital and intermediate goods plunge, the urge to consume remains strong, and imports of consumption goods continue to rise. It is a recipe for further inflationary pressure, even in the throes of recession. The result is to give a pretext for further restraint in monetary policy, thus closing a circle that squeezes the Mexican economy dry. Such is the pseudo-orthodoxy that the financial markets and the IMF now press upon the governments of developing countries. They find in many of the central banks enthusiastic agents of this doctrine. This pseudo-orthodoxy is best understood as a functional equivalent to the late nineteenth-century gold standard. Like that regime, it treats the weakness of governments in the initiation of strategies of national development as the problem rather than as the solution, and the dependence of governments on the winning of financial confidence as the solution rather than as the problem. All the more reason to question the wisdom of central bank independence in a country like Mexico. Here, however, is the surprising fact. It is not worth picking a fight with this restrictive monetary policy or with its agents and supporters. The cost would be great. The benefit would be small. And the most promising line of solution lies in a direction that avoids a direct confrontation. Interest rates have in fact come down. And although they are not at first-world levels -- especially not at the first-world levels characteristic of economies in recession -- they are at least within striking distance of first-world interest-rate levels in periods of economic growth. In Mexico the effect of lower interest rates on decisions to consume and to invest is far weaker than in the first-world economies or even than in the economies of many other developing countries. IT IS NOT WORTH PICKING A FIGHT WITH THE CENTRAL BANK, BECAUSE MEXICO LIVES UNDER A REGIME OF CREDIT RATIONING. For much of the economy, and over a vast range of decisions to invest and consume, the problem is less that credit is too expensive than that it is simply unavailable. It is a constraint that applies forcefully to the vast majority of businesses as well as of individuals in Mexico, who lack access to the international credit markets. The story is familiar. Mexican banks have the local knowledge to lend money to firms and consumers, but neither the incentives nor the culture to do so on a large scale, or across the broad range of economic activities. Foreign banks in Mexico may be more disposed to lend. For the most part, however, they have not yet either acquired the local knowledge or built the national branch system that would be required. Nor have they yet had to contend with regulatory demands and market forces that might drive them to perform a role Mexican banks have left unfilled. The failure of Mexican banks to fulfill the primary responsibility of financial institutions in a market economy -- the mobilization of saving for production -- is all the more unacceptable in light of the great sacrifices that the Mexican people have to had to bear to bail out the failed banks, a bailout that benefited the entire finance industry in Mexico. The oppressive fact of credit rationing in Mexico makes the struggle for a more expansionary monetary policy, in its traditional form, less relevant. It also provides a clue to what should be a major element in a program of economic reactivation. What can and cannot de accomplished through fiscal policy The exclusion of expansionary monetary policy invites attention to the possibilities of expansionary fiscal policy. The room for fiscal maneuver, however, is narrowed by what continues to be a very low tax take. I begin by reflecting on three errors in the conduct of your recent effort to raise the tax take by generalizing the value-added tax. The point is not to cry over spilt milk. It is to turn the lessons of the immediate past to good effect in the design of a reactivation program. The first mistake was to present the tax issue in isolation from the broader program of economic growth and economic democracy that it would serve. It was not good enough to show, as you did, the additional social spending for the poor that the additional taxes would finance. You also needed to present the fiscal reform as an integral part of a program capable of bringing tangible opportunity to the broad majority of working Mexicans. But it is not too late; there is still time. The second mistake was to cause so great a commotion, and to pay so high a political price, for what would have been a relatively modest increase of the tax take -- 2% of GDP -- even if the proposal had been accepted in its entirety. Given the price that had to be paid anyway, it would have been better to get more for it. A growth and inclusion program will neither require nor permit an across-the-board rise in general taxes. However, it will call for an aggressive use of tax incentives and penalties. To the extent that it succeeds, and begins to win a constituency, it opens the way for a new rise of the tax take in the mid-term future, with more tangible social benefit and less political cost. The third mistake, albeit the least important, was the most noticed. The emphasis on what is an admittedly regressive tax could and should have been accompanied by further gestures toward progressive taxation. Such gestures could have taken the form of narrowly targeted exemptions from the VAT, in favor a few items characteristic of popular consumption. Alternatively, they could have offered a symbolic beginning for a future form of progressive taxation: for example, a small asset tax levied on very large fortunes. Once again, paybacks to the poor are not enough. A program for economic growth and economic democracy creates the opportunity to define the central direction of your administration. In Mexico today you cannot promote growth by a general lowering of taxes and public spending. Even after your initial reform, both taxes and public spending remain too low to support a program of economic growth with social inclusion. However, you can and you must develop the ability of the government to use tax policy differentially, shifting the balance between finance and industry, between the money economy and the real economy, between consumption by the few and access to productive opportunity for the many. The chief obstacle to such an unconventional use of fiscal policy in Mexican conditions is the difficulty of preventing its degeneration into a distribution of favors to a coterie of well placed interests. Mexico must not be force to choose between a government that resigns itself to passivity and a government that surrenders to lobbies. The government's economic activism, in fiscal policy as everywhere, must be rule-bound and performance-oriented. The program of economic reactivation therefore has to develop in concert with institutions and procedures that "deprivatize" the state. Such institutions must establish the instruments for decentralized, market-friendly, experimental coordination between government and private enterprise. The unconventional expansionary fiscal policy for which I argue in this letter makes sense only as part of that larger effort. An unequipped population The fundamental reason why tens of millions of Mexicans remain poor is the same basic reason why Mexico finds itself unable to maintain economic growth in the face of a downturn forced on it from abroad: the complete denial to most Mexicans of the economic opportunities and the educational equipment for effective action. The logic of my proposal is simple: the effort to reactive growth can and should be used as the occasion to democratize the market economy in Mexico, decentralizing access to the instruments of production, and establishing a new set of arrangements for the relation between government and business. Unlike the economic proposals, the educational reforms cannot be expected to have short-term effect. However, they can be launched in the same climate of national mobilization that the economic project requires and encourages. Further ahead, the economic and the educational programs can converge. Given the reality of credit rationing, an unduly restrictive monetary policy is not the main problem, although it might become the main problem at a later stage. Given the need to preserve what remains an unacceptably low tax yield, your administration should not lower either taxes or spending. In fact, at the first political and economic opportunity, it should continue to raise both. So what is required? First, the organization of a system of decentralized credit, both within and outside the banking system. Second, the parallel development of arrangements for technology transfer and technical assistance: the development, for the economy as a whole, of equivalents to "agricultural extension." Third, the immediate launching of programs of adult education and vocational training, in collaboration with private business and local governments and in the context of a nation-wide educational program. Fourth, the unconventional use of governmental initiative to supplement the limitations of scale and capacity of the emerging sectors of the economy, either by the facilitation of systems of cooperative competition and pooling of resources or by the direct public production or provision of key missing inputs and capital goods. Fifth, aggressive use of tax incentives, stretching to the utmost the limits imposed by the Nafta and WTO agreements, to encourage investment, import substitution, and the adding of value to assembly and export industries. Sixth, as an extension of the use of tax incentives, a pro-job program, committing the government to suppress all payroll taxes (as well as to replace such taxes by an increment to the value-added tax) and to subsidize, through tax incentives, the employment and training of low-wage workers. Seventh, the establishment of program for National Development Vouchers that would provide a means to inject liquidity into the economy and to finance the expansion of output and the creation of jobs. These vouchers would amount to a form of public investment collateralized by future tax receipts and tied in value to a index determined by the aggregate tax yield of the federal government and the rate of economic growth. They would help kindle growth without either spurring inflation (because they would be destined for productive investment rather than consumption) or confronting, head-on, the Central Bank. Eighth, the development of a rule-based, performance-conditioned deal with big private businesses in Mexico. This deal would be struck, sector by sector, through a series of high-visibility meetings intended to identify the bottlenecks to import substitution, to a broadening of exports and an improvement of their quality. The government would commit itself to break some of these bottlenecks -- through regulatory and tax breaks, initiatives to renegotiate constraints imposed by international agreements, public investments in infra-structure, and improvements to the supply of skilled labor and technology -- in return for measurable commitments to invest in areas crucial to the strategy of economic growth. The first three of these
directions give practical effect to the attempt to connect the program for
growth with the broadening of opportunity. They tap the underutilized energy of
the broad majority of working Mexicans, who want to become more productive but
cannot. The fourth and the fifth make up, though the unconventional use of tax
instruments, for the limitations of conventionally expansionary fiscal policy.
The seventh compensates for the unavailability of conventionally expansive
monetary policy as well as for the relative inefficacy of such policy under
conditions of credit rationing. The eighth takes advantage of the resources of
big business to shape a practice of strategic coordination between business and
government that is consistent with the commitments to respect the market and to
"deprivatize" the state.
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