Walter Molano | Mexico: Lots of wood to chop

In less than five months, Andres Manuel Lopez Obrador, AMLO, will don the presidential sash, becoming the 58th chief executive of his nation.

There is a great deal of optimism that this will mark the start of a new era for Mexico. Not hailing from one of the traditional parties, he will take office with a mandate for change. Moreover, his party and allies will have a majority in the congress, allowing them the ability to pass the legislation needed to fulfil his long list of campaign promises.

This is the first time in more than three decades that Mexico elects a president from the ideological left. Since the 1980s, Mexico was a paradigm of economic orthodoxy, having introduced the Brady Plan to end the debt crisis, having introduced the privatisation wave that transformed the public sector in the emerging world and having been the stalwart defender of sound macroeconomic stewardship.

Now, Mexico finds itself with a leader vowing to improve social justice, reduce the widespread violence that has claimed the lives of tens of thousands of Mexicans and pay for the measures by reducing corruption. That is a lot of wood to chop.

AMLO made a lot of promises on the way to the presidential mansion of Los Pinos. He promised to introduce a new apprenticeship programme to help young Mexicans obtain the skills and training to get better jobs. The president-elect also vowed to increase assistance for the elderly, defined as people over the age of 68.

The programmes are estimated at 110 billion pesos, or US$7.5 billion. Furthermore, he announced the construction of two new refineries in the states of Tabasco and Campeche. The facilities will produce more than 300,000 barrels a day of gasolene, thus allowing Mexico to reduce its reliance on United States imports. The two refineries are estimated to cost US$6 billion, which will probably expand Pemex's balance sheet.

The new government intends to increase these expenditures, without taking on new debt obligations or eroding the fiscal balance. It intends to do this by eliminating corruption. Among the measures, the government will slash the salaries of senior officials by half.

Health insurance benefits will also be eliminated. This will affect the salaries of an estimated 30,000 senior officers. The salaries and benefits of the public sector rank and file, however, will not be touched. Benefits for former presidents will also be slashed in half.

While the measures have popular appeal, they will probably miss the mark. Research shows that the best means to reduce corruption is by improving public sector wages, thus removing the incentives for people to steal.

More important, the government needs to implement judicial reform in order to improve the independence of prosecutors. At the same time, Mexico needs to improve its rule of law in order to boost foreign direct investment, FDI, and the scope of financial intermediation. These are two factors that help explain Mexico's persistent low GDP growth rate.

FDI in 2017 was US$29.7 billion. While it was more impressive than the pathetic US$5 billion that arrived in Argentina, it was about a third that flowed into Brazil. This was despite the fact that Brazil was in the midst of impeaching its president and undergoing one of the worst corruption scandals in its history.

Furthermore, judicial reform would help boost financial lending. Recovery rates in Mexico are abysmally low, helping to explain why interest rates are so high and why banks are so reluctant to lend.

Given that consumption represents almost 70 per cent of Mexican GDP, the lack of credit confirms why the GDP growth rate is little more than its 1.24 per cent population growth rate. Morena's majority in the two chambers of congress would provide it with a meaningful opportunity to implement judicial reform, thus allowing the country to truly combat corruption and boost GDP growth.

On the social front, AMLO is considering the decriminalisation of marijuana. Surprisingly, more than half of the revenues generated by the major drug cartels come from the trafficking of marijuana, and the new measure could help combat the high level of violence.

On the immigration front, AMLO really has nothing to do. Net immigration to the US has been negative for years. The lion's share of undocumented migrants seeking entry into the US is from Central America. At the same time, there is a good chance that AMLO will finalise trade negotiations with the US.

President Trump will most likely take a personal role in the closing process, burnishing his image as the "great negotiator". This is a script that he has used successfully with North Korea and the EU, and it will probably form the centrepiece of his re-election rhetoric where he will list all of the accomplishments of his first term in office.

If this is the case, AMLO will start off on the right foot. However, he will be very busy because he will have a lot of wood to chop.

- Dr Walter T. Molano is a managing partner and the head of research at BCP Securities LLC.

wmolano@bcpsecurities.com