THE BANKER

 

The thinking behind Mexico's reforms

 

By Luis Videgaray | Published: 02 January, 2014

 

 

 

Mexico's finance minister, Luis Videgaray, details the herculean reforms his country is undertaking to improve the economy and increase the standard of living for all Mexicans.

 

 

On December 2, 2012, one day after president Enrique Peña Nieto’s inauguration, the federal government of Mexico and the leaders of Mexico’s three main political parties gathered and signed the Pact for Mexico. This agreement is of historic significance for Mexico. It has already played a key role in empowering an agenda of structural reforms that have long been necessary to improve the productivity, competitiveness and flexibility of the country’s economy. The Pact for Mexico further establishes the foundation for economic expansion that will substantially increase living standards for all Mexicans.

 

The Pact for Mexico sets aside political differences to advance a common agenda for Mexico with a clear objective: increased growth and development. In just this first year of President Peña Nieto’s presidency, the Pact for Mexico has had a substantial impact on most areas of our economy and society. For example, our Constitution and several laws have been amended and updated, strengthening Mexico’s legal framework, while at the same time improving the competitive advantages of the economy.

 

The main objectives of the structural reform agenda are to foster productivity, promote growth and enhance social development. The most important challenge Mexico faces is poverty. The government acknowledges that economic growth is the only sustainable way to improve the quality of life of the population and reduce poverty. The solution is to unleash Mexico's economic potential, which has been stagnant for the past 20 years. This slow rate of economic growth is primarily due to the low rate of productivity, which has essentially remained at levels seen in the 1980s.

 

Democratising productivity

 

Despite improvements in key industries, productivity remains the limiting factor for many economic sectors and regions, particularly those related directly to international markets. In light of this reality, we have identified as a primary goal reducing the productivity gap among people and across regions. The term we use to express both our approach and our goal is 'democratising productivity'. In pursuit of this goal, the vast and comprehensive structural reform agenda we have undertaken is a bold and ambitious step.

 

The first two structural reforms launched within this new framework of dialogue were the labour reform and the insurance industry reform. Together they established the blueprint of how to effectively transform key areas of our economy. The labour reform creates and empowers a more flexible labour market, something that is urgently needed to encourage a higher rate of formal employment, as well as to significantly increase productivity. The insurance industry reform introduces international best practices into our regulatory framework. It is important to note that these proposals were presented to Congress by the previous presidential administration, showing that the continuity of sound public policies has become a national goal in Mexico.

 

Next we set out to improve and modernise education. The foundations of this transformation were a constitutional amendment, along with both the enactment of new laws and changes to existing laws that will, in concert, transform our society and create greater opportunities for millions of children. Even though Mexico may only see the true benefits of the education reform in the medium and long term, this might be the most important reform of all in terms of improvement of human capital and its concomitant effects to foster development.

 

Building blocks

 

Another building block of the structural reform agenda was the telecommunications and economic competition reform. Access to knowledge and information is a key element for success in any country. This constitutional amendment improved the legal framework involving competition by granting autonomy to regulators. It will help create better conditions and services in the Mexican telecommunications industry for both companies and consumers.

 

By any standard, Mexico’s financial system is robust. Financial intermediaries have high levels of capital and the rate of non-performing loans is low. However, Mexico’s credit penetration in the economy is among the lowest in the world. This translates into few financing sources available to key economic agents. Small and medium enterprises (SMEs) have very limited access to formal credit, for example. Despite the fact that they generate 74% of the jobs in the country, they receive only 15% of the credit granted by financial institutions.

 

Consequently, to improve credit and reduce interest rates, Congress approved a financial reform. In this case, the goal was to foster competition, improve the legal framework, and strengthen the prudential principles applied to banks and lending agencies. The initiative originally presented by President Peña Nieto under the auspices of the Pact for Mexico was analysed, amended and approved by Congress. The process involved all political parties, and was achieved as the result of a vast dialogue and consensus between government, legislators and the financial sector.

 

Fostering markets

 

The financial reform introduces comprehensive measures to enable competition among private participants in the financial markets. It also redefines the mandate of Mexico’s development banks and transforms them into a more effective tool to foster markets, with special emphasis given to innovation, patent generation and the expansion of infrastructure. Key among these aims will be the promotion of the evolution, development and success of SMEs.

 

In addition, the reform acknowledges that the lack of certainty in contract enforcement has been a fundamental factor behind tight credit policies. To address this, it simplified the rules for the execution of credit guarantees, thus helping to preserve the rights of debtors. This reform will preserve and enhance the sound footing of Mexico’s financial system, and reinforce the current prudential framework by incorporating into law the Basel III capital regulations.

 

In September 2013, the ministry’s executive branch presented to Congress two comprehensive reforms, the fiscal reform and the social security reform. These reforms included changes to make tax laws more progressive. Moreover, the reform simplifies the tax system to promote compliance and, in particular, creates a special temporary regime tasked with increasing the ratio of formal employment to informal employment within Mexico.

 

Any increase in taxes needs to be accompanied by improved transparency and accountability, as well as a more efficient use of public resources. Therefore, the fiscal reform reinforced the framework to evaluate public expenditure to determine how effectively and to what extent it meets its objectives. Following best practices and based on a strong commitment to fiscal responsibility, the fiscal reform includes modifications to the fiscal responsibility law that established an implicit structural budget balance rule for Mexico. This rule preserves fiscal sustainability while allowing for a more countercyclical fiscal policy, more savings during the business cycle and increased transparency in the augmented public balance.

 

Tax issues

 

At the same time, by 2018 the fiscal reform is expected to increase tax revenue by almost 24%. This represents an increase of 2.4% of projected gross domestic product. The additional revenue will come from the elimination of exemptions and loopholes in corporate income tax by eliminating the lower rate of value-added tax in border areas by making individual income tax more progressive, and by taxing both dividend income and capital gains realised in the Mexican stock market. Finally, the fiscal reform includes new taxes intended to combat obesity in Mexico: a tax on sweetened beverages and a special excise tax for high-calorie foods.

 

The fiscal reform provides a sound basis for social security reform, which is pending final review by the Senate and state legislatures. It includes a universal pension system to grant a minimum retirement benefit to all Mexicans. It also establishes an unemployment insurance facility, along with increased resources for education, health and infrastructure. The fiscal and social security reforms will lead to more robust and capable human and physical capital, stronger domestic demand, a reduction in income inequality and more rapid economic growth.

 

[Shortly after Mr Videgaray wrote this article, Mexico’s energy reform was passed.] The importance of this specific reform cannot be overstated. It may well have the largest impact of all of the reforms Mexico undertakes. It will definitely have the greatest impact on growth, both by attracting investment and especially by creating large numbers of high-paying jobs.

 

Nevertheless, if Mexico is to realise the benefits of these far-reaching reforms, the implementation process will be crucial and that process has just begun. All efforts of President Peña Nieto’s administration will be committed to implementation and the resulting transformation of Mexico’s economy in 2014. The reform agenda marks a transformation that has not been experienced in more than a generation. It is a transformation that will lead to better economic and social conditions for all Mexicans. As President Peña Nieto said on the first day of his administration, the goal is for Mexico to achieve its maximum potential.

 

We are confident that the comprehensive reform agenda set in motion during 2013 will increase economic growth, development and the welfare of Mexican families. The steady improvement of our economic indicators will increase living standards for all Mexicans and reduce development gaps across all regions of the country.

 

Luis Videgaray is Mexico's finance minister.

 

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