Oil conundrum

OECD Economic Survey of Mexico 2009
OECD Observer

"This makes you my competitor", said oil pioneer Daniel Plainview on learning that his son wanted to quit the wells in California to drill his own in Mexico, in the 2007 movie, There will be Blood. And to be sure, Mexico did become a competitor, producing oil in the early 1900s and becoming the second largest producer in the Americas after the US by the 1990s.

However, with oil and gas exports being over 20% of Mexico's GDP in 2007, managing the impact of volatile oil revenue has been a challenge. According to the latest OECD economic survey of Mexico, because oil price fluctuations tend to be synchronized with the world economic cycle, the budget has a tendency to accentuate the swings, with more spending in good times and spending cuts during downturns. Moreover, Mexico's balanced-budget rule requires revenues to be matched by swings in spending, causing public finances to rise and fall like a nodding donkey.

The trick for policy is to smooth the injection of oil revenue into the economy over the business cycle and avoid abrupt changes in public spending.

Mexico has already established several oil-stabilisation funds for this purpose, but accumulated savings were capped at relatively low levels. A recent decision to raise the cap goes in the right direction, though Mexico should consider eliminating it altogether, the authors say. They warn that declining oil production will put pressure on public spending and suggest action, such as expanding the tax base since some 30-40% of budget revenues depend on oil, while non-oil taxes are only 10% of GDP.

Also, an energy excise tax should be introduced and some energy subsidies scrapped, because they benefit the well-off, encourage CO2 emissions and reduce interest in alternative energy sources.

Income support schemes can help low-income groups with their energy needs as can targeted subsidies. With the right reforms, Mexican oil would still be a competitor, but other areas of the economy would also benefit, and that would be good news for public finances.

ISBN 978-92-64-05441-7

©OECD Observer No 274, October 2009

Economic data


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