Economic Survey of Mexico 2009: Managing the oil economy – can Mexico do it better?

 

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The following OECD assessment and recommendations summarise chapter 2 of the Economic Survey of Mexico published on 30 July 2009.

 

Contents

 

Mexico faces the challenge of managing oil revenue

Like other large oil-exporting countries, Mexico faces the challenge of managing the macroeconomic impact of oil revenue. While such revenue provides useful resources to the economy, its management raises a number of difficult issues. Oil revenue tends to be highly volatile and the budget risks channelling this volatility to the non oil parts of the economy; indeed, in Mexico, public consumption and GDP are highly volatile by OECD standards. In addition, because oil price fluctuations tend to be synchronized with the world economic cycle, the budget has a tendency for pro-cyclicality, with more spending in good times and spending cuts during downturns. This is reinforced in Mexico by the balanced-budget rule, which requires matching the swings in revenues by parallel swings in spending.

Mexico: Revenues and expenditure¹
As a share of GDP

1. Includes the traditional budget and lending operations. Gasoline subsidies recorded as spending and oil revenues in gross terms. LP and electricity subsidies not included.
Source: SHCP.

Thus, the fiscal framework should be adjusted to better shield public expenditure from the high volatility of oil revenue. In some countries, this is achieved by transferring the bulk of oil wealth to future generations, thus minimizing the injection of oil revenue into domestic demand. In Mexico, however, it seems both efficient and fair that the current generation uses oil revenue to finance economic development, so as to raise present as well as future living standards. Hence, fiscal policy should seek to smooth the injection of oil revenue into the economy over the cycle and avoid abrupt changes in public spending. Mexico established several oil-stabilization funds for this purpose but accumulated savings were capped at relatively low levels, which made the funds less useful for the purpose of macroeconomic stabilization. The recent decision to raise the maximum size of the oil stabilization funds goes in the right direction, but Mexico should consider eliminating this limit altogether. Also, like other oil-exporting countries, Mexico should seek to strengthen the counter cyclical framework of the budget, by adopting a new fiscal rule adjusted for the cycle. This would lead to prudent fiscal management practices including a) smooth growth of public spending in line with economic growth, b) automatic savings of oil revenue above what is implied by the rule when the oil price is high and c) automatic spending of accumulated savings when oil revenue is low. This would improve the role played by fiscal policy in macroeconomic management, would phase in gradually the injection of oil wealth into the economy and would contribute to long-term sustainability. The appropriate level of the limit on the structural non-oil deficit would depend on various factors, many of which come with large uncertainties, such as level of oil extraction. Given these uncertainties, the limit for the non-oil structural deficit should be reviewed regularly, so as to stabilize the net financial position of the public sector: increases in net financial assets would suggest that there is space for running a higher non-oil structural deficit, while increases in net financial liabilities would call for tightening the non-oil structural deficit target.

Public finances should be prepared for the long term decline of oil

Declining oil production will squeeze the contributions made by PEMEX to the budget over the next two decades, putting pressure on social spending and infrastructure development. It is therefore essential to prepare the public finances for this decline. The recent reforms to improve governance of Pemex are welcome, but more needs to be done. The policy of keeping gasoline prices constant in real terms - which at times implies lower prices than in the United States -, and subsidies on LP gas and electricity for household use, are inefficient and unfair. Instead, gasoline prices should move in line with international reference prices, an energy excise tax should be introduced, and subsidies on other energy products should be removed. Keeping gasoline and energy prices at present low levels comes with few benefits: empirical research shows that the subsidy is mainly captured by well-off social groups and tends therefore to be regressive; it also leads to a distortion in the allocation of resources, reducing interest for alternative and sustainable sources of energy; finally it encourages the burning of hydrocarbons, with detrimental effects on greenhouse gas emissions and global climate change. While helping low-income groups with the price of energy might be a legitimate social goal, this can be achieved in better ways, for instance with means tested income support schemes or subsidies to cooking gas in poor areas. It is also essential to boost the non-oil tax base. About 30-40% of budget revenues depend on oil, while non-oil taxes are only about 10% of GDP, which is low compared to peers or the social needs of Mexico. While recent tax reforms are welcome, more needs to be done to broaden the tax base. Further reform that tackles in particular exemptions in both direct and indirect taxes is needed in line with recommendations in the 2007 Survey. Finally, more needs to be done to raise the efficiency of public spending in education and health, as discussed below.

 

How to obtain this publication

 

The complete edition of the Economic Survey of Mexico is available from:

The Policy Brief (pdf format) can be downloaded in English. It contains the OECD assessment and recommendations.

 

Additional information

For further information please contact the Mexico Desk at the OECD Economics Department at eco.survey@oecd.org

The OECD Secretariat's report was prepared by Nicola Brandt, Cyrille Schwellnus and Tonje Lauritzen under the supervision of Patrick Lenain and Piritta Sorsa. Research assistance was provided by Roselyne Jamin.

 

 

 

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