1. Perspectives on the Americas A Series of Opinion Pieces by Leading Commentators on the Region “Mexico’s Curse” by Gabriel Farfán-Mares External Consultant Public Management and Budgeting Inter-American Development Bank Washington, D.C. December 10, 2010 __________________The Success StoryMexico has overcome the economic crisis that badly hit the country during 2009.Although still fragile, a sample of three indicators demonstrates Mexico’s recovery.First, from January to October 2010, 850,000 jobs have been created. A simpleprojection predicts that 2010 will show the creation of more than a million jobs. Second,the consumer confidence index has significantly improved (15.9% in October 2010) andconsumption has somewhat recovered. 1 Third, Mexico has recently displaced Canadaas the number two exporter to the United States (non-oil exports), just after China. 2Although impressive, this is certainly not the first time that Mexico has reboundedfollowing a major economic downturn. Following the 1994-95 crisis, the country begangrowing at higher rates than before the crisis and by 1997, several indicators denoted aswift recovery. While the nature and depth of both crises are different, the datademonstrate that Mexico’s trade liberalization and proximity to the United States workas engines that have the power to pull the country out of economic predicaments.Unfortunately, this is only one side of the coin.1 See De la Rosa, Gustavo. 2010. "Crece confianza del consumidor 15.9%." in Reforma. Mexico City.2 Quintana, Enrique. Ibid."Tres buenas noticias."
2. 3The Other Side of the Coin: The Rentier StateMexico has succeeded in de-petrolizing its export sector and national economy.Nevertheless, an oil-supported fiscal policy has remained constant for almost fourdecades. The public sector has managed to maintain its dependence on oil, whosecontribution has ranged between 30 and 45% of the government’s total revenuebetween 1977 and 2010 (average 33%).On the other hand, from an economic standpoint, Mexico has nothing in common withrichly-endowed oil countries. Its economy and external sector are more diversified inmanufactures and services, although they remain highly focused on the U.S. market.Mexico has a very big private sector, which has expanded its investments regionallyand globally. The private sector consists of over 5 million firms (from individualentrepreneurs to medium- and large-size firms), more than 2 million employers and awork force of 50 million (out of a total population of 107 million). 4Because hydrocarbon-rich countries are often labeled as politically backward, it is alsoimportant to acknowledge that Mexico is an electoral democracy, particularly since itsonce-dominant party, the Partido Revolucionario Institucional (PRI) lost its majority inthe Chamber of Deputies 1997 and subsequently, the presidency in 2000.Nevertheless, the country is still muddling through to become a real democratic andliberal society. Political representation is effectively hindered by the presence of strong,centralized and nationally-based political parties that receive large amounts of publicfunds to build clientelist networks around elections, turning Mexico in one of the mostexpensive democracies in the world. 5 These strong clientelist networks are reinforcedby government patronage and welfare policies that focus on the distribution of public-sector jobs to the winning coalition on a non-merit basis–a true spoils system whichresults in a politically-biased allocation of transfers and subsidies to the population.Therefore, although Mexico cannot be compared to its Middle East and African oilrentier counterparts, it is an oil-rentier state that, from a comparative standpoint, suffersfrom some of the maladies associated with the oil curse.3 The rentier state concept was coined by Hussein Mahdavy to explain the institutional transformation of Iran in thecontext of its oil bonanza in the 1950s and has been used since then to assess the impact of oil in the structure andbehaviour of states. See Mahdavy, Hossein. 1970. "The Patterns and Problems of Economic Development in RentierStates: the Case of Iran." Pp. 428-467 in Studies in the Economic History of the Middle East: From the rise of Islamto the Present Day, edited by M. A. Cook. London, New York: Oxford University Press. Remarkably, this concepthas never been used to address the Mexican state’s political economy.4 Data from the Instituto Nacional de Estadística y Geografía and Consejo Nacional de Población.5 International Foundation for Electoral Systems. 2009. "Aplicación de la Reforma Electoral de 2007/2008 enMéxico desde una perspectiva internacional comparada." International Foundation for Electoral Systems, MexicoCity. 2
3. The Commodity CurseFor countries that are rich in hydrocarbons, oil is “the only game in town.” This fact hasinspired social scientists, analysts and policymakers around the world for many decadesto argue that a country is negatively affected by commodities (the so-called “commoditycurse”). Allegedly, oil tends to produce an array of negative phenomena: meagereconomic growth, violence, civil war, separatist movements, poverty andauthoritarianism. Yet, comparative studies have failed to provide conclusive evidence ofthe alleged “commodity curse.” They have only produced deceptive or inconclusivefindings, with many analysts concluding that oil is neither a curse nor a blessing. 6As a recent and comprehensive World Bank study on the overall impact of naturalresources in Latin America argues, commodities, and particularly oil, have been positivefor economic growth during the commodity boom and, in the long-run, have beensupportive of democracy. 7 The study concludes that “the preponderance of theevidence indicates that resource wealth, on average, neither undermines nordisproportionately promotes economic growth. Nor, it seems, is there any ‘politicalcurse’ (that natural resource abundance weakens democratic institutions and fuelslarge-scale conflict), at least not in LAC [Latin America and the Caribbean]”. 8After praising the same study, Stephen Haber, a researcher from Stanford University,contests the resource curse thesis by addressing the importance of building “what if,” orcounterfactual, reasoning. If resource rich countries had not had those resources,would they be better off today? He concludes that this is highly unlikely. While no onecan empirically contest that oil has been, and can be, a short-term blessing, no one hasexplored indirect, non-statistical and non-purely-economic, long-term perspectives onthe issue.In the long run, it can certainly be argued that commodities help to build the state. Yet,to endorse, as Haber does, “the report on commodities in Latin America by the WorldBank team [as] an important step in moving toward policies that will encouragesustainable development,”9 is, to say the least, a dangerous conclusion. Commodities,and among them oil, might be positive for countries in the short run. However, to arguethat they can provide sustainability to a developmental model in the region, andparticularly in Mexico, is a serious policy mistake.6 Rosser, Andrew. 2006. "The Political Economy of the Resource Curse: A Literature Survey." Institute ofDevelopment Studies, University of Sussex, Brighton.7 Sinnott, Emily, John Nash, and Augusto De la Torre. 2010. Natural Resources in Latin America: Beyond Boomsand Busts? Washington, D.C.: IBRD / The World Bank.8 Ibid., p. 579 Inter-American Dialogue. 2010. "Are Latin Americas Resources a Blessing or a Curse?" Inter-AmericanDialogue,, Washington, D.C., p. 4. 3
4. The same World Bank report, based on a paper published by the International MonetaryFund (IMF), 10 finds only one direct and statistically-robust effect that can be attributed tonatural resources, and particularly, to crude oil: the state’s tax effort. Oil rents are agovernment’s regular source of revenue and a direct threat to an effective tax effort.Each time a country is able to increase oil production, or to benefit from a higher oilprice, there is an “automatic” relaxation of the government’s tax effort.This is very relevant to Mexico, which, over the past 200 years, has not been able toconsistently sustain a taxation rate of more than 10% as a proportion of its GDP. As arecent report of the Economic Commission on Latin America and the Caribbean(ECLAC) on taxation capacity has noted, 11 Mexico ranks even lower than Haiti in itstaxation effort. One thing is clear: oil revenues undermine Mexico’s taxation effort.Taxes are not only a fiscal or financial indicator, but also reflect the quality of the publicsector, as fiscal sociology has emphasized. 12 As long as the government depends onthe contribution of individuals and firms to finance its activities, public servants andcitizens have positive incentives to enforce a productive and legal use of resources, aswell as government control and oversight, thereby increasing accountability. Taxes alsohelp citizens understand how and to what extent the state is connected to the marketand to what degree it can positively help spur economic growth. If a state does notdepend on taxes, it tends to behave independently from economic activity in thecountry, since it does not depend entirely on it, but instead, on oil production and itsinternational price. Under such conditions, the state’s decisions can be highly erratic,putting politics and short-term interests before the country’s development.Mexico’s Policy CurseOil not only undermines taxation capabilities and efforts, but, as a recent 10-yearresearch project demonstrates,13 it gravely damages the sustainability and quality ofpublic policies. When oil rents are treated as regular income, both the number and costof public employees soars. Perhaps more important, the unrestrained, discretionary useof public expenditures provides perverse incentives that impede the construction of amerit-based bureaucracy. Instead, it encourages extensive clientelist networks infederal, state and local welfare policies that tend to benefit current expenditures at theexpense of net fixed capital investment. Furthermore, in terms of both administrationand policy decisions, oil deeply transforms the state apparatus: the government’s needto control rents triggers an extreme centralization of public finances, as well as micro-management of the national budget. These developments undermine the efforts of10 Bornhorst, Fabian, Sanjeev Gupta, and John Thornton. 2008. "Natural Resource Endowments, Governance, andthe Domestic Revenue Effort: Evidence from a Panel of Countries." International Monetary Fund, Washington, D.C.11 Comisión Económica para América Latina. 2010. La hora de la igualdad. Brechas por cerrar, caminos por abrir.Brasilia: Comisión Económica para América Latina.12 Wagner, Richard E. 2007. Fiscal sociology and the theory of public finance: an exploratory essay. Cheltenham,United Kingdom: Edward Elgar.13 Farfán-Mares, Gabriel. 2010. "Non-Embedded Autonomy: The Political Economy of Mexicos Rentier State(1918-2010)." Doctorate Thesis, Government, London School of Economics and Political Science, London. 4
5. agencies and policymakers to do strategic planning at the sectoral level involving, forexample, health, education and transport. The substitution of oil rents for taxes freezesany attempt to implement new public management and results-based agendas.Institutions Do MatterAs the recent history of Latin America confirms, commodities, and oil revenues inparticular, can support economic growth, democracy, social stability and politicalconsensus, but they also can produce a policy curse within the state apparatus thatcreates and enforces negative incentives within and outside of the government. Publicinstitutions often underestimate, if not totally discard, the principles of scarcity andproductivity in their decision-making. When resources are inexpensive and easy to get,there is a generalized phenomenon of overspending by politicians, bureaucrats andeven worse, by society at large. Thad Dunning has argued that commodity bonanzasbring more benefits than costs because they reduce the redistributive costs ofdemocracy and tax reform. 14 Yet, once politicians, the public sector and society acceptthe idea of “manna from heaven,” or unearned affluence, they change and becomeoriented toward distributing the new-found wealth rather than producing wealth. AsMexico sadly demonstrates, the oil bonanza has helped the public sector grow at aconsiderably faster pace than the private sector and keeps detaching itself from the trueneeds of the economy and people. No matter how much oil revenue is available tobureaucrats and politicians, the state will be unable to use those resources productively.As a result, the country remains underdeveloped.What’s Next?Mexico remains stuck in the oil trap. Unfortunately, however, Mexican leaders,policymakers and society in general are not aware of the dangers inherent in the use ofoil to finance government operations, state policies or political processes. Most of therecent reforms addressing Mexico’s energy sector are focused almost exclusively onincreasing production and export levels. They do not consider oil’s role from a politicaleconomy or long-term public policy perspective.Mexico faces the potential of becoming a net oil importer in the coming years. Thismeans that the oil-based rentier Mexican state will be short-lived. The loss of oilrevenues could prove a blessing in disguise if Mexico is able to take advantage of thisdevelopment to transition to a more productive, efficient and modern economy that willbe more responsive to, and make better use of, its citizens’ talents and capabilities.14 Dunning, Thad. 2008. Crude Democracy: Natural Resource Wealth and Political Regimes, Edited by M. Levi.New York: Cambridge University Press. 5
6. Gabriel Farfán-Mares is an external consultant for the Inter-American Development Bank inWashington, D.C. Prior to this, he was a consultant at the Center for Economic Research and Teaching(CIDE) in Mexico City. From 2006-2008, he was director for budget analysis and team leader ontransparency for public management and budgetary reform at the Ministry of Finance in Mexico City’sgovernment. Dr. Farfán-Mares has twice been an advisor in Mexico’s Ministry of Foreign Affairs, and hasbeen a professor at universities in Mexico City, Monterrey and San Luis Potosí. The “Perspectives on the Americas” series is assisted financially by the Bureau of Educational and Cultural Affairs of the United States Department of State. All statements of fact or expression of opinion contained in this publication are the responsibility of the author. 6