FROM THE 1940s UNTIL THE MID-1970s, the Mexican economy enjoyed strong growth averaging more than 6 percent, single-digit inflation, and relatively low external indebtedness. These conditions all began to change during the 1970s. Expansionary government policies generated higher inflation and severe external payments problems while failing to produce sustained growth. Government spending outpaced revenues, generating steep budget deficits and increased external indebtedness. Low real interest rates also discouraged domestic saving.

A brief financial and economic crisis in 1976 signaled the need to address the economy's fundamental problems, but subsequent petroleum discoveries reduced incentives for reform and postponed the inevitable day of reckoning. The government expanded its debt-financed spending in the late 1970s in anticipation of continued low interest rates and high oil revenue. It also maintained a highly overvalued peso (for value of the peso--see Glossary), aggravating balance of payments problems, undermining private-sector confidence, and encouraging capital flight.

External conditions turned sharply against Mexico in the early 1980s, producing a deep recession that forced a fundamental change in the country's decades-old development strategy. Higher interest rates and falling oil prices combined with rising inflation, massive capital flight, and an unserviceable foreign debt to provoke an economic collapse. Lacking access to international capital markets, the government of Miguel de la Madrid Hurtado (1982-88) had to generate huge nonoil trade surpluses to restore macroeconomic balance. Import volume fell sharply at the expense of fixed investment and consumption. As a result of the government's stringent economic stabilization program, the fiscal deficit was eliminated, international reserves rebuilt, and export growth restored, but at the cost of lower real wages and extensive unemployment. Economic output remained flat between 1983 and 1988, and inflation remained high, reaching more than 140 percent in 1987. Real exchange-rate depreciation boosted the country's debt-to-gross domestic product (GDP--see Glossary) ratio by almost 30 percentage points between 1982 and 1987.

To control persistently high inflation and restore growth and international competitiveness, the government pursued a major policy reorientation in the late 1980s. It reduced state involvement in economic production and regulation and integrated Mexico more fully into the world economy. An anti-inflation plan was introduced in late 1987 under which the government, the private sector, and organized labor agreed to limit wage and price increases. In 1989 the government reached agreement with its external creditors on extensive debt restructuring and reduction.

In an effort to restore self-sustaining growth, the administration of Carlos Salinas de Gortari (1988-94) boosted investment as a share of GDP. It also accelerated the privatization of state-owned productive enterprises, both to raise state revenue and to promote economic restructuring and modernization. The government eased foreign investment regulations, stabilized the currency, deregulated the prices of most goods, and enacted extensive trade liberalization measures, including the reduction or elimination of import barriers and the pursuit of free-trade agreements with Mexico's trading partners, especially the United States.

The Salinas government allowed the currency to become increasingly overvalued during 1994, despite mounting trade and current account deficits resulting from trade liberalization and economic growth. It kept real interest rates high to ensure sufficient inflows of foreign (mainly short-term portfolio) investment to cover the current account deficit. During 1994 the government treasury issued a large number of dollar-denominated bonds (tesebonos ) to reinforce its capital position.

By the end of 1994, the almost total disappearance of Mexico's international reserves made the government's exchange-rate policy no longer tenable. The new administration of President Ernesto Zedillo Ponce de Leon was forced in December 1994 to devalue the new peso (for value of the new peso--see Glossary), despite promises to the contrary. The government's mismanaged new peso devaluation cost the currency nearly half of its value and the government much of its credibility and popular support. Inflation and interest rates rose sharply in subsequent weeks, throwing millions of Mexicans out of work and putting many consumer goods beyond the reach of the middle class, to say nothing of the impoverished majority. Public and private investment plummeted, and Mexico entered its worst economic recession since the 1930s. By early 1996, however, the economy had begun to recover, as capital inflows increased and most productive sectors registered positive growth rates.

For more recent information about the economy, see Facts about Mexico.

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Source: U.S. Library of Congress