I. Introduction
It is generally recognized that urban public finances should be judged
on the grounds of their capacity to yield sufficient resources, redistribute
income from the wealthy to the poor and induce substitutions that will
reduce the social costs of providing goods and services in cities. While
a thorough evaluation of the exercise of public finances in Mexico City
is beyond the scope of this document, its purpose is to present new evidence
on how the local government has financed the provision of infrastructure
and services during the recent past, and to suggest new directions towards
the task of contributing to the economic development of the most ancient
and probably most complex large city of the Americas.
To that end, this paper summarizes the experience of Mexico City's finances
during the recent period of structural adjustment of the country from
1983 to 1994 and surveys the challenges ahead in the process of providing
the resources for its sustainable development. Since this case study concerns
one of the largest cities in the world, the present account should prove
useful towards examining and understanding the role of large city finances
during periods of economic changes and as a background for the discussion
of new ways of financing the provision of "public" (in the economic
sense) goods and services in the growing number of urbanized areas around
the world.
In order to put into context the financial trade-offs it faces, Section
I contains a brief description of the economic characteristics of Mexico
City. It provides a summary balance of the resources and of the structure
of production and employment in the city. It also stresses the role of
Mexico's new open economy in modifying the nature of the difficulties and
opportunities for the sustainable development of its capital city, site
of one fifth of the total population.
Section II reviews the structure of financing of the city during the
period of the broad structural reforms of the Mexican economy, 1983-1994.
We distinguish between 1) a period of rapidly deteriorating financial results
(1983-1988) characterized by inflation-induced real income decline, unexpected
increases in expenditures (notably those resulting from the September 1985
mega earthquake), mounting debt, and increasing transfers, and 2) a period
(1989-1994) of recuperation and consolidation of financial stability with
a growing share of own-source resources in total revenues and the virtual
elimination of federal transfers.
To analyze the challenges ahead and possible solutions to urban development
financing, Section III first describes the main fiscal relations of the
Federal District with the federation as background to understand the present
policy dilemmas. It then reviews the financial future of Mexico City and
concludes that, in spite of recent advances, expenditure needs will grow
at a larger rate than expected total income. Therefore, in order to avoid
financial distress, Mexico City will have to pursue a new financial strategy.
The last part of the section suggests actions to mitigate potential public
finance disequilibria, specially related to 1) the provision of publicly
provided but economically "private" goods and services like
water provision and transportation services, 2) new ways of financing needed
infrastructure and 3) the construction of new relationships between the
federal government and Mexico City.
A summary of the findings and final remarks are contained in the concluding
section of this paper, which stresses that in financing city development,
shortsightedness in policy instrumentation will sooner or later exact a
cost. Only when guided by sound economic principles can public finance
policy lead to sustainable growth with improved efficiency and equity.
I. An Overview of the Salient Features of the Economy of Mexico City
I. 1 Mexico City Resources and their Distribution
Demographics
After reaching its first million in the 1930's, the population of Mexico
City grew during the period 1950 to 1970 from 3 million to about 9 million
at an annual average rate of 5%. Although by 1990 the rate had decreased
to 2.7%, total population reached 15 million, with a population in the
Federal District of about 8.2 million, and the rest in the nearby municipalities.
Today's total population is more than 17 million in the Metropolitan Area
of Mexico City, with the population of the municipalities outnumbering
the Federal District for the first time ever (8.5 million in the Federal
District and close to 9 million in the municipalities).
At the same time, the changing structure of population by age group
(Chart 1) meant that the relative importance of spending needs suffered
considerable modifications: the demands of the 0-14 years group (notably
basic education see Chart 2 and child care) declined at the expense
of the satisfaction of necessities for young people in the 15-29 years
group (jobs, training, public transportation, water infrastructure and
low income housing); adults in the 30-59 group (transportation infrastructure
and mid-income housing); and senior citizens in the 60 years and over age
group (specialized health and public assistance).
Basic Infrastructure
The resources needed to satisfy the basic needs of the population are
considerable, yet these are being met: 98% of households have drinking
water and sewage, 99% have electricity, and 75% have more than three rooms.
Two thirds of total housing is owned by its dwellers.
Transportation infrastructure is by far the largest in the country,
yet it is insufficient for the approximately 3 million vehicles that circulate
and congest the main freeways and streets. The metro system has already
178 kilometers, but at least two more lines are needed in the next five
years. There are about 3 thousand public buses and 100,000 taxis, microbuses
and other privately provided transportation vehicles to satisfy the more
than 30 million daily trips originating in the metropolitan area.
Employment
Industrial employment is 20% of the city total, ten points lower than
what it was in 1970 (Chart 3). This trend has been re-enforced by the economic
development program of the country, oriented to the global markets, and
by increasing constraints to polluting activities. Today, seven out of
ten jobs are in the services, commerce and transport sectors and one in
every four in the public sector. Economic activity in the city is turning,
inevitably, towards the service sector. The challenge is to prevent the
loss of productivity that follows the decay of industrialization.
L 2 Mexico City in the Context of Recent Structural Adjustments
Perhaps the most significant symbol of Mexico's recent structural reform
process which started in the mid-eighties with the first decisive trade
opening measures is the North American Free Trade Agreement, NAFTA, between
Canada, the United States and Mexico signed in late 1993 and put into effect
on January 1st, 1994. It represented a milestone culminating a decade long
effort to reform both internal and external economic relations which included
reductions of public sector activities its enterprises went from 1155
to about 200 in the decade , deregulation, new legislation to promote
foreign investment, strengthening of competition and, in general, a new,
open attitude to participate and take advantage of the global economy.
NAFTA meant the abandonment of a long standing policy of overprotection
to industry, import substitution, and closing of the economy that prevailed
since Colonial times and through most of this century. While permitting
a rapid expansion of the domestic market during the two decades following
World War II, that scheme eventually exhausted its ability to promote sustainable
growth and therefore better living conditions for Mexico's fast growing
population.
Although a more open economy and free trade will help reduce regional
imbalances in the country, for Mexico City it represented the weakening
of its traditional engines of development a captive internal market and
the benefits arising from the presence and activities of a large and expanding
public sector.
Since the beginning of the structural reform process, the population
of the
metropolitan area of Mexico City has been increasing much less than
projected in the early eighties. (Had those projections turned true, total
population would have reached 25 million by now.) Furthermore, large manufacturing
firms are finding other locations like ports and other well communicated
medium size- cities in central Mexico more attractive, as illustrated
by the fact that not a single one of those firms has opened or significantly
expanded activities in Mexico City in the last 6 years.
In terms of employment, those regional adjustments to an open economy
have meant that jobs in the Northern border with the United States have
grown 4 times faster than they have in Mexico City. Although heavily influenced
by the generalized effects of Mexico's present economic crisis, open unemployment
in Mexico City is now more than 7% after bottoming down at less than 3%
in 1991. Underemployment, however, has remained high, at about 20% of the
labor force.
In summary, Mexico City has a disproportionate share of the country's
human and physical capital but also significant unsatisfied demands. Moreover
the new open economy has meant not only more competition from abroad, but
also new competitors within our borders. But creating and preserving job
opportunities while keeping reasonable levels of living conditions is without
doubt the major challenge for the economy of Mexico City in the present
context of economic crisis, adjustment processes and changing structure
of the population.
II. Public Finance Results during the Structural Adjustment Process
II. 1 The Period 1983-1988
Mexico City finances experienced contrasting results in the early and
later stages of the recent economic reform process. After Mexico's debt
crisis of 1982, mounting inflation rates (which reached 159% in 1987),
the contraction of real income, a natural disaster, and increases in public
spending needs (notably in the transportation sector, "municipalized"
in 1981), among other factors, combined to produce a deterioration of the
real tax base, mounting federal subsidies and an unserviceable debt burden.
That situation is reflected in the structure of the sources of total
income during the period (Table 1) which shows that own-source income (including,
revenues from publicly run enterprises) accounted on average for only 16%
of the budget.
Revenue sharing resulting from the 1980 fiscal coordination agreement
between the federal government, the Federal District, the states and the
municipios represented, in round numbers, an average of 60% of the total;
debt financing eventually transferred totally to the federal government
given the impossibility to service it about 9%; and direct transfers
especially to subsidize public transportation constituted the remaining
15% of the total.
Table 1.
Sources of Financing of Federal District Expenditures
1983-1988 and 1988-1994
-Average percentage share in total income-
| ITEM |
1983-1988 |
1988-1994 |
| Own source income * |
16%
|
56%
|
| Revenue sharing |
60%
|
40%
|
| Transfers |
15%
|
2%
|
| Debt financing |
9%
|
2%
|
* Includes all local taxes, fees, urban improvement and miscellaneous
contributions, and income from public sector enterprises.
II. 2 The Period 1988-1994
In December 1988 it was clear that the public finances of Mexico City
needed a major reform in order to revert the large operational deficit
and the consequent increase in federal transfers and new debt financing.
Therefore, the system especially the property tax structure and values,
and the policy of water pricing was revised in order to achieve an increase
in own source income and regain stability. Table I summarizes the results
of the fiscal reform process in terms of the structure of financing. Note
that the average share of own source income in total financing jumped from
16 to 56%; consequently the share of the revenue from fiscal coordination
dropped from 60 to 40%; while that of debt financing went from 9 to 2%.
Transfers represented on average 2% of total financing, from 15% in 1983-1988,
and were practically nil by the end of the period, when subsidies no longer
went to public transportation, but to poverty alleviation programs.
Table 2 shows in detail the evolution of the main sources of income.
Note that while total income grew 3.3% per year in real terms on average,
own- source income grew 16% per year, compensating for the real decrease
of 1.3% in the shared revenue received from the fiscal coordination funds.
Actually the flow of subsidies from the rest of the country to the Federal
District was reverted. Today Mexico City generates about one fourth of
total revenue- sharing funds but receives less than 14% (due to the redistributing
component of the sharing scheme introduced in 1990).
Table 2 also displays two significant results of the fiscal reform process:
a fivefold increase in real terms of property tax revenues and a four-fold
increase in water fees collected. There is no precedent for a city of this
size making an adjustment of that magnitude in such a short period of time.
On the expenditure side, Table 3 shows the evolution of the main lines
of the budget during 1989-1994. Note that due to the increase in total
income, Mexico City has been able to achieve high cumulative growth in
total government spending, 34% over the whole period, to reach a total
of 17.5 billion pesos in 1994.
Regarding the structure of expenditures by program, in 1994 the share
of transportation (infrastructure, equipment and service provision) was
the largest, 22% of the total; followed by general administration, 19%;
security and police programs, 18%; public services, 17%, urban infrastructure,
17%, and pollution control programs (mainly reforestation and emission
control expenditures), 8%.
III. The Financial Future of Mexico City
Faced with a smaller share of resources from the Mexican federal government,
Mexico City has aimed since 1989 at strengthening local public finances
and improving the tax structure by simplifying the structure but at the
same time preserving equity; augmenting the taxpayers base; preventing
the misuse of resources of future generations through better debt planning;
stimulating the participation of private and social sectors in the financing
and provision of goods and services; decentralizing government functions,
stimulating the participation of citizens in the expenditure process, achieving
fiscal accountability and the efficient distribution of responsibilities
between central and local authorities; and improving the role of federal
investment and policies in local and metropolitan priorities and in joint
financing of specific programs. However, given the considerable expenditure
levels expected, that effort will not be enough in the forthcoming years
and new strategies in terms of financing are required.
To explore possible urban financing alternatives for Mexico City, this
section reviews the present fiscal relations between the federal government
and Mexico City, since they are essential to understanding the directions
of new strategies. It then analyzes the sources of new spending pressures.
Finally it suggests several policy orientations and actions to cope with
the potential devastating effects of not pursuing new schemes for urban
financing.
III. 1 Financial Relationships between the Federal Government and
the Government of Mexico City
The financial relationships between the federal government and the government
of Mexico City are the starting point in understanding the dilemmas for
financing its urban development. The salient characteristics of such relationships
are:
1. Until 1994, Mexico City was an administrative department of the federal
government, but it had local authority on taxes as any sovereign State
and municipality.
2. Budget legislation was passed by the National Congress as an item
of. the federal legislation. Rules and regulations in budget matters were
those of the federal budget.
3. Decreasing transfers from the federal government and increasing revenue
from local taxes gave the local administration more leeway regarding the
composition and, eventually, the size of the budget. By 1992, the federal
government was concerned only with the size of the financial deficit, because
of its macroeconomic effect.
4. The political reform process has given Mexico City its own branches
of government. The Major will be elected in 1997; the local elected Assembly
is now the authorizing body in fiscal affairs.
5. This new autonomy of Mexico City is relative to its past dependence.
Even today, given the relative size of Mexico City's economy and budget,
the federal government retains the power to veto any deficit beyond limits
set by Public Sector Borrowing Requirements considerations. Mexico City's
debt has to be approved by the National Congress and is sovereign debt.
6. The States and Mexico City work in tax affairs within the framework
of a national fiscal coordinating pact. Rules of revenue sharing provide
for major redistribution from high-income, high-revenue entities (i.e.,
Mexico City) to the rest. Mexico City used to receive close to 25% of revenue
shared and now receives less than 14%.
7. The scheme looks like a "zero sum game", where Mexico City
has been the biggest net loser. Within the Coordinating Pact, proposals
are currently debated to break the constraints. Obviously Mexico City is
a vocal proponent of new rules.
8. Structural changes in process could mean new fiscal faculties to
the States and the Federal District. Special federal taxes on production
and services could be revoked, permitting the individual States and Mexico
City to determine and administrate them. These modifications would mean
more resources and also more fiscal responsibilities.
9. Mexico City and the federal government have had another major rift:
public transportation tariffs provided by the City. Macro considerations
have prevailed and the city today offers the least expensive service
in Mexico, probably the world. But the strain on local finances has reached
its limit: service has deteriorated, major investment has been postponed,
and anarchy has ruled the growth of concessionaire services, underfinanced
and also under tariff control.
III. 2 Financial Challenges and a New Strategy for Mexico City
The financial challenges of Mexico City
Although Mexico City has achieved financial independence and stability,
there are significant challenges for its public finances. Among the most
salient future expenditure requirements are: 1) the maintenance of the
now considerable outstanding infrastructure, 2) additional investments
in new infrastructure, since the existing one is already insufficient (notably
Metro lines, freeways, waterworks, garbage disposal facilities), 3) Increasing
current expenses, including payroll payments, that are growing significantly
more than revenues, 4) strengthening of priority programs, like police
and justice provision, that require substantial additional resources, 5)
special water supply and water treatment programs that are metropolitan
in coverage, 6) new mandated pollution control programs and 7) provisions
for considerably large programs like health and education that are
currently administered federally, but could be transferred to the City.
The elements of the strategy
In order to provide resources to satisfy the new expenditure levels,
the government of Mexico City must pursue a new strategy concerning the
management of its public finances. The main elements of the scheme are:
1. Restructuring and new practices in government activities
The "re-engineering" of government, the preservation of quality
in the provision of services, and improved accountability require the downsizing,
contracting out, and privatizing of activities currently provided by the
government of the Federal District. By introducing competitive elements,
the aim is to obtain efficiency gains, improve equity and keep society
well informed about the use of its resources.
2. New private-public balances in financing the provision of urban
services.
Current trends indicate that Mexico City public services cannot be financed
entirely by local taxes. Given the constraints and inconveniences of a
large level of indebtedness, services will have to be met by user charges.
This strategy would result in a new balance between genuinely public economic
goods and services which would continue to be financed by taxes and
those that are currently provided by the public sector, but are "private"
in the economic sense, i.e., those that can be "individualized"
and that must be provided at non zero marginal costs.
Charging correctly for the consumption of those services in the case
of Mexico City the cases of massive transportation and water supply and
treatment are especially relevant has two major advantages: the internalization
of external effects (such as congestion of freeways or the abatement of
the dangerously low acquifer level) and the induction of cost minimization
practices among the providers of those services.
It is technically possible to adapt user charges to a broad range of
urban public services, such as transportation, water, recreation, among
others. However, it must be recognized that they can be inequitable. Therefore,
they must be complemented by a system of subsidies for low income households.
3. Review of federal fiscal relationships
As commented before, the relationship between the Federal District and
the federal government can be characterized as follows: 1) there are no
more subsidies to Mexico City; 2) the share of the Federal District in
revenue shared has decreased; 3) there is central control of tariffs and
4) the federal government has veto power on deficit and debt.
From the point of view of Mexico City's finances, the agenda for improved
fiscal relationships between the federal government and the Federal District
includes 1) the recognition that significant investments are metropolitan
in nature and therefore federal and state funds are required, 2) a revision
of the revenue sharing scheme to secure enough shared resources given expected
financial requirements, 3) autonomy in the determination of transportation
tariffs, and 4) flexibility and eventual autonomy in debt management.
4. A review of local sources of revenue
Mexico City has achieved what no other entity in the country has. More
than 50% of the budget is financed by local revenues, which have grown
at a much higher rate than federal taxation, especially during the stabilization
phase of the Mexican economy. However, the allocation effects of the package
of taxes and fees must be studied more in depth and revised in order to
prevent distortionary effects. At the same time, an examination of the
incidence of the tax structure is needed in order to minimize inequities.
5. The development of new methods of financing public services
To complement current fiscal efforts, a new and aggressive policy to
capture positive and internalize negative externalities must be pursued.
Among the mechanisms to capture positive externalities is the design of
improved systems to detect and recover for the city the benefits of the
appreciation of real state values arising from improved public infrastructure.
And in the case of containing negative externalities, much is to be done
to force individual economic agents to internalize the negative effects
of automobile congestion and polluting activities both from mobile and
fixed sources, since the recent introduction of old vehicle taxes, waste
disposal fees and gasoline over-pricing will not be sufficient to contain
those adverse effects.
6. Improved mechanisms for public awareness of the fiscal challenges
Finally, public consciousness of the formidable task of financing services
in such a large scale is a crucial element in the new strategy. Only through
the provision of permanent information on public finance performance and
the evaluation of the results obtained can society participate and willingly
contribute to the financing of the collective needs of Mexico City.
Concluding Remarks
This paper has documented Mexico City's relative progress towards financial
self-sustainability, certainty and stability. It reminds, however, that
just to preserve that equilibrium Mexico City has to keep "running"
in the financial field at an even more rapid pace. An adequate choice of
policies and instruments can make it possible.
The case of Mexico City adds to the variety of experiences in urban
financing, that show the plight and blight of major cities throughout the
world. In spite of the difficulties, sound public finances can still contribute
to materialize through adequate financing of public infrastructure, urban
services and social programs to effectively redistribute opportunities
the significant economic potential of our cities.
