The Uruguayan Experience with Liberalization and Stabilization, 1974-1981

Abstract

Uruguay achieved a dramatic turnaround in the face of very poor initial conditions from 1974-l981, an interesting case study in the role of stabilization cum liberalization programs. An important part of the adjustment involved dealing with external shocks over which Uruguay had no control. However, the economy's turnaround cannot be understood without also referring to the prevailing set of internal conditions and policies. After a review of the pre-reform period, this article reviews the major reforms and macroeconomic developments from 1974 through 1981. Some interesting lessons for liberalization and stabilization programs emerge. First, financial sector liberalization seems to offer substantial benefits, provided that the real exchange rate and the current account are not allowed to deteriorate too much. When public external indebtedness can no longer be used to offset private capital flight, a massive devaluation will be necessary. Second, stabilization in an economy with a long history of high inflation is a difficult and slow process. A preannounced exchange rate policy seems to have only a small effect on inflation and does not avoid the output-inflation trade-off. This policy is likely to produce a recession, running counter to the goal of increased exports.