Mexico's economy relies on tourism to return

13/01/2021

The recovery of the Mexican economy will require that external demand for goods and services be maintained at the current pace and that the demand for services, particularly tourism, returns, since this sector accounts for 77% of service exports.

Economy in Mexico lags behind due to lack of governance and business climate
Economy in Mexico lags behind due to lack of governance and business climate

It is important to note that the Covid-19 deepened the contraction of Mexico's economy. When industries and consumption rebounded, demand maintained the recovery. The global pandemic came at a time when the Mexican economy had contracted for five consecutive quarters due to factors such as the slowdown in investment and private consumption, as well as the uncertainties of the free trade agreement with the US and Canada.

The crisis over Covid-19 accelerated this trend, generating the largest contraction since 1929. The forecast for 2020 was a GDP of -9%. The economy fell by 17% between the first and second quarters, followed by a partial recovery of 12.1% in the third quarter, which was a good time to buy shares.

The pandemic also had a substantial impact on the labor market. Between April and May, 12.5 million people left the market and unemployment rose to 4.5% from 3.3% in March. Covid-19 also reduced the size of the labor force from 60.5% in February to 47.5% in April. By the end of the year, the recovery had returned 10.2 million to the market, but there were still 2.3 million to return.

Economists expect that the new U.S. government and the Mexican federal government's plans to increase spending on infrastructure along with the arrival of Covid-19 vaccines should stimulate demand for manufactured goods, which will help foreign-market oriented industries. On the other hand, a more favorable macroeconomic environment in the northern neighbor will also be positive.

The economy in Mexico lags behind

The International Monetary Fund (IMF) warned that Mexico's economic growth is lagging behind due to poor governance and the business climate. In a study entitled Comparing Latin America's Lack of Convergence with Eastern Europe: Is Low Investment to Blame? the international body noted:

"We studied the different components of GDP growth in Poland and Mexico since 1995, and the picture is very clear: the combination of human capital and productivity is an important positive factor in the European country, but often a negative factor in North America".

According to the document, governance and a good business climate are important for productivity growth. In countries where property rights are not guaranteed and governance is poor, businesses remain small and productivity low. Whereas, in well-managed countries, successful enterprises can grow in size and efficiency.

IMF analysis shows that countries with more human capital and better governance and business climate are often richer than countries where these variables are deficient. High human capital alone is not enough: this analysis shows that countries thrive only when governance also improves. In this context, it is not surprising that in both respects Mexico lags behind Poland.

"In general, the same is true for Latin America compared to advanced countries or emerging economies in Europe, which helps explain why it is relatively poorer. Of course, there are exceptions: in Chile, governance is on a par with some advanced economies and is better than in most of the emerging economies of Asia," it said.

A look at the history by the international body showed that, in 1989, on the eve of the fall of the Berlin Wall, the countries behind the Iron Curtain were much poorer than those in Western Europe, while today, some have income levels similar to those of Spain and Italy. This explained that convergence was rapid because human capital was already similar to that of Western Europe, while income was much lower in the early 1990s.

The strengthening of institutions contributed, and in this respect, the European Union (EU) played an important role. The prospect of EU membership led to further reforms and strengthened growth. Countries that joined or bid for membership experienced significant improvements.

While for Latin American countries, such as Mexico, the IMF concluded that the region lagged behind in the convergence process mainly for two reasons:

First, it did not have the same combination of high human capital and low income as the former communist countries. In fact, in the mid-1990s, the level of per capita GDP was slightly higher than would be expected with existing human capital.

Secondly, there was not a strong institutional improvement in Latin America as observed in Europe either. In fact, in many countries governance indicators worsened.