Don’t Celebrate Mexico’s Reforms Just Yet; Deficit spending is heading higher and the rule of law remains weak

Don’t Celebrate Mexico’s Reforms Just Yet

Deficit spending is heading higher and the rule of law remains weak.

MARY ANASTASIA O’GRADY

March 16, 2014 6:38 p.m. ET

Mexico’s Institutional Revolutionary Party (PRI) President Enrique Peña Nieto has been in office a mere 16 months, but his leadership has already changed the country’s international image. Constitutional reforms in energy, education and telecommunications, once thought to be impossible, have removed roadblocks to new legislation that could increase competitiveness and drive faster growth.

In many ways Mexico appears ready to leave behind its corporatist past in which business was under the control of a one-party state. Indeed, pundits have declared that success is a fait accompli.

But old habits die hard.

The southern partner of the North American Free Trade Agreement still has two gargantuan—and not unrelated—problems that threaten its progress. On a visit to Mexico in February I got an earful about both.

The first is Mr. Peña Nieto’s economic populism. He talks of markets and growth, but he’s also expanding the federal welfare state with new entitlements in health care and pensions. Even rich countries are having trouble keeping such promises nowadays. But Mexico also wants to skip the part about building wealth and just go straight to redistributing it. Deficit spending is heading higher than it has been for most of the past decade.

This is unsettling to many Mexicans who still remember the successive devaluations of the second half of the 20th century provoked by big-spenders with big dreams of big government.

After the 1994 peso crisis, the country swore off the deficit sauce. But the itch to spend other people’s money is woven into the politicians’ DNA and it gets worse when a windfall is on the horizon. Brazil got into trouble in the last few years after it discovered deep-sea oil and gas reserves and the ruling Workers’ Party immediately began spending the anticipated proceeds to win elections. Mexico’s politicians are not immune to such folly. It would be a pity if they were to interpret the opening of the oil sector to private investment as a blank check for the state.

Mr. Peña Nieto’s other big challenge is inherited: A weak rule of law.

Organized crime is flourishing in Mexico. Drug trafficking to U.S. consumers causes much of the violence. But extortion is also widespread. Millions of Mexicans are victims of local informal “tax” collectors. Sometimes these gangsters claim Robin Hood status, demanding payments on behalf of the “community.”

Yet hoodlums operating with impunity are a symptom of a larger problem. Seventy years of centralized PRI control and little economic freedom created a state culture of endemic corruption. Mexicans who wanted to get ahead were made to understand that it was better to cross the palms of the political class than go it alone.

President Ernesto Zedillo (1994-2000) began making institutional changes to challenge cronyism at the federal level and introduced political competition. In 2000 Vicente Fox of the National Action Party won the presidency, breaking the long PRI streak. Breaking with the PRI’s corporatist culture has proved more difficult. After more than a decade of improvements in transparency and accountability, there is still a long way to go.

Today the persistent shakedown of businesses at the local level is legendary. Investors complain that state and municipal governments too often use their power to extract payments—discretionary fees and bribes. Small and medium-size businesses are especially vulnerable.

Victims of government extortion rarely blow the whistle; it’s too dangerous. But they do talk. Transparency International, which publishes a “perceived corruption” index, ranked Mexico 106th out 177 countries in the world in 2013. It tied with Gabon and Niger and barely edged out Ethiopia.

The remaining vestiges of the old-style PRI is one reason organized crime, financed by the war on drugs, has been so hard to root out. When honest Mexicans go up against the gangsters they are not only bucking huge profit incentives but often powerful officials.

Congress and state-owned businesses have their own traditions. News in January that Pemex, the state-owned oil monopoly, purchased a financially troubled fertilizer company for a whopping $260 million raised eyebrows because the owner is a renowned political animal.

Building an ethical corporate and political culture requires minimizing the government’s role in the economy. This is why Mr. Peña Nieto’s energy reform is so crucial. Competition for Pemex will go a long way in reshaping Mexico.

Other developments do not inspire confidence. In the pending telecommunications reform, the state retains a role as a provider of broadband, diluting what is supposed to be a market reform in favor of political interests.

Mr. Peña Nieto is in a bind. To carry out his reforms, he needs the backing of the establishment. But he promised to pass anticorruption legislation and his legacy depends on it. He doesn’t have to do both at the same time. But he only has until the halfway mark in his six-year term to pass what matters, after which he will be a lame duck.