Mexico Still Has A Lot Going For It

Wall Street to Mexican President Ernesto Zedillo Ponce de Len: too little, too late. The Mexican stock, bond, and currency markets plunged following Zedillo's Jan. 3 speech outlining his emergency economic plan. An $18 billion credit line. No wage hikes. Government spending cuts. Continued privatizations of state-owned assets. Yet the financial community is condemning the plan as insufficiently bold to stem the peso's collapse and restore investor confidence in the Mexican economy.

Give Zedillo a chance. Yes, his response to the peso's free fall was inept, and his much-delayed speech was less than stellar. Yes, there's still plenty of risk of social unrest and political turmoil in Mexico. But the substance of the plan has merit. Zedillo is strengthening the economic ties forged last year with the U.S. through the North American Free Trade Agreement, especially by opening up the banking system completely to foreign ownership. He's accelerating the privatization of the economy. And by getting the major labor groups to limit wage increases, he's offering some assurance that the inflationary impact from the devaluation won't set off a wage-and-price spiral. The Clinton Administration, without a peep of protest from the Republican leadership, reacted appropriately, pledging to lend support to the embattled Mexican government. So did private bankers and international financial officials.

In part, Wall Street's negative reaction to the Zedillo plan may reflect their past mistakes about Mexico. All last year, U.S. brokers enthusiastically flogged Mexican bond and stock holdings to individuals and to supposedly savvy institutional investors while playing down the risks of investing in developing countries. Besides, few money managers predicted a massive devaluation. This is reminiscent of the 1920s, when Wall Street coined money by selling Mexican and other Latin American bonds to individuals--a strategy that backfired during widespread defaults in the 1930s. Back then, however, Mexico and other Latin American economies were dependent on highly volatile commodities.

Today, Mexico has a very strong industrial base and a growing middle class. A lot is going right in the real economy, and Zedillo, by speeding some key NAFTA reforms could end up by strengthening the system even more. The problem lies more in the financial markets, where some key risks were glossed over and everyone tried to make too much money too fast.

The Mexican eruption is not the first financial crisis in the global spread of free-market economics. And it's not likely to be the last. A similar set of risks exists for almost every other developing nation, from Argentina to China--though not all will succumb. The developing nations are creating vibrant manufacturing and service economies by following the same free-market blueprint: bringing inflation rates down, reducing budget deficits, liberalizing trade, and privatizing publicly owned companies. Yet in coming years, all emerging economies will experience a difficult transition, as Mexico has, from an authoritarian political framework to a more democratic system--a transition that will often create an economic or financial crisis.

The industrial world should do its best to keep instability in the developing nations to a minimum. But investors and industrial governments need to remember that in the emerging world, free-market capitalism is frontier capitalism. As anyone with a sense of American economic history should know, frontier capitalism is risky, but it pays off big in the long run.

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