MEXICO: BUDGET POLITICS--COURTING A CRISIS

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• Collection: General CIA Records
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• Original Classification: S
• Document Page Count: 28
• Document Creation Date: December 22, 2016
• Document Release Date: April 4, 2011
• Sequence Number: 1
• Publication Date: July 1, 1986
• Content Type: REPORT

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Directorate of See
Intelligence 25X1
Mexico:
Budget Politics-
Courting a Crisis
Secret-
ALA 86-10031
July 1986
254
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Directorate of
Intelligence
Mexico:
Budget Politics-
Courting a Crisis
Directorate of Operations.
This paper was prepared byl Office of
African and Latin American Analysis, with a
contribution by Office of
Leadership Analysis. It was coordinated with the
Comments and queries are welcome and may be
directed to the Chief, Middle America-Caribbean
Division, AL
Secret
ALA 86-10031
July 1986
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Mexico:
Budget Politics-
Courting a Crisis
Key Judgments A review of Mexican President de la Madrid's budget policies over the last
Information available three years demonstrates one basic fact-that short-term needs gutted his
as of 30 May /986 original program. Looking ahead, we believe that a likely continuation of
was used in this report.
the President's demonstrated persistence in politically biased fiscal policy
will greatly increase the likelihood of an escalating financial crisis. As
Mexico finds itself increasingly unable to finance its rapidly growing
budget deficit, it almost certainly will continue to turn to the United States
to provide financial transfusions and put pressure on international bankers
to keep credit lines open and reschedule Mexico's debt payments. Mexico's
need for continued US assistance in these areas in the future will place an
enduring strain on bilateral relations.
During the early years of his administration, President de la Madrid
appeared to be committed to slashing government spending. His widely
touted annual budget proposals promised to curb operating expenses-
particularly for subsidies and employment-while not excessively cutting
spending on public investment. Pressures to increase spending, however,
soon mounted on two fronts. Organized labor by late 1983 began clamoring
for an increase in living standards, which had fallen dramatically. At the
same time, the government, wanting to make a strong showing in the July
1985 midterm elections, began priming the pump as early as mid-1984.
Domestic pressures not only resulted in a higher level of spending than
originally planned, but also caused the President to alter his pattern of
budget allocations dramatically:
? Government operating expenses as a share of total public-sector spending
rose between 1982 and 1985 instead of dropping steadily as de la Madrid
had intended.
? To compensate for the inability to trim operating costs, public investment
fell dramatically-by more than 50 percent in real terms-from 1982 to
1985.
? Taken together, these two spending trends meant that the government
was able to cut the budget by only about one-half the amount that public
officials had projected during the first half of the President's term.
In our judgment, de la Madrid's revised overall spending strategy achieved
short-term political objectives, but only by sacrificing the country's longer
term economic health. Public-sector investment cutbacks have adversely
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ALA 86-10031
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affected the functioning of key sectors such as the petroleum, steel,
electricity, railway, and fertilizer industries. These cuts will only further
reduce Mexico's productive potential in the years ahead.
In our judgment, President de la Madrid is unlikely to change his fiscal
policy approach even if oil prices remain low over the remainder of his term
in office, preferring instead to increase the deficit despite the economic
risks. Indeed, the politically expedient moment for de la Madrid to make
dramatic changes in spending patterns probably has already largely passed.
With most politically aware Mexicans already looking toward the 1988
presidential election, and members of the economic cabinet jockeying for
favor, we believe that serious cuts in areas other than investment would be
even more difficult now than in the early years of the de la Madrid
administration. The President's decision to opt for politically easier
investment cuts during the early years of his term in office, however, has
reduced his flexibility to deal with Mexico's current financial problems.
With investment already cut, any new austerity program would have to
focus on politically more sensitive areas of spending.
From an economic perspective, Mexico's current fiscal policy approach is
fraught with risks. Domestically, economic growth will probably be
inhibited by government efforts to finance ever-increasing budget deficits.
At the same time, the role of the private sector could be noticeably reduced
as the government continues to absorb almost all domestic credit. As it is,
internal Mexican projections call for negative growth, rising inflation, and
a deterioration in the balance of payments this year. The Mexicans predict
that achieving the 3- to 4-percent annual growth tentatively planned for
1987 and 1988 would require at least $15 billion in foreign loans.
Internationally, the failure to check government spending enhances the
chances that de la Madrid will declare a moratorium on foreign debt
payments. We believe that he probably will continue to approach the
United States first for some sort of bailout program, stressing that the fate
of Mexico-and the US banking system-is in US policymakers hands.
Should no workable solution be achieved, we believe that de la Madrid may
decide to default on the debt as a bold gesture, much as Lopez Portillo did
when he nationalized Mexican banks in 1982-a decision that would send
political and economic shock waves through not only Mexico but the
international financial system.
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Key Judgments
Legacy of the Oil Boom
Grappling With the Need To Cut Spending
3
Swollen Operating Costs
3
Budget Cuts From a Sectoral Perspective
8
A. Methodological Notes on Budget Analysis
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Figure 1
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Mexico:
Budget Politics-
Courting a Crisis
Government spending accounts for about one-third of
Mexico's GDP and directly affects most aspects of
Mexican economic life. Budget allocation has
acquired great political importance since 1982 as it
increasingly has become an important tool in limiting
Mexico's financial needs and demonstrating
adherence to International Monetary Fund (IMF)
programs. At the same time, Mexico's economic hard
times have increased the importance of government
outlays as a means of political reward and control.
Spending decisions thus reflect President de la
Madrid's sensitivities to political pressures as well as
to economic considerations. In this light, many of
President de la Madrid's spending decisions can be
viewed as a crude measure of the relative weight given
to Mexico's priorities.
Against this background, this paper examines public-
sector spending patterns over the past three years and
focuses on the various pressures that engulfed de la
Madrid as he formulated Mexico's budget policies. To
accomplish this, we compare annual budget proposals
with actual expenditures to determine where the two
diverge, thus highlighting the areas where de la
Madrid was unable to follow through on his calls for
deep budget cuts. This study also briefly assesses the
economic and social impact on Mexico of de la
Madrid's policy direction, the prospects for change as
the country moves toward the end of the President's
term in 1988, and the implications of those
developments for the United States.
When he completed his six-year term in December
1982, President Lopez Portillo left behind a public
sector bloated by ambitious economic development
and consumption policies. Entering office
immediately following Mexico's discovery of large oil
deposits in 1976, he had used public-sector spending
even more enthusiastically than earlier presidents to
boost economic growth and redistribute income.
According to IMF statistics, the share of government
spending in the economy grew almost 30 percent
between 1977 and 1981, reaching about 40 percent of
GDP in the latter year. Over the same period, real
economic growth averaged 8.5 percent yearly.
The benefits of this rapid economic growth and
massive public spending were substantial. Lopez
Portillo's self-professed objectives were to lay the
groundwork for a modern economic infrastructure
and raise the standard of living for lower income
Mexicans. He achieved these objectives primarily
through public-sector spending:
? Public-sector investment more than doubled during
Lopez Portillo's administration, with the lion's share
going to the petroleum sector. The country's
electricity network also was dramatically expanded
and spending on public works projects, health
facilities, and railroads was doubled.
? Government spending on food subsidies nearly
quadrupled during his term in office. Farmers
received a higher official price for their products,
while the government provided basic goods to poor
urban dwellers at lower subsidized prices through
large-scale subsidies for basic foodstuffs, housing,
transportation, and heating and cooking fuels.
? The public-sector wage bill rose almost 50 percent,
creating large numbers of new jobs while holding
wages more or less constant, according to IMF
statistics. The government was able to create
enough jobs to maintain unemployment at levels
relatively low for Mexico, even as new entrants
flooded the labor force.
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Mexico's Major Budget Categories
In our analysis of Mexico's budget process, we
adhered to IMF statistical breakdowns of Mexican.
budget figures, which placed spending allocations
into operating and investment categories.a Using these
categories, we compared President de la Madrid's
publicly stated objectives in these two areas to actual
spending patterns during the first three years of his
administration. Within these two categories we fo-
cused on the spending components that the govern-
ment placed the most emphasis on in planning its
budget. These components are listed below as a
percentage of Mexico's 1982 budget allocations:
I. Operating expenditures (60 percent of total
allocations):
? Interest payment obligations on domestic and for-
eign debt (25 percent of operating outlays).
? Personnel costs, such as salaries for government
employees (20 percent).
? Central government transfer payments to help cover
the operating deficits-caused largely by price sub-
sidies and operating inefficiencies by Mexico's na-
tional electric company (CFE) and by its food
distribution enterprise (CONASUPO)-of its 26
largest public enterprises (15 percent).
a These data-accounting for 80 percent of the budget alloca-
tions-are not meant to be all inclusive, but are presented primari-
ly to highlight the character and scale of Mexico's budget alloca-
tions. The remaining 20 percent of Mexico's total budget
allocations, including items such as unclassified expenditures and
foreign exchange losses, do not fall in either of the two categories
and were judged to be either too difficult to determine or as not
having an impact on budgetary policy.
? Central government transfer payments to states,
municipalities, and other entities, goods and ser-
vices purchases, overdue debts, and financial opera-
tions make up the bulk of the remaining 40 percent
of operating expenditures-which we do not exam-
ine directly in this study.
II. Investment expenditures (20 percent of total
allocations):
? Investment by Pemex, including outlays for explo-
ration and development of new oilfields (30 percent).
? Public works projects such as roadbuilding and
maintenance of the country's overall transportation
network; construction of schools, health, and other
public facilities, rural development projects, irriga-
tion and other water projects (15 percent of invest-
ment outlays).
? Investment in the national electricity network (15
percent).
? Investment in Mexico's other 24 major public en-
terprises, including the government steel industry,
railway network, fertilizer plants, and others (10
percent of investment allocations).
? Property acquisitions, financial investment, overdue
debts, and a large "other" category make up the
remaining 30 percent of investment spending-
which we do not examine directly in this study.
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The former President's impressive achievements came
at the price of tremendous hikes in government
budget deficits that were underwritten by heavy
foreign borrowing. By the end of 1981, however,
international lending conditions began to sour.
Indeed, by the end of Lopez Portillo's term, Mexico
faced a current account deficit of almost $3 billion,
massive capital flight, and a sharply devalued peso.
Mexico was forced to plead for assistance from the
United States and other foreign creditors because the
country no longer could meet its import bill or service
its international debt.
Grappling With the Need To Cut Spending
Pressure from the IMF and international creditors
caused newly inaugurated President de la Madrid to
commit himself publicly to slash spending almost in
half during the three-year IMF program (1983-85)
instituted at the beginning of his term in office. To
accomplish this, he announced that the government
would refocus its role in the economy away from
income redistribution and industrial development
toward a less ambitious, laissez faire approach
reminiscent of the pre-1970s. From a budgetary
planning standpoint, de la Madrid and his economic
cabinet did not develop a specific three-year program
of spending cuts over the period, but instead outlined
budget targets only on a year-by-year basis,
responding in many instances in an ad hoc manner to
balance IMF requirements against domestic
priorities. A review of the general budgetary
guidelines
suggests that, overall, the government
wanted:
? Heavy reliance on the private sector to take the lead
in economic recovery. This was underscored in his
budget speeches, where de la Madrid emphasized
that he expected new export and investment tax
incentives to stimulate greater private business
activity leading to new investment, increased
exports, added employment, and reduced domestic
prices.
? Budget cuts occurring primarily in operating
expenditures, which make up the bulk of Mexico
City's budget outlays. Key areas included interest
payments, government subsidies to public
enterprises, and personnel costs (see inset).
? General protection for expenditures in public
investments, except for the petroleum industry,
which had benefited greatly from public investment
during the previous administration and certain other
industrial projects. Mexico's large public works
budget would be maintained to help minimize
unemployment.
De la Madrid's line of march was challenged almost
immediately by economic and political considerations,
and pressures to boost spending began to mount.
According to US Embassy and press reporting,
organized labor quickly began clamoring for an
increase in living standards, which had begun to fall
during the last year of the Lopez Portillo
administration and seemed almost certain to plummet
under de la Madrid's austerity program. At the same
time, de la Madrid's widely heralded plan to induce
an economic recovery led by private-sector investment
failed to produce results, aggravating the
government's economic difficulties. In addition to
these problems, the President almost 18 months into
his term increasingly became diverted by party
considerations. In general terms, as the Mexican
economy went into recession, the importance of
government spending as a tool of political reward and
control increased. At a very specific level, de la
Madrid faced important local and gubernatorial
elections in 1985, which caused him to place added
emphasis on political considerations from mid-1984
on when making spending decisions. These factors
forced de la Madrid, in our view, to diverge
substantially from his intended fiscal-policy path,
causing government operating expenses to remain
substantially over budget throughout the three-year
period, 1983-85.
Swollen Operating Costs
During 1983, the first full year of his administration,
de la Madrid intended to slash total outlays about 20
percent, according to IMF statistics, by cutting back
on operating expenditures. This approach failed,
however, as the government proved unable to do more
than trim operating costs.
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Figure 2
Selected Budget Indicators, 1981-86
Revenues from Pemex Nonpetroleum Government
Revenues"
Public-Service Debt Service
Payments
a Not including Pemex, Telmex, or Metro
subway system.
b Estimated.
c Projected.
According to a review of government announcements
and official statistics, the principal reason for the
failure was an unexpected rise in interest payments on
government debt. In formulating the budget, the
government underestimated by 50 percent the level of
inflation, and the consequent devaluation of the peso
in 1983 caused Mexico's peso-denominated interest-
payment obligations to run substantially higher than
originally projected. In fact, interest payments, which
were projected to rise by only about 10 percent in the
original budget plan, actually rose by more than 50
percent. As a result, interest payments soared from 25
to 40 percent of government operating expenses.
Difficulties in reining in operating expenditures were
not limited to one area. Government data show that
central government transfers to public enterprises,
projected to drop by 35 percent in 1983, ended up
rising by about 10 percent as officials moved to cover
rising deficits of the two public enterprises charged
with providing Mexicans with electricity (CFE) and
basic food products (CONASUPO) at low prices.
CFE's deficit, programed to decline by almost 40
percent, increased by almost 15 percent. According to
US Embassy reporting, the main reason for the
shortfall was the fact that increases in electricity rates
did not keep pace with the 60-percent rise in inflation
that boosted the utility's operating costs. The plan to
slice CONASUPO's operating deficit almost in half
also was jettisoned. The government continued to
subsidize food prices, which rose as the drop in the
peso and drought caused increases in the cost of
imported and domestically produced food products,
pushing CONASUPO's deficit up by 40 percent.
The government had more success with personnel
costs. The scheduled drop of 35 percent in 1983 was
nearly met-costs were cut by about 25 percent. Still,
the US Embassy reported that even though real
wages, factoring in inflation, fell by about 20 percent,
the government's reluctance to add to the unemploy-
ment problem caused by large layoffs in the private
sector significantly curbed its original intent to elimi-
nate many public-sector jobs. De la Madrid's decision
to boost military salaries and benefits also limited the
drop in overall personnel costs.
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Comparison of Proposed and Actual Budgets a
Overall public-sector outlays
1,501
1,117
1,198
1,037
1,109
971
Operating expenditures
906
741
878
742
820
722
Of which:
Interest payment
obligations
230
252
Transfers to public
enterprises
110
74
a These data are derived from statistics presented by the Mexican
Government to the IMF. They are not meant to be all inclusive, but
are presented primarily to highlight the character and scale of
Mexico's budget allocations.
The track record for 1984 was little better. According
to Mexican budget documents, the goal was to reduce
overall operating expenditures by 15 percent. IMF
statistics show that public-sector operating costs in
fact only dropped by about 5 percent when overdue
domestic interest payments are included. Looking at
individual accounts:
? Personnel costs, projected at the beginning of the
year to drop by almost 25 percent, were pared by
only 5 percent as the government became increas-
ingly reluctant to add to an already disturbing level
of unemployment as the economy continued to
decline.
? Central government transfers to public enterprises,
slated to drop by 30 percent, were reduced by only
half that amount as officials moved again to cover
large deficits, garnered principally by CFE and
CONASUPO.
? Interest payment obligations, previously scheduled
to drop by about 25 percent as Mexico City's overall
debt burden eased, dipped by only 10 percent.
A review of US Embassy and press reporting indicates
that, as in 1983, mounting labor pressure for wage
concessions and job security, the rising cost of financ-
ing the budget deficit, and Mexico City's continuing
difficulty in reducing public-enterprise deficits caused
the government to fall short of its goal.
Although official IMF statistics outlining Mexico
City's actual budget performance in 1985 have not yet
been released, US Embassy reports and official Mexi-
can data indicate that government spending alloca-
tions once again deviated markedly from budget
proposals. According to official Mexican Government
data, overall public-sector outlays increased slightly
last year-a far cry from the promised 10-percent
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reduction. As in 1984, the principal factors in the rise
came from interest, personnel, and public-enterprise
costs.
We believe much of last year's excess spending relat-
ed to the government's efforts to build popular sup-
port for the ruling party in the midyear elections. For
example, Mexico City not only failed to reduce the
number of workers on the government payroll, but it
also authorized large wage hikes prior to the elections.
Thus, instead of decreasing by the planned 15 per-
cent, personnel expenditures are estimated to have
increased by nearly 10 percent
transfers to public
enterprises were cut by only about 5 percent-less
than one-third the programed 15-percent drop. As in
previous years, CFE and CONASUPO produced
most of the overrun, according to the US Embassy.
Interest-payment obligations incurred to finance the
budget deficit, moreover-scheduled to fall slightly in
1985-increased by over 7 percent, according to
Mexican Government statistics, as mounting public-
sector demand for scarce domestic credit caused
interest rates to soar.
Compensating for Overruns
To compensate for the increases above planned oper-
ating expenditures, and yet hew somewhat to his
overall reduction proposals, President de la Madrid
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Figure 3
Mexico: Budget Spending Allocations, 1982-85
ended up reallocating funds away from investment.
The government also curtailed its highly touted emer-
gency employment programs in public works.
IMF statistics for 1983 show a significant decline in
investment outlays that, in percentage terms, far
outstripped cuts in operational spending. While the
overall level of operating costs fell only 5 percent,
investment was slashed over 40 percent. Investment
by public enterprises was reduced by one-third, in line
with the government's budget proposals. Spending on
public works-in contrast to de la Madrid's 1983
fiscal program, which called for almost no cuts-was
reduced by more than half. Mexico's national petro-
leum company, Pemex, was the hardest hit, suffering
a 40-percent drop in investment-this on top of a 20-
percent drop in 1982. In 1983 alone, Pemex cuts
accounted for more than 10 percent of all Mexican
budget reductions.
Government investment outlays in 1984, according to
IMF reports, fell by another 15 percent and account-
ed for one-third of all budget cuts in that year. Pemex,
which had been programed to drop by only 5 percent,
once again bore the brunt of the cuts-suffering a 20-
percent reduction. Actual cuts in public-enterprise
investment ended up being twice originally budgeted
levels. At the same time, Mexico's public-employment
program disbursed only about half of the amount
originally targeted.
Investment spending in 1985, according to IMF fig-
ures, once again took a back seat to other priorities,
dropping by another 5 percent despite de la Madrid's
plan to raise spending by 15 percent. Public-enterprise
investment, which had been expected to stagnate, took
the heaviest beating, falling by almost 10 percent.
Although we have no precise reporting on the exact
public-enterprise investment cutbacks.
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According to IMF statistics, with this spending ap-
proach the government over the past three years
neither reached the level nor achieved the pattern of
cuts envisioned during the course of Mexico's IMF
program:
? Overall public-sector cuts by the end of 1985 in real
terms equaled only about one-half the amount that
public officials had projected during the course of
the three-year Fund program.
? Interest payments on Mexico City's outstanding
debt grew to about 40 percent of total public-sector
spending because of the need to increase domestic
borrowing to finance the growing budget deficit-
well above the 25-percent figure targeted by the
IMF.
? Government operating expenses as a fraction of
total public-sector spending rose instead of dropping
steadily as de la Madrid and IMF officials had
intended.
? Public investment fell by over 50 percent in real
terms from 1982 to 1985-whereas it had been
projected to pick up during the past several years of
the IMF program.
Budget Cuts From a Sectoral Perspective
To understand the impact of the spending cuts on
Mexico, it is useful to take a sectoral look at which
economic groups or entities have been most affected
by the President's budget decisions. In using this
approach, it is important to distinguish between three
major sectors-public-sector industry, private busi-
ness, and labor-since the impact on each is different
and in turn so are the ramifications. The 26 key
public-sector enterprises in Mexico-which the gov-
ernment vows never to sell-together make up the
backbone of Mexico's public-enterprise system. Their
continued viability, crucial to any turnaround of the
present Mexican economic situation, in our judgment,
has been threatened by budget cutbacks over the past
several years. Private business, considered to have
been the catalyst for the country's enviable economic
growth record during the 1950s and 1960s, also has
been affected negatively by the government's budget
policies. Organized labor, which we believe is a key to
political stability, also has taken a beating over the
three-year period, even though it has been protected
more than the other two sectors.
Public-Sector Industry
Of the 26 key public-sector enterprises, Pemex is the
most important because it provides close to 70 percent
of the country's foreign exchange earnings and about
half of government budget revenues. Even so, Pemex
has been affected the most by the government's
spending cutbacks because of the President's determi-
nation, that reductions
in Pemex allocations were the least sensitive political-
ly. Pemex was forced to slash investment allocations
in half over the three-year period, according to IMF
statistics. Even these dramatic cuts were not enough,
however, and Mexico City also began pushing the
company to decrease the costs of production and
distribution to boost net oil earnings. As a result,
overall Pemex spending allocations fell by more than
50 percent during the period. Because of de la Ma-
drid's unwillingness to confront the powerful oilwor-
ker's union, however, the cutbacks were accomplished
by dramatically decreasing purchases of equipment
and spare parts while holding the line on personnel
and wage rates.
In the short term, the cutbacks have weakened Pe-
mex's ability to export. Pemex, in coping with budget-
ary limitations, reduced maintenance expenditures-
estimated by the US Embassy to be more than 50
percent below budget-by easing standards, reducing
parts inventories, and cannibalizing equipment. Most
recently, budget constraints have forced Pemex to
delay a badly needed equipment maintenance con-
tract
~s a result, Pemex-which as
recently as 1984 had the potential to export up to 1.8
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Figure 4
Petroleum Production and Export Outlook, 1978-2006
I I I I I I I I I I I I I I I
million b/d-no longer has the capacity to boost
production for export much beyond its current target
level of 1.5 million b d
Over the longer haul, the cuts made by Pemex forced
the oil company to curtail its petroleum exploration
programs sharply. This in turn could seriously jeopar-
dize Mexico's petroleum export capability further
down the road. Because of the reduction of its previ-
ously aggressive investment in oil exploration, Mexi-
co's proven oil reserves have been dropping over the
past several years, according to official Mexican
statistics. Pemex officials claim that Mexico could
become a net oil importer by the late 1990s unless
more funds are allocated to explore for new oil.
While reporting has not been as detailed regarding
the impact of investment cuts in other industries, US
Embassy and press accounts suggest similiar problems
exist:
Domestic
demand
? Mexico's publicly owned steel industry is beginning
to feel the effects of having operated without an
adequate maintenance budget for several years,
according to the US Embassy. Spare parts shortages
have held steel production in some plants to only 60
percent of capacity.
? Local press reporting indicates that officials have
been forced to condemn several fertilizer plants
because the government failed to maintain and
equip the facilities adequately.
? Both US Embassy and local press reports cite the
rapid deterioration of Mexico's public railway sys-
tem as another visible indicator of government
neglect. The press reports that rail stock is so
rundown that, at any one time, 25 percent of the
company's locomotives are undergoing repairs.
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? Local press reports claim that, as a result of the
cancellation of investments, Mexico's public electric
company, CFE, lacks the resources to cope with any
rise in demand for electric power.
The Private Sector
The impact of Mexico's budget cutback program on
productive potential has not been limited to public-
sector firms. Even though many private businessmen
in 1983 profited from the government's effort to
stimulate a recovery led by the private sector and
from measures such as low-interest financing, gener-
ous import licensing privileges for exporters, and
bailouts for companies in financial trouble, a review of
Embassy reporting shows that gains eroded rapidly as
the government began implementing its budget cuts.
For example, the sharp cutback in government pur-
chases from private suppliers, caused by the drop in
public investment, has hurt many Mexican compa-
nies. Meanwhile, heavy government borrowing to
cover operating expenses has caused a domestic credit
shortage that threatens to bankrupt many businesses.
Bank credit to the private sector is virtually nonexis-
tent, according to the US Embassy. Prominent Mexi-
can businessmen have told Embassy officials that a
recent suspension by state corporations of payments to
suppliers already weakened by tight credit could force
many private companies to shut down.
The private sector was also adversely affected by a
series of government pricing policy decisions. Govern-
ment price controls on agricultural and manufactured
goods cut deeply into private business profits. In
addition, to maintain a decent standard of living for
Mexico's lower income workers de la Madrid in 1984
imposed a two-tiered pricing strategy for basic goods.
Middle-income businessmen personally were hit hard
financially by the government's policies of charging
higher income earners more than double the prices
charged labor workers for food, electricity, and fuel.
While the net impact of government policy has weak-
ened private-sector productive potential, Mexico has
suffered from other side effects of its policies. The
pressure on the private sector has soured relations
between business and government.
The Labor Sector
While public and private business has been hurt in
recent years, the Mexican Government's efforts to
protect the living standards of workers and forestall
labor unrest have been relatively successful. Indeed,
the contrast between business and labor is one area
where the economic-political trade-off is most evident.
Even though real wages have fallen by nearly 40
percent since 1982, according to the US Embassy,
continued heavy subsidies for lower-income workers
on basic food items, housing, electricity, health care,
and public transportation facilities have kept price
increases on these basic items from rising as fast as
the overall rate of inflation. The US Embassy also
reports that, even though Mexico City's emergency
employment program has failed to materialize, the
government so far has kept public-sector layoffs to a
minimum. Fidel Velazquez, Mexico's national labor
union leader, willingly admits that union members
probably have fared better than other groups in
Mexico, at least since 1983, according to US Embassy
reports.
Nevertheless, labor leaders, reflecting the dissatisfac-
tion of rank-and-file workers with the state of Mexi-
co's economy, have stepped up demands on the gov-
ernment over the past year. Among the additional
concessions labor is pushing for, according to press
reports, are greater control over subsidies, possibly
through union-issued food coupons, and guarantees of
job security within the public sector. Focusing on real
wage losses over the past four years, Fidel Velazquez
also is pressing the government to increase the num-
ber of minimum wage hikes from two to three annual-
ly.
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A Mexican cartoon highlights the fact that the
petroleum industry can no longer sustain the
As public-sector resources have continued to dwindle
over the past several years, labor leaders also have
demanded increased political clout within the govern-
ment and the ruling party. In return for continued
support, organized labor has received a 10-percent
rise in its number of congressional seats, as
well as dozens of state and local offices. Organized
labor also now is prominently represented at all levels
of the ruling party and, to a lesser extent, within the
executive branch of the government.
Prospects and Implications for the United States
The President's decision to opt for politically easier
investment cuts during the early years of his term in
office has reduced his flexibility to deal with Mexico's
current financial problems. With investment already
cut, any austerity program will have to focus on
politically more sensitive areas of spending. There is
little likelihood, in our view, that de la Madrid will
make the difficult cuts needed in operating costs to
bring the budget into balance while allocating funds
for investment needs. If anything, he will be under
more pressure to heed labor demands for such benefits
as employment guarantees and subsidies in order to
contain social unrest. Even now, according to US
Embassy reporting, sales and liqui-
dation of many unprofitable public enterprises are
being delayed until the government can ensure that
such moves will not result in worker layoffs.' Press
and Embassy reporting also indicates that labor lead-
ers still may convince the government later this year
to increase the number of annual minimum wage
hikes to help workers keep up with inflation. More-
over, according to the US Embassy, electricity and
gas prices were rolled back in May in Mexico's third-
largest urban center, Monterrey, in response to pro-
longed street demonstrations by workers and house-
wives, and food coupons are being issued to most
workers to soften the impact of rising food costs.
We believe the politically expedient moment for de la
Madrid to make dramatic changes in spending pat-
terns probably has already largely passed. With most
Mexicans mentally gearing up for the 1988 presiden-
tial election and members of the economic cabinet
jockeying for favor, we believe that serious cuts in
areas other than investment will be even more diffi-
cult than in past years. Moreover, if de la Madrid's
past behavior is any indication of his priorities, elec-
tion-related spending probably will cause outlays to
rise considerably.
Many observers argue that the President's successor
will be in a better political position to take dramatic
economic policy initiatives. In our view, however, the
economic climate de la Madird leaves behind will
make it difficult for even the most astute politician to
impose tough measures. Even though de la Madrid
entered office facing a financial crisis, his problems
were softened by a booming petroleum industry and a
recent legacy of 8.5-percent GDP growth. His succes-
sor will have neither. Already, internal Mexican
projections call for negative growth, rising inflation,
and a deterioration in the balance of payments this
' We believe that the recent liquidation of the Fundidora Steel
Complex was an exception to this trend, aimed at convincing the
IMF and international bankers that Mexico is serious about
economic reform. We see no signs that this action, which threw
10,000 people out of work and precipitated large antigovernment
demonstrations, is likely to be accompanied by the elimination of
many of Mexico's other 200 or more money-losing public enter-
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A moderate journal depicts President de la Ma-
drid, Budget Minister Salinas, and former Fi-
nance Minister Silva Herzog painting themselves
into a corner.
year. The Mexicans predict that achieving the 3- to 4-
percent annual growth tentatively planned for 1987
and 1988 would require at least $15 billion in foreign
loans. Moreover, the country's public-sector, industri-
al, and transportation infrastructures, in our judg-
ment, have all been weakened over the past three
years.
At the same time, Mexico's budget performance can
only hurt its ability to attract badly needed foreign
funding. Given Mexico's poor budgetary track record,
foreign creditors are unlikely to help much in bridging
the growing gap between revenues and expenditures,
As a group,
they are united in pressing Mexico for serious signs of
economic reforms before doling out new loans for
1986.
We believe that as Mexico finds itself increasingly
unable to finance its rapidly growing budget deficit, it
will continue to turn to the United States to provide
financial transfusions and put pressure on the IMF
and international bankers to be especially lenient with
Mexico in keeping open credit lines and encouraging
new debt rescheduling exercises. Mexican officials
may agree to introduce domestic economic reforms,
encourage foreign investment, and liberalize the coun-
try's trade regime to qualify for new money, but we do
not believe that de la Madrid will go much further
than he has in the past to implement such changes.
Mexico City also will continue to look to the United
States for special deals, perhaps generous oil sales
arrangements.
In the event Mexico City cannot negotiate agreements
through US good offices to meet the country's budget
needs, we believe the Mexican Government would
seek to distance itself from Washington and probably
would pursue a more nationalistic policy toward for-
eign creditors. De la Madrid's inability to balance
financial constraints with the need to boost spending,
in our view, enhances the odds that he will take some
dramatic action, such as a declaration of a moratori-
um on foreign debt payments. We believe that he
probably would approach the United States first for
some sort of bailout program, stressing that the fate of
Mexico-and the US banking system-is in US
policymakers hands. Should no workable solution be
achieved, de la Madrid may decide that it is political-
ly more popular to make a bold gesture-as Lopez
Portillo did when he nationalized the Mexican bank-
ing system in 1982-than to make further painful
public-spending cuts
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Appendix A
Methodological Notes
on Budget Analysis
Our research has shown that Mexican budget statis-
tics are generally incomplete and unreliable indicators
of actual spending allocations. Academic researchers
have encountered the same obstacle. For example, one
prominent Mexican economist, in the introduction to
his own study of Mexico's budget process, began by
saying that "the budget for 1986 is still, as in the past,
affected by numerous contradictory figures, half-
truths in the official publications, and loopholes in the
data; preventing either rapid or consistent analysis."
In our judgment, this situation exists largely because
of the political sensitivity of government spending
decisions. By obfuscating budget data, the adminis-
tration is able to diffuse political pressures. In addi-
tion, the categories of data change from year to year,
making it difficult to construct a consistent time
series.
As a result, this assessment relies heavily on IMF
statistics to compare Mexican government spending
objectives with actual disbursement patterns during
the three-year period, 1983 through 1985, that Mexi-
co participated in an IMF Extended Fund Facility.
We realize that the data supplied by Mexico to the
Fund are likely to contain some of the same discrep-
ancies as other Mexican official budget information.
We believe, however, after extensive review of alter-
nate sources, that IMF data have the advantage of
being the most accurate and only consistent series of
proposed and actual budget figures currently avail-
occur, and the impact on key sectors in Mexico.
To the extent possible, we have attempted to over-
come many of the limitations inherent in using the
IMF time series. To offset the impact of inflation on
Mexican budget allocations and ensure accurate com-
parability from year to year, all references to budget
allocations are made in 1978 Mexican pesos, unless
otherwise specified. Where IMF data are lacking,
particularly regarding Mexico's 1985 performance
record, we have relied on analyses of official Mexican
data presented by private Mexican economic institu-
tions. Although the actual data are not entirely
consistent with the IMF series, we have been able to
piece together enough information to complete the
trend line. The lack of detailed categories presented in
the IMF series, prevents line-by-line, sector-by-sector
analysis. We are confident, however, of major spend-
ing trends, the political pressures that caused them to
able.
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Appendix B
Mexico's Fiscal Policy Team
De la Madrid's fiscal policy team has a fairly cohesive
profile that combines US postgraduate education and
a long working association with the President. These
technocrats, none of whom has ever been elected to
public office, have attempted to guide Mexico
through its worst economic crisis since the ruling
Institutional Revolutionary Party (PRI) consolidated
power in the 1920s. Although highly qualified and
experienced, they have been unsuccessful in their
attempts to improve Mexico's economy. Because most
members of this team would like to succeed de la
Madrid as president in 1988, we believe that they will
become more cautious and less forceful in their
attempts to make sharp budget cuts over the near
term for fear of being blamed for the government's
failure to lead the country out of the economic
doldrums.
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Miguel DE LA MADRID Hurtado
President
(since December 1982)
A technocrat with little grassroots political backing, Miguel de la Madrid is the ul-
timate decisionmaker on all economic policy matters. More of a planner than a
politician, de la Madrid makes decisions only after comparing several points of
presidential candidate.
De la Madrid, 51, holds a law degree from the National Autonomous University of
Mexico (UNAM), and an M.A. degree in public administration from Harvard
University. He worked for the Bank of Mexico and taught law at UNAM during
the early 1960s. In 1965 he joined the Secretariat of Finance, where he served, ex-
cept for a two-year stint at Pemex, until he became Secretary of Programing and
Budget in 1979. He held that post until September 1981, when he became a
Carlos SALINAS de Gortari
Secretary of Programing and Budget
(since December 1982)
A close friend and protege of President de la Madrid, Carlos Salinas de Gortari
controls Mexican Government budget expenditures. He appears to derive much of
his political influence from his close relationship with the President. For example,
we believe Salinas influenced de la Madrid to increase expenditures in early 1985
to help ensure PRI victories in the July 1985 gubernatorial and legislative
elections. Salinas would probably favor a payment moratorium on Mexico's
foreign debt rather than a drastic reduction in government spending to stabilize
the econom .
Salinas, 38, has strong presidential ambitions
His chances of being chosen, however, are diminished by his youth and the
general in the Secretariat of Programing and Budget from 1979 to 1981.
economy's poor performance. He has, nonetheless, followed the classic pattern of
achieving success in the Mexican bureaucracy: he has good family connections;
became active in the PRI early on; and has excellent educational credentials
including a B.A. in economics and an M.A. degree in public administration from
the National Autonomous University of Mexico, and both an M.A. and a Ph.D. in
economics and government from Harvard University. He worked in the Secretari-
at of Finance during the early 1970s. He was subdirector at the Institute of
Political, Economic, and Social Studies, a government think tank, and a director
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Gustavo PETRICIOLI Iturbide
Secretary of Finance and Public Credit
(since 17 June 1986)
A technocrat with extensive banking and fiscal experience, Gustavo Petricioli is
financially conservative and a moderate on the debt issue-he is the government's
pointman on refinancing negotiations with the IMF and foreign banks. A close
friend and adviser to President de la Madrid, he will, in our judgment, closely fol-
low the President's directives.
Economic policy formula-
tion had been hampered by sharp differences between Silva Herzog and Program-
ing and Budget Secretary Salinas.
previous post as director general of the National Financial Bank in 1982.
Petricioli, 57, is somewhat of an unknown because of his previous relative
obscurity. While earning an economics degree from the National Polytechnic
Institute, he joined the Bank of Mexico in 1948. In the succeeding 20 years he held
several positions at the bank and under its sponsorship received a graduate
economics degree from Yale. He transferred to the Finance Secretariat in 1967
and there, during the next decade, forged a close relationship with de la Madrid.
Petricioli then served as director general of the National Securities Commission
and director of Multibanco Comermex before de la Madrid named him to his
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 Mario Ramon BETETA Monsalve
Director General, Petroleos Mexicanos (Pemex)
(since December 1982)
A highly qualified, conservative economist, Mario Ramon Beteta has long been a
friend and adviser to President de la Madrid. He was de la Madrid's mentor when
both worked at the Bank of Mexico and the Finance Secretariat during the 1960s
and 1970s. His position on the fiscal policy team is due largely to Pemex's large
contribution to Mexico's revenue base. In our judgment, however, Beteta's
influence may be waning because of dramatically low oil prices
a debt payment moratorium or repudiation.
He favors increased foreign investment in Mexico and the
reduction of Pemex's domination of the economy. He has stated that he is against
commercial bank from 1976 to 1981.
We believe) that Beteta, 59,
may have presidential ambitions. His chances may be damaged, however, by
decreased oil revenues and poor relations with the powerful petroleum workers
union. He holds a law degree from the National Autonomous University of Mexico
and an M.A. degree in economics from the University of Wisconsin. He worked at
the Bank of Mexico in the 1960s before joining the Secretariat of Finance, where
he served successively as director general of credit, Under Secretary, and
Secretary. Before assuming his current position, he headed a leading Mexican
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