Economic History of Mexico - 1982 Crisis and Recovery

1982 Crisis and Recovery

The macroeconomic policies of the 1970s left Mexico's economy highly vulnerable to external conditions. These turned sharply against Mexico in the early 1980s, and caused the worst recession since the 1930s. By mid-1981, Mexico was beset by falling oil prices, higher world interest rates, rising inflation, a chronically overvalued peso, and a deteriorating balance of payments that spurred massive capital flight. This disequilibrium, along with the virtual disappearance of Mexico's international reserves—by the end of 1982 they were insufficient to cover three weeks' imports—forced the government to devalue the peso three times during 1982. The devaluation further fueled inflation and prevented short-term recovery. The devaluations depressed real wages and increased the private sector's burden in servicing its dollar-denominated debt. Interest payments on long-term debt alone were equal to 28 percent of export revenue. Cut off from additional credit, the government declared an involuntary moratorium on debt payments in August 1982, and the following month it announced the nationalization of Mexico's private banking system.

By late 1982, incoming President Miguel de la Madrid had to reduce public spending drastically, stimulate exports, and foster economic growth to balance the national accounts. Recovery was extremely slow to materialize, however. The economy stagnated throughout the 1980s as a result of continuing negative terms of trade, high domestic interest rates, and scarce credit. Widespread fears that the government might fail to achieve fiscal balance and have to expand the money supply and raise taxes deterred private investment and encouraged massive capital flight that further increased inflationary pressures. The resulting reduction in domestic savings impeded growth, as did the government's rapid and drastic reductions in public investment and its raising of real domestic interest rates to deter capital flight.

Mexico's GDP grew at an average rate of just 0.1 percent per year between 1983 and 1988, while inflation on an average of 100%. Public consumption grew at an average annual rate of less than 2 percent, and private consumption not at all. Total investment fell at an average annual rate of 4 percent and public investment at an 11 percent pace. Throughout the 1980s, the productive sectors of the economy contributed a decreasing share to GDP, while the services sectors expanded their share, reflecting the rapid growth of the informal economy and the change from good jobs to bad ones (services jobs). De la Madrid's stabilization strategy imposed high social costs: real disposable income per capita fell 5 percent each year between 1983 and 1988. High levels of unemployment and underemployment, especially in rural areas, stimulated migration to Mexico City and to the United States.

By 1988 (de la Madrid's final year as President) inflation was at last under control, fiscal and monetary discipline attained, relative price adjustment achieved, structural reform in trade and public-sector management underway, and the economy was bound for recovery. But these positive developments were inadequate to attract foreign investment and return capital in sufficient quantities for sustained recovery. A shift in development strategy became necessary, predicated on the need to generate a net capital inflow.

In April 1989, President Carlos Salinas de Gortari announced his government's national development plan for 1989-94, which called for annual GDP growth of 6 percent and an inflation rate similar to those of Mexico's main trading partners. Salinas planned to achieve this sustained growth by boosting the investment share of GDP and by encouraging private investment through denationalization of state enterprises and deregulation of the economy. His first priority was to reduce Mexico's external debt; in mid-1989 the government reached agreement with its commercial bank creditors to reduce its medium- and long-term debt. The following year, Salinas took his next step toward higher capital inflows by lowering domestic borrowing costs, reprivatizing the banking system, and broaching the idea of a free-trade agreement with the United States. These announcements were soon followed by increased levels of capital repatriation and foreign investment.

Due to the financial crisis that took place in 1982, the total public investment on infrastructure plummeted from 12.5% of GDP to 3.5% in 1989. After rising impressively during the early years of Salinas' presidency, the growth rate of real GDP began to slow during the early 1990s. During 1993 the economy grew by a negligible amount, but growth rebounded to almost 4 percent during 1994, as fiscal and monetary policy were relaxed and foreign investment was bolstered by United States ratification of the North American Free Trade Agreement (NAFTA). In 1994 the commerce and services sectors accounted for 22 percent of Mexico's total GDP. Manufacturing followed at 20 percent; transport and communications at 10 percent; agriculture, forestry, and fishing at 8 percent; construction at 5 percent; mining at 2 percent; and electricity, gas, and water at 2 percent (services 80%, industry and mining 12%, agriculture 8%). Some two-thirds of GDP in 1994 (67 percent) was spent on private consumption, 11 percent on public consumption, and 22 percent on fixed investment. During 1994 private consumption rose by 4 percent, public consumption by 2 percent, public investment by 9 percent, and private investment by 8 percent.