““A Model of Structural Reform and Economic A Model of Structural Reform and Economic Growth in Mexico”. Growth in Mexico”.

Alejandro Díaz-Bautista, Alejandro Díaz-Bautista, Ph.D.Ph.D.

Professor of International Economics at Colefand Distinguished ResearcherNational Council of Science and Technology

adiazbau@gmail.com

Presenting at the Annual Meetings of the Association of Borderlands Studies and the 56th Annual Conference of the Western Social Science Association.April 5, 2014, Albuquerque, New Mexico, USA.Hyatt Regency Albuquerque.

IntroductionIntroduction Since President Peña Nieto took office last year, Mexico has Since President Peña Nieto took office last year, Mexico has

been pushing for an ambitious agenda of structural been pushing for an ambitious agenda of structural reforms. Mexico recently enacted a structural reform of its reforms. Mexico recently enacted a structural reform of its telecommunications and broadcasting industries aimed at telecommunications and broadcasting industries aimed at increasing competition and investment. A fiscal reform and increasing competition and investment. A fiscal reform and a comprehensive financial reform aimed at boosting credit a comprehensive financial reform aimed at boosting credit was proposed by the current administration. was proposed by the current administration.

The Mexican government recently announced the energy The Mexican government recently announced the energy reform that is expected to include significant changes to reform that is expected to include significant changes to Mexico’s current oil and energy sector, partly aimed at Mexico’s current oil and energy sector, partly aimed at attracting foreign investment.attracting foreign investment.

IntroductionIntroduction The reforms are a result of the Pact for Mexico, by which The reforms are a result of the Pact for Mexico, by which

the current administration and the major political parties the current administration and the major political parties pledged to pass structural reforms in such sectors as pledged to pass structural reforms in such sectors as telecommunications, financial, energy, education and a telecommunications, financial, energy, education and a fiscal reform. fiscal reform.

The conference analyzes the impacts of the structural The conference analyzes the impacts of the structural reforms in Mexico’s economy during 2014, twenty years reforms in Mexico’s economy during 2014, twenty years after the passage of the NAFTA agreement. Mexico’s after the passage of the NAFTA agreement. Mexico’s structural reforms in the areas of telecommunications, structural reforms in the areas of telecommunications, financial, fiscal and energy sectors are expected to improve financial, fiscal and energy sectors are expected to improve long-term economic growth prospects.long-term economic growth prospects.

Fiscal ReformFiscal Reform

TAX REFORM HIGHLIGHTSTAX REFORM HIGHLIGHTS The Social and Tax Reform has several components worth The Social and Tax Reform has several components worth

mentioning:mentioning: 1. The health related tax1. The health related tax 2. Continuing zero percent tax to food and medicines2. Continuing zero percent tax to food and medicines 3. Harmonization of VAT (Value Added Tax) in all of Mexico at 3. Harmonization of VAT (Value Added Tax) in all of Mexico at

16%.16%. 4. Elimination of special treatment and preferential tax regimes4. Elimination of special treatment and preferential tax regimes 5.Establishment of limits on personal tax exceptions and 5.Establishment of limits on personal tax exceptions and

deductionsdeductions 6. Tax on stock and capital profits6. Tax on stock and capital profits 7. Elimination of IETU (Special Tax on Production and Services), 7. Elimination of IETU (Special Tax on Production and Services),

IDE (CashIDE (Cash Deposit Tax) and new ISR (Revenue Tax) lawDeposit Tax) and new ISR (Revenue Tax) law 8. Changes to the customs regulation 8. Changes to the customs regulation

Energy ReformEnergy Reform

The reforms would allow outside companies to participate in oil, gas and The reforms would allow outside companies to participate in oil, gas and natural gas liquids (NGLs) production in Mexico. Right now, production is natural gas liquids (NGLs) production in Mexico. Right now, production is limited to the state energy producer, Pemex.limited to the state energy producer, Pemex.

By allowing more participation in the country's energy sector, the reforms By allowing more participation in the country's energy sector, the reforms could increase oil production in the country and reduce the trade deficit could increase oil production in the country and reduce the trade deficit that Mexico has in every other hydrocarbon and derivative, such as natural that Mexico has in every other hydrocarbon and derivative, such as natural gas, oil products and petrochemicals.gas, oil products and petrochemicals.

By allowing third parties to fractionate natural gas, the reforms could even By allowing third parties to fractionate natural gas, the reforms could even provide the foundation for a petrochemical resurgence along the lines of provide the foundation for a petrochemical resurgence along the lines of what is already occurring in the US.what is already occurring in the US.

Telecommunications ReformTelecommunications Reform The reforms would raise or eliminate limits on foreign investment, create The reforms would raise or eliminate limits on foreign investment, create

two new national television channels and form a new independent two new national television channels and form a new independent regulatory commission along the lines of the U.S. Federal Communications regulatory commission along the lines of the U.S. Federal Communications Commission, with the power to unilaterally punish non-competitive Commission, with the power to unilaterally punish non-competitive practices, including withdrawing corporations' licenses. A second practices, including withdrawing corporations' licenses. A second independent commission would be able to order firms to sell off assets in independent commission would be able to order firms to sell off assets in order to reduce their market dominance.order to reduce their market dominance.

The existing commissions that oversee competition and The existing commissions that oversee competition and telecommunications have no independent ability to alter permits, order telecommunications have no independent ability to alter permits, order divestment or issue fines. Those powers sit with a Cabinet secretary, a divestment or issue fines. Those powers sit with a Cabinet secretary, a position that in the past frequently has been accused of bowing to position that in the past frequently has been accused of bowing to telecommunications firms.telecommunications firms.

The reforms would require TV networks to provide their programming free The reforms would require TV networks to provide their programming free to most cable operators, and require cable operators to carry all broadcast to most cable operators, and require cable operators to carry all broadcast channels, measures seen as essential for opening television markets to channels, measures seen as essential for opening television markets to competition. The changes would also block telecommunications and competition. The changes would also block telecommunications and broadcasting companies from indefinitely freezing regulatory decisions broadcasting companies from indefinitely freezing regulatory decisions simply by obtaining a private injunction, a peculiarity of Mexican law that simply by obtaining a private injunction, a peculiarity of Mexican law that has thwarted dozens of attempts to regulate media and communications has thwarted dozens of attempts to regulate media and communications firms.firms.

Financial ReformFinancial Reform President Enrique Peña Nieto promulgated the financial reform law, saying President Enrique Peña Nieto promulgated the financial reform law, saying

that it will promote responsible lending which will create true economic that it will promote responsible lending which will create true economic growth and greater productivity in Mexico.growth and greater productivity in Mexico.

He promised that changes to the lending rules would have a favorable He promised that changes to the lending rules would have a favorable impact on the national economy by making credit more easily available to impact on the national economy by making credit more easily available to Mexicans and local companies, as well as increasing and democratizing Mexicans and local companies, as well as increasing and democratizing productivity, which will facilitate entrepreneurs’ access to much needed productivity, which will facilitate entrepreneurs’ access to much needed resources. With “more and cheaper credit,” President Peña Nieto said that resources. With “more and cheaper credit,” President Peña Nieto said that small- and medium-sized companies will be able to grow, modernize and small- and medium-sized companies will be able to grow, modernize and generate more jobs for Mexicans.generate more jobs for Mexicans.

The four central objectives of the new banking law, according to President The four central objectives of the new banking law, according to President Peña Nieto, are to boost the Mexican development bank; to improve the Peña Nieto, are to boost the Mexican development bank; to improve the judicial framework providing more credit at lower interest rates; to judicial framework providing more credit at lower interest rates; to increase competition in the financial sector multiplying and improving increase competition in the financial sector multiplying and improving credit options for Mexicans; and to strengthen the soundness of the credit options for Mexicans; and to strengthen the soundness of the financial system.financial system.

U.S.-Mexico Relations, a Shift U.S.-Mexico Relations, a Shift from Security to Economyfrom Security to Economy

Economics is at the center of the relation Economics is at the center of the relation between both countries in 2013 and 2014.between both countries in 2013 and 2014.

The United States is Mexico’s largest The United States is Mexico’s largest trading partner, and the two countries trading partner, and the two countries engaged in nearly 500 billion dollars worth engaged in nearly 500 billion dollars worth of trade in 2012. Much of that trade is in of trade in 2012. Much of that trade is in what are known as intermediate inputs, what are known as intermediate inputs, referring to semi-finished U.S. goods that referring to semi-finished U.S. goods that are finalized with Mexican resources, a are finalized with Mexican resources, a process seen as increasing the process seen as increasing the competitiveness of both countries.competitiveness of both countries.

United States - Mexico Border States

Description:

• 10 border states.

• Nearly 2,000-mile (3,169 km or 1,969 miles) of international border.

• Population: more than 83 million.

The United States- Mexico border regionThe United States- Mexico border region

The ten Border States represent the largest binational regional economy in The ten Border States represent the largest binational regional economy in the world, with over 83 million people and a combined economy ranked the world, with over 83 million people and a combined economy ranked estimated at number four in the world in economic terms.estimated at number four in the world in economic terms.

This region has 51 border crossings, 32 bridges and seven federal railway This region has 51 border crossings, 32 bridges and seven federal railway routes, placing it as the busiest border in the world, with over 350 million routes, placing it as the busiest border in the world, with over 350 million people cross the border each year.people cross the border each year.

The economic slowdown and unemployment are among the issues that The economic slowdown and unemployment are among the issues that currently affect the people on both sides of the border. currently affect the people on both sides of the border.

The state of Arizona had an unemployment rate of 9.4 percent, Texas, 8.4 The state of Arizona had an unemployment rate of 9.4 percent, Texas, 8.4 percent; New Mexico, 6.7 percent, and California, 12 percent (the percent; New Mexico, 6.7 percent, and California, 12 percent (the highest), according to the figures from July 2011, compared to an highest), according to the figures from July 2011, compared to an unemployment rate of 9.1 percent in the United States during July 2011.unemployment rate of 9.1 percent in the United States during July 2011.

In July 2011, the northern border states of Mexico were also showing high In July 2011, the northern border states of Mexico were also showing high unemployment rates. The state of Baja California had an unemployment unemployment rates. The state of Baja California had an unemployment rate of 5.05 percent, Sonora, 5.65 percent; Chihuahua, 6.81 percent; rate of 5.05 percent, Sonora, 5.65 percent; Chihuahua, 6.81 percent; Coahuila, 6.27 percent; Nuevo Leon, 6.49 percent; and Tamaulipas, 8.81 Coahuila, 6.27 percent; Nuevo Leon, 6.49 percent; and Tamaulipas, 8.81 percent (the highest).percent (the highest).

The United States Mexico The United States Mexico BorderBorder

People cross the United States People cross the United States Mexico border every day to do Mexico border every day to do business, go shopping, visit family business, go shopping, visit family members, or simply to enjoy each members, or simply to enjoy each other’s tourism. other’s tourism.

This results in around 350 million This results in around 350 million crossings and almost $400 billion in crossings and almost $400 billion in trade each year, making it the most trade each year, making it the most important border region in the world.important border region in the world.

Economic Growth ModelEconomic Growth Model

To understand economic growth model, let’s look at the sources of economic growth….where does production come from?

( )LKAFY ,,=Real GDP

“is a function of”

Productivity Capital Stock

Labor

Real GDP = Constant prices (Inflation adjusted) value of all goods and services produced in the country.

Capital Stock = Constant price value of private, non-residential fixed assets.

Labor = Private and Public Sector Employment.

Productivity = Production unaccounted for by capital or labor.

A convenient functional form for growth accounting is the Cobb-Douglas production function. It takes the form:

βαLAKY = where 1=+ βα

With the Cobb-Douglas production function, the parameters have clear interpretations:

Capital’s share of income (what % of total income in the country accrues to owners of capital).

Labor’s share of income (what % of total income in the country accrues to owners of labor).

Elasticity of output with respect to capital (% increase in output resulting from a 1% increase in capital).

Elasticity of output with respect to labor (% increase in output resulting from a 1% increase in labor).

α β

3

2

3

1

LAKY =

Suppose we have the following Cobb-Douglas production function:

A 1% rise in employment raises GDP by 2/3%

A 1% rise in capital raises GDP by 1/3%

We can rewrite the production function in terms of growth rates to decompose GDP growth into growth of factors:

( ) ( ) ( )LKAY ∆+∆+∆=∆ %3

2%

3

1%%

Real GDP Growth (observable) Employment

Growth (observable)

Capital Growth (observable)

Productivity Growth (unobservable)

Our model of economic growth begins with a production function.

Real GDP

Productivity Capital Stock

Labor

Given our models production function, economic growth can result from

• Growth in labor• Growth in the capital stock• Growth in productivity

3

2

3

1

LAKY =

We are concerned with capital based growth. Therefore, growth in productivity and employment will be taken as given

Productivity grows at rate

AgPop

Pop

LF

LF

LL

=

Population grows at rate

Lg

Employment

Labor Force= Employment Ratio

( Assumed Constant)

Labor Force

Population= Participation rate

( Assumed Constant)

3

2

3

1

LAKY =

3

1

Aky =

Again, the key property of production is that capital exhibits diminishing marginal productivity – that is as capital rises relative to labor , its contribution to production of per capita output shrinks

y

k

Capital stock per capita

Output per capita

Lets assume that households save a constant fraction of their disposable income.

( )TYS −= θ

Savings

Income Less Taxes

Constant between zero and one

Again, convert everything to per capital terms by dividing through by the labor force

−=

L

T

L

Y

L

S θ ( )tys −= θ

c

time

Is a higher steady state worth the transitions structural reforms?

Growth of per capita consumption under old policy regime = 1.5%

Immediate drop in consumption as economy responds to policy change

Growth of per capita consumption increases during transition periodduring structural reforms.

Growth of per capita consumption returns to 1.5%

““A Model of Structural Reform and Economic A Model of Structural Reform and Economic Growth in Mexico”. Growth in Mexico”.

Alejandro Díaz-Bautista, Alejandro Díaz-Bautista, Ph.D.Ph.D.

Professor of International Economics at Colefand Distinguished ResearcherNational Council of Science and Technology

adiazbau@gmail.com

Presenting at the Annual Meetings of the Association of Borderlands Studies and the 56th Annual Conference of the Western Social Science Association.April 5, 2014, Albuquerque, New Mexico, USA.Hyatt Regency Albuquerque.

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