19 Jul 2006  Research & Ideas

Political Turmoil and Mexico’s Economy

Professor Noel Maurer's historical research into Mexico and other countries with unstable governments shows that their economies perform better than might be expected. Why? Key concepts include:

  • A country's political instability does not necessarily take down the economy—rules matter.
  • The final outcome of Mexico's disputed recent presidential election will tell how far the country has moved toward democracy.
  • U.S. attempts to reform domestic institutions of other countries have sometimes been sidetracked in favor of economic expediency.

 

What happens to a country's economy when its government is politically unstable, such as has been the case historically in Mexico? Can business get done under a strong-arm dictatorship, or when a government is too weak to protect the rights of its citizens?

In research examining Mexico's economic history, HBS assistant professor Noel Maurer considers these questions and opens the door to other queries involving issues of economics and governance that reach well beyond the United States and its neighbor to the south.

Mexico makes a good laboratory for studying these issues, notes Maurer—and the country's recent volatile presidential election just puts another twist in the story. Between 1910 and 1929, the country struggled through a revolution, a counterrevolution, a counter-counterrevolution, two military coups, three coup attempts, and two presidential assassinations. Even so, the Mexican economy registered growth during this tumultuous period.

"You'd think the economy would come to a crashing halt," Maurer says. "Except that when you look around the world, it turns out there are a number of countries, including Mexico, that have experienced political instability without having their economies fall apart. On average, such countries don't do nearly as well as liberal democracies; but there's still a mystery in that they're not doing as badly as the economists and political scientists would have predicted."

As Maurer delved deeper into twentieth-century Mexican history, he found a common thread running through the country's various shifts of power: reliance on a third party to enforce the rules (such as property rights) that make it possible to do business.

A stake in the game

Porfirio Diaz, for example, rose to power in Mexico in the 1880s and maintained his control in part by creating a banking system that functioned more as a kind of investment club, Maurer says. Local businessmen would agree to lend each other money to finance one another's companies, while also selling shares in a jointly managed bank to attract outside capital to their businesses. They also distributed shares of the bank to the state governor or made a loan to the local state government—with the understanding that it most likely would not be repaid.

A number of countries have experienced political instability without having their economies fall apart.

"The governor of that state now had a stake in the success of these particular business enterprises," says Maurer. "If the federal government tried to unilaterally renegotiate the deal, it would affect the livelihood of these very powerful state governors and probably cause the collapse of the Diaz regime. Similarly, a state governor could also try to renegotiate a deal—but Diaz was now strong enough to confront any individual governor."

This self-interested system of checks and balances worked well enough that the Mexican economy grew at an annual rate of 5 percent between 1877 and 1910, faster than the contemporary United States. "A dog with a bone in its mouth neither barks nor bites," Diaz is reported to have said.

When Franciso Madero became Mexico's new president in 1911, he attempted to govern as a liberal democrat and follow the rules of the Mexican Constitution. He lasted two years before being overthrown in a coup.

"It's difficult to impose a liberal democracy," Maurer remarks. "A system of rules only works if you believe the other guy is also playing by the same system of rules."

Today's presidential politics

Mexico's current election imbroglio—with only 0.58 percent of the vote separating the two leading candidates—poses an opportunity for the country's new democracy, says Maurer.

"Despite some intemperate statements, the major players show every sign of playing by the rules," Maurer says. Left-wing candidate López Obrador filed complaints with the Federal Election Tribunal, per the constitution, Maurer notes. And many prominent members of the opposition conservative party, if not conservative candidate Felipe Calderón, have defended López Obrador's right to challenge the results and demand a full recount.

"That said, the outcome depends on the opinions of López Obrador's followers. If they believe that it is illegitimate to challenge the Tribunal's decision (or the results of the recount) with violence, then Mexico will have completed its transition to democracy. If they don't, then Mexico will face some risks and its politics will remain opaque and confusing to outsiders attempting to do business there."

Is foreign investment enough?

NAFTA offers another insight into the economies of Mexico and other developing nations. In the working paper "Was NAFTA Necessary? Trade Policy and Relative Economic Failure since 1982," Maurer examines the trade agreement's impact on the Mexican economy.

"In and of itself, NAFTA is pretty successful," he says. "It creates a big wave of foreign direct investment in Mexico, and its manufacturing sector takes off. But in terms of Mexico's overall prosperity, this is pretty small potatoes."

And foreign investment is no substitute for domestic investment in institutions such as education, the judicial system, and health and social welfare programs.

A system of rules only works if you believe the other guy is playing by the same rules.

"Mexico has an incredibly low level of taxation. It simply lacks the public funds to invest in itself," Maurer says. "A lack of foreign investment is not why Mexico is less prosperous than Arizona," he concludes.

"While the cultural differences between the United States and Mexico have shrunk dramatically, its system is still somewhat foreign to a private businessman from the United States or Western Europe," adds Maurer. "The culture of a country like South Korea may be alien to a Western investor, but its judicial and electoral systems would be more familiar and seem to present less of a risk."

Maurer's research on the economic impact of the Panama Canal demonstrates another facet of foreign investment dynamics—in this case, the construction of a $375 million public works project that employed over 56,000 people between 1904 and 1913.

In "What Roosevelt Took: The Economic Impact of the Panama Canal, 1903-1939," Maurer finds that the economic benefits that accrued to Panama from the canal's construction were surprisingly minimal.

"You would think Panama would be well-positioned to get spillovers from the canal," he says. "But once I started to look at the data, it was difficult to find any spillovers above and beyond the actual cash payments made by the United States to the Panamanian government."

The United States and the world

That finding has led Maurer to a larger research agenda that considers how the United States attempted to reform the domestic institutions of other countries during the period from 1893 to 1941—and how that tendency continues to play itself out more broadly in the world today.

You're crazy to think that creating a strategically vital asset is going to give you leverage over a country's government.

In the case of the Panama Canal, for example, the United States was concerned enough about maintaining political stability in the country during the construction of the canal to install a fiscal agent there to oversee how the money given to Panama was being spent. Whenever the agent warned the State Department that all was not well, however, U.S. officials ignored the red flags.

"Essentially, the U.S. government was saying, 'We know, we know, but we're going to let them do what they want because the canal is too important,'" Maurer says. "The United States can try to ensure good government, but it backs down on that commitment because the flip side of Panama being important is that Panama can also interfere with the functioning of the canal."

An identical situation is playing out today with other massive infrastructure projects and Western institutions such as the World Bank and the International Monetary Fund, Maurer contends. In the case of the Chad-Cameroon Petroleum Development and Pipeline Project, the World Bank is acting as a watchdog to oversee the multinational project.

"The Chadian government wants to divert revenues to fight rebellions and pay off its enemies," Maurer says. "When the World Bank tries to enforce the original agreement—that the money be spent on socially constructive projects—the Chadian government threatens to shut down the pipeline." At that point, the U.S. State Department intercedes; the world oil market is too important not to acquiesce to Chad's demands.

"You're crazy if you think that creating a strategically vital asset is going to give you leverage over a country's internal government," Maurer remarks. "You're actually producing the reverse."

The costs of intervention

Despite the fact that frequent comparisons are drawn between the British Empire and the world today, Maurer argues that a more apt comparison can be found in American foreign policy between 1893 and 1941. His paper on the Panama Canal will be included in a future book with the working title Imperial Experiments: The First American Empire. In addition to a chapter on infrastructure projects, the book will include sections on investment, international trade, and political institutions.

"The United States is currently involved in political interventions in various countries," he says. "Some are military, some are financial. Does this affect the cost of capital? Does the borrowing cost for the sovereign governments go up or down, and what is the cost of capital for companies that have business in these countries?" At this point, Maurer adds, he has more questions than answers.

"I don't know what my overall conclusion will be yet, but I would like to draw some lessons from this eventually—either determine that these interventions are a good idea, and here is what can be done to make it work. Or, this can work, but only if a presence is maintained indefinitely. And of course there's always the possible outcome that these interventions are just a bad idea."

Maurer's research will take him to Afghanistan this fall, where he will be embedded with NATO troops. "The research is for the last chapter of the book, which will analyze current overseas interventions. In addition, many of the findings will go into an HBS case by Debora Spar, Gunnar Trumbull, and myself."

NATO's efforts in Afghanistan, says Maurer, superficially resemble U.S. actions in the Philippines a century ago.

"I'll be sharing what I've learned about foreign intervention and institution-building before World War II," says Maurer, "but the other purpose is to see directly what NATO's strategy looks like on the ground, and how well the parallels with the past really hold."

About the author

Julia Hanna is associate editor of the HBS Alumni Bulletin.