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					Sogang IIAS Research Series on International Affairs Vol. 2       39

   Foreign Direct Investment in Mexico after
             the Currency Crisis

                              Chong-Sup Kim
                    Graduate School of International Studies
                              Sogang University

1. Introduction

   After the foreign exchange crisis in Korea and Mexico, large-scale
foreign investment made in Korea and Mexico not only came to help
overcome the crisis but also to readjust their industry. However, in
Mexico there was a negative viewpoint for the foreign investment
because people thought the quick withdrawal of foreign investment
provided one reason to foreign exchange crisis. As a result, there is
more interest in foreign direct investment because it is steady and
long-termed compared to foreign portfolio investment.

   In viewpoint of macroeconomics, foreign direct investment can
provide stable supply of foreign exchange, and increase domestic
employment and exports. After foreign exchange crisis, foreign direct
investment has contributed to the supply of foreign exchange and the
expansion of international reserves. In view points of microeconomics,
foreign direct investment can induce to productivity increase,
introduction of new technology, and improved efficiency in
management. In the case of Mexico due to the crisis, the industries
40                          CHONG - SUP KIM

which hosted the more foreign direct investment had higher increases
both in employment and productivity.

     The purpose of this research is to analyze the positive effects of
foreign direct investment in process of recovering Mexican economy
from the foreign exchange crisis. In macroeconomics, we come to
analyze how much of foreign direct investment had contributed to the
stable supply of foreign exchange. Additionally we analyze the effects
of foreign direct investment on production, employment and wage.

2. Macroeconomic Background

     Mexico had been dependent on debt financing to attract foreign
currency in the 1970s and early 1980s. As the borrowing condition
deteriorated, Mexico had to face the foreign exchange crisis in 1982.
After the crisis it had been impossible to obtain a loan from the
international financial market for 10 years. Therefore since 1985, the
Mexican government had to begin launching structural reform
program in trade liberalization, stabilization, deregulation, financial
liberalization and privatization. By succeeding in the structural reform
and the debt negotiation, Mexico was then able to receive loans again
from the international financial market. As Mexico began opening the
capital market in 1990, over $20 billion of capital flowed in each year.
As a result, Mexico increased the international reserves but, real
exchange rate appreciated and consequently, the current account
deficit increased.

     Since 1993, foreign direct investment increased steadily due to the
expectation from the North American Free Trade Agreement, but as
most of the capital inflow was portfolio investment, Mexican
          Foreign Direct Investment in Mexico After the Currency Crisis    41

economy became very vulnerable to internal and external shocks. This
vulnerability of economy became true in 1994. Ever since the time
when the North American Free Trade Agreement came into effect in
the early of 1994, the political situation in Mexico became unstable,
and combining this with the increase in the interest rate in the U.S, it
caused a drastic drop in the capital inflow. As foreigners began to
withdraw funds from the Mexican bonds, there accumulated a strong
devaluation pressure for the exchange rate and the Central Bank could
not avoid the foreign exchange crisis even if the Central Bank had
spent most of the international reserve.

  After the crisis, from the first quarter of 1995 to the first quarter of
1996, Mexican economy had negative growth rate for 1 year and a
half. However, Mexico started to recover since the second quarter of
1996. GNP increased by 6% in the second quarter of 1996 and, by 7%
in the third quarter of 1996. The growth rate was 5.1% throughout the
whole year of 1996. Unemployment decreased to 4.1% in December
of 1996 compared to 7.6% in August of 1995.

       [Table 1] Mexicos Economic Indicators in 1995 and 1996

                                            1995                    1996
 Growth rate (%)                             -6.2                    5.1
 Inflation rate (%)                           52                    27.7
 Export (billion dollars)                    79.5                   96.0
 Export growth rate (%)                       33                     20
Source: Banco de México

  As shown in [table 1], the inflation rate in 1996 was 27.7% which is
far lower than 52% in 1995. The decrease in inflation rate led to a
42                         CHONG - SUP KIM

decline in the interest rates. The interest rate that was 110% in March
of 1995 decreased to 27.6% in the late 1996. Also, foreign exchange
market became stable. In 1996, the volatility of exchange was low
even compared to other countries that had stable economic conditions.
Composite Stock Price Index had dropped from 2400 in late 1994 to
1500 in February 1995 because of the currency crisis. However this
Index had increased since in late 1995, reaching 2700 in late 1995 and
exceeding 5000 in 1997. That resulted from the advantageous
international condition, a robust fiscal policy, consistent deregulation
and privatization, and a consistent monetary policy after the currency

     The most important cause of the recovery of the Mexican economy
was the increase in export and foreign direct investment. Export
increased by 33% in 1995 and by 18.7% in 1996. This involved
especially in the automobile sector, foreign sales, domestic sales, and
total sales increased by 25.4%, 56.1% and 35.6%, respectively. In
spite of the foreign exchange crisis, the foreign direct investment
increased continuously, as the Mexican government kept up with the
liberalizing policy after the crisis. Moreover, the devaluation of
exchange rate had contributed to improve the competitiveness of the
exporting sector.

     Due to NAFTA which entered into effect on 1st January of 1994,
Mexico was able to take more advantage of the huge U.S. market
easily. The share of export to U.S. in total export of Mexico had been
84%. Export to the U.S. increased by 28.4% and import from the U.S.
decreased by 1.7% in 1995, enabling Mexico to have 12.5 billion
dollars of trade surplus. Similarly, the trade balance with Canada
changed from 120 million dollar deficit to 600 million dollar surplus.
         Foreign Direct Investment in Mexico After the Currency Crisis   43

The trend in 1996 was similar to this, back in 1995.

  Since 1985, Mexico had progressed in the programs of trade
liberalization, deregulation, privatization and financial liberalization.
Therefore the economy system had            already been liberalized before
1994. IMF demanded to keep prolonging these reforms. Zedillos
government continued with the programs of privatization and
deregulation like Salinas government. As soon as Zedillos government
took power, it deregulated the sectors of transportation and
distribution of natural gas, allowing the private investment in these
sectors. Furthermore, Zedillos government had come to form the basis
for the privatization of railroad, liberalized the telecommunication
sector, privatized ports and airports, and began with the privatization
process of secondary petrochemical complex.

  These policies not only came to help foreigners obtain confidence
concerning the Mexican governments capacity to reform but also
brought some positive effects on the recovering economy. It was not
necessary for the government to give subsidies to insolvent enterprises
any longer and instead could improve the public finance with income
from privatization. In addition, the efficiency of other industries was
expected to improve, for the government had expanded the social
overhead capital. Foreigners believed that the policy of liberalization
should remain constantly going. As a result, the foreign direct
investment flowed in continuously. Since NAFTA had came into
effects, the inflow of capital in the form of foreign direct investment in
Mexico exceeded 74 billion dollars between 1994 and 2000. This
ultimately played a very significant role in overcoming the foreign
exchange crisis.
44                          CHONG - SUP KIM

3. The Change of Laws Relating Foreign Investment.

     Before the 1980s there was a negative viewpoint concerning the
foreign investment in Mexico. The basic idea behind this was that in a
semi-closed     economy,    foreign   investment   introduces   harsh
competition and reduces the profits of domestic companies in which
depend heavily on domestic demand. Mexico had limited foreign
direct investment due to the following reasons. Firstly, Mexico wanted
to protect the sectors that were improper to foreigners in reason for
national security and public interest. These sectors included those
related to army and elections. Secondly, for cases where the company
that invests, possibly becomes a monopoly, then the government needs
to limit the foreign investment. Thirdly, the government wanted to
protect the 'national wealth' against foreigners, limiting foreigners
from purchasing real estate. Fourthly, the government preferred debt
to stock issuing for the finance of a business project. Fifthly, by
limiting the share of foreigners, the government was in turn able to
make independent decisions regarding the technology type, firm
alliance, subsidies, etc.

     The Law to Promote the Mexican Investment and Restrict the
Foreign Investment(Ley para Promover la lnversion Mexicana y
Limitar la Inversion Extranjera: LPIMLIE) was made in 1973 by the
above reasons. As we can see from the name itself, LPIMLIE had
limited the investment of foreigners. LPIMLIE had categorized
economic sectors as follows.

     -sectors that only public company participate: Oil, primary
     petrochemicals, electricity, railroad, telegraphic communication,
     Satellite Communication, ports, airports, administration of
         Foreign Direct Investment in Mexico After the Currency Crisis      45

   heliports, etc.
  -sectors   that    only    Mexicans      can     participate:    Radio   TV,
   transportation, domestic airline·maritime transportation, gas
   transportation, etc.
  -sectors where the foreign share is limited to minority share: Mining
   up to 34%, secondary petrochemicals and auto-parts up to 40%
  -sectors where the foreign share is permitted up to 49%: When the
   Foreign Investment Commission authorizes, it can be permitted up
   to 100%

  However since the mid-80s, Mexico has gradually liberalized trade
and now become fairly open. In open-economy, domestic companies
cannot avoid competing with international companies any longer,
therefore the idea of limiting foreign investments for protecting
domestic companies does not make sense. Consequently, the law
based on foreign investment had to be revised to reflect this. So then
in 1989 LPIMLIE was revised in order for foreigners to get authorized
in investing more easily and small amount of investment be permitted

  The Law of Foreign Investment (Ley de Inversion Extranjera)
newly established in 1993, had been different from LPIMLIE as
Mexico decided to open the economy and the purpose of this law
changed the direction of promoting foreign investment. The new Law
of Foreign Investment however, still limited the sectors in which only
Mexicans could participate by Constitution. However again, because
the constitutional provision was interpreted in a more flexible way, the
Mexican government had then allowed for foreign investment in
sectors, in which that used to be traditionally be closed to foreigners.
46                            CHONG - SUP KIM

     In 1993, the only sectors that were limited to the participation of the
State were:

1) oil, 2) primary petrochemicals, 3) electricity, 4) atomic generation,
5) uranium mining, 6) telegram, 7) wireless telegraph, 8) post, 9) issue
of paper money, 10) copper keynote, 11) operation, administration,
and inspection of ports, airports and heliports

     Transportation by air, cable TV and express mail were excluded
from the category of sectors where investment was limited to the
Mexicans. However a credit association, development bank, and
professional services were newly included in this category. In the
other sectors, Foreign Investment Commission did not determine the
limit on foreign investment arbitrarily. Instead, the Commission
established a range in the limit of foreign share in each sector. But in
the case of some sectors, if foreigners wished to participate with more
than 49% of equity, then the authorization of the Commission was

     North American Free Trade Agreement (NAFTA) was negotiated at
around the same time when that foreign investment law was amended,
and because there was a provision about foreign investment in
NAFTA, it gave an effect to consolidate the tendency of liberalizing
the foreign investment. One purpose of North American Free Trade
Agreement was to expand investment opportunities in the territory of
member countries. Therefore, the principles of the MFN(Most
Favored Nation) treatment and national treatment were applied to the
investment of member countries. Also, uncertainty and risk for foreign
investors were substantially removed as NAFTA established that when
the State carry out confiscation, foreign investment must be accorded
         Foreign Direct Investment in Mexico After the Currency Crisis   47

national treatment and compensation must be made at market price.

  In the Decree of Foreign Investment Law promulgated in 1998,
transportation, storage and distribution of natural gas were excluded
from the category of sectors where only the State con participate. In
the electricity sector, self-generation of electricity, co-generation,
small scale generation, independent power production, production of
electricity for the purpose of export, import of electricity for self-
consumption, and emergent generation of electricity were excluded
from the category of sectors that were limited exclusively to the State.
The primary petrochemicals which were limited exclusively to the
State, were reduced to a few products including Methane, Propane,
Butane, Pentane, etc. The natural gas sector was also substantially
deregulated. Because of these deregulations and liberalizations, we
can say that Mexico is now a very open country with respect to
foreign investment.

4. Effect of foreign investment

  4.1 Stable supply of foreign exchange

  As explained before, the inflow of foreign capital consists of debt,
mainly being borrowed from the public sector especially in the 1970s
and the 1980s. However in the 1990s, it had changed to portfolio
investment, especially in government bonds as capital market opened.
Foreign direct investment began to increase entering into the year
1990 when the economic reform gained momentum, and with North
American Free Trade Agreement, it increased dramatically. Foreign
Direct Investment flowed in continuously despite the 1994 foreign
exchange crisis. The reasons of this increase are as follows:
48                           CHONG - SUP KIM

     First, because the objective of foreign direct investment is not short-
term profit, foreign direct investment is affected more by long-term
economic prospects than by short-term disturbance in the capital
market. The appreciation of the real exchange rate acted as an obstacle
to the tradable sector before the currency crisis in Mexico. Foreign
exchange crisis removed this overvaluation of the peso. Second,
economic instability could bring reversal of the liberalization policy,
but Zedillo's government fully accepted the IMF conditions and by
doing so could eradicate the concerns about policy reversal. Third,
privatization and deregulation, and amendment of foreign investment
law played an important role in increasing foreign direct investment.
As there was a decrease in the number of sectors in where foreign
investment was prohibited, and along with the investment procedure
was made transparent and simple, Mexico emerged as an attractive
country for investment to foreign investors.

     From the case of Mexico, we can observe that the foreign direct
investment is much more stable than debt or portfolio investment. In
the late 1970s, borrowing had been easy due to the abundant capital in
the international financial market. However since the 1980s, because
of the fact that the international interest rate increased and the public
debt of the Mexican government increased, international banks
resisted to roll-over the short-term loans and so, Mexico had to default
on its debt. This was the beginning of the debt crisis.

     In early 1990s, Mexico succeeded in the economic reform and
stabilization and when capital market was opened, large-scale foreign
capital came in mainly in the form of portfolio investment. One reason
to this was because the stabilization policy of Mexico was exchange-
rate-based stabilization. Under this policy government fixes exchange
         Foreign Direct Investment in Mexico After the Currency Crisis   49

rate or devaluates it a lot more slower than the price increase, in order
to lower down the inflation rate. As the interest rate is kept higher than
the devaluation rate, foreigners invest in bond markets aiming at the
difference in interest rates. There may be some risk in large-scale
devaluation, but this risk is not as high in the beginning of the policy.
However it could be seemed that the possibility of success is not so
high in the long-term because, it brings appreciation of the real
exchange rate and increases current account deficit. In this situation,
the economy become vulnerable to external or internal shocks, and
political or economic instability could cause mass withdrawal of
foreign investment. This may lead to currency crisis, as it had actually
happened in Mexico.

  The capital inflow in the form of debt or foreign portfolio
investment are very unstable compared to foreign direct investment. In
the 1980s, foreign direct investment had been very little, during the
time when Mexico was still suffering from the debt crisis of 1982 and
its growth rate was low. However, when Mexico succeeded in the
renegotiation of foreign debt and the large-scale privatization program
was launched, foreign direct investment began to increase. NAFTA
which came into effect in 1994, consolidated this trend. Foreign direct
investment began to increase steadily from the late 1980s onwards.
This is shown in [Figure 1].

  [Figure 1] shows that the inflow of foreign capital that was mainly
loan in the 1980s, changed to portfolio investment as capital market
opened in 1990. Before the foreign exchange crisis in 1994, the inflow
of foreign capital consisted mainly of investment in bonds. But
foreign portfolio investment decreased very fast in late 1994 and 1995
due to foreign exchange crisis , recording net outflow, and becoming
50                                       CHONG - SUP KIM

very volatile thereafter. As foreign exchange crisis broke out in East
Asia and Russia in 1997 and 1998, the whole Latin America was
especially affected by the contagion effect and Mexico was not an
exception. The effect appeared as a large drop in the inflow of foreign
capital. However, the main outflow was from portfolio investment
rather than foreign direct investment.

                                 [Figure 1] Capital Inflow in Mexico

     100 million dollars











                           II 90

                           II 91


                           II 93

                           II 94

                           II 95



                           II 98

                           II 99









































                                         Loans   FD I           i nvestm ent
                                                        P ortfolo I

     The share of loan in the capital inflow was lower in the 1990s
compared to the 1970s and the 80s. But, as international financial
assistance package became included in the figures of loans, loans look
like they have been increased in 1995. Thereafter loans seemed to
have decreased. But, this was because of the redemption of the
international financial assistance package. Therefore, if IMF relief
fund were to be excluded, there would not have appeared any
substantial change with the loan in 1995.

     If we compare foreign exchange crisis of Mexico with the case in
         Foreign Direct Investment in Mexico After the Currency Crisis   51

Korea, we can say that the process of foreign exchange crisis in
Mexico was significantly different from that in Korea. In the case of
Korea, international reserve had been exhausting due to the short-term
loan repayment of financial institutions mainly. While, in case of
Mexico, the reason had been because foreigners sold bonds of the
Mexican government and withdrew the money.

  The inflow of foreign direct investment was about 4.4 billion
dollars in each year of 1992 and 1993, and more than 10 billion
dollars in 1994. In 1995, more than 9 billion dollars of foreign direct
investment came in despite the foreign exchange crisis, and in 1997 it
increased to 12.8 billion dollars, which was the historic high. This was
because of the economic reform and NAFTA led foreigners to
maintain a positive view towards the growth prospects in spite of the
currency crisis. Export sector would benefit from the devaluation as
the competitiveness improved. Another important reason was the
amendment of the law that used to be an obstacle to foreign
investment. However the more significant reason was that direct
investment of the non-member countries that aimed at U. S. market
increased by North American Free Trade Agreement. In actual fact,
the share of United States in total foreign direct investment to Mexico
had decreased since North American Free Trade Agreement.

  As shown in [Table 2], the share of foreign direct investment in net
inflow of capital increased from 23% in 1990-1994 to 83% in 1997-
1999. On the other hand, loans decreased from around 18% of net
inflow to -18%(net outflow). The reason of this reduction in loans was
because Mexico had paid the international financial assistance
package given in 1995. Therefore, foreign direct investment has
become the most important source of foreign exchange since the
52                            CHONG - SUP KIM

foreign exchange crisis. Portfolio investment that had the largest share
of 60% in net capital inflow before the crisis, decreased to 36% of net
inflow after the foreign exchange crisis.

             [Table 2] Share in the net inflow of capital (%)

                      loans            FDI         Portfolio Investment
     1990-1994        0.18            0.23                 0.60
     1997-1999        -0.18           0.83                 0.36
Source: Own estimation with data from Banco de Mexico

[Table 3] Standard deviation of quaterly inflows (100 million dollars)

                      loans            FDI         Portfolio Investment
     1990-1994        22.6             8.3                 33.4
     1997-1999        32.3             9.4                 32.6
Source: Own estimation with data from Banco de Mexico

     Foreign direct investment is known to be far more stable than
portfolio investment because it flows in for long-term investment
purposes. From the calculation of the standard deviation for every
each element of capital inflow in Mexico, it appears that foreign direct
investment is the most stable. The standard deviation of loans was
higher in 1997-1999 than in 1990-1994 as can be seen in [Table 3].
That is, the volatility of loans had increased after the currency crisis.
Volatility of direct investment also increased after foreign exchange
crisis. However this result is too normal if we consider the larger
amount of foreign direct investment, and even if volatility of direct
investment increased, its standard deviation did not reach even to 1/3
of the other elements. The standard deviation of portfolio investment
was much higher than that of foreign direct investment before as well
           Foreign Direct Investment in Mexico After the Currency Crisis           53

as after the foreign exchange crisis. In conclusion, the foreign direct
investment increased after the currency crisis and provided a stable
source of foreign exchange.

       [Table 4] Foreign Investment in Asia and Latin America

                               Asia                        Latin America
                      FDI             Portfolio         FDI            Portfolio
    1991              6.09              3.38           11.34               14.71
    1992              6.34              5.27           13.90               30.35
    1993              6.67             16.49           12.04               61.11
    1994              6.53              8.3            24.86               60.85
    1995              8.66              17.0           26.05               1.67
    1996              9.51             20.04           39.34               39.98
    1997              12.13            12.63           50.66               39.74
    1998              4.86             -6.53             54                33.05
    1999              8.56             -3.31           45.63               2.08
Source: IMF

  The relative stability of foreign direct investment and portfolio
investment shows similar tendency in the other countries. We can
observe this tendency in the countries that were affected by the
contagion effect of the Mexican crisis in 1995, and also those affected
by the Asian crisis in 1997. When the Mexican crisis occurred in late
1994, the effect had spread to all Latin American countries and
therefore foreign portfolio investment in Latin America dropped
drastically. In 1996-97, the portfolio investment recovered, but it was
still substantially lower than the 1993-94 level. However the foreign
direct investment was not affected and it increased even steadily
despite the contagion effect. This contagion effect of the Mexican
crisis had also diffused even towards the Asian countries. Foreign
54                        CHONG - SUP KIM

portfolio investment in Asian countries decreased, whereas foreign
direct investment in this area increased. The reason seems to be that
Asian countries had looked more attractive in surface to the foreign
investors, rather than the economically unstable Latin American

     The trend was similar with the 1997 Asian crisis. As foreign
exchange crisis happened in Asian countries and Russia, portfolio
investment in Asian countries recorded net outflow in 1998 and 1999.
Foreign direct investment also decreased however in much smaller
degrees than the portfolio investment. Foreign exchange crisis in Asia
and Russia had affected Latin American countries, reducing the
portfolio investment to this region. But foreign direct investment was
not affected and even increased in this period. In conclusion, foreign
portfolio investment reacted sensitively on foreign exchange crisis of
the other countries, however on the other hand foreign direct
investment was stable. Therefore, foreign direct investment had been
founded to be a more stable source of foreign exchange than portfolio
investment or loans.

     4.2 Effect on employment

     Companies with foreign share contributed more into employment
than those without foreign share. In April of 1998, the number of
employees that were registered in Mexican Social Security Institute
(Instituto Mexicano de Seguro Social: IMSS) by companies with
foreign share was 2.12 million, 58% larger than 1.34 million in
December 1993. The share in the workers registered in IMSS, of
companies with foreign share, increased by 4.4% point, from 15.8% in
December 1993 to 20.2% in April 1998. Companies with foreign
         Foreign Direct Investment in Mexico After the Currency Crisis   55

direct investment generated 25% of new jobs. Considering that the
wage in companies with foreign share was 48% higher than the
average wage in 1998, we can say that foreign direct investment
increased employment       and wages.

  In the manufacturing sector which is the main sector that received
foreign direct investment, the employment by the companies with
foreign share increased by 55.8% from 0.89 million in 1993 to 1.39
million in 1998. This means that among the 1.04 million jobs
generated in the manufacturing sector, 47.7% was generated by
companies with foreign investment. Owing to this, the employment
share of companies with foreign investment in manufacturing sector
increased by 4.8% point; from 28.5% in 1993, to 33.3% in 1998. In
the service sector, employment of companies with foreign investment
increased from 120,000 to 300,000, generating more than 42.5% of
the new jobs.

  Analyzing by sub-sectors, in the sub-sector of electric and
electronics, the companies with foreign investment had generated
197,400 new jobs during 1994-1998. This contributed to the
employment growth rate of 64%, which was much higher than other
sectors. In the sub-sectors of rubber and plastic, companies with
foreign investment employed 23.4% of total workers in the sub-sector
and created 15,833 new jobs between 1994 and 1998. Owing to this,
employment in this sub-sector increased by 34%. In the sub-sector of
transportation equipment, companies with foreign investment
generated 55,799 new jobs, reaching an employment share of 61.4%
in the sub-sector. Companies with foreign investment generated
14,557 more jobs in the food industry, contributing 25.5% of increase
to employment of the sub-sector.
56                           CHONG - SUP KIM

     4.3 Effect on income

     The inflow of foreign direct investment is expected to increase the
capital stock and employment, and consequently increase the national
output. We can observe this effect also in Mexico. The best way to
measure this effect would be time-series analysis which analyzes the
relationship between the inflow of foreign direct investment and
output at national or sectoral level. However, since analysis period
does not take very long for time-series analysis and sectoral data of
FDI had not been available, we opted to take Mexico's 32 states as the
unit of analysis. In other words, the more FDI the state receives, the
higher growth rate of state output is expected. We used annual data
from 1995 to 1997 and employed regression analysis. We selected the
growth rate of gross state product as dependent variable, and the
logarithm of the ratio of FDI to gross product as independent variable.
The results of this regression analysis are shown in [Table 5]. As we
can see from [Table 5], the more FDI the state receives, the higher is,
the growth rate of the output. This effect is statistically significant.
FDI seems to explain about 12% of the output growth rate in each

                        [Table 5] Regression Results

 Dependent variable: State growth rate
 Independent variable             Constant             FDI/State Output
 Coefficien                         0.107                  0.0086
 t-value                            7.16                    3.57
 R = 0.119
          Foreign Direct Investment in Mexico After the Currency Crisis   57

5. Privatization and Foreign Direct Investment

  Public enterprises increased in number under import substitution
policy and were promoted due to the following reasons. First, as in the
case of nature monopoly, when there occur market failures, public
enterprise can be of the most efficient solution. Second, public
enterprise can distribute benefits to the people and realize social value
by providing goods at a low price. Third, economy can become less
vulnerable to external shock by expanding the public sector.

  In many cases, the public enterprise took an important role in the
import substitution industrialization strategy. When the market could
not substitute the imports, then the government itself had to intervene
in the production to substitute the imports. Specially, the government's
intervention could be justified more easily if there were structural
problems as sectoral bottlenecks. However, public enterprise extended
the participation from the strategic sector to the other sectors of the
economy where the market mechanism can efficiently work.
Regulation on private sector strengthened as public sector expanded.
The entry and exit of private companies in some industries in
particular, were regulated by the government and along with, price and
output were controlled. Many bureaucratic regulations were
introduced on the establishment of new companies. These restrictions
and control was a sign, reflecting the disbelief on the market

  Unfortunately, the intervention of the government resulted in
government failure and economic efficiency did not improve. The
reason was because the government did not have all the information
required to establish efficient policy, it did not select the best policy by
58                            CHONG - SUP KIM

interest group's pressure and bureaucracies' spoilage. Unnecessary
control and waste, and deficiency of suitable incentive system had
allowed the state enterprises to become inefficient.

     Foreign debt in Mexico came about the problem of state enterprises
in 1982, because 80% of public foreign debt had been borrowed from
state enterprises. The number of state enterprises increased from 845
to 1,155 during the government under Lopez Portillo (1976-1982) and
the financial situation of these public enterprises worsened throughout
this period. In 1981, public enterprises excluding PEMEX, the
Mexican state oil company, had to be responsible for the 50% of the
public sector deficit. Foreign exchange crisis had to happen because
public enterprises, were not able to earn the foreign exchange to pay
for the debt which had been borrowed from abroad.

     After the debt crisis, Mexico had to reduce the public deficit, and
the first target was the deficit in state public enterprises. Privatization
had been a good measure to secure liquidity in a short period from the
proceeds, as well as to remove the deficit of public enterprises that
had dried up the public finance. Besides, privatization could have the
following positive effects:

     -Through participation of the private sector, competition increases
      and microeconomic efficiency improves.
     -Debt can be reduced due to the income from the privatization
     -Public debt can be reduced in the long run because then, it forms
      no need to finance the deficit and additional investment of public
      enterprises, and because new tax base is being created by the
      privatized company.
     -With foreign participants, balance of payments may improve.
          Foreign Direct Investment in Mexico After the Currency Crisis   59

  -Macroeconomic stability may increase.
  -The quality of service may improve.
  -Capital market would develop by the broadening of the ownership

  Another difficulty in driving privatization had been the institutional
problem. If there is a person who purchases state enterprise, one has to
lower the product price after the privatization by the change in
government's policy or regulation, otherwise he may encounter a great
loss. If there is an uncertainty similar to this, those interested in
purchasing the company may not wish to participate in privatization.
This is because the least fact of even participating could present low
price reflecting the risk. Therefore, transparent institutional and
legislative framework was required to remove this uncertainty.

  Privatization and deregulation were first driven in the De la Madrid
administration. Privatization refers to the sale of public enterprises
whereas deregulation means the opening of a sector to private
investment. Between 1983 and 1987, De la Madrid government had
privatized 64 small and medium enterprises. Due to the deregulation,
the number of sectors in which only the State could participate,
decrease from 28 in 1982, to 13 in 1987. This time, sectors in which
the government had stopped participating were: car, medicine, fiber
etc. However due to the fact that the large state companies were not
privatized in this period, the effect on the industry and public finance
had been small. The revenue from privatization during this period was
2.6 billion dollars.

  After accumulating fair experience by the privatization of small
public enterprises, Mexico propelled the privatization program in
60                            CHONG - SUP KIM

Salinas administration. In 1989, the Mexican government decided to
privatize all public enterprises in sectors that were not designated as
strategic by the Constitution. The price of privatizing state companies
began to rise, as stabilization policy succeeded and the re-negotiation
of foreign debt reached an agreement in 1989. Large companies with
had monopoly power were privatized after 1988, including two airline
companies (Aeromexico and Mexicana), sugar company (Ingenieros
Azucareros), Mexico Telephone Company (Telmex), 18 city banks
and 2 steel companies(AHMSA, SICARTSA). The income from the
privatization of all the large companies with monopoly power had
reached much higher than before. Government revenue profited from
the privatization of 291 public enterprises between 1988 and 1991 was
14.5 billion dollars.

                 [Table 6] Proceeds from Privatization

                               1990    1991    1992    1993    1994 1990-94
Proceeds ($100 million) (A)     31.6 112.9      69.2    21.3     7.7   242.7
Number of Privatizations         57      48      35      22      12     174
(A)/GDP (%)                     1.47    4.83    2.83    0.85    0.29    2.00
(A)/Public expenditure1 (%)     2.41 16.11 12.76        3.48    1.65   11.48
Foreign capital (%)            31.60 36.58 18.72          0 71.77      28.74
FDI (%) (F)                    99.40 19.70      6.99      0       0    27.19
(F)/Total FDI                  37.68 17.08      2.06      0       0     7.85
1. Central Government expenditure
   Source: IDB

     As this revenue was used mainly to reduce the public debt,
privatization had come to help improve the public finance by reducing
the interest payment on the debt. The revenue had exceeded more than
16% of total government expenditure in 1991 as it can be seen in
                               Foreign Direct Investment in Mexico After the Currency Crisis                                  61

[Table 6]. This had increased the probability of success of the
stabilization policy and given higher confidence to foreigners on
which the economic reform would be maintained.

           Deregulation was driven abreast with privatization. The sectors of
petrochemical,                               telecommunication,                   highways,           electricity           were
deregulated and opened to private investment. In most cases where a
sector was opened to private investment, participation of foreign
investors would be permitted as well. Owing to this, foreign investors
participated in the privatization process. As shown in [Table 6], 30%
of the revenue from privatization in early 1990s was from foreign
investors. Therefore, privatization offered a good opportunity for FDI.
Among the total FDI made in 1990 and 1991, 37.68% and 17.08%
was made in relation with privatization respectively.

                                             [Figure 2] FDI by Sector: 1994-1999

 100 million dollars





























           When the privatization of the major sectors was completed, the
revenue and the FDI related to privatization, had decreased drastically.
62                          CHONG - SUP KIM

However, the privatization of state enterprises had an important
meaning in that it promoted the inflow of FDI in the privatized
companies first and to the manufacturing sector thereafter. FDI related
to privatization decreased remarkably after 1993 but the FDI in the
manufacturing sector, without any connection with privatization,
increased sharply as can be seen in [Figure 2].

     Therefore, privatization had exerted positive effects on the inflow
of FDI. First, when public enterprise was sold to foreign investors or a
consortium with foreign investors, large-scale foreign capital flowed
in. Second, FDI had increased after the company was sold to foreign
investors as an additional investment was made for the modernization
of equipment, new technology transfer and capacity enhancement.
Third, because privatization became accompanied by deregulation,
there was foreign investment in deregulated sectors. Fourth, capital
market developed and made it easier for foreigners to invest in
Mexico. Fifth, privatization had increased confidence in the
government policy and reduced the risk of investment.

6. Conclusion

     It is generally accepted that foreign portfolio investment is very
vulnerable to internal and external shocks, however the FDI is very
stable. It was found that this was true in the case of Mexico with
respect to the foreign exchange crisis of 1994 and the following crisis
in Asia, Russia and Brazil. Foreign exchange crisis affects not only the
country where the crisis breaks out however even into other countries
in a similar situation; drastically reducing foreign portfolio investment
through contagion effect.
         Foreign Direct Investment in Mexico After the Currency Crisis   63

  However, foreign direct investment had reacted in an entirely
different way. Far from decreasing after the currency crisis, FDI in
Mexico had increased. Neither East Asian nor Brazilian crisis reduced
FDI in Mexico. As a result, this ultimately shows that FDI is a more
stable source of foreign exchange than the foreign portfolio

  FDI brings various kinds positive effects. Since 1993, companies
with foreign share generated more new jobs than the others that were
without foreign share, and paid higher wages, contributing to increase
employment, as well as to improve the workers welfare. In addition,
FDI had also increased the GDP growth rate by increasing investment
and employment. In conclusion, we can say above all that FDI had
played an important role for Mexico to overcome its foreign exchange
crisis and accomplish higher economic growth.


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