Delegitimization of Mexico through lower oil prices

By Fester:

I've been tracking the narco-insurgency in Mexico for a while now as I think this is the foreign policy crisis that is most likely to be a 'surprise' during the next decade. The downturn in the price of oil is a destablizing influence for the Mexican central government. This is because Mexico is facing competing streams of hard currency with which different actors can do different things to cement or fracture competing primary loyalties.

Mexico's primary cash streams are remittances from citizens working out of the country; overwhelming in the United States, oil exports, manufacturing exports that are overwhelmingly sent to the United States, and drug smuggling. These cash flows are under threat.

Remittances are readily switchable from the overt economy to the gray and black markets. They are also under pressure from a weakening US economy; more specifically from a crushed construction sector. Manufacturing for export to the United States is weakening both to internal US demand dropping as we are in a consumer recession, and due to increased competition from near peer competitors. The higher price of petroleum has given Mexico some protection as Northern Mexico's proximity to US markets made transportation costs lower. However this protection is disappearing now as oil hits the mid-90s. Manufacturing is a job stream for Mexico, but it is not a massive cash stream for the state as it is a low margin business with plenty of near substitutes.

But the real problem for Mexican government authority and legitimacy is the two competing cash streams that are large and rent based. These streams are oil revenues for the government and smuggling/drug profits for the cartels. And here is where the Mexican government is in trouble over both the short term and the long term. This is different than the short term prognosis from earlier this year. The Mexican government receives roughly 40% of its revenue from oil exports. This is primarily economic rent that it collects. It is money available for redistribution, armed units, resiliency improvement, education and a host of other goods and services that can improve its standing of legitimacy and tie people's primary loyalties to the state.

Over the long run, Mexico is facing the Export Land problem.

Mexican oil fields are old and due to geology are producing less oil today than they were last year, and the year before that.  This is ongoing.  Assuming constant internal consumption, the amount available for export will decrease on an annual basis.  This is okay for a while IF prices are high and increasing as the total value of exports will be constant or increasing.

There are two problems with this scenario.  The first is the assumption that internal consumption is constant.  It is not.  It has been increasing and will continue to increase.  This decreases the quantity available for export.  The second is the drop in prices.  The combination of these two problems leads to significantly lower revenue for the state.  This has been the long run prognosis for a while.

However when oil prices were going parabolic, it provided a cushion for the Mexican state to make changes with little pain as it was flush with cash.  Now that prices are responding to both demand destruction due to increased efficiency and financial panic that indicates a global slow-down, that cushion is getting very thin at this time.  Legitimacy enhancing operations that previously were affordable and politically acceptable as choices were made in a non-zero sum environment will now be much harder to make as the fiscal and political environment is either a zero-sum or a negative sum environment.  Entrenched interests can not be easily bought off and re-aligned to the interests of legitimatizing the state. 

And when the state loses legitimacy and capacity to take care of basic needs, other actors and groups are willing and able to step in.  And one of those groups will be a diverse collection of gangs, mobs, militias and cartels. 

Comments

[Dave Schuler]

Neither the remittance system nor royalties from oil exports are remotely sustainable. The oil will run out and that time will be accelerated by PEMEX's enormous corruption. The remittance system exchanges different forms of social upheaval. Among the many problems is that when you export your young people they'll ultimately build lives of their own and be less willing to send money to the old country.

[fester]

Dave --- completely agree with you on remittances, however in the next few years (<5), I don't think this cycle will play out that far, but as an intermediate to long term problem --- hell yeah, creating new lives and new loyalties will reduce the flow of remittances.

[Dave Schuler]

It's already happening. Remittances have been flat or decreasing (on a seasonally adjusted basis) since the 2nd quarter of 2006. That's too early to be accounted for either by economic turndown or enhanced enforcement.