In the 1940s, Mexico adopted a state-led development strategy that relied on public-sector investment to integrate the national economy. Under the policy of "stabilizing development," the state promoted industrialization by encouraging import substitution, mobilizing domestic savings, and directing state credit toward priority investment projects. It followed conservative policies on interest and exchange rates in order to attract external capital to support industrialization. During the 1940s and 1950s, the government channeled public investment toward the agricultural sector, and especially into large-scale irrigation projects. During the 1960s, public spending was redirected toward expanding the nation's industrial capacity.

Although social infrastructure, such as medical and educational facilities, received some 25 percent of public spending, income distribution became steadily more unequal during the postwar decades, and the social needs of the rural poor went largely unaddressed. Popular acceptance of Mexico's post-1940 development strategy began to wane by 1970 as its inegalitarian consequences became clear. As public pressure for state redress of social needs rose, presidents Echeverría and López Portillo turned to destructive fiscal policies that nearly bankrupted the state and contributed to Mexico's economic collapse in the early 1980s.

After taking power in 1970, Echeverría turned away from the policy of "stabilizing development" that had closely linked Mexico's economic fortunes to those of the private sector. By expanding the state's role in directing and regulating economic activity, Echeverría hoped to promote both equity and prosperity while easing political pressures on the state. Higher public spending was also intended to alleviate the social and political tensions that had found violent expression in the riots at the Plaza of the Three Cultures in Tlatelolco in 1968 and threatened continued Institutional Revolutionary Party (Partido Revolucionario Institucional--PRI) rule (see Reconciliation and Redistribution, 1970-76, ch. 1).

Echeverría's improvidence produced a growing fiscal imbalance, which he financed through foreign borrowing. Mexico's public-sector deficit rose sharply from 2 percent of GDP in 1970 to 7 percent by 1976. Under Echeverría, Mexico resorted for the first time to massive external borrowing to finance these deficits. Extensive oil discoveries in the mid-1970s gave Mexico access to almost unlimited foreign credits, allowing the government to contract huge loans to finance the fiscal and trade deficits. The share of public-sector spending financed by debt rose from 32 percent in 1971 to 50 percent by 1977. The looming fiscal crisis, together with the president's intemperate rhetorical assaults on the private sector, undermined business confidence and soured the investment climate. The government's determination to maintain a fixed exchange rate despite rising inflation undermined the competitiveness of domestic production, discouraged new investment, and encouraged capital flight.

By the mid-1970s, the balance of payments disequilibrium had become unmanageable. Inflation increased from 3 percent in 1969 to an annual average of 17 percent between 1973 and 1975. The fiscal deficit rose from 3 percent of GDP in 1971 to 10 percent in 1975. During those same years, the current account deficit rose from US$0.9 billion to US$4.4 billion, and the foreign public debt more than doubled from US$6.7 billion to US$15.7 billion. The private sector responded with massive capital flight, both to protect against the expected peso devaluation and to protest Echeverría's attacks on the private sector.

By 1976 the government could no longer ignore the crisis. Complying with International Monetary Fund (IMF--see Glossary) requirements for contingency lending and private-sector demands, the government curbed the expansion of state industry and public-sector spending, restricted credit, and forced the economy into recession. In August 1976, the government allowed the peso to float, ending more than twenty years of exchange-rate stability. The peso quickly depreciated by almost 40 percent against the dollar.

Although the discovery of massive new petroleum deposits in 1977 briefly alleviated the fiscal pressures weighing upon the government, it also led officials to abandon their newly acquired habits of fiscal restraint (see Recovery and Relapse, ch. 1). The fiscally expansionist Secretariat of Programming and Budget (Secretaría de Programación y Presupuesto--SPP), which had been established in 1977 and given responsibility for public investment planning, grew in influence at the expense of technocrats from the Central Bank and Treasury Ministry, who were more concerned with maintaining macroeconomic efficiency and stability.

The dénouement of López Portillo's expansionary policies came in mid-1981. International interest rates rose and oil prices fell. Capital flight accelerated as the government defended the increasingly overvalued peso through short-term external borrowing. Despite the warning signs, López Portillo decided to postpone adjustment measures and maintain existing policy.

In late 1982, the incoming administration of President de la Madrid faced a raft of challenges: huge fiscal imbalances, unsympathetic creditor banks, an alienated private sector, and international institutions inexperienced in managing a global debt crisis (see The de la Madrid Sexenio , 1982-88, ch. 1). Mexico's public-sector deficit in 1982 amounted to 18 percent of GDP. Total public spending amounted to nearly 47 percent of GDP, compared with only 30 percent in 1977, while public-sector revenue rose during the same period from 24 percent of GDP in 1977 to only 30 percent in 1982. Both production and economic growth stagnated.

Despite having vowed to defend the peso "like a dog," in February 1982 the president allowed the dollar price of the peso to almost double to discourage foreign-exchange speculation. The exchange rate rose from more than twenty-six pesos per dollar in January 1982 to about forty-five three months later. In August of that year, the government announced three more dramatic devaluations of the peso and a ninety-day suspension of debt principal payments. It also began negotiations for bridge loans and rescheduling agreements with the United States treasury, the IMF, and private commercial banks. In September the government adopted full exchange controls and nationalized the domestic banking system in a mistaken effort to stem capital flight. In November the government concluded a rescheduling accord with the IMF, and in early 1993 it negotiated a US$10 billion rescue package with private banks.

In December 1982, de la Madrid announced what turned out to be his first stabilization package, the Immediate Economic Reorganization Program (Programa Inmediato de Reordenación Económica--PIRE). This two-stage program called for "shock" treatment in 1983 to restore macroeconomic balance, to be followed in 1984 and 1985 by a "gradualist" adjustment program to open the economy to market forces. The first phase was intended to restore price and financial stability by means of a sharp reduction in public spending and a steep peso devaluation. The government instituted a harsh austerity regime that held the growth in domestic spending far below the rise in total output.

De la Madrid's first stabilization package did not work as expected. The government had expected lower inflation and more realistic prices to produce strong economic growth by 1984. This did not take place. From early 1983 until mid-1984, the government adhered closely to the goals of a November 1982 agreement it had reached with the IMF. The agreement maintained highly restrictive fiscal and monetary policies and allowed wages to lag substantially behind inflation. The austerity measures and devaluations of 1983 eliminated both the fiscal and trade deficits, but at the cost of sharply reduced imports and a severe economic recession. Contrary to expectations, the inflation rate did not fall significantly, and voluntary private lending did not resume.

Increasingly concerned about Mexico's growing fiscal deficit and its failure to reach its economic targets, the IMF in September 1985 suspended disbursement of the loan it had approved in late 1982. This announcement led to another run on the peso and a new balance-of-payments crisis. The government reacted to the situation by imposing a series of devaluations and further harsh stabilization measures, including additional reductions in spending and domestic credit. Economic growth slowed and inflation surged, suggesting the failure of de la Madrid's first stabilization package.

In 1985 the Mexican government signaled a fundamental change in development strategy by reorienting economic policy toward trade liberalization and export promotion. It expected renewed export promotion to restore external balance and trade liberalization to restrain domestic prices by encouraging import competition. In July 1985, the government substantially reduced import licensing requirements and raised the share of total imports exempt from licensing. It compensated slightly for these measures by raising tariffs. The government also devalued the peso again, despite the inflationary consequences, to force previously protected domestic firms to become more competitive against imported goods.

In late 1986, the government cautiously relaxed credit to the private sector in an effort to ease the economy out of recession. External financing was again made available in 1987 following approval of a debt rescheduling plan proposed by United States Secretary of the Treasury James A. Baker III. The Baker Plan called for rescheduling some 83 percent of the US$52.2 billion of public-sector debt that Mexico had contracted prior to 1985. The debt would be repaid over a twenty-year period, with a seven-year grace period. Multilateral agencies agreed to lend an additional US$6 billion and commercial banks an additional US$7.7 billion, of which US$1.7 billion was contingency lending. The Baker Plan also provided for rescheduling some US$9.7 billion of private debt owed to commercial banks over a twenty-year period with seven years' grace. In all, the 1986 agreement provided Mexico some US$12.5 billion in new private and official credit.

After 1987 the government finally began to make progress against inflation. Endemic price instability had severely upset economic expectations, deterred much-needed investment, and hindered the country's economic recovery. In an effort to restore price stability, government policy makers decided in late 1987 to stop devaluing the peso at rates equal to or higher than the inflation rate. Even more important, in December 1987 the government forged a joint agreement with official leaders of the labor, peasant, and business sectors to restrain wages and prices. This accord, known as the Economic Solidarity Pact (Pacto de Solidaridad Económica--PSE), promised to reduce Mexico's monthly inflation rate to 2 percent by the end of 1988.

The PSE required further reductions in public spending and credit, higher tax revenue, and a tighter monetary policy. All were intended to reduce the fiscal deficit and curb inflation. The new revenue measures included an increase in the value-added tax (VAT), a new personal income surtax, and elimination of tax exemptions. The government raised prices of public goods and services, and allowed interest rates to rise in order to promote saving and reduce capital flight. The PSE also included a structural adjustment component emphasizing trade liberalization and privatization of state enterprises.

The plan soon produced results. The inflation rate fell considerably, living standards recovered slightly, and economic growth resumed. Annual inflation fell from 159 percent in 1987 to 52 percent in 1988. The gradual recovery of Mexico's international reserves in 1989 and 1990 allowed the government to sustain a credible fixed exchange rate and finance the deterioration in the external account caused by the tariff reductions. Although President de la Madrid was himself not highly popular as he approached the end of his six-year term, his government had sufficient authority and institutional strength to enforce the wage restraints included in the PSE.

President Salinas announced in January 1989 a new version of de la Madrid's PSE, called the Pact for Economic Stability and Growth (Pacto para la Estabilidad y el Crecimiento Económico--PECE), which he hoped would end Mexico's net capital outflow. Salinas's economic program received considerable external support (see President Salinas, ch. 1). In March 1989, Mexico and the United States reached agreement on a long-term plan to restructure Mexico's US$52.7 billion debt owed to commercial creditors. The plan, proposed by United States Secretary of the Treasury Nicholas F. Brady, was intended to attract new foreign investment, encourage return capital, reduce domestic interest rates, and foster higher growth.

In July 1989, Mexico signed an agreement in principle with an advisory committee representing its 500 or so international creditors. The final agreement was signed in February 1990 and went into effect the following month.

Mexico's public finances improved steadily during the early years of Salinas's presidency. Throughout the 1980s, the Mexican government had emphasized fiscal austerity while making little effort to raise tax revenue. This policy mix began to change under Salinas, as Mexican economic policy stopped holding domestic demand below output and began to tighten tax collection. The government broadened the tax base by reducing marginal tax rates, the maximum corporate and personal tax rates, and the number of personal income tax brackets. Between 1989 and 1992, the number of taxpayers increased by 45 percent. As a result in part of improved tax collection, Mexico went from a public-sector deficit of 9 percent of GDP in 1988 to a surplus of 2 percent of GDP in 1992, although the government began to relax fiscal policy thereafter.

In the wake of the currency collapse of late 1994, the government committed itself in March 1995 to reduce public spending by almost 10 percent in real terms; it raised the VAT from 10 percent to 15 percent, and it raised prices for fuel, electricity, and other publicly provided services. Although the anti-inflationary social pact among the government, business, and labor--the PECE--was not renewed in early 1995, the government announced in October 1995 a new pact with labor and business, the Alliance for Economic Recovery (Alianza para la Recuperación Económica--APRE), which established fixed rates of increase for wages and prices. Under the terms of the APRE, the government pledged to maintain a balanced budget during 1996. It also planned a 5 percent real reduction in current spending, as well as regular increases in prices of publicly provided goods and services. Unlike its predecessors, however, this measure was not called a "pact," and it included no provision for a crawling- peg exchange rate. The government's reductions in current spending and public investment during 1995 were especially severe because vastly higher interest rates had boosted the government's interest payments by more than 37 percent in real terms.

These spending reductions helped the government to move from a public-sector deficit of 1.7 billion new pesos in 1994 to a modest surplus of 815 million new pesos in 1995, the latter representing 0.05 percent of GDP. Public expenditure in 1995 totaled 424 billion new pesos, of which 72 billion new pesos (17 percent) went to interest payments, 67 billion (16 percent) to education, 65 billion (15 percent) to energy, and 62 billion (15 percent) to health and social security. For 1996 the government budgeted total public-sector revenue of 558 billion new pesos, of which 237 billion new pesos would come from taxation and 177 billion new pesos from state enterprises. It budgeted total net expenditures of 554 billion new pesos, of which the largest share would go to education, energy, and health and social security, as well as debt service.

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Source: U.S. Library of Congress