NCPA - National Center for Policy Analysis


October 13, 2004

Over the last few years, Mexico's economy has stagnated. Many blame the North American Free Trade Agreement (NAFTA). However, a new paper from the National Bureau of Economic Research argues that Mexico is struggling because it has not modernized its lending and contracting institutions.

What really hurts Mexico, say the authors, is the fact that its domestic market for credit is still suffering from the 1994 peso devaluation:

  • The amount of real domestic credit fell by an astounding 58 percent between 1994 and 2002.
  • For non-export companies, available credit has fallen by 72 percent.
  • Additionally, authorities do little if anything to borrowers who default on loans -- encouraging even borrowers who would could have repaid their debt into defaulting.

This credit crunch is causing bottlenecks elsewhere in the economy. The authors note that Mexico recovered from its 1994 peso devaluation by relying on export-oriented industries:

  • Export-oriented firms grew rapidly, because they could rely on international financial markets and were the main recipients of foreign direct investment.
  • However, those not in the export sector could only use Mexico's domestic credit market, where credit is severely limited.
  • Eventually, the nonexport firms could not supply the export firms with vital business inputs like freight services, repair, or critical materials.

Consequently, the export firms began to slow down, because they could not be supplied effectively. This caused Mexico's economy to slowdown, say the authors.

Source: Matthew Davis, "Mexico's Problems: Don't Blame NAFTA," NBER Digest, September 2004; based upon: Aaron Tornell, Frank Westermann, and Lorenza Martinez, "NAFTA and Mexico's Less-Than-Stellar Performance," National Bureau of Economic Research, Working Paper No. 10289, February 2004.

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