(FORTUNE Magazine) – TODAY Mexico's economy is vibrant, largely because of the free-trade policies of its dynamic, Harvard-educated President, Carlos Salinas. Since his election four years ago, Salinas, 44, has balanced his budget and calmed inflation. Next lies the challenge of the North American Free Trade Agreement (NAFTA), which, if approved, will bring down trade barriers between Mexico, the U.S., and Canada, and create the largest trading bloc in the world. In late November, Fortune managing editor Marshall Loeb spent two days with Salinas, traveling around western Mexico by presidential jet and helicopter on his customary rounds promoting his political program. In the frank interview that follows, the Mexican leader discusses the tough issues of trade, jobs, and investment and tells how he fixed the Mexican economy.

On Mexico's new economic alliance with the U.S.: A Mexican President, Benito Juarez, said over a century ago, ''Poor Mexico -- so far from God, so close to the United States.'' So you can see that the step we have taken toward closer economic ties to America has been very difficult. But I'm very encouraged by the fact that President-elect Clinton has recognized the need for good relations with a neighbor to the south that has 85 million people. His initiative to open a new era of cooperation has been received very positively by my government because we are convinced that a respectful relationship will be good for Mexico and the U.S. as well.

On NAFTA: I expect the agreement to be fully approved by next year, though it still requires additional steps. One is the formal signing by the leaders of Mexico, the U.S., and Canada, which should happen soon. From then on, it depends on the legislative process. In Mexico the Senate, in the U.S. the Congress, and in Canada the Parliament have to approve the agreement. There are many advantages. The treaty will provide Mexico, the U.S., and Canada with the clout to compete with other trading regions that are being formed in the rest of the world. Look at the European Community. It will have a full free-trade area and a tremendous competitive advantage that we will be able to face only if we get together. The Asian Pacific countries are also getting together. So this is the trend of the world. If we are to cope with the challenges of the end of the century, our three countries must get together.

On President-elect Clinton's wanting to make changes in NAFTA to protect jobs and the environment: The treaty is not open for renegotiation. We will certainly have to talk about different issues, like the environment, financial relations, drug trafficking, and migration. But in matters of trade, the NAFTA negotiations took us almost three years to conclude, and if one single line of the 2,000- page document were opened to revisions, the whole process would have to be started again, and we would not finish it during my administration ((which ends in 1994)). I would say that there are different ways in which we can address these issues, perhaps through codicils, and this is precisely what we will have to sit down and talk about in coming months.

On critics who say that NAFTA will cause high-paying American jobs to flee to $2-an-hour Mexico: If wages alone were the main element to decide the location of industrial activity, somebody said that Haiti would be the industrial capital of the world. The U.S. is losing jobs not to countries with lower wages but ones with higher wages like Japan and Germany. Besides, if we do not create additional jobs in Mexico, Mexicans will merely walk across the border looking for jobs in the north. We want to export goods, not people. Our intention with NAFTA is to create additional jobs and make wages grow, not to steal jobs from the U.S. So for me the fundamental element is that NAFTA will provide benefits for Mexican workers, American workers, and Canadian workers. For example, the U.S. automobile industry has gained tremendous competitive advantage thanks to the investment it has made in Mexico and the auto parts it gets from Mexico. This helps American workers because the car companies they work for are now more efficient and can compete more readily against both European and Japanese car companies.

On Mexican and American workers, both losing jobs from free trade: In the short run each country will have to implement its own actions to protect its workers. We in Mexico will move to create a social safety net during the transition to provide retraining for our workers as well as alternative sources of employment. To provide new jobs, first we have a program to build housing in Mexico. We plan to put up 300,000 new houses next year alone. Second, we are implementing a program to build new highways and to reconstruct the old roads.

On investment in Mexico: In the case of oil, our constitution establishes clearly that only Mexicans can own it. However, for many years now foreign firms have been participating in public bids for service contracts with the Mexican oil industry, and we propose to continue this policy. At the same time, we are privatizing many activities in the petrochemical industry, and there will be a new opportunity for domestic and foreign investors. We also welcome foreign investment in our other industries and in the stock market.

On turning around the Mexican economy: First, I would say that there are no models. We Mexicans responded to our own circumstances. We were very firm about reducing the budget deficit. We used to have a budget deficit of almost 17% of GDP. Last year it was 0% of GDP. This year and next we will have a surplus. We balanced the budget by cutting expenditures and increasing revenue at the ; same time. We cut expenditures by privatizing public-sector enterprises, which in Mexico used to drain lots of subsidies from the federal budget. The privatization process, which we did through public bids, allowed us to raise almost $52 billion. We used this revenue to reduce the domestic debt and thus cut our debt service. To cut costs further, we reduced the size of the bureaucracy dramatically by offering early retirement. We eliminated programs that were important to some special-interest groups but not beneficial to the general population. For instance, we now provide food subsidies only to those families who really need it. We revised priorities. Before, the government devoted much time to deciding which airplanes it should acquire to modernize the fleet of its airline company, but only 6% of the population used them. Today we channel our energy, political attention, and resources to the fundamental social programs that we have. We reduced tax rates but increased the tax base. We replaced regressive taxes like sales with more progressive ones like gasoline. We reduced the national sales tax from 15% to 10% while increasing the gasoline tax, which is progressive in Mexico because only a small part of the population owns cars.

On taming inflation: We are coming down from almost 120% inflation four years ago to 11% this year and single-digit inflation next year. At the same time, we have had real growth in per capita income for four consecutive years. We stifled inflation by reducing the budget deficit without falling into recession. This required a delicate balance between cutting costs and boosting spending on social programs. Our economic success has allowed us to develop a new attitude. A new optimism has been built in the country -- not because our problems have been eliminated. No. We still have many hard roads ahead. But Mexicans today have a self-confidence in themselves. We look at the future with determination. We know we can overcome our problems.

On social programs: The Mexican government has been able to have a very tight fiscal policy and at the same time increase expenditures on social programs. Let me tell you that we have increased spending on education more than 70% in real terms, which has allowed us to increase wages for our teachers, retrain them, improve the quality of our schools, and decentralize our educational system. We also have increased spending in health and have promoted more housing development in the country.

On Mexico's future: Two elements show that all these changes will be permanent. First, we are institutionalizing them. That is, they will not depend on one person, one President, but will be part of our institutional structure and therefore part of everyday life in Mexico. Second, the Mexican population is demanding that these changes continue. Why? Because people are deriving the right benefits from these transformations. Why? Because they are participating in this process of change. Why? Because these changes reflect their expectations and demands. Reform, then, is permanent in Mexico.

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