The precarious nature of Uruguay's primary-product export economy, so successful during the early decades of the 1900s, was gradually made clear for two distinct reasons. First, the sharp contraction of world demand for Uruguay's exports during the Great Depression showed the hazards of being at the mercy of external markets and foreign prices. Uruguay's export earnings fell by 40 percent between 1930 and 1932 as world demand contracted and importing nations adopted protectionist measures. Such a drastic decrease in earnings was only temporary, however. During World War II, prices recovered, making the export model appear viable again, if vulnerable. Still later, Uruguayan exporters were occasionally able to gain handsomely from world price increases. The most dramatic example of this phenomenon occurred during the Korean War (1950-53). Wool prices tripled temporarily as demand for cold-weather uniforms surged.

The volatility of export prices, which was itself troubling, also delayed recognition of the second, underlying limitation on Uruguay's export-based economy: the limited supply of livestock products. Production of beef stagnated by the mid-1930s, wool by the mid-1950s. With only minor modifications, ranchers continued to rely on the extensive production techniques used since the colonial period. Livestock production was therefore limited by the carrying capacity of the land. For many years, successful livestock producers had been able to expand their operations by simply purchasing or renting additional land, but after the tremendous expansion of both cattle ranching and sheep ranching during the early decades of the 1900s, this option was no longer available. Producers rejected the obvious alternative of increasing production levels by using more intensive techniques, such as fertilized pastures. According to a study published by the Economic Institute (Instituto de Economía) at the University of the Republic (also known as the University of Montevideo) in 1969, ranchers chose not to invest their profits in improved pastures because many more lucrative investments were available. Preferred investments included manufacturing (after World War II), urban real estate (during the 1950s), and overseas opportunities (leading to substantial capital flight during the 1960s).

The stagnation of livestock production undercut the export model that had brought Uruguay its prosperity. At first the nation was able to avoid complete economic paralysis by turning from livestock production to industrial development, from the dormant countryside to the dynamic city of Montevideo. Like most other Latin American nations, Uruguay responded to the Great Depression by implementing a policy intended to encourage diversification away from primary products, reduce imports, and increase employment.

The so-called import-substitution industrialization (see Glossary) strategy raised tariff barriers to discourage imports and protect new manufacturing enterprises. In addition to increased protectionism, several other conditions in Uruguay favored the in 1466 ndustrialization that accelerated beginning in the mid-1930s. Labor was plentiful in Montevideo 100,000 immigrants had arrived from Europe during the 1920s. Equitable income distribution also meant that there was a sizable middle-class market for manufactured products. Finally, wealthy livestock producers were ready to invest in new enterprises.

Industry developed rapidly under these conditions. The number of firms, most of them employing ten or fewer workers, tripled from 7,000 in 1930 to 21,000 in 1955. Apart from the growth of traditional types of enterprises (food, beverages, textiles, and leather), there was also substantial progress in heavier industries (chemicals, oil refining, metallurgy, machinery, and electrical equipment). Workers earned good wages, and production increased more rapidly than employment, meaning that labor productivity was on the rise. During the 1940s, industrial output overtook livestock raising as a share of GDP.

But the industrial boom was short-lived. One sign of trouble was the fact that 90 percent of manufactured goods were consumed within Uruguay. Because domestic industries had grown up behind high tariff barriers, they were not competitive on world markets. This common shortcoming of the import-substitution industrialization strategy was particularly serious, given Uruguay's small internal market. Although income distribution was equitable, the potential for home-industry expansion was limited because consumption was limited. Most industries reached their full potential just two decades after the beginning of the industrialization process. During the mid-1950s, imports of machinery and industrial equipment that were essential for the further development of heavy industry leveled off and then declined. Industrial growth ceased. With the stagnation of both industrial production and livestock production in the mid-1950s, Uruguay's economy entered what would be a twenty-year crisis. Real per capita income, which had grown rapidly during the early 1900s, increased at an average of only 0.5 percent per year from the mid-1950s to the mid-1970s. The period was characterized by declining exports, a negative balance of payments, decreasing reserves, and growing inflation.

The prolonged nature of the crisis, i.e., the two-decade lack of fundamental economic restructuring, had much do to with the government policies that were set in motion during the Batllist period. As two of the three pillars of Uruguay's economy (livestock and industry) crumbled, the third (the public sector) bore an increasing burden. State enterprises expanded until, by the 1960s, they generated 30 percent of GDP and paid 40 percent of all salaries. Once-dynamic state enterprises became expensive public works projects. Elaborate formulas were devised to allow Uruguay's two principal political parties--the Colorado Party and the National Party (Partido Nacional, usually referred to as the Blancos)--to dispense public-sector jobs in proportion to votes received. Economically, a change of the ruling party meant very little. Both parties were allied in upholding the social welfare model, which amounted to keeping the state enterprises and the bureaucracy afloat. To do so, they incurred a large foreign debt and penalized the livestock sector through domestic price controls. The economy turned inward through continued protectionism and artificially high exchange rates. As a result, the once-vital export sector could not develop the momentum required to pull the economy out of the doldrums.

The protracted economic crisis became a political crisis in the late 1960s. Within Uruguay the welfare state government could provide no answers to the twin challenges of urban terrorism and growing inflation. Outside Uruguay military regimes in both of its larger neighbors (Argentina and Brazil) cast long shadows, and international economic conditions made the insulation of Uruguay's economy more difficult. As the military regime took power in 1973, two international economic factors were particularly relevant: the quadrupling of oil prices (Uruguay imported all of its petroleum) and the closure of European Community markets to imported beef. These factors helped convince the military government that a major restructuring of the economy was needed.

Data as of December 1990