Barely two years ago, Brazil’s rapid economic growth andexpanding middle class made it the darling of financial markets, whereas Mexicowas better known for drug gangs and violence. With slow growth and stalledeconomic reforms, financial markets were about to write off Mexico as a lost cause.
How quickly countries’ reputations can change. Today, theBrazilian economy is stagnating,and no amount of infrastructure investment for the World Cup and the Olympicsseems able to pull it out of its rut. Mexico’s economy, by contrast, is expanding at a steady clip, pushed along by arecent boom in industrial exports to the United States.
So Brazil has become the star that disappoints, whileMexico is the underperformer that suddenly shines. What is going on?
For starters, financial markets’ behavior says more aboutthem than it does about the countries in question. With analysts focused moreon short-term figures than on structural trends, it is not surprising thatfinancial markets often fail to comprehend the real story.
That said, there are important differences in the way thatBrazil and Mexico have run their economies. And those contrasts suggest usefullessons for other emerging countries.
One difference is that Mexico’s economy is much more openthan Brazil’s. Mexico is not only a part of the North American Free TradeAgreement (NAFTA) with the United States and Canada, but also participates in aweb of other agreements extending to Europe and Asia. Brazil’s openness, bycontrast, is limited by the stricturesof Mercosur, a regional grouping whose commitment to growth through trade is shaky at best.
Of course, this difference between the two countries ismostly old news. What is novel is our understanding of how long thesedifferences in trade policies can take to yield appreciable gaps in economic performance.Back in 1994, when NAFTA entered into force, its advocates promised that thegains in jobs and growth would come quickly. They did not. Nearly two decadeshad to pass before a sufficient number of firms established operations inMexico to take advantage of access to the US market.
Other guruspredicted that China had an overwhelming advantage and would eventually suckall trade-related jobs out of Mexico. They, too, were wrong. Jobs were lost toChina in the first half of the 2000’s, but in recent years – as Chinese wages(measured in dollars) rose quickly – the advantages of producing in Mexico reasserted themselves.Mexico has also profited from the rise of just-in-time production in the US, which puts a premium on proximity and readyaccess to imported inputs.
A second crucial difference lies in the two countries’ mixof monetary and fiscal policies. Mexico and Brazil both implemented anti-crisisfiscal packages in 2009. But Mexico withdrew the stimulus promptly as its economy recovered, and haspursued a tighter fiscal policy than Brazil in the years since.
This is not desirable for its own sake, as conservativesmight argue, but rather for the additional scope that it creates for monetarypolicy. Mexico has been able to keep interest rates much lower – the basicpolicy rate is 4.5%, compared to 7% in Brazil (which is unusually low for thecountry) – while maintaining a lower inflation rate as well.
Both countries are vulnerable to inflows of “hot” moneyfrom rich countries, but Mexico’s lower interest rates have better insulated itfrom the resulting threat of upward exchange-rate pressure. Brazil’s realexchange rate has appreciated considerably in the last three years (with someups and downs in recent months), while Mexico’s has remained basically flat.And, of course, Mexico’s competitive exchange rate is a key reason why it hasbecome an export powerhouse,with the manufacturing sector accounting for 80% of merchandise exports.
A third crucial difference consists in how the twocountries have positionedthemselves in the world economy. Setting aside the recent African commodityboom, most economic growth has happened in three world regions with similarproductive arrangements. In East Asia, a host of countries produce componentsfor assembly in China (or elsewhere in the region) and subsequent re-export; inCentral and Eastern Europe, a similar phenomenon occurs with Germany as thehub; and, of course, in North America, both Canada and Mexico are increasinglyintegrated into the US market.
Auto parts and finished vehicles are the largest componentsof that shift in North America, but the story does not end there: electronics,telecommunications equipment, and many other goods are also part of the growth.Mexico’s export basket is dramatically larger and more diverse than it wasthree decades ago. The same cannot be said of Brazil – or, indeed, of any ofSouth America’s fast-growing economies.
These South American countries – Brazil included – ought tobe thinking about what will fuel economic growth if and when the commodity boomends. What new goods and services will Brazil and the others export a decadefrom now, and to which markets? Unfortunately, the region’s political andbusiness leaders have little to say on this issue.
Of course, we should be wary about jumping to definitive conclusions. Inrecent months, Mexican exports have been slowing, while domestic consumption ispicking up as a source of demand. And, given Brazil’s capable professionals andquality firms, its potential to sell stuff around the world, while relativelylimited by its trade relationships, should not be underestimated.
Perhaps Mexico and Brazil will one day become the northernand southern anchors of Latin American growth. That would give financialmarkets – and the citizens of the region – a genuine reason to cheer.