Santiago Levy | An economic agenda for Mexico’s new president

Mexico’s first female president, Claudia Sheinbaum, will take office on October 1, and for at least the first half of her six-year mandate, the coalition of parties that brought her to power will have a majority in both houses of Congress.

Sheinbaum’s first order of business will be defining the government’s 2025 budget. Here, the highest priority must be to shrink Mexico’s budget deficit – which will reach 5.8 per cent of GDP in 2024, compared to 2.0 per cent in 2018 – and thereby send a clear signal that the country’s debt is sustainable.

The next challenge will be to get the economy growing again. Under the outgoing administration of Andrés Manuel López Obrador, widely known as AMLO, annual GDP growth averaged just 1.1 per cent. Some might claim that slow growth was a result of the COVID-19 pandemic, not the government’s policies, but during the same period, the United States – Mexico’s largest trading partner – grew twice as fast. Mexico’s per capita income in 2024 will be the same as it was six years ago.

To boost growth, Sheinbaum will be told that she should seek to take advantage of the push in many Western countries, including the United States, for nearshoring – that is, shifting supply chains to countries that are friendlier and/or geographically closer than China. This trend – a reaction to both the pandemic and deepening tensions with China – could present an important opportunity for Mexico to attract more foreign investment.

But to seize it, the government must demonstrate a stronger commitment to the rule of law, including judicial independence. It must also expand access to, and improve the reliability of, energy supplies across Mexico. In recent months, the country has endured rolling blackouts – a result of an overstretched system operating with thin margins.

The energy imperative will be particularly challenging to meet. The good news is that there is significant room for Mexico to make use of renewables, and that Sheinbaum is committed to expanding renewable-energy capacity. The bad news is that she is committed to upholding her predecessor’s pledge to keep at least 54 per cent of electricity generation under state control. It will be very difficult to fulfil this pledge unless the state electricity company, Comisión Federal de Electricidad, rapidly increases its generating capacity while phasing out coal and diesel.

Beyond electricity, Mexico also needs more natural gas. However, its state-owned oil and gas company, Pemex – the world’s most indebted energy company – is not well-positioned to increase supply rapidly. Given this, Mexico’s best bet is to open production and transportation to private participants.

AMLO’s predecessor, Enrique Peña Nieto, attempted to do precisely that. But AMLO reversed most of the progress. Now, Sheinbaum must decide between maintaining Pemex’s dominant position – thereby putting more pressure on an already-strained federal budget – and reversing AMLO’s policy.

Unfortunately, even if all goes well, and Sheinbaum’s administration manages to take advantage of nearshoring and increase Mexico’s attractiveness to foreign businesses, this would still be insufficient to kick-start growth. In the three decades before AMLO’s presidency, Mexico’s annual GDP growth averaged just 2.0 per cent to 2.5 per cent. This is a very mediocre performance, given that Mexico during this period enjoyed a demographic dividend, a stable macroeconomic environment, and spectacular growth in manufacturing exports – which, at 40 per cent of GDP, now exceed those of the rest of Latin America combined. But none of this could overcome the effects of stagnant productivity.

Deep flaws

At the root of this stagnation are deep flaws in the design and operation of key institutions. In particular, Mexico’s social-protection system subsidises informal activities and imposes large costs on formal ones; its tax system subsidises unproductive firms and hampers the growth of small productive ones; and deficiencies in contract enforcement leave most firms without access to credit.

In Mexico, less productive informal firms can compete with more productive formal ones, thanks to lower tax burdens and labour costs, and the ability to skirt rules and laws. As a result, only a few high-productivity firms grow, while a much larger number of low-productivity firms survive, rather than being driven out of the market.

This means that investment is continuously wasted. One peso (of capital and labour) produces over 35 per cent more value-added in the formal sector than in the informal sector. And while jobs are constantly created, they are clustered in the unproductive informal sector. This situation has persisted despite the North American Free Trade Agreement and its successor, the United States-Mexico-Canada Trade Agreement. Why would nearshoring change it?

None of this is to argue that Sheinbaum should not try to make Mexico more attractive to foreign investment. Of course she should. But if the goal is inclusive growth, as Sheinbaum fortunately insists it is, she will have to go much further.

Sheinbaum must abandon two long-held but deeply flawed ideas: that informality will naturally disappear as growth accelerates, and that two different and unequal systems of social protection will advance social inclusion. Instead, she must commit to eliminating the perverse incentives that arise from the disparate treatment of formal and informal activities, including reforming the tax system to tax high-income households, not productive firms.

Mexico is a country with deeply engrained inequalities, where productivity has stagnated for decades. It needs a strategy to tackle both issues at the same time. Rhetoric aside, AMLO’s development strategy was, in essence, the same as that of his predecessors – none of whom delivered socially inclusive growth. More of the same policies will bring more of the same results. But if Sheinbaum is willing to tackle the formal-informal divide and build an inclusive and productivity-friendly welfare state, her presidency could prove truly transformative.

Santiago Levy, a non-resident senior fellow with the Global Economy and Development Program at Brookings, is a former chief economist and a former vice-president for Sectors and Knowledge at the Inter-American Development Bank.© Project Syndicate 2024www.project-syndicate.org