Both Chile and Mexico experienced severe economic crises in the early 1980s, yet Chile recovered much faster than Mexico. This study analyzes four possible explanations for this difference and rules out three, explanations based on money supply expansion, real wage and real exchange rate declines, and foreign debt overhangs. The fourth explanation is based on government policy reforms in the two countries. Using growth accounting and a calibrated growth model, the study determines that the only policy reforms promising as explanations are those that primarily affect total factor productivity, or how inputs are used, not the inputs themselves. Interpreting historical evidence with economic theory, the study concludes that the crucial difference between Chile and Mexico in the 1980s and 1990s is earlier government policy reforms in Chile, particularly reforms in policies affecting the banking system and bankruptcy procedures.
This article is a revision of an article published in the _Review of Economic Dynamics_ (January 2002, vol. 5, no. 1, pp. 166-205). The article appears here with the permission of Academic Press and Elsevier Science. Copyright 2002 by Elsevier Science. All rights reserved. This article was edited for publication in the _Federal Reserve Bank of Minneapolis Quarterly Review_. https://doi.org/10.1006/redy.2001.0150