Mexico and the U.S.: Good Fences Won't Make Good Neighbors

It's no secret that China's economy is booming, and that the large, quickly-industrializing country is becoming a serious contender as a new global power. China's sheer population numbers, as well as its technological innovations, make it the obvious focus of the U.S. public and private sector alike. In fact, China's appearance in the news is almost tiresome, with the prominent fear-mongering becoming almost commonplace.

However true and valid these claims may be, they do tend to draw attention away from other areas of the world experiencing rapid growth. When we think of countries that are developing new capabilities and have rapidly expanding economies, we often think of China, India, South Korea, and the like. Interestingly, such impressions can turn attention away from other emerging significant players. As a recent piece in The Economist pointed out, "America needs to look again at its increasingly important neighbour:" Mexico.

Within the past few days, The Economist released a cluster of articles (here, here, and here) in a clear push to bring attention to this rapidly-growing nation. At the risk of generalizing too liberally, the impression of Mexico among Americans is less than optimal. There seems to be an unspoken consensus that our southern neighbor is, more or less, just a collection of smoke-filled cities racked by drug wars and poverty. When it comes to Mexico, the reactionary thoughts are border security and smuggling crackdowns; especially within the Republican Party, the only policy that even relates to Mexico involves keeping them out. In 2009, in the midst of an American recession, the swine flu epidemic, and continuous bloodshed from organized crime, the Pentagon predicted that if things kept on this way, Mexico would become a "failed state." At the time, the news came as no surprise.

With the quickened pace of progress today, however, Americans need to continually update their perceptions and stereotypes. As we have seen time and again, globalization, technology, and international trade can turn everything around for a country in a matter of just a few years. Since this grim projection three years ago, Mexico has started to turn things around, positioning itself to become one of the top 10 economies in the world by the end of the decade. At the moment, it is already ranked slightly ahead of South Korea in terms of GDP. Latin America's second-largest economy occupies a strong place in its region, yet it will continue to remain in the shadow of South American powerhouse, Brazil. Right? Wrong. Surprisingly, according to The Economist's statistics, Mexico's growth outpaced Brazil's last year, and it is projected to grow twice as fast this year (4%). Though there is nothing to indicate it will "pass" Brazil in the near future, Mexico is certainly working hard to change its current position in the world.

A brief overview of the growing private sector, foreign direct investment, and industry in this country depicts a Mexico yet unknown to many Americans. Though the U.S. doesn't exactly have an economic giant lying dormant just beneath its southern border, there is every indication that this country will become even more important for American markets. To begin, the Mexican auto industry seems to provide some of the most shocking facts. Though largely constituted by foreign companies, this sector of production has seen enormous growth recently. In Cuernavaca, there is a Japanese-run Nissan factory "the size of a village," which will soon be churning out thousands of New York taxicabs. "About 80% of the parts in each car are made in Mexico," and the factories largely rely on local suppliers, which helps provide protection from fluctuating foreign currencies. Audi is also constructing a $1.3 million plant in Puebla, and Mazda and Honda are getting on the bandwagon as well. Amazingly, Mexico will be the fourth-largest auto producer in the world. Oil has also been a huge commodity in the Mexican economy, although the national monopoly is becoming a huge problem.

Mexico's pro-free trade attitude, sparked by NAFTA in 1994, has been very beneficial for the national economy. Today, Mexico boasts free trade deals with 44 different countries, and trade accounts for a larger part of its GDP than any other country. This aspect, however, has proven to be a double-edged sword. Its economic success is thus quite vulnerable to the ills or well-being of its trade partners. In 2007-2008, "thanks to its wide-open economy and high exposure to the United States it suffered the steepest recession on the American mainland: in 2009 its economy shrank by 6%." Additionally, China's entry into the WTO ten years ago undercut some of Mexico's export industries. Still, however, free trade has allowed the country to become one of the most important exporters to the U.S. By 2018, experts predict that the U.S. will get more of its imports from its southern neighbor than from anywhere else (provided Mexico continues its progress). Also, China's extremely competitive production is beginning to lose its edge, which is allowing Mexico to reap more and more of the benefit. As Chinese currency appreciates, wages and prices increase. In a free market, this makes Mexican labor and goods comparatively more attractive to the international community.

Also, to destroy a common conception, net immigration across the border is zero. More and more people are going back into Mexico, and the economic outlook there continues to brighten. In light of this, immigration reform shouldn't mean higher walls or longer border waits. Rather, the facts indicate the necessity of a full overhaul of the system and of the general mentality behind it.

One of the biggest "buts" about all of this, however, is the fact that Mexico still has significant problems with cronyism, violence, and the remnants of instability. Unfortunately, much of these projections seem to be based on the hope that these problems will begin to disappear, and that newly-elected President Enrique Peña Nieto will achieve his goal of administrative transparency and 6% growth. Although the murder rate is down in this country, and many of the most dangerous cities are becoming substantially safer, there are still some factors that could encumber further growth. First, the telecommunication situation is lacking in Mexico, so communication is made a bit slower and more difficult. Also, there is a significant problem with unions and monopolization. In order to really boot his country into gear and reach the 6% growth rate, President Nieto will have to break the back of the concentrated monopolies in several industries. Rich tycoons--specifically in the energy sector--are quite comfortable controlling their sectors of the economy. Though these measures will not be popular among the heads of these companies, promotion of competition is the only way that Mexico can rid itself of the problems of monopoly. Additionally, the nationalized oil company, Pemex, has been nearly sucked dry of its finances by the former Mexican governments. Lastly, due to past volatility in its economy, the banking and credit situation is less than optimal. Banks tend to charge 25% interest rates, and demand huge amounts in collateral. Clearly, this situation and lack of confidence will, as the article noted, tie the hands of Mexican businesses and discourage future ventures.

Still, the situation in Mexico is significantly better than many Americans believe or even would admit. With Chinese prices rising, Mexico has an amazing opportunity to sell its goods to its Northern neighbor, and thus strengthen the mutually-beneficial relationship. Its sheer proximity to the U.S. puts it at a great advantage, because goods on trucks can arrive in a matter of hours. In contrast, Chinese goods have to travel across an entire ocean, and one statistic equated a day in transit with a 0.6% - 2.3% tariff. Moreover, the number of skilled workers in Mexico is rising, and it apparently turns out more engineers than Germany (in terms of sheer numbers).

So, what would be the consequences of a stronger, more competitive neighbor? For one, trade would be greatly facilitated, and the quality of goods traveling across the border would be higher. Perhaps there would also be a stronger trade agreement, which would make the North American continent an even more powerful economic force. Although the U.S. will remain a highly attractive business environment, Mexico's cheaper labor and free trade policy will undoubtedly bring in more foreign ventures. Whatever happens, the U.S. will certainly have to change its policies and attitude toward Mexico. If the country continues to grow--which will be Americans' better interest--the U.S. can't continue to turn its back and try to keep illegal immigrants from hopping borders. If it has a significant economic power cropping up right next door, immigration, border, and trade reform will all be in order. This will likely be an extremely touchy issue, with crime still occurring and drugs, guns, and people constantly being smuggled, but there must be a restructuring of the system. Only through this will both nations elevate each others' economic markets, and perhaps work to solve one of the biggest problems within North America.

In the next week or so, President Obama will meet with President Nieta to discuss future opportunities and potential cooperation between the two countries. This will certainly be something to watch, because it will be the first of hopefully many steps toward a repositioning of this vital trade relationship.

Pessimism and the Fiscal Cliff

Though I tend to only read the Daily Mail for celebrity news and updates in the English tabloids, I opened the site today and discovered a significantly more weighty headline: "INVESTMENT EXTRA: Why ordinary investors should not put their money in to the US." It's certainly not uncommon for the Brits to bash Americans, but most of this talk tends to be about the political system, the southern "cowboy" culture, or the inordinate number of fast food restaurants. This time, however, it wasn't just playful banter.

According to this piece by James Coney, the so-called "fiscal cliff" isn't just spreading worry throughout the U.S. public and private sector--it is also reaching important sources of capital overseas. Although the election of a new president tends to boost enthusiasm and confidence in the U.S. economy, on Wednesday, November 7th, people had already turned their attention to the impending crunch. Put simply, this fiscal cliff involves a large bundle of spending cuts and tax hikes that will all take effect on January 1, 2013.  A CNN article released that day called this the "single biggest problem facing the United States," using the explanatory metaphor of a speeding car driving off of a cliff.

If no policy changes are made to avert the impending fiscal cliff, many fear that it could spell the ruin of not only American markets and businesses, but also those across the international economy. Once the new year arrives, a slew of spending cuts are slated to take place, affecting the defense sector and including several other discretionary cuts. Unfortunately, this is the inevitable fallout of the failed budget summit a while back. Compounding this is a number of tax hikes, which are caused by the expiration of the Bush era tax cuts. Within this, there will be a lowering of the Alternative Minimum Tax, which would push millions of families over the threshold into a higher income tax bracket. Altogether, this is projected to cause a $7 million increase in taxes over the next ten years, and siphon anywhere from $5 trillion to $7 trillion out of the U.S. economy. If this country "falls" completely off of the fiscal cliff, experts estimate that it will cut the GDP by 3-4%, which will undoubtedly cause recession in an economy that is currently only growing at 2-3%.

Just after President Obama's reelection, there was an unusually low level of chatter about the actual election results. Instead, almost instantaneously, people shifted their attention to the hopeful resolution of this fiscal cliff. With the administration set for another four years, both Republicans and Democrats are calling for this problem to be fixed right away--not only to avert the crisis that would come crashing down on January 1, but also to avoid the immediate problems associated with lack of confidence. As Christine Lagarde, head of the IMF, noted, the fiscal cliff has already caused huge uncertainty across the world, with major financial players unsure of how things will unfold.

Last Wednesday, both sides of the aisle were noting the sudden jolt to the Dow Industrial Average, and began speculation that the U.S. economy was headed for another downturn. The Daily Mail piece highlighted this uneasiness, putting forth five concrete reasons why investors should not continue to direct their money to American industries. First, the fiscal cliff will be difficult to avoid, and with unemployment already at 8%, there will be "lower consumer spending and higher state benefits." Additionally, entitlement spending is only expected to increase, profit margins are inflated and vulnerable, and it is difficult to find reliable, skilled fund managers in the U.S. Finally, the article questioned why anyone would choose an American fund when "some of the best global funds already hold masses of American stocks."

 The fiscal cliff is engendering anxiety in East Asia as well. Far worse than any of the China rhetoric tossed around in the debates, the threat of another significant domestic downturn would hurt the vital economic relationships between China and the U.S. Chinese leaders have expressed concern that the U.S. will "drag them down with it," and have made calls for Obama to abandon the political posturing and develop a more "constructive" relationship with them. According to Shaun Rein of China Market Research Group, "Regardless the leader, China needs the U.S. economy to prosper in order to keep export flowing and U.S. investment in China high -- which are important ingredients Beijing needs as it attempts to boost Chinese wages and beef domestic spending." In other words, China sees the threat of the fiscal cliff as a sort of mutually-assured destruction.

Put frankly, articles like these should cause mild alarm. When public, international news sources are calling for investors not to put their funds toward American endeavors, people should realize that change needs to be accomplished--and soon. Realistically, however, it is unlikely that things will unfold in such a detrimental fashion come January 2013. The American news media is marked by its obsession with all things "doomsday," and such hugely important issues tend to get priority on the President and Congress' to-do list. While I do not believe the U.S. will go tumbling down the fiscal cliff, all the way into the gorge of recession and complete stagnation, it would not be right to write off these pieces as overly-exaggerating. Perhaps the biggest worry with the fiscal cliff is not what could happen at the turn of the year, but rather what is already happening now: a rapid decline in confidence.

What John Maynard Keynes called "animal spirits" are alive and well, functioning sometimes to the benefit and other times to the total destruction of an economy. As John Cassidy notes in his book (discussed in the previous post), group psychology can explain many of the happenings in markets and can predict the behavior of one or multiple players in a given situation. In many past recessions and depressions, a permeating lack of confidence--starting quietly and then reaching critical mass--has been the main factor that tips the scales. Once this cycle has begun, it is extremely hard to encourage consumers to loosen their fists and re-start a pattern of spending. In the Thai example that Krugman puts forward, once there was a bit of trouble with households and businesses, investors quickly lost faith and jumped ship. This left Thailand in shambles, with a devalued currency and a reeling economy.

Once investors begin to lose confidence in the U.S., it could spread like wildfire. If significant, public steps are not made to remedy this situation and avoid playing chicken with the fiscal cliff, the U.S. should not hope to get out of the recession anytime soon. And, depending on the severity of this sentiment, the global economy could potentially worsen instead of heal. The actual impact of the spending cuts and tax increases should not be the main worry; rather, it should be the fore-running consequences, and the possible cycle of lack of confidence that could greatly increase the negative impact of these policies. If the threat of the fiscal cliff is not eliminated and potential investors' worries not allayed, all of the major players in the global economy could feel its impact.

How Markets Fail: A Rational Evaluation of Recent Crises and Financial Governance

What exactly happened in the economic crisis in the late 1990’s and the financial crisis of 2007? What is the role of the U.S. government and The Federal Reserve in containing these crises? How should we understand financial markets? Although all of these are quite broad and undoubtedly tough questions, John Cassidy manages to come to grips with them all in his recent book, How Markets Fail. Cassidy presents a thorough overview of “utopian” economic theories, primarily based on Adam Smith’s precepts, then translates and applies them in plain English to the recent economic crises. First providing a basis of the knowledge that influenced Alan Greenspan, Ben Bernanke, and other influential players, he untangles the web of problems that created the bubbles, evaluates behaviors, and proposes uncomplicated solutions. Overall, How Markets Fail is an excellent book for readers of all backgrounds and all levels of expertise; it is incredibly simple, given its comprehensiveness, and it imparts a wealth of useful knowledge at all stages.

Cassidy begins his book by outlining various components and aspects of “utopian economics.” Although his definition is somewhat vague, the term generally refers to the belief—notably held by Alan Greenspan—that markets are perfectly self-regulating, and that they naturally achieve an optimum state without government intervention. The book chronicles the development of pro-free market thought, and notes the major contributions of several individuals, such as Friedrich Hayek, John Stuart Mill, and Milton Friedman. Of course, there is also significant discussion of Adam Smith, whose concept of the “invisible hand” led many to believe that all markets are best left to their own devices (Cassidy 31, 36). Cassidy then moves to later work in this field, discussing price signaling, natural resource allocation, and a general support of a “hands-off” philosophy (Cassidy 42-43, 50). While Smith was actually skeptical of unregulated financial markets, over time, his views morphed into the false belief that markets are perfectly efficient and balanced when left untouched. Although Cassidy fails to explain how this happened, he makes a key point about which many, including Greenspan, were mistaken. It is clear that the “invisible hand” is undeniable, but a bit more discussion of the balance of free market and “planning” forces would have cleared up ambiguities in Cassidy’s position and would have segued nicely into his next points.

In the second and third sections of How Markets Fail, Cassidy unapologetically brings this idealistic conception to earth. His practical evaluation of the lead-up to recent financial crises is refreshing and adeptly-argued, explaining things in simple terms of incentives, group competition, and general psychology. Through this, Cassidy demonstrates the need of some government regulation and ownership, citing intellectual property protection and federal defense as some of the many beneficial and sensible examples (Cassidy 133, 136). He then moves onto a discussion of “rational irrationality,” or the confusing, self-interested behavior of financial players in response to incentives. This mode of thinking is incredibly useful, and it fits neatly within the overall depiction of the crisis. Essentially, there is always an incentive for firms and analysts to choose the most desired investments or stock (known as the “Keynes beauty pageant”), which leads to a lack of diversification and increased risk in the case of failure (Cassidy 178). Moreover, in a competitive market, there is an ever-present “prisoner’s dilemma.” Though lending groups may begin conservative, lending only to responsible businesses in order to ensure stability for all, there is always an incentive for one to game the system and offer loans to slightly riskier clients. Once this happens, bidding begins, and firms start pushing for more precarious loans. Such a phenomenon was forecast almost prophetically by Hyman Minsky, and was evidenced especially by the rapid expansion of adjustable rate subprime loans (Cassidy 208, 258).

After explaining the structural incentives driving this irresponsible behavior, Cassidy tackles the bubbles themselves. In the beginning of the five stages—displacement, boom, euphoria, peak, and bust—big lenders see high stock prices, rapidly expanding financial markets, and a safety net of government backing. Firms such as Citi Group, Goldman Sachs, and others, tried to “surf” the housing bubble, extracting maximum profits and hoping to jump ship just in time. Banks took on sizeable risks creating innumerable types of pooled capital, diversified risks, and hybrid loans, knowing full well that taxpayers would foot the bill if the projects failed (Cassidy 161, 184). While this was happening, the Fed continued to believe that recent innovations had made the financial system “resilient,” and that there was nothing to worry about (Cassidy 268). By contrasting this vicious incentive system—which created self-destructive rational irrationality—with the Fed’s hands-off approach, Cassidy makes it very clear why the market failed. It was only after the government stepped in, bailed out firms, socialized Fannie Mae and Freddie Mac, and realized the need for an active Fed that things began to get better. In Cassidy’s view, only government can counterbalance rational irrationality and create a framework of incentives that would reward responsibility, measured risks, and a degree of financial conservatism (Cassidy 329). 

In all, Cassidy’s take on market failure is quite thorough and logical, and there are few areas in which any would say that it is lacking. His choice to begin with the fundamentals of free market thought, and then progress to realistic evaluation of human behavior in complex financial markets, creates a straightforward explanation of a difficult topic. Moreover, Cassidy deftly cracks the disillusioned belief in Smith’s almighty invisible hand, presenting an argument for government intervention that would be received on both sides of the aisle. Still, however, one might wonder if any of this counterbalancing or checking could be done by the private sector—either by specifically-designated entities, or perhaps by agreement of the most influential players in the financial system. Similarly, though he is clearly a proponent of tempered government intervention, Cassidy is a bit unclear on when the Fed and policymakers ought to leave the market to its own devices. Of course, knee-jerk regulation may create stability and stop “bubble-surfing,” but it could easily smother innovation and de-incentivize growth. By delineating here between crisis and normal business cycle, Cassidy might have drawn a clearer line and supplemented his argument with intelligent discussion of a hotly-debated question.

While his ending proposal for re-structuring and re-thinking is quite reasonable, Cassidy unfortunately neglects one of the largest obstacles in monetary policymaking: time lag. Presumably, a good portion of his recommendations would be implemented as preemptive measures, and would already be in place when crisis threatened again. Still, he fails to mention that even a more active Fed would encounter difficulties, because it would take time for the economy to react to its adjustments. Furthermore, Cassidy notes that the housing bubble was unexpected, because Bernanke and others believed the economy to be immune to such a thing. Given the comprehensive, multi-perspective approach of this book, it would be quite interesting to see Cassidy’s projections about future crises. Though he proposes a model to combat some of these rational irrationality behaviors, there is likely still room for a new strain of financial busts. What his book intends, however, it achieves remarkably well. How Markets Fail is not only a lesson in foundational economic thought and mechanisms of crises, but also human behavior and group mentality—lessons that apply in any era or policy system.