Appendix 3. Oil and Economic Development in Mexico16

Niko Hobdari, Eric Le Borgne, Chonira Aturupane, Koba Gvenetadze, John Wakeman-Linn, and Stephan Danninger
Published Date:
April 2004
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Mexico is the world’s fifth largest oil producer and its tenth largest oil exporter. Mexico began to export oil in 1911, and its oil output expanded at an average annual rate of 6 percent between 1938 and 1971. Extensive oil discoveries in the 1970s increased Mexico’s domestic output and export revenues.

Although the Mexican economy maintained a rapid growth rate during most of the 1970s, it was progressively undermined by a combination of fiscal mismanagement and an overvalued real exchange rate, resulting in the sharp deterioration of the investment climate. In the mid-1970s, the government planned large public sector investment programs in industry, agriculture, and transportation. This expansionary fiscal policy, together with expansionary monetary policy, the postponement of crucial tax reforms, and a fixed exchange rate contributed to large balance of payments disequilibrium and intensified capital outflows. In 1976, the government devalued the peso by 45 percent. In the same year, Mexico agreed with the IMF on a stabilization program aimed at lowering inflation, building up reserves, and achieving macroeconomic stability. Oil discoveries in the south of Mexico in 1978 and a sharp increase in the world price of oil in 1979 greatly affected the country’s economic outlook. Private capital started to flow into the country, financing from the IMF was no longer needed, and the reform program was abandoned.

The improved terms of trade in 1979–80 brought windfall oil revenues and allowed the government to continue implementing an expansionary fiscal policy. Moreover, the government borrowed abroad against future oil earnings to further boost expenditures. Public investment increased and reached 30 percent of GDP in 1981. This growth was associated with a substantial increase in imported capital and intermediate goods. However, oil revenues were not sufficient to finance the large increase in imports and external imbalances were financed by foreign borrowing. The budget deficit rose, the current account deficit widened, and the real exchange rate was allowed to appreciate. Oil became the economy’s most dynamic growth sector, and the country’s dependence on income from the export of oil increased. The share of oil in total exports rose from 15 percent in 1976 to 78 percent in 1983. Government tax revenues were now heavily dependent on international oil price movements. When oil prices fell in 1981, the government decided not to cut prices for Mexican oil for several months and the volume of oil exports fell sharply. In 1982, the budget deficit reached 15 percent of GDP. In the same year, commercial banks refused to roll over government loans. In August 1982, Mexico suspended its international debt payments after falling oil prices made it impossible for the government to repay foreign loans. Around $30 billion of capital fled the country. The debt crisis led to currency devaluations and hyperinflation.

Mexico’s experience with oil revenue management is a good example of how the existence of abundant natural resources can create a false sense of security. Even windfall resources from oil during the skyrocketing oil price period could not sustain overly expansive public spending, and the country faced the painful need for adjustment later on. In fact, the discovery and exploitation of oil resources gave a false sense of security to the authorities and made them postpone the needed correction of the real exchange rate, balancing of the budget, and implementation of various structural reforms.

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