By George Friedman

A few years ago, I wrote about Mexico possibly becoming a failed state because of the effect of the cartels on the country. Mexico may have come close to that, but it stabilized itself and took a different course instead — one of impressive economic growth in the face of instability.

Mexican Economics

Discussion of national strategy normally begins with the question of national security. But a discussion of Mexico's strategy must begin with economics. This is because Mexico's neighbor is the United States, whose military power in North America denies Mexico military options that other nations might have. But proximity to the United States does not deny Mexico economic options. Indeed, while the United States overwhelms Mexico from a national security standpoint, it offers possibilities for economic growth.

Mexico is now the world's 14th-largest economy, just above South Korea and just below Australia. Its gross domestic product was $1.16 trillion in 2011. It grew by 3.8 percent in 2011 and 5.5 percent in 2010. Before a major contraction of 6.9 percent in 2009 following the 2008 crisis, Mexico's GDP grew by an average of 3.3 percent in the five years between 2004 and 2008. When looked at in terms of purchasing power parity, a measure of GDP in terms of actual purchasing power, Mexico is the 11th-largest economy in the world, just behind France and Italy. It is also forecast to grow at just below 4 percent again this year, despite slowing global economic trends, thanks in part to rising U.S. consumption.

Total economic size and growth is extremely important to total national power. But Mexico has a single profound economic problem: According to the Organization for Economic Co-operation and Development, Mexico has the second-highest level of inequality among member nations. More than 50 percent of Mexico's population lives in poverty, and some 14.9 percent of its people live in intense poverty, meaning they have difficulty securing the necessities of life. At the same time, Mexico is home to the richest man in the world, telecommunications mogul Carlos Slim.

Mexico ranked only 62nd in per capita GDP in 2011; China, on the other hand, ranked 91st. No one would dispute that China is a significant national power. Few would dispute that China suffers from social instability. This means that in terms of evaluating Mexico's role in the international system, we must look at the aggregate numbers. Given those numbers, Mexico has entered the ranks of the leading economic powers and is growing more quickly than nations ahead of it. When we look at the distribution of wealth, the internal reality is that, like China, Mexico has deep weaknesses.

The primary strategic problem for Mexico is the potential for internal instability driven by inequality. Northern and central Mexico have the highest human development index, nearly on the European level, while the mountainous, southernmost states are well below that level. Mexican inequality is geographically defined, though even the wealthiest regions have significant pockets of inequality. We must remember that this is not Western-style gradient inequality, but cliff inequality where the poor live utterly different lives from even the middle class.

Mexico is using classic tools for managing this problem. Since poverty imposes limits to domestic consumption, Mexico is an exporter. It exported $349.6 billion in 2011, which means it derives just under 30 percent of its GDP from exports. This is just above the Chinese level and creates a serious vulnerability in Mexico's economy, since it becomes dependent on other countries' appetite for Mexican goods.

This is compounded by the fact that 78.5 percent of Mexico's exports go to the United States. That means that 23.8 percent of Mexico's GDP depends on the appetite of the American markets. On the flip side, 48.8 percent of its imports come from the United States, making it an asymmetric relationship. Although both sides need the exports, Mexico must have them. The United States benefits from them but not on the same order.

Relations With the United States

This leads to Mexico's second strategic problem: its relationship with the United States. When we look back to the early 19th century, it was not clear that the United States would be the dominant power in North America. The United States was a small, poorly integrated country hugging the East Coast. Mexico was much more developed, with a more substantial military and economy. At first glance, Mexico ought to have been the dominant power in North America.

But Mexico had two problems. The first was internal instability caused by the social factors that remain in place, namely Mexico's massive, regionally focused inequality. The second was that the lands north of the Rio Grande line (referred to as Rio Bravo del Norte by the Mexicans) were sparsely settled and difficult to defend. The terrain between the Mexican heartland and the northern territories from Texas to California were difficult to reach from the south. The cost of maintaining a military force able to protect this area was prohibitive.

From the American point of view, Mexico — and particularly the Mexican presence in Texas — represented a strategic threat to American interests. The development of the Louisiana Purchase into the breadbasket of the United States depended on the Ohio-Mississippi-Missouri river system, which was navigable and the primary mode of export. Mexico, with its border on the Sabine River separating it from Louisiana, was positioned to cut the Mississippi. The strategic need to secure sea approaches through the Caribbean to the vulnerable Mexican east coast put Mexico in direct conflict with U.S. interests.

The decision by U.S. President Andrew Jackson to send Sam Houston on a covert mission into Texas to foment a rising of American settlers there was based in part on his obsession with New Orleans and the Mississippi River, which Jackson had fought for in 1815. The Texas rising was countered by a Mexican army moving north into Texas. Its problem was that the Mexican army, drawn to a great extent from the poorest elements of Mexican society in that country's south, had to pass through the desert and mountains of the region and suffered from extremely cold and snowy weather. The Mexican soldiers arrived at San Antonio exhausted, and while they defeated the garrison there, they were not able to defeat the force at San Jacinto (near present-day Houston) and were themselves defeated.

The region that separated the heart of Texas from the heart of Mexico was a barrier for military movement that undermined Mexico's ability to hold its northern territory. The geographic weakness of Mexico — this hostile region coupled with long and difficult-to-defend coastlines and no navy — extended west to the Pacific. It created a borderland that had two characteristics. It was of little economic value, and it was inherently difficult to police due to the terrain. It separated the two countries, but it became a low-level friction point throughout history, with smuggling and banditry on both sides at various times. It was a perfect border in the sense that it created a buffer, but it was an ongoing problem because it could not be easily controlled.

The defeat in Texas and during the Mexican-American War cost Mexico its northern territories. It created a permanent political issue between the two countries, one that Mexico could not effectively remedy. The defeat in the wars continued to destabilize Mexico. Although the northern territories were not central to Mexico's national interest, their loss created a crisis of confidence in successive regimes that further irritated the core social problem of massive inequality. For the past century and a half, Mexico has lived with an ongoing inferiority complex toward and resentment of the United States.

The war created another reality between the two countries: a borderland that was a unique entity, part of both countries and part of neither country. The borderland's geography had defeated the Mexican army. It now became a frontier that neither side could control. During the ongoing unrest surrounding the Mexican Revolution, it became a refuge for figures such as Pancho Villa, pursued by U.S. Gen. John J. Pershing after Villa raided American towns. It would not be fair to call it a no-man's-land. It was an every-man's-land, with its own rules, frequently violent, never suppressed.

The drug trade has replaced the cattle rustling of the 19th century, but the essential principle remains the same. Cocaine, marijuana and a number of other drugs are being shipped to the United States. All are imported or produced in Mexico at a low cost and then re-exported or exported into the United States. The price in the United States, where the products are illegal and in great demand, is substantially higher than in Mexico. That means that the price differential between drugs in Mexico and drugs in the United States creates an attractive market. This typically happens when one country prohibits a widely desired product readily available in a neighboring country.

This creates a substantial inflow of wealth into Mexico, though the precise size of this inflow is difficult to gauge. The precise amount of cross-border trade is uncertain, but one number frequently used is $40 billion a year. This would mean narcotic sales represent an 11.4 percent addition to total exports. But this underestimates the importance of narcotics, because profit margins would tend to be much higher on drugs than on industrial products. Assuming that the profit margin on legal exports is 10 percent (a very high estimate), legal exports would generate about $35 billion a year in profits. Assuming the margin on drugs is 80 percent, then the profit on them is $32 billion a year, almost matching profits on legal exports.

These numbers are all guesses, of course. The amount of money returned to Mexico as opposed to kept in U.S. or other banks is unknown. The precise amount of the trade is uncertain and profit margins are difficult to calculate. What can be known is that the trade is likely an off-the-books stimulant to the Mexican economy, generated by the price differential created by drug prohibition.

The advantage to Mexico also creates a strategic problem for Mexico. Given the money at stake and that the legal system is unable to suppress or regulate the trade, the borderland has again become — perhaps now more than ever — a region of ongoing warfare between groups competing to control the movement of narcotics into the United States. To a great extent, the Mexicans have lost control of this borderland.

From the Mexican point of view, this is a manageable situation. The borderland is distinct from the Mexican heartland. So long as the violence does not overwhelm the heartland, it is tolerable. The inflow of money does not offend the Mexican government. More precisely, the Mexican government has limited resources to suppress the trade and violence, and there are financial benefits to its existence. The Mexican strategy is to try to block the spread of lawlessness into Mexico proper but to accept the lawlessness in a region that historically has been lawless.

The American position is to demand that the Mexicans deploy forces to suppress the trade. But neither side has sufficient force to control the border, and the demand is more one of gestures than significant actions or threats. The Mexicans have already weakened their military by trying to come to grips with the problem, but they are not going to break their military by trying to control a region that broke them in the past. The United States is not going to provide a force sufficient to control the border, since the cost would be staggering. Each will thus live with the violence. The Mexicans argue the problem is that the United States can't suppress demand and is unwilling to destroy incentives by lowering prices through legalization. The Americans say the Mexicans must root out the corruption among Mexican officials and law enforcement. Both have interesting arguments, but neither argument has anything to do with reality. Controlling that terrain is impossible with reasonable effort, and no one is prepared to make an unreasonable effort.

Another aspect is the movement of migrants. For Mexicans, the movement of migrants has been part of their social policy: It shifts the poor out of Mexico and generates remittances. For the United States, this has provided a consistent source of low-cost labor. The borderland has been the uncontrollable venue through which the migrants pass. The Mexicans don't want to stop it, and neither, in the end, do the Americans.

Dueling rhetoric between the United States and Mexico hides the underlying facts. Mexico is now one of the largest economies in the world and a major economic partner with the United States. The inequality in the relationship comes from military inequality. The U.S. military dominates North America, and the Mexicans are in no position to challenge this. The borderland poses problems and some benefits for each, but neither is in a position to control the region regardless of rhetoric.

Mexico still has to deal with its core issue, which is maintaining its internal social stability. It is, however, beginning to develop foreign policy issues beyond the United States. In particular, it is developing an interest in managing Central America, possibly in collaboration with Colombia. Its purpose, ironically, is the control of illegal immigrants and drug smuggling. These are not trivial moves. Were it not for the United States, Mexico would be a great regional power. Given the United States, it must manage that relationship before any other.

Given Mexico's dramatic economic growth and given time, this equation will change. Over time, we expect there will be two significant powers in North America. But in the short run, the traditional strategic problems of Mexico remain: how to deal with the United States, how to contain the northern borderland and how to maintain national unity in the face of potential social unrest.