Did the debt crisis or the oil price decline cause Mexico's investment collapse?
This paper proposes a simple investment model that permits a test of the relative importance of Mexico's terms of trade decline, the reversal in net capital inflows, and the debt overhang, in explaining Mexico's investment decline in the early 1980's. The paper uses previously unexploited sectoral investment data between 1981 and 1985 to estimate the quantitative importance of these explanations. The data indicate that the main microeconomic mechanism driving the investment decline was the rise in the relative price of investment goods and further that the deterioration in Mexico's international terms of trade explains most of the increase in this relative price. Our preferred estimate is that about two-thirds of the investment decline was attributable to the terms of trade decline, while the termination of capital inflows explains the remaining third. The paper finds little evidence in favor of other debt crisis effects such as the debt-overhang effect or several other more subtle effects that have been proposed in the literature.
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- Ben S. Bernanke, 1983. "Irreversibility, Uncertainty, and Cyclical Investment," The Quarterly Journal of Economics, Oxford University Press, vol. 98(1), pages 85-106.
- Cukierman, Alex, 1980. "The Effects of Uncertainty on Investment under Risk Neutrality with Endogenous Information," Journal of Political Economy, University of Chicago Press, vol. 88(3), pages 462-475, June.
- Rodrik, Dani, 1991.
"Policy uncertainty and private investment in developing countries,"
Journal of Development Economics,
Elsevier, vol. 36(2), pages 229-242, October.
- Dani Rodrik, 1989. "Policy Uncertainty and Private Investment in Developing Countries," NBER Working Papers 2999, National Bureau of Economic Research, Inc.
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