Lessons for Greece from the 1982 Mexican debt crisis

In 1982 Mexico suffered a huge external shock. The price of oil – its major export – fell 65% between 1981 and 1986. Simultaneously, world interest rates surpassed 15%, making debt repayment impossible (Oks and van Wijnbergen 1994). Unlike Greece, Mexico received neither a bailout nor a debt-haircut at the beginning of its crisis. To rub salt in the wound, IMF funding stopped in 1985, right after a massive 8.1 magnitude earthquake stuck Mexico.1

Mexico’s external debt haircut – the Brady Plan – happened seven years after the onset of the crisis, and only after Mexico made permanent structural reforms while continuously servicing its debt.

Mexico’s debt service was painful – the public sector debt-service-to-GDP ratio averaged 15% between 1982 and 1988. In contrast, Greece’s debt-service-to-GDP ratio, which averaged 5% between 2008 and 2014, has been relatively light. See Figure 1.

Figure 1. Debt service (increased expenditure on public debt)

Sources: Eurostat, Ministry of Finance (Greece), and Centro de Estudios de las Finanzas.

Obviously, it would have been optimal for both the Mexican debt haircut and structural reforms to have occurred in 1982, and for Mexico to have received a bailout to smooth consumption during the rocky 1980s. Unfortunately this is not how the world works. In the late 1970s, Mexico had the time and the oil revenues to implement necessary structural reforms. Power-holders blocked attempts to reform during those good times.

The deep fiscal crisis and the lack of leniency from international organisations forced Mexican power-holders to have an ‘internal conversation’ on whether to become a liberalised economy or a statist economy. The outcome of such heated conversation was a radical trade liberalisation and privatisation program. Such decisions were politically difficult – they led to a deep political rift that ended in the breakup of the Institutional Revolutionary Party (PRI)’s long-lived hold on power.

Despite the forewarnings of experts, positive effects of the reforms became apparent quickly. The economy became a successful exporter of manufacturing goods and the value of manufacturing goods as a percentage of total goods exported increased sharply from 24% in 1982 to 71% in 1989. This is shown in Figure 2.

Figure 2. Mexico’s goods exports

Source: Banco de México.

After seven difficult years, there was light at the end of the tunnel – Mexico’s public debt-to-GDP ratio fell to 47% in 1989 (from 60% in 1982). In contrast, in the six years between 2008 and 2014, that of Greece increased from 109% to 176%. See Figure 3.

Figure 3. Public debt

Sources: European Commission, WDI and OECD.

In order to appreciate these contrasting experiences, the following figures compare Greece from the onset of its crisis in 2008 to the Mexico from the onset of its oil crisis in 1982.

We can capture the size of the negative external shock in two complementary ways:

• By the fall in the terms of trade (ToT) and
• By the collapse of private financial flows.

Figure 4 shows that Mexico’s ToT – the ratio of the price of exports to the price of imports – fell by 20% between 1981 and 1982, and continued falling every year, until by 1988 there had been a cumulative drop of 71%. In contrast, Greece’s ToT has declined by 5% between 2007 and 2013. The collapse in Mexico’s ToT reflected the fall in oil prices, as in 1981 oil represented 62% of its exports and 32% of its fiscal revenue.

Figure 4. Terms of trade (percentage ratio of the export unit value indexes to the import unit value indexes

Source: WDI.

Figure 5 shows the severe sudden stop. During the first year of crisis, private financial flows fell by 9% of GDP in Greece, while financial flows fell by 6% of GDP in Mexico.

Figure 5. Capital flows (Greece: Net private financial flows; and Mexico: net financial flows)

Sources: IMF BOPS and authors’ calculations.

An economy-wide indicator of the adjustment to the external shock is the current account, which measures the excess of national income over national spending. Figure 6 shows that in 1982 Mexico’s current account improved by a whopping 8% of GDP as it jumped from a -6% deficit in 1981 to a +2% surplus, and had a cumulative 5% surplus from 1983 to 1988. In contrast, Greece’s current account remained in deficit from 2008 until 2012. From 2008 to 2014 the cumulative current account deficit was 47% of GDP.2

Figure 6. Current account

Sources: IMF BOPS.

The fiscal response lays behind the different current account responses. Figure 7 exhibits the primary fiscal balance, which excludes debt service. Despite a sharp recession, Mexico’s primary fiscal balance improved 13 percentage points from a deficit of 8% of GDP in 1981 to a 5% surplus in 1983. This surplus remained until the Brady plan was implemented. In contrast, between 2008 and 2013 Greece ran a primary fiscal deficit (6% of GDP on average). It reached a surplus of 2% of GDP in 2014.

Figure 7. Primary balance

Sources: ECB statistical data warehouse, OECD and WEO.

How could Greece run a current account deficit in the face of huge private capital outflows? As we can see in Figure 8, the answer is given by the remarkable jump in public capital inflows, which is roughly equal to the current account deficit plus private capital outflows.3 The public capital inflows include disbursements under the IMF/EU programs and the EU bailouts of 2010 and 2011. They also include the increase in credit from the ECB to the Bank of Greece via the Target2 balances.4

Figure 8. Greek balance of payments

Sources: authors’ calculations using IMF BOPS.

In Mexico there was a sharp downsizing of the government, while in Greece there has not. First, Mexico’s total government expenditure fell from 25% of GDP in 1982 to 17% of GDP in 1989. In Greece, it increased from 51% of GDP in 2008 to 59% of GDP in 2013. It only started

to decrease in 2014. Second, Mexico experienced a decline in the government wage bill from 7% of GDP in 1982 to 5% of GDP in 1988. In contrast, the Greek government’s wage bill increased from 11% in 2007 to 12% in 2013 (see Figures 9 and 10).5

Figure 9. Compensation of public-sector employees

Source: Eurostat and OECD.

Figure 10. Total government expenditures

Sources: Eurostat and OECD, and WEO.

Were the 1980s a lost decade for Mexico? The answer can go both ways.

Yes, because Mexico suffered through years of structural change, as it was implemented in the midst of large net transfers abroad associated with debt repayment and a collapse in the terms-of-trade – GDP growth averaged only 0.2% over 1982-1988.

No, because the seven lean years witnessed radical trade liberalisation and the dismantling of the regulatory state, which led to a 4% average GDP growth in 1989-19946 (see Figure 11).7

Figure 11. Real GDP growth

Source: WDI.

Concluding remarks

The Mexican Debt Crisis shows that leniency from international organisations towards has not helped Greece. Mexico received no bailout in the wake of the 1982 crisis. Moreover, a debt haircut occurred only after seven years of continuous debt repayment. This lack of leniency induced deep structural reforms, which led to the development of a competitive export sector and improved fiscal finances.

This article is published in collaboration with Vox EU. Publication does not imply endorsement of views by the World Economic Forum.

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Author: Carlos Cantú is a PhD candidate in Economics, UCLA. KeyYong Park is a PhD candidate in Economics, UCLA. Aaron Tornell is a Professor of Economics at UCL.

Image: A European Union (L) and Greek flag wave in front of the Parthenon temple in Athens.  REUTERS/John Kolesidis