metadata: authors: 0: author: Borrell,Brent William
count: Mexico
docna: 0: docna: The Mexican sugar industry : problems and prospects
docty: Policy Research Working Paper
subtopic: Climate Change and Agriculture,Crops and Crop Management Systems,Disability,Services & Transfers to Poor,International Trade and Trade Rules,Economic Assistance,Access of Poor to Social Services,Competitiveness and Competition Policy,Crime and Society
teratopic: Water Resources
abstracts: cdata!: The Mexican sugar industry operates
            under strict government controls. The sugar parastatal,
            AZUCAR, and other state agencies govern virturally all
            aspects of pricing and, until recently, AZUCAR controlled
            virtually all aspects of marketing.  The purpose of this
            study is to make transparent the main economic effects of
            existing sugar policies.  Three broad measures are used to
            estimate the resource misallocation effects of intervention:
            the nominal rate of protection, the effective rate of
            assistance and the net subsidy equivalent.  Theoretical
            arguments are also used to demonstrate other potential
            inefficiencies in resource use.  To estimate the effects of
            efficiency-improving policies, an economic model of Mexican
            production, demand, stock demand and cane-pricing
            arrangements is constructed.  This model is linked to a
            model of the world sugar market to evaluate the trade and
            other economic opportunities which should arise from policy reforms.
geo_reg_key: 119228,517191
repnme: repnme: The Mexican sugar industry : problems and prospects
display_title: The Mexican sugar industry :
            problems and prospects
listing_relative_url: /research/1991/02/700063/mexican-sugar-industry-problems-prospects
topicv3: Crop Production m1326627 174,Trade m1326924 698,Anticartel Enforcement m1326983 1743,Social Assistance m1327201 1466,Black Market m1439229 BLA-3388
publishtoextweb_dt: 2010-07-01T00:00:00Z
historic_topic: Water Resources
origu: Policy, Research & Ect Affairs
no_of_pages: 65
author_keys: 0: author_key: 428677
model_extractions: <!-- Start of picture text --> Pet, n_#-kan tnm li<br><!-- End of picture text --> <!-- Start of picture text --> ilulml<br><!-- End of picture text --> WPS 596 Ihis paper- a product of the Intemational Trade Division, Intemational Economics Department- is part of a larger effort in PRE to understand the implications for world commodity markets of changes in developing countries' trade policies and to assist developing countries in designing good trade and industry policies. Copies are available free from the World Bank, 1818 H Street NW, Washington DC 20433. Please contact Pauline Kokila, room S7-040, extension 33716 (60 pages).

The Mexican sugar industry has been subject to extensive government controls over land ownership, cultivation, harvesting, milling, marketing, distribution, and pricing. The many objectives of these intervendons include protecting producers and consumers from world price variability, ensuring self-sufficiency, guaranteeing employment and social welfare, providing cheap milling services, and protecting domestic soft drink manufacturers.

Borrell's calculations show that although the interventions have helped stabilize industry rcturns to some degree, the estimated effective rate of assistance points to a high degree of resource distortion. In years when world prices were low, such as in 1985-88, the effective rate of assistance is estimated in the range of 70-390 percent.

econometric model of the Mexican sugar industry. This was linked to a global model of the world sugar industry. Stochastic simulations projecdng the Mexican sugar industry under these policies show consumption increasing faster than production and Mexico increasing its sugar imports. It appears unlikely that under such policies Mexico would return to being an exporter of sugar.

in simulations of a sugar industry operating under essentially free trade conditions, Mexico becomes a significant sugar exporter. Production, trade, and stocks are more variable, and consumption growth is curtailed. But welfare in the economy ac a whole would be increased substantially. The main beneficiaries would be sugar producers, and the losers consumers - but the loss to consumers would average less than US$3.20 per person per year.

To analyze the impact of changes in Mexican sugar policies, Borrell constructed an The PRE Working Paper Series disseminates the findings of work under way in the Bank's Policy, Research, and External Affairs Complex. Anobjective of the series is to getthese findings out quickly, even if presentations are less than fully polished. The findings, interpretations, and conclusions in these papers do not necess . ly represent official Bank policy.

Produced by the PRE Dissemination Centcr
# The Mexican Sugar Industry Problems and Prospects

by Brent Borrell

# Table of Contents

I. Introduction 1 I. Background 3 The Structure of the Industry 3 (i) Production 3 (ii) Consumption 6 Government Intervention in the Sugar Industry 7 III. The Economic Effects of Intervention 11 The Static Costs of Existing Price-Fixing Arrangements 11 The Effective Level of Assistance 14 The Effects of Intervention on Industry Costs 17 Overall Assessment of Economic Costs of Existing Policies 19 Recent Changes to Regulations and Controls 22 IV. Prospects for the Mexican Sugar Industry Under Different Policies 23 Illustration of the Effects of a Continuation of Existing Policies to 2004 23 The Effects of a Change to Free Trade 29 The Effects of a Guaranteed Minimum Price Scheme 35 Discussion of Simulation Results 36 V. Conclusions and Recommendations 37 Suggestions for Policy Reform 38 References 40 Appendix 1: The Nature of the Present Cost Burdens 41 Appendix 2: Model Specification, Estimation, and Limitations 52
# I. INTRODUCTIO*

1. The Mexican sugar industry operates<sup>under strict government</sup> controls. The sugar parastatal, AZUCAR, and other statt agencies<sup>govern</sup> virtually all aspects of pricing<sup>and, until recently, AZUCAR controlled</sup> virtually all aspects of marketing.<sup>State agencies also affect the</sup> cultivation and milling of cane and influence the operations of the sweetenerusing sector. Market forces appear<sup>to play only a minor role in the</sup> allocation of resources within the industry and between the industry and the rest of the economy. On theoretical ground,, and based on empirical evidence from other countries, there is a strong prima facie case for<sup>believing</sup> that the economic performance of the industry is highly constrained as a result of the interventions and that these imoOse significant costs on the wider economy.

2. The purpose of this study is to make<sup>transparen</sup><sup>**t**he main economic</sup> effects of existing sugar policies. Three broad measures are used to estimate the resource misallocation effects of intervention: the nominal rate of protection, the effective rate of assistance and the net subsidy equivalent. Theoretical arguments are also used<sup>to demonstrate other potential</sup> inefficiencies in resource use. To estimate the<sup>effects of efficiency-</sup> improving policies, an economic model of Mexican production, demand, stock

* Brent Borrell completed this study when he was employed as a<sup>long-term</sup> consultant with the International Commodity Markets Division; at the time he was on leave from the Australian Bureau of Agricultural and Resource Economics. Presently, Brent is Chief Market Economist with The Centre for International Economics in Canberra, Australia.
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demand and cane-pricing arrangements is constructed. This model is linked to a model of the world sugar market to evaluate the trade and other economic opportunities which should arise from policy reforms.

3. While the methods used to evaluate the<sup>current and potential</sup> performance of the industry have shortcomings, taken together they provide a broad indication of the costs and benefits of the different policies. Broad policy reccmmendations are made on the basis of the analytical results.
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# 1I. BACKGEOUND

# The Structure of the Industry

4. Mexico is a large producer and consumer of sugar in world terms but has switched from being a significant exporter to an importer during recent years; presently it is roughly self-sufficient in sugar. For the 20-year period to the mid-seventies, Mexico exported between 20X and 40% of its domestic production (see Table 1). Despite strong growth in sugar consumption, export performance was largely maintained due to reasonably steady advances in production. However, during the oil boom years from 1975 to 1982, production stagnated. Consumption, meanwhile, continued to increase strongly. From 1977 to 1986, Mexico was mostly a net importer of sugar. Only recently has Mexico returned to the world market as an exporter.

5. Production growth resumed after 1982, following policy changes (the :canero decree of 1979) which were intended to maintain real cane prices in the face of spiraling inflation. In 1987 and 1988, sizable quantities of sugar were exported, albeit due to some extent to a rundown in stocks. For 1989, net exports are estimated to be small and for 1990 imports will likely be necessary to meet the growth in consumption and a shortfall in production.

# (i) Production

6. Production is widely dispersed throughout 9 main geographical regions and 14 states (see Table 2). There are 70 sugar mills employing about 40,000
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Table 1: luppiy-Deamnd Balance Sheet for Mexican Sugar

||Production|Consumption|Net<br>Exports|End-Year<br>Stocks|Exports/<br>Production|
|---|---|---|---|---|---|
||-----------|---------<br>('000 to|ns)--------|------------||
|1960|1,530|1,121|462|404|0.30|
|1961|1,487|1,156|586|149|0.39|
|1962|<br>1,531|1,249|365|66|0.23|
|1963|1,735|1,312|393|96|0.22|
|1964|1,933|1,424|491|114|0.25|
|1965|2,107|1,478|555|201|0.26|
|1966|<br>2,266|1,555|513|399|0.22|
|1967|<br>2,412|1,650|572|589|0.23|
|1968|2,338|1,767|676|482|0.28|
|1969|2,564|1,875|625|554|0.24|
|1970|2,402|1,992|612|351|0.25|
|1971|<br>2,489|<br>1,920|551|369|0.22|
|1972|2,587|2,075|598|282|0.23|
|1973|<br>2,810|<br>2.298|586|207|0.20|
|1974|2,838|2,344|496|206|0.17|
|1975|2,636|2,526|217|1on|0.08|
|1976|2,710|2,675|13|121|0|
|1977|2,790|2,677|0|234|0|
|1978|<br>3,131|<br>2,934|74|363|0.02|
|1979|3,095|3,059|30|506|0|
|1980|2,457|3,152|-760|650|-0.30|
|1981|<br>2,642|<br>3,261|-673|705|-0.25|
|1982|2,739|3,514|-522|452|-0.19|
|1983|<br>3,076|<br>3,241|-819|1,106|-0.26|
|1984|',308|3,343|-273|1,349|-0.08|
|1985|3,492|3,547|66|1,227|0.01|
|1986|<br>4,068|3,451|219|1,625|0.05|
|1987|4,060|3,657|518|1,510|0.12|
|1988|3,908|4,070|1,014|334|0.25|

SourceS International Sugar Organization, London.
# Table 28 Mexican Sugar Procaction, by Region and State

|Region|state|1985 Sugar P<br>(Base estan<br>Private Mills|roduction<br>dar, tons)<br>Public Mills|
|---|---|---|---|
|Alto Veracruz|Veracruz<br>Oaxaca|326,214|418,516|
|Bajo Veracruz|Veracruz||422,014|
|Balsam|Michoacan||143,655|
|Centro|Morelos<br>Puebla||280,179|
|**Huastecas**|San Luis Potosi<br>Veracruz<br>Tamaulipas|65,907|358,324|
|Noroeste|Sinaloa<br>**Nayarit**|**46,822**|312,593|
|Occident.|Jalisco<br>Colima|107,837|401,402|
|Pacifico Sur|Oaxaca<br>Chiapas||144,388|
|Sureste|Tabasco<br>Quintana Roo|39,611|158,464|

Source: Latin America & Caribbean Country Department II, Agriculture Operations Division, World Bank.
-6-

workers and around 130,000 cane suppliers and 90,000 cara eutters. Average sugar production per mill, is around 50,000 tons per year, which is roughly equivalent to the average in Cuba but only about one-half the Brazilian average. Cane production is predominantly small-scale. The average area of cane harvested per supplier is 4.3 hectares. Most cane is harvested by hand, compared to Cuba and Brazil, where over one-half of the cane is mechanically harvested. About 40% of cane area is irrigated. Cane is usually grown in an eight-year cycle and is not grown in rotation with other crops. Other crops could be grown on cane lands; the two most likely are maize and beans.

7. Mills generally produce one or two of three grades of sugar: raw, estandar (mill white) and retined. About 16X of sugar output is in raw form, a little less than 35% is refined and the remainder (about 50X) is estandar. By-products include molasses, bagasse and a small amount of alcohol. About 25% of the bagasse (the cane fiber) is used as pulp in paper making (paper sales make up only a minor proportion of mill revenues). The remainder is burned as fuel in the mills.

# (ii) Consumption

8. Over the past decade the annual growth in consumption has averaged a little over 3%. Mostly this reflects Mexico's strong population growth; but relatively strong growth in disposable incomes during the late 1970s and early 1980s also stimulated growth. By international standards, pei capita consumption is high at around 40 kg. About 50% of sugar consumption is in the form of processed focts with the remainder being consumed directly. In 1988,
- 7 -

56Z of sugar purchased by the food-processing sector was used in soft drinks. Alternative sweeteners hold a very small share of the Mexican sweetener market.

# Government Intervention in the Sugar Industry

9. Government intervention is pervasive. It almost completely eliminates the normal workings of commercial markets in the allocation of resources. O Legal restrictions on the sale and renting of land largely influence who can grow cane and greatly influence the scale of operation as well as the methods of production.

O Regulations governing the pricing and delivery terms for cane establish the incentives which affect the quality of cane, the proportion of sugar and molasses produced from the cane, the technology used in mills, the narvesting and milling season length, the utilization of mills, the cane ratooning pattern (i.e., the number of years the cane plant is harvested before being replanted), the scheduling of h'arvesting and mill delivery, and many cultivation practices.

o Government ownership of many of the l.sills and centralized control of milling operations greatly affect their output, technology, investment, location, size and level of employment.

o The monopoly acquisition and marketing powers of the sugar parastatal "AZUCAR" mean that patterns of storage, distribution, handling, exporting and importing are centrallv
- 8 -

controlled--though recently changes have been implem4nted which reduce AZUCAR's monopoly powers. o Price fixing, price discriminetion and trade barriers determine the volume and pattern of production, consumption, trade and stocks, as well as the availability and range of sugar products.

10. The objectives of Mexican sugar policies are not explicitly intended to circumvent the workings of commercial markets nor to impose a system of (virtual) central planning on the industry. Intervention has a very long history. It was introduced to protect the industry from the volatility of world prices as early as 1856 and maybe before then. At that time prices were fixed and imports were controlled. Current policLes are the result<sup>of a</sup> complex series of political and economic responses to ptoblems and unintended consequences of the initial controls; rather than a deliberate, internallyconsistent policy. For instance, fixed consumer and producer prices (introduced with the objective of protecting both groups) created an tnintended cost-price squeeze which left many mills insolvent. Government buy outs and ownership of mills were the result even though there was not a deliberate policy of nationalization.

11. The accumulation of ad hoc responses lef .n its wake a wide variety of implicit objectives rather than a prioritized set of consistent goals. Over the last two decades the main purposes of intervention appear to have been:
- 9 -

- To protect the cane-growing sector during intermittent periods of very low world prices and to tax it heavily during short periods of extremelv high world prices (see Figure 1).

- To provide a level of social welfare to cane suppliers and mill workers in excess of that generally available to other rural

- groups.

- O To retain the small-scale cane production system to maintain rural employment.

- 3 To ensure a continuing supply of cheap milling services to the cane-growing sector and to expand employment in mills, irrespective of the implicit tax on private sector mills in general and the direct bud.3etary costs of st bsidizing public mills.

- To shiels ronsumers from variability in world prices, providing v--y high subsidies at times and extracting relatively small taxes at others (see Figure 1).

- o To protect domestically-owned soft drink manufacturers from foreign-owned competition through discriminatory pricing.

- To maintain a high degree of self-sufficiency in sugar production, and to encourage production through the provision of subsidized inputs.
Figure 1: MEXICAN<sup>CANE AND DOMESTIC SUGAR PRICES AND WORLD SUGAR PRICES</sup> <!-- Start of picture text --> 60 -<br>50<br>40 -<br>30<br>10<br>66 67 6B 69 70 71 72 73 74 75 76 77 7B 79 50 B1 02 03 04 05 B5 07<br>CWIMC O<br>-I WORLD PRICB °? CONSUMEIBF PRICE<br><!-- End of picture text --> 0 CANE PRICE
- 11 -

# III. **THE** ECONOMIC EFFECTS OF **INTERVENTION**

12. The influence of some forms of government intervention are reasonably direct and are quantifiable in terms of their effects on industry returns. Examples include the domestic sugar pricing arrangements and the subsidies paid directly to the industry. Other forms of intervention create indirect effects by modifying the production or marketing environment. Such intervention may cause costs of production and marketing to be higher than otherwise and the extent to which they distort costs is not easily quantified. Examples of such interventions include the cane payment arrangements and the restrictions on the sale and renting of land. While the net effect of intervention is difficult to determine, it would seem that Mexico holds some comparative advantage in the production of sugar. The high degree of regulation, however, raises many questions about the appropriate size of the industry and about its efficiency in resource use.

# The Static Costs of Existing Price-Fixing Arrangements

13. Some of the economic costs of the Mexican price fixing arrangements can be illustrated through the use of a static partial equilibrium analysis, such as is represented in Figure 2. In Figure 2A, the situation of Mexican prices being initially above world prices is depicted, such as was the case between 1985 and 1988. In Figure 2B the opposite initial situation is depicted. In both initial situations, WP is the world price, PP is the producer price, and CP is the consumer price which is set at a discount to PP.
# Figure 2: PRICE AND WELFARE EFFECTS<sup>GIVEN CHANGESINMEXICAN SUGAR POLICIES</sup>

<!-- Start of picture text --> Figure 2A<br><!-- End of picture text --> <!-- Start of picture text --> cP~~~~~~~~s<br>Cp TIn<br>CPP<br>WP h~~~~~~~~~~~~~~~~~~~~~~~~~<br>L TI<br>c'j. C' J~otX j t O'<br><!-- End of picture text --> <!-- Start of picture text --> DD<br>TX<br>~~~L TX J J<br><!-- End of picture text -->
- 13 -

Mexican producers manufacture Q,<sup>and AZUCAR exports T (the rest-of-the-world</sup> imports T). On domestic sales, the<sup>government must pay the difference between</sup> PP and CP; in Figure 2A it also<sup>must pay the difference between PP and WP;</sup> while in Figure 2B it earns a rent<sup>(WP-PP).</sup> 14. The free trade case is also depicted<sup>in Figures 2A and 2B. In these</sup> cases the world price replaces PP<sup>and CP as the ruling Mexican sugar price.</sup> Output cuntracts from Q to Q' and C<sup>expand to C' in Figure 2A. Trade changes</sup> from T to TI--from subsidized exports<sup>to free market imports. In Figure 2B,</sup> output expands to Q' and consumption<sup>contracts to C', thus allowing for an</sup> expansion in exports--T to TX. Small<sup>changes in world price are shown to</sup> occur in both figures due to changes<sup>in world trade, (iP to iP').</sup> 15. In both Figures 2A and 2B, Mexican<sup>welfare is greater in the case of</sup> free trade than under the current<sup>pricing arrangements. 1/ The costs and</sup> benefits of the present policies<sup>to the various parties are represented in</sup> Figures 2A and 2B as follows:

- loss in consumer surplus: (b + c<sup>+e + f + g)</sup>

- gain in producer rents: (a + b + c)

- loss in Mexican government revenue:<sup>(a+c + d+f+h)</sup>

- net cost to Mexico: (d + e + 2f +<sup>g + h)</sup>

- gain to consumers in the rest of<sup>the world: (i + k)</sup>

- loss to producers in the rest of the<sup>world: (i+j)</sup>

- net loss to the rest of the world:<sup>(j-k)</sup>

- 1/ The measures on welfare change<sup>used are producer rent and consumer surplus</sup> (see Mishan, 1968, and Willig, 1976).
- 14 -

16. In Figure 2B the costs and benefits of the present policies are as follows:

- gain in consumer surplus: (a + b)

- loss in producer rents: (a + c + d + e)

- loss in Mexican government revenue: (b + g - d - f)

- net cost to Mexico: (c + e + g - f)

- loss to consumers in the rest of the world: (i + j)

- gain to producers in the rest of the world: (i)

- net loss to the rest of the world: (j)

# The Effective Level of Assistance

17. The nominal rate of assistance (NRA), the effective rate of assistance (ERA), and the net subsidy equivalent (NSE) are three measures used to make a broad assessment of the distortionary influence of intervention on an industry. Of the measures, the ERA is the most comprehensive. It takes account of the main direct effects of intervention on both input and output prices, and provides an indication of the net assistance to the industry's value adding activities. To the extent that the assistance enables an industry to command and use more resources than otherwise, the ERA indicates the inefficiencies arising from the misallocation of resources in production. Estimates of the three measures are given in Table 3.

18. In recent years the ERA has mostly been large and positive. This has arisen largely because world prices were very low during this period and well
- lIs -

Table 3: Effective Rate of Assistance to the<sup>Mexican Sugar Industry</sup>

||Unit|1989|1988|1987|1986|1985|
|---|---|---|---|---|---|---|
|lue of Output|PESOm|2,732,000|2,732,000|2,732,000|2,732,000|2,732,000|
|SS Total<br>Inputs<br> <br>|||||||
|o materials<br>In milling<br> <br>|PESOm<br>|171,500<br>|171,500<br>|171,500<br>210000|171,500<br>210000|171,500<br>210000|
|o depreciation<br>in milling<br>|PESOm|210,000|210,000|,|,|,|
|o materials<br>and deprecia-|||||||
|tion<br>in growing|PESOm<br>|343,000<br>|343,000<br>|343,000<br>|343,000<br>|343,000<br>|
|o materials<br>in marketing|PESOm|129,500|129,500|129,500|129,500|129,500|
|Valueadded|PESOm|2,075,764|2,075,764|2,075,764|2,075,764|2,075,764|
|PLUS Assistance to Value<br>|||||||
|Adding Factors<br>|||||1|100000|
|osugar sales subsidy|PESO.|100,000<br>|100,000<br>|100,000<br>|00,000<br>|,<br>|
|3mill<br>loss subsidy<br>|PESOm<br>|285,000<br>|285,000<br>|285,000<br>|285,000<br>88000|285,000<br>88000|
|oAZUCAR admin. cost sub|PESOm<br>|88,000<br>|88,000<br>|88,000<br>|,<br>|,<br>|
|3storage cost subsidy|PESOm|450,000|450,000|450,000|450,000|450,000|
|Assisted Value Added|PESOm|2,998,764|2,998,764|2,998,764|2,998,764|2,998,764|
|LESS Assistance to Outputs<br>|||||||
|odomestic pricing|PESOm|-740,245|31,365|656,640|802,975|1,172,890|
|LESS Assistance to Inputs|||||||
|ofertilizer<br>subsidy<br>|PESOm<br>|92,635<br>|92,635<br>|92,635<br>|92,635<br>2|92,635<br>200000|
|**o**fuel subsidy|PESOm|200,000|200,000|200,000|00,000|,|
|LESS Assistance to<br>||||||923000|
|Value Adding Factors|PESOm|923,000|923,000|923,000|923,000|,|
|,assisted<br>Value Added|PESOm|2,523,374|1,751,764|1,126,489|980,154|610,239|
|Net Subsidy Equivalent|PESO.|475,390|1,247,000|1,872,275|2,018,610|2,388,525|
|Effective<br>Rate Assistance|S|18.8394|71.1853|166.204|205.948|391.408|
|Nominal Rate Assistance|S|-21.318|1.16139|31.6398|41.6259|75.2281|

Source: AZUCAR

- Notes: (a) Data for 1989 have been used to calculate assisted value added in all years, as assisted value added information for 1988 and earlier are not available--this probably does not change<sup>much</sup> from year to year.

- (b) Assistance to output has been estimated for all years--this can change greatly from year<sup>to</sup> year as the wortd price changes.
16 -

-

below the fixed prices on the domestic market. As a result the nominal rate of assistance was very high. The rise of world prices in 1989 caused the NRA and the ERA to decline substantially. If prices continue to rise (above about USC15/lb) it is likely that the ERA will become negative. The world market is notoriously volatile and cyclical. Every six to nine years the world price has boomed and been sustained well above the 15C/lb mark for periods of two to three years. Although data are not available to make reliable estimates of the ERA for earlier periods, it appears (see Figure 1 which gives an indication of the nominal rate of protection which is similar to the nominal rate of assistance) that the ERA was probably large and negative in 1963-64, again in 1973-76, and also in 1980-81. It is also likely that the ERA was probably large and positive in the intervening periods, such as that between 1985 and 1988.

19. It would appear that the main influence of intervention has been to inject some degree of stability into industry returns. Nonetheless, whether the ERA is positive or negative, that it is large indicates intervention has potentially distorted resource use to a very high degree. Such distortions can impose heavy costs on the industry and on the wider economy.

20. For example, as a result of intervention, production, consumption and trade are distorted through time such that optimal adjustments to changing world market opportunities are not made. Further, deadweight losses are imposed on the wider economy through the raising of tax revenues to provide contingent assistance. While the high degree of regulation, which has stemmed from the granting of assistance, may protect some producers or consumers from
- 17 -

changing market conditions, it penalizes others who may be made to bear higher costs or who are prevented from pursuing profitable opportunities. Therefore, instability of the world market is, to some extent, swapped for the vagaries associated with the political decision-making processes. Thus, any gains in terms of reduced uncertainty arising as a result of intervention are not clear-cut. Uncertainty has probably increased since Mexico entered its period of high inflation after the initial oil boom in the mid-seventies. Since then real returns have been heavily influenced by political decisions to adjust nominally-fixed prices, milling subsidies and other instruments. These have not been adjusted regularly nor in a predictable fashion.

# The Effects of Intervention on Industry Costs

21. The nature of the economic costs of intervention to the sugar industry can be illustrated by reference to the same static partial equilibrium analysis presented in Figure 2. Removal of interventions which allow industry costs to fall can be represented as a rightwards shift in the supply curve. In Figure 3, the effects of such a shift from the situations depicted in Figure 2 are demonstrated. In all situations production would expand and producer rents would increase by the shaded areas, adding to Mexican welfare.

22. No aggregate measure of the extent of the cost burden is available. However, AZUCAR (1989) demonstrates that a number of realistic changes in growing, milling and marketing could lower total costs of production by about 20X (these are discussed in general below). The types of changes indicated
'igure 3: PRICE ANi LtLLFAKL EFFECTS OF A SifIFT I-<sup>**THE**SUPPLY CUMYE</sup> <!-- Start of picture text --> '~ Sm }ligure 3A<br>PP<br>C1l<br>T X 1<br>I I.<br>r i ipure<br>IT~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~<br>l.n t . _ _ _ _ 5 |-_ ~~~~~~~~~~~~~Dw<br>Ci'"t<br>'~~~~~~ _ _ _ , , =_ _ _ I. // _ _ _ = _ _ _,<br><!-- End of picture text -->
- 19 -

were chosen for illustrative purposes only arnd do not purport to represent optimal changes. Cost reductions in excess of 20% may therefore be attainable over the longer term.

# Overall Assessment of Economic Costs of Existing Policies

23. It would take considerable data and detailed analysis to estimate the net effects of intervention on industry costs. Nevertheless, from prima facie evidence presented in Appendix 1, it seems reasonable to conclude that intervention presently imposes sizable cost penalties on the industry and may have done so for many years.

24. Legal restrictions on the sale and rental of land, for instance:

- a. prevent efficient farmL s competing with less efficient farmers for resources;

- b. cause more intensive use of expensive non-land inputs,

- c. restrict farm amalgamation, restricting the rate of capitalization, mechanization and achievement of economies of scale on-farm;

- d. limit the rate at which progressive farmers can introduce higher-yielding varieties of cane and new technology.
# - 20 -

25. Regulations governing the pricing and delivery terms for cane distort the incentives for growers and millers to maximize efficiency of the industry as a whole. For example:

- a. payment for cane is not based on the sugar c.ontent of individual farmers' cane, causing efficient farmers to crosssubsidize inefficient farmers, which reduces output generally, and increases the cost of milling--there are scale effects of milling cane of high sugar content which are not achieved;

- b. premiums and discounts on the price of cane through the season are not set, which distorts incentives to adjust season length to its optimum--leading to inefficient use of available milling capacity;

- C. mills can pass losses of sugar in milling back to farmers and have incentives to maximize molasses producton instead of optimizing sugar output; therefore, inefficient mill practices can be sustained and industry profit is not maximized;

- d. mills cannot change cane prices to adjust cane supplies to levels that allow optimal use of existing capacity.

26. Government ownership of milling assets and centralized (bureaucratic) decision-making processes:

- a. means that the market for milling capital is not competitive, which probably protects inefficient management, distorts the
- 21 -

location, size and capacity utilization of mills, and restricts financing of new technologies;

- b. locks entrepreneurship out of the industry and restricts the adoption of modern management ideas and system,;

- c. lacks flexibility to solve practical problems quickly;

- d. places political constraints on the profit function which has

lead to overmanning and generous wage settlements.

27. Price fixing and trade barriers, as well as insulating the industry from world trade:

- a. protect inefficiencies in marketing

- b. differential pricing of sugar causes waste in the sugar-using sector, reducing the amount of sugar available for export

- c. consumer protection varies inversely to industry protection adding to the inefficient use of sugar and other sweeteners.

In general, centralized (bureaucratic and political) decision-making processes and isolationist trade policies d') not provide for efficient mechanisms for allocating resources, either within the industry or between the industry and the rest of the economy. Also, the costs of intervention have the potential to grow over time. Virtually isolated from the world market, the structure of the industry may well diverge further and further from the economic optimum. Then, too, it should be noted that despite the cost disabilities imposed and the lost opportunities for adjustment, over the long term the industry has managed to grow while receiving on average relatively low rates of assistance. The potential therefore for improving the performance nf the
- 22 -

industry and its contribution to the wider economy may be considerable.

# Recent Changes to Regulations and Controls

28. On November 15, 1989, the monopoly import and acquisition powers of AZUCAR were removed. The requirement that millers pay a 50% tax to market sugar outside the AZUCAR distribution system has been effectively nullified by the granting of a 100l rebate on any such taxes paid. And in place of import licenses which were previously usec to exclude private imports, a 10 ad valorem tariff now stands as the only barrier to free entry. However, controls on prices remain and AZUCAR's monopoly exporting rights are unchanged.

29. Presently, the fixed domestic consumer price is roughly in line with the import parity price of sugar. Under existing policies, controls on price will be difficult to maintain if the world price changes. If it falls, imports would enter the country quite freely and undercut .he fixed domestic prices. If it rises, there will be strong pressure for black market sales. The production shortfall in the domestic market in 1990 will cause a rise in import demand. However, imports will be unattractive unless they can be sold through the black market at prices equal to or in excess of the world price. The costs of attempting to maintain price controls may be very large. For example, the policing costs of preventing black market activity are likely to be great. And, although black market activities may help improve allocative efficiency in some ways, efficiency losses through "double handling" are also likely to be large.
- 23 -

# IV. **PROSPECTS FOR THE MEXICAN SUCAR INDUSTRY** UWDER **DIFFERMfT POLICIES**

30. An econometric model of the Mexican sugar market was developed to illustrate the effects of the continuation of existing policies and to analyze alternative policies. The model is documented in Appendix 2. The main features of the model are:

- production, consumption and stock demand are explicitly modeled;

- yield and area are separately modeled;

- trade (net exports) is modeled implicitly as a residual;

- the Mexican market is linked to a world market model (by Wong, Sturgiss and Borrell, 1989) through trade;

- the model includes dynamic linkages of market variables from one year to the next, so that the effects of policy can be observed through successive time periods;

- the world model includes the domestic markets and policies of the four largest importers and four largest exporters, plus a rest-of-the-world sector;

- the world model captures the volatility in the world market.

# Illustration of the Effects of a Continuation of Existing Policies to 2004

31. To project the broad direction of the Mexican market under existing policies, stochastic simulations using the linked Mexican-world model were
- 24 -

performed. Stochastic simulations are performed tc capture the volatility of the world market. The model was run 60 times over the period 1985 to 2004 with different shocks representing random elements affecting production (such as the weather) being applied in each year and in each simulacion. The results presented in Table 4 are the averages of the 60 simulations. For the world price, the averages tend to mask the high level of price variability likely to occur (see the range of prices forecast).

32. Because the results presented are the averages of 60 simulations, they represent the average impact under a wide rango of potential market conditions. Therefore, the results should be regarded as illustrative of the potential impact under various market conditions rather than forecast effects based on current market conditions. The forward simulations are performed based on information up until 1985. The simulations therefore do not, for instance, take account of the recent, and mostly unexpected, decline in Mexican production--caused, in part, by frost damag.

33. Also, most exogenous variables are set according to those given in Wong et al. (1989). So, for this and the reasons given above, the price projections given in Table 4 should not be regarded as World Bank forecasts. They do, however, represent the type of price behavior that can generally be expected in the world market.

34. Mexican cane prices, consumer prices, the percentage extraction of sugar, and the stocks-to-production ratio are exogenously determined and are set from 1988 onwards at average levels over the period 1967 to 1987. (Strong
- 25 -

Table **4:** Projections of Mexican Sugar Production, Consumption, Trade a d **World** Prices, 1985-2004 (Unchanged Policy Scenario)

|Year|Production|Consumption|Not Exports|Year-End<br>Stocks|<br>World Price|World Price<br>Sim. i a/|**Cane**Price|
|---|---|---|---|---|---|---|---|
||-<br>----|--<br>(illion|tons)-------|----------|------(1984 U|S¢/lb)------|(1180 pesos/ton)|
|1985|3.45|3.31|0.726|0.76|7.9|6.7|448|
|1986|3,75|3,44|0.248|0.83|6.6|5.1|483|
|1967|3.98|3.63|0.394|0.88|9,6|7.4|435|
|196|4.29|3.67|0.551|0.94|10.7|12.6|330|
|1989|4.00|3.80|0.26|0.88|15.1|14.4|350|
|990|3.94|3.94|0.016|0,87|15.5|18.6|393|
|1991|3.98|4.08|-0.108|0.88|12.8|1o.7|393|
|1992|4.01|4.23|-0.223|0.88|15.7|17.5|393|
|1993|4.25|4.38|-0.185|0.94|26.7|17.9|393|
|1994|4.63|4.54|-0.001|1.02|24.7|26.8|393|
|1995|4.70|4.71|-0.029|1.03|15.4|25.5|393|
|1996|4.77|4.88|-0.128|1.05|12.3|9.7|393|
|1997|4.88|5.07|-0,209|1.07|13.3|9.8|393|
|1998|4.98|5.25|-0,292|1.10|15.8|16.4|393|
|**1999**|**5.09**|5.45|-0.382|1.12|16.3|21.0|393|
|_2000_|5.19|5,65|-0.481|1,14|15,6|25.5|393|
|2(01|5.07|5,86|-0.761|1.12|20.8|24,2|393|
|_2002_|5.40|6.08|-0.753|1.19|23.7|22,6|393|
|2003|5.50|6,31|-0.83|1.21|19.9|30.6|393|
|2004|5.60|6.55|-0.964|1.23|17.3|25,4|393|
|Mean o|f 1200 observ|dtions|||15.8|||
|Coeffi|cient of Vaci|dtion|||0.45|||
|Range|Min-Max o! 60|simulations|||3.1-50.1|||
|Sof O|bservationsih|ithe Range|||8.8-21.8x67|||

- a/ Simulation I wd'. the first ot ilie 60 stochastic simulations and was included to illustrate a moro realistic variability of prices than is evident in the averages of all 60 simulations given in the preceding columns.
- 26 -

econometric evidence could not be found to establish significant behavioral equations for these four variables.) The sugar equivalent cane price was assumed to be 60% of the mill door sugar price (40% of the sugar price is fairly representative of the milling margin in other major cane producers: Australia, Brazil, Colombia, Mauritius, South Africa and Thailand, which range from 30% to 502). A margin of US¢1.7/lb was assumed between the mill door and consumer prices.

35. As argued earlier, there is no direct relationship between cane, mill door and consumer prices, and milling and marketing margins can move in arbitrary ways. Government subsidies can greatly distort such margins. No attempt has been made to account explicitly for such subsidies in the model. Supply is modeled as a function of the cane price only. So explicit determination of the subsidies is inconsequential to the assumed supply response (see Appendix 2). Nonetheless, attempts are made later to account for the welfare effects of such subsidies. For the baseline simulation it was assumed that the number of mills owned by government in 1987 continued unaltered into the future.

36. The most striking feature of Table 4 is the trend towards increased imports which rise to around 1 million tons by 2004. Consumption is projected to continue to grow strongly in line with population growth, and to a lesser extent, income growth. Production meanwhile is shown not to increase as rapidly. Stocks tend to increase in line with general growth in the domestic market. The world price is projected to average US¢5.8/lb over the whole period (which compares with the 38-year average world price up to 1984 of
- 27 -

15.1C/lb). The range of all stochastically simulated prices (1,200 in total) is large, from 3.1C/lb to 50.1C/lb. Two-thirds of the observations lie within the range 8.8C to 21.8C/lb, and the coefficient of variation is high at 0.45 (although it is less than the 38-year historical coefficient of variation of 0.71 which partly reflects structural changes in the market). The first of the 60 individual simulations is shown in column six to give an indication of the typical cyclical variability in price.

37. The projected annualized rate of growth in production is around 2.5%, which is slower than that achieved in the previous three decades. For consumption, the annualized growth rate is around 3.5%, which is a little stronger than for the previous decade. In line with the assumptions about exogenous variables given by Wong et al. for developing countries, annual population and income growth were set at 2.5% and 2%, respectively. To test the sensitivity of the resulto given in Table 4, the model was run a second time while assuming annual growth in disposable income averaged 1% only. The results are giver. in Table 5 where it can be seen that the growth in consumption has been trimmed and production is much the same; it is interesting to note a slight reduction in average world price arising from Mexico's reduced import demand.

38. Many un-ertainties surround the ouLlook for Mexican income and sugar industry growth rates. Nonetheless, based on the simulation results it would appear unlikely that Mexico will return to the world market as a significant exporter of sugar, at least while it retains its existing policies. Population and income growth are likely to cause consumption to outstrip
- 20 -

Table 5: ProJections of Mexican Sugar Production, Consumption, Trade and World Prices, 1985-2004 01% Incom Growth Scenario)

|||||Year-End||World Price||
|---|---|---|---|---|---|---|---|
|Year|Production|Consumption|Net Exports|<br>Stocks|World Price|<br>SiM. I|Cane Price|
||----------<br>|--------<br>...(Million|Tons)------|----------|- ------(1984|US*/lb)------|<br>(1980 pesos/ton|
|1985|3.45|3.30|0.74|0.76|7.90|6.90|448|
|1906|3.75|3.40|0.28|0.83|6.60|5.10|483|
|19i7<br>|3.98<br>|3.58|0.45|0.68|9.50|7.40|435|
|,',,a|4.29|3.60|0.63|0.94|10.60|12.50|330|
|Ag9|4.00|3.70|0.36|0.08|14.90|14.30|350|
|1990|3.94|3.81|0.14|0.87|15.30|18.40|393|
|1991|3.98|3.93|0.04|0.88|12.60|19.40|393|
|1992|4.01|4.05|-0.04|0.80|15.60|17.30|393|
|1993|4.25|4.17|0.03|0.94|26.30|17.70|393|
|1994|4.63|4.30|0.24|1.02|24.40|26.30|393|
|iM95|4.70|4.43|0.25|1.03|15.30|25.10|393|
|1996|4.l7|4.57|0.19|1.05|12.10|9.60|393|
|1997|4.88|4.71|0.15|1.07|13.00|9.60|393|
|199|4.98|4.85|0.11|1.10|15.30|15.90|393|
|1999|5.09|5.00|-0.21|1.12|15.80|20.30|393|
|2000|5.19|5.16|0.01|1.14|15.10|24.90|393|
|2001|5.07|5.31|-0.21|1.12|20.20|23.90|393|
|2002|5.40|5.48|-0.15|1.19|23.00|22.20|393|
|2003|5.50|5.65|-0.17|1.21|19.30|29.70|393|
|2004|5.60|5.82|-0.24|1.23|16.80|24.40|393|
|Mean o|f 1200 Observ|ations|||15.50|||
|Coeff|icient<br>of Vari|ation|||0.45|||
|Range<br>Sof O|Min-Max of 60<br>bservations in|simulations<br>the Range|||3.1-49.5<br>8.8-21.3-67|||

Source: IECC), World 8ank.
- 29 -

production and it is likely Mexico will increasingly need to rely on imports to satisfy consumption growth.

The Effects of a Change to Free Trade 39. Earlier it was argued that price fixing and isolationist trade policies restrict profitable opportunities to adjust production, consumption and trade. It was also argued that regulations and controls which have been spawned to support interventionist policies impose severe cost burdens on the industry. A scenario was set up to test the trade effects and to estimate the welfare impacts of a change to free trade.

40. To simulate free trade, world prices were transmitted to consumers and producers in place of regulated prices. The baseline assumed that cane growers received 60% of the millers' (f.o.b.) price. Consumers were assumed to pay the world raw price plus 1.7C/lb for transport, handling and marketing. The 1.7C/lb margin was set in line with the assumed margin of the baseline simulation, assuming free trade would not alter the efficiency of marketing. Some anecdotal evidence suggests free trade may result in reductions in marketing margins. Apparently, since November 15, 1989, when AZUCAR's monopoly acquisition powers were abolished, the cost of transporting sugar from Veracruz to Mexico City has been halved. Failure to take account of such effects will tend to bias downward the welfare gains from free trade.

41. For the free trade scenario, it was also assumed that the government sold all mills from 1989 onwards and that growers shortened their ratooning
- 30 -

length by two years--thus increasing the average yields of cane. In terms of the earlier discussion, such changes shift the supply curve rightwards. As discussed in the Appendix 2, and in line with earlier discussion, government ownership of mills and ratooning length are important factors affecting cane supply. Changes in these factors with a move to free trade are representative of the types of supply shifts likely to arise from easing of regulations and controls which presently underpin interventionist policies.

42. The results of the free trade scenario are given in Table 6. Compared to Table 5, production, trade and stocks are more variable and consumption is curtailed. Production is much higher with the result that import demand is eliminated and replaced by significant exports. By adding to world supplies, the average world price declines. The effect of these changes on the welfare of producers, consumers, the government and the Mexican economy in general are given in Table 7. In the case of welfare changes in producer rents, account is taken of the increase in growing cost likely to arise from reducing the number of ratoons and increasing the proportion of plant cane in the composition of harvested cane. Costs of growing plant cane are greater than for ratoon cane. From industry data it was estimated that reducing the number of ratoons by two would increase the production costs by about USCO.5/lb-which must be offset against the gains from the increase in yield.

43. The welfare measures in Table 7 were calculated in the manner discussed in Section III. For computational ease, the welfare effects (producer rents) of the supply shifts were calculated by solving for the equivalent cane price increase needed to induce a supply response equal to
- 31 -

Table 6: Projections of Mexican Sugar Production, Consumption, Trsde and World Prices, 1985-2004 (Free Trade Scenario)

|Year|Production|Consumption|Net Exports|World Price|Cane Price|
|---|---|---|---|---|---|
||-----------|-(Million Tons|)------------|(1984 USC/lb)|(1980<br>Pesos/Ton)|
|1985|3.42|3.31|0.71|7.62|280|
|1986|3.61|3.43|0.14|6.45|237|
|1987|3.66|3.50|0.16|9.72|357|
|1988|4.05|3.60|0.38|11.22|412|
|1989|4.61|3.66|0.83|14.48|532|
|1990|5.47|3.79|1.50|12.39|455|
|1991|6.11|3.94|2.03|9.37|344|
|1992|5.83|4.03|1.86|11.90|437|
|1993|5.83|4.02|1.81|21.94|806|
|1994|7.23|4.16|2.76|21.24|780|
|1995|9.03|4.41|4.22|12.52|460|
|1996|8.73|4.59|4.21|9.28|341|
|1997|6.92|4.71|2.60|10.29|378|
|1998|5.72|4.80|1.18|13.31|489|
|1999|5.79|4.92|0.85|14.46|531|
|2000|7.12|5.10|1.73|13.50|496|
|2001|8.01|5.23|2.59|16.88|620|
|2002|8.60|5.38|3.09|18.38|675|
|2003|8.90|5.57|3.25|15.55|571|
|2004|8.80|5.76|3.06|13.75|505|
|Mean of|1200 Observat|ions||13.60|485.30|
|Coeffici|ent of Variat|ion||0.44||
|Range Mi|n-Max of 60 s|imulations||3.2-42.6||
|Z of Obs|ervations in|the Range||8.0-18.6=67||

Source: IECCM, World Bank
- 32 -

Table 7: Welfare Effects of a Switch to Free Trade and Liberalization of Domestic Control.

|Year|Producer<br>Welfare|Consumer<br>Government<br>Welfare<br>Revenue*|Economic<br>Surplus|
|---|---|---|---|
||-----------|---------<br>(1984 US$ Millions)-----|---------------|
|1985|-199.70|214<br>179|193.30|
|1986|-336.79|310<br>185|158.21|
|1987|7.66|75<br>203|285.66|
|1988|177.36|-11<br>176|341.86|
|1989|619.18|-287<br>162|494.18|
|1990|531.70|-192<br>192|531.70|
|1991|99.65|62<br>202|363.65|
|1992|471.74|-161<br>190|500.74|
|1993|2,057.74|-1,083<br>162|1,136.74|
|1994|2,222.30|-1,012<br>233|1,443.30|
|1995|680.46|-170<br>235|745.46|
|1996|-35.23|162<br>239|365.77|
|1997|184.72|26<br>244|454.72|
|1998|809.95|-403<br>248|654.95|
|1999|1,097.18|-595<br>263|765.18|
|2000|946.52|-425<br>275|796.52|
|2001|1,403.71|-664<br>186|925.71|
|2002|1,666.20|-760<br>362|1,286.20|
|2003|1,294.90|-556<br>339|1,077.90|
|2004|1,112.00|-470<br>333|975.00|
|Mean|740.56|-314<br>230.40|656.96|
|Benefit per$||||
|of transfer to||||
|consumers|-2.35|1<br>-0.73|-2.09|

* From elimination of profits and losses of exports and imports and from the elimination of subsidies to mills.

Source: IECCO, World Bank.
- 33 -

that arising from the rightward shift in<sup>the supply curve. The welfare</sup> effects were then estimated in the fashion shown in Figure 2.

44. The government revenue saved includes<sup>both direct subsidies to</sup> government-operated mills and indirect subsidies through<sup>present pricing</sup> arrangements. In recent years these have been sizable,<sup>as shown in Table</sup> A1.2.Under free trade such subsidies would be eliminated. The subsidies basically represent transfer payments from<sup>the government to the milling</sup> sector. Producer rents **are** calculated<sup>net of these subsidies. For</sup> calculating welfare effects it was assumed that the<sup>average rate of indirect</sup> subsidy per ton applying in the past decade would continue. The difference in time period reflects the availability of data.

45. For the economy as a whole, welfare is increased substantially in all years with a move to free trade. The main beneficiaries are producers. Consumers, on the other hand, generally pay higher<sup>prices and so are net</sup> losers. Producer gains arise from higher<sup>average prices, from increased</sup> production, from timing production increases and decreases in line with the world market price cycle, and from implied<sup>reductions</sup> in costs given by rightward shifts in the supply curve. Government gains, which in effect are savings to taxpayers, arise from eliminating subsidies on exports. The welfare gains are seen to increase through time because under protectionist policies the structure of the domestic market diverges increasingly from what is optimal under free trade and so the gains<sup>from a switch to free trade</sup> increase. The benefits have not been discounted to net present value terms.
- 34 -

46. For individual consumers the net cost each year averages less than US$3.20 per person, although in some years the cost may be up to four times this amount. However, due to the very low price elasticity of demand for sugar (see Appendix 2), consumptior. is only mildly curtailed even at high prices. Therefore, the effect on the sugar-using industries is not likely to be large.

47. For individual producers the annual gains could be substantial. But calculating the average ,mpact is complicated. Substantially more land is estimated to come into production and so it is reasonable to assume new farmers may come into the industry. Others may leave and farms may be amalgamated. Nevertheless, the average annual gains would amount to around US$3,174. Also, assuming no change in the number of mills, annual average gains of around US$4.2 million per mill are simulated. Mill workers and cane cutters may share some of the simulated gains to mills and farmers. Although significantly higher on average, incomes would tend to be more highly variable, in line with world prices. Even the variability in changes in producer rents shown in Table 7 do not fully reflect the possible variability in incomes. Individual simulations of the model show considerably more variability. The variability in world prices is probably the best indicator of potential income variability. Ninety-five percent of simulated prices lie in the range USC5.1/lb to USC26.2/lb; 67% lie in the range 8¢ to 18.6C/lb; the complete range of simulated prices is 3.2C/lb to 42.6c/lb.

48. However, in a free market it is unlikely that the full variability in world price would be transmitted back to producers due to the use of futures markets. Other special (long-term contractual) arrangements between traders
- 35 -

and the industry could flourish in a free market. Vertical integration between mills and sugar users may also lead to more stable prices at the producer level. In a free market, producers' demands for risk spreading may spawn the use of a great variety of instruments and arrangements. The type and degree of risk spreading required is likely to vary among producers. The use of a number of different instruments will allow for optimal risk spreading.

49. Often, government-operated risk-spreading schemes have been favored over privately-operated schemes in volatile commodity markets. However, it is not clear that governments have a comparative advantage in providing such services. When governments operate such schemes they are usually designed to apply universally to all producers. In fact, such schemes may be totally unsuitable for many producers. Moreover, because such schemes apply universally, restrictions must be enforced which introduce new regulations and controls. The parameters of the instruments may also become politically determined. Through time, therefore, rent-seeking can alter the nature of the instrument as well as its effects.

# The Effects of a Guaranteed Minimum Price Scheme

50. To examine some of the immediate impacts of a government-operated, risk-reduction scheme for producers, a further scenario was simulated. The guaranteed price was assumed to decline in steps of USCl/lb each year from USC5/lb in 1990 to zero in 2005. Hence, the scheme is assumed to be transitory, designed to provide a cushion to protect producers for a limited period as they adjust to prices on the world market. It was assumed that
- 36 -

whenever the world price fell below the guaranteed level the government would **make** up the difference.

51. The average guaranteed price over the scheme's<sup>15-year life is</sup> 8C/lb. Over all 60 simulations the percentage of prices falling below BE/lb is around 16X. Averaged out over all years and 11 simulations, the annual expected payment by government under this scheme would be US$95 million. The average annual expected increase in producer<sup>rents would be US$93 million,</sup> arising from an average increase in production of 1.5Z (or 0.1 million tons) and an expected _3.2Z_ increase in producer prices. In any particular year, payouts to producers of over US$1 billion may need to be made.<sup>For this</sup> reason, if it is considered to be politically desirable to protect producers for a limited period **as** they adjust to prices<sup>on the world market, direct</sup> income support may have considerable advantages over price supports. Direct income support is not open-ended; it provides less distortionary price signals to producers; and it can be targeted to those groups most in need of support.

# Discussion of Simulation Results

52. It would appear from the results presented that the main effect of current policy is to subsidize sutgar consumption. If the objective of policy is to continue supplying cheap sugar, it appears that the policy will<sup>be</sup> highly inefficient. For every US$1 transferred to consumers US$2.09 will be lost from the economy (in terms of lost opportunities).<sup>It will cost the</sup> government an estimated US$0.73 and producers an estimated US$2.35 to provide that support (see Table 7).
- 37 -

# V. COUCLUUIOU8 ANl DCOSWIDATOOS

**53.** Based on the evidence presented in this paper, it appears that the parformance of the Mexican sugar indusLry falls well short of its economic potential. Isolationist trade policies and the plethora of regulatory controls that have evolved over many years to support them, greatly limit individual initiative and opportunity in the industry; they fail to provide efficient mechanisms for allocating resources, either within the industry or between the industry and the rest of the economy.

54. The objectives of the sugar policy are not clear-cut. Policy appears to have evolved over a long period in response to a variety of political and economic pressures. Accumulated ad hoc responses through time mean there is not an explicit set of consistent and prioritized objectives. The main effects of policy appears to be to stabilize prices to cane growers, to deliver health services to cane-growing families, to disguise rural underemployment by creating jobs in sugar mills, and to provide consumers with cheap sugar.

55. Achievement of these objectives appears to occur at very high costs. Despite some benefits accruing to producers, the policy on balance appears to impose a high cost on them. It also imposes high costs on taxpayers and the overall economy. The only net gainers appear to be consumers, but the efficiency of the transfer of support to consumers from producers and taxpayers is very low. It would seem that less costly means of providing the same benefits to consumers could be devised.
- 38 -

56. At minimum, an efficient Mexicrn sugar policy would need to embody the following:

- more efficient mechanisms for allocating resources;

- individual farmers and millers be given incentives to specialize and pursue geographic, managerial or other production, technological or marketing advantages;

- the world price be recognized as the value (or opportunity cost) of sugar to the Mexican economy--despite the distortions in the world sugar market, the factors that determine sugar' s place in the Mexican economy and the comparative advantage of individuals and sectors of the industry should reflect international market realities;

- if it is deemed politically desirable to favor particular groups, support should be provided as much as possible through direct income support rather than via prices which distorts production and consumption decisions.

# Suggestions for Policy Reform

- a. Increase the mobility of land resources; for example, through competitive contract farming arrangements that encourage good arm managers to expand their influence and allow for larger parcels of land to be jointly farm-d.

- b. Privatization of mills.

- c. Allocation of regulations governing the pricing of cane in tandem with land and mill reforms to allow for negotiation between millers and growers over the price, quantity, quality, and delivery terms of cane.
- 39 -

- d. Dismantle remaining barriers to trade and allow world prices to be freely transmitted to domestic cane and sugar markets:

- e. AZUCAR's remaining monopoly acquisition, exporting and importing rights should cease, and in line with AZUCAR's other transitional watchdog and agency functions, it should monitor and anticipate demand of growers, mills, domestic users and traders for services which facilitate efficient marketing and help establish stability in the market through the use of commercial instruments--this might, for example, include helping traders tailor specific hedging strategies and services for groups of growers concerned about the inherent instability in the world price.