Academic journal article
By Bergoeing, Raphael; Soto, Raimundo; Kehoe, Patrick J.; Kehoe, Timothy J.
Federal Reserve Bank of Minneapolis Quarterly Review , Vol. 26, No. 1
Chile and Mexico, like most of the other countries in Latin America, experienced severe economic crises in the early 1980s that led to large drops in output. For these two countries, the paths of recovery from these crises differed markedly. Chart 1 shows that real output per working-age (15--64-year-old) person in Chile returned to trend in about a decade and grew even faster than trend during the 1990s. (1) In contrast, real output in Mexico was still about 30 percent below trend in 2000. For Mexico, like much of the rest of Latin America, the 1980s were a "lost decade" while for Chile they were a "found decade" in which the economy began to grow spectacularly. Only after 1995 did Mexico begin to grow as Chile had done in the 1980s.
In this study, we analyze four possible explanations for the different paths of recovery in the two countries.
The first explanation is the standard monetarist story that, short of inducing a hyperinflation, the more rapidly a country in a severe recession expands its money supply, the faster it will recover. Although this story is not often proposed for the cases of Chile and Mexico, we examine it because it probably is the most common story for both the severity of and the slow recovery from depressions like that of the 1930s in the United States.
The second explanation is Corbo and Fischer's (1994) real wage story for Chile's rapid recovery. After the crisis, the Chilean government reversed its previous policy of wage indexation and allowed real wages to fall sharply. Corbo and Fischer argue that this policy, together with policies that produced a rapid depreciation of the real exchange rate, fueled an export boom that was the principal cause of the rapid recovery.
The third explanation is Sachs' (1989) debt overhang story for Mexico's slow recovery. Sachs argues that Mexico's large external debt led new investors to fear that most of the returns on any new investment would be taxed to pay off old loans. Hence, new investors were discouraged from investing, and both investment and output remained low.
The fourth explanation is a structural reforms story. Chile had undertaken a series of structural reforms in the 1970s that set the stage for the successful performance of the 1980s. In contrast, Mexico undertook these reforms only in the mid-1980s or later. We examine reforms in a number of areas: trade policy, fiscal policy, privatization, the banking system, and bankruptcy procedures.
For each explanation we ask, Can it explain the different paths of recoveries in Chile and Mexico? We find that, although each of the first three explanations has some merit, none of these can account for the different paths of recovery: The standard monetarist story implies that Chile should have recovered more slowly than Mexico. The real wage story implies that exports should have boomed even more in Mexico than in Chile--and they did--but Mexico stagnated while Chile grew. The debt overhang story implies that Chile should have stagnated even more than Mexico.
A comparison of data from Chile and Mexico allows us to rule out only one part of the structural reforms story-- trade reforms. The timing of reforms is crucial if they are to drive the differences in economic performance of the two countries. During the decade following the crisis, Mexico's trade grew faster than Chile's, partly because Mexico was engaged in vigorous trade reform while Chile had already carried Out substantial reform (and, in fact, backtracked from 1983 until 1991). By the mid-1990s, Mexico was just as open as Chile.
To shed light on the ability of the other reforms to account for the different paths, we turn to a growth accounting exercise. We ask, How much of the differences in recoveries were due to differences in inputs of capital and labor and how much to differences in productivity? We find that most of the differences in the recoveries resulted from different paths of productivity. …