What’s Wrong with Mexico – Foreign Investment

In a previous post, I discussed how informality may or may not weigh on Mexico’s economic performance. Here, I will look at foreign investment, with a particular focus on foreign direct investment (FDI). The issue of foreign investment is a good proxy for a broader discussion about liberalization – i.e., does liberalization of trade and investment generate strong and sustainable economic growth and development. In this regard, Mexico presents a vexing case for proponents of the liberalization approach to economic policy. This issue is significant given that the consensus approach to economic reform among Mexican economic and political elites is further liberalization. The consensus view is that the reforms will attract foreign investment – which they likely will – but with the implicit assumption that increased foreign investment is universally positive.

Some Context – Mexico’s Economic Openness Since 1982

Since the 1980s, Mexico has pursued an agenda of economic liberalization, particularly in the areas of trade and investment. The reforms fell into the following main categories:

  • Trade Liberalization – starting with unilateral acceptance of the General Agreement on Trade and Tariffs (GATT) and culminating with the North American Free Trade. Agreement (NAFTA), Mexico can now boast having signed more free trade agreements than any other country.
  • Investment Liberalization – in 1993, Mexico passed the Foreign Investment Act, which repealed and replaced the country’s existing framework adopted in 1973, and eliminated ‘anti-foreign investor’ provisions such as performance requirements, capital controls, and domestic content percentages. The 1993 Act also opened up some industries and activities to foreign investment – e.g., mining, secondary petrochemicals, ports, transportation, land development along Mexico’s coasts. In some cases the new law imposed conditions on such investments, such as requiring they be made via local entities. Moreover, the 1993 Act preserved longstanding policies of excluding foreigners from investing in certain industries (most notably, oil and gas).
  • Privatization – in the 1990s, Mexico privatized whole swaths of the economy that had previously been entirely in the state’s hands, starting with the telecom and banking industries and followed by mining and air and sea transportation. From 1982-2003, the total number of Mexican State-Owned Enterprises (SOEs) dropped from 1,155 to 258, with 439 (38%) of the SOEs disappearing via privatization.
  • Deregulation – Mexico also adopted several measures that deregulated certain industries. For example, the Mexican government deregulated the trucking industry to encourage competition, by reducing barriers to entry and eliminating tariff ceilings.

Results of Economic Liberalization

fdi

At a macro level, the reforms adopted over the 1980s-90s did not generate the level of economic growth expected and hoped for by the Mexican authorities, averaging just 0.76% annual GDP growth from 1996-2012. Moreover, Mexico was comparatively less-insulated from the 2008 financial crisis, during which it experienced a 7.7% drop in GDP per working age person.

mex per capita gdp ppp

Despite Mexico’s economic underperformance, it appears that the reforms did generally have their intended effect. On foreign investment, FDI grew by 1,125% between 1990-2007. Mexico also substantially improved on more substantive measures like economic diversification, technological specialization, and economic complexity.

mex exports

Paradoxically, although the high levels of FDI in Mexico were associated with increased total factor productivity, they appeared to depress labor wages while increasing returns on capital. The disproportionate harm suffered by Mexico following the 2008 financial crisis was another likely effect of the success of the liberalization policies, as the country’s entire manufacturing sector is dependent on U.S. companies and consumers.

gdp rate

Good vs. Bad FDI

Mexico’s arguably net negative – and at best mixed – results from its liberalization efforts highlight the need for a more refined understanding of foreign investment than ‘yes vs. no’. The drawbacks of relying on FDI – including balance of payments problems at the national level – are not controversial. But the quality of FDI received can also benefit or damage the underlying development of an economy, beyond causing short-term fiscal or financial instability.

In Mexico, FDI was typically clustered in manufacturing activities at the end of a global supply chain, where all the high-value work is completed elsewhere. Mexico’s role in the supply chain is final assembly – e.g., before the car or TV is shipped to the US for sale. Such facilities are colloquially known as ‘screwdriver factory’ because the only tool needed to complete the job is simple like a screwdriver. The high-value work – design, programming,j fabrication, machining – is done in the USA, Germany, and East Asia.

Naturally, ‘screwdriver factory’ FDI generates jobs that are low-skilled and low-wage because their function is inherently limited to low-value assembly. Investment decisions in this area are dictated by labor costs at the low end of the spectrum, giving poorer countries a competitive advantage. But, this advantage will diminish to the extent that the workers at FDI-fueled jobs experience wage growth (i.e., enjoy the benefits of economic development). If labor costs grow above a certain point, the foreign investors will relocate to a different market with lower costs. In the meantime, the workers have not received any technical training and the host country has not received any meaningful technology transfers. You can get a sense of Mexico’s role in the global supply chain from this map of its 2008 exports (source).

en_explore_tree_map_hs_export_mex_all_show_2012

 

Also, the map of Mexico’s export destinations is striking (source)

en_explore_tree_map_hs_export_mex_show_all_2012

All of this is not to say, however, that all of Mexico’s inbound FDI was ‘bad’. Indeed, in industries like pharmaceuticals and medical devices, Mexico has received investments that are more permanent and add value and sophistication to the economy. But the few good investments won’t be enough to solve the problem.

Premature Deindustrialization

Mexico faces the prospect of ‘premature deindustrialization’, whereby manufacturing will cease to be a growing source of employment as wages rise, but before Mexico is able to capitalize on the benefits of increased manufacturing. Before the supply chain became global and then ‘unbundled’, countries receiving FDI could count on manufacturers to remain in-country for an extended period of time. In that era, the manufacturers transferred skills and technology to foreign operations because the other, higher-value elements of the business and needed to grow organically near production facilities.

China exploited the era of ‘clustered’ manufacturing most shrewdly, typically requiring Western companies to invest via a minority share in a joint venture with Chinese SOEs. Eventually, foreign investors learned that their Chinese JV partners were not trustworthy, such as when the Chinese company would set up companies to compete against the same joint venture. The outright theft of intellectual property and corporate secrets by Chinese partners has been called “the greatest transfer of wealth in history” by Gen. Keith Alexander (fmr Dir. of the NSA).

But in the era of the unbundled global supply chain, manufacturers do not have to commit to putting all their operations in one location or region. And the liberalization of capital movement has made relocating low-value assembly facilities quite simple. Thus, it is unclear whether low-value manufacturing FDI contributes to overall economic development. Also, increased FDI of the type Mexico has received seems to have a net negative impact on wages, raising the question of low-value FDI’s purpose.

What Should Mexico Do Next?

Mexico’s lack of success with liberalization in the past does not mean that the Pact for Mexico reforms are doomed. The Energy Reform – which aims to attract foreign investment into Mexico’s oil and gas industry – differs from past liberalization efforts as it (i) does not relinquish ownership over the industry; and (ii) the investment would necessarily be of a ‘high-value’ nature with ample opportunity for the transfers of technology, skills, etc. Similarly, the Telecom Reform at the least undoes the failures of the Telemex privatization, which was done without an adequate pro-competition regulatory framework in place. Attracting investment to this sector will result in technology upgrades from which Mexico will immediately benefit.

While the money is flowing into Mexico, the country also needs to invest heavily in upgrading its infrastructure and education system, which could possibly result from Pres. Pena’s infrastructure spending program and the Education Reform.

 

Posted in economic development, economy, fdi, investment, labor, oil and gas, reform | 1 Comment

Anticorruption Update – Wither the Commission?

In a previous anticorruption update, I addressed the stalled reform involving the National Anticorruption Commission, and how the creation of a Special Prosecutor for Corruption Crimes further hindered the Commission’s creation. It seems things have gotten worse for the hypothetical Commission since that time.

Special Prosecutor… [insert name here]

Late last month, the Senate initiated debate on naming the head of the Special Prosecutor, which until now has remained vacant. The person initiating the process was Pablo Escudero Morales of the Green Party (PVEM), who also is President of the Anticorruption Commission in the Senate (unlike in the U.S., the Mexican Green Party is Center-Right and is generally allied with the PRI).

About a week later, local media outlets reported that the PRI fraction in the Chamber of Deputies was planning to avoid approving the new Anticorruption Commission, considering it duplicative of the Special Prosecutor. A PAN representative was quoted as saying that his fraction would propose transforming the commission into a Federal Tribunal with Administrative Responsibility.

Pena Administration Opposes Commission?

About the same time, Minister of Finance Luis Videgaray visited the Senate, which is supposed to consider the legislation creating the Anticorruption Commission (approved by the Senate late last year. According to Senator Arely Gomez, secretary of the Anticorruption Commission in the Senate, Videgaray indicated that, in the Pena administration’s view, there is no need to create the Anticorruption Commission, as this role could be adequately performed by the Special Prosecutor. Importantly, Videgaray was head of Pena’s campaign and is in charge of all economic reforms under the Pacto por Mexico – i.e., he is a credible source as to the President’s thinking. Essentially, Videgaray (via Gomez) explained that the creation of the Special Prosecutor, plus the transformation of the Attorney General office into an autonomous entity, means that Pena has already fulfilled his promise to create a specialized anticorruption body.

About one week after Videgaray’s statements, on September 8, Pres. Pena addressed the group – Los 300 – at their annual dinner. In his speech, Pena elaborated on the need for a new ethical culture in Mexico, as a starting point for reducing corruption in society. He added that this push should start from the top down, with the creation of new institutions designed to combat acts of corruption. Pena then referred to the new ‘tools’ available for anticorruption measures, starting with the Special Prosecutor and the Institute for Transparency. Pena continued by noting that the political parties are currently discussing the Commission. Other than that sole mention, Pena was did give any indication as to whether or not his administration still saw the Commission as an essential element of the reforms. Here is his speech (the discussion of the anticorruption reforms starts at 37:00):

PRI-PAN-PRD Fight in Chamber of Deputies

Finally, last week Deputy Arely Madrid, President of the Anticorruption Commission in the Chamber of Deputies, declared that the proposal to create the Commission is “imprecise, insufficient, lacks teeth, and cannot be approved just to give speeches and create a new office.” Other legislators were quoted agreeing with Ms. Madrid. PRI Deputy Reyes Gamiz stated that he thought Pres. Pena left this reform for the end because it is difficult to agree among the three parties. Indeed – the next day members of the PAN and PRD fractions in the Chamber of Deputies publicly stated that they consider the Commission to be essential and demanded that the PRI move the debate forward.

What’s Next?

The trouble with the Commission has everything to do with the precarious route by which majorities are obtained in the Mexican Congress. As this helpful infographic illustrates, either the PAN or PRD, plus some of the minor parties, are able to block any constitutional reform (which requires 66.66% of the votes). Thus, passing the bill sent down by the Senate would require agreement from significant portions of either the PAN or PRD.

My guess is that Videgaray’s statements are consistent with Pena’s thinking. He’s too close to the president to go off his leash in such a way, and Pena’s statements at the 300 dinner were far from a full-throated defense of the Commission. It will be interesting to see how this plays out, especially if the Special Prosecutor is named and gets up and running before the Commission debate is resolved.

Posted in corruption, legislation, Pact for Mexico, politics, reform | 1 Comment

Pacto por Mexico – Energy Reform Passed

Last week, Pres. Pena signed into law the secondary legislation implementing the Energy Reform under the Pacto por Mexico. The final contours of the law did not differ significantly from the changes made by the Senate, discussed here. This is a significant reform, as reflected by these comments from the local press:

  • “[The Energy Reform] is the most significant in recent years and will change the way the energy sector operates in Mexico…This was unthinkable until the past few years and will end the government’s monopoly in this sector after 76 years.” (El Financiero)
  • “After 364 days, Pres. Pena unveiled the most iconic and controversial measure of his administration: an initiative to amend the Constitution and open the energy sector to domestic and foreign private investment, a 180 degree turn in the existing legal framework since the nationalization of oil in 1938.” (CNN Mexico)

In addition to signing the legislation into law, Pres. Pena announced ten steps aimed at expediting the implementation of the reforms (with deadline in parentheses):

  1. Ronda Cero (August 13) – announce the results of the ‘Round Zero’ – in which PEMEX claims certain oil fields for itself – on August 13. In the subsequent announcement, PEMEX was assigned 83 percent of Mexico’s probable and possible reserves.
  2. Ronda Uno (August 13) announce the fields opened up to the first ‘Round One’ bidding in early 2015. As part of Round One, Mexico hopes to attract investment into 169 exploration and extraction blocks. The public tenders for these blocks will happen sometime between May and September 2015.
  3. ‘Decentralized’ Bodies (August) – create the National Center for the Control of Energy and the National Center for the Control of Natural Gas.
  4. New Regulators (August) – the President will send to the Senate his nominees to head the National Hydrocarbons Commission and Energy Regulatory Commission, as well as independent advisers to PEMEX/CFE and the Petroleum Fund.
  5. New Fund (September) – create Mexican Petroleum Fund and promote the development of national providers/contractors for the energy industry.
  6. Human Resources (September) – present the decree on the strategic program for the formation of human resources in the energy sector.
  7. Regulations (October) – publish all regulations pertaining to the secondary legislation.
  8. Research (October) – present the decree restructuring and modernizing the Mexican Petroleum Institute.
  9. Clean Energy (October) – publish guidelines for the issuing of clean energy certificates.
  10. Environmental Agency (next 90 days) – publish the rules for the national agency for industrial security and environmental protection in the hydrocarbons sector.

In several cases, the updated timeline is much quicker than previously anticipated (via El Financiero):

de_prisa

According to experts at the Mexico Institute, the most significant event will be the publication of the regulations in October, which will essentially fill in any detail gaps left by the secondary legislation. In the meantime, however, it is safe to conclude that Mexico’s Energy Reform is seen as a major step forward for the country and a major political win for Pena. Whether it will meet expectations is a question for a future post.

Posted in economy, energy, legislation, oil and gas, Pact for Mexico, reform, Uncategorized | Leave a comment

Anticorruption Update – Stalled Reform, Policing PEMEX/CFE

Forgotten Reform

As discussed in previous posts, corruption in Mexico is a serious issue, costing the country up to around 9 percent of GDP. Thus, it’s not surprising that corruption has made its way onto the reform agenda of the Pacto por Mexico. The Mexican Senate passed the anticorruption initiative in December 2013, but the legislation never made any progress in the Chamber of Deputies. The legislation’s most noteworthy element is the creation of a National Anticorruption Commission, which would have the power to investigate, administratively punish corrupt acts, and refer criminal cases to the Prosecutor General.

The Commission would supplant the Ministry of Public Administration (Secretaria de Funcion Publica or SFP), whose sad anticorruption site serves as a reminder of its imminent irrelevance. The disappearance of SFP is probably for the best – its anticorruption enforcement has declined markedly – by about 50 percent in the last year and a half. Moreover, even  though the SFP has meted out around USD 10.8 million in fines over the past three years, it only collects in about 0.1 percent of cases. The problem is the SFP’s lack of ‘teeth’, something which the anticorruption reform was supposed to correct. But SFP’s incompetence has been magnified by a lack of leadership as Pres. Pena has delayed appointing a Minister of Public Administration in anticipation of the reform.

At first, the anticorruption reform seemed to be one of the top priorities for the administration. But the reform has been stuck in legislative purgatory since January, when the Senate passed the measure and handed it to the Chamber of Deputies. Since then, the Committee on Transparency has met three times but never took up the anticorruption reform; absent an extraordinary session, the soonest we could see movement on the reform is in the September 1 – December 15 session.

In the meantime, the status of the anticorruption reform has been confused by the creation of a Special Prosecutor for Corruption Crimes (Fiscalia Especializada en Materia de Delitos Relacionados con Hechos de Corrupcion), within the office of the Prosecutor General. The Special Prosecutor would have the ability to investigate and criminally prosecute violations of Mexican anticorruption law. But this entity also seems to have been left leaderless, and I cannot find any information on it from the Prosecutor General website. Some have argued that the Special Prosecutor spells the end of the Anticorruption Commission, but I’m not so sure. In any case, the existence of overlapping, equally powerless anticorruption agencies naturally has not been effective in combating corruption.

One potential explanation for the anticorruption reform delay: it was a strategic decision by Pena to minimize PRI-PAN tensions while passing the other reforms, on energy and telecom, for which he needed PAN support. Any anticorruption drive will almost certainly be focused on conduct occurring in the previous PAN government(s) (e.g., the Banamex case). This is partly out of necessity – the PRI has not been in charge long enough for there to be many post-PAN cases. But, whether fair or not, any cases brought against Panistas will probably be viewed as politically-motivated, and could undermine PAN support in the legislature. With the major reforms passed, Pena may be ready to end his ‘truce’ with PAN and launch an anticorruption drive.

PEMEX Anticorruption Plan

Although the overarching anticorruption reform is languishing in congress, the soon-to-be-enacted Energy Reform contains several specific anticorruption provisions.

Why does PEMEX need special attention when it comes to anticorruption? It is often considered the most corrupt entity in the federal government, with 80 percent of Mexicans associating the company with corruption. About one out of every three Mexico-related foreign bribery enforcement actions by the US authorities involve improper payments to officials at PEMEX (some case studies).

A good portion of PEMEX’s numerous and costly legal battles involve corruption claims against former employees related to schemes like using offshore shell companies to resell diesel fuel to PEMEX at artificially inflated costs. Notably, in many of these cases the ex-officials who engaged in improper conduct have been neither imprisoned nor fined.

The current version of the Senate’s revised Law on PEMEX and Law on the Federal Electricity Commission includes 50 anticorruption-related changes (extract from Senate document here). Most important, the changes include:

  • a new article that expressly states that all contracts with PEMEX/CFE are covered by the Federal Law on Anticorruption in Public Procurement, which was enacted in 2012
  • transparency requirements on public procurement contracts with PEMEX/CFE, including creation of a public system with information on contracts from past 5 years
  • mandatory creation of an anonymous whistleblower system
  • development of a system at each entity for identifying, systematizing, and administrating the risk factors associated with public procurement
  • definition of the basic qualifications a prospective contractor must meet (e.g., technical/financial capacity, previous experience, fiscal status)

The intended effect of these provisions is to discourage and prevent corruption in the multi-billion-dollar public procurement opportunities that will open up as early as 2015. Indeed, the Energy Reform auctions will be more closely watched – both in Mexico and abroad – than usual. Indeed, the foreign investors that PEMEX is hoping to attract agree: anticorruption measures must be incorporated into the Energy Reform for it to be successful.

I suspect, however, that the measures described above will not have much of a deterrent effect absent a dramatic and publicly-visible increase in enforcement, particularly against the still unpunished ex-PEMEX officials whose misdeeds are a matter of public record. Which brings us back to the Anticorruption Reform: if it isn’t effective – not to mention enacted – it is doubtful the Energy Reform will achieve its goals.

Posted in corruption, economy, energy, legislation, oil and gas, Pact for Mexico, pemex, politics, reform | 2 Comments

What’s Wrong with Mexico’s Economy – Informality

Journalists are running out of adjectives to describe Mexico’s recent economic performance: disappointing, slow, lackluster, stalled, etc. But they are not running out of people to cheerily forecast that improvement is right around the corner. This is the narrative pivot for all coverage on Mexico’s economy: things are not doing as well as hoped/forecast, but signs of improvement abound!

mex gdp growth rate

It should come as no surprise that Mexico’s economy is underperforming – it has been doing so for quite some time, averaging just a 0.63 percent GDP growth rate between 1993 and 2014 (never exceeding 3 percent). But the flagging economic growth has had to compete with the perception and expectation of improvement generated by the Pacto por Mexico reform program. Although it’s unreasonable to expect structural reforms to produce measurable improvements over the short term, it seems such an expectation is not uncommon.

So what is really wrong with Mexico’s economy? And will the reforms help? This post looks at informality, with some background on Mexico’s geographic disparities.

Two Neighborhoods 

In real estate, a ‘neighborhood price effect’ refers to the tendency of a single home’s value to be influenced by the value of surrounding homes. Sometimes, a relatively higher-value home is dragged down by surrounding lower-value homes, and other times a lower-value home is pulled up by surrounding higher-value homes.

By analogy, Mexico is in two neighborhoods: the relatively higher-value North America, and the lower-value Central America. From the Mexico City area on north, the country is generally more industrialized, urbanized, wealthy, and modern. Indeed, the country’s top 10 urban centers – containing 36 percent of Mexico’s people – are all in this area. To the south, the country is overwhelming rural, poor, and underdeveloped (Merida and parts of the Yucatan perhaps being an exception).  The precise geography is more complicated: in fact, rich Mexico includes a northern band, the federal capital, and parts of the Yucatan and Baja California. But the concept generally holds, as this helpful map demonstrates (via Wikimedia Commons):

Mexican States Per Capita GDP PPP by similarly-situated countries

The disparity is significant: while Chiapas = El Salvador, DF = France. Numerically, DF’s USD 23,130 GDP per capita is more than 6x that of Chiapas (USD 3,657). In contrast, Washington, D.C.’s per capita income is only double that of Mississippi. So, imagine taking the differences between D.C. and Mississippi and magnifying them by 300 percent – that’s the reality of Mexico’s two neighborhoods. Keep in mind that, unlike the US comparison, the DF area accounts for 18 percent of Mexico’s population and 35 percent of its economic output; the D.C. area has 2 percent of the US population and 3 percent of its economic output.

Two Mexicos

Perhaps the most contagious meme explaining Mexico’s poor economic record is the ‘Two Mexicos’ concept, widely attributed to a McKinsey report with the same title. In reality, Pres. Enrique Peña Nieto (EPN) was the first to articulate this concept in his December 2012 inaugural address:

We are a nation that is going at two different speeds. There’s a Mexico of progress and development. But there’s another, too, that lives in the past and in poverty.”

[“Somos una Nación que crece en dos velocidades. Hay un México de progreso y desarrollo, pero hay otro, también, que vive en el atraso y la pobreza.”]

The central hypothesis of the McKinsey report is that Mexico’s developmental bifurcation originates from differences in productivity levels, with high-productivity enterprises creating high-wage jobs and low-productivity enterprises, low-wage jobs.

I have a few reasons for being skeptical of this explanation. The report itself notes that wages at unproductive ‘traditional’ enterprises fell by 2.4 percent from 1999 to 2009, while wages in Mexico’s more productive, largest companies “have remained static, despite rapid advances in productivity.”  But the report does not explain how boosting productivity will raise wages, if it has not done so for those already in high-productivity sectors. Sure, average wages at larger enterprises are higher than ‘traditional’ enterprises, but there are a list of reasons why – e.g., formal education/training – other than productivity. Also, if wages at high-productivity enterprises have been stagnant, wouldn’t pushing more workers into this segment put downward pressure on wages? Most important, productivity is defined in the report as output per worker – i.e., greater productivity = generating more output with less workers. Thus, dramatic increases in productivity at traditional enterprises would, at least initially, increase the unemployment rate, which would depress wages even further.

The Geography of Informality

At a broader level, it appears that McKinsey is largely describing the macroeconomic impacts of Mexico’s ‘two neighborhoods’. The villains in their analysis are the ‘informal’, traditional, low-productivity enterprises, with informality referring to non-compliance with regulatory requirements (e.g., don’t pay taxes, use bribes). But the report assumes that these informal enterprises are sitting side-by-side with formal counterparts. In fact, informality is concentrated in Mexico, largely along the geographic lines described above, with Oaxaca over 2x more informal than Chihuahua:

informality rateUnsurprisingly, the informality rankings basically match productivity rankings:

mex productivity index by state

That is not to say that the richer, urban centers are uniformly formal – DF is half formal and half informal – but the concentration of informality in certain regions suggests broader historical trends. Maybe poor physical and civil infrastructure in Chiapas make being a ‘formal’ business irrational – the costs exceed the benefits.

Also, the fix for informality in DF may differ from Chiapas. For example, Chiapas has the second-highest level of informality in Mexico, but is the fifth easiest state in which to do business, according to the World Bank (DF is dead last). Thus, while regulatory burdens may promote informality in DF, other factors may be at fault in Chiapas.

Harmful Effects of Informality

Informality is an across-the-board constraint facing formal companies in Mexico – indeed, companies consider it the most significant business constraint, beating out taxes, financing, crime, and corruption. In principle, taxes, financing, and corruption would all diminish as constraints following a reduction in informality. More taxpaying enterprises would broaden the base and allow the Mexican government to ease the burden for all. Less cash-based enterprises means more bank customers, thereby increasing funds available for lending. And regulatory compliance eliminates the supply-side need for paying bribes. But it’s difficult to know in which direction causation flows – e.g., high levels of corruption create a competitive advantage for informal enterprises.

Much of the research on the informal economy has focused – like McKinsey – on the negative impact it has on productivity, and by extension on per capita income. Other research – looking at the subnational level within Mexico – has found that informality flourishes in areas with the following characteristics:

  • Low economic development
  • Many microenterprises (< 10 employees)
  • Low quality labor skills
  • High cost to start a business
  • Restrictions on foreign direct investment
  • High levels of corruption

Again, the causal link is not clear, and could easily flow either way. Still, it may be easier to craft government policies combating the characteristics listed above, rather than aiming at a nebulous concept like ‘informality’.

But is it really that bad?

There is a dissenting view on informality’s effect on economic growth. Some research has found that, in Mexico, informality is typically in the form of self-employment that provides the informal worker with a significant premium in earnings. And others have identified a positive correlation between informality and economic growth.

The central question is the extent to which informality is the cause or effect of the harmful effects with which it is associated. In other words, but for its informality, would an informal business be more profitable? The answer is not clear. For example, research shows that, in addition to lower education levels, informal workers tend to be older as well. Thus, it is debatable whether formal enterprises are more productive because they are formal, or because they are more likely to employ younger, more highly educated workers.

Despite the less-than-certain causal link between informality and depressed growth, informality probably hurts more than it helps. It is impossible to draw a bright line distinction between formal and informal firms – many formal, ‘registered’ firms engage in informal behavior as well. By allowing Mexican enterprises to engage in regulatory/legal compliance a la carte, informality reflects a weak rule of law (from OECD Economic Survey of Mexico 2013):

mex rol

This ‘lawless cynicism’ has been a challenge facing Mexico since the colonial era, and has precluded the creation of a modern, effective state. Therefore, combating informality is an important component of Mexico’s efforts to modernize, even if the concrete economic benefits are unclear.

Will the Reforms Reduce Informality?

There is no single reform under the Pact for Mexico aimed at combating informality. But several of the initiatives have the potential, in principle, to reduce informality:

  • Financial Reform – if the financial reform succeeds in opening up access to credit for more Mexican businesses – particularly small businesses – it should discourage informality because banks will not lend to businesses without tax receipts.
  • Telecom Reform – if the telecom reform succeeds in increasing access to high-speed internet at lower costs, it may lower informality by encouraging informal businesses to adopt technological improvements that could push them into the formal sector. Increased FDI in this sector should also have a negative impact on informality.
  • Energy Reform – if the energy reform can lower energy costs for commercial consumers, it may reduce informality because, as McKinsey points out, many informal enterprises purchase electricity as individual consumers at lower, subsidized rates. Increased FDI in this sector should also have a negative impact on informality.
  • Education Reform – if the education reform has the effect of raising educational achievement by Mexican students, it could reduce informality because informal enterprise employees are more likely to have low levels of education
  • Anticorruption Reform – the currently stalled anticorruption reform should inhibit informality. Increased anticorruption enforcement would raise the risk premium for corrupt officials, resulting in higher value bribe requests and higher costs for informal enterprises. As the costs of informality increase, more enterprises should be pushed into the formal sector.

Collectively, the Pact for Mexico reforms seem likely to reduce – directly or indirectly – the level of informality in Mexico, although the delay in passing the Anticorruption Reform is concerning. Also, it is difficult to estimate the degree to which the reforms will have an impact on informality, and when this impact is likely to materialize.

But, as McKinsey notes, the Mexican government already has a more effective tool at its disposal: enforcement agencies. Mexico is not known for sustained, predictable, and rational levels of enforcement. And if the government cannot rely on competent, professional, and neutral enforcers, the quality of the laws it passes does not matter. Thus, the Mexican government must increase both the likelihood and costs of enforcement – e.g., for tax fraud – against informal enterprises, thereby diminishing the benefits linked to informal practices.

Additional resources: research on informal sector

Posted in corruption, economy, informality, legislation, Pact for Mexico, reform, rule of law, Uncategorized | 4 Comments

Pacto por Mexico – Energy Reform Update

It has taken a bit longer than expected for the secondary legislation of the Energy Reform to make it through the Congress. On Wednesday, the Senate published the changes made to the secondary legislation in committee, all of which can be viewed here. Yesterday, July 17, the Senate held an extraordinary session to discuss the changes. At this session, the Senate approved ‘in principle’ one of the four categories of changes – to the Law on Hydrocarbons. A ‘detailed’ discussion in the Senate continues today and tomorrow, possibly extended into Monday. On Wednesday, July 23, both the Senate and Chamber of Deputies will then consider the changes to the secondary legislation, with the aim of final approval by the first week of August at the latest.

Here is a roundup of the most significant of the 250 changes to the secondary legislation:

  • No expropriation – previously, the secondary legislation had included a provision allowing for land needed for development of hydrocarbons to be expropriated for reasons of ‘public utility’ (i.e., similar to ’eminent domain’ in the U.S.). Both the PAN and PRD demanded this be removed. The compromise is language allowing for ‘temporary occupation’, and requires the company carrying out the activities to pay a percentage of profits and compensation for any damages to the landowner
  • No activities in protected areas – the original secondary legislation only ‘limited’ exploration and extraction of hydrocarbons from ‘protected areas’ (zonas de salvaguarda). The PAN’s change prohibits these activities entirely.
  • Reduced foreign investment options in transportation of fuels – the PAN’s changes prohibit foreign participation in the road transportation of fuel, and limits it to 49 percent in rail, ship, and airplane transportation. The PAN explained that completely opening this sector to foreign participation would undermine SMEs.
  • Control over PEMEX/CFE directors – the original secondary legislation allows the President to nominate the independent directors of both PEMEX and CFE and, if no action is taken within 30 days, their nominations would be approved. The PAN change now treats this silence as a rejection. Also, in the previous draft, the President had the sole authority to remove PEMEX and CFE directors; now, such removals must be approved by the Senate.

 

Posted in economy, energy, legislation, oil and gas, Pact for Mexico, pemex, reform | 1 Comment

Pacto por Mexico – Telecom Reform Passed

On Monday, July 14, President Enrique Peña Nieto (EPN) signed the much-delayed telecom reform into law (full text of the reform here, in Spanish).

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EPN’s administration is fond of using infographics to communicate, and the telecom reform was no exception. The first of these infographics explained the ABCs of the reform: Assuring universal access to television, voice, and data throughout the country; Buenos precios (good prices); and Calidad de servicio y contenido (quality of service and content).

EPN’s next infographic describes the six pillars of the telecom reform:

  1. Strengthening fundamental rights – by protecting free speech and expanding access to information
  2. Upgrade the legal framework for the telecom industry
  3. Strengthen the institutional framework – through creation of Federal Telecommunications Institute (IFETEL) and Federal Competition Comission (COFECE)
  4. Promote competition
  5. Push for improved infrastructure
  6. Establishment of a Policy of Universal Digital Inclusion and a National Digital Agenda – so that 70 percent of all locations and 85 percent of all SMEs have access to high-speed internet

Another infographic described the main benefits to individual consumers provided by the telecom reform:

  • No more long distance charges starting January 1, 2015
  • The ability to change mobile providers for free, with no conditions, and within 24 hours
  • If a mobile service provider does not deliver quality service, consumers are entitled to bonuses and discounts
  • Free internet hot spots in 250K parks and public spaces
  • Ability to consult one’s cell phone balance at no cost
  • More competition in the telecom sector to generate more options and better prices
  • Prepaid cell phone cards will no longer expire in 2 months, and will last at least one year
  • Pay TV subscribers are entitled to watch open TV channels at no extra cost
  • No more phone calls from telecom providers promoting services, absent consent
  • Strong sanctions for businesses that obstruct competition

Some additional major changes:

  • Free speech – no blocking of content for national security reasons (except for in prisons)
  • Big brother – telecom service providers must provide authorities access to private user communications in order to ensure compliance with the law, including real-time geolocation data
  • Data retention – telecom operators must retain user data for 24 months, including name, communication type, origin and destination of communication, date, geographic location, etc.
  • Dominators – the law permits one dominant player in broadcast and another in telecom (i.e., cannot be the same firm).
  • IP protection – adds protection to retransmission of TV broadcasts
  • Increased penalties – from 6 to 10 percent of the bad actor’s revenue, with option of doubling the fine for repeat offenders; 5 percent penalty for content violations
  • America Movil broken up – the reforms indirectly caused Carlos Slim – owner of America Movil – to decide to sell off portions of his holdings, resulting in a split of his wired telecom provider (Telmex) and wireless provider (Telcel). This was the issue that garnered the most attention in the US and UK press, including allegations that IFETEL did not take a similarly tough stance against Televisa, whish is dominant in the broadcast sector
  • Videogame ratings – videogames may now receive a content-based rating like movies

Wins and Losses for Civil Society

The elimination of content blocking on ‘national security’ grounds was a major victory for civil society groups, but even more impressive are the final law’s provisions on net neutrality. Previously, the proposed reform allowed for content-based ‘fast lanes’ on the internet, which could allow service providers to ‘prioritize’ content for reasons contrary to their users’ interests (e.g., speeding up sites of affiliates or companies that purchase marketing packages).

Mexican civil society organizations flooded the Mexican Senate with letters opposing the ‘closed internet’ provisions in the former draft of the reform. The result of this effort is Chapter VI (Articles 145-146) of the final law, which explicitly addresses net neutrality. In short, this section clearly prohibits service providers from content-based ‘filtering’. It does, however, permit providers to take measures to administer their network traffic, but these measures will need to comply with ‘authorized policies’ of IFETEL and can only be aimed at ensuring the quality or speed of service for the user. Also, Art. 146 makes clear that providers are allowed to offer users different tiers of internet speeds (e.g., pay more for higher speeds), but these offers may not be content-based.

The provisions on monitoring and data retention were fought by civil society and privacy advocates, but ultimately remained in the final law. These organizations are now calling on the Federal Institute on Access to Information and Data Protection (IFAI) to intervene and challenge the monitoring and data retention provisions in court.

The organizations may have a point, although the obligation to cooperate with investigating authorities is probably less significant than it seems – I doubt any provider would refuse to cooperate with a lawful investigation under the preexisting legal framework. But the retention requirements in Art. 190 are quite broad and onerous. Providers need to construct a digital database to hold the retained data for 12 months “in systems that allow for real-time consultation and delivery to authorities.” After the 12 months have passed, the provider must retain the data for an additional 12 months “in a system of electronic storage … [permitting] the delivery of requested information to the authorities within 48 hours.”

The data that must be retained:

  • Name/business name and address of subscriber
  • Type of communication (voice, vmail, data, etc.) or other services (MMS, call forwarding, etc.)
  • Data necessary to trace and identify the source and destination of telephone communications (dialed number, number of lines on account)
  • Data necessary to identify the date, time, and duration of communication, messaging, data transfer, etc.
  • Date and time of the initial activation of service and the location ID where service was initiated
  • If applicable, identification and technical characteristics of the devices, e.g., international manufacturing codes, subscriber equipment
  • The geolocation data for all telephone lines

It is hard to imagine that any provider will be able to just manually drop all these data points into an Excel spreadsheet, and thus a semi- or fully automated system is necessary. Perhaps most service providers already collect this data and it’s just a matter of reorganizing it. More likely, it is going to be a big financial and logistical mess for them.

Also concerning is the retention obligation’s duration, which at 730 days is quite long and similar to the highly-controversial European Union Data Retention Directive (DRD), which the European Court of Justice overturned in April precisely because of the long retention period. In contrast, U.S. law only requires 180 days of retention, and only upon government request (i.e., no default duty to retain). The volume and duration of data retained, plus the urgency with which providers must respond to government requests, make it more concerning that the final law does not contain any judicial procedures for challenging government requests and no notification provisions for users. It will be interesting to see how IFAI reacts to the retention/cooperation provisions.

Takeaway for Foreign Providers

The telecom reform – like much of Pacto por México – is intended to stimulate foreign direct investment into industries that have been lagging behind due to insufficient competition and underdeveloped infrastructure. Although the oil industry is unique, all Mexicans with whom I speak perceive the quality and speed of telecom services up in the United States as better than those in Mexico and at a fraction of the cost.

One example: I purchased a simple local cell phone and a pay-as-you-go SIM card – nobody but family members know my number, and yet I receive around 10-15 unsolicited texts per day offering services I don’t want (even if I did want them, the text tells me to click ‘OK’ to purchase, but this is impossible because there’s no account to be charged on a prepaid plan). I am hopeful that harassing texts will be included in the prohibition on unwanted marketing by providers.

The reform is also significant because it is already proving effective at breaking up one of the biggest market players, which is arguably responsible for the lack of competition over price and quality. No U.S. or European company is interested in entering a market with such stacked odds – but the telecom reform appears to be leveling the playing field.

Additional Resources:

A lot of the Mexican news sites have compiled useful pages (in Spanish) about the telecom reform. I recommend:

 

 

Posted in Uncategorized | 1 Comment

Energy Reform Update

As discussed in the last post, Pres. Peña (EPN) introduced draft implementing legislation for the Energy Reform at the end of April. Below is a brief update on the legislature’s review of the implementing legislation.

On June 4, the working sessions to review the implementing legislation began meeting, with a scheduled completion date of June 19 (detailed calendar in Spanish here).

On June 8, the Mexican press reported that the Senate was preparing 87 changes to EPN’s draft implementing legislation (Senate document in Spanish here). For example, the Senate’s proposal makes the National Hydrocarbons Commission responsible for approving exploration and development for hydrocarbons extraction; EPN’s draft had given that  power to the Secretary of Energy. At this time, it does not appear that the Senate’s proposed changes materially alter the nature of the energy reform as relates to opening of the market to foreign investors.

As always, readers can find all primary source documents related to the Energy Reform at this page.

 

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Energy Reform – Secondary Legislation Introduced

On Wednesday, April 30, President Peña (EPN) submitted to the Chamber of Deputies draft secondary legislation package implementing the far-reaching energy reform proposed under the Pacto por Mexico. Although the reform was ‘passed’ by the legislature in December of last year, it lives largely a conceptual existence until the secondary legislation is passed. The proposed secondary legislation was reportedly closely planned and agreed upon by PRI and PAN, which gives the package a high likelihood of passing.

Overview

The secondary legislation package is divided up into 9 categories, with 21 legal modifications (9 new laws* and 12 amended laws):

  1. Hydrocarbons (Law on Hydrocarbons*; Law on Foreign Investment; Mining Law; Public-Private Partnerships Law)
  2. Electricity (Electricity Industry Law*)
  3. Geothermal (Geothermal Energy Law*; National Water Law)
  4. National Agency for Industrial Security and Environmental Protection of Hydrocarbon Sector (Law on the Nat’l Agency for Industrial Sec’y and Env. Protection of Hydrocarbon Sector*)
  5. Productive State Enterprises (PEMEX Law*; Law on the Federal Electricity Commission*; Law on Federal Public Entities; Law on Acquisitions, Leases, and Services of the Public Sector; Law on Public Works and Related Services)
  6. Regulators and Basic Law of Federal Public Administration (Law on Regulatory Bodies for Responsible Energy*; Basic Law of Public Administration)
  7. Fiscal (Hydrocarbons Revenue Act*; Law on Federal Rights; Fiscal Coordination Law)
  8. Law of the Mexican Petroleum Fund for Stabilization and Development (Law on the Mexican Petroleum Fund for Stabilization and Development*)
  9. Budget (Law on Federal Budget and Fiscal Responsibility; General Law on Public Debt)

Preliminary Observations 

  • The reform reaffirms that oil exploration and extraction and the underlying resources are ‘strategic areas’ belong exclusively to the state.
  • But to further the exploration and extraction cause, the state may offer concessions to PEMEX or enter into contracts with PEMEX or national or international private companies.
  • The contract types will include – service (paid in cash), shared utility (paid by % of utility) or shared production (paid by % of production), or license agreement (contratos de servicios, de utilidad o produccion compartida, or de licencia)
  • The contracts may be awarded only after a public tender; terms of the contracts must be made public
  • The reform opens up the marketing, distribution, and sale of oil and gas products, as well as the construction of pipelines (basically everything post-extraction)
  • Local content rules for exploration and production, ramping up to 25 percent by 2025
  • Identifies the National Hydrocarbons Commission as the only body that may award contracts for exploration and production, and only after a public tender
  • An entire chapter (Chapt. II, Arts. 83-89) deal with anticorruption/transparency, and establish information that must be disclosed, and establishes specific anticorruption offenses for participants in the contracting processs
  • The reform aims to lower PEMEX’s tax burden from 79 to 65 percent
  • Generally attempts to correct a historic wrong by giving PEMEX more autonomy over its operations and finances
  • New obligations for PEMEX and CFE to make public certain information on their operations
  • Establishes new transparent National Petroleum Fund to help stabilize the economy during economic shocks

Reaction

Thus far, the reaction has been generally positive. Canacintra – a major industrial trade group – expressed its approval of the secondary legislation package immediately. BBVA Bank stated that the package as currently drafted will likely prove successful at attracting foreign investment to Mexico. Foreign industry experts seemed to agree with these assessments, citing the flexibility inherent in the reforms.

 

 

Posted in economy, energy, legislation, oil and gas, Pact for Mexico, pemex, reform | 3 Comments

Mexico’s New Anticorruption Initiative – Facelift or Reconstructive Surgery?

In a previous post, we asked how Mexico should approach the urgent need to reduce the level of corruption in the country. Indeed, anticorruption measures are one of the key reform promises of the government’s Pacto por Mexico.

Mexico’s problem addressing corruption in the past has not been the product of a deficient legal framework. Mexico’s Penal Code criminalizes both active and passive bribery (Art. 222), bribery of foreign government officials (Art. 222 bis), abuse of power (Art. 220), and trafficking in influence (Art. 221) (see Annex 4 of the OECD Phase 3 Report on Implementing the Anti-Bribery Convention for English translations). Rather, as we previously reported, the central weakness in Mexico’s anticorruption framework is the lack of enforcement, and the lack of enforcement stems from assigning anticorruption work to weak institutions (i.e., Secretaria de la Funcion Publica). Thus, the Pacto por Mexico directs the creation of a new anticorruption agency, and we previously reviewed what characteristics an effective agency should have.

On December 13, the Mexican Senate passed the anticorruption reform required by the Pacto. The reform – available here (Spanish) – consists of several additions to the Constitucion Politica de Los Estados Unidos Mexicanos. The most important addition is a new Article 113(III) (starts on page 141 of the document), which establishes a new National Anticorruption Commission. The main points of Art. 113(III) include:

  • Anticorruption commission will be responsible for prevention, investigation, and punishment of corruption offenses
  • The commission will have the power to mete out administrative sanctions – suspension, dismissal, disqualification, and monetary fines – but not criminal sanctions; the fines may not exceed more than three times the benefits received or damages caused by the corruption offense
  • In cases involving criminal violations, the commission will pass the case along to the Procurator General of Mexico
  • The commission is an autonomous public agency with its own legal identity and assets
  • The head of the commission will be appointed by the senate based on a proposal from the parliamentary factions; the head holds office for seven years and may not hold other employment during the term
  • The commission must develop programs and activities to promote ethics and honesty in the public service and a culture of respect for the law
  • The commission will have an Advisory Council, presided over by three citizens appointed by the Senate, a representative of the executive branch, a representative of the Supreme Auditor of the Federation, and a representative from the Federal Institute for Access to Public Information (IFAI)
  • The commission may issue general or specific recommendations to the three branches of government, aimed at preventing corruption

The anticorruption reform is currently pending approval by the House of Deputies, which should take up the issue when it returns on February 1.

So far, the reactions the reform have been limited, possibly because it was released over the holidays, as well as the focus on the violence in Michoacan. But some anticorruption practitioners have been critical of the reform. Specifically, the experts felt that the commission’s head and citizen members should not be appointed by the Senate – one of the very bodies the commission should be policing. Moreover, observers argued that the commission’s recommendations should be binding on the government entities to which they are issued. Finally, the critics noted that the reform puts off the task of articulating a ‘national system for combating corruption’, as required by the Pacto

Although the critics raise valid points, many of their concerns can either be addressed by the House of Deputies or may not materialize in practice. Most important, the reform creates a commission that in principle avoids the problems with the existing Secreteria de la Funcion Publica – i.e., the new commission is legally independent/autonomous, and may initiate investigations and mete out sanctions. Thus, the new anticorruption commission has a better chance at carrying out its mandate to prevent, investigate, and punish corruption. The first major test of the commission will be who is appointed, and will indicate whether it will turn out to be a serious entity or not.  

 

Posted in corruption, legislation, Pact for Mexico, reform, Uncategorized | 3 Comments