This PDF is a selection from an out-of-print volume from the NationalBureau of Economic Research

Volume Title: The Role of the Computer in Economic and SocialResearch in Latin America

Volume Author/Editor: Nancy D. Ruggles

Volume Publisher: NBER

Volume URL: http://www.nber.org/books/rugg74-1

Publication Date: 1974

Chapter Title: Economic Alternatives for Mexico: A Quantitative Analysis

Chapter Author: Alan S. Manne

Chapter URL: http://www.nber.org/chapters/c6623

Chapter pages in book: (p. 211 - 230)

IECONOMIIC ALTERNATIVES FOR MEXICO:A QUANTITATIVE

ALAN S.Stanford University

11. INTRODUCTION

This work is intended as a step toward multilevel planning—identifying theinformation flows necessary for consistency between project, sectoral, and macro-economic decisiqns. (Parallel process-analysis models of Mexico's agriculturaland energy sectors have been constructed.) To build a macroeconomic model thatwill yield shadow prices relevant to specific project decisions, it appears essentialto allow for labor inputs. Otherwise, it is implied that the marginal productivityof labor is zero. With a constant-returns technology, this, in turn, implies that themarginal productivity of capital will coincide with the economy-wide averageoutput-capital ratio. As noted by Harberger (1967, p. 142), a zero shadow pricefor labor (hence a high shadow price for capital) is "virtually a kiss of death forprojects with long gestation periods or long economic lives.'9

For a macroeconomic model to generate meaningful criteria for project deci-sions, it is not sufficient that "labor' have a positive shadow price. Since theskill-mix differs substantially among alternative investment projects, and sincewage differentials between skill groups appear quite wide in Mexico, it is essentialto separate labor by skill categories. Skill disaggregation is easier said than done.

In our initial experiments, we adopted a manpower requirements formulation—hoping to avoid the data difficulties inherent in a human-capital-formationapproach. The manpower availability in each skill category was projected exoge-

though the supply of labor skills were completely inelastic. Employingthis formulation, plus an activity-analysis technology that turned out to be virtuallyas rigid as a Leontief system, we ran into major difficulties with respect to theshadow price of labor. The efficiency price differentials between skills were eitherzero—or with a minor perturbation in labor availability, these differentials becameunbelievably large.t Under the influence of Marshall's dictum ("natura non fad:saliwn"), we have therefore searched for additional elements of substitution and

°A revised version of this paper will form a chapter in a forthcoming book titled Multi-LevelPlanning: Case Studies in Mexico, North-Holland Publishing Co. Data-gathering and computationswere supported by the Development Research Center of the International Bank for Reconstructionand Development. The results were written during a year in which the author held a Ford Foundationfellowship at the Center for Advanced Study in the Behavioral Sciences.

t The author is indebted to Leopoldo Solis for having provided access to the resources of theDepartamento de lEstudios Económicos, Banco de Mexico. Helpful comments on successive draftswere received from: Bela Balassa, Gerardo Bueno, Yves Franchet, Louis Goreux, Donald Keesing.Janos Kornai, Mordecai Kurz, Saul Trejo R., and Thomas Vietorisz. The drafts were typed carefullyand cheerfully by Maureen Seymour. All computational aspects—including programs for matrixgeneration—were handled by Richard Inman with the assistance of Enrique Novelo Berrón. Thespecific facts, methods of analysis, and conclusions are the sole responsibility of the author.

'Much the same experience is reported in Bruno (1966, pp. 343—45). Apparently, in both thesenumerical models, there was insufficient indirect substitution via international trade to avoid knife-edge behavior of the shadow price with respect to the exogenously specified availability of labor skills.

2112 Economic and Social Research in Latin America

have turned away from regarding labor skills as a demographically given primaryfactor of production. Much like Correa and Tinbergen (1962); Spiegelman, Baum,and Talbert (1965); Adelman (1966); and IBowles (1967); the current version of

includes endogenous time-phased activities for upgrading unskilledinto skilled manpower. Also included are activities for capital-labor substitutionin agriculture and for short-run substitution between skills. Our calculationssuggest that Mexico is approaching the end of the labor-surplus phase of herdevelopment, and that capital-labor substitution could become increasinglyimportant.

With the exception of labor, the dynamic multisector linear programmingmodel (for short, IDJ[NAMIICO) follows along familiar lines. Among the standardingredients are: a 115-sector current-account interindustry matrix, capital coeffi-cients linking investment demands to capacity expansion in each of six future timeperiods, and alternative activities for trade-balance improvement.2 part, foreignexchange is viewed as an exogenously given primary resource—and in part, as anitem for which there exist substitution possibilities. un addition to foreign-exchangeearnings .through traditional exports and tourism, the model allows for the possi-bility of exporting manufactures from high-cost "infant" industries, lit is supposedthat foreign exchange is also available through capital inflows—one portionon concessional terms and another portion through direct private foreigninvestment.

Altogether, the programming matrix contains some 300 constraint rows, 400activity columns, and 4,000 nonzero coefficients. At this size, numerical optimiza-tiion did not prove to be a bottleneck. The model evolved during a two-yearperiod of experimentation. With a continuing series of improvements in the basicdata, there were six successive versions of the "basic case." Eventually, a special-purpose program was written ito generate the matrix and to facilitate datarevisions.

2. ALTERNATIVES TO THE BASIC CASE

For ease in future reference, we define the "basic case" to be the one describedin memoranda 71-9, 71-12, and Table 1 contains a list of the eight alter-natives to be evaluated here. These eight cases refer to alternative formulationsof constraints on the primary factors of production: foreignexchange and labor. Also considered are alternatives to the maximand adoptedfor the basic case: aggregate consumption, subject to a "gradualist" constraint onthe time path and a target annual growth rate g = 7 percent. The eight alternativesare examined one at a time—neglecting interactions between them.

The individual alternatives stem not only from different value judgements asto what is desirable, but also from different practical judgements as to what is

It is assumed that the reader is already familiar with standard references on dynamic numericalplanning models, e.g., Adelman (1966); Chenery and MacEwan (1966); Bruno (1967); Eckaus andll'arikh (I 968); Bruno, Dougherty, and Fraenkel (1970); and Murakami. Tokoyama, and Tsukui (1970).

These reports are available upon, request to the Development Research Center. Internationall3ank for Reconstruction and Development. 1818 H Street, N.W,, Washington, D.C. 20433. Eventually.they will appear as chapters in Multi-Level Planning: Case Studies in Mexico.

TAB

LE I

ALT

ERN

ATI

VES

TO

TH

E B

Asi

c C

AS

E

.

Ass

umpt

ions

Und

erly

ing

the

Bas

ic C

ase

Alte

rnat

ive

Ass

umpt

ions

Iden

tifIc

atio

n N

umbe

rof

Alte

rnat

ive

Cas

e

Max

iman

d: a

ggre

gate

con

sum

ptio

n, su

bjec

t to

grad

ualis

tre

stric

tion

and

annu

al g

row

th ta

rget

g7%

Max

iman

d: sa

me

exce

pt g

row

th ta

rget

g =

6%M

axim

and:

sam

e ex

cept

gro

wth

targ

et g

=8%

Max

iman

d: d

isco

unte

d co

nsum

ptio

nM

axim

and:

term

inal

con

sum

ptio

n

1 2 3 4

Initi

al d

iffer

entia

l of 3

0% b

etw

een

dom

estic

cos

ts a

nd fo

reig

n-ex

chan

ge e

arni

ngs f

rom

hig

h-co

st m

anuf

actu

red

expo

rtsD

irect

priv

ate

capi

tal i

nflo

ws (

FDF'

) res

trict

ed to

an

aver

age

of5.

0 an

d a

max

imum

of 5

.5 b

illio

n pe

sos i

n an

y on

e ye

ar

Initi

al e

xpor

t cos

t diff

eren

tial =

50%

Sam

e av

erag

e ra

te, b

ut—

exce

pt fo

r the

initi

al a

nd te

rmin

al y

ears

—no

lim

it on

inflo

ws (

FDP)

in a

ny o

ne y

ear

5 6

Incl

udes

con

stra

ints

on

the

supp

ly a

nd d

eman

d fo

r lab

or sk

ills

Allo

ws f

or c

apita

l-lab

or su

bstit

utio

n in

agr

icul

ture

thro

ugh

activ

ities

1(4

'

Labo

r con

stra

ints

elim

inat

edD

oubl

ed m

argi

nal p

rodu

ctiv

ity o

f lab

or in

agr

icul

ture

, the

reby

doub

ling

cost

of a

ctiv

ities

1(4

'

7 8

0 0 0 C)

CD

b-s

C.) 0

Economic and SocialL Research in Latin America

politically or technically feasible—e.g., one policymaker will say that the basiccase is altogether too pessimistic in projecting the subsidy required for promotingmanufactured exports; another will say that we have been too optimistic on thisscore. Case 5 permits us to check for the indirect implications of these alternativeviews. Similarly, through case 6, we may examine another aspect of theexchange constraints—the year-by-year limits on the inflows, of foreign privatecapital.

A priori, it might be supposed that alternatives 5 and 6 would have a significanteffect upon the GDP growth rate. Similarly, one might have anticipated sizablemacroeconomic effects from such alternatives as: (1) and (2), changing the annualgrowth target to 6 or 8 percent; or (3), changing the maximand to discountedconsumption; or (4), changing the maximand to terminal consumption.

Under each of these alternatives—when taken one at a time—it turns outthat the 1968—1980 optimal annual ODIP growth rate varies only between 6.8 and7.11 percent. The output growth rates for individual sectors also tend to be insensi-tive to the variations considered under cases 1—6. The effects are concentrated upona comparatively small number of primal variables: the amount of capital-laborsubstitution within agriculture, the inflows of foreign capital, and the marginalexport activities for trade-balance improvement.

11t is not until we turn to cases 7 and 8—those involving the labor constraints—that the alternatives become radically different. Case 7 is calculated as thoughthe marginal productivity of labor in Mexican agriculture were zero, as thoughthere were no social costs of rural-urban labor transfer, and as though the socialproduct foregone by creating human capital were also zero. With the labor-surplus hypothesis carried to this extreme, all labor constraints may be neglected.The marginal productivity of physical capital would rise to 30—33 percent per year—virtually identical to the incremental ratio of aggregate output to physicalcapital. This also means that the 1968—1980 optimal annual GIDP growth ratewould be 7.6 percent, and that each sector's output requirements would be increasedcorrespondingly.

From the viewpoint of income distribution, perhaps the most significantalternative is case 8. the labor constraints are reintroduced. ilt is supposedthat long-term credit is made available to the agricultural sector on more favorableterms than heretofore, and that this policy is pushed far enough so as to doublethe marginal rate of substitution of capital for unskilled agricultural workers.The macroeconomic and foreign-trade effects are not sizable, but the incomedistribution then shifts significantly in favor of unskilled labor.

For our quantitative comparison of alternatives, the results are summarizedin Tables 2 through 7. (Further details are to be found in the computer listings.These are available for inspection in the author's office.) Tables 2 through 7 arearranged as follows:

Table 2. Macroeconomic resultsTable 3. Resource gap—financial flowsTable 4. Foreign-exchange projections, 1980Table 5. Efficiency prices of foreign exchange and foreign aidTable 6. Gross production levels, 1980Table 7. Employment, efficiency wages, and labor income, 1980

'Per

iod

1 =

2..

2Per

iod

S=

4.

rTl 0 0 I

TAB

LE 2

MA

CR

OEC

ON

OM

ICR

ES

ULT

S

[bill

ions

of19

60pe

sos]

Ann

ual

.

CO

N'

SA

W'

INV

'G

DP'

mps

, 196

8-80

SAV

4—SA

P°—

GD

Ø—

GD

P°

GD

PG

row

thC

ase

Iden

tific

atio

n19

741

1980

219

74'

1980

219

74'

1974

'19

802

1968

—80

0B

asic

cas

e30

3.6

445.

881

.913

6.8

81.9

128.

238

5.5

582.

626

.3%

6.9%

Ig

=6%

308.

144

8.8

78.3

123.

978

.311

5.2

386.

457

2.7

23.0

6.8

2 g

=8%

298.

944

1.9

89.0

150.

289

.014

2.6

387.

859

2.1

29.6

7.1

3D

isco

unte

d co

nsum

ptio

n29

8.9

442.

690

.715

2.3

91.8

144.

738

9.7

594.

930

.07.

14

Term

inal

con

sum

ptio

n29

5.8

434.

489

.414

8.8

86.5

145.

438

5.2

583.

230

.06.

95

50%

exp

ort c

ost d

iffer

entia

l6

No

annu

al li

mits

on

FDPt

303.

130

3.7

444.

644

6.0

81.3

83.2

136.

314

3.2

81.3

87.6

127.

612

5.5

384.

438

6.8

580.

8S8

9.2

26.3

27.7

6.9

7.0

7La

borc

onst

rain

tse!

imin

ated

316.

647

8.4

89.5

146.

689

.513

7.9

406.

162

4.9

26.0

7.6

8D

oubl

ed c

apita

l-lab

or su

bstit

utio

n ra

te30

0.2

437.

386

.113

2.3

86.1

123.

638

6.3

569.

626

.06.

7

rn 0 0 0 0 p

TAB

LE 3

RES

OU

RC

E G

AP—

FIN

AN

CIA

LF

LOW

S'

[bill

ions

of 1

960

peso

s)

t'J 0\

Fore

ign

Dire

ct P

rivat

e C

apita

l Inf

low

s, FD

P''7

1'7

4'7

7'8

0'8

3'8

6C

ase

Iden

tific

atio

nI

23

45

6

Less

: Int

eres

t and

Pro

fit R

emitt

ance

s on

Dire

ct P

rivat

eC

apita

l Inf

low

s of P

rior Y

ears

'71

'74

'77

'80

'83

'86

12

34

56

0B

asic

case

5.0

5.5

5.5

5.5

3.5

5.0

Ig

=6%

5.0

5.5

5.5

5.5

3.5

5.0

2 g=

8%5.

05.

53.

55.

55.

55.

0D

isco

unte

dcon

sum

ptio

n3.

05.

55.

55.

55.

55.

04

Term

inal

cons

umpt

ion

00

02.

45.

55.

05

50%

expo

rtcos

tdiff

eren

tial

5.0

5.5

5.5

5.5

3.5

5.0

6N

oann

ualli

mits

onFD

P5.

09.

99.

30.

80

5.0

7La

borc

onst

rain

tsel

imin

ated

5.0

5.5

5.5

5.5

3.5

5.0

8D

oubl

ed c

apita

l-lab

or su

bstit

utio

n ra

te5.

05.

51.

33.

25.

55.

0

—4.9

—7.5

—10

.4—

13.2

—16

.1—

17.9

—4.

9—

7.5

—10

.4—

13.2

—16

.1—

17.9

—4.

9—

7.5

—10

.4—

12.2

—15

.1—

17.9

—4.

9—

6.5

—9.

3—

12.2

—15

.1—

17.9

—4.

9—

4.9

—4.

94.9

—6.

1—

9.0

—4.

9—

7.5

—10

.4—

13.2

—16

.1—

17.9

—4.

9—

7.5

—12

.7—

17.6

—17

.9—

17.9

—4.

9—

7.5

—10

.4—

13.2

—16

.1—

17.9

—4.

9—

7.5

—10

.4—

11.0

—12

.7—

15.6

Plus

: Con

cess

iona

l Cap

ital_

Inflo

ws L

ess I

nter

est,

FC' —

INF

C'7

1'74

'77

'80

'83

'86

Case

Iden

tific

atio

n1

23

45

6

= R

esou

rce

Gap

, RG

AF'

'71

'74

'77

'80

'83

'86

12

34

56

Bas

ic c

ase

2.4

2.0

.9—.9

—2.9

—4.

7I

g =

6%2.

42.

0.9

—.9

—2.9

—4.

7g=

8%2.

42.

0.9

—.9

—2.

9—

4.7

Dis

coun

ted

cons

umpt

ion

2.4

2.0

.9—

.9—2.9

—4.

7Te

rmin

alconsumption

2.4

2.0

.9

—.9

—2.9

—4.

750

%ex

portc

ostd

iffer

entia

l2.4

2.0

.9

—.9

—2.

9—4.7

No

annu

al li

mits

on

FDP'

2.4

2.0

.9—

.9—

2.9

—4.

77

Labo

rcon

stra

ints

elim

inat

ed2.

42.

0.9

—.9

—2.

9—

4.7

Dou

bled

cap

izal

-labo

rsub

stitu

tion

rate

2.4

2.0

.9—

.9—

2.9

—4.

7

2.5

0—

4.0

—8.

6—

15.5

—17

.62.

50

—4.

0—

8.6

—15

.5—

17.6

2.5

0—

6.0

—7.

6—

12.5

—17

.60.

51.

0—

2.9

—7.

6—

12.5

—17

.6—

2.5

—2.

9—

4.0

—3.

4—

3.5

—8.

72.

50

—4.0

—8.6

—15.5

—17.6

2.5

4.4

—2.

5—

17.7

—20

.8—

17.6

2.5

0—

4.0

—8.

6—

15.5

—17

.62.

50

—8.

2—

8.7

—10

.1—

15.3

0 2 3 4 5 6 8

'By year and

perio

d.Periodt=1:1971.

t=3:

1977

.1=

5:19

83.

t=2:1974.

1=4:1980.

t=6:1986.

CD

CD p I

TAB

LE 4

FOR

EIG

NE

XC

HA

NG

E P

RO

JEC

TIO

NS

. 198

0[b

illio

ns o

f 196

0 pe

sosj

Impo

rts

0B

asic

case

41.1

3I

g=6%

38.9

52

g=8%

43.2

73

Dis

coun

ted

cons

umpt

ion

43.8

74

Term

inal

con

sum

ptio

n43

.11

550

% e

xpor

t cos

t diff

eren

tial

40.3

76

Noa

nnua

llim

itsor

iFD

P'41

.15

7La

bor c

onst

rain

ts e

limin

ated

43.2

58

Dou

bled

cap

ital-l

abor

subs

titut

ion

rate

39.7

1

Exog

enou

sly

spec

ified

upp

er b

ound

. Z?(

l -1-

e,)'

2Ex

ogen

ousl

y sp

ecifi

ed lo

wer

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nd,

+

Cas

e Id

entif

icat

ion

0 0 0 C)

Mer

chan

dise

Exp

orts

, at P

rodu

cers

' Pric

es.

i'=I

23

45

67

89

10

item

.

4.90

3.78

.54

5.80

.98

.62

2.07

.29

.72

2.18

4.90

3.78

.54

5.80

.98

.62

2.07

.29

.72

2.18

4.90

3.78

.54

5.80

.98

.62

2.07

.29

.72

1.80

4.90

3.78

.54

5.80

.98

.62

2.07

.29

.72

2.18

4.90

3.78

.54

5.80

.98

.62

2.07

.29

.72

2.18

7.77

3.78

.54

5.80

.98

.62

2.07

.29

.72

2.18

4.90

3.78

.54

5.80

.98

.62

2.07

.29

.72

2.18

7.77

3.78

.54

5.80

.98

.62

2.07

.29

.23

2.18

4.90

3.78

.54

5.80

.98

.62

2.07

.29

.72

2.18

7.77

3.78

.54

5.80

.98

.62

2.07

.29

.72

2.18

4.90

2.36

.45

2.88

.58

.31

0.66

.12

.23

0.56

00

TA

BLE

4 (c

oncl

uded

)

C) 0 0 S C) 0 C)

CD

CD 5.

2 3 4 5 6 7 8

Expo

rts o

f Hig

h-C

ost

Man

ufac

ture

s, at

Prod

ucer

s' Pr

ices

,

Cas

e Id

entif

icat

ion

Fore

ign

Exch

ange

Ear

ning

s. at

Mar

ket P

rices

Res

ourc

e G

ap.

RG

AP4

=Im

port

s—

ZA

4—

Zr4

Mer

chan

dise

Exp

orts

,2To

uris

m.

ZA'

Zr4

Bas

icca

se12

.01

g =

6%10

.13

g =

8%13

.34

Dis

coun

ted

cons

umpt

ion

13.4

8Te

rmin

al c

onsu

mpt

ion

9.21

50%

exp

ort c

ost d

iffer

entia

l8.

26N

o an

nual

lim

its o

n FD

P'19

.84

Labo

r con

stra

ints

elim

inat

ed4.

84D

oubl

ed c

apita

l-lab

or su

bstit

utio

n ra

te10

.84

39.1

410

.63

36.9

610

.63

40.2

310

.63

40.8

310

.63

35.9

010

.63

38.1

210

.89

48.1

910

.63

33.6

018

,29

37.7

810

.63

—8.

64—

8.64

—7.

59—

7.59

—3.

42—

8.64

—17

.67

—8.

64—

8.70

Exog

enou

sly

spec

ified

upp

er b

ound

. Z?(

l + c

)'2—

Exo

geno

usly

spec

ified

low

er b

ound

. Z?(

l + e

,)12

0—

-•18

.29

—10

.63

2 Z

A4

= m

erch

andi

seex

ports

, at m

arke

t pric

es.

.865

8ZA

4 =

mer

chan

dise

expo

rts, a

t pro

duce

rs' p

rices

=+

ZM

'..1

125

Z44

= c

omm

erce

mar

gins

on

mer

chan

dise

exp

orts

..0

217

ZA' =

serv

ice

mar

gins

on

mer

chan

dise

exp

orts

.

rn C) 0 0 C) -t CD

TAB

LE S

EFFI

cIEN

cYP

RIC

ES

OF

FO

RE

IGN

EX

CH

AN

GE

AN

DF

OR

EIG

N A

ID

1960

Pes

os W

orth

of M

axim

andt

per

Tho

usan

d 19

60 P

esos

Wor

thof

Item

Fore

ign

Exch

ange

(row

s [F'

})Fo

reig

n A

id (r

ows [

FGA

P'}

)

Cas

e Id

entif

icat

ion

1974

219742

Effic

ienc

y Pr

ice

of F

orei

gnEx

chan

ge R

elat

ive

to P

rice

ofTr

adab

le M

anuf

actu

res

"Ow

n" R

ate

ofIn

tere

st o

nFo

reig

n

1974

—80

.Annual

Rat

e19

742

0B

asic

cas

e72

.40

24.7

272

.40

24.7

2I

g6%

77.0

726

.17

77.0

726

.17

2g

=8%

74.4

120

.55

61.8

525

.98

3Discounted consumption

547.92

238.20

759.36

333.96

4Terminalconsumption

373.61

290.17

1,284.79

892.21

550%exportcostclifferential

82.08

29.92

78.49

29.9

26

No annual limits on FDP'

71.3

127.22

62.97

27.22

7Laborconstraintseliminated

130.91

.24.61

130.91

24.61

8Doubledcapital-Iaborsubstitutionrate

53.59

22.96

53.59

22.96

1.15

1.15

1.15

1.15

1.16

1.13

1.13

1.13

1.02

1.20

1.28

1.35

1.05

1.21

1.17

1.17

1.13

1.17

20%

20 24 IS 4

18 17 32

IS

Exce

pt fo

r cas

es 3

and

4. i

he m

axim

and

is C

ON

', an

d th

e un

its o

f mea

sure

men

t of e

ffic

ienc

y pr

ices

are

ther

efor

e id

entic

al. I

n ca

se 3

. the

unit

of m

easu

rem

ent

refe

rs to

dis

coun

ted

cons

umpt

ion;

in c

ase

4. to

term

inal

con

sum

ptio

n.2

Perio

d I

= 2

.Pe

riod

1=

4.

I

TAB

LE 6

GR

OSS

PR

oDuc

rioN

LE

VE

LS. 1

980.

BY

SE

CT

OR

[bill

ions

of l

960

peso

s]

Cas

etde

ntifi

catio

nA

gric

ultu

re(1

)M

inin

gP

(2)

etro

leum

Foo

d(3

)(4

)T

extil

es(5

)W

ood

(6)

Che

mic

als

(7)

Non

met

allic

(8)

0B

asic

cas

e74

.68.

639

.011

2.8

54.8

22.6

54.8

14.9

Ig

= 6

%73

.38.

438

.3l1

2.0

54.6

2l.9

53.7

14.0

'2

g =

8%

76.3

8.8

39.5

112.

954

.723

.155

.616

.0*

3D

isco

unte

dcon

sum

ptio

n76

.28.

939

.711

3.3

54.8

23.3

55.9

16.1

*

4T

erm

inal

con

sum

ptio

n74

.48.

838

.910

8.5

53.4

22.6

53.6

15.9

'5

50%

exp

ort c

ost d

iffer

entia

l77

.48.

538

.811

0.9

54.4

22.3

53.8

14.9

6N

oann

ualli

mits

onF

DP

76.5

8.7

39.5

118.

155

.823

.357

.415

.27

Labo

rcon

stra

ints

elim

inat

ed80

.0*

8.8

41.3

*11

5.7

58.7

'23

.656

.115

.9*

8D

oubl

edca

pita

l-lab

orsu

bstit

utio

nrat

e74

.08.

438

.011

0.1

53.6

21.9

53.2

14.4

Bas

ic M

etal

sM

achi

nery

Con

stru

ctio

nE

lect

ricity

Com

mer

ceT

rans

port

atio

nS

ervi

ces

Cas

e Id

entif

icat

ion

(9)

(10)

(II)

(12)

(13)

(14)

(15)

0B

asic

case

37.0

100.

159

.!19

.819

6.7

24.2

161.

0I

g =

6%

34.9

95.2

53.9

'19

.419

3.9

24.1

159.

1

2g

= 8

%39

.l'10

4.4

64.9

'20

.219

9.1

24.2

162.

1

3D

isco

unte

d co

nsum

ptio

n39

.6'

106.

l'65

.4'

20.3

200.

224

.316

3.5

4T

erm

inal

cons

umpt

ion

38.6

103.

865

.9'

19.9

196.

323

.816

1.3

550

%ex

port

cost

diffe

rent

ial

36.3

98.4

59.9

19.7

195.

524

.116

0.4

6N

o an

nual

lim

its o

n F

DP

38.1

101.

858

.520

.019

8.2

24.3

161.

57

Labo

rcon

stra

ints

elim

inat

ed37

.910

5.5'

65.4

'21

.l'21

0.2'

26.2

'17

0.3'

8D

oubl

ed c

apita

l-lab

or s

ubst

itutio

n ra

te35

.796

.756

.819

.3l9

2.0

23.6

156.

6

NoT

E: *

Diff

ers

by m

ore

than

5%

from

Icve

l sho

wn

for

basi

cca

se.

tTJ 0 0 0 ci.

C,, 0 0 C

D

CD pa CD I-t 0 p

0 0 ()TA

BLE

7EM

PLO

YM

ENT,

WA

GE

S,

AN

D L

AB

OR

INC

OM

E,19

80,

BY

LA

BO

R S

KIL

L C

ATE

GO

RY

'

Empl

oym

ent.

(mill

ions

of p

erso

ns)

-S

kill

Cat

egor

ySu

btot

al.

Tota

l.C

ase

Iden

tific

atio

n1

23

45

1—4

1—5

Effi

cien

cy W

ages

. Ann

ual A

vera

ge C

ente

red

on19

802

(thou

sand

s of 1

960

peso

s per

man

-yea

r of s

kill

s)

Skill

Cat

egor

y

I2

34

5

0B

asic

case

.183

1.31

02.

673

9.52

16.

765

13.6

8720

.452

Sg

=6%

.176

1.28

62.

619

9.26

57.

350

13.3

4620

.696

2 g

=8%

.189

1.32

82.

720

9.75

96.

359

13.9

9620

.355

3D

isco

unte

d co

nsum

ptio

n.1

911.

339

2.74

19.

836

5.99

614

.107

20.1

034

Term

inal

cons

umpt

ion

.187

1.31

92.

693

9.66

75.

734

13.8

8619

.600

550

%ex

portc

ostd

iffer

entia

l.1

821.

305

2.66

19.

467

6.88

413

.615

20.4

996

No

annu

al li

mits

on

.186

1.31

82.

698

9.62

36.

901

13.8

2520

.726

7La

borc

onst

rain

tsel

imjn

ated

.193

1.38

72.

839

10.1

349.

895

14.5

5324

.448

8D

oubl

edca

pita

l-Iab

orsu

bstit

utio

nrat

e.1

781.

274

2.60

29.

254

7.23

913

.308

20.5

47

112.

153

.423

.07.

53.

910

6.8

53.7

23.4

7.5

3.9

129.

459

.924

.17.

94.

275

.941

.817

.78.

24.

841

.821

.112

.78.

75.

511

1.6

52.0

22.9

7.6

4.0

117.

953

.824

.27.

94.

2—

——

——

90.2

52.8

24.2

-11

.37.

9

'Ski

ll ca

tego

ry s

=I

:en

gine

ers

and

scie

ntis

ts.

s =

2:

s =3:

$ =

4:s =

5:2A

vera

ge o

f eff

icie

ncy

othe

r pro

fess

iona

l and

tech

nica

l wor

kers

.ad

min

istra

tive

and

cler

ical

wor

kers

.m

anua

l and

sale

s wor

kers

out

side

agr

icul

ture

.un

skill

ed a

gric

ultu

ral w

orke

rs.

wag

es fo

r 197

7, 1

980,

and

198

3, n

orm

aliz

ed b

y du

alva

riabl

efo

r con

sum

ptio

n go

ods.

TAB

LE 7

(con

dude

d)

Labo

r Inc

ome

=E

mpl

oym

ent

x Ef

ficie

ncy

Wag

es(b

illio

ns o

f 196

0 pe

sos)

Skill

Cat

egor

yTo

tal.

Cas

e Id

entif

icat

ion

I2

34

SI—

S

0B

asic

cas

e20

.570

.061

.571

.426

.424

9.8

Ig

=6%

18.8

69.1

61.3

69.5

28.7

247.

42

g =

8%24

.579

.565

.677

.126

.727

3.4

3D

isco

unte

d co

nsum

ptio

n14

.556

.048

.580

.728

.822

8.5

4 Te

rmin

alco

nsum

ptio

n7.

827

.834

.284

.131

.518

5.4

550

%ex

port

cost

diffe

rent

ial

20.3

67.0

60.9

71.9

27.5

248.

56

Noa

nnua

llim

itson

FDP

21.9

70.9

65.3

76.0

29.0

263.

17

Labo

r con

stra

ints

elim

inat

ed—

——

——

—

8D

oubl

edca

pita

l-Iab

orsu

bstit

utió

nrat

e16

.167

.363

.010

4.6

57.2

308.

2

445.

856

%44

8.8

5544

1.9

6244

2.6

5243

4.4

4344

4.6

5644

6.0

5947

8.4

—

437.

370

rTl

C,

Agg

rega

teC

onsu

mpt

ion

(bill

ions

of 1

960

peso

s)La

bor I

ncom

e as

Fra

ctio

n0

CO

N4

ofA

ggre

gate

Con

sum

ptio

nC

)pa C

I) 0 C)

CD

CD pa pa I

Economic Alternatives for Mexico 223

3. ALTERNATIVE OBJECTIVE FUNCTIONS

Cases I through 4 all deal with the problem of welfare distribution betweensuccessive generations—near future versus distant future increases in aggregateconsumption. Somewhat surprisingly, these different objective functions do notlead to great differences in the absolute levels of consumption during the earlytime periods. (See Figure 1 and Table 8.)

Aqgregote consumption, CONt(billion 1960 pesos)900

Ratio 5c01e

800—

700 —

600— / -

500— —

400 - -Bostc case;

onnuol growth target g=7% ,

/4erminal Consumplion moximand;/ 30% limit on marginal propensity

300 —to save —

200 I

Year 1968 '71 '74 '77 '80 '83 '86 '89Period! 0 1 2 3 4 5 6 7

FIGURE I ALTERNATIVE TIME PATHS OF AGGREGATE CONSUMPTION

TABLE 8AGGREGATE CONSUMPTION, CONt: Emci OF ALTERNATIVE OBJEcrIvEs1

[billions of 1960 pesosj

Case Identification1968

01971

1

19742

19773

19804

19835

19866

19897

0

234

Basic caseg = 6%g = 8%Discounted consumptionTerminalconsumption

208.8208.8208.8208.8208.8

251.4254.1248.7245.3245.9

303.6308.1298.9298.9295.8

367.5372.3362.2363.5359.5

445.8448.8441.9442.6434.4

541.8540.0542.2542.5535.9

659.3648.6668.7692.7700.1

803.3777.9828.0848.6857.6

1.By year and period.Period 1=0:1968. t=3:1977. t=6:l986.

1=1:1971. (=4:1980. t7:1989.t=2:1974. 1=5:1983.

224 Economic and Sociall Research in Latin America

For cases I and 2, the tradeoffs are examined through variations in theasymptotic target growth rate—still retaining the restriction that the time pathbe of the gradualist form with increments of consumption growing geometricallyat the annual rate of g.4 lln case II, for example, the target rate is reduced from 7to 6 percent. This policy would make it possible to increase CON' from 251.4 to254.1 billion pesos. Higher consumption levels would also be achieved duringperiods t = 2, 3, and 4, but lower levels during all subsequent time periods.Symmetrical effects are obtained when the target growth rate is raised to 8 percent.That is, case 2 provides lower consumption levels than the basic case duringperiods 11 through 4, but higher levels thereafter.

Although these alternatives differ from each other by less than 1 percent inthe absolute levels of near-term consumption, they do have different implicationsfor near-term fiscal policy. By lowering the annual growth target from 7 to 6cent, the 1968—1980 marginal savings propensity is reduced from 26.3 to 23.0percent. (Table 2.) This means lower taxes and lower prices on the products ofpublic-sector enterprises. Over the long term, of course, this "soft" option leadsto a lower aggregate growth rate and lower employment opportunities. Conversely,if the growth target is raised to 8 percent, the required 1968—1980 marginal savingspropensity is 29.6 percent. The fiscal policy tasks would become correspondinglymore onerous, but the 1980 employment opportunities would then increase from113.7 to 114.0 million jobs within the four highest-paying skill categories. (SeeTable 7.)

lln all cases, we have supposed that there are political constraints uponMexico's fiscal policies, and that it would be infeasible to push the marginalsavings propensity above 30 percent.5 With the gradualist objective function(cases 0, 11, and 2), typically it turns out that the 30 percent savings limit is aredundant constraint.6 When the gradhalist objective function is replaced by thatof maximizing discounted consumption (case 3) or terminal consumption (case 4),the savings constraints become critically important. Without them, the time pathof aggregate consumption is exceedingly erratic from one period to the next. Witha 30 percent upper bound upon the marginal propensity to save, then—even undera growth-maximizing criterion such as terminal consumption—there are no sharpdiscontinuities in the optimal consumption level between two successive periods.When the savings constraint is operative, the specific form of the objective functionhas little effect upon the optimal values of the primal variables.7

For numerical evaluation in case 3, we have taken 15 percent as the annualldiscount rate on future consumption,° and have retained 7 percent as the annuall

For the properties of the gradualist consumption maximand—and its relation to postterminalgrowth—see Hopkins (1969) and Manne (1970).

For the statistical base period 1960—1968, the marginal savings propensity was 23.2 percent.6 In case 2. the 30 percent limit on the domestic savings propensity is binding only during periods

2,3, and 4. Even during these periods, the shadow prices are quite low for the savings constraints, rows(GSAV').

The optimal dual solution is sensitive to differences in the objective functions. For example, itturns out that the 1974—1980 "own" rate of interest on foreign exchange is 15 percent per year in case 3.and 4 percent in case 4. (See Table 5.)

In principle, the consumption discount rate is a subjectively determined parameter—one thatexpresses the social rate of time preference. It is sheer coincidence that the same numerical value hasbeen employed as for the cost of foreign private capital.

Economic Alternatives for Mexico 225

target for postterminal growth. Case 4 has the identical constraints as case 3, buta different objective function. Like a "turnpike" growth model, the maximand isCON7, the level of aggregate consumption reached during the terminal year.Despite the difference in appearance, it can be shown that there is a close relation-ship between the objective functions considered in cases 3 and 4. The latter maybe viewed as a special case of the former—a limiting case obtained by loweringthe discount rate sufficiently. With this interpretation, the objective functions ofcases 3 and 4 have the identical structure—that of discounted consumption. Theonly difference is that the consumption discount rate is 15 percent in case 3, andthat it approaches 7 percent in case 4. The numerical results (Table 8) imply thatthe optimal solution is insensitive to variations in the discount rate within a ratherwide range—7 to 15 percent per year. With this form of model, apparently theupper bound on the marginal savings rate has far more influence upon the optimalconsumption path than does the subjectively determined time discount rate.

4. EXCHANGE

un the basic case, it turns out that the efficiency price of foreign exchange isII. 15—taking the domestic producers' price of tradable manufactures as thenuméraire. 8efore advocating that 15 percent is therefore an appropriate tariffrate or export subsidy or adjustment in foreign-exchange parity, it is essential tocheck through the reasoning that led to this numerical result. un DINAMICO,one of the least reliable econometric components is the marginal cost of exportearnings. The basic case was set up as though there were no limits upon the exportof high-cost manufactures. It is supposed that the domestic cost of theseproducts will exceed the foreign exchange earnings by 30 percent at the time thatthe manufactured item is first exported, and that this cost differential will drop tozero through the experience acquired during an 18-year period.9 As an alternative,case S is calculated as though these marginal export items will have an initial costdisadvantage of 50 percent rather than 30 percent. We continue to suppose thatwill require 18 years of experience before the cost differential can be eliminated.

Case 5 makes little or no difference in the macroeconomic results (Table 2),the pattern of foreign capital inflows (Table 3), the aggregate requirements forimports (Table 4), the gross production levels (Table 6), or the employment levels(Table 7). From the viewpoint of overall reliability of IDINAMICO, it is fortunatethat the principal effects of this parameter change are concentrated upon a smallnumber of variables: the commodity composition of exports (Table 4) and theshadow price of foreign exchange (Table 5). lIt becomes optimal to reduce the 1980exports of high-cost manufactures from 12.01 to 8.26 billion pesos, and to offsetthis Loss of foreign exchange through an increase in agricultural exports. Associatedwith this shift in the direction of comparative advantage, there is a shift in the

e Presumably, in order to provide a financial inceVtive [or the export of high-cost manufacturesfrom individual enterprises, it would be necessary to provide export subsidies. Such subsidies might takea number of forms—either outright or in the form of permission to import raw materials and equipmentduty free. (Mexico is not a member country of GATT [General Agreement on Tariffs and Trade].)With any of these measures, there are administrative difficulties—but no more so than in the case ofexisting import restrictions. The principal difference between an import tariff and an export subsidyis that one provides an inflow of pesos to the treasury, and the other generates an outflow.

226 Economic and Research in Latin Aitnerica

shadow price of foreign exchange. It no longer remains 11.115, but increases to 11.35in 11980—still taking the price of tradable manufactures as the numéraire. Case 5also means that foreign aid would have a higher marginal productivity than in thebasic case.1°

Case 6 provides an instance of interdependence between the optimall timepath of capital inflows, the shadow price of foreign exchange, and the compositionof exports. IHiere we have eliminated the limits on the private capitãilinflows (t = 2. . . 5), but have retained the overall constraint that theaverage inflows are not to increase above the 19711 rate. Case 6 has little effect uponthe macroeconomic iresults or the gross production or the employment levels. Theeffects are concentrated upon the sources and uses of foreign exchange. litbecomes optimal to allow exports to lag and to incur a sizable foreign-exchangedeficit during periods 2 and 3, then to push up the level of manufacturedexports to 19.84 billion pesos in period 4 (1980), and to irun a sizableexchange surplus (17.67 billion pesos) in that year. Associated with this shift inthe time pattern of exports, the shadow price of foreign exchange would irise overtime—from 1.05 to 11.21 between periods 2 and 4 (11974 and 19809 respectively).This also means that the marginal productivity of foreign aid would be lowerduring period 2 and higher during period 4 than in basic case. (See Table 5.)

From case 6, we cannot conclude that year-by-year constraints on foreigncapital inflows are essential in a model of this type. Other devices may also beemployed to avoid sharp discontinuities in the time pattern of exports. Amongsuch devices are: an upward-sloping supply curve of foreign capital, asloping demand curve for exports, or a recursive programming constraint on therate of growth of exports.1 Among these alternative devices, the simplest toestimate is the limit on private capital inflows. For the basic case,this has the disadvantage that the upper bound is an effective constraint duringthe early time periods, and that the unknowns appear to be predetermined.It does not happen, however, that the upper bound is always an effective constraintduring the initial time periods. For examples, see cases 2,4, and 8 in Table 3.

5. EMPLOYMENT AND IINCOME

For case 7. the labor constraints have been eliminated. This makes it possibleto achieve a significant'y higher aggregate growth rate, higher output rates in

10lExcept for cases 3 and 4, the 30 percent limit upon the marginal savings propensity is notcritical constraint. Except for these cases, therefore, it makes little or no difference whether the impactof additional foreign aid is measured through the shadow price of the foreign exchange rows (F') orthrough the resource gap rows Cases 3 and 4 are typical of the "two-gap" phenomenon.There, foreign aid has considerably more leverage than foreign-exchange earnings alone. For furtherdiscussion of the two-gap model, see the interchange between Chenery and Strout (1968) and Fei andRanis (1968).

The shadow price of the domestic savings rows (GSA V') may be read off from Table 5 here. In allcases, this equals the difference between the shadow price of rows (F') and (FGAIP'). To prove thisproposition, refer back to the coefficients of the resource gap activity RGAP and of the concessionallforeign aid activity in Table 4, memorandum 71—13.

Let denote the exports of item I during period t, and let denote the maximum feasible rateof growth of this item between periods: — I and t. Then a recursive programming constraint on exportswould be written: � (I + - See Day (1963); and Dougherty, and Fraenkel (1970).

Note that a recursive programming constraint refers to pairs of unknowns, but that the exportbounds in DINAMICO are imposed upon individual unknowns.

Economic Alternatives for Mexico 227

individual sectors, and greater employment opportunities outside traditionalagriculture. (See Tables 2, 6, and 7.) 11t has already been noted that a zero shadowprice for labor implies a high shadow price for capital. Almost equally dramaticare the implications for comparative advantage in foreign trade. With a zeroshadow price for labor, it becomes optimal to set agricultural exports and tourismearnings at their upper rather than their lower bounds, and to place less dependenceupon high-cost manufactured exports. (See Table 5•)12 Case 7 is included herefor the sake of completeness—not because we believe that it provides a irealisticbasis for projections.

lincreasingly, Mexican policymakers are directing research toward the sourcesinequities in income distribution. There is strong evidence that, along with the

increase in average incomes, the extent of inequality worsened between 1950 and11963. (During those years, the Gini coefficient of inequality increased from 0.50to 0.55.) ltn part, this problem arises from interregionall differences in develop-ment—and from imperfect labor mobility between regions. un 11965, for example,the 8 highest-income regions accounted for 30.3 percent of the total population,and produced 11,075 pesos per capita. The 17 lowest-income regions, with 43.8percent of the population, produced only 2,417 pesos per capita. (Source : Navarrete[11970, p. 411 and Table 8].)

Not only regional but also occupational differences are a significant sourceof inequalities. During each of the years between 1950 and 1967, in industry andservices the per capita output exceeded that in agriculture by a factor of approxi-mately 5:1. Even within agriculture—despite the post-Revolution policies ofagrarian reform and land redistribution—the pattern of development has been

un the irrigated districts of the north, farming is commercialized andproduces high economic returns. Elsewhere—in the central plateau and in thesouth—subsistence agriculture is hard pressed to keep up with the demographicpressures. (See Solis [1970, pp. 148 and 291].)

DINAMXCO is too highly aggregated to be helpful in analyzing the detailedregional aspects of income inequalities and labor mobility. Case 8 is focused ononly one dimension of the tradeoff between aggregate growth versus equity inincome distribution. As proxy measures for these concepts, we have taken aggregateconsumption and labor's income share, both as of 11980 (t = 4). 13y measuringlabor's income at efficiency wages, we have, in effect, adopted the view that moneytransfer payments could not be large enough to achieve a significant redistributionof real income between social classes. (if money transfers could be made sufficientlylarge—and transfers entailed no loss in productive efficiency—the question of agrowth-equity tradeoff would not arise.)

Case 8 has been constructed as follows: Suppose that public infrastructureinvestments are made available for the benefit of the smaliholders in the denselypopulated central and southern centers of Mexican agriculture. These investmentsmight take the form of extension services, roads, tractors, irrigation, and land

12 Rather than suppose that the marginal productivity of labor is zero in all skill classes (case 7),it might have been worth exploring a less extreme version of the labor-surplus hypothesis. Suppose, forexample, that the only change in the basic case had been to assume that unskilled agricultural labor hasa zero or a low marginal product. It would then be optimal to shift the composition of foreign-exchangeearnings—setting agricultural exports at their, upper bounds and reducing the exports of high-costmanufactures.

228 Economic and Social Research in Latin America

leveling. To the extent that the aggregate demand for agricultural products isinelastic, these investments might have to be made at the expense of northernagriculture. It is possible that this would lead to a loss in economic efficiency, butthat nonetheless—from the viewpoint of income distribution—this would proveto be a desirable shift in investment policy.

For case 8, it is supposed that this reorientation of agricultural policy ispushed far enough so as to double the marginal rate of substitution of capital forunskilled agricultural workers.'3 It turns out that this would have a significant

Labor income (billion 1960 pesos)325

.8300 —

275— .2Key:1 g6%2 g8% .63 Discounted consumption4 Terminal consumption5 50% export cost differential

250 — 6 No annual limits on FDPI •osic case_8 Doubled capital-labor

substitution rate

225 —

200 —

175 —

425 430 435 440 445 450Aggregate consumption, CON4 (bLilion 1960 pesos)

FIGURE 2 INcOME DISTRIBUTION VERSUS AGGREGATE GROwTH, 1980

13 For the basic case, at a point of time y years after 1960. it is assumed that it would require15(1 thousand pesos of capital to replace one unskilled agricultural worker. For case 8. thismarginal rate of substitution is instead taken to be 30(1.02)'.

Economic Alternatives for Mexico 229

effect not only upon the efficiency wage of agricultural workers, but also uponthat of unskilled urban workers. (See Table 7 and Figure 2.) Other policy measureswould also affect labor's share, e.g., case 2, where the target annual growth rateis raised to 8 percent. None of the alternatives, however, would exert as pronouncedan effect upon income distribution as would this shift in the direction of agricul-tural investments. In 1980, this would make it possible to double the income ofunskilled agricultural workers—from 26.4 to 57.2 billion pesos at 1960 prices.Total labor income would increase from 249.8 to 308.2 billion. The loss in aggregateconsumption (from 445.8 to 437.3 billion pesos) might well be worth the gain inequity from such a policy.

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