Breaking Mexico out of middle income trap

On December 1, Enrique Pena Nieto will assume office as Mexico’s new president — returning the long-ruling Institutional Revolutionary Party (PRI) to power after a dozen years in opposition.

Awaiting him — amid drug wars, public safety challenges, immigration issues with the U.S. — is an overarching challenge: helping his country break out of what economists call the “middle income trap.” In this “trap,” a developing country advances to the point where it cannot compete either with lower wage economies in manufacturing or with more advanced economies in high skill innovation. It’s stuck somewhere in the middle between.

Charting an escape from the middle income trap is at least as urgent as drug wars and immigration problems. Unless it finds a way out, Mexico’s global competitive position — already lagging thanks to institutional inertia — is at risk.

Because of its size, population and economic structure, Mexico is — and has to be - a significant manufacturing economy. For example, Mexico has become an important global auto parts producer. Still, inadequate investment rates, difficulties of forming companies, the lack of truly world-class sectoral players and leap-frog advances of more innovative global competitors have caused the country to stall — impeding delivery of a modern living standard to an aspiring population. Additionally, Mexico’s manufacturing is positioned squarely in sectors that compete directly with China and other lower-wage Asian economies. Even the market access advantages of NAFTA and Mexico’s nearly global network of free trade agreements can’t fully level the playing field. The reason is that Mexico’s problems are inside rather than outside the country.

Mexico needs increased productivity growth across the board, in both traded sectors such as manufacturing and non-traded sectors such as retail trade, logistics and financial services. Necessary reforms range from building a truly modern education system, to infrastructure improvements, to curbing corruption, to bringing Mexico’s huge informal economy into the open. It is a daunting agenda.

Yet Mexico’s new administration could green light one reform that would yield a big step forward without the major public investment or institutional upheavals most of the others require.

As the U.S.-based Information Technology and Innovation Foundation has noted, the widespread use of information and communications technology is a major driver of economic growth. Bringing high-speed internet to businesses, government and consumers is particularly powerful. Among OECD member countries, Mexico is dead last in broadband deployment. That’s ironic because, otherwise, Mexico’s teledensity (the number of telephones per person) is among the best in Latin America and is comparable to some European nations. One simple reform could boost Mexico’s competitiveness in broadband, too.

Mexico’s telecommunications and informatics sector is dominated by the privatized former government telecommunications monopoly, TELMEX. The dominance of this huge company has led to a commanding (70 percent) market share of cellular service. TELMEX benefits from Mexican regulators’ continued use of an outmoded system for billing cellular customers for calls, known as “calling party pays.” This system assures a constant stream of revenue from the company’s competitors, whose customers make most of their calls to the TELMEX’s land-line or cellular numbers.

Meanwhile, TELMEX offers its customers plans that minimize revenues flowing in the opposite direction. The result: Mexico’s smaller telecom providers pay into this behemoth, leaving them with less to invest in deploying broadband service more widely. Meanwhile, TELMEX faces limited competitive pressures to upgrade and expand its own broadband services throughout the nation. An OECD report from earlier this year, requested by Mexico’s government, estimated the resulting deadweight loss at 1.8 percent of GDP — a very costly choice for an economy that must grow to meet Mexicans’ needs.

A new president’s inauguration is always an opportunity for a fresh look and a new direction. Mexico’s telecommunications regulators could switch Mexico to a “bill and keep” payments system for completing cellular calls — one in which each competitor simply bills its customers for the services it provides and keeps the revenue. This is the system most widely used among other OECD nations — who so outpace Mexico in broadband coverage. German scholars Ralf Dewenter and Jorn Krusse have shown that, in mature cellular markets like Mexico’s, a bill and keep system stimulates competition, lowers user charges, and incentivizes customers to keep their phones turned on — to “stay connected” to their high-quality, wide-coverage networks.

The consequence would be more revenue for investment in faster, wider-scale broadband deployment by a wider number of telecom competitors — bringing the business efficiency and entrepreneurship benefits of the internet much faster to Mexico’s citizens and economy. This is just what the OECD’s report to the Mexican government recommended.

Recent decisions from the Mexican Supreme Court have strengthened the nation’s telecom regulators to open doors to reform. A case about to be decided will signal either a continuation or a reversal of this trend at the dawn of a new national administration.

President-elect Pena Nieto should make known his support for continued reform.

If the Supreme Court continues to back Mexico’s independent telecom regulators and if, with the backing of the new president, those regulators move Mexico to a more modern and incentivizing telecom revenue model, the resultant boost for Mexico’s broadband deployment would be a major step out of the middle income trap.

Dr. Alejandro Ibarra-Yunez is professor of Economics and Public Policy at the Monterrey Institute of Technology. Richard Bennett is a senior research fellow at the Information Technology and Innovation Foundation.

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