Thursday, 14 February 2019

Domestic Factors at Play

In my last post, I described what I deemed to be the main external factors that led to the Latin American Debt Crisis. However, some Latin American countries were hit a lot harder by the debt crisis than others. This indicates that there were a number of domestic factors at play.

The fact that Latin American countries were receiving extortionate international loans allowed governments to increase spending without having to raise taxes. Thus enabling governments to embark on spending programmes that relied on a never-ending supply of loans. It now seems painstakingly obvious that this was completely unsustainable. When funding started to run out in the early 1980s governments were unable to raise taxes or cut spending fast enough to cover the difference.

Another important factor behind the debt crisis is the fact that a lot of countries in the Latin American region including Mexico embraced import substitution and did so at the expense of their export sectors. Most subsidies like tax credits or low-interest loans went to manufacturers producing for the home market. Currencies were allowed to become artificially overvalued relative to the dollar. This encouraged the import of key raw materials and capital goods, simultaneously hurting the productivity of export sectors.

When countries could no longer pay off old loans with new ones, they needed to find a way to raise the dollars necessary to repay the dollar-denominated loans they had taken out. The obvious way to do this would be to increase exports. However, the export sector had been left extremely disadvantaged making this a very difficult task.

Over the coming weeks, I will be looking at the consequences the debt crisis had on Mexico and Argentina. Focusing further on country-specific factors that may have fuelled subsequent currency crises in each country.

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