Did the debt crisis or declining oil prices cause Mexico's investment collapse?

Abstract

The author proposes and estimates a microeconomic investment model to determine the relative importance of three explanations for Mexico's investment decline in the early 1980s: the decline in oil prices; the termination of capital inflows; and the effects of debt overhang and uncertainty. He uses investment data for private industries between 1981 and 1985, which have yet to be used in addressing the question under discussion. The data indicate that the main microeconomic mechanism driving the decline in investment was a rise in the relative price of investment goods - especially the relative price of machinery (a traded good in Mexico). Moreover, the decline in trade (driven by falling world oil prices) explains much of the increase in this relative price. The decline in Mexico's international terms of trade was probably the most important ultimate cause of the increased relative cost of machinery, but the reversal in net capital inflows to Mexico probably also played a role in increasing this relative price. On this point, the evidence is not as clear. After controlling for these effects, the author finds little evidence that the effects of debt overhang and uncertainty had much to do with the investment decline. The author points out that investment in Texas and Louisiana (which were also riding the oil boom of 1973-81) also fell in 1981-86, and adverse commodity price shocks also affected many other heavily indebted countries. At the very least, commodity price shocks (such as Mexico's decline in oil prices) as a direct cause of declining investment levels in the 1980s have been insufficiently emphasized in the literature on the effects of the international debt crisis.Banks&Banking Reform,International Terrorism&Counterterrorism,Economic Theory&Research,Environmental Economics&Policies,Financial Intermediation