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NO?97 I The Heritage Foundation 214 Massachusetts Avenue N.E. Washington, D.C. 20002-4999 (202) 546-4400 November 15,1990 PRIVA~TION IN MEXICO GOOD, BUT NOT ENOUGH INTRODUCIION Mexi co has undergone many positive changes since President Carlos Salinas de Gortari assumed office in December 19

88. A program of market-oriented reforms has been instituted, and the economy shows signs of improvement. Inflation has fallen from 159 percent in 1987 to 19.7 percent in 1989, and the rate of growth has risen to 2.9 percent. All in all, Salinas has generated new hope for Mexicos future and he has secured the public trust.

The most encouraging aspect of Salinass modernization program is its conce rn to reduce government participation in the economy and give the private sector a primary role in revitalizing growth. As a result, privatization of Mexicos huge state-owned sector has become a key factor in the governments approach to economic reform.

S alinastroika. President Miguel de la Madrid began a privatization program to alleviate-a mounting fiscal deficit and.to combat runaway inflation. Yet the impact of the program has been marginal. In contrast, Salinas has taken bold steps to privatize impor tant companies traditionally reserved for exclusive state ownership and control. In 1988, the government privatized the nations largest airline Mericana deAviacion In 1989, the telephone corporationTELMEX was put up for sale.

In May 1990, Salinas reprivati zed the state-run banking system and allowed private full (and partial) majority ownership of the eighteen national banks.The decree has since received congressional approval, and a new set of banking and finance regulations has been formalized. Salinass b old initiative was necessary to stimulate the financial system, bring back expatriate capital from abroad, and generate the confidence required to attract new foreign investment Note: Nothing written here is to be construed as necessarily reflecting the v i ews of The Heritage Foundation or as an attempt to aid or hinder the passage of any bill before Congress b The process of privatization in Mexico has not occurred in a vacuum. Many other reforms have been made to complement privatization and stimulate gro wth.

Trade liberalization has continued, and an aggressive program of dere gulation has been pursued notably in the truck and automobile industries, secondary petrochemicals, and agriculture. In addition, cumbersome restrictions limiting foreign investments have been lifted, and an open war against corruption has been waged Also , Salinas has decided to enter into formal negotiations with the United States to craft a free-trade agreement.These are all positive signs of a shift to a market economy.

Deeply in Debt. A host of difficulties remain, however.The country is deeply in debt , externally and internally.The foreign debt stands at $93 billion the second largest in Latin America.The domestic debt totals more than $65 billion, and its in terest payments alone absorb almost 80 percent of expenditures to service the debt. A substan t ial portion of budget costs are generated by the need to finance the losses of the so-called strategic and primary industries, such as electricity the Agricultural Supply Commodities Board (CONASUPO) and the railroad com pany. Mexico is in urgent need of direct investment, but it is doubtful it can attract long-term commitments and recapture flight capital abroad under the unstable conditions caused by debt sive reforms are required. Two factors have hurt recent privatization processes.

First, the governme nt has failed to implement the kind of institutional changes which successful privatization requires. The present juridical framework, for ex ample, stifles freedom of exchange and condones government interference in vir tually all sectors of economic lif e. Second, the government has yet to adopt the strategies needed to make privatization a lasting success. A spread the wealth ap proach of popular capitalism, while suited to Mexico, remains an unexplored pos sibility.

A far more reliable test of Salinass commitment to the free market lies less in his limited privatization programs than in whether he radically reforms the present system and allows private ownership of strategic and primary sectors. Among other top priorities are privatizing the ejih rural plots, as well as repealing the overly protectionist Foreign Investment Law enacted in 19

73. These changes would consolidate his acclaimed but as of now overrated image as a champion of economic freedom.

In essence, the privatization processes undertaken in Mexico thus far do not go far enough to eliminate the root causes of Mexicos crisis.The Salinas administra tion must make more systemic changes if it intends to reap the rewards of a suc cessful program of privatization. Salinas should Repeal the Fore i gn Investment Law. This would help to restore financial stability and attract new flows of foreign investment capital for newly trans ferred corporations to private owners. It would also ameliorate current problems by finding potential buyers willing to p u rchase and modernize ineffi cient state-owned enterprises with outdated equipment Salinas is conscious of the need to create a climate of confidence. More aggres 2 End the Pacto. A government-business-union pact of price controls has been in place since 1 9

87. It is impossible to assess real progress toward a free market until this freeze is lifted. Success in transferring companies from the public to the private sector is unlikely to omr in the absence of an uncon trolled market climate, based on the free interplay of supply and demand 4 Extend ownership to strategic and primary sectors. The privatization of huge and wasteful state monopolies is essential to preclude a resurgence of hy perinflation and to activate sustained economic recovery. The reprivat ization of the banks, astrategic sector, was a courageous and commendable decision.

It should be followed up by privatization of other important state enterprises oil, primary petrochemicals, electric power, railroads, and others Juridical reforms. Many ju ridical changes are needed to accelerate privatiza tion from local legislation to constitutional articles. A free and competitive at mosphere must be created for recent privatizations to work in stimulating growth 4 Popular Capitalism. The current strateg y of using privatization only as a method to rationalize the governments role in the economy should be replaced by a broader program aimed to supply the vast majority of Mexicans with a real opportunity to share the wealth.This will neutralize popular disc on tent with crony capitalism and unleash suppressed productive forces. It will also supply a popular alternative to introduce a sorely needed system of private property rights in areas like the agrarian sector.

The U.S. should pressure the Salinas adminis tration to deepen internal adjust ments. Also, it should stimulate awareness of the positive social and economic benefits of privatization and the market economy. This fundamental aspect of a sound policy of privatization is underplayed by the Mexican pro g rams current ap proach THE MEXICAN CRISIS AND BEYOND Few countries have experienced such pronounced decline in economic develop ment and standards of living in such a short time as the crisis suffered by Mexico in the past eighteen years. Prior to 1970, t h e nation enjoyed three decades of sus tained growth and stability.The economy averaged annual growth rates of 6 per cent. Also, per capita revenue and real wages rose at steady paces. Inflation was stable, and the peso was a respectable 12.5 to the U.S. d o llar ment assumed a self-appointed role of economic rector, and began to practice economic interventionism on a wide scale. This new shift in public policy was jus tified on the grounds that it would enable Mexico to attain national sovereignty economic i n dependence, and an equitable distribution of wealth The Results of Rectorship. In 1970, under Luis Echeverria, the Mexican govern The ensuing years witnessed a progressive growth of government intervention public spending rose, state-owned enterprises mul t iplied, and overall economic ac 3tivity became heavily regulated.To finance its many public programs, the govern ment borrowed heavily from abroad, and used monetary expansionism as a mechanism of growth. So far, the results of rectorship have been disast r ous: per capita revenue has fallen and real wages have lost 47 percent of their original pur chasing power since 1970.The inflation and devaluation rates since 1970 have been higher than the total accumulated rates in the preceding 150 years.Today the pes o averages a dismal 2,900 to the U.S. dollar.To boot, foreign debt skyrocketed from a manageable $4 billion to a staggering $107 billion.

Not surprisingly, the structural imbalances brought about by widespread inter vention in the economy squandered financ ial resources to wasteful ventures and destroyed confidence in the economy.This generated a massive flight of domestic capital.To date, esfimates indicate that more than $80 billion are deposited in overseas accounts economy. His practice of broad-based r e form reflects a commitment to reduce the size of government, curtail federal spending, and give the private sector the main burden in achieving stability without inflation. So far the evidence is positive this year inflation was expected to fall to 15 per c ent2 and growth to surpass the 3.5 percent mark. Further, the public deficit in 1989 was 63 of the gross domestic product 66.9 percent less than the projected deficit for that year, 43.7 percent less than in 1988, and a full ten points less than in 1987 a u thorities claim that privatization has played an important role in stabilizing the economy and that these encouraging signs are proof of a sustained effort to limit government intervention in the productive private process. Both claims are unwar ranted.Th e results obtained in revamping public finances owe less to structural change and state divestitures than to precarious short-term measures: the debt relief renegotiation reached in July 1989, an ensuing fall in domestic interest rates and fiscal revenues accrued from the 2 percent tax on corporate assets levied in January of .the same year.

The hard fact is that the main source of stabilization experienced in Mexico con tinues to be the economic regime of price and exchange controls first imposed in Decemb er 1987 under the name Economic Solidarity Pact.This freeze in wages and prices was renewed in 1988 at the outset of Salinass presidency, under the new heading of Pact of Stability and Economic Growth.Thus far the expiration dates on this New Pact have be e n extended on three occasions.The most recent Rectorship Redefined? Salinas inherited a weakened and impoverished There are reasons, however, to view these figures with skepticism. Public 1 This figure is taken from a 1988 study by Morgan Guaranty Trust C o . Recently, at a public address in Mexico City MIT economist Rudger Dornbusch estimated that overseas accounts could be as high as $200 billion. However, the estimate of $80 billion is widely regarded as more credible 2 This goal will not be met.The infla t ion rate reached 21 percent in September. Now, new estimates for the annual rate range from 235 percent to 30 percent. Analysts concur that this implies yet another postponement of the Pact of price controls, especially in view of the upwming congressiona l elections in mid-1991 4one, in June of this year, strongly suggests the critics worst fears: if the controls were lifted, inflation would shoot up, and the peso could devalue by as much as 20 percent. To suppress inflation fails to offer more than artifi cial temporary relief, It can also prove devastating in the short run Salinas should strive to slash the federal budget far more than he has done so far.The public sector continues to be an overwhelming burden on the national economy.

Its share of the total external debt is over 75 percent. Public expendi tures as a percentage of the GDP, fell from 17.7 in 1988 to 16.8 in 19

89. Mexico must beware of the precedents set by Brazil under the Plan Cruzado and Argen tina under the Plan Austral, where failure to adopt strict disciplinary measures in fiscal policy occasioned a resurgence of hyperinflation and stagnation PARADOXES OF MEXICAN PRIVATIZATION An ideal step would be to extend privatization targets to the primary parastatal state-owned) enterprises that absorb massive federal subsidies. In general, the large-scale privatization of Mexicos inefficient and wasteful public areas repre sents a good opportunity to divest unprofitable concerns, alleviate foreign and domestic debt burdens, channel new investmen ts, and bring back a sizeable por tion of domestic flight capital.This would enable Salinas to meet the goals set in the National Development Plan, as well as the broader objective to modernize the economy.

In essence, a sound pro gram of privatization combines three fundamental fea tures into a single process: 1) a negative problem-solving adjustment in current economic imbalances; 2) a positive growth-based shift to a consumer-dominated economy; and 3) a non-abrupt transitional p eriod of structural change. Unfor tunately, government officials do not understand that privatization must be part of an ongoing political process before it can generate economic progress.

Awkward Approach. This failing is no more obvious than in the origi nal purpose of the program to disincorporate parastate entities initiated under Miguel de la Madrid.The program was officially drawn up as part of the conditions imposed by the World Bank, the International Monetary Fund, and other creditor institu tions, in exchange for substantial debt relief.Two crucial flaws impeded demonstrable success. The main objective was confined to introduce more ef ficiency in the public sector and rationalize government interference in the macroeconomic scene. However, this di d not imply a shift away from central planning and towards a market-based system. Consequently, disincorporation was limited to small parastatid companies (many of which existed only on paper).

The main monopolies were left completely untouched.

The Mexican Ministry of Budget and Programming reports that vast numbers of parastatals have been disincorporated: from 1,155 in 1982 to 377 by the end of 19

89. An official reduction to 250 entities is planned by 1994.This is expected to bring further removal of state participation from four of the thirteen economic sec 5tors now operating under the governments control.The future goal is to retain partial or complete control in nine areas.

The wide array of divested sectors include airport and airline services, c offee and sugar, mines and steel mills, fishing and forestry, truck and auto parts manufac turing, tourism and hotel services, cement industries, urban transport, and stock exchange houses. A large number of smaller areas (eg refreshments and private mail ) have also been freed from direct state control. In 1989,49 cases of disincor poration were concluded, which reportedly generated substantial savings. The Min istry scheduled an ambitious agenda for 19

90. It expected to finalize the sale of CANANEA, a hu ge and highly inefficient mining enterprise, along with two other mines,TELMEX ahd ASEMEX Unimpressive Numbers. These results are significant in comparison to previous years. However, behind the official numbers lie less than impressive accomplish ments.T h e persistent policy of insulating the strategic industries from private ownership has been costly and counterproductive.They represent the vast bulk of Mexicos parastatal sector.The 778 divested companies account for less than 15 percent of government ass e ts (excludingTELMEX, the steel mills and the banks whose sale remains to be finalized).The remaining portion is almost entirely ex hausted by strategic state-owned monopolies.These are meager in number and yet operate at astronomical losses, thus requirin g constant federal funding. In 1989 they were responsible for 91.6 percent of the public sector deficit.The parastatal deficit for the same year was reported at approximately $175 million.The agricul tural supply monopoly, CONASUPO, and the Federal Electri c ity Commission cur rently finance up to 55 percent of their annual expenses with government transfer subsidies. Other money losing enterprises include the steel parastatal SICARTSA, the fertilizer parastatal, FERTIMEX, the railroad FERRONALES in addition to many small enterprises which form part of the bureaucratic machine.

Not surprisingly, the savings obtained by Mexicos privatization program are less than impressive: an approximate $1.5 billion during an eight-year period. This is negligible compared to the $700 million in subsidies needed to finance the losses of the remaining state-managed companies in the first quarter of last year alone.

The five gigantic parastatal companies listed above absorbed 92 percent of the total sum of government transfers assigned .to the parastatal sector.

The matter has turned from bad to worse in 19

90. So far government transfers for the first six months of the year have surpassed the $1.6 billion mark.This repre sents an increase of 9.2 percent in relation to 19

89. Some 94 percent of the as signed resources were absorbed by five entities alone: CONASUPO and the Federal Electricity Commission, FERTIMEX, FERRONALES and the Mexican Social Security Institute, IMSS. Further, the government projects that $2.2 billion wil l be required to service the outstanding debts of all the aforementioned com panies.

Disincorporation vs. Privatization. This finding reflects the misplaced basis of disincorporation. Privatization is really just a special case of disincorporation.

The official description of the term is: to restructure and rationalize inefficient 6 parastatal entities by means of four different techniques: 1) the sale of parasta tals to the private or social sectors; 2) their transference to state or local govern m ents; 3) extinction or liquidation of bankrupt entities; 4) the fusion of two or more state organisms?

Falling Short. Here privatization figures only as an option. A process of disincor poration need not coincide with the goals of privatization. In fact, t hese techniques often fail to meet the criteria of genuine cases of privatization: transference of as sets and managerial control from the public to the private sector.This is even true of sales to private owners, where transactions sometimes involve spec i al corporate privileges and conditions which compromise competitive economic activity. For in stance, under the transference approach, inefficient enterprises are restructured into smaller ventures run at the local level. But this does not imply an end to politi cal control, nor does it correct the problem of underperformance.Thus, these tech niques fall short of privatization.

The practice of liquidation (the most commonly utilized method of privatiza tion) has also shown some significant shortcomings in disincorporating important public entities. Mexicos government recently announced the liquidation of the primary sugar-processing parastatal AZUCAR SA, along with several affiliate farms known as hgenkx. The decision was prom ted in part by the prevailing em barrassing inefficiency of Mexicos sugar sector. Yet it plans to form a new com pany with the capital remains of sugar farms, where it will retain majority share holding.The same procedure has been set forTABAMEX and IMECAFE: state managed regulatory b odies will be instituted with the proceeds obtained from ex tant productive units. In both cases the form has changed, but the substance remains intact.

Officials assert that this approach is necessary to fo, the role of these and other agricultural compan ies in servicing the needs of the rural classes.The phrase fortify, not privatize has become a standard motto used by public authorities to describe the reorganization of these state entities. Yet, it reflects a common failure to appreciate the fact that privatization constitutes the best means to truly fortifjl economic performance.

CONASUPO. In October of 1989 the government expressed its intention to restructure the agricultural supply monopoly, CONASUPO, as part of a general program to modernize the vast and chronically underdeveloped agricultural sector.

The decision has been interpreted as an attempt to privatize the company, and hailed for that reason in international circles 3 See Oscar Verra Ferrer, La Privatizacion en Mexico: Causas y Alcanzes, i n priwtizaciOn: El Inevifable Sendetv del Gigcurre Decrecienfe (Mexico D.F Centro de Estudios en Economia y Educauon, 1988 pp. 109-113 4 Mexico has the potential to be a leading sugar exporter, yet the government was forced to hprt 800,OOO tons of raw sug a r in 1989 in order to meet domestic demand.This figure is expected to rise to l,ooO,ooO tons in 1990 7 9 CONASUP0 should be privatized. Its dismal financial record and perpetual lack of performance make it the state-owned entity that consumes the most of t he state budget. Its total expenditures in 1989 exceeded $2 billion. For every peso it spent the company required 53 cents in the form of transfer subsidies Dubious Rationale. The government unveiled a broad-based program to eliminate generalized subsidie s for CONASUPO and to restrict them to the neediest areas.To meet this objective it planned to sell 163 storage facilities auction off 589 super-markets and nine food-processing plants, and shut down operations in higher-bracket zones. The plan also stipul a ted fued reductions in the commercialization of basic foodstuffs, from ten to two. But behind this plan lies a dubious rationale: to reduce the companys participation in urban sectors in order to fortiv and expand it in rural sectors. Once again, the subs tance chan ges, but the form remains the same.

In effect, the government has not expressed its intention to privatize and relin quish managerial control of CONASUPO. Nor does it contemplate substituting the collectivist agricultural system with a market sy stem. Evidence corroborates this finding: projected outlays of CONASUPO for 1990 are 43 percent higher than last year; for every peso it expects to spend it will require estimated federal trans fers in excess of 60 cents. In the first half of this year it has already absorbed sub sidies in excess of $800 million.The figure is 44 percent higher than the amount as signed in the first half of 1989 and constitutes over 50 percent of all transfer sub sidies assigned to the state sector for the first six months of 1990.

Mexicos program of disincorporation falls short of being a free market-based program of privatization. According to Oscar Vena Ferrer, a leading specialist in privatization, the fundamental problem is that disincorporation lacks a well defined con ceptual sche e to orient it and to replace the current model of centralized rectorship Y METHODS OF DISINCORPORATION The Mexican Ministry of Treasury and Public Finance has released figures which indicate that from December 1982 to December 1989 more than 800 state owned companies were authorized for disincorporation. Thirty percent of them are scheduled to undergo the process. The liquidation approach has been the method most used but also the one which exhibits the slowest rate of change: 34 percent of t he authorized total of 292 remain in process.

Information Issues. The four techniques of disincorporation liquidation, ex tinction, fusion, and transference are comparatively easy to monitor. However sales are far harder to assess. No detailed official inf ormation is released by the government prior to many sales, and the information that is made available is 5 Ferrer, op. cif p. 142 (translation by Roberto Salinas 8 often contradictory and presented in confusing terms. This has been a major prob lem in th e past, which still remains to be corrected.

The most prominent recent sales include the National Hotelem hotel chain, the copper mining establishment MeriCMa de Cobre, the two airlines Areomexico and MericmU, in addition to many small chemical, textile an d agricultural concern. A highly publicized sale in 1989 was Diesel Navastar, a large truck manufacturer.

The fact remains, however, that a great majority of transactions have been con ducted with too much secrecy.This has hurt the credibility of the meth od of disin corporation, which is the most representative of all privatization methods. It has also tainted the popular image of privatization as crony capitalism.

A case typical of this harmful trend occurred in August 1989, when the sale of 23 entities was reported in the news media based on information supplied by govern ment agencies. Only 15 of these 23 enterprises had been authorized for sale.The remaining one-third were not known to be the property of government.The specific terms of sale and the a c tual prices at which companies were obtained were also unavailable to the public. To boot, many transactions took place in a clandes tine form. More generally, there are numerous cases where the specific conditions under which particular private bidders p u rchased an authorized company are completely unknown.These include Ceday LmiMb (a cement block factory Avmtmm MexiCana (a wools manufacturer Nueva NaciOnal Tertii Manufactutera del Salt0 (a textiles concern and hductm Quihakm e Indrcstriales del Bajio (an industrial deodorant and insecticide complex disincorporated. The government has released data which seem to suggest a notable improvement in reducing the burden of parastatal expenditures on the federal budget.The public sector deficit (as a percentage o f the GDP) has fallen from 113 percent in 1988 to 6.3 percent in 1989.This, however, has not been the result of cuts in federal expenditures, but of a substantial amplification of the fiscal base through increased tax revenues. Still, expected outlays for 1990 (which in clude debt-sewicing payments) are lower than outlays in previous years. Also transfer payments have declined over the past three years.

A study released by the Instituto Tentologico Autonomo de M.0 (ITAM the leading technocrat institution in the country and the national analogue of MIT, af firms that, with the exception of ELMEX and the two airlines, privatization has had a mild impact in healing public finances. The budget transfers have yet to diminish in substantial amounts.The study poin ts out that only small firms have been privatized, which have not been an excessive burden on the federal budget 6 Thus, the ITAM study concludes that little has been done to solve the problem.

Naturally, part of the problem is that major programmed divestitures have not yet begun.The government expects to raise more than $20 billion from the sales of Assessments. Opinions diverge on how many state-owned enterprises have been 6 The study is reported El Unived, October l2,1989, p 43. It was released prior to the sale of the banks 9 TELEMEX, all eighteen banks, CANANEA copper mine, the vast steel holdings and other minor enterprises.The financial impact of this is positive, but will not be felt in the near term.

F or instance, the government has set a price of 6 billion for the sale of TEL MEX. It is seeking investors willing to inject $4 billion, which together with projected earnings for the next four years will yield the estimated sum of $10 bil lion needed to m o dernize the company by 1994.The process of selling the firm began in August of this year.The final set of buyers is scheduled to be formally an nounced in December. According to Jacques Rogozinski, head of the Office for Privatization, potential bidders i n clude four national groups and six international ones among them Grupo Alfa and Desc, U.S. West and Southwestern Bell, and Telefonia Espanola. Yet Banco Intemacional, the institution charged with the sale and divestiture of TELMEX, has reported that the p r ocess may be postponed until mid-1991, owing to lengthy and cumbersome auditing procedures to deter mine the value of its assets. Similarly, plans exist to disincorporate important com panies like FERTIMEX, SICARTSA, and ASEMEX, but this has not happened.

Future progress remains to be seen. However, there is reason to be optimistic An important series of steps have already been taken. Yet, it would be wrong to conclude that all is well. An examination of the aims and claims of Mexicos privatization program reveals certain shortcomings which strongly suggest that it must undergo some fundamental changes in order to afford notable and lasting benefits MEXICAN PRIVATIZATION IN PERSPECTIVE Unfulfilled Criteria. The Center for Privatization in Washington D.C. i d entifies four factors that must be present in any feasible program of privatization7 1) A firm commitment by the host government 2) Reasonably priced enterprises with short-term profit potential 3) A spread the wealth approach to broaden equity ownership 4) A creative strategy to quell internal discontent with privatization.

At present, none of the outlined criteria are fully met by Mexicos privatization program.The conditions obviously overlap. For example, failure to satisfy the last two criteria casts d oubt on a genuine commitment to privatization 7 See Peter Young, The Enterprise Impemtive (London: The Adam Smith Institute, lW p. 13 10 A fifth prerequisite should be added as well. In Mexico, privatization represents the tip of the iceberg in the struct u ral change required to produce a healthy and satisfy the basic criterion for a successful privitization program I I growing economy. Here too, despite recent achievements, the program has yet to Pragmatic Liberalism. Arturo Damm Amal, Professor of Economi c s at the Panamericana University, characterizes the Salinas administrations approach to privatization as a case of pragmatic liberalism; it has a sufficient degree of liberalization to attract new investment capital and prevent internal collapse, but insu f ficient to infer a principled commitment to a fre -market and the structural transformations which the shift to the latter implies. Damm Arnal states that a set of difficult steps must be taken for the governments program of internal reform to succeed The y are to: 1) extend privatization to sectors legally restricted to the exclusive management of the state, such as the petrol, electricity and railroad industries; 2 repeal articles 27 and 28 of the Mexican Constitution, which detail criteria for strategic a nd primary sectors and prohibit any form of private ownership of them. On the one hand, it seems clear that Salinas is simply not willing to go this far. In his first Presidential Address in November 1989 he stated that state owner ship of strategic secto rs, including PEMEX, CONASUPO, FERRONALES and electricity, are irreversible. On other occasions he has described these same sec tors as untouchable, citing both constitutional articles 27 and 28 in support of his decision.

On the other hand, there are important indications that this trend might change.

The decree to reprivatize the banks required congressional and senatorial ap proval to amend article 28 and thereby restore the constitutional text to its original, pre-1982 form.This initiative was essentia l to supply legal credibility to the presidential decision and set a positive precedent for future possible changes.

In the process of ratification Salinas was able to form a coalition between mem bers of the PRI and the moderate right-wing party PAN.Ther e was minor quib bling about the details of reprivatizing the banks, but approval came without any significant political mishap 8 I It would be wrong to suggest that the sale of other strategic concerns are next.

Nevertheless, the possibility of joint ven tures in oil and electricity are currently being considered.The Federal Electricity Commission is the second leading money-losing parastatal, behind CONASUPO. It absorbs massive amounts of state transfer payrllents and suffers a significant lack of produc t ive investment. In the first six months of 1990, the electricity commission required federal transfers in excess of $290 million, which is 20.3 percent higher than the subsidies con sumed in 1989 for the same time. Similady, bureaucratic obstacles plus co n tinued mismanagement have been responsible for sharp declines in the productive invest ment of PEMEX, the petroleum enterprise. For example, investment in 8 Personal interview With Arturo Damm Amal 11 r c petrochemical exploration and exploitation has dec r eased 75 percent during the last eight years. For every dollar obtained through all petrol-related sales, only 0.03 cents is destined towards technological investigation, innovation, and im provement. Thus, though PEMEX is one of the ten most important oi l companies in the world, it has suffered a constant decline in productivity: from 3 million bar rels per day in 1982 to 2.5 million in 1989.The Mexican Petrol Institute claims that PEMEX requires $4 billion in new investments for upkeep and modernization.

Without it, Mexico might become a net importer of crude by the middle of the next decade These factors have persuaded the Salinas administration to pursue the pos sibility of joint ventures in oil and electricity with domestic and foreign private in vesto rs, despite the substantial political risk involved. So far offers for invest ment in the oil sector have been extended to Alfa, Qdsa, Mitsubishi, Dow Chemi cal, and Shell and Exxon.This is good. It is a far cry from privatization, but the ab sence of pri v ate ownership and voting power does not necessarily imply that this form of joint venture represents a fund-raising gimmick masked as authentic economic reform. On the contrary, the advent of private participation in these sen sitive areas could function a s a prelude to future privatization. Nonetheless, the motivation is clearly and purely pragmatic, arising out of the financial need to channel productive investments in these sectors Legal and Economic Restrictions. In general, then, it is uncertain wheth e r Salinass government has demonstrated a full and firm commitment to privatiza tion. An examination of primary achievements in this field seems to supports this conclusion. The two most talked about cases of disincorporation in 1989, Mexicana and TELMEX, c ontain crucial legal and economic restrictions on ownership and entrepreneurial direction. In the former case the government has retained 40 per cent equity which it intends to sell to a consortium of investors called Grupo Fal con, once the pre-set three -year trial period of capitalization of $500 million ex pires. Yet the government has also reserved rights to keep its partial ownership jn the event that it considers it necessary.This arrangement is less than expected from genuine privatization.

An equal ly questionable arrangement afflicts the privatization of TELMEX. The company is in dire need of restructuring. It is one of the most inefficient yet most expensive telephone companies in the world. Demand is overwhelming and supply is scarce.TELMEX is no w unable to service almost two million applications for new telephones. Twenty-year waits for telephones have been reported. There is one telephone for every 10,OOO people and Over 10,OOO villages have no phone sys tem at all. Some $10 billion in capital i nvestment will be needed to modernize the national telephone service.

Nevertheless, under the terms of disincorporation, the government will retain 25 percent equity and entrepreneurial control of the company. Also, external owner ship is limited to 49 percent and new investors will only hold non-voting shares.

The arrangement also contains a disturbing and very ambiguous juridical clause which re-affirms the governments role as rector over nornativity of the telecommunications sector. This proviso was all egedly introduced to guarantee 12 the contracts of the companys 50,OOO employees (it has a bloated average of 12 workers per 1,OOO lines; Bell Atlantic has approximately 4 to 5 per the same num ber). However, it can be easily be interpreted in many ways, one under which the government retains effective and complete control of the company.This is not en couraging.

These two instances of partial privatization underscore free-market advocate Edgard Masons harsh but poignant accusation that the current policy of disincor poration is merely seeking to privatize without privatizing -that is, to reap the rich financial and capital-gathering rewards which normally accompany the sale of wasteful public concerns without surrendering control of the enterprises. This strategy of financial pragmatism is detrimental to the free-market goals of real privatization. It is also apt to discourage several potential investors.

Selling the Banks. The presidential initiative to sell the banks is probably the most welcome economic reform made by the Salinas administration so far.The ad vent of a free - trade agreement with the U.S the need for a constant flow of in vestments, and the parallel need to lure flight capital back home, convinced authorities to return the banks to the private sector. The immediate-run impact of the announcement has been extremely positive: an estimated return of almost $3 billion in domesgc capital, and the inflow of $5 billion in fresh foreign invest ments, for 1990.

Unfortunat ely, an evaluation of the structure and terms of sale of the eighteen banks reveals that the initiative is yet another disappointing case of quasi-privatiza tion. A new block of bank and financial legislation was enacted in June 1990 to regulate the proce s s of selling the banks and their future behavior within the na tional financial system. Nevertheless, the legislation contains severe restrictions on the nature of ownership and distribution of assets, which buyers and analysts feel is bound to delay the privatization of the banks. The principal problem, as usual, is that the regulations enable government to retain rectorship and roundabout con trol of assets and administrative decision-making.

The structure of TELMEXs equity will be partitioned. A series of stocks (so called A-type) will be sold exclusively to Mexican persons or groups through an auction system; it will represent 51 percent of ownership and define control of the bank. Another series of stocks (type B) with a limit of 49 percent will be so l d through the stock-market; their acquisition is open to the controlling owners, but not to foreigners. Finally, a C-type series will be sold in international markets and are exclusive for foreign investors 9 A corollary benefit of privatizing the banks w a s that it repaired the obvious anomaly that, Owing to continued expansion in commercial trade, future private banks auld operate in Mexia.These banks would be owned by foreigners, whereas domestic ownership would remain prohibited. Further, it also corred e d the related anomaly that Mexicans could be free to pursue minority stock ownership in banks abroad, but not in their own home land 13 I The government intends to sell A-type stock to national financial institutions and stock-brokerage houses, who will b e able to control 100 percent equity.The rules state that the sale of C-type stock is optional, depending on the discretion of the controlling group. Moreover, a maximum limit of 5 percent has been placed on individual equity ownership.The penalty for exce e ding the limit is tremendous compulsory sale of equity back to the bank, at half the price, with revenues to be collected by government.The latter will also exercise discretionary power over board appointments in the form of a veto power In essence, the n e w bank legislation and the terms for the reprivatization of the banks contain five drawbacks, most of which originate from the governments's un willingness to relinquish de jure control of the national banks. They are 1) The terms of sale contain a judici a l clause similar in letter and spirit to the one inTELMEX's terms of sale ,which states that the government will retain ret torship over normative behavior of the banks In fact, the banks are being "con cessioned" back to the public according to article 2 8 of the Constitution. There is no reliable guarantee of property ownership under these conditions of "rector ship 2) The legislation is exceedingly restrictive. Individual investors must tolerate a 5 percent limit on stock ownership with no voting rights a nd government control over managerial decisions Also, they must cope with bureaucratic discretion over their commercial association with other investors. It is bound to scare many inter ested buyers away because the discretionary power of authorities may i nterpret two investors with a business association as officially "one thereby having formal grounds to expropriate their assets and impose a penalty. The legal ambiguity of this rule, and the possibility of arbitrariness, compromise the goal of a genuine c ase of bank reprivatization ly harsh. Pedro Ape, the Minister of Finance, has categorically denied any foreseeable revision on the 30 percent limit, claiming that enough capital exists in the domestic private sector" to purchase remaining majority percent a ges. None theless, spokesmen for interested foreign banks have stated that in the absence of a modification in the new legislation to allow more than 5 percent individual ownership and more than minority participation, the inflow of foreign capital is ver y unlikely. Representatives of Morgan GuarantyTrust, Bank of America and Rothschilds Co. concur that more realistic rules are required to achieve an inter nationally respectable financial system.The measure to sell the banks is welcome but the process of d i vestiture betrays the spirit of privatization in its failure to in spire ownership confidence and attract much-needed investment 4) The government will not surrender all control over the national bank system First, it intends to continue its role in so-ca l led "development banks eg Nacional Financiera and "regional banks eg BANRURAL and BANPESCA These institutions finance "primary" projects in industrial and rural sectors of the economy.They total more than fifty altogether. None has been authorized for pri v atization, despite their prevailing and notorious inefficiency. Second, the 3) The legislative restrictions on foreign investment and ownership are illogical 14 3 government seeks to fashion a financial system of mixed participation and does not plan to s e ll all 100 percent of the banks. In fact, authorities have revealed that it intends to retain majority ownership in the countys three largest banks BANAMEX, BANCOMER and SERFIN) to prevent preferential practices and avoid the concentration of financial po w er. These two factors suggest that the reprivatization of the banks is, once again, a case of partial privatization 5) The new legislation does not foster a competitive banking system. Only new regional banks can be established. Also, the regulations proh i bit competition by foreign banks.They may set up offices to undertake international operations but they will be unable to practice standard banking activities. This set of serious failings suggests a lack of commitment to rid the state of public companies . To privatize, one must privatize completely Pricing Problems. Another serious problem blocking efforts to enlarge the pro gram of disincorporation is a lack of commercial interest in the enterprises put up for sale. The Salinas government has been able to privatize one of 70 parastatal companies put up for sale in the first year of its administration the 25 percent sale of Mexicana equity to the Falcon consortium. And it has only finalized the sale of 35 out of 88 scheduled companies. All of these were sma ll entities, averag ing a price of $10.6 million each.

The reported reasons for this failing are twofold 1) the economic inviability of state companies, and 2) their status as underdeveloped entities with highly ob solete equipment. FERTIMEX, the fertilize r company, though a prime target for privatization and huge in size, falls in both categories. It suffers salient technologi cal backwardness and is a leading recipient of state subsidies. In the first half of 1990 it consumed more than $160 million of fe deral funds.This is 39.4 percent higher than the transfers assigned during the same period in 1989.Thus, the com pany lacks short-term attraction for investors.This pushes prices of such entities downward.

The lack of profit potential hinders efforts to disincorporate public sector com panies. A characteristic example is the complicated sale of CANANEA, Mexicos largest copper mining concern. It was nationalized in 19

82. It was put back on the auction block in 19

88. All attempts to sell the firm failed u ntil August of this year. It has been recently acquired by copper magnate Jorge Larrea, amid public charges of favoritism, obscurity, and rent-seeking ficient and uncompetitive (the costs of production for one pound of copper is 90 cents, 30 percent highe r than standard international costs The company has also suffered acute labor unrest. In August of 1989 Salinas declared it bankrupt.Two months later the mine was reopened with half of the original staff. It remained on the selling block for nine months wi t h no firm offers in sight.The purchase price was reset at approximately $400 million, 50 percent less than what the government sought to sell it for in 1988.The companys bleak financial prospects and its highly turbulent labor history discouraged several i nterested buyers, some of which The problems in selling CANANEA were almost inevitable. It is extremely inef 15 i claimed that the government should have paid investors to take over the mine. It was finally sold for $475 million, after lengthy and complex pricing procedures Major Problems. Two salient cases of poor profit potential are SICARTSA and AHMSA, the state-owned steel holdings.The disincorporation of both entities presents problems of major proportions. Each company requires enormous sums of capit a l investment in equipment and modernization. For example the construc tion of new steel industries requires an estimated sum of $100 million to $200 mil lion. Yet, the capital required by SICAREA alone is twentyfold. Furthermore both parastatals are leadi n g recipients of government transfers. Not surprisingly no immediate investor interest has followed the announcement of the disincor poration of SICAREA and AHMSA An attractive but underplayed.option to lure new buyers and increase the demand for state-run concerns is debt-for-equity swaps MexiCana de Cob once an inefficient copper mine, was privatized in 1986 through a swap involving $1.36 billion in foreign debt in exchange for equity in the amount of $680 million. A debt-equity swap is contemplated for t h e terms of sale of the steel mills. Swap operations were suspended in late 1987, but recently reinstated in April of this year.They constitute an effective twl to remedy the pressing lack of interest in Mexican state companies. More leniency in foreign in vestment regulations would function as an ideal complement.

The principal difficulty in price and valuation mechanisms is the system of price and exchange controls. It is impossible to determine the fixed market value of cur rent candidates for privatizati on without a price system based on the free interplay of supply and demand.The liberalization of wages and prices is indispensable to accelerate the sale of unproductive enterprises. Similarly, market-set exchange rates would open access to foreign credit , making long-term investment more plausible. gram are amateurish and counterproductive by most international standards.

There is a substantial lack of awareness of the "social" value of privatization and the opportunity it brings to widen equity ownership via techniques designed to democratize national wealth. On the contrary, privatization is perceived by some Mexicans as anti-revolutionary capitalist exploitation.

There is some basis to these accusations.The secrecy and absence of open infor mation whic h have characterized numerous transactions has damaged the reputa tion of privatization. A sony precedent was set in the 1987 sale of minority shareholdings in BANCOMER and BANAMEX, the two largest nationalized banks. Equity shares were sold to a privileg ed clientele with close political ties to Crony Capitalism. The methods of privatization employed in the Mexican pro 16 government agencies at undervalued rices. Those people thereafter made enor mous profits in stock-market trading.

The precedent has not been reversed. For example, with the sale of Mexicana shares, serious misgivings were expressed in the Mexican news media about the governments unwillingness to disclose concrete information about the bidders who competed against the Falcon Group for 25 p ercent ownership of Mexicana.

The implicit message is that political patronage again played a role in the selection process. More recently, the sale of CANANEA was marred by accusations of cronyism, preferential treatment, and widespread obscurity in proce ss of acquisi tion In June 1990 the company was awarded to the industrial group ICA. A month later the decision was declared null and void and a new date for auctioning was set. In August the company was awarded to Jorge Larrea on the basis of a better of f er 7 million more in cash plus a guarantee to invest $300 million in the mines productive infrastructure. In the meantime, another offer was issued by SIN TEMEX group, for $600 million. Yet, the offer was ruled out.The reasons remain unclear, but the pres i ding judge claimed the offer was extemporaneous.This has provoked charges of obscure negotiations and political favoritism from spokes men for ICA and SINTEMEX. Larrea reportedly has close ties with the govern ment. He now controls 95 percent of copper pr oduction in Mexico and 5 percent worldwide.The critics contend this is no coincidence.

The similar lack of information in the sales of several small enterprises has meant the irreversible loss of a good opportunity to give privatization a positive image fr om the outset of the program. However, after seven years of flawed anti democratic strategies, it is harder to form a popular consensus in support of methods such as employee buyouts and individual stock-offerings. Many critics construe these options as e mbellished descriptions of methods designed to enrich powerful labor leaders and corporate cronies, and hence to keep the wealth only for the few.

Nevertheless, a spread-the-wealth approach of popular capitalism remains avail able . It has been successfully used and marketed in Chile. In Mexico it could prove beneficial to the vast majority of underprivileged citizens, enabling family mem bers to become rightful owners of their property. It is also a strategy that would short-circu i t the long entrenched hostility to foreign influence and corporate ex ploitation. the wealth is the extraordinarily backward agrarian sector. It has become stand ard practice to describe it as chaotic. Food productivity suffered a sharp fall of 66 percent in 19

89. Corn and bean production fell 87 percent and 72 percent Po An ideal place to test popular capitalism and give many an opportunity to share 10 See Young, Privatization in Mexico: Robust Rhetoric, Anemic Reality, Heritage Foundation Buc&punder No 611, October 22,1987, p. 6 11 See, for example, Luis Gdo Bemas editorial Winera de Cananea, Uno Mar Uno, July 13,1990 17 1 respectively. Misery is pervasive: 90 percent of the estimated 3.4 million rural peasants earn a salary below the minimum wage, a da i ly income of less than $4.00 Widespread poverty and unproductivity are the principal causes of the huge flow of illegal immigration into the U.S. and of the massive flow of rural people into urban centers, notably in Mexico City. The fundamental blame bel o ngs to the col lectivist system of agrarian reform, which has prevailed for more than 70 years This system has destroyed the foundationof a thriving rural economy: private property rights. It has redistributed six times the amount of arable land in Mexico .

The ej& farm terrains cannot be bought or sold.They total 26,OOO and must be shared by millions of native farmers.The lack of juridical security in property titles has signified social and economic chaos. It has also produced an excessive depend ence on food imports. In 1988 the government spent $3.5 billion on imported food.

This staggering amount will grow to $4.5 billion in 1990 A good way to resolve the problem would be to privatize the ejih plots and to extend private ownership titles to the peasant community. A well-designed plan would accomplish two ends in one step: it would unleash much needed productive initiative and give many farmers a priceless opportunity to own and farm land as they saw fit.The great majority of them would surely welcome t h is change with en thusiasm This illustrates how privatization can generate social well-being. Unfortunately the policy of using land reform for political rather than economic purposes has clouded the judgment of public officials opposed to rural privatiza t ion.The private sector has exerted much pressure on the Salinas administration to implement these policies in the agricultural economy, but so far to no avail. Internal political forces remain deeply opposed to market-oriented reforms Unpopular Capitalism . Many political obstacles to privatization have under mined the progress of the Mexican program.This problem reflects a lack of crea tive strategies to appease popular discontent with privatization. Salinas has defended the current program by stressing th a t divesting money-losing enterprises will enable the state to channel financial resources to enlarging basic services like health, housing and education.This is laudable but unlikely to gain immediate popular support. More effective options, like stock-em ployee ownership plans are being considered for the sale of small parastatals. However, they have yet to receive the attention they deserve.

The present approach to privatization is not well-founded. It has to be revised to guarantee long-term success. The social value of privatization has been greatly un derestimated. This has produced uncreative and clumsy policies which have done more harm than good. The lack of popular strategies structured to spread the wealth reflects an unduly narrow concern on the n eed to eliminate pressing finan cial problems, whatever the consequences.The source of this no other way ap proach has been aptly described by analyst Raul Conde The policy of disincorporation constitutes a pragmatic solution to financial pressures, rathe r than an effort to democratize the property of state-run entities and 18 liberalize the market.The owners change, but the economic policies remain the same.n Partial Support. The success of privatization in other regions of the world owes much to the conv i ction that prosperity and economic well-being requires a system of private ownership and free competition. Thus, well-defined goals and principles have accompanied privatization programs in order to ensure their success. An es sential component of these p r ograms has been to supplement privatization with yet other market-oriented changes. In this way, newly privatized companies can function amid a competitive atmosphere free of excessive legislative restrictions ful privatization.The deregulation efforts ha v e not been sufficient to rid the economy of forces hostile to both privatization and a competitive market.The foreign investment revisions of May 1989 are a good example.The 1973 Foreign Investment Law places a 49 percent restriction on foreign stock owne r ship. The new procedures permit 100 percent ownership in certain nonstrategic areas of the economy, notably tourism. They also allow minority ownership in the secondary petrochemical industry. This represents a step forward, but it is not enough. The rece n tly programmed sales of AHMSA and SICARTSA are unlikely to occur without foreign participation in view of the vast amounts of fresh capital required to modernize the two steel mills.The same applies to FERTIMEX, the fertilizer concern. However, these area s fall under the rubric of strategic, where foreign ownership is prohibited by law. Without further modifications in foreign invest ment legislation, scheduled privatizations will fail to attract the interest of foreign investors.

Sound privatization procedures presuppose a mature and safe financial market.

In Mexico, progress in this area has been impeded by wasteful spending practices and eight years of a government-owned banking system.The announced privatiza tion of the banks has helped to restore a cl imate of confidence. Now, the challenge is to accelerate their sales to strengthen and perpetuate confidence, and to bring spending practices under strict control.This is needed to recapture flight capital deposited in overseas accounts, safe from inflati on and expropriation, and thereby to ease future privatization efforts by luring would-be investors to invest in projects at home.

Many critics complain that the disincorporation program merely succeeds in shifting unwanted monopolies from public to privat e hands. This harbors some truth. A proper climate of free competition must exist to avoid private monopo lies and stimulate sustained commercial growth. Much progress has been made in economic liberalization, particularly in trade. However, Mexico remain s a long way from becoming a free and competitive economy. This has blocked the free market goals of privatization as well as specific attempts to sell important state run companies, such STELMEX and CANAN The Mexican program has failed to heed this fundam e ntal ingredient of success 12 See his oped article De Monopolio F+ubliw a Monopolio Privado? V,ll in Novedodes, November 10.1989 19 A recent embarrassing case was the unsuccessful attempt to sell PIPSA, the government newsprint monopoly in October of last year. Salinas offered national newspaper publishers the opportunity to purchase PIPSA as a symbol of his com mitment to freedom of speech.The proposal contained a proviso to lift restrictions on newsprint imports after the sale became final. The offer was declined because no publisher wished to purchase an unprofitable and inefficient business that would have to compete unfavorably in the international market with more ad vanced firms Since 1989, however, Salinas has taken the steps to put priorities in pr oper order In April he decreed the liberalization of the newsprint paper market, there by ending the governments monopoly on producing and importing paper. Permits are no longer required; and imports will be subject to a standard 15 percent tariff.

This constitutes a step forward in creating a much needed competitive market in this area, and in facilitating the sale of PIPSA.

No Sound Privatization. The five demands of sound privatization have not been met.The government should seek international expertise in reshaping its program and in constructing a politically feasible alternative.This could function as a decisive factor in removing present obstacles and extending the program to impor tant areas of the economic infrastructure, such as the oil and elect r icity industries OBSTACLES TO PRIVATIZATION In Mexico there is much resistance to privatization and the ideological position it represents. Major political and intellectual opposition has forced public officials to adopt a purely pragmatic no other way ap proach to privatization. This sharp resistance stems from fear of exploitation and bitter memories from the past, when foreign intervention in railways, petrol, and electric power was strong, and wielded much political influence.

The Mexican privatization program will not go very far unless these obstacles are overcome.These can be divided into three: ideological, juridical, and political 1) Ideological Obstacles. The ideological opposition in Mexico to privatiza tion has been consistently strong. Importan t intellectual circles are still influenced by the socialist model of economic statism, despite its marked unpopularity almost everywhere else. A widespread objection is that privatization constitutes an in tolerable threat to national sovereignty. The sal e of strategic industries is per ceived as generating an unwanted dependency on outsiders, placing those cherished enterprises at the mercy of foreign imperialism ing out domestic interests. The announced divestiture of the state steel com panies was conde m ned by leaders of all the socialist parties, including the Democratic Revolutionary Front and the Popular Socialist Party. A similar con demnation followed the decree to reprivatize the banking sector. Consequently any attempt to extend privatization to o i l and electricity would likely meet with furious opposition. Salinas has declared these industries untouchable. Yet all are The Salinas administration has received constant criticism from the left for sell 20 in dire need of development and massive restru cturing. Privatization could fulfill these needs.

In Mexico, as elsewhere, cries for national sovereignty are accompanied with demands for exclusive state ownership. This has enabled a few to mask their per sonal and highly lucrative interests with handy n ationalist rhetoricme public good would be far better served by transferring state enterprises to the mass of private citizens and retaining a majority share of ownership. In fact, parastatal busi nesses are controlled far more by the government than by t h e private sector.Thus the vested interests of a handful of high bureaucrats have been falsely equated with the public interests of the entire nation A popular complaint often lodged against privatization is that it causes un ernployment.The standard respo nse to this standard objection is that hard transi tional adjustments may create short-run unemployment, but that the advent of a competitive and prosperous society eventually widens employment opportunities.

In Mexico, this has not persuaded authorities a nd analysts who contend that poten tial unemployment constitutes a social cost higher than the economic cost of keeping state companies alive.This assertion is empty rhetoric. It ignores that money-losing state-run companies are often a leading cause of u n employment They absorb massive amount of resources which could have been destined to productive job-creating ventures. The policy of subsidizing inefficient and wasteful enterprises, together with an explosive bureaucratic a oll, has signified the loss of two jobs for every needless make-job employee reform in Mexico is institutional and judicial barriers. The constitutional articles 27 and 28 prohibit foreign and domestic private ownership of all the national economic infrastructure The strategic and prim a ry sectors (namely, oil electricity, railroads, primary petrochemicals, and so forth) are the sole and ex clusive property of the government under these articles.They are a major barrier to privatization and the development of a market economy true and fa l se. Some strategic industries have been put up for sale notably the telephone company and the banks.The former was unconstitutional under article 28; the latter required deleting a constitutional clause introduced in 1983, seven months after President Jos e Lopez Portillo expropriated the banks in September of 19

82. Several declarations have been issued voicing this concern, includin an official statement from.dissident PRI members opposed to selling TELMEX.

This has forced the Salinas administration to compromise and seek measures to temper domestic discontent.Thus, the terms of sale for the telephone company contain a legal stipulation that the government shall retain normative rectorship over national tele c ommunications.The very same stipulation was introduced in F 2) Juridical Obstacles. An overlooked obstacle to privatization and free-market Some officials claim that these articles play a purely cosmetic role.This is both 54 13 See Luis Pams, Hacia Donde v u Salinas (Mexico D.F Editorial Diana, 1989 p. 168 14 See Julio Cesar Lopez Garcia Privatization El Financiem, October 3,1989, p. 42 21 f the terms of sale of the national banks.This gives.govement potential leverage to exercise full control over these tw o vital areas, thereby forestalling full privatiza tion A more serious problem is the lack of clear and certain limits to what qualifies as strategic and primary. This endows government officials with a tacit but ar bitrary power to expropriate whatever co n cern they happen to conveniently regard under those categories (this is what happened in 1982 when the banks were nation alized in the name of the public interest).The main government rationale for disincorporating new entities is the idea that these no l o nger require the presence of the state. Yet, future administrations may easily disagree.The lack of reliable constitutional private property rights and the possibility of overturning parastatal government concessions discourages long-term prospects for pr ivatization.

The most disturbing juridical barriers to market reforms are the modifications of constitutional articles 25 and 26 introduced in February 1983, during Miguel de la Madrids administration.The purpose of these new clauses was to elevate economi c rectorship to constitutional level. Yet the term rectorship is a euphemism for authoritarian central planning. The amended texts contain senten ces copied almost verbatim from articles of Soviet and Cuban Constitutions.ls A free and competitive society i s incompatible with a legal antecedent that binds government with a constitutional obligation, according to article 25, to plan, con duct, coordinate and orient all national economic activity The current package of economic reforms is unlikely to bring lo n g-lasting benefits as long as these constitutional articles remain unchanged.The Salinas government should revoke articles 25 through 28 of Mexicos Constitution.This would strengthen the causes of privatization in two important ways. It would in crease pr ospective candidates for privatization with new and attractive targets. It would add impetus and credibility to the program of market-oriented reform and create a stable juridical climate hospitable to the changes brought about via struc tural change.

Unfo rtunately, the prospects for near-future juridical revision are dim, not withstanding the successful amendment of article 28 to permit the reprivatization of the banks It remains true that the PRI lost precious congressional seats in the 1988 November ele c tion and no longer enjoys the two-thirds majority in Congress required to modify the Constitution An immediate option would be to seek an al liance with members of the PAN who now occupy congressional posts, similar in style and spirit to the coalition fo r med to guarantee legislative approval for Salinass initiative to return the banks to the private sector.This would enable Salinas to obtain the two-thirds majority required to change constitutional articles 15 See the comparisons made in Luis Pauw and Car o lina R. de Bolivar, Economics, Politics and Culture in Mexico in John Goodman and Ramona Martinez-Baden, eds Fighting the War of Idea in Latin Arnerico (Dallas: National Center for Policy Analysis, 1990 pp. 7678 22 But deep tension between the PAN and PRI is likely to short-circuit future at tempts to construct a successful coalition 3) Political Obstacles. Two political obstacles have damaged the national privatization program. Both have public and private sector origins.The policy of privatization does n o t enjoy strong political backing. Few transactions have gone without opposition from syndical forces and dissident PRI constituencies The policy of handing out special concessions to organized labor leaders in order to secure political votes has created a status quo hostile to privatization.The privileges include rights to intervene in managerial operations.Thus, the shift in administration and entrepreneurial structure which occurs in a privatization scheme threatens vested interests. According to PEMEX A dministrative Subdirec tor Ernesto Marcos Giacoman, the existence of well-entrenched syndical organiza tions is a principal obstacle to disincorporation.

Similarly, privatization has provoked visible discontent within the PRI, where reactionary groups exert considerable pressure to structural changes and revision.

For the most part the motives are insincere. Many members are simply unwilling to give up highly lucrative deals in the parastatal sector. Fraud and corruption have been rampant: clandestine part nerships and misappropriated funds have enabled a select few to enrich themselves for prolonged periods of time. For ex ample, it is estimated that for every peso destined to the state-run agricultural areas, only 30 cents reach the companies involved. Ma n y cases have recently been exposed, notably the massive frauds in BANRURAL and BANPESCA, two state owned credit agencies which finance development projects in the fishing and agrarian sectors. Salinas has made heady and courageous efforts to fight cormp t ion, but this continues to be a definite obstacle to privatization and economic reform.

The prevalence of special privileges is not confined to the public sector. Private businessmen enjoy many corporate concessions and exemptions. This has hurt privatizat ion in two ways: it has encouraged not only rampant cronyism, but op position to the follow-up reforms necessary to ensure competition and free entry to the market. While the majority in the private sector enthusiastically welcome the reprivatization of t h e banks, other minority groups are opposed. This is no surprise, since a return to a privately managed bank system is bound to trigger structural adjustments which certain businessmen in the private sector wish to avoid DEBT-EQUITY SWAPS New attention has been focused on the role debt-equity swaps can perform in selling state-owned enterprises. A limited swap program existed from 1986 to 19

87. It was suspended in November 1987.The date is significant: it was both at the height of Mexicos inflationary cris is, and barely prior to the commencement of the pact of price and exchange controls.The reasons for dropping the pro gram were the familiar ones: supposedly swaps were inducing perilous inflationary pressures, and subsidizing investments that would have b e en made anyway 23 I The Old Program. Mexicos previous debt-swap program retired $3.8 billion in outstanding foreign debt. The amount equalled 56 percent of direct foreign in vestment made during the period in operation. Nonetheless, the Program was abando ned.

A debt-equity swap need not produce inflationary pressures. The program in Chile, which has been combined with privatization of state-owned enterprises avoids the potential danger of inflation by exchanging debt-notes for company shares instead of new ly emitted local currency. Similarly, studies show that a con sistent or mature swap program does not lack additionality; on the contrary the continuity of a program eliminates uncertainty an works in attracting direct investments that would have been pla c ed elsewhere designed to allay concerns with swaps and to repair the alleged failings of previous plans. It was activated in April of 1990.The new program was instituted as a result of a requirement in the debt-reduction agreements reached under the Brady Plan.

It sanctions an annual sum of up to $1 billion in swap operations in the next three to-four years Debt-swaps are now limited to privatizations, tourism, agriculture, and in frastructure development projects-already approved in the annual budget. In this way, potential inflationary effects are neutralized as the government will not need to print new currency to redeem debt notes acquired in the secondary financial market.

The scheme sets strong restrictions on admissible debt swaps.The operations hav e a ceiling of 3.5 billion in the three-to-four-year pefiod set for the pro gram. Public authorities claim that if the program shows signs of success, the government may extend it beyond 1993, with higher ceilings for swap investments.

At present, investo rs are only allowed to exchange debt for 50 percent of acquired assets.The rest must be financed with direct cash.This restriction was placed in order to guarantee the flow of new hard currency, and hence secure additionality Also, discounts on acquired d e bt may not surpass 35 percent of nominal value Neither of the two cited reasons for suspending the program withstands analysis t The New Program. The approach of the governments new scheme is 16 See MelanieTammen, Energizing Third World Economies: The Rol e of Debt-Equity Swaps, Heritage Foundation Backpunder No. 736, pp. 6-

8. Mexicos Fmance Miter Pedro Aspe has been a fierce critic of debt-equity swaps (although he himself proposed viable debt-for-assets swap scheme in March of 1989 at the annual meeting of the Interamerican Development Bank Analysts persuaded by Aspes continued criticism that swaps fuel inflation have failed to explain the counterexample of Chile. Chile is Latin Americas nation with the most aggressive swap scheme yet with the lowest lev e ls of inflation. Also, the criticism was rdy an attempt to find a scapegoat for blaming inflation on other factors unrelated to excessiVe government spending. Mexicos inflation rate in 1987 was 159 percent, its highest in history.The true cause of this wa s an exorbitant monetary supply rate of 129 percent provoked by the need to cover a huge public deficit.On this point, see Sergio Sarmientos oped piece, El Retorno de 10s Swap, in El Financiem, December 11,1989 24 Finally, access to swap operations will no w be open to domestic investors. A sub stantial sum of expatriate capital is expected return via swap investments.

Swap operations are being considered for many companies targeted for sale to the private sector.They includeTELMEX and the steel mills SICARTSA and AHMSA, CANANEA PIPSA, and CONASUPO supermarkets in urban areas.

An auction system will be used for state-owned companies obtained through swaps. No majority ownership will be open to foreign investors. This year 27 opera tions were approved fr om a total of 359 applications. A total of $860 million will be retired in debt in exchange for investment projects in infrastructure, agricul ture, and tourism.The swaps approved for privatizations were minimal, as were the number of operations licensing new foreign investment.

The new swap program is encouraging in many ways. It is a clear improvement on the previous program in linking swaps with privatization and in substituting con ventional swaps of debt-for-currency with debt-for-assets techniques. N everthe less, the program also has important limitations. Many foreign observers complain that the sanctioned annual amounts of $1 billion are severely 1imited.The actual amount of investments channeled through swaps are less than the already low oeil in& in view of the 35 percent discount on foreign debt.This means that only $650 million per year have to be allocated among several different areas. Some of these such as tourism and infrastructure, require very large amounts.

Similarly, the 50 percent restr iction in swapping debt notes for equity shares acts as a disincentive for potential investors unwilling to pay the remaining half in hard cash.The most troubling flaw with the new scheme is its low debt-reduction im port. By 1993, it will retire only hal f the sum cancelled through the swap scheme in Chile. This is even lower in GDP terms, since Chile's represents only 15 percent of Mexico's GDP. In effect, the total savings to be obtained over a three-to-four-year period equal the annual savings in debt-s ervicing costs reached through the foreign debt-relief agreement finalized last February. Mexico needs a far more ag gressive debt-swap scheme to bolster sorely needed investment and retire substan tial sums of its still gigantic foreign debt.

A Creative A lternative. A large and aggressive swap program could help in im portant ways to fix the various pricing problems which have persistently hurt ef forts to sell state-owned companies. However, critics contend that this would be detrimental to the nation an d would leave it at the mercy of excessive foreign economic domination. It is often said that swaps "discriminate" against domestic investors. This merely masks an underlying "fear" that swaps contribute to the loss of economic independence. Again, this tu r ns an economic (and financial) issue into an emotional or political debate about "national sovereignty could work to nullify it. A study done in the Mexico City-based Center for Free Enterprise Research suggests that the government could institute a type of domestic debt-swap" program by exchanging internal debt notes in the form of privately held treasury bills with voting in three banks and other large parastatals.

This move has several advantages: it would transfer money-losing parastatal This view, whi le misplaced, is pervasive. There are innovative alternatives which 25 COMPANIES SLATED FOR PARTIAL OR FULL PRIVATIZATION SALE PRICE INTERNAL in trillions DEBT of pesos March 1989 COMPANIES SERFI IN I lo I AHMSA I 5.3 I TOTAL I 118.3 I 118.3 I enterprises to private hands thus removing a main source of inflation and inefficiency; it would eliminate the need to ex tend huge sums in transfer sub sidies to the public sector; it would help modernize Mexicos financial market by attracting important amounts of d o mestic investment capital; it would en courage the repatriation of flight capital; it is appropriately nationalistic; and it is feasible The principal virtue of this proposal is that this type of ag gressive domestic swap pro gram would eliminate a very l arge portion of Mexicos perni cious internal debt, together with all debt-servicing costs in one single step This would generate a huge savings.

Mexicos internal debt repre sents a far more serious obstacle to alleviating public finances and revamping grow th than its external debt. It has soared above the 65 billion mark, and is roughly equivalent to 25 percent of the GDP. In 1989, for every peso spent in servicing debt-payments, the government allocated 77 cents towards internal inter est-payments and onl y 23 cents to foreign debt payment.The same amounts are projected for 1990.The debt-servicing outlays for internal debt now constitute 42 percent of total federal expenses.This comes as a result of the governments need to finance payments of interest rates on treasury bills and other securities, rates that must be kept extremely high to attract investments.The interest rate on 28 day treasury bills called CEES now stands at 30 percent.

A policy of domestic debt-swaps would solve the problem occasioned by a fast rising internal debt, and eliminate the need to finance unproductive activities with domestic debt contraction.The CETES and other securities choke the public sec tor with abnormally high interest-payments and make money markets soar.These could be e x changed for shares in certain important parastatal companies. Luis 26 TOWARD Pazos, General Director of the Center for Free Enterprise Research, has 17 proposed a list of companies for privatization (see table on previous page internal debt has since rise n to 152 trillioaTwo options remain plausible. First the additional amount could be exchanged for other state-owned entities.The swaps would not involve discounts over the nominal face value of CETES and other debt certificates. Nonetheless discount option s could be offered to en courage investors reluctant to participate in the swap program. Second, a partial swap scheme could be instrumented, involving the exchange of stocks inTEL MEX, the two steel concerns and the three banks for internal debt-certifica tes. In this way over 60 trillion pesos could be cancelled in internal debt, that is, roughly 40 percent of debt outstanding.

The governments current failure to take such proposals seriously reflects lack of creativity in bolstering privatization together with aggressive and plausible debt reduction techniques. Moreover, this kind of swap scheme would not have infla tionary impacts, because it involves debt-for-assets swaps. On the contrary, the proposal has a strong anti-inflationary component in its outr i ght elimination of the principal cause of deficit spending: internal debt-contractions and enormous debt servicing costs AU these companies have been programmed for partial or full privatization.The L MODERN MEXICO The Salinas administration has made conc r ete efforts to reverse the state inter ventionist trend initiated and sustained by his predecessors. Many market oriented initiatives have been undertaken, including some viewed as unimaginable just a few years ago. These welcome changes are an essential i ngredient in the general program to modernize the national economy and return Mexico to the pre 1970 days of stability and growth guarantee modernization. Salinass sustained onslaught on what he calls statal giantism is a step forward. His moves to privat ize major state enterprises reflect a serious intention to reduce the size of government. But this is not enough.

Economic democracy and consumer sovereignty are needed as well to ensure that Mexico grows and prospers and that the success and social benefi ts of privatization are realized. A purely pragmatic motive is both precarious and insufficient Conviction or Convenience? Mexico nevertheless needs more changes to RECOMMENDATIONS To modernize means to improve, revise, and show willingness to make the re quired changes. A set of fundamental reforms should be made to consolidate the 17 See Hacio Don& w Solinas, pp. 171-1

73. A wsmaV version of this domestic swap scheme is currently under consideration for the partial sale of equity ownership in some of the more indebted and less rentable banks 27 in war against statal giantism and give privatization a fundamental role in revitaliz ing the economy Thus the Salinas Administration should Undertake Juridical Reforms. A necessary condition for long-term success f ul privatization is an institutional framework which protects private property. The Salinas administration should fashion radical reform in the nations legal sys tem, and provide a constitutional foundation to changes made and already un derway. A top pri o rity should be to revoke or substantially modify constitution al articles 25 through 28, which give the government exclusive prerogative to own strategic areas of the economy, and manage primary activities, under the role of rector and official planner. A n other priority is to deregulate the economy and introduce a more competitive system in various sectors of the na tional infrastructure. These reforms are required to vitalize the package of privatizations structured by the Salinas government and take the p rogram to its last consequences by targeting industries such as oil, ele rici and rail roads as possible candidates for private domestic ownership Revise foreign investment legislation. The 1973 Foreign Investment Code is a major barrier to privatization. It allows only a 49 percent foreign minority ownership of all domestic businesses. This has discouraged many potential foreign investors from participating in scheduled privatizations A serious prob lem with the current program is the inability to find bu y ers willing to invest massive capital in the technological innovation of underdeveloped companies A large part of this problem could be solved by legally allowing majority shareholding in corporations like FERTIMEX, SICARTSA, AHMSA, and TELMEX.The Salinas administration has corrected many of the follies made by its three presidential predecessors.The more open policy toward foreign in vestment is a welcome initiative, but requires revision of the 1973 provision to make it more than a temporary, short-lived measure. Salinas could do this by forming a political coalition with the PAN party, similar in style to the strategy to repeal the constitutional clause which prohibited private ownership of the banks End the UPacto.w A free and stable price environment i s essential for business planning and the correct valuation of state-run assets. Privatization is an on going process of structural change whose chances of success feeds on suppor tive public policies. The labor-management-government pact of price and ex c hange controls inhibits the free market aims of privatization by preventing prices from finding their place in a free economy based on supply and demand.

The pact should end and stricter monetary discipline should be adopted; sec torial solidarity is no su bstitute for monetary stringency. This would restore free and realistic economic climate, and hence stimulate the repatriation of l 18 See Noe Cruz Serranos editorial ZaVenta de Paraestatales, Hasta Sus Ultimas Consecuencias, in El Financiem, September 25 , 1990.The editorial describes an offiaal document which details the governments plan to ultimately reduce state control of the economy to eight strategic entities 28 4 4 flight capital together with a continued flow of new investments. Many privatization t argets still on the calendar would thereby become feasible.

Support popular capitalism. A broad-based program to expand the popular ownership of family jewels should be adopted. This strategy of popular capitalism has worked well in other less developed countries.

Also, it is a politi cally effective way to divest state concerns. The Mexican program has proceeded in a piecemeal fashion where sales based on complicated and cum bersome valuation mechanism have tended to degenerate i nto insider deals and cronyism. This has given privatization a misleading and negative image.

The government should replace its current strategy with a positive and popular alternative.

Some recent progress has been made on this front. Eight small fishin g parastatals will be sold off through the stock exchange market.This will help to set a precedent for other privatizations. In the industrial sector employee-ownership plans remain an attractive possibility. In the agrarian sector, systems based on socia l vouchers could be used to establish property rights and facilitate the disinconception of companies like CONASUPO and FERTIMEX In Mexico, a popular alternative plan would help neutralize demagogical cries of revolutionary betrayal, and give privatization a positive social value. A program based on broad ownership results in a convergence of individual interest and is essential to spread the free market message in countries where capitalism is often conflated with crony mercantilism Shift the focus of the p rivatization program. The national program of privatization should be redefined from its current model of pure financial pragmatism to one embracing a general spread the wealth approach. The privatization of fields like the oil industry, electric power, r a ilroads, education social security, rural land-plots, and other strategic and primary concerns would thereby become a real possibility.This requires reorienting the role of the state as economic rector towards an institution responsible for guarantee ing t he property rights and the free operation of the market. At present, the Salinas administration uses populist arguments to justify privatizations in process; namely, that the disincorporation of parastatal entities is necessary to rationalize the economic role of the state and to allow it to channel funds saved through the program towards public needs like education, housing and food. A more creative approach would be to fashion an awareness program designed to teach the lay public the positive social aspe cts of privatization, and the various methods whereby vital services can be efficiently supplied by mass 29participation of citizens. An ambitious alternatives such as the privaption of large parastatals via domestic debt-equity swap should be pursued.

The U.S. has direct interest in seeing that this set of reforms is instrumented. It would help in considerable ways to neutralize a radical left-wing movement led Cuauhtemoc Cardenas son of the revered hero Lazar0 Cardenas who ex propriated oil interests in 1 938.This movement is very strong, calling for a return to central planning and full-scale protectionism. Furthermore, a reform of the present privatization program would help to ease the way towards econdmic in tegration and free trade with the United Sta t es. An obstacle to the bilateral free trade agreement negotiations is the fear of massive structural dissimilarities in the two economies. A popular, full-scale program of privatization in Mexico would help allay this worry The U.S. could help Mexico fulf i ll the required set of reforms in the Mexican privatization program by pursuing the following policies 4 4 Redefine the Brady Plan. The debt-relief accord reached in February of this year has been hailed as a landmark debt reduction achievement. It reduce d debt burden by 20 percent, and cut annual obligations by 3 billion for the next three to four years. While this is undoubtedly positive, the Brady Plan errs in locating foreign debt as the principal cause of economic backwardness in Mexico.ao The Bush Ad m inistration should insist that debt-relief alone is insuf ficient to end stagnation in a structural fashion, and that the root of recovery lies in large-scale internal reform. A policy of debt reduction tends to per petuate irres$ynsible monetary policy9 and to delay required reforms such as privatization.

Use fh!e trade negotiations as leverage. The advent of formal free trade be tween Mexico and the U.S. implies a good opportunity to convince the Mexican authorities of the need for a more open and market -oriented economy. The U.S. representative to the free trade agreement negotiations Carla Hills, has sought to include constitutional and foreign investment modifications as a condition for the accord.This reflects the acute concern that reforms on this f r ont, such as the May 1989 revision on foreign investments have been a result of administrative decrees that lack legal permanence. Spe I 19 Other creative and realistic alternatives include privatization of education and social security-based voucher syst e ms and the private provision of public services.This has had huge success in Chile, a country with a similar cultural background, social pradices and economic strudure.That is to say, there is ample precedent that these alternatives are feasible to a coun t ry like Mexico 20 See MelanieTammen, "ReducingThitd World Debt: Private vs. Public Strategies," Heritage Foundation Backpvunder No. 699, April 10,1989, pp. 11-13 21 Huge parastatal companies such as CONASUP0 and the Federal Electricity Commission continue to absorb massive amounts in federal subsidies, and should be privatized if only for this reason. In fact, public spending as a percentage of the GDP rose 7.2 percent in 1W. The main danger of debt-relief is precisely that it tends to delay adoption of st r ict fd discipline and elimination of wasteful public concern 30 cial emphasis should be placed on lifting investment restrictions, liberalizing strategic" sectors, and instituting reliable guarantees of private ownership This would open up broader objecti v es for Mexico's privatization program Offer technical assistance. A serious practical problem with the policy of disin cop tion in the past has been the absence of a politically popular pro gram. The U.S. can and should help the Mexican government to fram e a practical program fashioned to broaden equity ownership through stock and employee participation. The free-market objectives of privatization cannot be successfully transmitted amid the context of cronyism and rent-seeking.The Bush administration shoul d extend technical expertise to correct this flaw and replace the curient system with a program which places emphasis on a public awareness of the social value of privatization B CONCLUSION Mexico's package of privatizations is one of the biggest in the wo r ld. The presidential initiatives to expand the program to "important" economic sectors such as telecommunications, infrastructure, and banking, has won it enviable inter national acclaim. MlT economist Rudiger Dornbusch and British Prime Minister Margaret Thatcher have lauded the Salinas administration for its many privatizag tion efforts and have commended its program of reforms as a model to emulate.

Notwithstanding the good reputation that Mexican privatization enjoys, a detailed analysis of the program reveals that "publicity has outstripped perfor rnanc It is necessary to restructure current policies to meet the conditions of successful privatization. It is vitally important to introduce solid private property rights and give constitutional permanence to the transference of assets from the public to the private sector Good but not Great. President Salinas has demonstrated commendable political courage in privatizing state companies considered "untouchable" just a few years ago. He now faces the new cha llenge to expand the program to "strategic" sectors and allow mass domestic ownership of the nation's most vital economic interests.

The key to extending the national privatization program in this fashion is politi cal and popular will. It represents an in valuable opportunity to start anew, and revise the pro gram in a way that meets the prerequisites of successful and profitable privatization. Further, large-scale privatization would remove obstacles 22 See Young Primtiation in Mexico pp. 11-U near-future transformation into an "economic powerhouse" is David Goldman's article "A Revolution you can Invest In F&a, July 9,1990, pp. 48-51 2A This phrase is taken from Daniel James's succinct comment on this issue Fear of Open Market Il?rc WallSbwt Jtwnal, April 24,1990 23 A typical example of the arguably overrated image Mexico now enjoys for its "economic revolution" and its a letter to the editor, "Mexico Phobii 31to sustained progress and open up new opportunities to pursue competitive trade and a smooth econ o mic integration within expanding world markets administrations lagging difficulty in balancing public finances and adopting sound monetary policies. In turn, this would engender a financial climate of stability thereby facilitating the return of flight ca pital and continued flows of productive in vestments.The ambitious goals of 50 billion in investments and a 9 percent invest ment rate by 1994 would then become a realistic possibility.

The Salinas administrations rekord of privatization is good, but not g reat. A great deal has been done, but a great deal more remains to be achieved. Salinas should seek structural reform in the juridical system to guarantee private owner ship lift restrictions on foreign investments; expand the program to strategic see tor s of the economy; end the extant regime of price and exchange controls; and formulate public awareness programs together with a policy of popular capitalism designed to expand equity ownership among the Citizenry A basic ingredient for economic modernizati on and prosperity is market oriented reform. In Mexico, the fundamental re-orientation of the national privatization program is essential to bring about a climate of sustained stability and economic growth.

A free, modem and prosperous Mexico would then si mply be a matter of time Internally, a broad program of privatization would help alleviate the Prepared for The Heritage Foundation by Roberto Salinas Academic Director Center for Free Enterprise Research Mexico City, Mexico 32