AMLO Shoots Himself in the Foot

 

The ability to invest in fundamental public goods – human and physical capital — is a primary characteristic that differentiates one emerging market country from another. The process of building-out infrastructure is particularly fraught with risks because of the complexity and flexibility of contracts, so countries also differentiate themselves in their ability to conduct business ethically and complete projects at reasonable costs.

Over the past weeks, we have seen this process at work, with very different outcomes. On the one hand, in China two enormous infrastructure projects were inaugurated – 1. The Hong-Kong Macau Seabridge;2. The Hong-Kong to the Mainland Bullet-Train link. On the other hand, in Mexico the incoming president canceled the new Mexico City Airport, the country’s largest and most needed project.

The decision this week by Mexico’s President-Elect, Andres Manuel Lopez Obrador (AMLO), to scuttle the new $13.3 billion airport being built on the outskirts of Mexico City is emblematic of the political obstacles face by many developing countries to provide basic public goods.

No one disagrees that Mexico City needs a new airport. The city’s main  airport has been saturated since the 1990s, which is very problematic for a country with a growing tourisn industry. Nevertheless,  over the past two decades multiple proposals for a new airport have been abandoned after fierce opposition from indigenous communities and environmentalists.

AMLO’s opposition to the current project, which is about one third completed, has been known for over two years, and he expressed it many times during the presidential campaign. He decried the complexity and cost of the project, as well as environmental considerations. But his main objection has been a belief that the contracts were awarded without transparency to political cronies of the outgoing party.  During the campaign AMLO had said: “It has been proven that this airport is going to be very costly for the country… It’s a bottomless pit… This isn’t a good deal for the country, for Mexicans. It is for a small group of contractors, they are going to make a lot.”

In an essentially symbolic process aimed at justifying his decision, AMLO hastily organized a “popular referendum,”  to “let the people decide.” This occured this past Sunday and resulted in 70% of the one million votes counted agreeing with the candidate to cancel the project.

The following day, a visibly delighted AMLO held a press conference praising the exercise in direct democracy: “The citizens took a rational, democratic and efficient decision. The people decided. And we have to keep on creating the democratic habit. Where there is democracy, corruption does not exist.”

AMLO’s decision to cancel the project, the biggest infrastructure project of the administration of President Enrique Peña Nieto, will result in very large losses (estimated by the WSJ at $5 billion) for bondholders, suppliers and contractors, including Mexican magnate Carlos Slim, one the biggest supporters of the project.

What has just happened in Mexico is not unusual at all in emerging markets. Ironically, as many countries have become more democratic, they have also lost the capacity to invest in public goods. This is particularly true in Latin America where democratization since the 1980s has implied a more free and inquisitive press, a more activist judiciary and independent regulatory agencies captured by special interests. In a country like Brazil where this has been accompanied by a dramatic expansion of the welfare state aimed at providing “social justice,” the state has found itself handcuffed, without funds and facing an incredibly laborious process to get anything done.

Ironically, in many emerging markets when the “grease” of corruption is not allowed to work things come to a complete stop. One of the companies involved in the Mexico City airport project, Grupo Hermes, is related to Carlos Hank Gonzalez, a well known Mexican politician linked Pena Nieto’s party, who famously quipped “a poor politician is a poor politician.” In a similar vein, it used to be said about a former governor of Sao Paulo, “he may steal, but he gets things done.”

The case of China is interesting. China’s unprecedented build-out of public infrastructure since the 1980s is a truly remarkable achievement which has brought the quality of infrastructure from one of the worst in the world to a very high level. However, it is no secret that the construction sector is ridden with corruption and that many of the great fortunes of China have been created by the unethical ties between contractors and municipalities. Not surprisingly, when President Xi Xinping came to power several years ago promising a total crackdown on corruption, for a while, activity came to a stop.

The same goes for India, where kickbacks in construction contracts essentially finance all political campaigns. Politicians and construction contractors in India have long worked under the assumption that the relationship is mutually beneficial and sustainable as long as contractors deliver the promised service. This has resulted in a certain risk aversion, where politicians will only work with the most efficient and technically competent contractors.

A similar approach goes in Turkey, where construction firms have worked closely with the Erdogan regime. As in India, Erdogan has been a tough task-master, demanding competency from contractors.

It is interesting to look at the connection between infrastructure and corruption. We can do this by looking at both the World Economic Forum’s 2019 infrastructure ranking (WEF) and Transparency International’s Corruption Index (Link).The first chart below shows the top 100 of WEF’s infrastructure ranking of 142 countries. The next chart shows the top 90 of the 154 countries covered by the corruption index. A final chart looks at where the primary EM countries fall in this infrastructure-corruption matrix.

Transparency International, Corruption Ranking

 

We can draw some interesting insights from these charts. Basically, there are three distinct groups of countries:

Group 1 – Good Infrastructure with low cost of corruption.

• This includes all developed countries. We can venture to say that the ability to provide public goods at a low corruption cost is an intrinsic characteristic of development.
• In EM, only Chile, Taiwan and Poland make the cut, and, in this sense, these countries can really be considered developed. Korea is borderline. Corruption has become a major political and social-media issue in recent years, and it may well fall rapidly from the current high levels.

Group 2 – Relatively Good Infrastructure with High Corruption.

• These are the “He may steal, but he gets things done” countries. Corruption is high and costly, but politician and contractors have worked it out so that both sides benefit and infrastructure gets built.
• In EM, China is the master of this group; Mexico, Malaysia, Turkey, Thailand, India and South Africa also qualify.
• The direction that Mexico will take under AMLO will be interesting to see.

Group 3 – Bad Infrastructure with High Corruption.

• In these countries, politics have become so dysfunctional that the “return” on corruption is near zero. Included in this list are: Brazil, Argentina, Indonesia, Vietnam, Columbia, Peru and the Philippines. At the extreme of this category and in a class of their own are semi-failed states: for example, Venezuela and Nigeria.
• Most emblematic of this condition has been Venezuela under its Bolivarian regime. Thirty years ago, Venezuela had one of the best infrastructures of any developing country; today it ranks 118^th in the WEF report. Venezuela now has zero capacity to invest in public goods, all of its fiscal resources either dedicated to welfare programs or syphoned-off to the offshore accounts of regime cronies.
• Brazil faces an interesting situation today. It currently has the worst-of-all worlds, with very high corruption and close to zero capacity to carry out infrastructure public works. The election of Jair Bolsonaro was a repudiation of the kickback-driven political system, so going back to that model is impossible. To a considerable degree, the success of the new government will depend on quickly finding a new way to do business.

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Interview with Doug Kaas (RIA)