The Other Side of the Reforms

Luis Rubio

Ralf Dahrendorf, German-British professor, wrote that “conflict is a necessary factor in all processes of change”. As the reforms that the government has proposed begin to be implemented, the complexity that such a process entails becomes clear.

In its economic dimension, the thrust inherent in all reforms is that the incentives of all of the parties involved require alignment –sectors, social groups, and the government- in order for the country to progress. The sense of this concept is that currently a divergence lives on in the actions and motivations of the political and economic actors in Mexican society and that all that needs to be done is to align them. In conceptual terms, the proposal is impeccable but it suffers from a contradiction from the start: the problem does not lie in the incentives but in the objectives. That is, it’s not that some participants in the society or in the markets are mistaking their chosen path, but that, in effect, they espouse distinct objectives.

From the viewpoint of market functioning, informality –a prototypical example- presents a fundamental challenge due to the difficulty encountered in the carrying out of exchanges between formal and informal actors because the latter cannot emit invoices. For similar reasons, informal enterprises cannot grow because their condition of informality hampers their obtaining credit or attracting personnel with skills that are tradable in the modern marketplace. The question is whether informality is what the economists term a market “failure” (a mere distortion) or whether it is a distinct phenomenon.

A great deal of informality derives from the complexity of the  paperwork and red tape involved in registering new businesses and maintaining the condition of formality, above all in terms of tax-compliance and labor requirements, those of social security and the rest. In addition to the latter, there are circumstances that have made informality attractive and not only because informal businesses evade certain outlays (such as taxes) or costs (such as labor and tax bookkeeping) but that, for example, electricity costs go up when consumption rises or when the user is a company, and the costs of labor registration rises when the number of employees does.

All of these factors make the formalization of companies expensive but, as in the case of inconclusive (or failed) political transitions, they’re not the only explanation. If the entire problem were to reside in the cost of formalization, the fiscal, labor, and Social Security authorities would have an enormous incentive to diminish those costs in order to promote their legalization. However, the problem is more complex than that and has a distinct explanation.

Much of the cost of registering enterprises refers to municipal authorities, which have turned the informal businesspersons into a political base. For those authorities, the incentive does not lie in entrepreneurs becoming formalized, growing, and prospering, but in maintaining their political support base so that the career of the municipal president, representative or party member will flourish. That is, the politician’s incentives are in perfect alignment with informality and there is no reason, from their perspective, to modify the status quo. In addition to this political logic, there is an economic rationality that is inherent to the development of a political clientele: because what is not charged in the form of taxes is levied as informal dues, traditionally by representatives of the formal authority and, more recently, by organized crime.

Something similar is happening in the manufacturing sector that has not modernized, that is not highly productive and that is pummeled by imports, which frequently enter the country as contraband. That non-modern and highly unproductive industrial sector has survived in its present state in good measure due to subsidies and other means of protection, such as import duties. All of these instruments keep a vast sector of the economy alive and without modernization mainly because the authorities fear the unemployment that can be generated by the collapse of these companies.

But, as with informality, protection begins with a logic of serving the public (in this case fear of unemployment). While from an economic perspective it would be better to induce a gradual liberalization that would have the effect of modernizing these enterprises, it wouldn’t take politicians long to identify the benefit of perpetuating their hunting grounds. In this way, what begins as a job preservation strategy rapidly becomes a mechanism for developing political clienteles at the service of a private cause.

Informality and protection, those sources of unproductivity that deduct growth from the Mexican economy, possess a flawless clientele rationale that renders them permanent. Within the context of the political transition that the country is undergoing at present, clientelism has the effect of obstructing the democratic maturation of the country because it ministers to the beneficiaries of the control. That is, political clientelism lies behind informality and both undermine the growth of the economy: they subtract from it.

Thus, it is not that the country is incapable of reforming itself (the reforms that didn’t advance for years or those that were thwarted in the secondary stage), but instead that there are all-powerful interests that profit from the status quo.