Brazil: The Invisible Expenses

Claudio L. S. Haddad

During this year, the Brazilian government promoted sterilized interventions in the FX market, acquiring international reserves , which now exceed $170 billion. It seems that upon reaching a certain amount, the government may use a share of its international reserves in a fund geared towards the promotion of industrial policy. In our view, this fund tends to further expand public expenses in a way that may damage the country, especially if we consider Brazil’s previous experiences with similar ideas.

A significant share of public expenses is ‘invisible’ and recorded ‘below the line’ in the budget through the increase in public spending. Take, for example, the data regarding the net and gross general public debt. The gross general public debt reached $0.87 trillion (R$1.66 trillion) in August, equivalent to 65.4% of GDP. From this amount we subtract receivables in an approximate amount of $0.27 trillion (or R$0.52 trillion) to reach the net public debt: $0.58 trillion (R$1.1 trillion) or 43.1% of GDP. The two main components from the receivables are the international reserves and the unemployment insurance funds (FAT) that reached $66.32 billion (R$126 billion) in August. Such an amount is transferred to the banking system for loan operations from the National Development Bank (BNDES), and the National Treasury receives, as revenue, 6% per year. A share of the public sector debt is external and hence denominated in US dollars. However, in August it accounted for $131 billion, less than half of the total international reserves. The remaining indebtedness is denominated in domestic currency (BRL) and accrues market rates (fixed or variable). Therefore, subtracting the revenues from the gross debt to reach the net debt may have an accounting meaning but lacks any economic reasoning. This is so because in the case of the unemployment insurance (FAT), the receivable grow at slower rate than the debt and in the case of international reserves there is a currency exposure in the balance sheet has gone against the Treasury lately. In brief, even in a scenario of balanced budget (or fiscal equilibrium) ‘above the line’, the net debt would still be increasing since the liabilities grows faster than the assets. The difference portraits the so-called ‘invisible expenses’ and reflect the subsidies not included in the government budget balance sheet.

Such expenses have always been present in the Brazilian economic policy. A major component that explains the recent increase in the public sector indebtedness is the 1998 sale of public securities indexed to the USD or ‘swaps’. These securities were acquired by the private sector and used as a ‘hedge’ against any devaluation. However, after the 1999 devaluation such sale proved to be extremely expensive for the Treasury besides being useless since it did not prevent the devaluation. Afterwards, with the implementation of a flexible exchange rate regime it was expected that the Treasury to get rid off such a ‘trap’. However, despite the government statements reassuring the continuation of the current exchange rate regime, it is also actively intervening in the exchange rate. This behavior shows that spending other people’s money is always easy, especially when it is done in an ‘invisible’ way.

The spending of tax payers’ money for the unattainable goal of preventing exchange rate appreciation ,has been justified on the grounds of an imaginary ‘Dutch disease’ and to irreparable damages to the country that are not clearly spelled out and which would possibly occur in unpredictable future. Still, it seems that the worst is yet to come and the government wants to move one step further by using the slogan of industrial policy to ‘help’ companies and industries that somehow are considered worthy in the industrial chain. This is because according to the news, the government may use a share of Brazil’s international reserves in a fund whose main goal is to support Brazilian companies that are willing expand abroad. The fund would provide the resources for the government to subsidize these companies. Alternatively, the fund could be used to raise the BNDES capital to alow it to increase the volume of subsidized loans to the private sector.

According to the government, the project was inspired by the sovereign wealth funds (SWF) that are being created with excess reserves by a few emergent markets like China. However, the goal of such funds is to spread out the risk into different asset categories. The assets of these funds are basically securities and stocks of companies located outside the country. However in the case of Brazil, in either one of the two alternatives, the government would transfer the international reserves to national entities in exchange of liabilities issued by them. The process would work as if the government gets into debt as a way to increase spending using the resources to subsidize companies. In turn, the project bears no similarity whatsoever with the asset allocation of the China’s SWF. Indeed, it resembles a new way of implementing industrial policy, with a ‘modern’ look that makes it less noticeable. The initial USD purchase by the government becomes irrelevant once it would avoid a greater demand from companies that were willing to invest abroad or it would be exchanged by domestic currency and geared towards an increase in investment in Brazil. In both cases, the final impact on the exchange rate would be zero. A similar impact would be achieved without Central Bank intervention.

The above idea has two major flaws. First it represents an increase in the expenditures that are not in the government balance sheet. Second, the idea necessarily implies that ‘winners’ will be chosen in advance to be the privileged ones. The international experiences with similar policies have displayed extremely poor outcomes. The French government, for example, wasted billion of Euros between 1960s and 1990s to attempt, without success, the creation of winners in the technology field¹. In Brazil we have countless examples of huge amount of resources wasted with similar policies.

In the last three years, we have observed an exceptional performance of the capital markets. In the same period, the financial system, through the ‘private equity’ funds have provided an increasing amount of resources to Brazilian companies. This important development proves that there is no shortage of financing for good projects and ideas. The sound Brazilian companies that need financing for export or internationalization purposes can obtain these resources through the private sector, without using the proposed fund. Such fund, in turn, tends to bring back a system of privileges and waste of resources, triggering a set of bad habits mostly because the core foundation of such system goes against a good allocation of resources.

Excess of money without ‘ownership’ and appropriate accounting is a key for disaster. The government should stop acquiring reserves. However, in case it keeps the same policy, it is fair to claim that the costs of such policy to be explicitly shown to society.

Measuring the Costs of International Reserve Accumulation in Brazil, Argentina and Mexico

In a previous piece here, we measured the sterilization costs associated with international reserve accumulation by Brazil, Argentina and Mexico, between 2003 and 2007. In this piece we measure the costs of holding reserves by these three countries. The main difference between the previous piece and this one is that we are not concerned about sterilization policies. The debate is relevant because according to Dani Rodrik the net reserve holdings of developing economies has increased sharply: from 6% of GDP in 1995 to 30% in 2004. This rise has led to a renewed focus on the costs and benefits of holding large amounts of reserves, and new research that tries to assess the scale of reserve holdings needed to limit emerging markets’ exposure to a sudden stop in private capital flows.

Rodrik does not provide a number for the optimal level of reserves but argues against the massive accumulation of reserves that developing economies have been building since the 1990s. In 2004, developing countries lost 1% of their GDP by holding more reserves than the amount required to cover three months of imports. He argues that current levels of reserve holdings are excessive.

Rodrik emphasizes that government reserve accumulation is often the counterpart of private sector flows, and argues that conceptually, the difference between the rate private lenders charge private sector borrowers for short-term external lending and the rate of return on the government’s reserve assets offers the best measure of the social cost of holding reserves. However, given data difficulties, Rodrik uses the historical average of the EMBI spread as a proxy for the private sector borrowing rate in his calculations. Rodrik defines excess reserves as reserve holdings greater than required to cover three months of imports and – using a 500 basis point spread – argues that the cost of excess reserves in 2004 is almost 1% of emerging economies’ GDP. His back of the envelope calculations also suggest that protection against the sharp output swings associated with sudden stops in capital flows is also worth about 1% of emerging market GDP. However, Rodrik argues that a decrease in the short-term external debt of emerging countries could reduce the risk of a sudden stop at a lower overall social cost than high levels of reserves.

Instead of using the EMBI spread, we used the yearly changes in the short term interest rates for each one of the three countries. In turn, following Rodrik’s methodology we use the Libor (6 months) as a proxy for short term external lending. Clearly, the difference between the short-term domestic interest rates and the Libor is the cost of accumulating reserves.

In table 1 we provide the net international reserves for each country. In table 2 we have the yearly change in net international reserves for each country, the percentage change in the short term interest rates and the 6 month Libor. In table 3, we calculate the interest rates differential defined as short term domestic interest rates minus the short term external interest rates. This difference (that we would rather not coin ‘risk premium’) is one way of measuring the opportunity costs of holding reserves. In table 4 we multiply the yearly change of international reserves by the interest rates differential and obtain the cost of accumulating reserves for each of the three countries on a yearly basis.

In the case of Brazil, the total cost of reserve accumulation between 2003 and 2007, is $13.3 billion. According to Lipschitz, Messmacheer and Mourmouras the estimates of the cost of holding reserves based on the difference between domestic and foreign interest rates tends to overstate the real cost of holding reserves, as most estimates ignore capital gains (and losses) from exchange rate changes. Since the currencies of most emerging markets have tended to depreciate over time, the costs of holding reserves are often overestimated.

Holding reserves is costly, but without reserves, a sudden stop in capital flows leads to sharp falls in consumption and output. According to Garcia and Soto developing countries should hold 10% of their GDP as international reserves to prevent sudden stops. Using this measure, we notice in table 5 that only Mexico did not aim to accumulate more than 10% of GDP as international reserves. In 2007, both Argentina and Brazil have more than 10% of its GDP as reserves. In brief, the idea that Brazil is accumulating ‘too much’ international reserves seems to be true. What remains to be seen is whether the Brazilian government will indeed implement a sovereign wealth fund to deal with excess reserves (international reserves minus short-term debt) or will create a fund to subsidize the domestic industries, as explained by Claudio Haddad.

Michael Bloomberg Blasts Protectionism

Michael Bloomberg Blasts Protectionism

The founder of the eponymous financial information services empire and current New York mayor Michael Bloomberg has just penned an op-ed in the Financial Times warning against mounting protectionist sentiment Stateside. Of course, Mayor Mike is hardly a disinterested party. His city benefits from a continued influx of foreign funds which would likely dissipate in the event of harsh protectionist measures. And, doubtlessly, his Bloomberg services would suffer a downturn in client activity should America get Dobbs-ified. Strongly pro-trade rhetoric does something that should prove instructive to media hounds out for a quick story: Mayor Mike isn't likely to run for office given that he is not making concessions to trade bashing rhetoric, now favored (or more likely affected) by even the likes of Hillary Clinton. There is nothing new in his arguments here, though they ought to prevent more silly stories on Bloomberg being a possible Jewish bachelor president.

The US economy has turned downward. People are feeling insecure. There are grave concerns about jobs moving overseas and about losing ground to Asian countries. Heavy pressures are mounting on the presidential candidates in both parties to pander to protectionist and even isolationist sentiments. The year, however, is 1992. Fortunately, the two parties’ candidates – Bill Clinton and George H.W. Bush – refuse to cave in to the pressure. They resist the special interests and stand strong for the long-term health of the American economy – and the country begins one of the greatest economic expansions of our history.

Today, we would do well to remember this lesson. It is easy to say that times have changed and take a more protectionist viewpoint. In fact, times have changed. Dramatic advances in technology and increased global trade are creating enormous economic opportunities, but also challenges. If America is to remain the world’s economic superpower, it must capitalise on the opportunities and confront the challenges. Countries that run away from globalisation in the 21st century – as with those that ran away from capitalism in the 20th century – will pay a heavy price for decades to come.

This week I am meeting with business leaders and government officials in Beijing and Shanghai to discuss the increasingly important relationship between the US and China – and the opportunities that we hold for each other. Some in the west believe that a growing Chinese economy is a threat. As a businessman, and now as mayor of the world’s largest financial capital, I believe the opposite is true: Chinese growth is, in fact, an opportunity for the US and the world, because the global economy is not a zero-sum game. We all share in each other’s success.

A growing China creates jobs for our export producers, keeps consumer prices low, expands our choice of goods and services, and increases our access to capital and talent. It also intensifies pressure on China itself to act responsibly on international issues, including security, trade, product safety and climate change. Our serious differences with China in these and other areas must be managed through engagement, not used as excuses to pursue politically expedient – and economically wrong-headed – short-term retaliatory measures.

What of the argument that China is taking jobs from America? Those jobs – if they did not go to China – would go somewhere else. The US government cannot keep them here through costly consumer-funded tariffs and taxpayer-funded subsidies. We learnt that lesson the hard way in the 1970s, when congressional protection of the automotive industry only hurt Detroit and helped its foreign competitors.

When politicians suggest that the benefits of globalisation go primarily to low-wage countries, they are playing to people’s fears. In fact, globalisation benefits every country that maximises its strategic advantages – and no country has more strategic advantages than the US. We are blessed with many of the best universities in the world; an enormous domestic consumer market; the most cutting-edge technological, medical and scientific research communities; deep capital markets that offer financing to businesses of every kind; and a level of freedom, opportunity and diversity that is unmatched.

These strategic advantages are a powerful magnet for the investors, entrepreneurs and innovators who are pioneering new fields and creating good jobs. But when the federal government builds walls around industries, it also blocks the exploration of new frontiers. Countries that offer open and fair access to new frontiers will be the winners in the new global economy, while those that build barriers will increasingly see their productivity decline and their innovators move elsewhere.

The opportunities created by globalisation will raise salaries and living standards for American families, but the transition can be difficult. The way to help workers affected by globalisation is not to prop up uncompetitive industries, but to assist the people who are displaced, so that they do not bear the costs of globalisation alone. This means strengthening our support of displaced workers and increasing investment in them, so that we can help them acquire the skills that the new economy demands.

At the same time, we have a responsibility to prepare today’s students for tomorrow’s economy. To compete in the 21st century, our students must learn more mathematics, more science, more engineering and more computer technology. Students around the world are outpacing American students in these subjects and unless we change that we will begin falling behind. That is why I have made public education reform a top priority in New York City and the progress we have begun making – substantial gains on math and English scores and graduation rates at 20-year highs – offers hope that by injecting accountability and standards into schools, we can aim for excellence, rather than settle for mediocrity.

Investing in infrastructure is equally critical to a nation’s competitiveness. China is finishing what will be the world’s largest airport terminal in Beijing. It is building 20,000km of railway lines and has already built the world’s fastest train, which runs at a top speed of 267mph. These are the kinds of investments we need more of in America if we are to keep pace with our international competition.

The new global economy holds enormous promise for fulfilling the American dream – that each of us can build a better life for our family. But capitalising on that promise requires courageous leadership. We had it in 1992 and we could use more of it now.

Mexico: Happy Anniversary, Senior Presidente

With a year under his belt, President Felipe Calderon celebrated his first anniversary in good spirits. The Mexican economy grew 3.7% y/y during the third quarter, beating the 2.8% y/y growth rate that was posted during the previous period. The government passed an important tax reform, which will add 1.2% of GDP in revenues. Although the fiscal reform did not achieve the intended goal of widening the contributor base, it should help reduce tax evasion and avoidance. At the same time, new forces are breathing life into the Mexican industrial sector. Unfortunately, President Calderon still faces important challenges at home that will prevent Mexico from achieving its full potential.

The winds of change are blowing across the Mexican industrial landscape. A decade ago, Mexico was the light manufacturing base for the U.S. However, China’s incorporation into the WTO was a heavy blow for Mexican industry. Much of the Maquila sector was idled due to the onslaught of cheap Asian goods. However, two new forces are fueling a revival. The first force is the growing protectionism in the U.S. Asian firms are using Mexico as a launch pad to penetrate the U.S. market. This is particularly evident in the television sector, where Asian manufacturers are moving their assembly operations into Mexico. Not only does this give them better access to the North American market, it helps them avoid the damage that often occurs during the long journey. The second force is the rapid escalation of health and pension benefits in the U.S. The spiraling costs, along with rising energy prices, are squeezing automobile manufacturers, forcing many to decamp to Mexico. The exodus is not limited to the automobile manufacturers, much of the auto parts industry is also heading south. Today, automobiles and auto parts represents 20%, or $50 billion, of Mexican exports to the U.S. This is several times larger than Mexican oil exports. The same is happening in the aerospace industry. Insurance premiums are weighing heavily on all labor-intensive industries in the U.S., forcing them to seek friendlier markets. Some experts believe that, in less than 10 years, Mexican aerospace components will outstrip automotive exports. These two forces are the reasons why net foreign direct investment (FDI) continues to pour into Mexico, despite the staunch competition from the other side of the Pacific.

Unfortunately, President Calderon still faces important challenges at home. The first, and most pressing, is the war against the drug cartels. The escalation of violence in Mexico is reaching Colombian proportions, with gruesome massacres of policemen, politicians, reporters and innocent bystanders. The drug lords are penetrating the Mexican political and military systems, using their enormous resources to corrupt and secure control. The drug industry is also moving some of its distribution into Mexico, creating new social problems in urban areas. At the same time, President Calderon faces an increasingly hostile political environment. He was able to wrest important concessions out of the major political parties, but there was a cost. Esther Gordillo, the leader of the Teacher’s Union (SNTE), defected from the PRI and was instrumental to President Calderon’s victory. However, she is cashing in her chips, securing lucrative concessions for the teachers unions, which will end up absorbing most of the additional revenues generated by the fiscal reforms. She is also blocking all initiatives to revamp the Mexican education system, a crucial element needed to increase the value-added content of the manufacturing process. Unfortunately, Mexico needs to improve its education system in order to move up the development curve.

As President Calderon completes his first year in office, he is accredited with several successes. He accomplished important reforms. The Mexican economy is on a solid track, and it has none of the excesses that are evident in the other parts of the region. However, Mexico still faces important challenges at home, especially on the social and political fronts. Unfortunately, President Calderon’s closest ally may the greatest impediment to Mexico realizing its full potential.

Chavez Launches Banco del Sur

The presidents of Venezuela, Brazil, Argentina, Bolivia, Ecuador and Paraguay have launched Banco del Sur, the new South American development bank.

It is expected to have capital of about $7bn (€4.8bn, £3.4bn) and designed to promote integration by funding infrastructure and energy projects.

Uruguay's president, Tabaré Vázquez, was also expected to sign the founding treaty yesterday evening when he arrived in Buenos Aires to attend the inauguration, as was Argentina's president, Cristina Fernández. Colombia, however, has pulled out of the project, the brainchild of the Venezuela's President Hugo Chávez, and Chile has remained on the sidelines.

Finance ministers of the seven countries now have two months to translate the ideals into practice.

Venezuela and Brazil are expected to be the biggest contributors but how the funding will be shared, how the bank based in Caracas will operate, what projects it will finance, and who its president will be, have yet to be defined.

Critics say the new bank is an expensive waste of time given the presence of other multilateral lenders such as the IMF and World Bank, but its founders say it will help free the region from "imperial" domination.

Chávez could be the comeback kid in '08

by Andres Oppenheimer

While Venezuelan President Hugo Chávez suffered a huge defeat in the Dec. 2 referendum -- independent election monitors say he lost by a wider margin than officially announced and only accepted his loss under pressure -- he may still make a significant comeback in 2008.

Internationally, Chávez could add new countries to his petrodollar-fueled ''anti-imperialist'' bloc and regain some regional stature as early as next year. There will be elections in Paraguay and the Dominican Republic in 2008, followed by elections in El Salvador in 2009.

It is not farfetched to think that -- for a small fraction of what he spent financing presidential campaigns in other countries -- he could add Paraguay, and later El Salvador, to his ''Bolivarian Alternative of the Peoples'' alliance.

This would expand his group of allied countries -- now made up of Cuba, Bolivia, Ecuador and Nicaragua -- and help him resurrect his standing as a regional leader.

To be sure, the opposition's victory in Venezuela's Dec. 2 referendum, which would have turned Venezuela into a Cuban-styled ''socialist'' country and allowed him to become president for life, will most likely force Chávez to spend more time focusing on consolidating his own support base at home.

Exit polls show that Chávez's defeat was not so much due to major gains by the opposition, but by the fact that Chávez's own supporters failed to turn out. Chávez got three million fewer voters last Sunday than in the 2006 presidential elections.

There were three recurrent concerns among Chávez's sympathizers: that he spent too much time abroad, that he gave out too much money to boost his image abroad instead of spending it on Venezuela's poor, and that his love affair with Cuba would lead to the abolishment of private property in Venezuela.

MORE TIME AT HOME

''Chávez will have to spend more time at home, and will have less time to focus on other countries,'' says Patricio Navia, a New York University professor who was in Caracas for the referendum. ``But he will have a major opportunity in Paraguay, where he can exert his influence with relatively little money, and no need to travel.''

Paraguay's leftist Liberation theology retired bishop Fernando Lugo, who political rivals in Paraguay describe as a Chávez ally, is a strong opposition candidate for the April 2008 elections, in a country that has been controlled by the Colorado Party for the past six decades. Lugo's campaign slogan is, ``change or death.''

In El Salvador, the rightist ARENA party will face a formidable challenge from the leftist Farabundo Martí National Liberation Front in 2009. The FMLN, which lost several elections fielding old-guard former Marxist guerrillas as its candidates, has recently nominated Mauricio Funes, a journalist who presents a more moderate and modern image, as its new presidential candidate.

At home in Venezuela, Chávez has a lot of things going for him. He still controls the Congress, the Supreme Court, 20 of 22 governorships, much of the media, and -- perhaps more importantly -- a windfall of petrodollars from Venezuela's oil bonanza.

Chávez will most likely concentrate on rebuilding his support base through a combination of spending more resources at home, and strengthening mechanisms of political control such as his Bolivarian Circles -- Cuban-styled neighborhood watch committees -- to make sure that recipients of state subsidies vote for him in the next elections.

DIVIDED OPPOSITION

In addition, Chávez may benefit from a divided opposition. While opposition leaders showed great political maturity by uniting to defeat Chávez's proposed constitutional reforms in the recent referendum, it's not so clear that they will be smart enough to unite on an anti-Chávez ticket in upcoming local and national elections.

My conclusion: Chávez's recovery or demise will depend -- as it always has -- on world oil prices.

His megalomania has always been directly proportional to oil prices: He campaigned as an anti-corruption democrat in 1998, when oil prices were at about $8 a barrel, and ended up proposing a constitution that would have allowed him to become an almighty president for life in 2007, when oil prices reached almost $100 a barrel.

As long as oil prices remain at their current levels, and the United States continues buying $34 billion a year in Venezuelan oil, Venezuela's narcissist-Leninist leader will remain pretty strong. He suffered a bigger blow than many of us expected, but he is by no means out of the game, neither at home nor abroad.

Lessons for Mexico in Brazil’s Boom

In the energy sector, open markets work

“God is Brazilian!” declared President Luiz Inácio Lula da Silva upon the recent discovery of massive new oil reserves off Brazil’s coast. But while God deserves a share of the credit for Brazil’s good fortune, so too does former president Fernando Henrique Cardoso, who fought to reform Brazil’s state oil company, Petrobras, in the mid-1990s. As Mexican president Felipe Calderón considers reforming Mexico’s national oil company, Pemex, he would do well to reflect on how Brazil became a world leader in energy production.

During his two administrations, from 1995 to 2003, Cardoso continued a privatization program initiated by a predecessor, President Fernando Collor de Mello, that transformed many of Brazil’s most prominent government-owned enterprises into publicly traded corporations. Companies such as Acesita (steel), Embraer (airplanes), Telebras (telephones), and CVRD: Companhia Vale do Rio Doce (mining) went public and have exhibited astonishing growth ever since—becoming respected world leaders in their industries and creating jobs and wealth for the Brazilian people.

None of these full privatizations, however, was as controversial as the partial privatization of the Brazilian oil company Petrobras. Shortly after taking office, Cardoso faced a strike by the oil workers’ union that shut down production for more than a month. Taking a page from the Margaret Thatcher and Ronald Reagan playbooks, Cardoso ordered the strikers to return to work or face dismissal. As gasoline and natural-gas supplies began to dwindle, public opinion turned in his favor, and Cardoso was able to push through legislation that turned Petrobras into a quasi-public corporation open to foreign investment and competition. The company raised capital through a listing on the New York Stock Exchange. Today, under Petrobras’s two-tier stock structure, the federal government maintains a slight majority of voting shares, but about 60 percent of overall equity is now in the hands of outside shareholders. Foreign operators can enter into partnership agreements with Petrobras or even bid against the company for offshore drilling rights. The creation of an independent board of directors has improved corporate governance, as has the adoption of international accounting standards and other transparency measures.

As a result, over the past decade Petrobras has gone from an inefficient industry laggard to one of the world’s most respected publicly traded energy firms. Petrobras is now a leader in deep-water oil exploration and natural-gas discovery and delivery. The company has also been at the forefront of Brazil’s efforts to produce efficient sugarcane-derived ethanol. Brazil’s domestic oil production and reserves have doubled, and Petrobras now has a market capitalization of over $200 billion, with operations in 27 countries, including the United States.

Mexico, on the other hand, forbids private investment in its energy sector, strictly interpreting its 1917 constitution’s statement that all subsoil resources belong to the Mexican people. But while many countries, from Canada to Norway to China, regard oil and gas reserves as national assets, only Mexico and North Korea ban any type of foreign—or even private domestic—investment in those industries. Private firms haven’t played any real role in Mexico’s energy sector since March 18, 1938, when President Lázaro Cárdenas seized the assets of British and American petroleum companies—a date still celebrated in Mexico as “Expropriation Day.”

As a result, Mexico’s national oil company, Pemex, is notoriously inefficient, less a corporation than an arm of the Mexican government. Because the government depends on Pemex to fund over a third of the federal budget, there is often little money left over to invest in expensive exploration in the Gulf of Mexico’s deep waters, where experts believe vast reserves of untapped oil and natural gas exist. And as a result of years of underinvestment, Mexico’s oil production has begun to stall.

President Calderón gave a major address in September, telling the Mexican people that “oil reserves have been consistently falling” and that the decline was “severely threatening” government finances. He warned that current reserves would last only nine years. Given the critical nature of the situation, one would think that Mexicans would be eager to open up their energy sector; but Mexico’s “oil patrimony” has long been a political third rail. Andres Manuel López Obrador, the populist who lost a close presidential race last year, recently held a rally in Mexico City and said he would call for mass demonstrations if the Calderón administration tries to “hand the nation’s oil over to foreigners.”

Public opinion polls, however, suggest that Mexicans may be moving away from López Obrador’s nineteenth-century heroic nationalism and toward Calderón’s twenty-first-century pro-business pragmatism. Common sense is gaining a foothold in Mexico, and the idea of at least “partnering” with foreign companies (such as Petrobras) is no longer taboo. In fact, Pemex has recently begun offering some very limited service contracts to foreign firms. Recently adopted legislation slightly reduces Pemex’s tax burden and promises billions in investment—but still much less than what experts say is needed. As energy analyst George Baker puts it, “Giving Pemex more money is all very well, but a commercial framework is needed to control, administer, and account for the money.”

What Mexico needs is Brazil-style reforms that would create a real corporate-governance structure for Pemex and open up the nation’s energy monopoly to foreign investment, competition, and expertise. President Calderón is expected to introduce an energy-reform proposal in the coming weeks. His campaign slogan in last year’s election was “mas inversion, mas empleos” (more investment, more jobs). The Brazil example shows how much a country can gain with that philosophy; will Calderón and Mexico have the will to adopt it?

* Charles Sahm directs a Latin American initiative for the Manhattan Institute and is president of Inter-American Advisors, LLC.