Mexico - Current economic position and prospects

RESTRICTED Report No. WH- 1 94a This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION CURRENT ECONOMIC POSITION AND PROSPECTS OF MEXICO December 1, 1969 Western Hemisphere Department  CURRENCY EQUIVALENTS US$1 12.50 pesos 1 peso (Mex.$) us$0.08 1 million pesos = US$80,000.00  TABLE OF CONTENTS PaRe Number MAP BASIC DATA SUMMARY AND CONCLUSIONS I. DEVELOPMENT STRATEGY AND ACHIEVEMENTS IN PERSPECTIVE The Climate for Economic Growth ........................ 1 Overall Growth Performance . Investment and Savings ............. 4 Agriculture .......... 5 Industry and Mining .. Tourism ................. ... 7 Public Utilities .. . . . 8 Tr&nsport ........ ... . . 8 Education and Public Health ......................... 8 Public Finances. 9 Public Sector Investment ................................ 10 Public Investment Financing ............................ 11 Credit, Prices and Capital Market ........ .............. 11 Bal.arce of Payments .................................. 13 II. DEVELOPMENT PROBLEMS AND STRATEGY FOR THE 70' s Introduction . .................................. 15 Agriculture ........... ....................... 16 Fishing .................................. 22 Industry .................................. 22 Forestry .................................. 23 Mining .................................. 24 Power .................................. 24 Transport ......... ......................... 25 Education and Public Health . ........................... 25 Population ........................... 26 III. OUTLOOK FOR PUBLIC FINANCE AND INVESTMENT Public Finances ....... ..................... 29 Public Investment: 1969-75 ............................ 30 Key Public Investment Sectors .......................... 33 Agriculture ............................ 33 Forestry ........................... 35 Industry ....... 35 Transport ....... 36 Power ....... 37 Tourism ....... 37  Page Number IV. BALANCE OF PAYMENTS PROSPECTS AND CREDITWORTHINESS The Current Account Deficit ............................ 39 Export Promotion ........... ................... 4o Tourism ............................. 42 External Capital Requirements .......................... 42 Creditworthiness .......... ................... 43 STATISTICAL APPENDIX I. Population and Employment II. National Accounts III. Balance of Payments and External Trade IV. External Debt V. Public Sector Finances VI. Monetary Statistics VII. Agricultural Statistics VIII. Statistics on Other Sectors IX. Prices and Wages This report is based on the findings of an economic mission to Mexico in April/May 1969 composed of Messrs. Murray Ross, Chief; N. Ingemar Ahlstrand, Investment Program Analyst; George I. Beier, Fiscal Economist; Jose A. Bronfman, Transport-Economist; Nicholas G. Carter, Quantitative Planning Economist; Harold L. Manning, Agricultural Specialist; Richard C. Manning, Agricultural Economist; Guy P. Pfeffermann, General Economist; Shigebaru Takahashi, Agricultural Economist; Bertil WLlstedt, Industrial Economist; Norman Nowak, Tax Administration Specialist (Consultant); Roy M. Pai-ra, Agricultural Economist (Consultant}.  I,:  BASIC DATA * Area l,73,000 so. khn. Population (1968) 47.3 million Density per sq. km. 2L Rate of growth p.a. 3. 4 percent 1967 1968 .i 69 GNP, current prices (Mex.$ billion) 301.4 334 3 27.) Per capita (US$) 528.0 566.o 5ti. Real growth (percent) 6.4 7.1 7.0 Percent of current ONP Gross Fixed Investment (including inventory accumulation) 19.9 20.0 20.0 Consumption 82.7 82.7 852.3 Balance of Payments Current Account Deficit 2.6 2.7 2.3 Gross Savings 17.3 17.3 1-7. Federal Government Revenues 7.5 7.9 7.5 GDP, 1950 constant prices (Mex.$ billion) 114.3 122.5 131.0 Sectorial Origin (percent): Agriculture, Forestry, Fisheries 15.8 15.3 - Mining 1.5 1.4 Petroleum 3.2 3.2 Manufacturing 26.5 27.0 .. Construction 3.9 4.0 0. Power 1.5 1.6 .. Transport and Communication 4.1 4.0 Government Services (including Defense) 2.7 2.6 *, Other (mostly services) 40.8 40.9 ... Money Supply (Mex.$ billion) Change in percent 8.0 13.0 Price Movements (Percent) GNP Deflator 4.1 3.5 Wholesale Price (Mexico City) 2.9 1.9 Cost of Living (Mexico City) 2.5 3.2 .. * 1969 Data Projected   1967 1968 1969 Public Finances (Mex.$ billion) Federal Current Revenues as percent of GDP 7.b 7.8 7.7 Curren" .Revenues 47.0 53.5 6C) 3 Current Expenditure 36-5 40,.2 L6.5 Current Account Surplus 10.5 13.3 13.8 Change in Percent (10.5) (26.7) (3.8) Non-Recurrent Revenues 0.1 0.3 0.X Surplus of Non-reporting Agencies 0.6 o.6 0.6 Capital Expenditure 19.0 21.2 23.a Financial Investment o.8 1.8 ?.1 Overal. Deficit 8.6 8*6 11 Balance of Payments (US$ million) Exports of Goods and Services 2,206 2,476 2;"'.'6 Imports of Goods and Services 2,923 3,297 351i Current Account Deficit - 61. - 748 - 760 Change in Percent T =80) T -2 T - 2 Medium and Long-term Capital Inflow (public) 676 728 7114 Mediuxi and Long-term Capital Outflow (Public) 395 465 Public Medium and Long-term Capital (Net) 281 263 286 Private Medium and Long-term Capital (Net) 130 260 3 0C Other Capital (Net) 181 -112 82 Errors and Omissions 165 460 1J45 Change in Reserves (- means increase) -40 -50 -25 Total Reserves at End of Period 621 701 726 (in months imports) 2) 7F2) ) Medium and Long-Term External Public Debt (US$ million) Total Outstanding (end of period) 2,648 3,O50 3,355 of which undisbursed 486 613 . Annual. Debt Service 620 526 601 Debt Service Ratio (percent) 28 22 22 IMF Position (US$ million) Quota 270 270 Drawings outstanding - - Relationship to Monetary or Customs Area Member of LAFTA   SUMMARY AND CONCLIJUSIONS 1. Mexico s econony has continued to expand at a remf&r,%xb.1e "ate (6-7 percent .x year), stimulated in the pas-t few years by a sharp .increC.ec in fixed investment, particularly in the public sector. A>.hougbl prices of selected cormodities have come under pressure in 1969, thc! -',z;e in the general price level in recent years has been quit.e moderate (about -4 ppr-@ cent a year). Since 1966, however, exoansion has been accompanied liy a relatively small, but stl 11 significant vide irg of the gap bef-een df-. - tic savings and investment and a doubling of the externed. defioi.: tn r)in.ren2. account. The rise in exports, which had previously been one oi' the ymos t dynamic elements in the econonmr, has flattened out, while impcarts (salf of which consist of investmen-t goods) have gone on increasing vtth the grc-vt"i of GDP. There has also been a fairly sharp increase in intezeis ;., dividencdc and other factor payments abroad. The resulting increase in external bor-, rowing has raised the total of Mexico's mediiLn- and long-ter7. debt fry- US$2.5 billion at the end of 1966 to an estimated US$3.3 bill ion s;%t end of 1969, and while the ratio of externa]. debt service to cur:;Tet a'>- count earnings has risen only slightly because of improv:,ven.uts in tb.< structure of the debt, it is still around 22 percent. At the same time there has been some increase in short-term liabilities, mainly to U.S. and Eurooean commercial banks. In addition to rolling over these liabi- lities, Mexico now has to make annual amortization payments on its medi.uM- and long-term debt of over US$450 million a year, so that the gross ex^- ternal borrowing of the public sector alone is around US$750 million a year and gross medium- and long-term capital inflows of all kinds in exces,n of US$1 billion a year. 2. Quite small changes in such aggregates as domestic savings and investments can have a relatively big impact on the balance of payments, and the Mexican economy is now so large (GDP around US$30 billion or approximately one-quarter of the gross product of all Latin Americe.) thai the absolute numbers are striking. According to preliminary official. statistics, the current account deficit has risen from US$340 million in 1966 to around US$750 million in 1969, and this has been associated with an incresse in gross fixed investment from 19 percent to Just over 20 percent of GDP, while the ratio of domestic savings to GDP has remained more or less constant at around 19 percent. The true current accoult de- ficit in the balance of payments is probably smaller than the above figures indicate, because there has been a large positive movement in "errors and omissions", which cannot be wholly attributable to the capital account. Nevertheless, Mexico is having to borrow abroad on a scale that is matched by very few other developing countries, and this must be a matter for con- cern when international capital markets are so tight. 3. The Mexican authorities recognize that, unless more is done to increase both domestic savings and exports, the growth of the econo,ny Wi1). be slowed doVn by a shortage of foreign exchange. However, with a change in the Administration impending twelve months from now, they have not, yet decided on a definite course of action, and this report indicates variovs alternatives open to them, with particular attention to steps that might be  - ii - taken to accelerate the growth of foreign exchange earnings, since it is the balance of payments which appears to be the overriding constraint. It should be emphasized that the projections in the report are those of the mission and not of the Mexican Government. What actually happens over the next five years will depend very largely on the decisions which the Government takes in the course of the next 18 months in such critical areas as public expenditure, taxation, import and export policies, tourist promotion, agriculture, rail transport and industry. Historically tran- sition years have often been associated with sharply stepped-up public expenditure and rapidly mounting external public sector indebtedness. T'he long-term prospects set out in this report are not unfavorable; they will not be realized, however, unless strict restraint is exercized in 1970 by the Federal Government and the decentralized public sector agen- cies. This is so because the balance of payments situation is serious and external public sector indebtedness already quite heavy. 4. Mounting internal pressures for more equal distribution of in- come and the general wage and salary increases to be granted during 1970 under the new labor law, make it all the more urgent that tax revenues should be stepped up. Extensive tax evasion has long been a weakness of the fiscal system in Mexico, and consideration could be given to strengthen- ing tax administration and enforcement by the introduction of computeriza- tion and modernized auditing, which might well raise tax revenues by as much as 20 percent over the next few years. In addition, there is scope for restricting the promotional and other expenditures which businesses are presently alloved to deduct for tax purposes. Meanvhile, a value- added tax, which was to have been introduced this year, is now due to replace the present sales taxes towards the end of 1970, and with improved administration this could increase the tax intake by a further 5 percent. According to the mission's projections, these various measures might raise the combined tax intake of the Federal Government and the Federal District (Mexico City) from just under 9 percent of GDP at present to nearly 11 percent in 1975 - still, of course, a very low level of taxation by com- parison with other countries, but low taxes in Mexico have traditionally been accompanied by a high rate of private savings, a substantial part of which has been tapped by the public sector through the banking system. 5. There is acknowledged to be considerable scope for further in- creasing public savings, as well as for economizing in the use of capital, through improvements in transport policies and planning. The annual gross deficit of the State railroads (i.e. the operating deficit plus provision for capital consumption) has increased steadily from the equivalent of around US$100 million in 1965 to nearly US$160 million today, and while freight services are relatively efficient, passenger services are losing money heavily. There is considerable room for improvement also in the operations of the Mexican ports which have given rise to widespread com- plaints amongst exporters about high costs and shiDning delays. More generally, while great progress has been made in the last 20 years in creating a modern transport system, the development of the different modes  of transrort has not oeen coordinated vithin the fr8inework o' *.A overall transport nolicy, and the variougs gencies involves tend to `heir own plans without suffc ient regard to national economic priodT'itiies It is particularly important now that greater emphasis should bo L!t'ern to expandcung the network of secondary and feeder roads, so as to iDteiotate the mass of the rural population more fully into the maTrkf e_ o e.W 6. Agricultural policies are of critical importance to thv J.ancc of payments, especially since about; three-quarters of Mcxi.cos s.orte still consist of agricultural end livestock products. There are Ma ntvitoer of steps which could be taken by the Mexican authorities to -.ncrease ther3 exports. For example, a cotton export agency could be set up to c:scrce.liALe policy and help in improving frm management, eradicati:.-g pests and d-:cs maintaining adequate quality standards and securing better watetl mAW;,-eent. The eu-bargo on exports of female cattle tso the United Sttet,es - *e Fer- manently lifted without prejudice to domestic meat surplie6. 1,r<.;.vterm agreements for the export of fruit., vegetables and meat d'ght be negr3tiated with the United States ifn order to minimnize yea.r-to-year f iuctuivt.Ions in.1 the norms prescribed by the United States Government. Various things could be done to increase supplies and reduce costs of farm. machineryj fertilizers and other agricultural inputs. Special efforts could be made to recapture Mexico's share of the United States shrimp market which has dropped since 1967 from 38 to 32 percent. A new approach could be adopted with respect to the development of Mexico's forest resources. Most of these questions are currently under study in Mexico, but concrete proposnlE, for government action have not yet been decided upon. It is particularly important that energetic steps be taken to bring about a recovery In pro- duction and exports of cotton which have suffered a serious set-back since 1966. 7. The export promotion effort will also depend to an important ex- tent on what is done to increase industrial efficiency and lower industrial costs. Manufacturing industries are less heavily protected in Mexico than in some other countries in Latin America, but effective protection is stil]. high, being provided partly through tariffs, partly through import restric- tions and partly through subsidies of one kind and another. In spite of this, Mexico is already exporting quite a wide range of manufactured goods on a small scale to the United States as well as to-LAFTA countries, and general policies aimed at making local industries more competitive can make a lot of difference to exports in the long run. The Bank of Mexico is examining the possibility of introducing a scheme under which medium- and long-term credit would be made available on special terms for the ito-- dernization and expansion of manufacturing industries with an export po- tential. If such a scheme proves feasible, it could be linked with mea- sures to raise productivity in the industries concerned and to overcome specific obstacles to the expansion of their exports (e.g. through im- proved marketing arrangements, better product design, quality control, etc.). 8. 'While the principal obstacles to the expansion of Mexico's mer- chandise exports are to be found at present on the side of swoply rather than demand, import restrictions imposed by other countrie.i present serious  - iv - difficulties in the case of some Products such as meat, tomatoes and cotton textiles. The United States market is, of course, particularly important to Mexico, and no other country in Latin American stands to gain so much from the new emphasis being given by the United States Administration to the trade aspect of HeTisphere relationships. 9. The mission's projections of merchandise exports, which have made no allowance for any relaxation of trade restrictions abroad, visua- lize an overall rate of growth of 4 percent a year between now and 1975. This would be in line with the trend over the past two or three years, but much below the rate of expansion achieved in earlier neriods. It is probably rather on the pessimistic side. A faster rate of growth in exports should certainly be attainable if export promotion is accepted by the Government and the private sector in Mexico as a task of the high- est national priority. Among other things, there can be considerable possibilities for the further development of "border industries". 'This is a matter for negotiation with the United States Govermment. 10. ilenever successful the Mexican Government is irs its policies for promoting merchandise exports, tourism remains the single most promising field for achieving a rapid increase in foreign exchange earnings in the years ehead. Gross foreign exchange reoeipts from touriam have been rising since 1960 at an average rate of 13 percent a year, but an even faster rate of growth is called for in future if the expansion in the economy is not to be held back by foreign exchange constraints. The mi4sion has in fact projected a rate of growth of 17 percent a year, which would raise earnings from their present level. of around US$500 million a year to US$1,280 mil- lion by 1975. If it is to achieve this target, the Government will have to take energetic action to break some of the existing bottlenecks to massive tourist expansion by creating the infrastructure required to open up new resort areas, by negotiating cheaper air fares and more charter flights for tourists travelling to Mexico and by encouraging the building of many more hotels catering especially to the less affluent visitors. The Mexican authorities are aware of the possibilities, but have been somewhat hesitant to accept all the implications of a mass tourist drive and have consequently been moving rather slowly in developing programs of public investment in this sector. 11. The mission has examined other ways in which the balance of pay- ments might be improved, so that a high rate of economic growth can be maintained without adding excessively to Mexico's external indebtedness. The ratio of merchandise imports to GDP has been falling gradually over the past ten years. The trend was temporarily reversed in 1968 because of abnormal imports of both capital goods and consumer goods, but the report assunes that the earlier trend will be resumed from now on, and it is important that it should be because there is little scope for com- pressing other items of overseas expenditure. Indeed, factor income pay- ments and expenditures by Mexicans travelling abroad must be expected to go on increasing fairly rapidly. The report therefore concludes that, on the assumption that the economy grows at the rate of 6 percent a year  (about the same as in the past), a 60 percent increase in foreign exchange earnings from merchandise exports and tourism combined will be needed between nov and 19T5 to prevent 1Mexico's external debt service ratio from rising above its present level of around 22 percent. Even thta vill only be vossible so long as the average terms of external borrowing continue to be favorable (in 1968 medium- and long-term loans obtained by the pub- lic sector in Mexico averaged T percent Interest, 2-1/2 years grace and 9-1/2 years maturity). 12. Gross external borrowing by the public sector is already running at around US$750 million a year, and what the renort envisages is a con- tinuation at this level, with year-to-year fluctuations mainly reflecting the variable amounts of amortization falling due. Net borroving rises above US$300 million a year in the early 197T'Os, but Is then projected to decline to US$250 million in 19T4 and US$200 million in 1975 as pub- lic savings increase. To satisfy its gross requirements of external ca- pital. Mexico will probably have to rely to an even greater extent than in the past on suppliers credits and project loans from international agen- cies, since the market for bond issues may continue to be rather limited. 'This makes it all the more important that project loans should include a substantial amount of local cost financing. The need for such financing arises in large part from the fact that more than half the gross inflow of funds into the public sector will be needed to provide for debt repay- ment. At the same time, the direct foreign exchange component of projects tends to be relatively low because Mexico produces for itself the majority of the capital goods it requires. 13. Mexico's impressive record over the past decade in combining a high rate of economic growth with the maintenance of internal and external financial stability has fully justified the support which the country has received from the international financial community. The continuance of this support will depend on Mexico's ability to find a satisfactory solu- tion to the problems of fiscal policy and balance of payments management outlined in this report. If energetic action is taken by the authorities to deal with these problems, it should be possible to avoid any serious slowing down in the rate of economic expansion. Some sacrifice of growth might, however, be necessary in the short run to safeguard Mexico's cre- dit standing abroad in the event that policies for the promotion of foreign exchange earnings from exports and tourism prove to be less suc- cessful than has been assfumed here. More emphasis would then need to be given to economizing in the use of foreign exchange by restraining the more import-intensive forms of consumption and investment.   I. DEVELOPMENT STRATEGY AND ACHIEVEMEMiT IN PE'RSPECTIVE The Climate for Economic Growth 1. Mexico's highly commendable growth and industrialization perform- ance during the last 20 years places it in the forefront of the developing world. The reasons underlying this successful evolution are many and com- plex, but a number of them stand out as crucial. Foremost, a far-reaching agrarian revolution that deeply modified the institutional framework waz successfully carried out and agrarian reform bjecame a main policy-objective of every government since 1910. The fact that a turbulent revolution and widespread land redistribution did not engender protracted economic chaos contributed decisively to the building up of a sense of national self-con- fidence and to the emergence of a spirit of creative economic nationalism. Foreign economic power was severely curtailed in key sectors, several basic industries were nationalized and foreign capital inflows were restricted by "mexicanization" policies. This was also accompished without impni.-g economic growth because a dynamic indigenous entrepreneurial chass developed in all branches of the economy and the public sector emerged as an aggres- sive force deeply committed to the growth process. The exceptional political stabiliTy and continuity of purpose born of the 1910 revolution have been of paramount importance throughout this period. In many ways, Mexico has coped successfully with some of the most difficult challenges that face & great many developing countries today: it found enduring political stability in the wake of an agrarian revolution, it struck a workable balance between public and private sectors, and it delineated the respective realms of domestic and foreign investment with realism and flexibility. All these factors contributed to establishing an atmosphere of confidence propitious to economic growth and social development. 2. The relationship established between the private and the public sectors has been among the most important aspects of Mexico's long-term development strategy. Already by the end of the 1930's the division of relative spheres between the two sectors had been largely delineated. The private sector was encouraged to play a leading role in economic development but its activities were to be circumscribed and subordinated to the over- riding considerations of overall governmental objectives. The public sector preempted some crucial development functions both in the form of broad eco- nomic policy formulation and incentives for the economy as a whole and by means of direct participation in economic activities e.g. power and petro- leum. After testing various alternatives, government development policies settled upon growth with price stability. Both political and institutional factors have favored this policy through continuity of management in the Ministry of Finance and the Central Bank. Bolstered by a strong and imagina- tive Central Bank, skillful coordination between monetary and fiscal policies was instituted and exchange rate stability has been maintained for nearly 15 years. This contributed to creating a climate of confidence at home and abroad. The Central Bank has exercised power over credit regulation as well as over its allocation between private and public sectors. The favorable tax treatment and maintenance of high protective tariffs also contributed to the creation of a climate of confidence conducive to high savings and investment rates in the private sector. Public investment in infrastructure and public sector industries complemented and guided private efforts. Rep- resenting about one-third of total investment, public sector investment has  - 2 - played a crucial role in creating an adequate infrastructural basis. Gen- erally, economic policy has been pragmatic and flexible, exempt from ideo- logical dogmatism. Thus, while land reform was actively implemented in most parts of the country. the Government encouraged growth of large comimercial- type agricultural enterprises in the northern regions and elsewhere. Like- wise, while Stmexicanization" of foreign-owned industries was pursued, Mexico velcomed foreign capital in a variety of vital sectors of the economy. Favorable tax treatment and maintenance of high protective tariffs, import quotas or even complete exclusion of some imports, encouraged domestic and foreign private capital and contributed to quite impressive rates of indus- trialization. 3. The public sector a&e Cesa Int2uenced directly the pattern of economic growth. Because of early nationalizations, the entire petroleum and basic petrochemical industry is part of the public sector. Almost all the electric power system belongs to the public sector and some 40 percent of value added in transportation is generated by the public sector. The public sector also encompasses mining enterprises, manuracturing plants and such vital services as banking institutions, etc. On the whole, public sec- tor institutions have given a good account of themselves both in terms of management and financial results. Of all the major public economic enter- prises, only the railways experience heavy losses. This successful insti- tution-building aspect of Mexico's public sector development policy has been an estential reason for success. The Mexican public sector has attracted tome of the most talented personnel into its various institutions and enterprises. On the whole, these have been managed vith a high degree of professional competence and inmagination, and have often played the role of innovators, opening up new development paths to the Drivate sector. Institutiots such as OFF, PEMEX, NAFIN, and the several development funds of the Bank of Mexico, Justifiably acquired reputations as solid enterprises in Mexico and abroad. They have done much to attract ctpital and to improve allocative efficiency in critical areas of development, such as infrastruc- ture, agriculture and industry. The achievemuent of there objectives has not infrequently required the by-passing of inefficient organizations, e.g. in the field of agricultural credit, and the establishment of new institu- tions for implementing specific aeveiopment objeceties. 4. b8ecause of the pervasiveness of the public seetor and the respons- ibility of public investment for as much as one-third ot gross domestic in- vestment, allocation policies have a critical importance for the Mexican economy as a whole. Traditionally, there was no formal planning process in Mexico. Priorities were established pragmatically by each of the public entities without long-term guideliness or overall coordination. Until quite receatly priorities were reasonably clear. After World War II over half of total public sector investment was allocated to transportation. Railroads and roads were considerably improved during that period; at the same time, large-scale. irrigation proJects 'were undertaken. During the fifties' the main emphasis was on petroleum, petrochemical and power. The share of agricultural investment declined steadily. Later, as the complex- ity of the Mexican econony increased and basic needs had been satisfied, investment priorities became less obvious. Some efforts at long-term  - 3 - overall planning were made In the early 1960's, but actual public Invest- ment decisions continued to be decentralized and pragmatic. The sharp increase in public investment during 1964 -- a 40 percent jump over the preceding year -- came somewhat as a shock and prompted a recognition of the need for tighter control over public investment. Closer coordination between the public entities involved, and particularly among the Ministry of the Presidency, the Ministry of Finance and the Central Bank, was grad- ually established as a result. A major advance in this connection was the consolidation of over 20 decentralized public sector agencies, representing over 90 percent of public sector investment, in the federal budget. A new investment planning system was inaugurated in 1967 and it has become a part of Mexico's institutional framework. Under the new system, investment priorities are determined on an annual basis, loosely connected to longer- term forecasts. The Ministry of the Presidency has powers of coordination and control over all public sector investments and jointly with the Ministry of Finance formulates the annual public investment financing plpa. The new system remains pragmatic, is evolving slowly but solidly ax.A should further improve allocatlve efficiency. 5. The foregoing have been the basic ingredients of the climate for economic growth. Government policies succeeded in establishing a climate of confidence that oves much to political and institutional continuity and financial stability. The public sector contributed a great deal to stimulate economic growth by building up sound institutions in critical areas and by pursuing imaginative development policies, frequently opening up new avenues for private initiative. Fiscal, monetary and foreign trade policies suc- ceeded in keeping private savings and investment at high levels and in pro- moting rapid industrialization and agricultural development. Overall Growth Performance 6. During the past 15 years Mexico experienced a period of sustained economic growth at an average ainual rate of 6.5 percent in real terms, while population grew at a rate of 3.4 percent -- a very high rate by inter- national standards facing Mexican authorities with fast-growing demands for investment in social fields. Although policy objectives have never been formalized in an official long-term development plan, government consistently gave the highest priority to growth of production and maintenance of price stability over the current account of the balance of payments and regional disparities. The leading sector by its size and growth performance has been industry. Spurred by the growth of the domestic market and by a far reaching import-substitution policy the industrial sector has become the largest in Mexico, increasing its share of GDP to 27 percent. Power, construction, petroleum and petrochemicals all shared the dynamism of the manufacturing sector, evidencing a remarkable degree of coordination between public and private sector efforts; together, these sectors grew at an average annual rate of 8.5 percent between 1954 and 1968, a very satisfactory performance. Although agricultural growth has been slower (only slightly in excess of population growth) some important structural changes were effected: in particular, self-sufficiency in basic foodstuffs was achieved during the mid 1960's, largely as a result of massive irrigation investments in the  --4 - northern regions; and exports of agricultural and livestock products pro- gressed at a. relatively satisfactory pace. However, outside the irrigated regions agriculture progressed at a very sluggish rate; productivity and incomes of the bulk of the agricultural Dopulation have remained low, posing perhaps the most difficult troblem in Mexico todav. Investment and SavinEs 7. Setisfactory overall groath was possible because of high savings and investment rates. Since 1960 gross domestic investment averaged almost one-tifth of GDP, of Which about nine-tenths was financed by na- tional savings and the balance by capital inflows from abroad. Public sector investment represents about one-third of total investment. Public sector borroving amounted to over 40 percent of public sector investment. Aet external borrowing has remained at a high level, averaging about one- sixth of public sector investment Since 1960. Reliance of the public sector on borrowed resources has become very heavy and fiscal policies urgently require reorientation. A# far as the overall picture is concern- ed, the investment rate increased steadily since 1965 while the savings rate started lagging after 1966. In 1967 and 1968 the overall savings- investment Rap, vhich had been insignificant in 1965 and nonexistent in 1966, widened to US$200-251) millict per year. or nearly one percent of GDP This accounts for part of the serifous balance of payrrzts deterioration in 1967. 8. As the Mexican economy dtveloped, the pattern of investment changed. The respective share of the four largest recipients of invest- ment suggest the direction of chan"e (see Annex I, Table 7). Although manufacturing still receives the l1.rgest share of total investment, it declined from about 30 to 25 percebt since the mid-fifties. Conversely, as the tertiary sector developed, the share of investment in private services increased. Together manuracturing and private services absorb nearly half of total gross investment. As Mexico's transportation net- work improved, relatively smaller x,ortions were devoted to investment in that sector; since the mid-1950's transportation's share of investment fell from 14 to 12 percent of total investment. Agriculture is the fourth large- st investor; its shsre declined from 12.5 percent during the mid-1950's to 9.4 percent in 1965-1967, reflectihg slackening interest on the part of the private sector as well as of the Government. The share of mower increased from 6 to 8 percent, reflecting the high margina-l demand. Sccial investment showed the highest rates of increase; population pressure and rising demand for social services led the Governittent to increase social investment (urban and rural services, health, education, state and local governments) from 5.6 percent of total investment during the mid-1950's to about 9 percent in the mid-1960's. If population pressure continues to mount, the share of social investment is bound. to increase even further, diverting more re- sources frot directly productive investment. Among the sectors that have declined in their investment effort, mining is the most significant. Mining investment has remained static since the early 1950ts and its share has dipped from 0.7 percent of total investment in the mid-1950's to 0.2 in 1965-1967. The causes of this decline and what it portends for the Mexican economy ere examined elsewhere.  -5- Agriculture 9. Mexican agricultural policy during the last 15 years was almed at increasing output to reduce dependence on food imports. Massive irri- gation investments in the northern areas and price policies encouraging grain output were the main tools in this effort. These policies were successful in that the country became self-sufficient in grains towvrds the mid-1960's. Irrigation investments in the northern regions were com- plemented by the provision of other essential sacilities and incentives to a relatively small group of agricultural enterprises: credit, agricultural research, tax concessions, technical services, etc. Exports increased as a side-effect of the rise in output rather than as a result of export- promotion policies. 10. Price policies have had a decisive influence on the cost and growth of agricultural production. Prices for various products vere regu- lated pragmatically without a coordinated general framework. Sojme prices, like grains, were supported to encourage farmers to prtoduce. Other prices, like meat and milk products, vere subjected to ceilings to favor consumers. Still other prices, like those of fertilizers and agricultural machinery, were kept high through trade policies. Generally, subsidies were chanelled into agricultural products rather than into inputs. High cost of modern inputs and &rtificial support prices for grains discouraged the adoption of cost-saving methods of production. Likewise, official price policies are reputed to have frequently hampered the development of livestock and dairy production: price ceilings on output combined with high feed-grain costs discouraged growth of animal husbandry in relation to its potential. 11. Mexican policy-makers concentrated the application of investment resources and modern inputs in the large-scale northwest and northeast agricultural enterprises, thus deviating in this instance from the spirit of the agrarian revolution in order to stimulate output. Once the frontier of import-substitution in grains had been reached, in 1965, the growth in the value of crops produced slowed down to 2.4 percent annually despite rapidly rising physical volume of agricultural output. This occurred mainly because of a shift to lower valued crops, stimulated in part by government support policy and because of decline in some export prices. Thus, with achievement of self-sufficiency, one of the main justifications used in the past for concentrating scarce modern inputs in the northern regions no longer obtained. However, the need to push exports still mili- tates in favor of such concentration. 12. While the growth of agricultural output has been on the whole satisfactory, the beneficial effects on rural incomes and increased con- sumption of goods and services were confined to certain areas with an agricultural labor force of less than half a million. In contrast, little and only sporadic effort in the form of investment, credit, research, tech- nical services and modern inputs was applied to the traditional agricultural areas which support some 18 million Mexicans. With the failure of produc- tivity, output and purchasing power to advance satisfactorily in these areas, a significant potential market for goods and services could not be tapped and the benefits of low-cost mass production were not realized.  - 6 - Concentration of modern inputs to limited areas has also widened the gap between the modern and the traditional sectors in agriculture. It is only quite recently that the Government reoriented its thinking and prepered programs to help develop the poorer agricultural areas in which the bulk of the rural population lives. A maJor reorientation of agricultural policies seems in order to bring the bulk of the rural population further into the monetary economy and thereby broaden the domestic market. Industry and Mining 13. Mexican industrY has grown at a fast rate during the post-war period and has become the largest single sector in the economy. Growth was spurred by the expansion of domestic demand and by import-substitution. Industrial development shows the successful interrelation between dynamic entrepreneurs and a growth-oriented public sector. Economic infrastructure works carried out by the Glovernment and a high rate of public investment in basic industry (oil, petrochemicals, basic chemicals, iron and steel, gas) stimulated industry as a whole. Industrial development was also en- couraged by fiscal policy; capital. income is hardly taxed, favorable tax treatment is extended to corporations and evasion rates are reputed to be high. Furthermore, Government refrained from raising labor costs exces- sively through social legislation and wages have on the whole continued to rise in line with productivity. This policy has maintained the non-labor share in national income quite high. Perhaps the most important incen- tive to industrialize has taken the form of trade policy. Effective pro- tection on manufactured products is high. This was established during the early stages of industriaL growth. By now the limits to import-substitution have been largely reached in respect of consumers goods and closely approached in respect of intermediate and capital goods; for the latter, more than 80 percent of total supply is produced locally. The usefulness of "infant indus- try" protection therefore may be questioned on grounds of efficiency and production costs. The implications of the policy on agricultural prospects are discussed in detail in Chapter II. While Mexico's industrialization policies have been successful in terms of physical output, know-how and employment, they have prevented the establishment of a competitive climate and may have encouraged uneconomic investment allocation. This in turn is frequently reflected in high prices generally, a problem of international competitiveness and relatively poor quality standards associated with pro- duction for a "captive" market. This situation has hindered development of large-scale industrial exlports. The Mexican administration has become increasingly aware of this situation. 14. Mining, one of the oldest activities in Mexico, progressed at a very slow rate, by some 2.5 percent per year during the last 15 years. Mexican mines developed mainly for world markets under the impetus of foreign capital inflows. As domestic demand increased with industrialization a balance had to be struck between export promotlon -- minerals make up 15 percent of exports -- and long-term domestic requirements. Moreover, the nationalist ideology of the revolution evidently conflicted with foreign- controlled enclaves extracting non-reproducible resources. On the other hand, international firms have been often best suited to carry out produc- tion and marketing effectively. As a result, policy has been somewhat  - 7 - ambiguous. A "mexicanization" policy was carried out aiming at ultimate Mexican control of the sector. High production and export taxes were instituted which discriminated in favor of Mexican enterprises. However, this policy seems to have been enforced in a somewhat ambivalent manner, allowing possibilities for effective foreign management. The uncertainties surrounding mining have worked against vigorous expansion aud may present problems for domestic users of minerals as well as for exports. Tourism 15. Tourism has been one of the most successful and fastest growing sectors. The accession c' Acapulco to the ranks of the world's top holiday resorts and the success of the 1968 Olympic Games show the great ability of Mexican entrepreneurship in this field. Tourism is extremely important as a foreign exchange earner, because it helps offset part of the chronic trade deficit. Mexico enjoys a comparative advantage in tourism because of its location, climate, geography and culture; moreo'rer because of the advanced stage of economic development, the import content of tourism is very low by international standards. 16. Since 1960 the number of tourists increased from about 750,000 to nearly two million per year. U.S. tourists to Mexico City and Acaptlco make up the bulk of the tourist flow. Tourist expenditures increased at a rate of 13 percent per year, the fastest growing source of foreign exchange. Brilliant as this picture appears, some critical aspects must be pointed out. The rise in tourism expenditures lagged behind the Caribbean area and Hawaii. This seems to have been due less to lack of private sector initiative than to a late government awakening to the dynamic role it can perform in tourism. Limited infrastructure remains the main bottleneck to tourism development. Given adequate government initiative there is no reason why Mexico should not surpass the Caribbean region's 16-17 percent annual growth rate. 17. Moreover, net tourist receipts have increased at a moderate rate since 1960, about 9 percent per year. This is because Mexican tourist ex- penditures abroad have increased sharply, at over 20 percent per year. Should the present trends continue, Mexico's tourism surplus would disappear some ten years from now. The most effective way to avoid such a situation seems to be to plan for large-scale tourism. This requires a new approach. European examples show that given proper infrastructure and the vicinity of a high-income region, tourist flows can increase to several millions per year in a matter of a few years. The proximity to the United States and the remarkable ability of Mexican entrepreneurs to cope with the rising demand for tourism strongly suggest that present plans might be consider- ably broadened aild the pace of their implementation stepped up. So far the Government intends to develop a handful of additional tourist resorts along the Pacific coast and in Yucatan. Since tourism is the most promis- ing area from a balance of payments standpoint, and since the example of other countries suggests a much broader vision can lead to success, a change in vision may be required at this point. Instead of thinking in terms of some seven million tourists ten years from now, it might be beneficial to set a target of 10 to 15 million tourists by the end of the next decade.  Public Utilities 18. The power sector grew at a very fast rate since 1950, averaging about 9.6 percent per year. Installed capacity increased nearly fivefold since 1950 and the share of the public sector in total output increased from 75 to 90 percent. Electricity rates were unified in 1962 and since then the current account surplus of the public power sector averaged about 20 percent of its current revenues. Residential and commercial rates are 65 percent above average, industrial rates 30 percent below average and rural rates 37 percent below average. Industry absorbs slightly over half of total sales and its share is steadily increasing. Agricultural demand for power represents onlty 6 percent of total demand, and the share of agriculture in total demand has declined. Out of the 20 million rural Mexicans, electric power is available to 7 million, or to twice as many as in 1964. Transport 19. A good deal of progress has been achieved in the transportation field. During the 1940's over half of total public investment was allocated to railroads and roads. As a result, Mexico is ncw endowed with a modern road network of approximately 41,000 miles, when in 1940 it amounted to only about 6,ooo miles. Pe.ved roads accounted for 5,000 miles in 1940 and 25,000 in 1968. Though the length of the railroad network changed little since 1940 its quality has been considerably improved and the entire loco- motive fleet is now diesel-electric. The railroad system, however, still requires large financial subsidies from the government budget. The question is whether it is desirable to maintain cheap local services for use as a means of income redistribution, when alternative economically superior means of transportation could be used. Airport construction has also pro- ceeded expeditiously with the result that a modern airport system is in existence. 20. Past transport investment was carried out without a coordinated plan. In many instances new roads unnecessarily duplicated existing rail- road lines; there was more emphasis on connecting major urban centres at the risk of duplication than on providing transportation to the rural areas. While roads and railroads received a large share of investment, port facil- ities remained inadequate. It has become clear to the Government that an overall transport strategy must be developed, and that more attention must be devoted to rural feeder roads, to penetration roads and to ports. Education and Public Health 21. Mexico's school system has expanded at a fast rate during the last ten years. Primary school enrollment increased from 58 percent in 1958 to about TO percent in 1968, while the school-age population increased at about 3.8 percent per year. In spite of heavy public sector expenditures a great deal remains to be done. Between 1958 and 1968 the number of pri- mary schools increased from 30,800 to 42,700 and the teacher population from 95,200 to 167,900. This was achieved by increasing public expenditure  - 9 - on education from below 15 percent to about 25 percent of the federal bu&get. In spite of this effort, the number of pupils per teacher increased from 43 to 48 and about 30 percent of children aged 6 to 14 remain outside the scope of the educational system. Moreover, education expendittures focused largely on urban centers and the gap between rural and urban eduration msy well have widened in spite of rising expenditure. Considerable efforts have also been made in secondary and higher education. However, tremendous population pressure severely limits progress in all realms of education. 22. The situation in public health parallels that in eduention. Although expenditures rose considerably -- by 16.5 percent per year between 1961 and 1967 -- this sharp increase was a reflection of the very loi b&ce and only about one-half to one percent of GDP is devoted to publit healt' services. The number of doctors per inhabitant is still relatively !*ow (less than six doctors for 10,000 people in 1965) and the ratio actu&lly declined slightly from 1960 to 1965 in spite of an increased entry rave into the profession. Furthermore, the geographical distribution o" serv- ices is highly concentrated: whereas the Federal District has one doctor for 450 persons, the least well endowed district of CThiapas bas onl,y one. for 9,500 persons. Scarcity of doctors is matched by lack of hospital facilities. It appears that the private and the public sector have con- centrated hospital services in the same (urban) areas. Public Finances 23. The behavior of public finances reflects efforts made by the Mexican authorities to streamline and strengthen their tax system. Very important efforts were made between 1960 and 1965. In 1961, tex administra- tion Was improved, controls tightened and auditing procedures improved. In 1964, the tax system was simplified and the number of tax schedules reduced. TheBe efforts proved reasonably successful. From a very low base, federal revenues increased steadily by some 13 percent per year, raising their share in GDP from 7 percent in 1960 to slightly more than 8 percent in 1965. Particular efforts were made to increase the share of income tax. Nearly 60 percznt of the increase in federal revenues came from income taxes: personal income tax increased fastest, followed by business income tax. Row- ever, taxes from income on capital declined in absolute terms. Tax collection improvements did not affect the basic fiscal structure: tax coverage and the degree of progressivity hardly changed. In particular, agriculture remained largely outside the scope of taxation. In 1966 gross tax on agriculture represented only .013 percent of value added and contributed only about 2 percent to total tax revenues. Agriculture has remained virtually exempt from income tax. Likewise, income from interest and rent is very lightly taxed. Evasion rates remained very high, notably outside the Federal District. Policy was firmly embedded in the general strategy of promoting entrepreneur- ship, favoring private savings and re-investment. While efficiency in tax collection improved between 1960 and 1965, little progress toward greater equity was achieved. Tax reforms had little impact on the public sector's current surpluses because expenditures increased at a rapid rate; public sector savings remained at about 4 percent of GDP.  - 10 - 24. Taxation on enterprises was reduced in 1965, causing some loss of revenue in 1966. This was compensated by new fiscal measures; however, in spite of these efforts, federal revenues fell below 8 percent of GDP and total public sector savings below 4 percent. Evasion rates are still very high, capital revenue is very lightly taxed, and tax enforcement outside Mexico City can be greatly improved. This suggests a need for further im- proving the fifscal system. Unless tax revenues are stepped up, Mexico will have to rely increasingly on borrowed funds for financing public sector investment. There appears to be &aple scope for increasing the share of federal revenues in GDP without affecting private investment rates adversely. Also, because of the high overall income level attained, the time may have arrived to reexamine the basic structure of the tax system with a view to improving equity as well as efficiency. Public Sector Investment 25. or all the tools used by the Mexican authorities to develop and shape the economy according to policy goals, public investment has certain- ly bneer. aSoxg the most inrortant or.es. The overa11 Ehare of utblic irnvest- ient Sn GD2 hEE been kept fair-ly on3tEmr dartng the last 20 years, i. ha EmolultedI to 5 to 7 percent of GEDP -- stout one--tlird of gross iiowestic r.vestmenri. This relatively high level of putblic fnve3thent provinde a Etron- sMtF.t lxs to economic activity, ir year. of low TFrivate irLvestIent it als3 pertonmed anti-cyclical flmctiorn.s More importarct for the design of development than the overall leVel, the distribution of public investment has played an essential role. The present structure of the Mexican economy is to no small extent the consequence of decades of shifting public invest- ment priorities. 26. Transportation received the lion's share of public Investment during and after World War II; about half of total public sector investment went into roads and railroads, ports and airports. By now Mexico is endowed with an extensive modern transport system, although secondary and feeder roads, as well as ports, need further development. As a result, the share of public investment going into transportation gradually fell to about 20 percent. Industry, petroleum and power, the most dynamic growth sectors of the econony, received massive public investments through the 1950's and 1960's, once basic communications needs had been satisfied. Industry, pe- troleum and power's share grew slowly and reached about 40 percent in 1969. The trend in public investment in agriculture is of particular interest because of the relationship it bears to agricultural performance. Before 1950 agriculture received about 20 percent of public sector investment, and agricultural output grew at a. highly satisfactory pace. However, ae the top priority shifted to industry and power, publie investment in agriculture declined to about 8 percent of the total and agricultural output barely sur- passed population growth. It is only during the last few years that the share of agriculture picked up again to 23 percent. Lastly, the rise of the share of public investment resources allocated to health and education from about 5 percent in the mid-1950's to about 9 percent in the mid-1960's re- flects efforts at improvinlg social standards in the face of mounting popu- lation pressure.  PUBLIC SECTOR INVESTMENT FINANCING AND EXTERNAL DEBT AMORTIZATION, 1960-68 (BILLIONS OF MEXICAN PESOS) 30 3 0 } EQUALS GROSS EXTERNAL BORROWING Eli_ _ 25 25 20 20 I r5 190 19609216 9416 9616 9 I0 1960 1961 1962 1963 1964 1965 1966 16 I BRD -4533   Public Investment _'inancing 27. The pattern of public investment financing renfectis politicae. and. administrative change. During the early part of this decmde public sector investment increased at &L very fast rate -- nearly IN20 neraent per annum between 1961 and 1964. Despite vigorouv efforts at strengthenin. public finances, the current surplus of the public sector increased a-r, a rate only slightly under 9 percent per year in thce years. As a. result5 an increasing share of investment had to be financed throuigh bnrro,ing. In the course of three years, between 1961 and 1964., interal. borrowing more than trebled and net exterrial borrowing more thar, doubled. In 1.964 half of public sector investment vas finalnced from borrcived funds. The incoming administration was rightly alarmed at; this situation. it redt..e;d public investment from 8 to 6 percent of GDP in 1965. In 1966 public io- vestment increased only very slightly while public sector sa8vigs 2eiined somewhat. A serious disruption was to follow in 19Q', when p'-?c irnvect- tQent went up by over 30 percent while public sector sa-rings only increased by about 10 percent. The increase in the public sector savings-investment gap amounted to some US$300 million and was carried through 1968. Thi.s accounts largely for the marked increase in net external borrowing after 1966. 28. Reliance on external capital for public investment financing reached a peak in 1964, when 22 percent of investment was financed from net external borrowing. Between 1960 and 1964 about 17 percent of invest- ment was financed in this way. Since 1965 the share has averaged 10 per- cent. However, the rate of increase of gross external borrowing since 1965 exceeded that of the previous several years and, largely due to pressure of external public debt amortization requirements, poses a serlous problem. Since 1960 gross external borroring increased by about 11 percent annually but amortization requirements grew by over 13 percent per year. This means that Mexico will continue for some years to suffer the effects of heavy external borrowing in terms of levels of amortization requirements. A substantial and enduring increase in public sector savings is urgently required to arrest this growing dependence on uninterrupted access to very large gross capital inflows. Credit, Prices and Capital Market 29. Very close cooperation exists between the monetary and fiscal authorities. The Central Bank of Mexico has greater pover over credit regu- lation and its allocation between private and public sectors than in most countries. Monetary policies have been used mainly to maintain reasonable price stability and to shift to the public sector a high proportion of private savings for investment. The main policy instrument used to con- trol effective demand and resource allocation is a complex set of reserve requirements varying according to liabilities, types of lending institutions and to time. Up to 40 percent of marginal savings channeled into financial institutions are invested in government securities or sterilized in cash.  - 12 - The mechanics of the system indicate the power of the Central Bank: most marginal savings of private banks are withdrawn by the Central Bank and loanable funds are then returned to the commercial banks at the Central Banks' discretion. 30. Relative price stability was maintained through the exercise of sound monetary policy. Since 1960 yearly price increases averaged 3.6 percent, a good performance by international standards. Money supply in- creased by about 11 percent per year, or roughly at the same pace as GDP. During 1968 prices increased by 3.5 percent, and the Mexico City cost of living by about 3.2 percent. Although data is very scarce, it appears that real wages have not outstripped productivity in recent years. Recent wage agreements suggest that prices may increase at a slightly faster rate in 1969 than last year. A more detailed analysis of price trends is not meaningful because of inadequate data. Credit policy succeeded in main- taining prices relatively stable partly because it did not curb demand for imncrts appreciably. In 1968 consumer goods imports increased considerably. 31. The overall savings rate increased from about 16 to nearly 19 per- cent of MDP between 1960 and 1963, reflecting rising incomes, and increas- ing confidence In the currency. Liabilities of the banking system increased at a very fast rate, over 15 percent per year during the laist fei years. Part of the increase in savings channeled into the banking system is due to high interest rates paid on deposits. 1968 lending rates ranged from 12.25 percent for savings banks to 15.18 for deposit banks. Investment banks' lending rates averaged 13.09 percent in 1968. These high lending rates enabled the banks to offer high interest rates to depositors. In response to upward movements in interest rates abroad, domestic interest rates were further increased this year. 32. The structure of banking has changed radically during the last 15 years. Commercial banks used to dominate the scene; now they control only about 20 percent of liabilities. Mortgage banks expanded at a rate of about 25 percent per year, then slowed down, about five years ago, to a growth rate of 15 percent per year. The fastest growing financial insti- tutions are the financieras, or investment banks. Their growth rate during the last five years exceeded 30 percent per year. This is a result of economic development and government policy; the creation of investment certificates di- verted savings to the financieras. Structural change in banking is evii- denced by the growing share of medium- and long-term financing: 20 years ago, less than 10 percent of bank financing was over one year, now about 40 percent. 33. In spite of government efforts to stimulate productive investment credit, particularly for agriculture, the pattern of credit allocation changed little since 1960. The share of industry in total outstanding private sector balances has remained stable, around 60 percent, that of commerce around 25 percent. The share of agricultural credit decreased from 17 to 15 percent. The marginal share of agriculture is lower than its average share, suggesting difficulties in the way of channeling a larger share of resources into the rural sector by way of the private banking system without government- al assistance.  - 13 - 34. rThe structure of the Mexican eapital market suggests a marked preference on the part of the public for fixed income bonds as against variable income assets; in 1968,. 94 percent of registered stock exchange transactions were in fixed income assets. Although self-financing remains the major source of private investment, and while family-owed businesses are still the rule, a gradual shift toward public stock can be discerned in recent years. The Mexican stock market has emerged from its embryonic sts.e: since 1960 the total volume of transactions increased from 5.1 billion pesos to about 28 billion pesos. Balance of P&yments 35. Mexico's foreign trade increased at a slightly slower rate than GDP. Since 1960 imports of goods and nonfactor services (g.a.n.s.) 6talined from 12 to 9.5 percent of GDP because of import-substitution policies, while exports (g.a.n.s.) fell from 10.4 to 8.7 percent of GD?. On the whole, the balance of goods and nonfactor services showed remarkable stab.l3ity; imports exceeded exports annually by only some 3 percent between 1960 srLd l968. Imports included about 80 percent of nonconsumer goods. About. two- thirds of capital goods imports were financed by foreign credits or rein-- vestment of foreign firms. Mexico's import performance was reasonable on the whole and was not a major cause of disequilibrium. The weakest element in the balance of goods and nonfactor services has been commodity exports. They still depend overwhelmingly on agriculture (directly or indirectly in the form of processed agricultural goods). They increased quite satisfac- torily between 1960 and 1966 (averaging 8.3 percent growth per year), but dropped sharply in 1967, and failed to resume the pre-1967 level until now. Trade losses were largely offset by the fast rise in tourism and border trade earnings. Nonetheless, the 1967 drop forced the attention of policy- makers toward the vulnerability of commodity exports; the latter make up half of Mexico's total goods and nonfactor services export earnings. 36. Net outflows of factor income payments have more than trebled since 1960 and accounted for over 80 percent of the current account deficit. About 40 percent of the factor income payments abroad consist in transfers on direct private investment (profits and dividends); interest on public debt accounted for about one-quarter of factor income payments abroad. Thus, in 1967 commodity exports dropped and the current account deficit nearly doubled, requiring a drastic increase in external borrowing. Errors and omissions increased rapidly during the last four years, suggesting some underestimation of exports, overestimation of imports and unregistered net capital inflows. In spite of this margin of error the situation is very serious, and Mexican authorities have become increasingly aware of the need to push exports. 37. Because of its high international credit standing Mexico has been very successful in attracting large amounts of external capital to fill the current account deficit. Direct private foreign investment alone has averaged nearly US$100 million per year since 1967, excluding reinvest- ments. But public sector borrowing made up the bulk of total gross borrow- ing; the latter reached about US$1.2 billion in 1968 of which about US$730  - 14 - million was borrowing by the public sector. Between 1960 and 1968 Mexico's gross public sector external borrowing averaged nearly US$500 million per year. Net public sector external borrowing jumped up by some US$200 mil- lion in 1967, and remained at that high level in 1968, as a result of a widening gap between public sector savings and public investment. Mexico's external medium- and long-term public debt is one of the largest among de- veloping countries; it rose from US$850 million to US$3 billion since 1960, or from two-thirds of current nonfactor foreign exchange earnings to about 130 percent. In the face of these developments, Mexico undertook to "roll over" her external debts and "stretch out" maturities in the process. Par- ticular efforts were made to reduce the share of debts of less than five years' maturity. These efforts have been fairly successful in recent years: since 1965 the share of debts under five years dropped from about 23 to 19 percent of total debt outstanding. As a consequence of heavy reliance on external borrowing to close the public finance gap, Mexico's public exter- nal debt service obligations are very heavy. Debt service on the public and Dublicly guaranteed external debt amounted to about US$530 million in 1968 or about 22 percent of current foreign exchange earnings. Thus, Me- xico has achieved rapid growth in output and price stability at the cost of rising external indebtedness. Mexico's widening current account deficit and its mounting external debt all point to a need to strengthen efforts at increasing foreign exchange earnings, raise the level of public sector sav- Ings, and further improve the maturity structure of the public external debt.  II. DLVELOPMZ PROBLEM AND STRATEGY FOR THIE TOj Introduction 38. More than most developing countries, Mexican growth nits relied, predominantly on expansion of the domestic market; since 1954 about 70 percent of real per capita growth can be attributed to expandiug dn_M-atic effective demand. The irnnonsnce of the domestic market v1: increase further as additional itport-substitutton becomes more difficult to a- chieve. During the 1950s the growth of domestic effective demsnd ac- counted for about 60 percent of GDP per capita growth; since t'aen it ac- counted for nearly 85 percent. This has crucial implications for develxp- ment policy. The serious question now arises whether past strategr mltv not be modified to cope with this change ira the nature of the erovth pro- blenm. This zhapter examines the sectorsl implications of WxJir