Eurasia Group's weekly selection of essential reading for the political risk junkie - presented in no particular order. As always, feel free to give us your feedback or selections by tweeting at us via @EurasiaGroup or @ianbremmer.
Makes It: A Transformed Society, Economy, and Government"
Shannon K. O'Neil, Foreign Affairs
There are plenty of underappreciated bright spots in Mexico. This piece gives a compelling recent economic history of the country and spells out the risks and opportunities Mexico faces today.
Kurdistan the Taiwan of the Middle East?"
Kevin Sullivan, RealClearWorld
Is Kurdistan a rare winner in an ever-turbulent Middle East?
Oil and Gas"
Elisabeth Rosenthal, New York Times
How does energy use differ around the world? A staggering fact: New York State's 19.5 million residents consume as much energy as the 800 million residents in sub-Saharan Africa (excluding South Africa).
Kingdom's Problem with Religion"
Simon Scott Plummer, Standpoint
In 2011, there were an estimated 67 million Chinese Christians and rising. Some predict that in a few decades, Chinese Christians could outnumber those in the US (there are currently 170 million and falling). How will China's religion demographics affect its development?
Just Declare War on Apple? Sure Looks Like It"
Gordon Chang, Forbes
China: Unparalleled arrogance, undisclosed agenda"
Real People's Daily"
Jonathan Dehart, The Diplomat
It seems like an anti-Apple campaign is brewing in China-but who is behind it? What's the motive? Apple CEO Tim Cook's January prediction that China will become the company's largest market looks inauspicious in hindsight. One thing is for sure: social media is exploding in China and Weibo is upending the calculus of information flow and control.
Note: Today is the first in a series of posts that detail Eurasia Group's Top Risks for 2013.
Since the onset of the financial crisis in 2008, investors and companies have focused mainly on risks in developed world markets. But as conditions in the U.S. and Europe continue to improve in 2013, the most worrisome risks will again come from emerging market countries. These countries are fundamentally less stable than their developed world counterparts, and some of their governments used a period of favorable commodities prices and the benefits from earlier reform to avoid the tough choices needed to reach the next stage of their political and economic development.
Some of these emerging market nations face more difficult challenges than others, and much depends on the degree of political capital each leader will have in order to make unpopular but necessary changes. These countries can be divided into three broad categories according to the complexity and immediacy of the risks they face and the longer-term upside they offer.
The first category includes the best bets:
The second category of emerging market economies are at risk of considerable volatility.
Lastly, there are the underperformers, those countries where risks will overshadow returns.
On Friday, we'll profile Risk #2: China vs Information.
HOANG DINH NAM/AFP/Getty Images
By Carlos Ramirez
At first glance, the Institutional Revolutionary Party (PRI) is the clear winner of Mexico's July 1 presidential election. But a closer look at the results reveals a more muddled picture. On the surface, the PRI certainly came out ahead: After 12 years in opposition, Mexico's once-hegemonic power reclaimed the presidency and engineered a strong congressional coalition. Also, when Enrique Pena Nieto is inaugurated on December 1, the party will have governors in place in 22 states and control of a majority of state legislatures. Meanwhile, the PRI's main rival, the currently ruling National Action Party (PAN), fielded a third-place presidential candidate, lost control of the key states of Jalisco and Morelos, and saw itself reduced to the third-largest party in the lower house of congress.
The PRI's pick-ups and the PAN's failure to retain the presidency were largely predicted in the weeks preceding the election. What came as a surprise was Pena Nieto's inability to reach the critical 42 percent threshold of total votes, which translated into a weaker performance for the PRI in the congressional races. The party failed to achieve working majorities in both chambers, and the outcome fell far short of the PRI's expectations-especially in the senate, whose members are elected every six years. So in a dramatic turn of events, Pena Nieto will assume the presidency but will have to depend on legislative support from the PAN to secure his agenda.
The electoral outcome has damaged the center-right PAN, but it does have this one lifeline. As a pivotal party in congress, it will be the only powerbroker with which the PRI will be able to negotiate structural reforms. This is the inverse result of the 2006 election, which may provide some consolation to PANistas who watched the policies of outgoing president Felipe Calderon repeatedly held up by the PRI over the past six years. This time, it is the PRI that will be tied to the PAN for the entirety of the Pena Nieto administration.
This ironic turn of events clearly was not part of the PRI's plan. Pena Nieto intended, after winning by a double-digit margin and capturing both chambers, to propose moving forward on many long-stalled reforms, to secure congressional approval with or without PAN support, and to avoid having to undermine the vested interests that make up his constituency. The goal was to demonstrate the PRI's effectiveness from the outset and achieve solid results. The Mexican public, in turn, would see 12 long years of obstructionism and stalled reforms quickly vanish. But that plan collapsed last weekend.
So why, exactly, is the outcome so bad for the PRI? From a business perspective, it seems reasonable that the PRI and the PAN would come together to enact needed reforms. According to Pena Nieto and his advisers, the PRI is pursuing the same reforms that the PAN tried (and failed) to pass during the Vicente Fox (2000-2006) and Calderon (2006-2012) administrations: fundamental changes in the areas of labor, fiscal policy, energy, and competition. The PAN has no deep-seated ideological opposition to any of these (unlike the other major party, the Democratic Revolution Party, or PRD). And it does not have strong ties to the groups with an interest in maintaining the status quo. Conventional wisdom, therefore, would say that Pena Nieto will find a way to get the PAN on board to pass the relevant legislation.
It is not that simple, however. If the PAN learns from its historic defeat, it will quickly come to terms with the fact that it now has a golden opportunity over the next six years to push for a much deeper transformation of Mexico's political and economic landscape. In particular, the PAN can offer support for the PRI's structural reforms in exchange for dismantling the vestiges of the old PRI-led corporatist coalition that survived Mexico's transition to democracy. (The PAN struggled against this coalition during its 12 years in the presidential residence.)
Accomplishing such a feat is a pretty straight-forward task, as there is no shortage of issues on which the PAN can seek concessions in exchange for supporting reforms. The list is large -- underscoring the many problems left untouched during the past dozen years-but certainly achievable. Here are some of the topics that could be up for negotiation:
There is no question that the PAN will support these structural improvements. After all, the party's only chance of returning to power relatively quickly is if Mexico breaks with its corporatist past and modernizes at a faster pace. The real question is whether Pena Nieto is serious about enacting real change-serious enough that he is willing to defy the rent-seeking coalition that backs him. If he is truly committed to advancing reforms (and is ready for the epic, vociferous resistance sure to emanate both from within his own party and from the PRD), then Pena Nieto might succeed in becoming the first president to usher in a historic transformation. In that scenario, the country will have undergone unprecedented economic reforms during his administration and will function in 2018 within a renovated institutional framework that empowers Mexicans to reach their real potential. If, however, Pena Nieto is not committed enough -- if he ends up preferring accommodation rather than transformation, and if the dead weight of the PRI's past prevails once again -- then Mexico will remain condemned to the same mediocre performance witnessed over the past decade.
The stakes for Pena Nieto are clear. Will Mexico's new president be transformational, or will he prefer to continue playing the role of a soap-opera actor? Like Mexico's famed telenovelas, the election had a surprise ending.
Carlos Ramirez is an analyst in Eurasia Group's Latin America practice.
By Carlos Ramirez
Allegations that WalMart-Mexico's executives bribed local officials to speed up permitting for new stores highlight the issues of corruption in Mexico, but will have little impact. In the short term, the Mexican federal government has announced an investigation regarding the federal permits granted to the retailer. But that seems to be a political response to the growing criticism of inaction by the authorities rather than a serious case against the company. Because the allegations of wrongdoing relate to local-level permitting, any federal investigation will likely turn up little, if anything, of note. Furthermore, with the present federal administration entering its last few months, the investigation will probably fail to reach any meaningful result before its November 30 deadline.
In reality, federal officials are legally constrained from pursuing the allegations. They would first need a formal accusation by a third party before being able to launch any investigation regarding the alleged bribery. Furthermore, the division of powers under Mexico's constitution gives states and municipalities control over construction and most environmental permits, and national prosecutors have limited leeway to investigate local affairs other than when federal crimes are suspected.
A formal investigation at the state and/or municipal levels is even less likely. Since Mexico's transition to democracy, political power has shifted from the once all-powerful presidency toward the 32 state governors and the mayors of some of Mexico's biggest cities. The governors have strengthened their leverage over important decision-making within their jurisdiction through their control of local institutions. Increased budgetary and debt resources, with little related accountability and transparency (which increase the likelihood of corruption), have only reinforced the governors' political clout. Moreover, because the alleged corruption occurred five or six years ago, and reelection is banned in Mexico, politicians who served at that time will no longer be in office, which would further complicate a formal investigation.
Ultimately, both federal and local governments welcome companies that bring jobs and economic activity and that will likely to trump other considerations. WalMart-Mexico is currently Mexico's largest private sector employer with more than 210,000 employees. Local and federal authorities are unlikely to constrain WalMart-Mexico's growth, particularly when citizens cite jobs as among their principal concerns. In fact, federal and local authorities are likely to continue to regard the company as an important contributor to the economy.
In the short term the most likely immediate outcome for WalMart-Mexico is increased scrutiny of its operations by the media, competitors, and NGOs that oppose its presence in the country, but this is unlikely to hamper the company's ability to keep expanding in Mexico.
The episode does raise questions about whether Mexico's next president, to be chosen in July, will be able to tackle the lack of local-level transparency and accountability. Not only do governors face few checks, but the ban on reelection also means that politicians have few incentives to govern with any concern for their longer-term public reputation. If Enrique Pena Nieto from the Revolutionary Institutional Party (PRI) wins the July election, cooperation between federal and local authorities would improve in some areas. Calderon was frustrated with the lack of cooperation from the states on security, leading to tense relations, especially with PRI governors.
But the fact that the PRI controls most states and many municipalities means there are few incentives for a PRI president to seriously attempt to improve transparency. If elected, Pena Nieto is likely to prioritize the need to win support from governors for his own agenda, rather than pursue the complex political reforms needed to seriously tackle accountability and transparency issues at a local level.
Carlos Ramirez is an analyst with Eurasia Group's Latin America practice.
Daniel Aguilar/Getty Images
By Carlos Ramírez and Allyson Benton
The ruling National Action Party's (PAN) Josefina Vázquez Mota won the internal party presidential primary on 5 February, easily defeating former finance secretary Ernesto Cordero by about 15 percentage points. This is the first time that a mainstream political party in Mexico has selected a female candidate for president. Although surprising for some outside observers, the news was not unexpected for those watching PAN politics over the past year. A variety of opinion polls had consistently shown that Vázquez Mota's service as Secretary of Social Development, Secretary of Education, and most recently as PAN legislator and lower chamber party whip had raised her name recognition and popularity well above the other competitors.
Vázquez Mota's selection will raise hopes among some groups that Mexico will elect its first female president. However, the incumbent PAN faces several challenges from its main rival, the Institutional Revolutionary Party (PRI), and its candidate, the telegenic Enrique Peña Nieto. A recent poll by Consulta Mitofsky reflects the uphill battle she faces: Peña Nieto commands 40 percent support to Vázquez Mota's 24 percent, with the left-leaning Andrés Manuel López Obrador from the Democratic Revolution Party (PRD) only four points behind her; 17 percent of voters expressed no preference and 1 percent supported another small party. Although the PAN will see increased support after having finally named a candidate and the start of formal campaigning at the end of March, the party and its first ever female candidate face three critical challenges.
The PAN has held the presidency since 2000. Any incumbent party, especially a two-term one, needs a highly favorable economic environment to counteract the erosion of support that accompanies voters' increasing familiarity with the government in power. The PAN successfully navigated the 2008-2009 global financial and economic crisis and a deep domestic economic recession, but voters may find it difficult to reward a party that has overseen lackluster average yearly per capita GDP growth of 0.5 percent during the two terms. The modest growth expected over the next few months is unlikely to assuage voter concerns.
The deterioration of Mexico's security environment since President Felipe Calderon took office in December 2006 is another potential liability for the PAN. Mounting drug-trafficking-related violence continues to grab headlines, and there is an overwhelming sense that the country is losing the war against the drug traffickers. As a result, the election will be in good part a referendum on Calderon's security strategy, a pillar of which has been the use of armed forces instead of local law enforcement agencies. Although Calderon retains considerable support on this front, a majority of voters support a change in the security strategy, although they are undecided about what the new approach should be.
The PRI candidate meanwhile benefits from several advantages heading into the race. Peña Nieto has successfully staked out a centrist position that appeals to a broader constituency than just the traditional PRI faithful. The strategy appears to be assuaging voter concerns about the potential return to power of the formerly authoritarian party. The PRI also has a structural political advantage given its control of 20 governorships out of 32. Governors have emerged as powerful political figures in Mexico's evolving political landscape and they can marshal significant state-level resources to assist in campaigns.
Despite these challenges, Vázquez Mota is likely to be a competitive candidate this July. She has strong national-level name recognition and likely counts on solid support from the PAN's traditional constituents in the middle classes and the business community. Additionally, her status as the first female candidate from a mainstream party could help her attract independents (about one-third of the electorate) and first-time voters. Many swing voters might be reluctant to support the PRI -- despite Peña Nieto's best efforts at convincing voters that it has changed -- or the more radical left-leaning López Obrador. Vázquez Mota's likely strategy is to present herself as representing continuity with popular PAN polices, such as its free-market and pro-investment economic policies and its popular healthcare and housing initiatives -- but as also able to critique the current administration on other fronts, such as security policy, where she will offer improvements.
The PRI remains favored to win the race, but Vázquez Mota's selection has probably made it a much closer race than originally anticipated.
Carlos Ramirez and Allyson Benton are analysts in Eurasia Group's Latin America practice.
ALFREDO ESTRELLA/AFP/Getty Images
By Carlos Ramirez
The death of Mexico's Interior Secretary Francisco Blake in a helicopter crash on Nov. 11 initially sparked fears of foul play, perhaps by drug traffickers. The early evidence, however, points to a tragic accident caused by bad weather and all but rules out any sabotage or criminal intent. As a result, the policy ramifications of his death will be limited.
The government immediately called for an exhaustive inquiry into the accident and has been forthcoming with evidence. The Ministry of Communication, formally in charge of the investigations, provided enough information in the days following the crash to dispel speculation that foul play was involved. According to analysis, the best explanation so far is that heavy fog in the area contributed to pilot error that resulted in the helicopter crashing on a hillside. There is no evidence of mechanical failure or signs of sabotage.
The similarity to an earlier incident likely prompted the government's relative openness. The accident occurred three years after the death of the former interior secretary Juan Camilo Mourino in a plane crash in Mexico City. Mourino's death also initially generated suspicions of sabotage by drug traffickers and that speculation likely underpinned the government's response this time around.
Like Mourino, Blake was a close associate of President Felipe Calderon. He joined the administration in 2010 as Calderon's fourth interior secretary. Blake and Calderon grew close when both served in the lower chamber of congress between 2000 and 2003. Although he was a surprise choice to head the Interior Secretariat, he impressed with a low-key but effective approach to negotiating with the opposition.
The policy implications of Blake's death, however, will be limited. The Interior Secretariat plays an important role in government affairs ranging from congressional negotiations to elections, but it is more a facilitator than policymaker. Also, all major initiatives-such as labor reform-are on hold until the next president takes office (there is only one full congressional session before the July 2012 presidential election). The secretariat has also ceded much of its earlier oversight of security policy to other agencies. And while Blake was an effective mediator between different institutions involved in day-to-day security policy, his death will not disrupt policies designed and implemented by the Public Security Secretariat, the Secretariats of Defense and Navy, and the Attorney General's Department.
Carlos Ramirez is an analyst in Eurasia Group's Latin America practice.
FRANCISCO VEGA/AFP/Getty Images
By Ian Bremmer and David Gordon
An increasingly ferocious and costly battle with drug cartels will continue to occupy much of the Mexican government's time and resources in 2011. There's a serious risk of more dramatic episodes of violence -- including of higher-profile assassination attempts on government officials, security forces, and business figures.
Since taking office in Dec. 2006, President Felipe Calderon has presided over a startling rise in drug-related murders. The government is gaining ground in the fight against organized crime as the military and federal police generate important arrests, cartel members are killed, and drugs, cash, and arms are seized. The cartels are on the defensive, the government shows no signs of letting up, and coordination between Mexico and the United States on drug and security-related issues has improved dramatically.
But there are negative results, as well. Fragmentation of the leadership of the cartels has only increased the likelihood of deadly conflict within and among these organizations. Surviving traffickers try to ward off municipal and state cooperation with federal security efforts, increasing the likelihood of assassination of local officials. And with steady demand for narcotics in the United States and demand on the rise in Mexico, surviving and new trafficking groups will compete to fill any voids in the drug supply chain left by other groups.
More broadly, the political consensus in Mexico in support of the Calderon administration's tough approach to drug violence is weakening. The security issues were a plus for the president and his National Action Party (PAN) during his first two years in office, but that's no longer the case. This provides the opposition Institutional Revolutionary Party (PRI), which controls a majority of state and municipal governments, with incentives to push back against the federal government's efforts to consolidate weak, inefficient, and compromised municipal police forces.
In 2011, four patterns are likely to surface. First, violence will remain high. Second, the security threat to public officials, especially at the local level, will increase. Random acts against domestic and foreign businesses and even U.S. government assets, while a lesser concern, will also present risks. Third, the violence will remain largely concentrated along Mexico's northern border and in west coast states. Finally, ongoing Mexican and U.S. efforts against the cartels, especially in the border region, will make transportation to the United States increasingly difficult. As a result, traffickers will seek to develop local distribution networks. This will keep violence high in large, wealthier cities like Guadalajara and Mexico City, and increase cartel activity in tourist destinations like Acapulco and Cancun.
In the medium to long term, the Mexican government's counter-narcotics strategy -- mixing police and military operations with institutional reforms -- will yield more progress. But in the meantime, we're likely to see a lot more violence in 2011. The downside impact on Mexico's economy, particularly on the tourism sector, will continue.
On Friday, we'll discuss our final Top Risk for this year -- the risk that a wave of money flooding into emerging markets will include bad bets on a half dozen countries where investor confidence may well be misplaced.
Ian Bremmer is president of Eurasia Group. David Gordon is the firm's head of research.
By Allyson Benton
The drive-by murders of a U.S. consulate employee, her husband, and the Mexican husband of another employee in the Mexican border town of Ciudad Juarez this weekend have pushed Mexico's drug violence back into the American media spotlight. Even before these shootings, a spike in deadly violence linked to the Mexican government's campaign against drug cartels has provoked charges that President Felipe Calderon has started a war his government can't win.
The problem is a serious one for Mexico's security, its politics, and its people. But it's important to put this violence in perspective.
Rates of violent crime are on the rise in Mexico, but they remain lower than in the not-so-distant past -- and lower than today's violence in other Latin American countries of comparable size and wealth.
First, Mexico's murder rate has fallen sharply from a decade ago. The National Public Security System reports that in 2008, the most recent year with available data, 12 people per 100,000 were the victims of murder. In 1997, the number was 17. In the late 1980s, the murder rate hovered near 20, according to the National Statistics and Geographic Institute.
Second, drug-related murders are focused almost entirely in the northern and western states where cartel activity is concentrated. Murder rates among citizens not involved in the drug trade continue to decline.
Finally, here's a bit of regional perspective. Mexico's 2008 murder rate of 12 per 100,000 is less than half the most recent (2006) reported rates for Brazil (25). Colombia's murder rate has fallen dramatically thanks to President Alvaro Uribe's investment in security, but in 2009 the rate was still at 35. In Venezuela in 2008, the murder rate reached 58, a number that appears to be rising. Only Argentina, with 5.3 murders per 100,000 people in 2007, suffers from less deadly violence among the wealthier Latin American countries. The FBI puts the US murder rate at 5.4.
Foreign investors and business people also fear the risk of kidnapping in Mexico. Here again, the numbers put the problem in context. Kidnappings in Mexico have fallen from 1.1 per 100,000 people in 1997 to 0.8 in 2008 -- though the number may be increasing again. As for the regional comparison, though reliable data is hard to come by given that some victims choose not to report it, kidnapping rates in Venezuela have increased dramatically in recent years to an estimated 2.4 per 100,000 people. Colombia's rate has declined dramatically in recent years, from a high of 8.9 in 2000 to just 0.5 in 2009.
Violent crime, particularly involving the drug trade, is a serious problem for Mexico and the country's people. But context is crucial for issues so easily sensationalized.
Allyson Benton is a Latin America analyst at Eurasia Group.
Jesus Alcazar/AFP/Getty Images
By Eurasia Group analysts Allyson Benton and Patrick Esteruelas
As the Mexican government continues to face serious public security problems caused by the nation's drug cartels, fears are mounting that investors may lose confidence. In Mexico's current economic climate, where GDP could contract by as much as 8 percent in 2009, according to the OECD, any potential downward pressure on the economy sets off alarm bells.
Since he took office in 2006, President Felipe Calderon has pursued a twofold strategy against organized crime. The government has deployed the military to key drug trafficking regions in the north and along the west coast to root out cartels. It has also pushed important institutional reforms through congress to help make the country's police forces and judicial system more efficient. Nonetheless, the level of narcotrafficking violence has grown nearly threefold during Calderon's time in office, from an average of 2,195 deaths in 2006 and 2007 to an estimated 6,000 total deaths expected in 2009. In addition, drug traffickers appear to be moving into other illicit activities like extortion rackets and kidnapping rings, as the number of such reported crimes has risen dramatically in the past two years. These rising public security problems could suggest that Mexico is heading along the same path as Colombia, but there are some important distinctions to consider.
A few factors, in particular, make Mexico's state of affairs quite different from the situation in Colombia. First, the government still maintains control over its territory and has not ceded ground to narcotraffickers at any time. Second, although the fight against the cartels has resulted in higher rates of violence, the hostility remains largely contained in a few states and among narcotraffickers vying for improved positions within the cartels or between them. Third, Mexico's drug trafficking violence on a per capital basis remains significantly lower than Colombia's. Even after years of President Alvaro Uribe's successful hard-line security policy against Colombia's narcotraffickers, violence in this country remains quite high: There were a total of 16,000 reported homicides in 2008 in a country of 45 million people. In Mexico, in contrast, narcotrafficking related violence is expected to cause about 6,000 casualties in 2009, in a country of more than 100 million. Fourth, Mexico's narcotraffickers have not targeted civilians in order to support a campaign of fear against the government, even if they do continue to target public officials specifically involved in the fight against them.
In Colombia, in contrast, the nation's narcotraffickers embarked on a public fear campaign that targeted civilians and political elites, even if they had little to do with narcotrafficking or the fight against it. Finally, and most important, Mexico's narcotraffickers have no unifying political agenda. In contrast, Colombia's narcotraffickers -- in particular, the Revolutionary Armed Forces of Colombia (FARC) -- originated out of a drive to see their left-leaning interests represented in the nation's political and party system, and they still claim to have such political aims. A unifying political agenda, however tenuous, helps reinforce the structural integrity and thus durability of groups when under pressure from the government.
In the end, the stark contrasts between Mexico and Colombia explain why investor confidence in Mexico does not appear to have waned as a result of the country's public security woes. As long as President Calderon stays firm in his stance against organized crime, investors will continue to base their judgments about Mexico on the government's capacity to push through badly needed fiscal and economic reforms rather than the level of narcotrafficking violence.
FERNANDO CASTILLO/AFP/Getty Images
By Ian Bremmer
It's been a rough year for Mexico. The global economic downturn has inflicted heavy damage by reducing demand for Mexico's oil, depressing tourism, and limiting the flow of remittances into the country from Mexicans working in the United States. These are Mexico's three largest sources of foreign currency. The broader economy has taken a serious hit, one that will probably be worse than the officially expected 5.5 percent contraction.
Throw in swine flu, which has killed more than 100 people inside the country, sickened 6,000 more, and cost Mexican tourism billions of dollars on top of that. Add the government's war against drug cartels, which has killed thousands of civilians in recent months. And then Earthquakes in April and May contributed to a feeling that everything has gone wrong at once.
But Mexico is no failed state. President Felipe Calderon enjoys domestic approval numbers in the mid-60s, in part because a majority says his government is making progress in battles with the drug gangs. His National Action Party (PAN) will probably lose some seats in July's lower house elections. But those losses will profit the centrist Institutional Revolutionary Party (PRI), not the populist Party of the Democratic Revolution (PRD). In fact, after threatening to bring Mexico's government to a standstill following his very narrow loss in the 2006 presidential election, PRD heavyweight Andres Manuel Lopez Obrador has succeeded mainly in marginalizing himself. Government handling of swine flu won't be much of a factor in the elections, because some of the most seriously affected areas are governed by opposition parties.
The drug war could seriously complicate U.S.-Mexican relations by spilling over the border to a degree that the U.S. mainstream media can no longer ignore. And Calderon's government is unlikely to make more than marginal progress on key economic reforms for the foreseeable future. The fiscal picture just isn't quite dire enough to force the political compromises on which serious liberalization will depend.
Still, there are plenty of reasons why Mexico remains on a long-term path toward growth and greater prosperity. First, dependence on exports to the United States isn't such a good thing for the moment, but over the longer term, it will push Mexico to new heights. The U.S. economy will recover. Mexico's economy will follow. That's good for exports, remittances and tourism. U.S. investment will continue to flow into Mexico, particularly as U.S. market access to China becomes more difficult in years to come as the Chinese leadership begins to more actively favor Chinese companies at the expense of foreign competitors.
But the best news for Mexico became obvious during that much disputed 2006 election. Following Lopez Obrador's loss (by less than one percent of the vote), he declared victory and challenged the official result in court and in the streets. For days, tens of thousands of his supporters brought traffic to a standstill in central Mexico City. Yet, Mexico's courts and legislative bodies continued to function and markets avoided sustained damage. The election proved that Mexico's people have enough confidence in the country's public institutions to allow the democratic process to run its course.
Mexico is having a bad year. Recovery will take time. But it will recover its position as a politically stable and dynamic emerging market and a sound long-term investment bet.Brian Baer-Pool/Getty Images
By Preston Keat
Investors are currently worried about the credit worthiness of a number of emerging market countries, and their fears have been compounded by the global economic slowdown and credit crunch. Argentina, Hungary, Pakistan, Ukraine, and Venezuela are among the most serious cases. Will these countries be able to implement policies that will change perceptions, or will they end up radically devaluing their currencies or defaulting on their sovereign debt?
Sovereign credit and currency risk models can give indications of what they "need" to do to avoid a market crisis. But they have little to say about what they actually "will" do. It is this "willingness" component that is typically driven by politics.
Politicians usually understand that certain policy choices may generate a market crisis -- market participants warn them about the implications of their actions frequently, after all. So in order to forecast whether a country will follow through with the right policy mix to avoid a crisis, it is essential to understand both the policy objectives and political constraints facing the politicians in charge.
The following is a classic case from Mexico, featured in "The Fat Tail," where political dynamics trumped economic logic, and led to an economic crisis with long lasting political implications:
In late 1994, Jaime Serra Puche, a rising star in Mexico's Institutional Revolutionary Party (PRI) and the country's newly appointed finance minister, was expected to manage a currency devaluation without stirring up political or economic trouble. The celebrated negotiator, famous for delivering on the North American Free Trade Agreement (NAFTA) failed on both counts. Mexico experienced a massive, rapid devaluation of its currency (the peso), which helped to strip the PRI of its dominant hold on Mexico's political landscape.
Forced to marry the PRI's political agenda with the demands of modern capital markets, Serra was probably doomed to fail, and he became a scapegoat for the "peso crisis." But the real story is about the PRI and its approach to maintaining single-party dominance.
That decades-long dominance is a testament to the power of graft and political patronage. The party was essentially run as a massive Tammany Hall organization, dispensing economic benefits to the leadership of different social groups, such as trade unions, state and agricultural employees, and regional party bosses. The Peruvian novelist Mario Vargas Llosa aptly called PRI's rule "the perfect dictatorship."
Yet the manipulation of economic policy for political gain would ultimately break the PRI's grip on power. Its inability to retire its patronage machine contributed substantially to the 1994 peso crisis and the party's first ever political defeat two years later. This crisis illustrates perfectly how political factors can trigger a financial crisis.
In the years preceding the 1994 currency collapse, the PRI's Carlos Salinas administration (1988-94) carried out ambitious market-oriented economic reforms that produced a significant reduction in inflation and the implementation of NAFTA. Before the crisis, Mexico's economy was in erasonable shape, although a growing account deficit would probably have eventually made a currency devaluation necessary.
Economics alone cannot explain the peso crisis. A devaluation could have been technically managed to ensure a soft landing. As one group of observers pointed out, the Mexican currency crisis was driven by poor political responses: "The state of illiquidity at the end of 1994 was due to unexpected shocks that occurred throughout the year, and the inadequate policy responses to those shocks."
Mexico was running a current account deficit, at least in part, because it was entering an election year. To maintain the PRI's grip on power prior to the August 1994 presidential elections, the government embarked on a plan to improve economic conditions. This had been standard PRI operating procedure for the previous 70 years: every six years, the party would increase public spending before an election to buy off key groups of voters.
The Salinas government launched the usual PRI spending spree, allowed cheap credit, and avoided making a much-needed correction in the exchange rate. It was no secret during early 1994, before the December peso devaluation, that Mexico would need to devalue its currency-markets expected it, and many investors headed for the exits to beat the rush. But a devaluation or a rise in Mexican interest rates before an election was a political poison pill the PRI was not prepared to swallow. Not in 1994. Not six years after Carlos Salinas had won by the narrowest of margins, possibly as a result of electoral fraud.
Patronage politics were compounded by a number of other unexpected political events that intervened to force the Mexican government to artificially stabilize the economy to win popular support. First, the left-wing Zapatista guerrilla uprising in the state of Chiapas frightened foreign investors. Three months later, the PRI's initial presidential candidate, Luis Donaldo Colosio, was killed in Mexico's first high-profile political assassination in decades. Ernesto Zedillo, an uncharismatic technocrat, took his place. Finally, a series of kidnappings of prominent businessmen further exacerbated investor anxiety. The government's decision to try to mitigate the political turbulence rather than tackle the economic situation with sound corrections to fiscal, monetary, and exchange rate policies made matters worse.
So during 1994, the PRI needed, more than ever, to use economic means to keep its political machine running. It was not prepared to do what markets were implicitly asking for: effect an orderly devaluation of the Mexican currency and rein in spending. By keeping the peso strong and public spending high, essential voter blocs and interest groups were kept on the PRI's side. This strategy proved politically successful. In December 1994, Zedillo was elected president of Mexico. But economically, the PRI created a time bomb with a very short fuse. During the same month Zedillo was elected, Mexico finally decided to devalue its currency. Zedillo devalued the peso by 15%, to 4 pesos per dollar. This was too little and too late: the devaluation resulted in widespread market panic. The peso promptly went fell from 4 pesos to over 5.5 pesos per dollar and continued to weaken through the winter, reaching a low of 7.45 in March. This triggered the worst economic crisis in Mexico in half a century. It also raised concerns about a potential Mexican default on its sovereign debt, which was only averted through prompt intervention by the IMF and the U.S. government. They combined to stabilize the peso with a $50 billion bailout.
The "December mistake," as the crisis came to be known, also severely weakened Zedillo's political standing. Zedillo found himself caught between the need to legitimize his presidency by making concessions to the opposition to gain approval for his costly stabilization plan and the PRI's hard-line stance that he should make no economic or political concessions. Zedillo was forced to sacrifice party approval for the sake of the economy, and in 1996 he implemented an electoral reform that proved to be a significant step toward political liberalization. The next year, the PRI lost its absolute majority in the lower house of congress for the first time since it was created. It was the beginning of the end for the PRI's one-party rule: in 2000 an opposition presidential candidate (Vicente Fox) was elected for the first time in 71 years.
The most interesting angle to this story is how political logic and interests trumped economic rationality. Economists often assume that governments will choose to implement sound economic policies. The peso crisis was not a bolt from the blue in political terms. Economists knew the peso was overvalued; some notable ones had been advising a devaluation of the currency well before the crisis. Capital markets had also noticed the Mexican budgetary and currency imbalances, and foreign capital was leaving the country. However, what economic analysis did not capture is that the PRI could not devalue the peso, for political reasons. Ultimately, the pain and the cost that the Mexican economy and its people had to bear as the result of the devaluation were the price that the PRI had to pay for the continuation of its rule. Only by understanding the nature of the country's (or party's) specific political constraints does that become obvious.
Excerpt reprinted with permission from The Fat Tail: The Power of Political Knowledge for Strategic Investing published by Oxford University Press. Copyright © 2009 by Oxford University Press, Inc.
The Call, from Ian Bremmer, uses cutting-edge political science to predict the political future -- and how it will shape the global economy.