A Perfect Storm is Coming to Mexico

Jorge G. Castañeda

Countries don’t disappear, it has been said, but sometimes they do encounter perfect storms. These do not threaten their existence, yet they can represent major challenges to their welfare and integrity. Mexico may be on the verge of such a perfect storm as it enters a new year fraught with multiple perils and few opportunities.

Three dark clouds threaten Mexico’s future in 2018: Donald Trump’s tax overhaul, the possible end of Nafta and a presidential election that may introduce an era of turmoil and uncertainty for the economy and Mexican society at large.

The first threat has little to do with Mexico’s policies or control of its destiny. Whatever one thinks of the new tax regime in the United States, there is little question that it belongs strictly to the American domestic policy realm, unlike immigration policy, which has been the subject of several agreements between the United States and, among others, Mexico and Cuba.

Nonetheless, with regard to tax policy, the problem for the United States’ neighbors lies in the consequences it may have on their domestic economies. This is a typical internal economic policy issue of the United States, like raising or lowering interest rates, with major international repercussions. For Mexico, it is quite likely, economists say, that Trump’s tax reform entails three significant downsides.

First, Mexican conglomerates may decide to move their headquarters and legal residence to the United States to take advantage of a now much lower corporate tax rate (30 percent in Mexico versus 21 percent in the United States).

While this would not necessarily transfer jobs from one country to the other, it may discourage foreign, or even national, investment in Mexico. If big Mexican multinationals such as Cemex, Bimbo, Televisa or Mexichem were to relocate north of the border, why shouldn’t smaller companies, or potential newcomers, do the same?

Second, American corporations with large investments in Mexico might decide to take advantage of other favorable provisions aside from the tax rate differential in the tax overhaul and repatriate money and jobs to the United States.

Finally, the tax package could easily dissuade American firms from investing in Mexico — which is partly what it was meant to do, even if it ultimately did not include a border tax or a value-added tax. As it is, direct foreign investment in Mexico has been either stagnant or dropping (especially as a share of gross domestic product) over the past couple of years; this might bring on a drastic reduction.

Theoretically, Mexico could counter all this with its own Trump-like tax changes — except that the blow to government revenues would be devastating. As it is, Mexico has one of the lowest tax rates among the countries in the Organization for Economic Cooperation and Development. Lowering them would create a severe fiscal problem. Especially since south of the border, few serious people believe that cutting taxes raises revenues.

The second ominous possibility lurking on Mexico’s horizon is the end of Nafta, or, at best, the indefinite postponement of renegotiation, perpetuating uncertainty. Talks are scheduled through March or April. But given Mexican presidential elections on July 1, and a United States midterm vote in November, it would be impossible for a hypothetical agreement to be ratified by both Congresses, and perhaps the Canadian Parliament, before early 2019.

This would deter foreign investment at least until the new rules are determined and also allow the Trump administration to continue to threaten a Nafta blowup to obtain concessions from Mexico on other issues.

“Hypothetical” is a big word. Such little progress has been made on America’s stringent demands that there is no agreement in sight.

The Trump administration wants the so-called rules of origin renegotiated, requiring, for example, that at least 50 percent of a Nafta-produced car be made of American parts. Washington also wants disputes settled in American courts (and not in the more neutral arbitration bodies set up by the treaty), limits on the export of some agricultural products from Mexico to the United States, and the entire agreement revisited every five years.

With these sticking points hanging over the talks, President Trump’s negotiators may any day invoke Nafta’s Article 2205, which provides for a signatory’s exit from the treaty in six months.

While Mexico will survive without Nafta, the impact on foreign investment, much more than on trade, would be devastating for the first few years. This is not good news for an economy that is expected to grow less than 2 percent in 2018, and has expanded recently at an average rate of barely 2 percent per year. Lower growth means less employment, which, among other things, could prompt greater emigration from Mexico to the United States.

The third squall ahead lies in the presidential election. This will be the fifth consecutive democratic vote for Mexico: a first in its history. That in itself is a major achievement. And the election promises to be fundamentally free and fair: another accomplishment. But the outcome, at least according to most current polls, promises to be problematic. The reason is Andrés Manuel López Obrador, the left-wing politician and presidential candidate better known as AMLO.

The issue is not so much whether Mr. López Obrador, the former mayor of Mexico City, will win — he is a clear front-runner — but rather whether the domestic and foreign business communities believe he will. They appear to, and are already acting in consequence, generating the beginnings of a self-fulfilling prophecy. Similarly, predictions of his being another Hugo Chávez or Luis Echeverría (Mexico’s populist president of the 1970s) may or may not be valid; the question is whether investors trust those forecasts. They seem to, and are either delaying projects in the pipeline or postponing new ones until after the election.

Many expect that Mr. López Obrador will indeed attempt to keep many of his promises. These range from a de facto reversal of energy reform and canceling construction of a new airport in Mexico City to higher (necessary) spending on fighting poverty.

One of his most intriguing recent commitments, amnesty for drug-cultivating peasants and engaging in conversations with cartel kingpins, while innovative and bold, might be considered anathema in Washington. Again, these promises may be red herrings, so to speak, but if enough decision-makers subscribe to them, their effect is the same as if they came true.

What these three clouds imply for Mexico is a protracted period of insignificant growth after a long period of mediocre growth. They probably entail more drug production, migration and violence. Poverty and inequality, which have both shrunk slightly over the past 15 years, will rise again.

None of this is good news for Mexico. Under ideal international circumstances, that would be formidable challenge; with Donald Trump in the White House, it can be a nightmare. Other than believing in miracles — the United States economy, as opposed to Wall Street, is on the cusp of an extraordinary boom; China will come to Mexico’s rescue; eradicating corruption in Mexico will solve all problems — there are no credible alternatives.

A pity that Mexico proved unable to take advantage of its last 25 years of good fortune in dealing with the United States. Now only God and the Virgin of Guadalupe can help.

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