One of the first victims of the economic crisis of the 1970s was conventional Keynesian economic policy. The decade's crisis was marked by historically unprecedented, simultaneous, high inflation rates and high unemployment rates, which the dominant economic theory of the time—the Keynesian tradition—was unable to explain. This combination of high inflation and unemployment—and the corresponding recession it produced—was coined "stagflation" by Tory MP Iain Macleod in a speech to British Parliament in 1965. Stagflation overtook the British economy in the 1960s and 1970s and the US economy in the mid- to late-1970s.

Because Keynesian theory considered high unemployment and high inflation to be mutually exclusive—so much so that the conventional policy "medicine" for inflation was a dose of unemployment—stagflation dealt a staggering blow to the credibility of Keynesian anti-recessionary economic policy. Into the theoretical vacuum stepped the "neoclassical" Monetarists led by Milton Friedman. This transfer of ideological leadership—within the ranks of both economic orthodoxy and the political regimes in the US and Britain—sharply changed the way governments and central banks perceived the goals of fiscal and monetary policy.

Stagflation in the US and UK created a world economic slump that created increasing difficulties for public finances in the most developed countries. In addition, inflation corroded the corporate world's ability to make economic forecasts with any degree of accuracy. Because of this, economic policy became increasingly focused on fiscal austerity and price control [through tight interest rate policies], all of which contributed to a further worsening in the State’s capacity to finance its growing debt.

Third World debt also became a problem during this crisis. The excess of liquidity in the world market, represented by a cheap dollar, induced many underdeveloped nations to contract huge debts, which had to be paid at increased interest rates after the shift in economic policy took place. This is the case of most Latin American countries, which, under the Import Substitution Industrialization [ISI] policies of the 1930s [see sidebar] to the 1970s, had managed considerable advances in industrialization.

Import Substitution Industrialization policies managed to finance robust growth for several decades—by protecting nascent industries from stronger competitors in the global market, until they were able to compete. But by the 1970s, ISI had run out of steam in Latin America. In the early 1970s there were many capitals in the world market—Euromarkets, petrodollars—all available for borrowing at seductive interest rates [even negative ones]. Most of the newly industrialized countries [NICs] contracted increasing amounts of debt, sometimes with floating interest rates that were renegotiated every six months!

For example, the Brazilian external debt skyrocketed as a pretext for investments in infrastructure planned by the military governments. In 1973, Brazil’s external debt accounted for 7.9% of the country’s GDP, while in 1978 it already represented 15.2% of the GDP. Mexico’s situation was not fundamentally different. From 1978-81, the Mexican government pursued an expansionary fiscal policy that created an average of 8.2% real economic growth. It borrowed extensively from foreign—principally US—sources to finance investments in infrastructure and industry, social services, and debt servicing. In addition, Mexico ran huge budget deficits, borrowing 44% of the nine largest US banks’ capital in 1981.

However, because of the crumbling of the economic Golden Age—and the corresponding radical restructuring of the Bretton Woods regime—the international situation suddenly changed at the end of the 1970s. By then the combination of recession and higher world interest rates made the debt obligations in the Latin American NICs intolerable. [Between 1975 and 1984, the US prime rate grew from 5-7% to 18%—that is, 8%, in real terms] Exports fell and interest payments shot up.

In Mexico, oil made up three quarters of all exports, so as oil prices fell, government revenues did, too. In addition, with high interest rates, the interest burden climbed from $5.4 billion in 1980 to $8.2 billion in 1981. These interest rate increases, initiated by the Reagan administration, let loose a full-fledged financial crisis.

From January to August 1982, a run on dollars meant that US dollar deposits in Mexican banks grew from $9 billion to $12 billion. Ninety percent of the bank accounts in Mexico were already denominated in dollars even though peso accounts were paying 23% higher interest.

Capital outflows also sped up during the first part of 1982. By July, around $14 billion had disappeared into foreign bank accounts and another $25 billion found itself "miraculously" invested in US real estate. Finally, on February 17th, 1982, the Banco de México allowed the peso to float. The devaluation that followed eventually amounted to 43%. Besides stimulating exports, the government hoped that devaluation would slow capital flight.

This process has many painful social consequences, as well as economic ones. In Mexico, unemployment skyrocketed. Income inequality grew. The inflationary pressures created by IMF-orchestrated debt-policy meant that rising prices placed a huge burden on Mexican society, and devastated the poor.

However, the deepest consequence of this crisis was the realization that the ISI model of financing development—based on external borrowing and state-led import substitution—had reached its limit in Latin America. The waning of ISI regime paved the way to establish economic policy under the guidance of the Bretton Woods institutions. The implementation of the new economic policy in the following decade is the story of the neoliberal conversion of Latin America.

What does this mean for resistance in the US, the belly of the beast? Consider that the peso's collapse marked an historic restructuring of relations between the US and Latin America, in line with Britain's and the US's increasingly aggressive stance toward Latin American nations. As ISI—and its Keynesian policy structure—were pushed out, the changing global economic and political relations under Reagan and Thatcher brought in neoliberalism and the militarism required to enforce it. Growing resistance to neoliberalism in the Third World, particularly in Latin America, laid the groundwork for the birth of aligned resistance to neoliberalism in the US.

Decolonization, ISI, and the Rise of the Third World

World War II left the European colonial powers in a greatly weakened state. Unable to hold onto their colonial territories due to weakness and pressures from growing national liberation movements, the European empires began to unravel. From 1945 to 1981, one hundred five new states joined the United Nations, swelling its ranks from 51 to 156 member states.

During the era of decolonization, the world was divided into three geopolitical blocks. This division reflected the hardening of relations as the Cold War set in between the capitalist West [First World] and the Soviet-led [Second World] blocs. "Third World" referred to the non-European world, which was largely poor, and had — for the most part — been colonized by Europe. The Third World was also home to half the globe's population.

With the coming of political independence, the new Third World nations set about the task of overcoming the legacy of colonialism. This also led to a shift in the way development was conceptualized. If colonialism was characterized by a “dual mandate” to bring civilization and development to the non-European world, then independence meant development was now a universal project, one that could be administered by European and non-European alike.

At the center of this post-colonial project was the goal of industrialization. Under colonialism, economic development had an external orientation focused on supplying Europe with raw materials to feed Europe’s industrial revolution. 

Consequently independence meant a shift toward an inner-directed development, one that would create the conditions for self- expansion.  Import Substitution Industrialization [ISI] was a development strategy that emerged from Latin America and was implemented with varying degrees of success by most of the Third World.  The aim was to eventually “catch up” with the First World.