Economics History Essay

During the 1980s Mexico experienced what Latin American social scientists call a change in its â€Å"development model. † Gone is the import-substitution industrialization model that characterized Mexico since the 1930s. Instead, Mexico has become an open economy in which the state’s intervention is limited by a new legal and institutional framework. Under the new model, the tendency is for the market to replace regulation, private ownership to replace public ownership, and competition, including that from foreign goods and investors, to replace protection. Nothing illustrates the change in strategy more vividly than the pursuit of a free trade agreement with the United States, first mentioned by Salinas in June 1990, and the constitutional reform of land distribution and the ejido system adopted at the end of 1991 (Watling, 1992). What prompted this change in development strategy? Mexico had taken a risk in the 1970s by borrowing heavily in world capital markets and indulging in over-expansive policies, and then paid dearly when oil prices fell and world interest rates rose. Adjustment to the new circumstances required a policy that would increase net exports, generating foreign exchange to service the external debt. Because the government, not the private sector, owed most of the external debt, fiscal policy also had to change in order to increase revenues and cut noninterest expenditures. The restoration of growth required changes that would build confidence and encourage private capital inflows by means other than commercial bank loans, which were no longer available. Finally, to make the economy more flexible and competitive in a global context, the rules that governed the flow of goods and investment had to change. In mid- 1982Mexico was in a deep economic crisis. The international environment was adverse to a Mexico saddled with foreign debt. World interest rates were high, the price of oil, Mexico’s main export, was falling, and commercial banks had stopped lending. This unfavorable international environment exacerbated the consequences of domestic imbalances and contributed to rampant inflation, capital flight, and chaos in the financial and foreign exchange markets. To confront the internal imbalances and accommodate the adverse external conditions, Mexico was compelled to adjust its expenditures, reorient its output, and find new ways to foster growth. In the early 1990s Mexico gained recognition as a country successfully managing economic adjustment and reform. Inflation slowed, flight capital was returning, domestic and foreign investment was rising, and per capita output began to grow. The path to recovery, however, had been far from smooth. Well into the late 1980s, analysts wondered why Mexico’s recovery was so slow despite the sound macroeconomic policies and structural reforms it had instituted. The slow recovery imposed high social costs on the Mexican population, as per capita real disposable income fell on average by 5 percent a year between 1983 and 1988. For some six years the Mexican government focused economic policy on restoring stability, particularly on lowering the rate of inflation and keeping the loss of international reserves in check. It finally succeeded in 1988, when inflation decreased from monthly averages close to 10 percent at the beginning of the year to about 1 percent by year’s end. However, growth did not follow. Only a combination of more decisive external support and a shift in Mexico’s development strategy managed to produce a turnaround. The changes regarding the role of the state in economic matters and the country’s economic interaction with the rest of the world are particularly striking. Reforms sought to reduce state intervention and regulation so as to open new investment opportunities, build business confidence, and create a more flexible and efficient incentive structure. These reforms have called for substantial modifications in the legal and institutional frameworks of the economy that will shape the country for decades to come. In the late 1970s, on the mistaken assumption that the rise in world oil prices and the availability of cheap external credit would continue, the Mexican government engaged in a spending spree. The resulting fiscal deficit increased inflation rates and the trade deficit. The fiscal and external gaps were filled with external borrowing. In 1981, when the price of oil began to fall and external credit became more expensive and of a shorter maturity, the Mexican government failed to implement fiscal and relative price adjustments to adapt to the new, less favorable conditions. Fear of an imminent devaluation of the peso fueled capital flight, and a large nominal devaluation followed in early 1982 (Banco de Mexico, 1983). As inconsistent policies were pursued, the macroeconomic environment became increasingly chaotic. Capital flight continued, and as reserves were depleted and no more credit was available to service debt payments, in August 1982 the Mexican government had to declare an involuntary moratorium on its debt, triggering a debt crisis that soon acquired global proportions. Tensions between the private sector and the government peaked in September 1982, when the government announced the nationalization of the banking system (Banco de Mexico, 1983). When Miguel de la Madrid’s government came to power in December 1982, it confronted the unenviable task of restoring economic stability in the face of a hostile domestic private sector and reluctant external creditors. In other Latin American countries the political resistance of different social groups expressed in massive strikes or threats of coups added to the climate of economic instability and made the necessary adjustment more difficult. However, Mexico’s difficulties cannot be blamed on the political resistance of wage earners or other social groups to absorbing the costs of adjustment. In Mexico, policymakers enjoyed remarkable freedom to act during six years of economic hardship. There were no serious wage conflicts, threats from the military, peasant uprisings, or active guerrilla movements.