The military government was at first able to redirect and revitalize the economy. During the first phase of stabilization and structural adjustment, from 1973 to 1978, government policies had two central goals: to reestablish an export-oriented growth policy and to eliminate inflation. In pursuit of the latter, the government tightened the money supply, sharply cut the public budget, and held real wages down. The effort was partially successful. Inflation declined from over 100 percent per year during the 1960s to about 50 percent per year in the 1973-78 period. To reorient the productive sectors of the economy, the government eliminated most price controls, lowered tariff barriers from a maximum of 346 percent in 1974 to 180 percent in 1977, and subsidized exports. Foreign-exchange and financial markets were also made more liberal, increasing Uruguay's integration with world markets. The immediate results were dramatic: from 1974 to 1978, GDP increased by an average of 3.9 percent per year, after two decades of stagnation. Real exports grew by 14 percent annually during the same period, and productive investment increased by 16 percent per year.
Dissatisfied with some aspects of the economy's performance, however, the government again adopted several measures between 1978 and 1982. These included passing a foreign investment act (designed to attract foreign investment), reducing government spending, and selling off a few state enterprises.
Inflation, which had dropped below 40 percent in 1976 but had since increased again, remained the primary target of the new stabilization policies. Authorities believed that two factors were fueling inflation: the influx of external funds (allowed under liberalized financial regulations) and the continuing price increases by local firms, still protected from foreign competition because tariffs had only been reduced partially. The government, then, saw continued inflation as a problem caused by incomplete economic liberalization and moved to accelerate reforms. Banks were largely deregulated as reserve requirements were eliminated and foreign currency deposits allowed. Import tariffs for most products were reduced, allowing increased foreign competition. Export subsidies were reduced or eliminated. In addition, the government began announcing moderate exchangerate devaluations several months in advance in an attempt to slow inflation and discourage currency speculation.
These measures reduced inflation somewhat, but instead of stabilizing the economy, they disrupted the gradual process of economic recovery that had been under way for several years. Uruguayan firms, many of which had reoriented production toward exports after 1974, faced rising internal costs when subsidies were removed. At the same time, they became less competitive abroad because devaluations did not keep pace with inflation. Banks responded to deregulation by making risky loans, many of which became nonperforming as the expansion slowed. The public deficit increased, especially when the government stepped in to rescue several major banks. External debt increased when the government was forced to borrow abroad. A second oil shock in 1979 (the first was in 1973-74) and an Argentine devaluation in 1981 both hurt Uruguay's trade balance. As the restructuring process broke down, capital flight became rampant.
The military government's attempt to regain economic stability during its last two years in office resulted in a severe recession. After increasing over several years to a high of 6.2 percent in 1979, GDP growth slowed to 1.9 percent in 1981 and plunged to -9.4 percent in 1982. Real GDP declined by onesixth from 1982 to 1984. Unemployment increased to 13 percent, further increasing the burden on the nation's welfare system. During its last three years in office, the government's most significant accomplishment was far more modest than its earlier reforms: it reduced the public deficit from 18.4 percent of GDP in 1982 to 9.2 percent at the end of 1984.
As the military government prepared to leave power after a turbulent twelve years, five major issues confronted economic planners. First, the government had succeeded in reorienting production toward exports, but by the mid-1980s traditional export markets were growing less hospitable. For example, world beef prices had fallen, partly because of subsidized competition from the European Community. Second, the public sector, which played a large role in Uruguay's economy, faced a growing internal and external debt burden. This reduced savings available to finance private investment and made it difficult for the government to meet its social security obligations. Third, many firms and banks were financially weak, the former because of debts incurred before the recession and the latter because of nonperforming loans. Fourth, unemployment remained high. Finally, inflation, a primary target of the attempted reforms, had increased from 50 percent in 1983 to 72 percent in 1985. The first and second issues were concerned with enduring themes: the importance of livestock exports and the government's role in the economy. The third, fourth, and fifth issues were products of the reforms that had brought Uruguay out of stagnation without completely restructuring the economy.
Data as of December 1990