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This past winter both the outgoing director of the CIA and a separate Pentagon report declared political instability in Mexico to be on a par with Pakistan and Iran as top-ranking threats to US national security. It was an exaggeration; Mexico is not yet a “failed state.” On the other hand, it is certainly drifting in that direction.

A vicious war among narco-trafficking cartels last year killed at least 6,000 people, including public officials, police and journalists. The country leads the world in kidnappings (Pakistan is second). And with the global crisis, the chronically anemic economy is hemorrhaging jobs, businesses and hope.

Not surprisingly, voters turned against President Felipe Calderón’s right-wing National Action Party (PAN) in the July 5 midterm elections. But the left-wing Democratic Revolutionary Party (PRD)–which many believe was robbed of the presidency in the 2006 election–has ripped itself apart with factional infighting. So frustrated Mexicans gave their Congress back to the Institutional Revolutionary Party (PRI), whose decades of corrupt authoritarian rule were supposed to have permanently ended in 2000. At least, thought many voters, the PRI knows how to keep order.

Mexicans are of course responsible for their own country. But geography has always forced them to play out their history in the shadow of their northern neighbor. “Poor Mexico,” goes the saying. “So far from God, so close to the United States.” Today, Mexico is a prime example of the socially destructive effects of the neoliberal economics promoted throughout the world by the US governing class.

The North American Free Trade Agreement–proposed by Ronald Reagan, negotiated by George Bush I and pushed through Congress by Bill Clinton in 1993–is both symbol and substance of neoliberalism. It was sold to the citizens of the United States, Mexico and Canada with the promise that free trade in goods and money would transform Mexico into a booming middle-class economy, dramatically reducing illegal immigration and creating a vast market for US and, to a lesser extent, Canadian exports.

Fifteen years later, Mexico is still unable to create enough jobs to employ its people. Out-migration has doubled, and on both sides of the US-Mexico border labor-market competition has kept wages down. At the top, income and wealth have ballooned. It is no accident that among NAFTA’s prominent godfathers were former Treasury Secretary Robert Rubin (Democrat) and former Federal Reserve chair Alan Greenspan (Republican), whose fingerprints are all over the current global financial disaster.

I was an opponent of NAFTA. Still, I thought the best case for it was that efficiencies from economic integration could at least make US and Mexican businesses more internationally competitive. But even that argument turned out to be worth no more than a share of Bernie Madoff’s hedge fund.

Several years ago I gave a speech to a group of businesspeople in Mexico City. Those from the multinational banks and corporations thought NAFTA was a great success, but smaller Mexican businessmen saw it differently. You Americans, said one, promised that with your technology and our cheap labor, we’d be partners in competing with Asia. Then you opened up your markets to China and invested there instead. “Sure,” he said. “We can make TV parts for half what it costs in the United States. But the Chinese can make them, and ship them, for a tenth. So instead of closing the gap between Mexico and the United States by raising wages, we have to narrow the gap between Mexico and China by lowering them.”

When I mentioned the conversation to a New York investment banker who had lobbied for NAFTA, he conceded that his side may have talked vaguely about partnership with Mexico. But he shrugged and added, “Things changed”–that is, profit opportunities in China dwarfed anything Mexico had to offer.

The Wall Streeters had little interest in making Mexico more competitive. They also had little interest in making the United States more competitive. Their purpose was just the opposite: to disconnect themselves and their corporate partners from the fate of any particular country. The World Trade Organization, the opening of the US market to China and a parade of bilateral trade agreements followed in NAFTA’s wake.

In Mexico, the political and financial elite were willing collaborators. For example, NAFTA opened up Mexican banks to foreign ownership: political insiders who had bought the giant Banamex from the government for $3.2 billion and gotten the government to provide it with permanent subsidies then sold the firm, with the subsidies, to Citigroup for $12.5 billion. Today roughly 90 percent of the banking system is owned by US and other foreign investors, who do not have to recycle Mexicans’ deposits, or the Mexican government’s money, back into Mexico but can invest them anyplace in the world.

The Banamex deal was negotiated by Rubin after he became Citigroup’s $17 million-a-year executive committee chair. In the late 1980s, when he was at Goldman Sachs, Rubin had midwifed the privatization of Mexico’s phone system to Carlos Slim, a politically connected Mexican businessman. Slim then used the monopoly profits from his high phone rates to invest all over the globe–including a substantial ownership stake in the New York Times. The latest Forbes rating says he’s the world’s third-richest man.

Still, as long as the US economy was blowing dot-com and subprime bubbles, the neoliberal model seemed stable. US investors got Mexican bank deposits and cheaper labor on both sides of the border. Through out-migration to the States, Mexico’s oligarchs got rid of frustrated workers who might otherwise have been politically troublesome. The economy also benefited from hard-currency remittances migrants sent back home.

Another infusion of cash to the Mexican economy, unacknowledged in the official statistics, is the roughly $25 billion in illegal drug exports to the States. Today, with remittances, oil prices and tourism depressed, the narco trade is probably Mexico’s largest single earner of hard currency.

NAFTA and the neoliberal ideology it represents are certainly not the root causes of narco-trafficking. But they have been major factors in its recent monstrous growth. For starters, the trade agreement created a two-way overland superhighway for contraband; the Mexican drug lords use the dollars they have earned from their exports to import guns, aircraft and sophisticated military equipment from the United States to fight their territorial wars. By wiping out small Mexican farms that could not compete with heavily subsidized US agribusiness, NAFTA also expanded the pool of unemployed young people that provides the narco-traffickers with recruits. And banking integration under NAFTA made money laundering much easier.

Perhaps most important, NAFTA has helped maintain the corrupt network of Mexican oligarchs. The 1988 presidential election–which the then-ruling PRI had to steal from the PRD to win–shocked the establishment on both sides of the border. By opening up Mexico to US money and influence, NAFTA was a way, as the US Trade Representative said to me at the time, “to keep the Mexican left out of power.”

Until the 1980s, Mexican drug (mostly marijuana) smuggling to the north was modest in scale and generally tolerated by successive PRI governments. Their message was: we don’t care what you sell to the gringos, but no rough stuff here, keep it away from our kids and of course share a little of the profit under the table. But the US-backed neoliberals who took over the PRI in the 1980s had closer ties with the Mexican cartels. The brother and father of president and NAFTA champion Carlos Salinas–hailed in Washington as a good-government reformer–were widely accused of being connected to the drug business. In Salinas’s first year in office his national police chief was found with $2.4 million in drug money in the trunk of his car.

In the 1990s, as the geographically better-positioned Mexican cartels muscled out the Colombians as chief cocaine retailers to the US market, their profits and political influence grew. But so did the rivalry among them and their allied government factions for control of trade routes. Bullet-riddled bodies began showing up on the streets, making the public nervous.

Seeking legitimacy after his 2006 election was tainted by charges of fraud, President Felipe Calderón declared war on the narco-traffickers. It was a popular gesture, but given that the police, the military and the legal system are heavily infiltrated by the gangs, it backfired. The narcos reacted with horrific violence–assassinations, beheadings and mutilations of police and soldiers as well as thugs, brazenly displayed on YouTube. Losing control, Calderón appealed to George Bush II for help. The result: the Mérida Initiative, a $400 million-per-year program to provide aircraft, military equipment and training to the Mexican police and military.

After decades of keeping its distance from the United States, the Mexican military–like the armed forces of Colombia, Honduras and other Latin American countries–is becoming a Pentagon client. In turn, Mexican society is itself becoming militarized. Corrupt local police are being replaced by soldiers who may be slightly less corrupt but who are a greater threat to human rights and democracy. An April Human Rights Watch report identified seventeen specific cases of abuse by the Mexican military, including “killings, torture, rapes, and arbitrary detentions.”

To his credit, Barack Obama has acknowledged what his predecessors failed to: that the US demand for drugs and its supplying of arms makes it an enabler in the rise of narco warlords. But he has also made it clear that neither issue is on his administration’s agenda. Moreover, just as Bill Clinton carried the water for George Bush I’s NAFTA, Barack Obama has endorsed Bush II’s Mérida Initiative.

Given the unwillingness of US politicians to deal with the demand side of the market, the Mérida Initiative is not likely to be any more successful in eradicating the drug trade than the $6 billion Plan Colombia has been. The best one can hope for is some sort of market-sharing deal among the cartels that would be implicitly endorsed by the Mexican government while Washington tactfully averts its eyes. Given that in many areas, drug money is the chief source of campaign financing, a PRI-dominated Mexican Congress might be just the right forum for a cynical, but welcome, end to the killings.

Meanwhile, the drug violence has frightened away tourists and investors, making Mexico’s recession even worse. Most forecasters expect the economy to contract some 6 percent this year–a huge hit to a country in which 45 percent live on $2 a day or less. Calderón’s response is to tread water–rescuing big businesses that speculated on Wall Street derivatives and dribbling out a bit more public spending–while waiting for the United States to once again suck up Mexico’s surplus labor.

But even when the US economy recovers, it is unlikely to re-create the credit boom that kept the NAFTA deal afloat. In the post-crash era, the United States will finally be forced to address its trade deficits and its massive foreign debt. Americans will have to slow down consumer spending, increase savings and sell more to–and buy less from–the rest of the world. If Mexico could not prosper during fifteen years of exporting goods and people to a bloated US consumer market, it is hard to believe it will be able to do so when that market has slimmed down.

The entire relationship must be rethought. In this regard, Obama’s abandonment of his campaign pledge to renegotiate NAFTA was a missed opportunity. A renewed debate over the trade deal could have spurred public discussion of the failure of neoliberal economics, the “war on drugs” and an immigration policy that ignores conditions in Mexico that drive people across the border. It could have been a forum to think through the question of how continental integration can work for working people rather than just investors. For example, what kind of cooperative transportation, energy and green industrial policies would make the people of three nations–now bound together in one market–globally competitive?

Obama’s Wall Street advisers have no more interest in this sort of change than did Bush’s. And without a new economic direction, life for the average Mexican will surely worsen and social tensions rise. Some Mexican friends point out that the revolution against Spain erupted in 1810 and the one against the US-backed dictator Porfirio Díaz in 1910. And in 2010… ?

In any event, Mexico’s growing troubles will not stay conveniently on the other side of the Rio Grande. Build a ten-foot wall, and desperate people will find twelve-foot ladders. Free trade will, of course, continue to flourish; Homeland Security Secretary Janet Napolitano estimates that Mexican drug cartels are now operating in 230 US cities.

So, thanks to the people who brought you the subprime mortgage disaster, the credit freeze and the Great Recession, the next Mexican revolution may come closer to home than you think.