A decade lost and found: Mexico and Chile in the 1980s

We thank the participants at the Minneapolis Fed's "Great Depressions of the Twentieth Century" Conference-especially Pete Klenow-and participants at seminars at the Centre de Recerca de Economia de Benestar and the East-West Center for helpful comments. We are also grateful to Edgardo Barandiarán, Bob Lucas, Rolf Luders, Jaime Serra-Puche, and especially Ed Prescott for useful discussions. Jim MacGee provided invaluable research assistance. Patrick Kehoe and Timothy Kehoe thank the National Science Foundation, and Raimundo Soto thanks the Banco Central de Chile for research support. The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System. Chile and Mexico experienced severe economic crises in the early 1980s. This paper analyzes four possible explanations for why Chile recovered much faster than Mexico did. Comparing data from the two countries allows us to rule out a monetarist explanation, an explanation based on falls in real wages and real exchange rates, and a debt overhang explanation. Using growth accounting, a calibrated growth model, and economic theory, we conclude that the crucial difference between the two countries was the earlier policy reforms in Chile that generated faster productivity growth. The most crucial of these reforms were in banking and bankruptcy procedures. Journal of Economic Literature Classification Numbers: E32, N16, O40.