2012-10 Does the balance of payments constraint explain the slowdown in Mexican economic growth after trade liberalization?

This paper investigates why the average growth rate of the Mexican economy has been so disappointing since the trade liberalization of the late 1980s. Some previous work has argued that the growth slowdown can be attributed to a tightening of the balance of payments constraint on Mexico’s growth, due to a rise in the income elasticity of import demand that outweighed the increase in export growth after trade liberalization. However, such an aggregative approach ignores the distinction between imports of final goods and intermediate goods, which is important in Mexico due to the high intermediate import content of manufactures—especially those produced for export. To address this issue, this paper presents a disaggregated model of the balance of payments constraint with two types of exports (manufactured and primary commodities) and two types of imports (intermediate and final goods). The empirical results show that the balance of payments constrained (equilibrium) growth rate did not fall, but instead rose slightly post-liberalization, so this model cannot account for the actual growth slowdown. Instead, the analysis points to an important role for the real exchange rate, which is overlooked in the balance of payments constrained growth model, as well as internal obstacles and policies.