Mexico - Basic economic report (Vol. 3 of 6) : The present

1972/14 DOCUMENT OF INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION Not For Public Use IReport No. 192-ME Ksit,,-Jt<0A ti* & C. EILES THE ECONOMY OF MEXICO A BASIC REPORT (in Six Volumes) VOLUME III THE PRESENT June 27, 1973 Latin America and the Caribbean Department This report was prepared for official use only by the Bank Group. It may not be published, quoted or cited without Bank Group authorization. The Bank Group does not accept responsibility for the accuracy or completeness of the report.  CURRENCY EQUIVALENTS US$1 = Mex$12 .5 Me $1- = US$o.o8 Mex$l million = US$80,000 FISCAL YEAR January 1 - December 31  192-I4E THE ECONCMY OF MEXICO A BASIC REPORT (in six volumes) VOLUME III THE PRESENT June 27, 1973 Latin America and the Caribbean Department   CONTENTS Chapter Page I INTRODUCTION : ISSUES AND OPTIONS 1 A. ISSUES 1 B. MACRO-ECONOMIC POLICIES AND TRENDS 1970-1973 4 C. MACRO-ECONOMIC OPTIONS, 1973-1976 5 II THE INSTITUTIONAL AND FINANCTAL FRANEWORK OF MACRO-ECONOMIC POLICY 7 A. INTRODUCTION 7 B. EFFICIENCY 11 C. SOCIAL ASPECTS OF THE FISCAL AND FINANCIAL SYSTEM 24 D. FINANCIAL STABILITY 28 E. PROSPECTS AND ALTERNATIVE PUBLIC SECTOR STRATEGIES 32 III THE SECTORS t PROBLEMS, POLICIES AND PROSPECTS 52 A. INTRODUCTION 52 B. AGRICULTURE, FORESTRY AND FISHERIES 52 C. INDUSTRY 93 D. TRANSPORT 1 25 E. TOURISM 137 F. SOCIAL SECTORS 140 IV THE BALANCE OF PAYMENTS 161 A. RECENT STRUCTURAL CHANGE 161 B. FINANCING THE CURRENT ACCOUNT DEFICIT 165 C. PROSPECTS 167   LIST OF TABLES III-II-1 Sources and Uses of Resources, 1965-1971 III-II-2 Government Expenditures in Various Countries III-II-3 Summary Funds Flow, 1965-1971 III-II-4 Summary Public Sector Finances, Average of 1965-1971 III-II-5 Public Savings, 1965-1971 III-II-6 Savings of Public Enterprises, 1965-1971 III-II-7 Public Enterprise Investments, 1965-1971 III-II-8 Tax Revenues, 1965-1971 III-II-9 Tax Rates on Earings Derived from Fixed Income Assets III-I-i-0 Excise Taxes, 1970-1971 III-II-11 Holdings of Banking System Liabilities by Enterprises and Individuals III-II-12 Allocation of Bank Lending, 1950-1970 III-II-13 Public Expenditures on Social Services, 1970 III-II-14 Public Medical Institutions : Doctors and Hospital Beds, 1969 III-II-15 Public Revenue and Expenditure Projections, 1973-1976 III-II-16 Public Saving and Possible Investment Expenditures, Projections for 1972-1976 III-II-17 Public Investment Program III-II-18 Public Investment Shares III-II-19 Maximum Public Internal Borrowing, 1973-1976 III-II-20 Public External Borrowing, 1973-1976 III-II-21 Public Sector Borrowing, 1972-1976 III-II-22 Alternative Fiscal Strategies III-II-23 Rate Increases (Actual and Prospective) in the Goods and Services of Decentralized Agencies  III-II-24 Percentage of GDP in 1976 III-II-25 Price Effects of Passing Through PEMEX and CFE Price Increases III-III-1 Agricultural Production - 47 Selected Crops, 1960-71 III-III-2 Exports of Merchandise by Commodity, 1960-72 III-III-3 Water Use and Productivity in Selected Irrigation Districts, 1969 III-III-4 Projected Demand and Supply for Major Agricultural Products, 1976 III-III-5 Yield Effects of Extension Service by Crops and Selected Regions, 1971 III-III-6 Past and Projected Growth Components by Major Crops III-III-7 Apparent Domestic Consumption 1971 and Projected Consumption * 1976 III-III-8 Agricultural Export Projections, 1976 III-III-9 Supply and Demand of Mechanical Wood Products, 1965-1985 III-III-10 Energy Consumption, Gross National Product and the Energy/GDP Ratio, 1951-71 III-III-11 Distribution of Total Energy Consumption, 1951-1961-1971 III-III-12 Domestic Consumption of Hydrocarbons III-III-13 Liquid Hydrocarbons Reserves and Production, 1956-71 III-III-14 Gross Additions to Crude and Natural Gas Reserves III-III-15 Gross Imports of Crude and Refined Products, 1971, Estimated 1972-76 III-III-16 PEMEX Investment Program, 1971-76 III-III-17 PEMEX Investments 1973-76 III-III-18 Financing the Investment Program (PEMEX Figures) 1973-76 ITT-III-19 The Financing "Gap", 1973-76 III-III-20 Alternative Trends in Hydrocarbons Imports III-III-21 CFE Investment Program  - 3 - III-III-22 Manufacturing Sectors in 1970 III-III-23 Profit Rates : 1967 III-III-24 Industrial Concentration III-III-25 Summary of Regulation of Decree 23 of November 1971 III-III-26 Samples of Wages in Mex$ per hour paid by 22 Firms Located in Three Zones Defined by the Decentralization Law of November 1971 III-III-27 SOP Proposed Highway Expenditures 1970-76 III-III-28 Ports - Total Traffic, 1970 III-III-29 Aviation Investment III-III-30 Civil Aviation - Proposed Investment by Agency, 1971-75 III-III-31 Education 1970 - Enrollment III-III-32 Apparent and Actual Enrolments in Relation to Age-Group 1970 III-III-33 Urban-Rural Contrasts in Primary Education, 1969 III-III-34 Expenditure Requirements in Education, 1973-76 III-III-35 Projections of Medical Services and Costs III-III-36 Nutrition - 1968 III-III-37 (a) Housing Conditions, 1970 - Water Supply III-III-37 (b) Housing Conditions, 1970 - Drainage III-III-38 Housing Conditions, 1970 - Density of Occupation III-III-39 Dwelling Construction, Investment and Breakdown by Sources of Finance from 1965 to 1970 III-III-4;O Planned Rural Development Program, 1973-76 III-IV-1 Structure of Manufactured Exports III-IV-2 Balance of Payments Projections III-IV-3 Imports of Crude Petroleum  LIST OF FIGURES III-1 Money and Prices III-2 Actual Prices Compared with Theoretical Prices III-3 High-Powered Money and its Determinants III-4 Composition of the Forested Areas of Mexico III-5 Numbers of Dwellings According to Principal Materials used for Walls, Roofs and Floors, 1970.  I. INTRODUCTION : ISSUES AND OPTIONS A. ISSUES Introduction 1. Some of the social and economic problems which confronted the new administration of President Luis Echeverria in November 1970 arose from the niggardliness of the Mexican environment. Others were associated with restraints on international trade. Many were linked with the commissions and omissions of the social and economic policies of earlier administrations. 2. With regard to the Government's perception of social and economic problems there are, in the absence of a Development Plan, three sources of information: (a) statements by the President and other members of the administration, including the President's Inaugural Address of November 1970 and his Annual Addresses of September 1971 and September 1972; (b) legislative proposals put before Congress since November 1970; (c) budgetary plans. 3. On the basis of these sources, it appears to be the Govern- ment's view that the two major issues for the country in the medium term (1970-1976) are: (i) how to maintain sustained growth with price and balance of payments stability, and (ii) how to distribute the output of that growth in such a way as to alleviate poverty, particularly but not exclusively in rural areas. Growth and Stability 4. In the light of past trends and of theoretical assumptions about the nature of growth, sustained expansion in the medium term would seem to have the following implications: (i) the maintenance of a high level of domestic savings and the continued inflow of foreign private and and public capital; (ii) the maintenance of a high level of investment, implying that the public sector should perform its traditional role as a source of infrastructural development and of utility services in order to prevent the emergence of bottlenecks to growth (and disincentives to private investment) and that the private sector (including the foreign private sector) should remain willing to invest and reinvest in productive enterprises; (iii) the maintenance of the institutional bases of the confidence which has been developed between the public and private sectors in the past 15 years; (iv) the control of inflation to a level consistent with"stability" 1/ in order to maintain confidence in the economy on the 1/ i.e., inflation should not be more than 1 or 2 percent above the level of world inflation.  - 2 - part of both savers and investors, implying that the expansion of the money supply should be consistent with the rate of economic growth; (v) the preservation of a realistic exchange rate between the Mexican peso and the U.S. dollar; (vi) the absence of serious constraints to growth in the external sector, implying that the current balance of payments deficit should remain consistent with a manageable debt service burden. 5. It is necessarily difficult to define what would be an "acceptable" growth rate. However, past government policy and public reactions seem to indicate that a long run rate of less than 6 percent would be generally regarded as unsatisfactory while current expectations are probably closer to 7 percent. Poverty 6. Political equilibrium is necessarily the major goal of any government and adjustments in social and economic policy may frequently be related to this goal. Against the background of the analysis presented in Volume II, it may be argued that recent economic policies have not only promoted rapid growth but have also served to accommodate the most powerful groups in Mexican society. However, insofar as poorer members of society may have become relatively more articulate in recent years, a change in government policy towards them may have political implications. 7. It was shown in Volume II that although poverty has decreased over time, the relative status of the poor appears to have worsened. Moreover, social modernization and the development of the information system have probably tended to create new desires for consumption and an increased awareness of disparities in consumption levels among those who lack access to non-essential goods and services. 8. Poverty in Mexico must therefore be seen in terms of the numbers of those who are poor; in terms of contrasts between the condit- ions of the poor and of those who are not; and in terms of geographic and contrasting rural-urban conditions. Government action to reduce poverty could focus on: (i) the growth of employment opportunities, particularly in the countryside, and thus the redistribution of income towards the poor, and/or (ii) the provision of social goods and services, particularly in the fields of education and health, and thus, in the short run, an implied improvement in the "quality of life" and, in the longer run, an implied increase in human productivity. Given the distribution of poverty, it might be assumed that an action program of this kind would have a rural rather than an urban emphasis.  -3- Other Issues 9. While growth and poverty are the major issues of the period 1970-1976, it is clear that the Government is also concerned about other problems. These include the existing concentration of population and economic activity, particularly in the Valle de Mexico. Regional concentration is clearly related to the presently unequal distribution of employment, income and public sector social goods and services. It is also, however, an issue which refers to the increasingly serious dis- economies of urban agglomeration in Mexico City and, finally, to the process of environmental pollution, again in the Valle de Mexico. 10. It is also clear that the Government is anxious to achieve an acceptable balance between national demands for autarky on one hand and national needs for foreign capital and technology on the other. Finally, an issue which has not as yet emerged into a clear focus but which may well do so before 1976, is that of population planning. This essentially has long term implications (which are discussed in Volume IV of this Report) and is therefore different in kind from the major issues of grawth, stability, poverty, and such other issues as regional develop- ment and foreign participation which have been mentioned. In the long run, however, a persistent population growth rate of 3.5 percent must inevitably raise serious issues about the course of economic and social change, and it is desirable that these issues should be confronted sooner rather than later. Reprise : Issues and Objectives, 1970-1976 11. Most of the concerns of the present Government have in common the search for balance and imply recognition of existing disequilibria in the country's economic and social structures. It is likely, however, that the Government would also acknowledge an implicit difference in the relative importance of its several goals and that sustained growth with stability remains, as in the past, an important objective. If, therefore, the pursuit of other objectives were to conflict with the achievement of this goal, it is likely that their relative importance would become explicitly apparent. However, insofar as a minimum growth rate of 6 per- cent would be an acceptable goal, it can be argued that growth in excess of this rate might be forgone if it were necessary to do so in order to achieve additional objectives, although there is no a priori assumption that such a trade-off would occur.  - 4 - B. MACRO-ECONCMIC POLICIES AND TRENDS, 1970-1973 12. The present Government appears to be more concerned with the issues of poverty, regional balance and control over foreign part- icipation in the economy than many of its predecessors. In the first two complete years of the presidential term (1971 and 1972) the policies adopted indicate moreover that its concerns are real. Prog- ressive legislation on housing, agrarian reform and water use has been introduced, an expanded rural works program has been elaborated, the concern with regionalbalance has been translated into legislative action, and so too has the objective of introducing a greater measure of control over foreign participation in the economy. 13. It is clear, however, that the commitment to sustained growth and stability is also very real. In 1971 a combination of factors which included some uncertainty on the part of the private sector regard- ing the intentions of the new Government, an attempt by the Government to redress a deteriorating balance of payments situation by reducing external borrowing, and action to maintain the stability of the peso, were among the factors which contributed to a decline in economic activity and to a growth rate of only 3.7 percent (barely more than the rate of population increase). To the extent that Government policy was a causal factor, the events of 1971 should, however, be seen as evidence of willingness to sacrifice rapid growth in the short (one-year) run in order to achieve larger objectives in a six-year administration, rather than as a commitment to stability at all costs. Moreover, the measures taken probably had a more drastic effect than was anticipated, and it is in any case extremely difficult to be certain of the relative import- ance of policy measures on one hand and autonomous factors (including the U.S. recession) on the other. 14. With the recovery of confidence in 1972, there was substantial new growth in the private sector while the public sector, following the customary trend of Presidential cycles, 1/ underwent renewed expansion; the growth of exports and of domestic demand also contributed to a real growth rate of about 7.0 percent. 2/ The choice of policies, and the conjunction of favorable external circumstances thus served to bring the economy back on to its historical course of rapid growth and relative financial and balance of payments stability. 1/ See Volume II, para 58. 2/ The growth rate for 1972 assumed throughout this Report is 6.8 per- cent. The Banco de Mexico estimated in May 1973 that the actual rate was in excess of 7.0 percent.  - 5 - C. MACRO-ECONOMIC OPTIONS, 1973-1976 15. The relationship between policies and trends in sectors which are largely or completely dominated by public expenditures is inevitably closer than in those which are dominated by private enter- prise. Given the structure of the Mexican economy, the relationship between policy and trends is thus particularly close in the agri- cultural, energy, transport, and social sectors, in which the public sector accounts for most of the investment while public expenditure policy is not an important direct determinant of sectoral trends in, for example, manufacturing or tourism. Even in these sectors, how- ever, fiscal, monetary and specific sectoral policies have important indirect relationships with private investment decisions. Public expenditure, fiscal, monetary and sectoral policies together there- fore provide a general framework of direct and indirect determinants of economic change. 16. In order to estimate the probable course of economic growth in the medium term, a model of the Mexican economy was constructed. 1/ While it contains many elements of a formal analysis, it also contains several elements of judgment and omits some relationships which might normally be included in a formal equilibrium or disequilibrium analysis. Projections derived from this model show that the foreign exchange con- straint which has dominated economic policy-making in recent years would probably be of limited importance through 1976 provided the growth rate did not exceed 7 percent. 17. While this projection basically represents an extrapolation of past trends and, in terms of implied levels of investment appears to be consistent with those of the future, it does not initially allow for the effects of arn major change in Government policy. It is clear, however, (as will be demonstrated in the analysis which follows) that unless additional resources are generated in the public sector, it will be impossible to finance expenditures which are needed to ensure sustained growth in key sectors (energy and power) in which public enterprise plays a dominant role, and in which productive capacity is therefore a function of public investment. As a consequence of capacity constraints in these industries (and in other sectors in which output is closely related to public investment), the growth potential of the economy would be increasingly impaired and there are therefore direct links between public investment, sectoral capacity, and macro-economic growth. It is also clear that in the absence of additional financial resources it will be impossible to develop Government programs designed to alleviate the incidence of poverty and to improve the personal and regional distribution of consumption by means of direct public expend- iture - both current and investment. 1/ See Technical Note #6.  - 6 - 18. The essential difference between a development strategy based on past trends and a strategy of change designed with the objective of achieving both sustained growth with stability and accel- erated social progress, would lie in modified fiscal and expenditure poLicies. 19. It will be argued that such a change is both desirable and feasible, and that both sets of goals can be achieved. It is assumed, hov!ever, that: (i) while a new strategy of growth and development would be predicated on a change in public sector finance, (ii) the quantitative aspects of monetary policy would (in order to achieve the goal of internal stability)remain unchanged, and (iii) the public sector institutions which would, in the context of a new strategy, be required to absorb additional resources, could, within certain identifiable limits, do so. 20. The three chapters which follow represent an attempt to demonstrate that this argument is valid and that the Government can, if it adopts a new economic strategy, expect to achieve its several goals through 1976, although this is not to suggest that it would, within a four-year period, be feasible to resolve all of the country's problems. The objective, realistically, would be to produce a relative but sub- stantive change in the economy and, in so doing, to re-direct the course of Mexican history in the last quarter of the 20th Century.  II. THE INSTITUTIONAL AND FINANCIAL FRAMEWORK OF MACRO-ECONOMIC POLICY A. INTRODUCTION 21. A summary outline of the fund flows through the fiscal and the financial system in Mexico is shown in the following table: Table III-II-1 : MEXICO : SOURCES AND USES OF RESOURCES, 1965-1971 (percent of total resources) Total resources 100.0 GDP 98.6 Import surplus 1.4 Public Expenditure 13.6 Public Investment 5.9 Public Consumption 7.7 Financed by: Fiscal System 1/ 10.1 Financial System 2.7 External Borrowing 0.8 Private Expenditure 86.4 Private Investment 14.2 Private Consumption 72.2 Finamced by: Directly 83.2 Financial System 3.2 1/ Including surpluses of enterprises of about 0.5 percent. Note: Figures are averages of annual percentages. Source: Appendix Tables. The following characteristics of the fiscal and financial system clearly stand out: relative to other countries at comparable stages of develop- ment, the investment and saving levels in the economy are on the high side; the size of the public sector final expenditures is small (see Table III-II-2); financial intermediation is quite developed; and the  - 8 - Table III-TT-2 GOVERNMENT EXPENDITURES IN VARIOUS COUNTRIES GNP Per Capita Government Expenditure (US Dollars) (% of GDP) 1970 1970 or 1971 Argentina 1,360 14.4 Venezuela 1,020 21.4 Singapore 920 19.1 Uruguay 820 15.3 Chile 720 22.0 Mexico 670 13.1 Costa Rica 560 16.6 Peru 460 16.9/1 Nicaragua 430 12.2 Brazil 420 20.0/2 Malaysia 380 24.3 Guatemala 360 10.2 Colombia 340 10.0 El Salvador 300 12.2 Republic of Korea 250 19.2 Morocco 230 22.6 Philippines 210 12.1/1 Thailand 210 18.8 Sources: GNP per capita: World Bank Atlas, 1972. Government expenditure: International Financial Statistics, May, 1973, except for Mexico which is calculated from data supplied by the Ministry of Finance and Public Credit. IFS does not have data for Mexico. /1 1969. /2 Estimate.  t I 4~~~~~~~~~~~~~~~~ 4 Table III-II-3 :EXIC0: SUMMARY FUNTDS FLOW, 1965-1971 (billions of pesos) 1965 1966 1967 1968 1969 1970 1971 Total Resources 254.95 282.23 310.86 344.80 378.31 427.h2 461.13 PD? 252.03 280.09 306.32 339.15 37h.90 h18.70 455140 Imiport surplus 2.92 2.1 Ilt.5h 5.65 3.41 8.72 5.73 Public Sector Expenditures 3h.82 37.09 1O.66h 50.92 55.93 57.79 .56.75 1. Public investment 16.83 15.84 17.30 23.62 25.22 23.79 23.84 2. Public consumption 17.99 21.25 23.31h 27.30 30.71 34.00 32.91 Financed by: 34.82 37.09 40.64 50.92 55.92 57.79 56-75 1. Net fiscal transfers 23.64 32.22 35.79 39.37 42.62 48.60 49.20 a) Domestic_/ 23. 29.98 31.31 34.90 39-03 43I34 -759 b) Net external borrowing 0.16 2.24 4.48 4.47 3.59 3.26 2.61 2. Noet rmonetary transfers2/ 11.18 4.87 h.85 11.55 13.31 9.19 7.55 Private Sector Expenditures 220.13 245.15 270.22 293.87 322.hO 369.63 _0_43 _ 1. Private investment3/ 31.83 38.29 49.33 49.89 52.09 67.22 65.56 2. Private consumptio'/ 188.30 206.86 220.89 2h3.98 270.31 302.41 338.82 Financed by: 220.13 245.15 270.22 293.87 322.t0 369.63 404.38 1. Directly 217.24 233.64 257.78 . 284.69 303.50 348.91 386.90 2. 701onetary transfers5/ 2.89 11.51 12.h4 9.18 18.90 20.72 17.h8 1/ Current revenues (tax + non-tax) + capital revenues - extrasystem current transfers. 7/ Net internal borraoing + use of Treasury cash balances. 3/ Residual derived as difference between gross domestic investment and public sector investment. E/ Residual derived as difference between domestic consumption and public sector consumption. Includes changes in stocks. Calculated as the difference between the change in total banking system lending (including the Bank of Mexico) and net internal borrowing of the public sector. Source: Appendix Tables  - 10 - dependence on external funds has not been excessive. Taking seven- year averages of ratios does not conceal any significant changes over time since all of the series in the table were quite stable during this period (see Table II-II-3) which is in itself a significant character- istic of the Mexican economy. 22. Since 1965, the fixed capital formation ratio has been in the order of 20 percent of GDP. This compares with a national savings rate of about 18.5 percent, the difference being accounted for by external savings. Public sector 1/ capital expenditures - including the activities of the Federal Government, the Federal District, the other states, and 16 large public enterprises - account for less than one-third of total in- vestment. 2/ 23. The contribution of the public sector to aggregate savings is even lower, its share in the total being about one-eighth, 3/ the difference being made up primarily by the transfer of private savings to the public sector through the financial system. In recent years the flow 1/ The public sector in Mexico is cmposed of the Federal Government; the Federal Distdct, which is the local government for greater Mexico City; 29 states; 2 territories; and numerous public entities either owned or controlled by the Government. The analysis throughout this Chapter is based - in line with the Mexican public accounting system - on a definition of the state enterprise sector (a term used both for enterprises and other types of autonomous agencies) which includes 16 organizations accounting for about 80 percent of the total trans- actions of the autonomous public entities (excluding the financial institutions). These enterprises are: 1 petroleum company : PEMEX 2 power companies : CFE and Cia. de Luz y Fuerza del Centro. 4 railway campanies : Ferrocarriles Nacionales, Ferrocarril Pacifico, Ferrocarril Chihuahua-Pacifico, and Ferrocarriles Unidos del Sureste. 3 social welfare agencies : CONASUPO0 INDECO, and Loteria Nacional. 3 highway and airway entities : Caminos y Puentes Federales de Ingresos y Servicios Connexos, Aeroportos y Servicios Auxiliares, and Aeromexico, S.A. 1 forest agency : PROFORMEX. 2 social security agencies : ISSTE and IMSS. Consistent data are not available for finances of municipalities; hence these are not included in the discussion of the public sector. Estimated expenditure of municipalities were around 2 billion pesos in 1969. 2/ Fixed capital formation in the public sector is less than the total of capital expenditures, since the latter also includes capital transfers and the financial investments which are sometimes in the nature of transfers. 3/ Net of transfers to the private sector.  - 11 - of funds through financial institutions has risen to about 6 percent of GDP. Of this, about 40 percent is borrowed through various channels and is used by the public sector; the rest finances private expendit- ures. 24. Official statistics indicate that the level of public current expenditure is quite high, mainly in respect of public enterprises. However, when the data are netted out for intermediate payments, the current expenditures which approximate the national accounting definitions of public consumption appear to be rather low - in the neighbourhood of 7-8 percent of the GDP. This picture is also borne out by the data on fiscal revenues. The tax ratio, both federal and local, amounts to 9 percent of the GDP, and total public resources, including social security contributions and the net operating surpluses of the public enterprises do not exceed 12 to 13 percent. 25. By comparison with other less-developed countries, Government involvement in the economic system is quite limited. As suggested in Volume II of this IReport, the relationship between limited Government involvement and rapid growth on the one hand, and the apparent failure of the system to spread the benefits of growth to the population at large on the other, is probably close. 1/ Moreover, the internal and external economic stability which has been maintained over the last decade is also related to this strategy. In the analysis which follows, a less aggregated approach is taken and an effort is made to highlight the major fiscal and financial issues which have a bearing on present trends and future prospects. B. EFFICIENCY The Fiscal System 26. Public sector expenditures play a relatively small role in the production process, total spending by the consolidated public sector as defined above being about 16 percent of the GDP. However, net of social security and other current transfers, total public expenditures for consumption and investment amount to about 12 percent of the GDP, whereas total public revenue is equal to about 10-11 percent of GDP. This is quite a low level by caaparison with most other countries, especially when the stage of development is taken into account. 2/ 1/ See Volume II, Chapter IV, in particular. 2/ Kuznets: "Quantitative Aspects of the Economic Growth of Nations".  - 12 - Table III-II-4 : MEXICO : SUMMARY PUBLIC SECTOR FINANCES, AVERAGE OF 1965-1971 (percent of GDP) Federal Federal Other 14 Public Social Govt. Dist. States Enter. Security Total Current revenue 1/ 7.7 0.9 1.3 0.7 1.9 12.5 Public Consumption 4.1 0.3 1.3 0.0 2.1 7.7 Transfers from public sector -1.4 -0.1 -0.9 0.0 0.0 -2.3 Saving 2.2 0.5 -0.9 0.7 -0.2 2.4 Transfers within public sector -1.6 0.0 0.0 1.1 0.5 0.0 Resources for investment 0.7 0.5 -0.9 1.7 0.3 2.4 Investment 2.8 0.6 0.1 2.4 0.2 6.1 Borrowing (net) 2.2 0.1 0.9 0.7 -0.1 3.7 Internal 1.8 0.1 1.0 0.3 -0.1 2.8 External 0.3 0.0 0.0 0.5 0.0 0.8 1/ Current revenue equals net income Source: Appendix Tables Note: Figures do not always add, due to rounding. 27. This aggregate picture is modified by two features of public expenditures in Mexico. First, total spending on defense amounts to only about 0.6 of one percent of GDP, one of the lowest levels of military expenditure in the world. The level of public funds which can be used for other purposes is therefore higher than is implied by the comparison of aggregate data. Moreover, in the broader context of total resources, this means that only a small portion of total resources is allocated to this unproductive use - which is no doubt an important factor in explain- ing the overall efficiency of the economy. 28. Second, the level of public investment compared to public con- sumption is relatively high. Public consumption expenditures 1/ are not only low - about 7.7 percent of GDP, excluding transfers, but this ratio has not, as in many developing countries, increased over time. The maintenanc e of low levels of public consumption has enabled the public sector to finance about 40 percent of total public investment from its own savings. 1/ Public expenditure on final goods and services in terms of national income concepts.  - 13 - 29. The Federal Govermnent has been the main source of savings, generating more than 90 percent of total public sector savings on average in the period 1965-1971. Since 1968, the surplus on current account of the Federal Government has exceeded the total for the public sector as a whole. Table III-II-5: MEXICO: PUBLIC SAVINGS, 1965-1971 (percent of GDP) 1965 1966 1967 1968 1969 1970 1971 Federal Govermnent 1.1 2.1 1 .9 2.2 2.1 2.7 2.3 Federal District 0.6 0.6 0.6 0.5 0.5 0.5 0.4 States -0.7 -0.8 -0.9 -1.0 -1.2 -0.8 n.a. Public Enterprises 1.0 0.9 0.8 0.4 0.6 0.1 0.0 Total 2.0 2.8 2.4 2.1 2.0 2.5 1.9 I/ 1/ Assuming that the States saved at the same level in 1971 as in 1970. Source: Appendix Tables. This is the result of continuing dissavings by local governments and the declining surpluses of the public enterprises. The operating sur- pluses of the public enterprises declined from 1955 to 1971 even in absolute terms and in 1972 their consolidated savings were probably zero. Table III-II-6: MEXICO: SAVINGS OF PUBLIC ENTERPRISES, 1965-1971 (billions of pesos) 1965 1966 1967 1968 1969 1970 1971 Petroleum 2.7 3.1 2.8 2.3 3.1 2.5 2.2 Power 0.9 1.0 1.0 0.9 1.1 1.1 1.0 Railways -0.3 -0.5 -0.6 -0.8 -0.8 -1.2 -1.7 Highways & Airways 0.1 0.1 0.1 0.1 0.1 0.3 0.4 Social Security -0.6 -0.4 -0.2 -0.6 -0.6 -1.3 -1.0 Social Welfare 1/ -0.2 -0.7 -0.6 -0.6 -0.5 -0.7 -0.8 Total 2.6 2.6 2.5 1.3 2.4 o.6 0.1 1/ Including CONASUPO, INDECO, and Loteria Nacional. Source: Appendix Tables  - 14 - 30. This decline came about mainly as a consequence of the rising operating deficits of the railways and the social security agencies. The two traditional generators of surpluses, PEMEX and the power companies, were hardly able to maintain their nominal profits, which meant a decline both in real terms and as a ratio of GDP. Although the sales of both petroleum products and electricity increased substantially from 1965 to 1971 (the period for which consistent data are available) prices which were not adjusted to the rising costs in either case precluded a parallel increase in profits. On the other hand, the losses of the railway companies continued to increase on an almost uniform trend. 31. Direct government involvement in economic activities in Mexico has not extended beyond such basic industries as petroleum, steel and fertilizer, and the public utility areas such as power and transport- ation. In recent years, more than 90 percent of total investments by the public enterprises has been undertaken by the petroleum, power and rail- way companies. Table III-II- 7 : MEXICO : PUBLIC ENTERPRISE INVESTMENTS, 1965-1971 % of Total Petroleum 41 Power 40 Railways 9 Steel and Fertilizer 8 Others 2 Total 100 Until 1972, PEMEX was able to finance most of its capital expenditures from its own operating surplus, and partly by borrowing - mostly from external sources (Appendix Table 5-22). The power companies, on the other hand, received budgetary transfers - in the order of about 1.5 billion pesos per year - to augment their own savings of about one billion pesos. In addition, however, the power companies were also forced to borrow. Government reluctance to adjust petroleum and electricity prices in the face of rising costs increased the financial needs of both industries. As shown in some detail in Chapter III, the situation is particularly critical in the case of PEMEX because future needs for rising imports of oil will be coupled with rising world prices. Substantial budgetary subsidies, heavy borrowing, or reductions in badly needed investment, and thus growing capacity constraints, would be consequent on a failure to increase hydrocarbons prices.  - 15 - 32. A similar sequence (discussed further in Chapter III) would apply to the power companies while inaction to raise railway freight tariffs represents one of the chief factors in increased pressure on public finances. However, as suggested in Volume II, from the view- point of private sector dynamism, it can be argued that limited govern- ment involvement in productive activities together with subsidized prices for basic industrial inputs were important elements in facilitating the rapid growth of the private sector in recent decades. 33. While the direct involvement of the Government in economic activities has been limited in magnitude and scope, Mexico has succeeded in developing an efficient social overhead capital structure to service the growth of modern industry. This success has mainly been the result of the careful selection of key areas and the pragmatic handling of administrative and financial problems. 34. Moreover, the key growth of the private sector has not been restricted by Government intervention through fiscal and financial policy measures. 1/ Total taxes collected at the Federal and local Government levels do not exceed 9 percent of GDP. This is quite a low ratio, particularly at Mexico's stage of development. 2/ Although by internat- ional comparisons the share of income taxes in total tax revenues is on the high side - about half - the level is not high in relation to total national incane. Tax revenues on production and transactions (including foreign trade) are low, amounting together to less than 5 percent of GDP, while capital and property taxes are negligible. 35. The income tax system in Mexico has evolved in the light of attempts to adapt the cedular system of income taxation - in which incomes are taxed on the basis of sources of income rather than on the total irrespective of the source - to a modern financial society in which commercial and industrial capital and wealth are mainly owned in the form of bearer securities. The impersonalization of capital and thus capital income has therefore been carried to extremes and attempts to move toward a global income tax system have been frustrated. It is still not obligatory to combine incomes from capital with other incomes in determining the applicable tax rate. Even the treatment of undistributed profits has oscillated between subjection to or exemption from taxation over time. 36. The Mexican income tax system as it has evolved suffers from the same weaknesses as in many other developing countries, namely, narrow base, lack of progression and poor tax administration. Although in the ultimate analysis, improvements in the administration hold the key to adequate taxation of incomes, a move towards the global tax system will facilitate efforts to increase the efficiency and the equity in income and corporation taxes. Particularly, taxation of income from capital has to be based on firmer grounds than is the case now, and this necessitates a careful review of the system of bearer shares and bonds to make sure that this does not serve as a loophole for tax evasion. 1/ See Volume II, Chapter II. v/ Chelliah: "Trends in Taxation in Developing Countries".  - 16 - Table III-II-6 : MEXICO : TAX REVENUES, 1965-1971 (percent of GDP) 1965 1966 1967 1968 1969 1970 1971 rederal Taxes 6.92 6.34 6.46 6.82 6.96 7.22 7.29 Income Taxes 3.35 2.97 3.24 3.47 3.65 3.69 3.68 Turnover Taxes 0.97 0.98 0.97 1.08 1.13 1.17 1.15 Excises 1.03 0.94 0.98 1.00 0.98 1.02 1.24 Import & Export Duties 1.30 1.08 1.00 0.96 0.80 0.95 0.84 Other Taxes 0.27 0.37 0.27 0.31 0.40 0.39 0.38 Local Taxes 1.52 1.52 1.52 1.60 1.62 1.59 1.60 1/ Property Taxes 0.32 0.32 0.33 0.34 0.33 0.35 Other Taxes 1.20 1.20 1.19 1.26 1.29 1.24 TOTAL 8.44 7.86 7.98 8.42 8.58 8.81 8.89 1/ Estimate Source: Appendix Tables 37. There may be some merit in a progressive corporation tax (as in Mexico) on the assumption that these corporations are either family owned or foreign owned. Hence, the real question may be reduced to two general issues of income taxation which occur in many less- developed countries: inefficient tax administration and the wise use of bearer securities. Since the last major reform of the income tax system in 1964, when the system was simplified by reducing the number of schedules, only minor adjustments have been made. 38. The tax reform of January 1972 involved six major changes. First, the maximum marginal rate on the taxable income of individuals was raised from 35 percent to 42 percent (the same rate as the maximum for business incomes). Second, the withholding rates on income from bonds was raised from a maximum of 4-10 percent to a maximum of 15-20 percent on interest yields of more than 9 percent. Third, individuals were allowed to take advantage of lower rates in cases where the combination of their incomes from capital with other income entitled them to do so. Fourth, accelerated depreciation was allowed for in the context of industrial de- centralization. Fifth, taxation of corporation profits was limited to those portions effectively distributed. Sixth, deductions for publicity expenditures in the year they were made were limited. The trend of coll- ection data indicates that the only measure to have a significant effect was that referring to tax withholdings from interest income. It is ex- pected that the additional revenue due to this change in 1972 was about  - 17 - Table: III-II-9: MEXICO: TAX RATES ON EAUIHNGS DERIVE FFRM FIXED INCOME ASSETS (In per cent per annum) Tax Rates Beginning January Until Janutry February-December 1973 Annual Interest 19721/ 1972 2 - 1 Not more than 74/ 7-8 2 6 6 10 8-9 3 12 12 16 9 10 14 10- 10.6 5 lo.6 - 1i 11- 12 6 16 21 12- 13 7 20 13- 14 8 14 - 15 9 Above 15 10 Source: Mlinistry of Finance. 1/ Bef%re the January 1971 tax measures, earnings derived from interest on promissory notes (raar_es) in both domestic and. f.oreign currencies where subject to a 10 n)er cent tax rate. After these neasurc-s, such earnings are szbjt-ect to the same. r&tes as other fixe-3--income asset:,. 2/ Anplicable to nominal assets h.eld ty residents. 3/ Applicable to bearer's assets and to all assets held by nonresidents. 4/ Or 7.2, if interest is cOYITmounded.  - 18 - 1.5 billion pesos. In January some further modifications to the income tax system were introduced, together with modifications in certain other taxes; a comparison of these changes is shown in Table III-II-9. 39. The adoption of a global tax framework would be a useful step toward better tax administration. Some of the modern techniques of tax reporting and auditing procedures are usually linked with global income tax systems. Some of these procedures and techniques may be adopted in a mixed system such as that of Mexico. Progress has already been made in developing a systematic registry of taxpayers. The major open issue, however, is that of eliminating the tax benefits arising from ownership of bearer securities. A reform in this area would be a major step in the establishment of a modern tax system in Mexico. 40. The target of moving towards a global income tax system should provide the framework for new legislation, but should not defer the efforts to increase yields and to improve the distribution of the burden in the present system. For, after all, the income and corporation tax systems are not totally different mechanisms, but differ in their basic emphasis. One example of such a revision were the increases of rates on income from fixed-income securities which were introduced in 1972 and 1973. Another was the restriction on the publicity expenses of business chargeable to costs. The set of questions which are related to depreciation allowances is not important only for revenue purposes, but also in terms of its implications for capital versus labor-intensive production methods. This probably applies to a large group of tax incentives and allowances. 41. The problems associated with indirect taxes are less intricate. The first point to be made concerns the very low yields of these taxes. The proceeds of a turnover (sales) tax which was raised from 3 percent to 4 percent in January 1973 are shared between the Federal Government and the States; this has produced revenues of more than one percent of GDP for the Federal budget. When the turnover tax is taken into account to- gether with all other excise taxes, the ratio rises to about 2.3 percent of GDP. This is low compared to the average level of around 4-5 percent of GDP in other less developed countries. 1/ The comparison is even more unfavorable in respect of yields on import duties, where a ratio of 0.73 of one percent is perhaps the lowest among less-developed countries. 42. So long as expected revenues from sales and production taxes are as low as they now are in Mexico, any reasonable combination of general turnover taxes and selected excises could yield an equivalent revenue without causing major distortions in the production process, although if a serious attempt were made to raise the level of indirect tax revenues by a substantial amount and to introduce progressivity into the system, the way this was done could have important repercussions on the productive process. Under a program of luxury taxes introduced in 1971, the sales 1/ Chelliah, op.cit.  - 19 - tax on a list of consumer items was raised from 3 percent to 10 percent. It may have been that the sluggishness in the sales of these goods which occurred in 1971 i7as the result of the general. slowdown in the economy and that the impact of the tax was therefore e-aggerated, but the tax was modified in 1972. A high rate for the seke of progressivity at the lest round of transactions may in fact impose an undue burden on that level of activity and it may be desirable to place most of the emphasis on the few excise taxes which fall on relative1y conspicuous forms of consumption. 1/ Table III-II-10 : MEXICO EXCISE TAXES, 1970-1971 1970 1971 L Bottled drinks, beer, alcoholic beverages 611 14 1,805 32 Manufactured tobacco 965 23 1,135 20 Electricity, petroleum and derivatives 1,450 34 1,280 23 Telephones ).t24 10 h95 9 Ownership or use of automobiles 345 3 350 6 Others 467 11 493 9 TOTAL 4,262 100 5,558 100 43. Taxes on foreign commerce form a very small part of govern- ment revenue, having lagged behind the growth of the economy. This is mainly because the ratio of import and export taxes to the volume of foreign trade has been falling. The fall is particularly significant in the case of export duties (from 6.4 percent of export value in 1965 to 2.7 percent in 1971). This reflects a declining trend after the deval- uation of 1954 when high duties were imposed to tax windfalls to exporters arising from exahanS rate adjustments. Customs duties on imports amount to about 11 percent of CIF value. This bears little relation to the degree of protection enjoyed by local producers since the main instrument of protection has been the quantitative restrictions of imports. 1/ This has in part happened because tax revenues from cigarettes and beverages now amount to more than half of the total excise tax revenues.  - 20 - Furthermore, the system of exemptions and reductions in respect of duties is widely used for the imports of certain industries and for the imports of the public sector. This policy has evolved in such a way as to maximize financial, returns in modern industry without undue regard to economic rates of return or social benefits. For as long as the present strategy of trade and industrialization is adhered to, import duties will continue to represent a small - and possibly dim- inishing - component of public sector resources. 44. Probably the most important distortions caused by fiscal measures are those related to labor-capital costs. High social security premiums, high depreciation allowances, profit-sharing schemes, fiscal incentives for decentralization, and the new payroll taxes earmarked for workers' housing all result in the distortion of labor-capital costs in favor of capital; some of these effects are discussed further below. The Financial System 45. Although, as shown in Volume II, public sector deficits and borrowings in recent years have been substantial, and the strains imposed on the domestic credit market and the balance of payments have at times been severe, the overall stability of the economy has been preserved thanks to the achievement of improved discipline over public spending agencies and the breadth of the domestic financial base. In the last two years (1971-1972), the administrative machinery for regulating both external and internal borrowing has been further strengthened against the blkground of improvements in this regard which began in the mid-1960s. External borrowing by the autonomous public enterprises has been subjected to the explicit consent of the Ministry of Finance and Public Credit and this has helped to improve the maturity profile of the external debt. h6. Borrowing by the public sector has been in the order of about 3.5 percent of GDP over the last seven years, roughly about two-thirds from internal and one-third from external sources. On a thin financial base, Uhis ratio of borrowing might have created stability problems. But in Mexico, thanks to the rapid growth of non-monetary financial assets, the banking system has been able to provide total financing in the order of 6 percent of GDP per annum. This expansion in the monetary liabilities of the banking system was correlated with the growth of nominal national income. Time and savings deposits, deposits in foreign currency, obligations (pagares) denominated in pesos and in foreign currency (U.S. dollars), and bank bonds rose from 3.4 billion pesos to 162.33 billion pesos in the period 1950-1971 - a compound annual growth rate of 20.5 percent - largely as a result of innovations in the banking system. As can be seen in Table III-II-11, the relative shares in the savers' portfolio of banking liabilities of the classical savings forms - time and savings deposits - have been fairly constant over the past two decades, while those of bonds and obligations denominated in both pesos and foreign currency (U.S. dollars)  - 21 - have increased by 220 percent. This growth was mainly the result of a policy of allowing private finance companies (financieras) to pay substantially higher rates of interest on thei.r liabilities (primarily bonds, one-year obligations and peso-denominated 180-day to 360-day time deposits) which, having de facto liquidity, could however be redeemed on demand at par plus accrued interest. 1/ The growth of mort- gage banks has been a further important factor. Table III-II-11 : MEXICO : HOLDINGS OF BANKING SYSTEMI LIABILITIES BY ENTEaPRISES AND INDIVIDUALS (percentages of total holdings) 1950 1955 1960 1965 1970 1971 A. "Money" Liabilities 64.5 54.5 43.8 35.7 26.8 24.8 1. Coins & currency 30.7 25.5 19.9 14.8 10.7 10.0 2. Demand deposits 32.4 27.3 22.8 20.2 15.1 14.4 3. Other sight deposits 1.4 1.7 1.1 0.7 0.7 0.4 B. "Savings" Liabilities 35.5 44.5 56.2 64.3 74.2 76.2 4. Savings deposits 5.6 6.0 5.7 6.5 5.5 5.5 5. Time deposits 1.7 1.2 0.9 1.6 1.4 2.0 6. Deposits in foreign currency 3.2 7.3 5.0 2.9 1.6 1.3 7. Peso obli.gations 7.5 13.7 17.0 22.4 19.2 19.6 8. Bonds 8.0 5.6 6.2 15.2 28.8 30.0 9. Obligations in foreign currency 9.0 11.4 20.9 15.4 16.3 16.4 Source: Appendix Tables 47. As in savings mobilization, the Mexican approach to the allocation of banking resources has been both innovative and pragmatic. The channelling of funds to the public sector was accomplished mainly by means of the reserve and portfolio requirements and through special- ized institutions, whereas the allocation of resources in the private sector depended largely on the market mechanism, the rate of interest performing a much more active role than in most developing countries. One indication of this market flexibility is the absence of any signif- icant shortage of "industrial finance", since the distribution of banking funds reflects the large share which has gone to private industry. 1/ The perfect liquidity of bonds, which has been a significant factor in resource mobilization does not seem to have introduced problems for demand management.  - 22 - Table III-II-12 : MEXICO : ALLOCATION OF BANK LENDING, 1950-1970 Increase in Credits (as percent of total) 195o-55 1955-60 1960-65 1965-70 Federal Government 12.8 11.0 31.0 24.8 Industry 48.7 52.2 46.7 44.6 Agriculture and Livestock 19.8 13.6 10.1 6.5 Commerce 18.1 22.9 11.6 21.2 Mining 0.3 0.0 0.3 2.6 Total 100.0 100.0 100.0 100.0 Source: Appendix Tables 48. The banking system in Mexico is mainly composed of exclusive- ly public sector or private sector institutions. The former category includes the Banco de Mexico, financial intermediaries such as Nacional Financiera and the Banco de Obras and specialized credit institutions. The latter includes Deposit and Savings Banks, Trust Funds (Fiduciarias); Finance Companies (Financieras), Mortgage Banks, and a number of other less important institutions. There are in addition several mixed (public-private sector) institutions including the Banco Internacional and the Banco Mexicano and some specialized auxiliary institutions including the Stock Exchange. 1/ In general, the institutional pattern of the banking system has been quite responsive to the needs of modern industry and has accommodated its lending policies to the needs of these sectors. However, efforts to channel more funds to such areas of social priority as peasant agriculture and small-scale industry have not been successful. 49. Organized securities markets have made only a minor contribution to savings mobilization and resource allocation. In the period 1964- 1969 a total of only 1,186 million pesos of new equity was issued through the three stock exchanges in Mexico City, Monterrey and Guadalajara. 1/ See Volume II, para 41 ff. 2/ Measures introduced at the end of 1972 referring to reserve requirements on newly created 180-day deposits in deposit banks are designed to improve this situation.  - 23 - In this same.period, the banking system raised net new funds totalling 81,107 million pesos through "savings instruments" alone - that is, time and savings deposits, pagares and bonds. To a great extent, the minimal. contribution of securities markets can be traced to the strong competition which has been offered by the banking system, the savings instruments of which are very attractive to surplus units. Yields on common stocks and industrial bonds actually traded on the exchange average 8 percent to 12 percent before taxes. Pagares and bank bonds, on the other hand, yield between 9 percent and 10.6 percent. The absence of risk plus the perfect liquidity (redemption on demand) make banking instruments more attractive. However, there are no real incentives for firms to issue stock in lieu of bonds or to channel new issues through the stock exchanges. The 1,186 million pesos which were issued through the exchanges in 1964-69 represented only about 25 percent of the approximately 4 billion new stock which was authorized and issued by Mexican corporations during that period. 50. Given the flexibility of the banking system, the limited dev- elopment of the stock exchanges has not so far created a major bottleneck of finance. Since there is no apparent shortage of equity capital through self-financing, firms have not riot felt the need to raise external equity capital to any large extent. As the economy grows, the activities of the stock exchanges both in terms of new issues and of their roles as secondary markets should be expected to grow. For the time being, however, there is no reason why new incentives to increase stock i.xarket transactions should be created - other than that of providing more information and better disclosure practices. Any proposal to abolish the de facto liquid- ity guarantee for bank bonds as a means of stimulating the stock exchange system should take due account of the basic function, which is now performed - that of transforming short-term liabilities into long-term finance. 51. Because of its success in mobilizing funds and its flexibility in allocating credits, the financial system is credited with having made a major contribution to the growth of the economy. This success in tailoring allocations in the private sector to market incentives has, however, to some extent, made it difficult to use the financial system for the achieve- ment of social ends. Like the fiscal system, the financial system has been essentially oriented to the promotion of prosperity in the modern sector without particular regard to social development; these aspects of both systems are dixcussed below.  - 24 - C. SOCIAL ASPECTS OF THE FISCAL AND FINANCIAL SYSTEMS The Fiscal System 52. In the last section it was argued that although the role of public expenditures in directly productive sectors was not large, public sector policies have been oriented to the promotion of private business interests. It seems clear, however, as argued in Volume II, that the public sector has not played an active role in spreading the benefits of prosperity to the poorer sections of the population and to less developed regions of the country and that fiscal policies in recent years have had some characteristics which have run counter to the growth of employment. 53. A functional distribution of public expenditure constructed from fragmentary data available is shown in Appendix Table 5.6, and the extract shown in Table III-II-13 shows the amounts spent by the total public sector on social services are very low. Table III-II-13 : MEXICO : PUBLIC EXPENDITURES ON SOCIAL SERVICES, 1970 billion pesos % of GDP Education and culture 9.1 2.2 Health 2.1 0.5 Social Security 10.3 2.5 Total 21.5 5.2 54. Moreover, a large part of the small volume of total spending on social services is concentrated in the Distrito Federal. As a result, per capita expenditure in primary education in the Federal District is twice as high as the country-wide average, while the figure for secondary education is four times as high, and a similar pattern also affects health expenditures. In addition to concentration in urban areas, health benefits largely accrue to participants in social security schemes and to their families. There is a striking contrast (Table III-II-14) between the small proportion of services administered by the Ministry of Health (which deals with the poor) and those provided by the social security agencies and other public enterprises.  - 25 - Table III-II-14 : MEXICO : PUBLIC MEDICAL INSTITUTIONS: DOCTORS AND HOSPITAL BEDS, 1969 Doctors Hospital Application Employed Beds Social security agencies 11,963 17,916 Railways and PEMEX 1,584 2,130 Federal District 589 2,0h2 Defense and Marine Ministries 867 1,950 Health Ministry 4,217 22,358 TOTAL 19,220 46,396 Source: Anuario Estadistico, 1970 55. The high share of social security involvement in social services also has implications in terms of the cost of labor, since a large part of social security costs are financed through premiums paid by employers and employees. The cost of social security to the employer varies between 9.6 percent and 15.0 percent of wages (assuming that the 3.8 percent paid by the employee is not shifted). Although this may be regarded as a gain for organized labor in increasing its share in the surplus generated by modern industry and hence a progressive move in distributing income, longer term effects may lead to quite contrary results by reducing the level of employment (or slowing down the increase in employment. Some of the measures which have been adopted in recent years as progressive measures resulting in better income distribution immediately may, in similar fashion, produce negative effects on employment over the long run. One examvle is the Drofit-sharine scheme in industry which is biased towards making labor-intensive techniques less attractive to businessmen, but perhaps the most important is the workers' housing scheme - INFONAVIT - which was introduced in May 1972. j 56. Under this scheme, employers pay a compulsory levy equal to 5 percent of wages and salaries (up to a maximum limit) to a special fund established to finance low-cost housing for workers. According to the legislation establishing INPONAVIT, the Government will contribute an endowment of 2 billion pesos and in the first year of operations, 1972, 1/ It arises from a new Labor Code introduced in 1970.  - 26 - INFONAVIT expected to command total resources of 3 billion pesos - 2.4 billion from payroll levies and 0.6 million from the budget as part of the Government's contribution. In coming years, revenues are expected to rise to about 4 billion pesos per year. This scheme has been one of the most progressive social measures of recent years. Its pattern of financing is such, however, that it may tend to raise the marginal cost of labor and may thus produce a reduction in the potential growth of demand for labor. 1/ 57. The net increase in the cost of labor to firms will actually be less than 5 percent of the wage bill, since this levy will be con- sidered as a cost item for income tax purposes. To the extent of the resulting decrease in income tax payments, INFONAVIT will in effect be financed by the Government. Nonetheless, it would seem preferable to finance social programs of this kind through additional income, capital or lump-sum taxes, or through sales taxes. 58. There are no studies of the incidence of the tax burden in Mexico, and it was not possible to undertake a systematic study of this subject within the confines of this Report. However, as mentioned earlier, the progression in income taxes is probably no worse than in many less- developed countries, and indirect taxes do not include rates which are obviously regressive. Yet the system as a whole does not make full use of taxation on the basis of income and wealth proxies. Property taxation, which is virtually untapped in Mexico, is an important case in point. The total revenue received from urban and rural property taxation, which is a State tax, in 1970 was 1045 billion pesos or only 0.34 percent of the GDP. The inefficiencies are due to the faulty system of valuations, very low rates (in the Federal District 0.525 of one percent on 75 percent of assessed value for rural property and 1.26 percent on 75 percent of the assessed value for urban property), and inefficient administration. This subject should be given high priority for attention, both on the grounds of equity, and for revenue reasons, in any revision of the tax system. The Financial System 59. The selective credit mechanism, operated through the portfolio requirements for the banks, the activities of the specialized banks, and the use of extra-budgetary funds, constitutes a complex system of credit rationing. In the absence of better data it is not possible to estimate 1/ IOFONAVIT itself generates jobs in the construction industry, but since it is intended to build a constant number of dwellings per year, this will not increase employment once INFONAVIT reaches its "normal" operating level.  - 27 - the magnitude of the funds rationed to priority areas through these means, but it is clear that the total magnitude of credit rationing is not large relative to the total resources flowing through the fin- ancial institutions. 60. Technically the banks in Mexico operate under a 100 percent reserve system, which means that the composition of bank assets is specified by the Banco de Mexico. Each type of liability is subject to specific reserve requirements - vault cash, interest, and non-interest bearing deposits in the Banco de Mexico and Government banks, with the residual being lent to various sectors designated by the financial authorities. Free resources constitute on average 25 percent of total liabilities. The priority areas generally specified by the Banco de Mexico are tourism, agriculture, housing, medium- and small-scale industry, exports, and projects in agriculture and industry approved by the Ministry of Finance. It is not possible to calculate weighted averages for port- folio requirements, but the marginal reserve requirement is about 30 percent of the total banking and non-banking liabilities. However, most of these priority loans are given on commercial terms. Lower lending rates are stipulated for only 4-7 percent of the increase in demand deposits, 10 percent of time deposits and 15-30 percent of mortgage bank funds. 61. Loans to the agricultural sector through the banks amount to about 7.8 percent of total credits, but a very large proportion are made up of commercial credits to large scale agricultural producers. The volume of concessionary agricultural credits is sma34; credits of this kind are generally extended by the Government bankstand constitute about 20 percent of total loans to agriculture. The other categories of concessionary credits are those made by commercial banks to ejidatarios and lower income farmers and account for between 2 and 3 percent of their resources at 7.6 percent interest, and loans by the two agriculture funds administered by the Banco de Mexico: Guarantee and Development Fund for Agriculture, Livestock and Poultry (EFIA) and the Special Fund for the Financing of Agriculture (FEFA). The resources of these Funds come from external borrowing and portfolio requirements of cammercial banks. 62. Loans for low-cost housing are administered by the mortgage banks and by the Banking Operation and Discount Fund for Housing (FOVI). The savings banks also lend for "social" housing. Mortgage banks allocate 15 percent of their resources to loans for social housing at 6 percent interest and another 15 percent of their resources to housing loans at 9 percent interest. FOVI has been working with an endowed capital of 509 million pesos and has extended a line of credit of 82 million pesos for 1/ i.e., Banco Nacional de Credito Agricola, Banco Nacional Agropecuario, and Banco Nacional de Credito Ejidal.  - 28 - construction of 2,600 low-cost housing units in various parts of the country. Loans for low-cost housing committed by mortgage banks and savings banks with the participation of FOVI amounted to 960 million pesos for the construction of 18,000 units by 1972. With the creation of INFONAVIT in 1972, loans for social housing will increase sharply. 63. Although precise data on the magnitude of concessionary loans rationed to the priority areas by administrative fiat are lacking, on the basis of available fragmentary information, it seems that agri- cultural loans to small farmers have been inadequate and may indicate the need for larger efforts on this front. On the other hand, housing loans have been relatively sizeable. From an institutional point of view, the Mexican financial system possesses the flexibility and cap.city to contribute to the achievement of social progress. D. FINANCIAL STABILITY 64. Following the distinctly inflationary period of the 1940s and early 1950s, Mexico, as shown in Volume II (Chapter II) has exper- ienced relative price stability. The years 1950-1957 were marked by price fluctuations on a trend of inflation around 8.2 percent, price increases peaking in 1954 at the time of the devaluation of the peso. 1/ Subsequent attempts at stabilization led to the effective dampening of inflationary pressures. From 1957 to 1968, the GDP deflator increased at the relatively low average annual rate of 3.5 percent. Some inflat- ionary pressures re-emerged after 1968, when prices increased on average at about 4.5 percent per annum, and the price rise in 1972 is estimated at between 4 and 5 percent. 2/ During specific years, prices in Mexico have been influenced by devaluation, agricultural supply shortages, the level of economic activity in the United States, which affects "border" trade and tourism, and wage adjustments every two years. Superimposed on this is the six-year cycle of Presidential elections which has been discussed in Volume II of this Report. 1/ See Volume II, para 62. 2/ The Banco de Mexico estimated in May 1973 that the actual rate was in the order of 5 percent.  - 29 - FIGURE III-1 500.0 MONEY AND PRICES IA Money supply (Ml) + 300.0 0 0 . 300.Q .'' 0 i ,* 20Q,0 P at constant 1960 prices (Y) o x - -4t / "9 x,_ GDF deflator (P) 10 1c0.0. 4 , O0 . - 7~ 0.0~ 60.0 4 .- g 50.0v,' _- 40.0 . 1950 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1 9651966 1967 1968 1969 1970 1971 65. Although some of the price increases in specific years can be attributed to cost-push factors and to specific factors in the economy of the type mentioned above, the long-term trend of the absolute price level has been similar to the trend of money supply expansion and as observed in Volume II, there is very close correlation between the money supply (coins and currency in circulation plus demand deposits), and the price level over the last 20 years. Theoretical prices calculated for this period are cmpared with actual prices below:  - 30 - FIGURE III-2 iso.o - ACTUAL PRICES CCMPAR?M WITH THEO-REICAL PRICES (GDP Deflator, 1960 = 100.0) 140.0 - 130.0 Theoretical prices 120.0 110.0 Actual prices 1CO.0 - o0X 8 0.0 - 70. 0- 80.o ';0.0' 60.0- - / 50.0 1951 1952 19%3.1954 1955 1956 1957 1958 3959 19(i0 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 The close correspondence between these two series cannot be exclusively attributed to serial correlation (see Technical Note #7). 66. The money su.pply as defined above - made up of the currency and the demand deposits in the baiking system - is determined by central bank monetary expansion, bank reserve policies (deposit/reserve ratio) and the public's preference between holding currency and deposits (deposit/ currency ratio). From 1950 to 1971, central bank monetary expansion was the main determinant of the money supply, the reactions of the banking and the general public playing only a minor role. Hence, the analysis of the factors which contributed to the expansion in the monetary liabilities of the Banco de Mexico largely explains the policies which were responsible for the increase in aggregate demand and those which aimed at restraining this expansion.  - 31 - FIGURE III-3 HIGH-POWERED MONEY AND ITS DETERMINANTS 23,000.0 20,O00.0 High-Powered Money - 15,000. 10,000.0' 3 *--;; - . Foreign Sector Federal GovernTment 0 5,000.0 , *-- Enterprises & Individuals 0.0 - -- -5,000 .OB .anks -9,000.01 1950 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 :1962 1963 19641965 1966 1967 1968 1969 1970 1971 67. The monetary expansion by the Banco de Mexico has, in general, been the result of increases in foreign exchange reserves and of lending to the public enterprises and the Federal Government. The relations of the central bank with the banks have resulted, throughout the period, in net indebtedness of the Banco de Mexico to the banking system; this has had deflationary effects. As argued in Volume II, monetary expansion in the early 1940s and 1950s emanated chiefly from Federal Government borrowing (except during 1955 and 1956 when Mexico's exchange reserves more than doubled - in pesos - as a result of the 1954 devaluation). Since the mid-1950s, public sector borrowing has been the  - 32 - main factor in monetary expansion, first in respect of borrowing by the public sector enterprises (until 1963) and later in respect of Federal Government borrowing (1963-1970). This underscores the role of the banking system as one of the primary sources of public sector financing, with the Banco de Mexico as intermediary, and points to the effective use of bank reserve requirements as a tool of monetary policy. 68. Although year-to-year fluctuations in production and prices in the future will be affected, as in the past, by a variety of internal and external factors, in the long run the trend of prices will depend - if the relationships postulated above are valid - on the growth rate of the economy and the expansion of the money supply. Assuming that the economy could continue to grow by about 7 percent per annum, the monetary authorities should avoid inflationary increases in the money supply. 1/ The feasibility of doing so will depend mainly on the demands made by the public sector on the financial system and on the policies of monetary management for hand- ling these demands. So far, the mechanism of demand management has been quite efficient in fine tuning and has been very sensitive to inflationary signs. The Banco de Mexico plays a pivotal role, cooperating with the Ministry of Finance on matters of general policy and maintaining a continuing dialogue with the financial institutions concerning short-term monetary and credit developments. The rapid increase in public sector borrowing during the last six years has, as described above, been accommodated by pre-empting an increasing volume of funds from the banking system without creating major deficiencies in credit availabilities for the private sector, and the magnitude of public sector deficits in coming years will certainly be an important factor in determining whether successful demand management can be continued. E. PROSPECTS AND ALTERNATIVE PUBLIC SECTOR STRATEGIES Introdduction 69. Looking at the structure and past trends of public finances, the alternative strategies for peublic sector policies emerge in quite distinct profiles. A strategy based on the continuation of existing taxation and public sector pricing policies would be likely to lead to a slightly declining level of public investments relative to GDP in the medium-term. Given that increasing investment is needed in order to maintain the level and the quality of output in public enterprises and to facilitate an effective attack on poverty, such a strategy could result either in reduction in needed investments or an increase in public sector pressures on domestic and external borrowing. While the short and medium-term consequences of continuing present policies should not be exaggerated, it is evident that a shortfall in needed public investment would have significant effects on social and economic conditions and the longer-term consequences would be particularly serious. 1/ With price increases of 4 percent the rate of money supply expansion should not exceed 3percent; at 5 percent it should not exceed 1', percent. in 1973. This specifically refers to M1.  - 33 A Projection Based on Past Trends 70. The current revenues of the Federal Government have an elasticity of slightly higher than one with respect to GDP when adjust- ments are made to eliminate the effects of changes in the system derived from observed buoyancy trends. Current expenditures 1/ of the Federal Government were projected on the basis of their past growth trends in relation to Federal revenues. According to these projections, Federal Government current revenue would increase from 6.4 percent of GDP in 1972 to 8.6 percent in 1976 and current expenditures would rise from 6.0 percent to 6.4 percent of GDP. The ratio of Federal District savings to the GDP is assumed to remain constant (0.5 percent). 71. Future levels of operating surpluses in the public enter- prises will depend on their productivity, pricing policies, wage and employment policies, and the volume of their social security expenditures. In the absence of knowledge about these variables, the assumption of no- change is taken to mean no adjustment in the prices of hydrocarbon products, power, and railway freight services, and no significant change in welfare expenditure. These assumptions would lead to diminishing surpluses in the petroleum and power industries and to increasing deficits in the railway industry. Starting from a level of zero in 1972, public enterprises would have an increasing negative balance in their surplus account. Although it is difficult to quantify this with any degree of precision, the range of this deficit on current account would be within 2-3 billion pesos in 1976. It is therefore assumed that the current deficit in the public enterprise sector would increase by half a billion pesos per year unless tariff adjustments were made. 2/ 72. The INFONAVIT housing scheme is expected to generate funds from payroll levies in the order of 3-4 billion pesos. These funds will be used for land purchase, housing construction, and house purchase loans. Because these funds are earmarked for specific purposes they are shown as separate items in the public sector projections. 73. Given these assumptions, the public sector, excluding INFONAVIT would generate savings equivalent to about 2.7 percent of GDP in 1973, and to about 2.5 percent of GDP in 1976. (Table III-II-15). The volume of public investment expenditures which could be undertaken in the future on the basis of these assumptions would be determined by the amount of net borrowing from internal and external sources. The projection given below (Table III-II-16) assumes that the volumes of deficit financing from 1/ See definition in footnote to para 28. 2/ Including Federal Government, Federal District, and the 16 major public enterprises and agencies, but excluding the state governments which have not generated savings of any importance.  - 34 - Table III-II-15 : PUBLIC REIENUE AND EXPENDITURE PROJECTIONS, 1973-1976 (billions of current pesos) 1973 1974 1975 1976 Federal Government Current revenues 1/ 47.4 52.9 59.1 66.1 Current expenditures 34.6 39.0 43.9 49.5 Saving 12.8 13.9 J71 Federal District Saving 2.8 3.1 3.5 3.9 Public Eiterprise Saving -0.5 -1.0 -1.5 -2.0 INFONAVIT funds 3.0 3.3 3.6 4.0 TOTAL Savings 18.1 19.3 20.8 22.5 1/ Allows for estimated effects of January 1973 tax changes. internal and external sources would remain at the level of the average for the past seven years in relation to GDP. According to this projection, the level of public investment (excluding INFONAVIT) in relation to GDP would rise very slightly in terms of the recent historical average, but on a declining trend. The inclusion of INFONAVIT invest- ments would raise the public capital formation ratio by about 0.5 percent of GDP. Table III-II-16 : MEXICO : PUBLIC SAVING AND POSSIBLE INVESTMENT EXPENDITURES PRiOJECTIONS FOR 1972-1976. (billion pesos) 1973 1974 1975 1976 GDP (Current prices) 1/ 561.4 623.1 691.6 767.7 Public Saving (including INFONAVIT) 18.1 19.3 20.8 22.5 Public Borrowing (net) Internal (15.1) (16.8) (18.6) (20.7) External ( 4.5) ( 4.9) ( 5.5) ( 6.1) Total Resources for Investment 37.7 41.0 44.9 49.3 INFONAVIT 3.0 3.3 3.6 4.0 Other Investments 34.7 37.7 41.3 45.3 Other Investments as % of GDP 6.1 6.0 5.9 5.9 1/ Assumes real growth of 7.0 percent.  - 35 - An Alternative Strategy (a) Public Sector Expenditures - Investment Expenditures 74. In the first two years of the present administration (1971 and 1972) the Government's concern with poverty was not reflected in public expenditure to any significant degree. This was, first, a measure of the fact that the aggregate resources mobilized by the public sector were in line with the trends of earlier years, which was in turn a reflection of the fact that there were no major changes in the pattern of resource mobilization. Moreover, the allocation of available resources reflected, with few exceptions, traditional priorities. This was un- remarkable, given that many aspects of public investment are "demand- driven" and that investments in the energy, steel and transport sectors, for example, are closely linked to the maintenance of sustained growth and to the assumption that neglect of investment in these sectors would lead to capacity constraints in the medium if not in the short run. 75. Changes in the established pattern of public investment are also circumscribed by the .ct that most projects have construction phases which extend over more than one year. Notwithstanding the tradition that an outgoing administration does not encumber an incoming one with heavy commitments, 1/ a new Government working within fiscal, stability, and balance of payments constraints, thus faces certain difficulties in intro- ducing drastic changes in the investment profile. Changes are also con- strained by variations in the project preparation capability of different public sector agencies. Some, notably the Ministry of Public Works (SOP) have, over time, developed considerable project implementation capacity. But in many institutions including those of the agriculture, health and education sectors which are precisely those to which the Government now wishes to accord special priority, the traditional level of project im- plementation (and thus financial-absorptive capacity) has been weak. In the light of these considerations the Government has placed considerable emphasis on the strengthening of the planning and project implementation capacity of Ministries and public sector institutions and has laid particular stress on those which would be critically important in the context of a strategy to reduce present imbalances in Mexican society. 76. Finally, the continuation of past trends in the early part of an administrative cycle is to some extent a reflection of the fact that a new Government requires time in which to define the major issues, assess the policy options which may be open, and to undertake preliminary activities which will underpin any particular line of policy which it may wish to develop. 1/ See Volume II, para 57.  - 36 - 77. By 1973 the issues seem fairly clear and, as argued earlier in this chapter, the options in respect of macro-economic policy seem reasonably well defined. ivioreover, the Government has taken certain measures to increase the administrative and project implementation capacity of the public sector, the status quo being such that PiMEX, CFE and most other public sector enterprises have substantial absorptive capacity - as we]l as - (in several cases) an urgent need to utilize it. Among Government agencies the strength of SEH and SOP remains outstanding, although the absorptive capacity ._f other agencies may have been recently improved. In the social sector, certain constraints will probably persist in the short run but would probably not be so severe as to impede the absorption of new investment resources. Moreover, in view of its part- icular concern to alleviate rural poverty, the Government has shown some tendency to take the existing distribution of administrative strengths and weaknesses as given and to transfer new and untraditional responsibili- ties to the strongest agencies. This applies particularly to the roles which may be played by SOP and SHH in the implementation of an expanded rural development program. 1/ 78. Parallel to these efforts to strengthen the public sector in order that it might acquire greater strength in project development and implementation, the Government, continuing the strategy begun by the preceding Administration, has taken measures to further rationalize the process of project preparation and to etablish a basis for multi-year rather than single-year investment planning. This strategy has two parts. First, the Ministy of the Presidency has attempted to coordinate the preparation of public investment proposals and for this purpose has developed consistent guidelines for project selection. These require that projects should: (a) contribute to economic growth; (b) imply greater national self- sufficiency and reduced import requirements, or (c) generate employment or otherwise contribute to the better distribution of income and consumption. 79. Under the new system all projects and investment programs submitted to the Ministry of the Presidency are classified and evaluated at an early stage in their preparation, which implies that the Ministry has the nominal capacity to influence any project from its inception. In practice, within the framework of new priorities, the degree of influence exercised by the Ministry tends to vary inversely with the technical capacity of the agency proposing a project. 80. The second aspect of the new system of expenditure planning concerns the establishment of a series of ad hoc commissions which include the Agricultural Investment Commission, the Rural Development Investment Commission, the Commission for the Analysis of the Education Sector, the Transport Commission, the Energy Commission, the Steel Commission, and the Mining Commission. All were established between 1971 and 1973 and 1/ See Volume III, para 377.  - 37 - each contains representatives of the government agencies and institutions which are most directly interested in the sector concerned. Further details on the commissions are included in Chapter III in the context of the analyses of sectoral problems, policies and prospects. 81. Collectively, they are becoming increasingly important in terms of project selection and preparation and are likely to fulfill an increasingly important role as intermediaries between single institutions on one hand and the central authority of the Subcomision de Inversiones y Financiamento Publico on the other. This body includes representatives of the Ministries of the Presidency and Finance and has its own technical staff in the Ministry of the Presidency. It is increasingly concerned with the elaboration of long range investment programs and although it has been functioning since 1967, 1/ its importance has been considerably enhanced by the emphasis on longer term strategy which has developed during the present administration. Its most important achievement to date is probably that it has succeeded in replacing the traditional system of expenditure allocations (a fixed percentage to each Ministry) with a system which is, in principle, designed to reflect overall national priorities and needs. 82. In 1970, the last year of the preceding administration, actual public investment was in the order of Mex$27.5 billion. This was about Mex$8.0 billion more than was spent in 1965. In 1971, investment was in the order of Mex$22.9 billion. The original investment program for 1972 was in the order of Mex$28 billion but in the light of at least three supplementary allocations during the year, the final level of actual investment in 1972 was probably in the order of Mex$334 billion. 2/ 83. On the basis of the trend of public investment expenditures which would arise in the absence of a new fiscal strategy, it has been shown (Table III-II-16) that the level of probable investment would not exceed Mex$37.7 in 1973 and would rise to only Mex$49.3 in 1976, and it has been suggested that this level of investment would not allow the Govern- ment to achieve its stated goals. In terms of the allocation pattern of such an investment program, it is assumed that the "demand-led" sectors would probably continue to receive substantial shares of available resources, although if the needs of the social sectors were in reality pressing political demands, it might be extremely difficult to ignore them. It is clear that something - monetary stability, the balance of payments, an attack on poverty or sustained growth - might have to yield. But it is not within the purview of this Report to suggest what decisions might be made because they would obviously imply political rather than economic choices. Moreover, given that an effort to increase the absorptive capacity of the public sector in respect of investment expenditures has already been made by this adnin- istration, a substantial amount of excess capacity (in terms of institutional ability to "absorb" investment resources) would be likely to emnerge. 1/ See Volume II, para 59. 2/ Including INFONAVIT.  - 38 - Table III-II-17 : I2XICO : PUBLIC INLESTI,2iT PROGRANII (in billions of current Pesos) Total 1965 1970 1965-70 1971 1972 1973 1974 1975 1976 Total PIP 1_.O 2?7.j 2.29.0 41.5 52.1 58.4 65.8 I Public Utilities/Industry 5.8 11.0 51.3 9.3 12.0 15.3 8 19.? 21.6 Pemex 3.5 5.4 5.3 6.0 8.2 9.4 10.6 11.6 CFE/Centro 1.4 4.5 3.2 4.6 5.1 6.o 6.5 6.9 Steel 0.5 0-3 0.4 0.6 1.0 1.5 1.3 1.3 Other 0.4 0.8 0.5 0.8 1.0 1.4 1.5 1.8 II Agriculture 1.1 3.8 14.0 3-3 4.4 4.6 5.6 6.3 7.5 SRH 2.8 2.3 3.5 3.4 3.9 4.3 5.2 SAG 1.1 0.3 0.6 0.7 0.7 0.9 1.1 1.3 Other 0.7 0.3 0.2 0.5 0.8 0.9 1.0 III Transport/Communications 6.1 28.6 4.6 6.3 7.1 8.0 9.1 10.2 SOP 1.8 3.2 2.7 3.2 3.5 4- 4.7 5.1 RH 1.2 1.3 0.9 1.6 1.9 2.0 2.4 2.5 Ports 0.1 0.3 0.2 0.5 0.5 0.6 0.8 0.9 Air 0.4 0.2 0.4 0.4 0.5 0.5 0.5 o.6 STC -- 0.8 0.4 0.4 0.5 0.7 0.7 0.9 Other -- 0.3 -- 0.2 0.2 0.2 0.2 0.2 IV Social Sector 1 2.4 6.o 30.2 5 1 9.1 10.2 11.8 13.3 15.1 Urban/Rural Works'2 1.3 1.4 1.1 2.0 2.0 1.7 2.2 2.7 Universities/CAPFCE 0.8 1.0 1.2 1.9 1.9 2.5 2.9 3.4 Health/IlSS/ISSTE 0.2 0.9 0.6 1.6 2.2 2.9 3.2 3.5 Federal District -- 2.2 2,1 3.0 3.1 3.7 3.9 4.4 lietro -- -- -- -- 0.4 0.3 0.2 0.1 Other 1.1 o.6 0.1 0.6 0.6 0.7 0.9 1.0 V Rural Development -- 2-5 4.0 5.1 6.3 VI Administration/Defense 0.3 o.6 2.6 0.6 0.8 0.8 1.1 1.1 1.1 VII INFONAVIT -- -- 3.0 3-3 3.6 4.0 1/ Urban Works only after 1973. INFONAVIT is not strictly a public sector agency but is regaraed as such for the purposes of this analysis. Sources: Secretaria Presidencia, Inversion Publica Federal 1965-70, Mexico 1970, Secretaria Hacienda, preliminary 1971, 1972.  - 39 - 84. Assuming however that a new fiscal strategy were adopted and that the level of public borrowing were to be moderately increased, the investment program shown in Table III-II-17 would appear to be consistent with financial availabilities, absorptive capacity, and govern- ment policy objectives, and would, on an annual basis, reflect the programmed sequence of fiscal and borrowing measures which is described below. 85. In general, the growth of the investment program would be closely related to the search for qualitative goals in 1973, 1974, 1975 and 1976. Allocative patterns would change on an incremental basis in such a way that by 1976, as compared with 1970, a radical re-ordering of priorities would be reflected in its structure. 86. Two areas would be outstanding in this respect (Table III-II-18). First, the relative shares of transport and communications and the public industrial sector would decline, notwithstanding the growth of investment in public enterprises. Second, the rural development program would grow dramatically, while the shares of the social sector and agriculture would remain steady, thus emphasizing the sectoral impact of allocative change. Some of this program would probably be implemented even if a new fiscal strategy were not adopted, although for reasons already given, it is difficult to be certain of this. What is now described as "rural develop- ment" has however been included in the public investment program for some years past and is not therefore an entirely new, but rather an ongoing but greatly expanded activity. - Current Expenditures 87. While evaluation of the absorptive capacity of the public sector in respect of investment expenditure presents certain difficulties, the difficulties involved in estimating absorptive capacity in respect of current expenditures are generally greater. In the context of a macro- economic strategy of no-change, it is assumed, as shown earlier, (Table III-II-15) that the relationship between marginal revenue and expenditure would follow the historical trend. The implications of this trend in terms of government policy objectives cannot be precisely estimated, but would almost certainly imply no real growth in social expenditures. It is also possible that it might be difficult for the public sector to implement biennial wage revisions for public employees in 1973 and 1975 which are scheduled in the context of minimum wage legislation. 88. Assuming, however, that new fiscal and borrowing measures were introduced, it is estimated that marginal current expenditure might grow less rapidly than marginal investment expenditures. This is partly because in the short term of 3-4 years, difficulties can be foreseen in the expansion of current expenditure incertain sectors, particularly in respect of teaching and medical personnel, where numbers cannot be rapidly  - 40 - Table III-II-18 : MEXICO : PUBLIC INVES24ENT SHARES 1970 1976 1. Public Utilities/Industries 40.0 32.4 2. Agriculture and Rural Development 13.8 22.8 3. Transport/Communications 22.1 15.2 4. Social Sector 21.8 22.6 5. Administration/Defense 2.3 1.5 6. INFONAVIT 1/ 5-7 100.0 100.C 1/ INFONAVIT is not regarded as part of the public sector by the Mexican authorities: it is nevertheless shown under this heading in this Report. increased. It is recognized that the growth of investment expenditures would imply an associated growth of current expenditures (i.e., directly linked with new investment). But insofar as several agencies now have considerable "excess capacity" in terms of administrative and technical personnel, a higher level of investment could probably, in the short term, be absorbed without a proportionate increase in staff and thus current expenditures. An alternative allocation at the margin could of course be made which would provide for additional current expenditures and a lower level of investment if, as the details of a new strategy were elab- orated, it were to be decided that such an alternative would be preferable in terms of the achievement of government objectives. (b) Financing an Alternative Expenditure Strategy - Introduction 89. The 1973 expenditure proposals of the public sector (announced in January 1973) imply substantial increases in both current and capital expenditure over recent levels. With regard to financing, while tax measures (also introduced in January 1973) will yield some additional revenues 1/ it appears that failing the introduction of further tax increases during the year there would be a large discrepancy between total planned 1/ It is estimated that the additional income of the Federal Government from tax changes introduced in January 1973 will be in the order of Mex$1.5 billion.  - 41 - expenditures and 1robable revenue, particularly in view of the fact that the measures taken do not include any changes in public sector enter- prise prices. This would imply, either: (a) that planned expenditure would not be made because financing was not available, or (b) that it would be financed through increased internal and/or external borrowing. 90. In view of the trend in recent years to strengthen government controls over external borrowing and to maintain an acceptable level of debt service burden, and in view of the importance of maintaining control over domestic inflation, it seems improbable that either internal or external borrowing would, in fact, be substantially increased. The question arises, however: what is the maximum feasible level of borrowing which is consistent with financial and balance of payments stability? - Internal Borrowing 91. The preemption of banking resources (including those of the Bnnnco de Mexico) by the public sector has increased rapidly since 1906 and now stands at about 40 percent of the net annual increment in bank credits. The extent of the public sector's recourse to the banking system in coming years will depend on the expansion of resources and their allocation between the public and private sectors. Excessive public demands on the banking system would be reflected either in rapid monetary expansion leading to inflation and balance of payments difficulties or a reduced level of availability for the private sector. The maximum volume of feasible net internal public borrowing in the medium term must thus be projected in such a way that the constraints of stability and the needs of the private sector are taken into account. It is easier to quantify tLie former: frcm past data it is estimated that the increase in the growth of the monetary liabilities of the banking system, consistent with a growth rate of 7 percent and a price increase of about 4 percent, would be around 13 percent per annum. 1/ From past trends, it is also estimated that the non-monetary liabilities of the banking system would continue to grow at a faster rate than the money supply (around 15 percent). On the basis of these projections, the ratio of banking resources to GDP would show a slightly rising trend in coming years, reaching 6.8 percent of GDP in 1976. This would, however, be very sensitive to "the" rate of interest and to other aspects of monetary policy. 92. If the financial system were fully exploited, it would be possible to increase the rate of public borrowing as a ratio of GDP by about 0.6 - 0.7 percentage points without necessarily creating inflationary pressures. But the transfer of this amount of resources from the banking system to the public sector would not only reduce availabilities to the 1/ See footnote to para 68.  - 42 - private sector, but might also have negative effects on the development of the financial system. For these reasons, net borrowing by the public sector from the banking Vrstem should probably not greatly exceed 3 percent of GDP. This is higher than the historical average of 2.7 percent but lower than what it would be if the public sector continued to preempt 40 percent of banking resources at the margin, and thus implies a maximum increase of 0.3 percent of GDP in terms of past trends. Table III-II-19 : MEXICO : MAXIMUM PUBLIC INTERNAL BORROWING, (1973-1976) (Current Mex$ Billions) 1973 1974 1975 1976 GDP 561.4 623.1 691.6 767.7 Maximum Net Internal Borrowing 17.0 19.1 21.3 24.3 % GDP 1/ 3.0 3.0 3.1 3.1 1/ Ratio in period 1965-1971 : 2.7 percent. - External Borrowing 93. The level of net external public borrowing shown in the following table is designed so as to avoid a debt service ratio of more than 25 percent - the maximum debt servicing burden experienced in recent years (Chapter IV). This would imply a moderate increase over the average level in the period 1965-1971 which was equivalent to 0.8 percent of GDP. Table III-II-20 : MEXICO : PUBLIC EXTERNAL BORROWING (1973-1976) (Current $Mex Billions) 1973 1974 1975 1976 GDP 561.4 623.1 691.6 767.7 Net External Borrowing 6.0 7.0 8.0 8.4 % GDP 1/ 1.1 1.1 1.1 1.1 1/ Ratio in period 1965-1971 : 0.8 percent.  - 43 - - Aggregate Net Borrowing 94. Some additional resources could therefore be mobilized by recourse to borrowing and whereas aggregate internal and external borrowing in recent years has amounted to about 3.5 percent of GDP, it would be possible on the basis of the preceding argument to increase the aggregate level to 4.2 percent of GDP by 1976. It is stressed, however, that this would represent a limit and that an increase in internal borrowing could introduce undesirable competition with the private sector for internal resources. 1/ Moreover, with respect to 1973, the resources which could be mobilized in this way would not be sufficient to finance required investments. Projecting investment requirements through 1976 it is clear, moreover, that the same argument would apply to subsequent years, even on the assumption that current expenditures did not increase above recent historical levels which, in view of the social objectives of the Government, is not really a plausible assumption. Table III-II-21 : MEXICO : PUBLIC SECTOR BORROWING (1972-1976) (Current Mex$ Billions) 1973 1974 1975 1976 Total saving 18.1 19.3 20.8 22.5 Aggregate Net Borrowing 23.0 26.1 29.3 32.7 Investment requirements 46.4 50.8 56.7 65.8 Resources Available for Investment 41.1 45.4 50.1 55.2 Gap 5.3 5.7 7.4 10.7 95. If, indeed, account were taken of the fact that current ex- penditure would inevitably rise in the context of a major effort to attack poverty, the shortfall in resources would clearly be substantially greater than that shown in Table III-II-21. For these reasons the "maximum" borrowing strategy could not succeed by itself, even if the risks inherent in it were acceptable. 2/ 1/ Except to the extent that the private sector can borrow abroad on equivalent terms. 2/ It is of course true that borrowing could exceed these levels if a higher level of inflation were accepted and if the debt service burden was increased.  - 44- 96. It follows, therefore, that additional resources must be mobilized by means of tax and/or tariff changes. The contrasts between a tariff emphasis and a tax emphasis are shown in Table III-II-22 (A and B). The projected level of current expenditure and the levels of total savings are the same in each case; the difference concerns the choice of emphasis, since both alternatives would involve tax and tariff measures. - Tax Measures 97. Not only is the tax ratio low, but the marginal tax rate is also low. Under the assumption of no change in taxation, the marginal rate 1/ (for the Federal taxes) estimated and used in the projections in Table III-II-15 is about 9.0 percent. As noted earlier. this is a low level when compared with a mean rate of about 15 percent in other less- developed countries. 98. Starting from such a low tax rate and aiming at a higher marginal tax rate, numerous combinations of tax measures could be consid- ered in order to achieve given revenue targets. One important constraint in devising a tax package would be the need to maintain the dynamism of the modern sector. This would imply that measures which might frighten capital out of industry - or even out of the country - should be avoided. Nevertheless, in addition to measures designed to improve tax administration, to eliminate loopholes, and to increase withholding rates wherever it is equitable to do so, it is recommended that a major emphasis should be put on property taxation and on income from bearer shares. 99. One of the least exploited but progressive sources of taxable capacity in Mexico is property taxation. The present revenue from this source, which is under the jurisdiction of state governments, is very low because of deficiencies in evaluation, low rates, and poor administration. In particular, higher taxation on urban property could produce substantial revenues without undesirable side-effects. Since urban property ownership is also a good proxy for wealth, it would be a progressive tax. 100. In indirect taxation, various alternative measures could be considered in order to improve revenue yields. Sales tax rates could be further increased in a graduated sequence from 1973 to 1976 with some differentiation introduced to make the system progressive. Alternatively, the whole system of indirect taxation could be restructured in the form ofa value-added tax. This would reduce market distortions arising from high rates which might be justified on the grounds of revenue or equity. A value-added tax (which has been discussed on and off in Mexico during the last three or four years) would also produce two important by-products; it would provide a check on income tax bases and it would provide an opportunity to reorganize revenue-sharing schemes between the Federal and State Governments, which are now in a very confused condition. 1/ With respect to income.  Table III-II-22 MEXIOO : ALTERNATIVE FISCAL STRATEGIES (Billions of Mex $) A (Tariff Emphasis) B (Tax Enphasis) 1973 1974 1975 1976 1973 1974 1975 1976 GDP(Current Prices) j 561.4 621.0 686.2 755.8 561.4 621.0 686.2 755.8 Federal Government - Current revenue 2/ 47.4 53.5 61.5 72.5 47.4 54.6 64.0 76.8 - Curent Expenditure 3 35.1 40.8 47.7 57.2 35.1 40.8 47.7 57.2 - Current Savings 12.3 12.7 13.8 15.3 12.3 13.8 16.3 19.6 Federal District Savings 2. 3.1 3.5 37.9 2 3T 33- 3. 3.9 Public Enterprise Savings 2. 7.0 3 16 INFONAVIT Funds 3.0 3.3 3.6 4.0 3.0 3.3 3.6 4.o Total Savings 20.5 26.1 29.3 33.5 20.5 26.1 29.3 33.5 Net Borrowing - Internal 16.8 18.6 20.5 22.6 16.8 18.6 20.5 22.6 - External 6.2 7.4 8.6 9.7 6.2 7.4 8.6 9.7 - Total 23.0 26.0 29.1 32.3 23.0 26.0 29.1 32.3 I _== - . Total Investment Resources 43.5 52.1 58.4 65.8 43.5 52.1 58.4 65.8 INFONAVIT Investment 3.0 3.3 3.6 4.0 3.0 3.3 3.6 4.0 Total Resources Other Investment 40.5 48.8 54.8 58.8 40.5 48.8 54.8 61.8 Total Investment Requirements 43.5 52.1 58.4 65.8 43.5 52.1 58.4 65.8 1/ Real GDP increases at 6.8 percent in 1973, 6.7 percent in 1974, 6.5 percent in 1975, 6.2 percent in 1976 (see text for explanation). From 1973 onwards allows for effects of 1973 sales tax reform. 3/ Assumes current expensitures increase at 15 percent (1973), 16 percent (1974), 17 percent (1975) and 19 percent (1976).  - 6 _ - Tariff Measures 101. Together with tax reform, additional revenues should be raised by means of aaending the price policies of the public enterprises, especially those concerning hydrocarbons products and power, railways and water services. It is estimated that required revenue increases based on price adjustments in these sectors could produce net increases in receipts equal to about one and a half percent of GDP by 1976 according to the measures taken. 102. The Government has repeatedly delayed rate increases for PI1EZ and CEE in recent years. The needs for substantial increases are discussed in detail in Chapter III, but generally refer to the need to improve the financial viability of the enterprises. In 1972 the Government agreed in principle to rate increases for CFE which would generate sufficient savings to finance at least 18 percent of its investment expenditures if action had been taken by December 1972 or by at least 25 percent thereafter. 103. With regard to PEREX, the financial situation has deteriorated for a number of reasons, but mainly because the enterprise has not been granted price increases for its basic products, including all hydrocarbons, since 1958. The Board of Directors of PMEEX has recommended price in- creases which would have a weighted average of 24 percent. Assuming they were introduced in mid-1973, these measures would yield about 2.0 billion pesos in additional revenues, but would actually cover the existing fin- ancing gap only for 1973. In a world of rising prices and growing exploration and production costs, PfMEX will require additional revenues to those based on a 24 percent average price increase, and it is assumed that unless these resources were to be obtained through government transfers (Alter- native A) supplementary tariff increases of about 5 percent per annum would be required in 1974-1976 (Alternative B). 104. In the case of the National Railways, it is expected that freight rates will be raised on a selective basis as of January 1974. In the case of water, a decree was passed in January 1973 increasing water rates by about 100 percent in the Federal District. From the standpoint of equity, it is understood that provision would be made to ensure that the burden of tariff increases would be adjusted to income differentials. Electricity rates would thus vary with respect to income level and PEMEX increases would allow for a subsidy on public transport by means of price discrimination. In respect of water tariffs, discriminatory pricing has already been applied. - Aggregate Change 105. Taking account of all the additional resources which would become available if tax and tariff revenues were increased, it is estimated that the total increment in public revenue would amount by 1976 to about 2.4 percent of GDP.  Table III-II-23 s MEXICO: Rate Increases (Actual and Prospective) in the Goods and Services of Decentralized Agencies Distribution of Demand Private Rate Increase Rate Increase Rate Increase Public Sector House- Percent Market Prices in Billions as percent Sector Industry holds Total (in percent) of Mex.$ ofC GDP in 1976 1973 1976 CFE - Electricity 25 40 35 100 29 950 2,500 0.33 PEMEX - Hydrocarbons 20 40 40 100 39 2,000 9,400 1.6 D.F. - Water 10 25 65 100 100 230 300 0.04 6/ F.N.M. - Railways 15 75 10 100 18 250 420 o.06 / 13 percent privately generated electricity. g/ Based on 1973 electricity sold. Projection by CFE. j Net of 50 percent price increase for fuel inputs from mid-1973 onwards. g/ Includes increases in Gasoline (20 percent), Diesel (27 percent), Kerosene (30 percent), Combustion Oil (50 percent), Natural Gas (20 percent) for overall increase of 24 percent in 1973. Additional 5 percent increase in 1974, 1975 and 1976. / SRH and Bank Staff Estimate. F.N.M. and Bank Staff appraisal. The rate increase is planned for January 1974. Source: Staff estimates, Energy Commission, SRH, National Railroads, PEMEX and CFE. Note: GIP: 1973 = 552.2 billion pesos, 1976 = 734.9 billion pesos.  - 48 - Table III-II-24 : MEXICO : PERCENTAGE OF GDP IN 1976 _A" / "B" 1/ Extra tax revenues 0.8 1.4 Extra tariff revenues i .6 1.0 1/ See options in Table III-II-23. 106. This, however, would represent the end year effects of a strategy of change in public sector financing which would logically be spread over several years. It is assumed at the time of writing that some measures could be introduced before the end of 1973 in respect of tariff increases in PEKEX and CFE and that as from January 1974., further tariff measures would be introduced in respect of the railways. With respect to new taxation, however, it is assumed that a new strategy should be carefully phased over 1974, 1975 and 1976 in such a way that the maximum revised level would be reached in the final year. (c) The Implications of an Alternative Strategy 107. Given that the proposed strategy is based on the premise that internal and external stability should be maintained, it is not consider- ed that the measures proposed would be likely to produce either inflationary or balance of payments difficulties. With regard to tariff measures, analysis shows that even if tariff increases amounting to 1.6 percent of GDP by 1976 were introduced (Alternative A), the effects on internal prices would not be severe. 108. By the nature of the output (hydrocarbons, electric power, rail transportation, and water) of the enterprises, the first round effects of price increases for these products would be widely diffused across the economy. They are sold both as inputs and as consumers goods. As inputs they seldom make up a large part of a firm's cost structure, but to the extent that costs were to increase, some part of the increase would probably be passed on to users and part would be absorbed by profits and wages in the fims concerned. While the effect would be very widespread, it is likely that the major portion would be passed on to final goods. On these assumptions, the incidence of the increase in prices would pro- bably fall on consumption and investment in the same proportions as these make up GDP: 80 percent and 20 percent. 109. Table III-II-25 shows the possible effects of increases in public enterprise prices, on prices in other sectors of the economy, on the assumption that each sector passed on each increase in its input prices. The calculations of price increases in each sector are based on  - 49 - Table III-II-25 : MEXICO : PRICE EFFECTS OF PASSING THROUGH PEMEX AND CFE PRICE INCREASES Structure of Consumption(%) Low Income High-Income Price ($300-600 ($6,000-i10,000 Sector Increase per month) per month). Agriculture 1.3 34.2 16.3 Mining 5.3 0.9 - Petroleum 40.0 1.3 0.9 Food, beverages and tobacco 1.9 29.2 12.1 Clothing and textiles 1.9 10.6 14.6 Wood, paper and furniture 1.7 1.7 1.4 Chemicals and rubber 1.7 0.4 0.9 Non-metallic minerals 5.3 - - Base metals 4.6 - - Metal products 2.3 2.7 7.0 Construction 1.9 - - Electricity 29.0 * o.6 1.3 Commerce 0.5 - - Transport and communications 4.5 1.2 7.4 Services 0.6 17.5 38.0 * By assumption Total effect on cost of living of low-income families: 1/ 2.2% Direct effect only: 0.7% Total effect on cost of living of high-income families: 1/ 2.2% Direct effect only: 0.7% 1/ Does not allow for effects of discriminant pricing - actual effect should therefore be more progressive.  - 50 - assumed increases of 29 percent in the price of electricity and an increase of 24 percent in petroleum products the first year, and an increase of 5 percent in the three following years in hydrocarbons products. These measures, together, would transfer about 1.6 percent of GDP to PE4EX and CFE. The average increases in the national price level might be in the order of 2 percent but far less confidence should be placed in the absolute size of the price increases (which also depends on monetary factors) than on the pattern of relative prices indicated. 110. As might be expected, the effects are concentrated on the energy using sectors - basic metals, non-metallic minerals, mining, and transport. The increase in final goods is much less. From Table III-II-25 it appears that the effects of the price increases would raise the cost of living of high and low-income families by about the same amount, but this impression is misleading because the calculation does not take account of discriminant price increases as a result of which their incidence would bear more heavily on high income than on low income groups. 1/ More generally, this analysis almost certainly overstates the inflationary effects of tariff adjustments. If, for example, half of the increases were to be absorbed in profits and other production costs, the inflation implied would be reduced to 1.0 percent over four years and the actual price effect would thus be much less than an annual rate of 0.5 percent and would not be incompatible with stability goals. Moreover, any in- flationary effects arising would be relative to whatever rate of in- flation is current in the medium tenm. The projections shown in Table III-II-22 allow for price increases of 4.0 percent per annum. 111. With regard to growth, if it were assumed that the full impact of the fiscal strategy were to fall on savings, the assumption would be an extreme and essentially limiting one and would arise only if the resources transferred to the public sector were to be used either for consumption or for relatively "unproductive" investment (as measured by the ICOR).Z/Using this assumption as a "limiting case" Table III-II-22 (A) and (B) shows the extent of the decline in the growth rate which would be consequent on a transfer of resources to the public sector, in an amount equivalent to 2.4 percent of GDP in 1976. Given that this assumption about the productivity of public sector expenditure is an extreme one, it is more likely that the impact on growth would be much less severe. This argument assumes however that a strategy of fiscal reform could be carried through in such a way as to avoid any indirect negative consequences for savings and investments in the private sector and would thus be predicated on the strength of the understanding between the public and private sectors which has been developed over the last 15 years. It would suppose that the Government could find ways and means of raising additional revenues without provoking negative psychological reactions which might affect both domestic and foreign savers and investors. 1/ The details of the Government's proposals about discriminant pricing were not available. See Technical Note #8.  -51 - 112. But, in addition to the assumption that this understanding may be sufficiently good to make the premise a realistic one, there is a strong supporting argument. This refers to the rates of profit which are customarily obtained on private investment (both in securities and in fixed capital formation) in Mexico. Given that these rates are higher than can be generally obtained elsewhere, and given long term confidence in the strength and prospects of the Mexican economy, there is no reason to assume that savers or investors would cease to save or invest. 113. Focusing on the changes in fund flows alone, and the possible effect which these may have on the growth rate, it is reasonable to suppose that a significant increase in public sector expenditures - over 30 percent in a period of four years - would have insignificant effects on savings, investment or growth. This conclusion follows logically from the small size of the public sector at present relative to the savings ratio in the economy. The probable burden of fiscal reform on private consumption flows is also very small, the burden being further alleviated by the trend of a high growth rate. Therefore, the issue of a trade-off between growth and equity strategies should not be exaggerated as far as the effects of fiscal changes are conceived in terms of reduced private resources. In other words, the growth-cost of diverting additional resources to public expenditure, at the range of magnitudes discussed, is likely to be minimal. 114. On the other hand, it seems very probable that the cost of pursuing welfare objectives (in terms of sacrifice from growth) would rise substantially if the policies pursued led to instability in terms of politics, prices or external payments. It is not within the purview of this Report to consider the political effects of the diffusion of the benefits of growth. Humanitarian considerations, as expressed by the Mexican Goverment, are sufficient to justify such a program. Nor is there any conflict between domestic price and external stability and increasing public resources at the orders of magnitude discussed. On the contrary, an expanding public revenue program would reduce the risks of excessive public borrowing either from the domestic banking system or from abroad, and therefore contribute to the maintenance of both internal and external equilibrium.  III. THE SECTORS: PROBLEMS, POLICIES AND PXiOSPECTS A. INTRODUCTION 115. It has been argued in Chapters I and II that, whereas Mexico could almost certainly continue to achieve rapid growth in the medium term (through 1976), the failure to undertake new investment in certain sectors, particularly energy, would imply that growth would be constrained in the longer term by inadequate productive capacity. Moreover, the failure to mobilize additional public sector resources would imply that social expenditures could not be expanded on a sufficient scale to have any real impact on the poverty which characterizes much of the nation. 116. It was also argued, however, that a new fiscal strategy was not only desirable as a means of achieving both economic and social ob- jectives, but also feasible. The differences between a strategy which implies no change in current macro-economic policies and an alternative strategy which would imply the substantial growth of the public sector through 1976, have so far been alluded to in only general terms. This chapter is concerned in part with the detailed implications of alternative strategies at the sectoral and subsectoral levels. Given, however, that the contrasts vary fram one subsector to another, depending primarily on the extent of direct public sector participation and are thus far greater in, for example, the energy sector than in other industrial sectors, Chapter III, in addition to its focus on the sectoral and subsectoral implications of alternative fiscal and expenditure strategies, is also concerned with non-expenditure aspects of sectoral problems, policies and prospects. These include, for example, decentralization and protection policies in the manufacturing sector and price support policies in the agricultural sector. They also include factors which are unrelated to Government action such as trends in export markets, which may have an important bearing on sectoral prospects. The general objective therefore is to provide a broadly based analysis of the major sectors which takes account of both the implications of fiscal alternatives and of such other factors as may be relevant to the determination of medium.-term prospects. B. AGRICULTURE, FORESTRY AND FISHERIES Agriculture (a) Introduction 117. While Government policies for agriculture have until recently 1/ been successful in achieving their production objectives, they have fallen short of achieving welfare goals. The problems of rural unemployment, 1/ Since the mid-1960s however agricultural growth has been less than 2 percent per year.  - 53 - high levels of income concentration and accelerated rural-urban migration are intimately linked with the structure of the agricultural sector. 1/ The vast majority of Mexico's peasants - sane two million smallholders and ejidatarios and probably a larger number of landless have been bypassed by rapid economic growth and barely participate in the market economy. This is in many ways a consequence of policies which, except for Agrarian Reform, have tended to focus on rapid increases in productivity and to benefit a rather snall number of commercial farmers. 118. Mounting social pressures in the countryside and disappointing production performances in recent years may, however, indicate that a turning point has been reached in Mexico's agricultural development and that structural conditions may impose increasingly severe constraints to growth. The more easily developable water resources of the northern coastal areas have already been exploited; the extension of the cultivated area is becoming increasingly difficult; the further growth of output must increasingly depend on farmers who are less sophisticated than those in commercial agriculture; and the ecological conditions of the promising but so far virtually unutilized southern Gulf regions pose problems for which technological solutions have yet to be found. (b) Production and Export Trends 119. Recent years have seen a shift away from extensive development as the main determinant of changes in output to an emphasis on greater intensity and productivity. The composition of agricultural output has also changed (Table III-III-1). Livestock production increased more rapidly than crop production after the mid-1960s and its share of total sector output has risen to some 30 percent. There were particularly significant increases in pork, poultry and egg production, although the growth of output of beef and milk has fallen behind the growth of demand. Among crop subsectors there was a mixed picture with impressive growth in output of cereals such as wheat and sorghum and of tomatoes, and a generally disappointing performance in the growth of oilseed, cotton, sugar and vegetable production. There were also regional variations; fruit pro- duction for example expanded rapidly in the northern coastal areas but less quickly than expected in the tropical south. 120. Corn (maize) and beans are the bases of the Mexican diet 2/ and the subsistence crops for most of the rural population. Corn is cultivated on nearly 60 percent of the rainfed and 10 percent of the irrigated crop producing area and its production, stimulated by a favorable support price, has exceeded domestic demand in recent years. Bean production and yields (which fluctuate strongly with climatic conditions) havealmost doubled as a consequence of varietal improvements and of a shift to irrigated areas, resulting in output increases of nearly 90 percent. 1/ See Volume II, para 93 ff 2/ See Volume II, para 130 ff and Volume III, para 361 ff  - 54 - Having realized self-sufficiency in the late 1960s, Mexico had to import wheat again when a profit squeeze led to drastic reductions in the harvested area in the late 1960s. 121. The output of cotton, traditionally the largest single agricultural export, has rapidly declined since reaching a peak in 1968. As a consequence of competition from other crops, insect pests and labor problems, cotton production is now ccncentrated mainly in irrigated areas and in 1972 the harvested area was 500,000 hectares; this compared with a peak area of 727,000 hectares in 1965. Although sugar cane yields increased at an average annual rate of more than 6 percent in the 1960s, absolute levels (70 tons/ha) are still low, as is the effieiency of the processing industry. Output of fruits and vegetables has increased rapidly in recent years;although these crops account for only 7 percent of the harvested area, they mece up 20 percent of total crop value. 122. Mexico has two major cattle producing areas: the semi-arid northern range lands which mainly produce feeder cattle for the U.S. market, while the output of the wet and dry tropical grasslands in the south supplies most of the domestic market. Data on beef procdiction and stocks are conflicting, but pasture management and husbandry are generally considered to be deficient; the calving rates are in the order of 50 percent, the maturation period is lengthy, the rate of breeding stock replacement is slow, and pasture quality is inadequate. Dairy production is concentrated in the irrigation districts of the central plateau, most milk being produced under a relatively inefficient stall-feeding system using alfalfa. A rate of production growth of 5 percent per annum has been insufficient to meet the growth of domestic demand, and the deficit has been balanced with imported skimmed milk. The output of pork and poultry has increased with the growth of demand and while the latter industry is generally considered to be efficient, the pork offtake rate could be considerably improved. 123. Mexico's agricultural exports (Table III-III-2) have benefited in recent years from such favorable external factors related to the U.S. market as increased prices for cotton, and winter/early spring vegetables, a meat deficit in the U.S., and the transfer of part of Cuba's former sugar quota. The most important agricultural export items have been tomatoes and livestock products, each of which accounts for about 17 percent of total agricultural exports; cotton (21 percent), sugar (15 percent) and coffee (13 percent) make up another 49 percent, the remainder consisting of fruits, vegetables and tobacco. 124. While fruits and vegetables have been exported with considerable success, their emerging dominance on the U.S. market has provoked sporadic import regulations which have made production planning difficult. The levels of sugar and coffee exports have been determined by quotas while cattle and beef exports have also been restricted by export quotas which have been designed to hold down domestic prices. Mexico has not however been able to take advantage of the favorable world market situation for cotton in the light of the declining production trend noted earlier, while in order to place its maize surpluses on international markets, it has  Table T-III-1 AGkOgJII73LRAL P?i0TCTTO7l -- 47 SFIECTED CMIDPS, 19tn-71 (thous.n'1 retri., tons) 1960 1961 1962 196), 131. 13.6; 3966 1'X7 19(,8 1969 1970 1971 Cereals Bar] ey 180.4 174.1 151.1 185.6 770.6 193.2 223.0 203.4 25?.7 204.4 283.6 306.0 Corn 5,419.8 6,246.1 6,337.4 6,b7O.2 8,1 t4. 0 39,.36L, 9,2f1.5 8,/03.0 9.o,r,. 8,1t5.5 y,o40.6 9,60).0 Oats 67.6 68.4 611.3 78.8 79,8 20.0 62.7 142.6 41.7 2S.3 30.9 31h.0 Rice 327.5 332.9 289.0 296.4 ?7t . 4 177.5 37e.2 1417.9 347.2 396.6 ,402. 1 4104 3orghum 209.3 290.6 295.9 1402.2 555,6 7147.0 1,411.o 1,(66.6 1,326P.0 2,L53.0 2,7'8.1 2,2xj.,) Wheat 1,190.0 1,401.9 1,455.3 1,703.0 1,'26.6 1,657.7 1,611.9 2,o61.14 1,780.1 2,381.8 2,216.4 1,9X0.O mar Sugar cane 19,542.0 18,108.0 18,651.0 20,963.0 23,4.23,r 26,536.0 27,367.0 21,269.0 2A,8145 . 31,996.0 29,012.0 30,7140.0 Roots ffeots 38.9 37.5 45.0 142.3 45.4 1V6,7 148.' 13.8 l413. 39.1 b2.7 146.2 Potatoes 294.1 303.3 379.5 414.0 1413. 318,7 3485.5 308.8 415.1 841.0 42?.J l412.t3 Sweet potatoes 92.0 92.1 102.8 125.7 1?9.1 11'1.0 1414.9 159.14 122.8 132.4 15(.2 1i56.8 Sweet roots 21.5 22.2 27.2 33.1 35.6 32.9 .s 27.l 30.3 31.0 3l.0 21.6 Puilns 528.2 723.3 655.6 677.3 89. 5 859.5 1,013.2 980.2. 856.9 806.4 925.1! 1,OX0.0 Jroad beant 29.8 22.8 29.8 36.6 37.3 37.9 38.6 39.0 34.2 27.6 28.4 31.? Chiles (dry) 16.8 17.2 16.5 18.5 20.6 22,1 22.5 2i?.9 23.1 24.2 2f,.3 2?.9 Chick peas 1174.7 135.1 129.1 97.2 122.8 135.14 i5i.8 m65.3 179.3 166.94 1S7. 1 17(.0 Lentils 3.1 3.7 4.3 5.3 5.b 5. , 5.5 5.2 5.5 3.6 14.1 4.4 Vetch 6.2 5.4 1.7 b.9 5.1 5.1 5.2 3.7 3.4 2.9 4.5 8.,8 Oil Crons Cottonseed 812.6 766.6 932.9 811.4 219.6 1,007.5 &,6.1 772.8 9146.0 6714.0 5146. 658.7 Copra 180.0 198.8 203.9 16L,.8 167.5 16f. 17I).0 161,.6 114.7 114o.0 107.1, 7.8.0) I Safflower 32.0 41.4 46.8 47.2 47.7 79.6 ?36.2 7149.0 10,'.1 208,9 792?. A 1(03.O Sesace 129.2 146.8 157.8 169.3 171.7 15L4., 16'.?7 195.3 1l9.1 165.0 182.', 210.0 Soybeans 5.0 19.7 56.7 56.3 6'.3 S';.9 9L.5 1;1.0 275.2 286.6 211.2 220.0 Fresh b1e C0h14les (grecn) 90.5 96.8 109.2 122.7 133.6 13LI,4 167.1 199.5 193.7 256.3 210.7 21i.6 Egplant 1.3 3.2 3.3 3.7 3.9 4,f, It.8 h4.6 1,q 7.2 9.7 13.2 Garlic 14.2 14.2 16.5 16.8 16.2 16.6 17.0 0.;9p, 28,.6 36.1 32.6 33.5 Green beans 7.6 10.4 9.8 9.8 10.1 10.' 11,2 7,.7 1';.3 le.3 :4.' 15.7 Green peas 12.2 12.3 12.8 12.3 114.o 14, 1 1,.8 ??.9 21.8 17.7 19,8 2t.9 Onions 60.9 614.0 83.8 96.0 101.5 o?.98 1'3,0 1'C. 3 1 7'.6 1145.6 152., 1S8. 4 Tosiatoes (Pitormsta) 388.6 453.1 433.8 4%2,2 7 44,5.0 553.9 5.? 6;17.n 664Q. 7 743.2? 9140). 956. I Tomaloes (cascara) 12.5 17.4 17.7 1S.5 19.C 20.0 2).6 37.0 33.8 52.6 '13.2 53.9 Fr,its- N7nenas (Roatan) 317.3 340.9 366.6 413.3 ?1.' 1;42C.7 1434.7 74Li.7 33?.4 307.5 525 0) 592.0 Bariar,as (other) 296.3 305.8 3143.8 526.5 c27.3 5314,? S142.9 14'7.7 418.0 447.4 63I. 0 627.0 Figs It.5 5.3 5.9 6,9 7.1 7.2 7.14 8.3? 8.7 8.5 3 t3. 9.3 Melons 80.7 94.7 186.7 18,1.3 188.5 259.5 21'.- 212.4 223).0 175.6 17i.8 183.8 Oranges 766.5 772.4 882.5 8531.8 '45.3 363.14 83P.0 1,ff.S 1,638.2 1,698.9 1,551L.7 1,670. 0 Pineapples 180.5 177.4 177.9 193.3 '97.8 268. 9 2e,.2 299.14 25t .o 276.6 A0; 3.5 361.0 Strawlerries 23.3 24.9 31-.3 33.1 31S.14 ';, S 1hi3.7 1?7.1 115.2 15y,.8 117.7 122.C WaLemeloro 133.5 198.4 317.? Qs O 5 414,.0 3L. 6 1 k7.Is l0' . 152.5 ?27.3 231,7 .58H.3 Ncits Peanuts 89.3 93.7 94.8 92.8 95.4 80.4 89.9 74,.1 82.3 72.9 89.6 80.0 Cacao and Coffee Cacao 23.7 26.9 29.5 30.1 76.1 20.5 724.5 28., 113.7 1I.8 35.1 16.9 Coffes 126.0 141.0 132.2 178.0 19'.) 180.') 362.0 174.0I 171.9 171.0 It'8.'; 192.0 Fibre., and Tndustrial iSeeds Cot- n 476. 1 449.8 547.4, 476.1 5I3.6 591.2 508.2 4I' : 555.0 395.7 326.'7 386.5 Henequen 155.6 156.u 156.14 171.7 73L l''17.l 176.f 13, ., 117.1 11,1.1 L1 41.1 IL3.4 niaseed 15.3 15.0 15.0 13.7 114.1 16.17 77.4 14.5 l .7 12.1 .9.9 25.0 Other Tobecco 72.0 66.9 67.4 67.6 67.7 58.7 56.5 1,?.2 143.2 7''.2 7.,. 82.7 Alfalfa 4,240.4 4,230.1 5,092.9 5,132.1 5,501.9 5,6t4.8 5,i?2fi. 7,613.7 7,'484.7 7,913.9 8,7)5.e, 9,120.0 Vanilla 0.3 0.2 0,2 0.1 .l r. I 3.I (.l 0.1 .1 (.1 n,l So S l8m,i4satiry of A3ricultlre , An,.rrson Clayton rd o., co, 'hc lan f' Tn: t :, ! re ,- :.l Qr r ,d ,rY-n -.>  Table III-III-2 t IICO : EXPORTa OF MERCHANDISE BY COWIODITY, 1960-72 (value in US$ mil-licns, volume in thousand metric tons, unit value in US$ per metric ton) - ~~~~~~~~~~~~~~~~~~~~~~~~~~~Jan 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1971 1972 19721/ Cotton val. 157.9 15.9.9 218.3 195.6 17o01 212.1 221.9 143.6 170.3 196.0 123.7 117.6 22.0 50.6 143.0 vol. 316.3 305.2 425.2 370.1 320.0 409.0 o 429.5 270.5 315.9 370.2 213.8 166.1 33.2 64.9 180.0 u.v. 499.2 524.1 513.4 528.4 531.7 518.7 516.8 530.9 539.2 529.4 578.8 707.9 663.1 779.2 795.o Tomatoes val. 25.5 14.1 20.2 24.5 33.9 35.1 62.9 49.6 57.6 84.1 107.7 91.0 84.2 93.4 102.0 vol. 159.2 95.7 136.3 141.3 152.9 161.5 217.4 212.8 239.8 276.9 365.3 311.9 288.4 310.9 340.0 u.v. 160.0 146.9 148.2 173.5 221.7 217.6 289.1 233.0 240.1 303.8 294.9 291.8 292.1 300.3 300.0 Coffee val. 71.7 71.7 70.0 49.1 95.2 73.1 83.5 60.2 77.4 73.9 86.1 81.1 44.6 39.0 77.0 vol. 83.0 89.2 91.3 66,6 100.9 78.1 92.3 74.7 95.4 93.9 80.9 91.1 48.1 43.3 85.o u.v. 804.2 767.4 737.3 9h-3.4 935.6 904.5 805.9 811.8 786.7 1,064.0 890.3 927.4 901.2 905.0 Corn val. 22.0 __ 0.2 -- 3.5;-9 77.2 46.7 72.6 46.5 43.6 -- 17.0 10.0 18.5 31.0 vol. 457.3 -- 3.5 -- 282.4 1,346.8 851.8 1,253.9 896.1 788.4 0.1 276.7 153.6 357.4 600.o u.v, 70.0 . 57.1 . 56.3 57.3 54.9 57.9 51.9 55.3 . 61.5 64.8 51.6 51.0 Melons and Canteloupes val, 7.9 9.6 9.9 10.7 11.8 14.4 13.7 12.6 9.1 12.7 15.5 16.9 16.8 16.1 16.0 vol. 80.2 68.1 69.3 79.8 83.8 96.9 91.8 89.9 72.7 98.1 129.3 149.9 148.0 152.8 154.0 U.V. 98.0 141.2 l14.3 134.3 140.6 148.8 148.7 139.7 125.5 129.5 89.3 112.8 113.4 105.5 105.0 Tobacco val. 0.6 0.7 2.5 5.5 4.4 3.3 6.2 5.5 4.6 8.6 11.1 11.7 8.5 13.0 29.0 vol. 1.3 1.4 4.4 12.5 9.0 5.2 10.2 7.1 4.5 8.3 10.8 10.8 4.9 9.8 21.0 u.v. 1466.4 488.6 572.7 441.2 485.8 640.1 612.6 780.1 1,024.1 1,043.0 1,026.8 1,087.7 1,743.8 1,324.0 1,380.0 Wheat val. -- -- 0.1 5.0 35.8 41.6 3.9 12.6 -- 11.8 1.5 2.1 2.1 -- -I vol. -- -- 1.0 72.3 575.9 684.5 46.8 212.4 0.1 ?47.3 29.9 24.5 24.5 -- __ u.r. . . 121.9 68.6 62.1 60.8 82.6 59.3 191.0 47.8 49.9 85.9 85.9 Beans val. -- -- 0.4 5.3 3.4 2.7 15.6 10.0 11.14 5.0 0.9 -- -- 4.7 7.0 vol. -- -- 2.4 31.6 20.1 16.5 102.0 65.8 79.8 53.5 11.3 -- __ 18.8 30.0 u.v. . 155.2 167.3 168.1 162.9 153.1 151.2 143.0 92.7 76.5 . * 250.8 230.0 Wheat seeds val. -- -- -- 0.1 0.1 8.0 0.3 0.7 1.7 9.0 0.1 0.2 0.5 Fresh strawberries val. 0.1 0.1 0.1 0.3 ... ... 1.5 3.9 4.3 7.2 8.4 8.9 7.5 6.6 8.0 Resin val. 4.6 6.4 6.3 7.2 5.7 3.6 3.5 3.9 3.7 6.1 5.9 8.2 3.8 4.7 9.0 Henequen fibre val. 3.9 4.7 6.2 5.4 4.1 4.1 3.4 3.9 3.8 2.7 2.8 5.0 1.9 1.9 4.5 Forage val. 4.6 5.4 6.o 5.1 6.7 5.7 4.3 4.2 1.7 1.2 2.6 3.5 3.1 0.4 1.0 Other seeds val, ... ... ... ... ... ... 6.8 7.8 1.1 1.7 2.1 3.1 1.0 9.4 25.0 Chicle val. 2.6 3.7 3.2 2.9 1.5 2.6 2.0 2.1 2.1 3.8 3.5 2.6 1.0 1.6 3.5 Vegetable wax val. 2.5 1.9 1.7 1.6 2.0 1.6 1.9 1.4 1.4 1.7 1.6 1.9 1.0 1.0 2.0 Cotton lint val. 2.2 3.0 2.9 3.6 3.0 2.6 3.5 4.0 3.6 2.4 1.7 0.1 0.1 0-5 1.0 Sorghum seeds val. -- -- -- -- -- -- 1.7 19.6 7.1 2.2 0.2 -- -- -- Oranges val. 1.4 2.2 1.3 4.0 5.8 5.9 1.8 2.1 4.4 2.8 2.2 3.8 ... ... ... Other val. 12.6 17.7 20.0 32.1 24.8 26.3 27.7 24.5 3?.1 34.2 30.9 39.8 15.0 28.0 64,0 Total Jgricultural Pr,oducts val. 320.1 301.0 369.3 357.9 424.1 512.0 512.6 452.1 442.5 502.4 410.1 423.3 222.7 289.6 522.5 1/ Estimates. Values rounded to US$ 0.5 million.  Table III-III-2 t EXPORTS OF MERCHMADISE BY COIMODITY, 1960-72 (cont ' d). (value in US$ millicns, volume in thousand metric tons, unit value in US$ per metric ton) II. Livestock and Fishing Products Jan. L-Jue 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1971 1972 19721/ Live Cattle val. 33.2 42.1 53.2 36.7 22.8 38.1 42.3 38.0 56.7 68.8 79.2 74.6 24.2 39.9 80.0 VZ2/ 395.7 549.7 766.2 553.9 357.9 557.4 589.5 524.2 711.9 840.4 933.6 756.2 312.7 400.2 730.0 u.v._ 83.9 76.6 69.4 66.3 63.8 68.3 71.8 72.5 79.7 81.9 84.8 98.7 77.4 99.8 110.0 meat val. 9.6 15.8 21.2 26.7 18.4 17.2 26.1 20.4 33.5 39.0 42.4 42.3 23.8 22.7 54.0 vol, 18.8 26.1 28.0 33.7 23.4 22.1 27.7 21.4 32.6 35.4 37.2 34.7 19.6 17.9 42.0 u.v. 512.7 607.2 756.1 794.1 782.8 777.9 940.4 952.9 1,027.1 1,102.7 1,10i.3 1,219.0 1,214.0 1,267.6 1,285.0 Honey val. 2.3 2.8 3.7 3.6 5.3 4.6 5.2 4.8 5.8 5.4 5.4 4.6 3.1 8.0 13.0 vol. 15.8 17.5 21.8 18.5 22.9 23.6 27.8 23.7 30.4 26.0 22.6 17.3 11.9 21.4 35.0 u.v. 144.6 157.9 169.1 196.6 230.3 193.7 185.4 202.6 191.9 208.3 238.2 267.3 257.6 374.1 380.0 Other val. 1.0 1.9 2.3 2.0 1.4 1.4 2.8 2.7 3.2 4.0 4.3 4.2 2.1 2.0 4.0 Total Livestock Products val. 46.1 62.6 80.2 69.0 47.9 61.3 76.4 65.9 99.2 117.2 131.3 125.7 53.2 72.6 151.0 Shrimp val. 34.1 43.7 45.9 51.7 53.5 42.7 53.5 61.5 49.6 45.8 63.0 69.1 23.5 28.8 73.0 vol. 32.2 26.5 34.7 34.6 32.1 27.0 29.9 32.2 25.4 22.9 28.8 3l.0 '0.5 12.6 32.0 u.v. 1,060.5 1,650.8 1,324.8 1,491.9 1,667.9 1,578.9 1,787.5 1,908.5 1,948.4 1,993.9 2,188.7 2,230.1 2,231.5 2,288.3 2,290.0 Other Seafood val. 2.2 2.4 2.3 1.8 1.9 1.9 2.1 1.4 1.8 2.9 3.1 3.8 ].6 2.8 6.o vol. 6.8 6.1 6.1 5.8 4.9 4.2 5.1 3.0 3.7 6.5 5.1 6.5 2.9 4.3 9.0 u.v. 320.5 394.8 375.1 317.8 397.0 449.9 418.8 458.3 488.0 450.5 610.1 585.3 544.3 635.o 650.0 Other Marine Products val. 0.2 0.2 1.2 1.2 1.4 1.4 1.7 1.2 1.6 1.8 1.9 2.3 0.9 1.2 3.0 Total Fishing Products Val. 36.5 46.3 49.4 54.7 56.8 46.0 57.3 64.1 53.0 50.5 68.0 75.2 26.0 32.8 82.0 TOTAL LIVESTOCK AND FISHING PRWUCTS val. 82.6 108.9 129.6 123.7 104.7 107.3 133.7 130.0 152.2 167.7 199.3 200.9 79.2 105.4 233.0 1/ Estimates. Values rounded to us$ 0.5 millicn. 2/ Volume in thousand heads, unit value in US$ per head.  - $8 - been necessary for the Government to pay subsidies in recent years. 125. Milk powder, wheat and oilseeds are now the principal agri- cultural imports but except in unusually poor harvest years, account for a very small proportion of total imports; even in 1970-71, a bad harvest year, they only amounted to 8.8 percent of merchandise imports. (c) Problems and Policies - Introduction 126. The agricultural policy of the present Government has the following broad objectives: (a) the growth of output to satisfy domestic demand and to take advantage of export opportunities, and (b) the generation of more employment in agriculture and the growth of agricultural incomes. These objectives are, in general, sought through agrarian reform, irrigation development, research, extension, price and marketing policies, and the provision of credit. - The Institutional Framework 127. The institutional framework of the agricultural sector in the past has been characterized by a proliferation of agencies without clearly defined responsibilities and with overlapping functions. The Ministry of Agriculture (SAG) is the principal agency and is directly responsible for informal production planning, research, extension, seed production, and data collection and evaluation. However, the dominant agency in the sector has been the Ministry of Hydraulic Resources (SRH), the importance of which reflects not only the climatic conditions of agricultural production in Mexico and the inevitable emphasis on irrigation, but also the technical and administrative competence of its staff. The Department of Agriculture and Colonization (DAAC) like most other non-engineering agencies has been handicapped by shortage of staff aid expertise but the effective- ness of CONASUPO, the public marketing and price regulating agency for agricultural products is now improving. Besides these institutions, more than one hundred other agencies are also engaged in agriculture, the most important being the national sugar, cotton, and coffee commissions. 128. As part of the overall program of institutional development, the Government has recently taken energetic measures to bolster the assist- ance and service agencies, to improve inter-agency coordination, and to clarify their responsibilities. Programming departments have been established in a number of agencies in order to improve the quality of pre-investment studies and of project preparation, and to facilitate longer-term planning. The attempt to transform SAG and DAAC into more effective institutions could be crucial for the future development of the sector.  - 59 - - Agrarian Reform 129. A new, development-oriented Agrarian Reform Law was enacted in 1971, only a few weeks after the present administration took office. Its main objective is the transformation of the ejido 1/ into an efficient production unit, and focuses on the integral development of ejido resources; it refers to small scale industries, handicrafts, mining and tourism, as well as agriculture. Ejidos have been granted juridica. status and can now contract on the same basis as other enterprises. The genetU assembly of the ejido, which may now enforce the implementation of economic programs through majority votes, is however intended to become an informal planning body rather than a mere forum for the discussion of legal conflicts. The law also aims to promote the democratization of ejidos, the basic organization of which remains unchanged, whereas the functions and responsibilities of ejido officials are now defined in detail. Elections must be by secret ballot and terms of office are limited to three years, with one re-election. 130. To improve planning and decision making in the rural sector, the existing National Agrarian Register will be expanded into a complete catalogue of private rural properties, communities and ejidos. The new law establishes deadlines for completion of the various steps involved in land redistribution, and transfers the power to resolve disputes on agrarian rights and assets to state agrarian commissions and places greater restrictions on the expropriation of ejido or communal land. The maximum farm size remains unchanged at 100 hectares irrigated equivalent but in order to prevent further fragmentation, the minimum size of a redistributed unit has been raised to 10 hectares irrigated equivalent. 131. The new law thus remedies an important deficiency of the previous Agrarian Code by preventing the common practice of subdividing large estates into smaller units which were often owned and operated jointly by single families. Unless it can be shown that the smaller units are independently managed, fragmentation is no longer a basis for exemption from expropriation. On the other hand, the law provides for new certificates of inaffectability for combined livestock/crop production units which will be exempt even if subsequent land improvements by the owner increases the carrying capacity to more than 500 head (the maximum permissible size of livestock holdings according to the law). 2/ Since the fear of expropriation is considered to be the reason for the excessively extensive nature of livestock operations, these certificates should facilitate the rapid growth of anirnal production. Major responsibility for the implementation of the new Code rests with the Department of Agriculture and Colonization (DAAC) which in the past has 1/ See Volume II, para 48. 2/ The Agrarian Reform Law is in fact ambiguous because Article 249 restricts the maxiilnm size of livestock production units to 500 head of cattle, whereas Article 250 indicates that the maxmimn farm size for livestock is 400 hectares of natural pasture - or 800 hectares in arid zones.  - 60 - been mainly concerned with the legal and administrative problems of land expropriation and redistribution, but is now emerging as a more powerful agency. To facilitate compliance with its new responsibilities, DAAC has been reorganized and decentralized into three divisions which are respectively concerned with (i) e.jido organization and development; (ii) agrarian affairs, and (iii) colonization. 132. The main emphasis will be on economic programs designed to improve ejido incomes. Since most ejidatarios have in the past had little if any contact with the Government, radio programs, correspondence courses and regional training centers are now being operated to acquaint some of them with their new rights and responsibilities and to ensure that the new measures are not frustrated by local interests. DAAC will also prepare integrated development plans and projects, organize training courses to prepare ejidatarios for activities proposed in the plan, and provide technical assistance in production and organization. 133. While the division which is responsible for ejido development and organization is clearly the principal instrument for implementing DAAC policy, the other divisions also have important functions. The provision of definitive land titles for ejidatarios and private farmers is a necessary condition of effective land and water- use. So too are colonization schemes to achieve a more balanced spatial distribution of population and resources. 1/ 134. While there is obviously further scope for land redistribution, the Government has decided against a policy of reducing the size of large farms as a means of improving the productive capacity of small farmers, and it is intended to proceed with the rapid issue of certificates of owner- ship. This suggests that productivity increases will be emphasized. However, the Government's aim to complete the legal aspects of agrarian reform by 1976 would require the issue of definite land titles to all ejidatarios, comuneros and private landholders, and although budget alloc- ations for this purpose have been tripled since 1970, the target seems overly optimistic in the light of the administrative burden involved. 2/ 135. It is, moreover, debatable whether certificates of ownership for livestock farms should be issued at the intended speed, given that SAG and DAAC estimates of livestock carrying capacity in different ecological regions vary greatly. Since these estimates determine the maximum size of holdings, underestimation would result in the creation of larger farms 1/ See Volume II, para loo. 2/ In the absence of new fiscal measures, there might also be financial constraints.  - 61 - than are stipulated in the Agrarian Reform law which would moreover be protected against redistribution. In order to stimulate production without foreclosing the possibility of further redistribution, consideration should therefore be given to the publication of stocking rate estimates and of limiting certification for the time being to smaller farms. The publication of these estimates would give livestock farmers a more precise framework for investment planning while allowing time to determine official stocking rates (as opposed to actual yields). This is particularly important because little is known about the ground- water resources of large livestock farms - which could be developed after certificates had been issued. 136. As indicated in Volume II, 1/ the distribution of agricultural resources and rural population is severely imbalanced and as a measure of improvement, DAAC has begun a program of construction of new ejido centers in the sparsely populated south, transferring small farmers fran the Central Zone and providing them with housing, food, and technical assist- ance on resettlenent. - Irrigation 137. The Federal Water Law promulgated in 1972 seeks to rationalize water management by means of combining dispersed legislation under one heading and making it more compatible with actual needs. The law defines property rights, establishes priorities, provides for an organizational framework for water-use management, and authorizes the Ministry of Hydraulic Resources (SRH) to plan, execute and operate all water projects in which there is public participation. 138. The use of water for agricultural purposes is second in importance only to that for domestic and industrial use. 2/ SRH programs for the introduction of modern farming and irrigation techniques, extension services and credit facilities have been established, and cooperative farming is being encouraged in irrigation districts. The most important feature of the law is the size limitation on private (or ejido) farms in newly developed irrigation and drainage districts at a maximum of 20 hectares and a minimum of 10 hectares. These provisions should help to guarantee a more balanced distribution of the benefits of public irrigation programs and avoid excessive fragmentation. 1/ Volume II, para 100. 2/ In terms of priorities established under the Water Law rather than in terms of quantity - agricultural use actually accounts for some 80 percent of total water demand.  - 62 - 139. Public investment in irrigation has been primarily concentrated in the northern coastal regions, 1/ which now account for over 85 percent of the reservoir capacity which has been built up since 1940. But because: (a) further expansion in the north may be confronted by ph,s4--al lir4-ts to surface water availability, (b) there are serious social problems among smallholders in Central Mexico, where land pressure is particularly severe, and (c) demand for agricultural products is rapidly increasing, it seems likely that irrigation policy will require a new orientation. This would be primarily directed at: (i) the development of the southern river deltas, (ii) the achievement of greater efficiency in existing irrigation districts, (iii) the intensification of small scale irrigation and ground- water development schemes, and (iv) the development of supplementary irrigation for tropical agriculture. 140. Geographic Emphasis. The present Government is in fact shifting the emphasis cf bhe irrigation program away from the northern coast- al areas, although tentative SRH programs through 1976 include 380,000 hectares in the northwest (Sinaloa, Aguamilpa, Fuerte), the remainder consisting of 230,000 ha southeast of Mexico City (Panuco, Papaloapan), and 170,000 ha in the southwest (Balsas); the north would thus continue to receive a relatively important share of total resources. 141. The southern river deltas may, however, become major sources of agricultural production growth in the future. Their climatic and soil conditions differ markedly from those in the arid and semi-arid zones and the farmers are far less experienced in modern farming and marketing practices. 2/ The development of the deltas would therefore involve relatively fewer major const=tion works and require greater participation from agencies other than SRH thal have the irrigation districts which have already been developed. The role of SRH in the south would be further modified by comparison with its role elsewhere by a greater emphasis on drainage, flood control, soil conservation and supplementary irrigation. The SRH staff, who have achieved a high level of excellence in large dam construction, have had little opportunity to acquire the necessary expertise with which to meet this new challenge and this would, at least temporarily, imply a constraint. 142. Efficiency. Inter-irrigation district differences in yields and the low (