- - Thursday, July 12, 2012

After 12 years away from Mexico’s White House, Los Pinos, the Institutional Revolutionary Party (PRI) is back. Enrique Pena Nieto won the July 1 election by 7 percentage points, and his party substantially increased its power by winning gubernatorial and congressional races. The question now is what the once and future ruling party will do on its return. Mexico stands at the cusp of becoming a leading and globally competitive market-based democracy, but so far it has been held back by strong monopolies, a weak judicial system and, increasingly, basic safety concerns.

To overcome these challenges and move past its current subpar 3 percent gross domestic product (GDP) growth potential, Mexico’s new government needs to pass and implement several important economic and political reforms, including opening the energy sector, improving access to financial markets, and undertaking broad fiscal restructuring. Ingrained social and political opposition to these reforms may prove too powerful for President-elect Pena Nieto to overcome fully. However, piecemeal gains that increase productivity and growth are possible, especially in the short term.

The boldest steps are needed to revamp Mexico’s energy sector. Since 2004, oil output has dropped by nearly a quarter. The state-owned oil monopoly, Pemex, does not have sufficient financial and technological resources to reverse this trend, barely stabilizing production in 2010. Prospects of further output declines are worrisome, and the risks are both economic and political. Oil revenues account for a third of the government’s budget, and without changes, Mexico is poised to become a net oil importer even before Mr. Pena Nieto’s six-year term is complete.

Those opposing any opening of the energy sector point to the Mexican Constitution, which establishes state ownership of Mexico’s oil reserves. The Calderon administration’s modest 2008 energy-sector reform worked within these limits, enabling Pemex to offer only incentive-based service contracts to foreign firms. This scheme, however, has failed to entice widespread investment, as international oil companies remain hesitant to lend technology or participate in risky ventures without the upside of concessions or output-sharing contracts. Opening the sector, as Mr. Pena Nieto hinted he may try to do, will require forging tactical alliances to create the necessary two-thirds congressional majority.

Mexico’s growth was also held back by the financial sector’s legal and regulatory framework, which gives creditor protection short shrift in favor of a culture of nonpayment. Compared to other countries, Mexico’s domestic credit lending to the private sector is low, making up just 25 percent of GDP, compared to 86 percent in Chile and more than 100 percent in China. Hit hardest are small- and medium-size enterprises.

Mexico also needs to get its fiscal house in order, starting with a revamping of the country’s tax system, to make it more efficient and increase revenue in the process. On the expenditure side, it needs to phase out any subsidies that may divert public-sector pesos from more urgent programs. Reforms addressing Mexico’s social ills such as poverty and health care will go a long way toward garnering necessary popular support.

As important as economic reforms are for Mexico, so too are changes to the political system. Mexico is the only country in which no politician - from the president to the local mayor or council member - can be re-elected. While devised nearly a century ago to weaken the hold of caudillos, or strongmen, these laws encourage politicians to ignore citizens, because those who vote officials into office will not have the chance to do so again. Instead, the laws cater to the whims of party leaders, who hold sway over nominations to subsequent political posts. It also gives elected officials little incentive to invest in projects that take more than a few years to bear fruit - including reforming police forces, court systems or local bureaucracies - since they will no longer be in office to reap the electoral rewards. Mexico needs to change these laws, increasing the responsiveness of politicians to voters, if it hopes to create a stronger, more accountable government.

Winning this election may turn out to be the easy part for Mr. Pena Nieto. Once in office, he will have to govern and negotiate not just with opposition parties but with his own colleagues to get anything done. Backed by a unified PRI that had a single focus during the campaign, Mr. Pena Nieto will now have to unite differing interests and perspectives around his agenda. This cobbling together of broader coalitions and overcoming vested interests will require a great deal of political capital and finesse. If Enrique Pena Nieto succeeds, Mexico could be a very different place at the end of his term. If not, it will stagnate and be left behind in the global race.

Nader Nazmi is director of the Latin America Economic Research group at BNP Paribas in New York. Shannon O’Neil is Douglas Dillon Fellow for Latin America Studies at the Council on Foreign Relations and publishes the Latin America’s Moment blog at cfr.org.

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