SANTIAGO – Barely two years ago, Brazil’s rapid economic growth and expanding middle class made it the darling of financial markets, whereas Mexico was better known for drug gangs and violence. With slow growth and stalled economic reforms, financial markets were about to write off Mexico as a lost cause.
How quickly countries’ reputations can change. Today, the Brazilian economy is stagnating, and no amount of infrastructure investment for the World Cup and the Olympics seems able to pull it out of its rut. Mexico’s economy, by contrast, is expanding at a steady clip, pushed along by a recent boom in industrial exports to the United States.
So Brazil has become the star that disappoints, while Mexico is the underperformer that suddenly shines. What is going on?
For starters, financial markets’ behavior says more about them than it does about the countries in question. With analysts focused more on short-term figures than on structural trends, it is not surprising that financial markets often fail to comprehend the real story.
That said, there are important differences in the way that Brazil and Mexico have run their economies. And those contrasts suggest useful lessons for other emerging countries.
One difference is that Mexico’s economy is much more open than Brazil’s. Mexico is not only a part of the North American Free Trade Agreement (NAFTA) with the United States and Canada, but also participates in a web of other agreements extending to Europe and Asia. Brazil’s openness, by contrast, is limited by the strictures of Mercosur, a regional grouping whose commitment to growth through trade is shaky at best.
Of course, this difference between the two countries is mostly old news. What is novel is our understanding of how long these differences in trade policies can take to yield appreciable gaps in economic performance. Back in 1994, when NAFTA entered into force, its advocates promised that the gains in jobs and growth would come quickly. They did not. Nearly two decades had to pass before a sufficient number of firms established operations in Mexico to take advantage of access to the US market.
Other gurus predicted that China had an overwhelming advantage and would eventually suck all trade-related jobs out of Mexico. They, too, were wrong. Jobs were lost to China 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 ready access to imported inputs.
A second crucial difference lies in the two countries’ mix of monetary and fiscal policies. Mexico and Brazil both implemented anti-crisis fiscal packages in 2009. But Mexico withdrew the stimulus promptly as its economy recovered, and has pursued a tighter fiscal policy than Brazil in the years since.
This is not desirable for its own sake, as conservatives might argue, but rather for the additional scope that it creates for monetary policy. Mexico has been able to keep interest rates much lower – the basic policy rate is 4.5%, compared to 7% in Brazil (which is unusually low for the country) – while maintaining a lower inflation rate as well.
Both countries are vulnerable to inflows of “hot” money from rich countries, but Mexico’s lower interest rates have better insulated it from the resulting threat of upward exchange-rate pressure. Brazil’s real exchange rate has appreciated considerably in the last three years (with some ups 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 has become an export powerhouse, with the manufacturing sector accounting for 80% of merchandise exports.
A third crucial difference consists in how the two countries have positioned themselves in the world economy. Setting aside the recent African commodity boom, most economic growth has happened in three world regions with similar productive arrangements. In East Asia, a host of countries produce components for assembly in China (or elsewhere in the region) and subsequent re-export; in Central and Eastern Europe, a similar phenomenon occurs with Germany as the hub; and, of course, in North America, both Canada and Mexico are increasingly integrated into the US market.
Auto parts and finished vehicles are the largest components of 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 was three decades ago. The same cannot be said of Brazil – or, indeed, of any of South America’s fast-growing economies.
These South American countries – Brazil included – ought to be thinking about what will fuel economic growth if and when the commodity boom ends. What new goods and services will Brazil and the others export a decade from now, and to which markets? Unfortunately, the region’s political and business leaders have little to say on this issue.
Of course, we should be wary about jumping to definitive conclusions. In recent months, Mexican exports have been slowing, while domestic consumption is picking up as a source of demand. And, given Brazil’s capable professionals and quality firms, its potential to sell stuff around the world, while relatively limited by its trade relationships, should not be underestimated.
Perhaps Mexico and Brazil will one day become the northern and southern anchors of Latin American growth. That would give financial markets – and the citizens of the region – a genuine reason to cheer.