metadata: authors: 0: author: O'Mara, Gerald T
1: author: Ingco, Merlinda
count: Mexico,United States
docna: 0: docna: MEXAGMKTS : a model of crop and livestock
            markets in Mexico
docty: Policy Research Working Paper
subtopic: Climate Change and Agriculture,Oil Refining & Gas Industry,Crops and Crop Management Systems,Livestock and Animal Husbandry,International Trade and Trade Rules,Food Security
teratopic: International Economics and Trade
abstracts: cdata!: The genesis of the model MEXAGMKTS was
            the perception that agricultural policies in Mexico (and
            many other countries) are often second-best responses to the
            negative side effects of broad macroeconomic and
            international trade policies.  MEXAGMKTS was designed to
            allow analysis of the relationship between such agricultural
            policies and different macroeconomic and international trade
            regimes.  MEXAGMKTS is part of a set of interlinked
            macroeconomic and sectoral models of Mexico and the United
            States (with enough specifications for the rest of the world
            to close the system).  The authors discuss the historical
            context in which MEXAGMKTS was developed as well as its
            economic structure, estimates, and validation.  They present
            a stand-alone, counterfactural application of a trade
            liberalization scenario for Mexico.
geo_reg_key: 119228,517191
repnme: repnme: MEXAGMKTS : a model of crop and livestock
            markets in Mexico
display_title: MEXAGMKTS : a model of crop and
            livestock markets in Mexico
listing_relative_url: /research/1990/07/700225/mexagmkts-model-crop-livestock-markets-mexico
topicv3: Agriculture and Food Security m1326205 435,Crop Production m1326627 174,Trade m1326924 698,Livestock m1504490 4024,Petroleum Industry m1583790 4710
publishtoextweb_dt: 2010-07-01T00:00:00Z
historic_topic: International Economics and Trade
origu: Policy, Research & Ect Affairs
no_of_pages: 66
model_extractions: <!-- Start of picture text --> Policy, Reserch, and External AtIf$<br><!-- End of picture text --> <!-- Start of picture text --> Agricultural Policies|<br><!-- End of picture text -->

WPS 446

- This paper a product of the Agricultural Policies Division, Agricultural and Rural Development - Department is part of a larger effort in PRE to understand the dependence of domestic agricultural markets on domestic macroeconomic policy and the macroeconomic and trade policies of major trading partners. Copies are available free from the World Bank, 1818 H Street NW, Washington DC 20433. Please contaot Cicely Spooner, room N8-035, extension 30464 (61 pages with graphs and tables). The genesis of the model MEXAGMKTS was The conclusion: If human consumption is the perception that agricultural policies in the welfare criterion, trade liberalization imMexico (and many other countries) are often proves the average consumption possibilities for second-best responses to the negative side effects the Mexican people. Lower prices for maize and of broad macroeconomic and international trade soybeans shift consumption possibilities outpolicies. ward, with an increased price for sorghum offset

The conclusion: If human consumption is the welfare criterion, trade liberalization improves the average consumption possibilities for the Mexican people. Lower prices for maize and soybeans shift consumption possibilities outward, with an increased price for sorghum offset by efficient input substitution in livestock production.

MEXAGMKTS was designed to allow analysis of the relationsnip between such agricultural policies and different macroeconomic and international trade regimes. MEXAGMKTS is part of a set of interlinked macroeconomic and sectoral models of Mexico and the United States (with enough specifications for the rest of the world to close the system).

The cost of this improvement is significantly less domestic production of maize and more variation in producer prices for maize and sorghum. As a result, maize imports may reach very high levels on occasion. For a government that prefers to produce most of a major food grain domestically, this may be a high price to pay. But in the long term, the food security cost of maize imports appear to be much lower.

O'Mara and Ingco discuss the historical context in which MEXAGMKTS was developed as well as its economic structure, estimates, and validation. They present a stand-alone, counterfactual application of a trade liberalization scenario for Mexico.

The PRE Working Paper Series disseminates the findings of work under way in the Bank's Policy, Research, and Extemal AffairsComplex. Anobjective of theseries is to getthcse findings out quickly, even if presentations are less than fully polished. e findings, interpretations, and corPclusions in these papers do not necessarily represent official Bank policy.

Produced by PRE Editorial Services
MEXAGMKTS: A Model of Crop and Livestock Markets in Mexico by Gerald T. O'Mra and MerLnda Ingco Table of Contents <!-- Start of picture text --> I. Introduction 1<br>I. Historical Perspective 1<br>M. The Strategic Role of Agriculture In Mexican 8<br>Economic Policy<br>IV. Role and Structure of XAGMKrS Model 10<br>V. Functional Specification of MEXAGMKTS Model 12<br>VI. Application of MEXAGMKTS to Counterfactual Trade 19<br>Liberalization Scenario<br>Footnotes 32<br>References 33<br>Appendix A Parameter Estimates of MEXAGMKTS Model 34<br>Appendix B: Graphical Presentation of Validation Test<br>of MAGMKT 44<br><!-- End of picture text -->
# A MODEL **O;'** CROP AND LIVESTOCK COMMODITY MARKETS IN MEXICO (MEXAGMKTS)

## I introduction

The genesis of the model MEXAGMKTS was the perception that agricultural policies In Moxico (and many other countrles) are often second best responses to the negative side effects of broad economic policles akned prknarily at macroeconomic and International trade obJectives. Glven this perspective, It was natural to want to study the relationship of such agricultural policles to differig macroeconomic and lnternatlonal trade policy reghies. The outcome has been a research project that models policy interaction effects by means of controlled counterfactual shnulation experknents. The model MEXAGMKTS Is a member of a set of Interlinked models at macroeconomic and sectoral levels of Mexico and the U.S. (and enough specification of the rest of the world to close the system). This paper discusses the development of MEXAGMKTS In terms of historical context, economic structure, estkuation and validation and presents a stand-alone counterfactual applicatlon to a trade liberalization sconario for Mexico.

## 11 Historical Perspective

To assess the extent to which agricultural policy In Mexico has been formulated to facilltate broad economic policy objectives, It Is useful to brlefly review the history of Mexican economic policy over recent decades. For about four decades, Mexican economic pollcy was strongly Inward iooking, featuring promotion of domestic manufactures by means of protective tariffs and (later) kmport quotas. During the
2 19506 and 19606, policy encouraged capital formatlon through domestic savings and tax collection and recourse to foreign capital. Real GDP grew annually at 7.2 percent with per capita GNP rising by 3.7 percent and gross fIxed Investment at 8.2 percent annually over the perlod. Domestic prices grew at an annual rate of 4.3 percent, and external borrowing was a stable proportion of GDP over the period. The peso-dollar exchange rate was held at 12.5 (over 1954-76) despite a relative lack of effective exchange controls. It Is well known that the economic pollcy Just described knposes kuplicit taxation on exporting sectors that Is a function of the degree of protection to Import competing sectors. In the absence of countervailing policy toward exports, such a policy tends to dkninish export supply and earnings. The countervailing pollcy adopted by the Goverrvnent of Mexico In this period with respect to agriculture was a program of significant public Investments In Infrastructure (largely Irrigatin and highway construction) that stkiulated agricultural supply by reducing delivered costs to urban and external markets and thus offset the effect of the dominant economic policy on the sector. Durlng this period agriculture and livestock GDP grew at average rates of 3.0 and 2.7 percent, respectively, with yleld Increases and area expansion contributing about equally to agricultural outpui growth and growing populatlon and Incomes, Increasing demand for livestock products. As a share of GDP, sectoral output decreased from 18.6 percent In 1955 to 8.8 percent In 1972. Throughout almost all of this period, Mexico was a slgnlficant net exporter of agrlcultural commoditles.<sup>1</sup> In 1950, the Mexican Congress mandated broad powers to the federal government to regulate domestic prices via administrative flat Internally and through tarlffs, quotas and exclusive trading rights wlth respect to external trade. In the period of the 50s and 60s (and subsequent ones), the prices for maize, beans, wheat
3 sorghum, soybeans (and other ollseeds) were supported by<sup>government guarantee</sup> prices. Although the ease of access of the small farmer to guarantee<sup>prices has</sup> varied over tkme, the guarantee prices have been largely<sup>effective In providing a floor</sup> to the prices of these commoditles.2 Nonetheless, the real Index of farm gate prices fell significantly throughout the perlod.2 The success of the golden age just described contained<sup>the seeds of Its own</sup> destruction as the Inevitable Inefficlencls of a sustalned<sup>policy of strongknport</sup> substitution eroded Mexican competitiveness. By the early 1970s,<sup>Mexican agricultural</sup> exports were being replaced by agricultural kIports. In the normal course of events, Mexico would have been driven by the Increasingly Inefficient<sup>kIportsubstitution policy</sup> toward a policy of export promotlon. However, as events unfolded, Mexico was blessed (cursed?) with the discovery of large petroleum deposits<sup>that converted the</sup> country Into a maJor exporter of oli. While this temporarily solved<sup>the problem of</sup> export earnings, It did nothing to deal with the Inefficlncy<sup>of theknportsubstitutlon</sup> pollcy. In the ensuing era of expanding petroleum exports,<sup>alded by sharp Increases</sup> In real petroleum prices In 73-76 and 79-81, Mexico collected<sup>very large natural</sup> resource rents. In the now familiar dutch disease fashion,<sup>the dissapation of these</sup> rents significantly Increased the demand for nontradables, pulling resources<sup>away from</sup> productlon of tradeables through factor price Increases<sup>that reduced external</sup> competitiveness vla their effect on costs. In simple consequence,<sup>the export sector</sup> became predominantly oil based. In agriculture, the dutch disease<sup>pulled labor toward</sup> other sectors, especlially constructlon, as the public<sup>sector dissapated petroleum</sup> rents through massive Increases In public Investments<sup>(which grew at 16.5 percent</sup> annually over 73-81). At the same time, the rest of the world was Inundated by petro-dollars that Middle Eastern oil producers were unable<sup>to absorb domestically.</sup>
4 In a clhate of opinion that foresaw ever Increasing petroleum prices, the bankers recyclig petro-dollars were led to favor Investments In countrls well endowed with oil reserves. Thus, Mexican pollcymakers were confronted with an apparently Inexhaustible supply of external capital to augment the Increased natural resource rents, and all notions of a hard gcovernment budget constraint vanIshed. Necessary policy adjustments such as tax reform, liberalizatlon of tariff and non-tariff barrie s to kmports, etc. were postponed. Both the Increase In petroleum rents and the Influx of foreign capital stbnulated the supply of money and crodit, and the era of price stabglty ended as inflation Increased to 21.4 percent annually (over 1972-81). To add fuel to the fire, In 1977 the government estabilshed a system of coverage of foreign debts by the central bank. This aliowed Moxican firms to got forolgn credit at the same cost as domestic funds, which was tantamount to fixig of the pesodollar exchange rate to stabilize a system of free convertibility between demand deposits denominated In pesos and dollars (Ie., the so called "mexdollar" deposits).<sup>4</sup> Whllo agriculture also benefited from the government Investment boom, It received less than many otler sectors (public Investments In agriculture Increased at 13.1 percent annually); and the benefits did not offset the dutch disease effects. From 1972 to 1980, an esthiated 900,000 workers left the agricultural sector. In consequence, the country was forced to rely heavily on food kmports. The Income effects from the petroleum boom accelerated a shift In household consumptton away from maize and beans toward commodities with high Income elasticities, e.g., livestock commoditles. In addition, the diffusion of Iprted technology that lowered the costs of livestock productlon, i.e., semi-mechanized production of pork, poultry and eggs through selective broodkg and carefully designed composite foods, kept the supply of some lIvestock commoditles elastic. The result of all this was a shift In cultivated
5 acreage toward fodder crops and away from food grains. Toward the end of the petrokboom perlod (1979-81), concern over the relative docilne ot agriculture resulted in initiation of the Mexican Food Program, or the SAM as It was known from Its Spanish acronym. Thl program was promoted polltically as a venicle for restoring food self-sufficlency. The SAM did raise guarantee prices somewhat, but Its main thrust was an effort to offset dutch disease effects by reducing farm level costs through input subsidies, especlally for credit, fertilizer, seed and pesticides. The credit component channeled the loans from the agricultural development banks into short term crop production, while the subsidlzed credit through the commercial banks went heavily toward livestock (over 50 percent). Slnce part of the loans covered worker wages, for small farmers employing self and family labor the development bank lending was a quasi Income malntenance program; and when delinquent loans were forgiven, these converted Into Income transfers. However, credit was biased toward the more commercial northern regions of the country, so that any income transfers to poorer regions were likited. Slnce the SAM maintalned low consumer prices for ba:ic foods, e.g., maize, beans, wheat, meat, milk, eggs, vegetable oil, required producer subsidies were quite large given that the policy of controlled prices provided consumptlon subsidies to consumoers In general. In sknple consequence, the SAM resulted in a signlficant transfer of resources to agriculture, with the transfer as a percent of sectoral GDP ranging from 28 In 1979 to 42 In 1982.5 The petroleum boom ended sharply in 1982, wlth the combination of faltering oil pricos and the disinflation initiated by Chalrman Volker of the U.S. Federal Rosorvo Board that had pushed interest rates world wido to very high levels. The crisis that followed from Mexico's resultant Inabillty to service Its external debt, with the final push coming from heavy flight of domestic capital as the trend of events became
6 cwar, markod the **begWnng** of the **present** era of debt restructurin and structural adjuetment of economic policy. Thls event coincided with the waning days of the sexonlo of Prosident Lopez Portillo, who prQceeded to nationalized the Banks In a successful effort to renege on the convertibility of the mexdollar deposits. The hmdbato result was a total halt to the flow of external credit Into MexIco.<sup>6</sup> This In turn forced a sudden and large devaluation of the peso. When the flow of extornal loans did resume vla bilateral and multilateral credits, the conditionallty was demanding; and a sustakied process of externally driven adjustment beganz The first **phase** of adjustment came wlth an UP mediated stabilizatlon program which featured fiscal austerity that reduced the public sector deficit from 17.6 porcent In 1982 to 8.9 percent In 1983, and a restructuring of external debt wlth commercial banks was negotiated. The large devaluatlon knproved the current account, but the required reduction In expenditures yielded a deepening stagflation. Inflation Increased from 58 percent In 1982 to 102 percent In 1983, while rAal GDP decreased by 5.9 percent between 1982 and 1983. However, from 1983 to late 1987, a combination of governmont expenditure Increases and declining revenues from petroleum resulted In growth of the flscal deficit relative to GDP. Moreover, up to mid 1985, tho rate of deprociation of the peso was exceeded by the rate of Inflatlon, Increasing the real exchange rate with the Inevitable decrease In non-oil exports.

In Juy 1985, the de la Madrid administration Instituted refonn measures which depreciated the peso more rapidly than prios Increased, resulthg In a 50 porcent drop in the roal exchange rate over the following year (wlth an assist from the uiftects on expectations from the precipitous drop In world petroleum prices In early 1986). The 1985 reforms also started to reverse the policy of global subsidies to
7

**consmr** on **basic** foods, and these wero largely ellminated by the nd ot 1986 in favor of a prograw of subsIdIes targeted to the poor. Thb Pormitted Initiating **reforms** akned at adjusting producer prIce guarantees to bcrder prloe levels. These measures stimulated agricultural exports, the dollar value of which Incroased 44 percent from 1985 to 1988. More generally, the liberalized policles also sharply stimulated manufactured exports from plants along the border with the U.S. that assemble goods for external markets using duty free Imports and favorable U.S. tarIffs. As part of the trade liberalization measures, Mexico joind the General Ageement on Trade and Tariffs (GATT) In 1987, resulting In reductions of maximum tariffs from 100percent to 20 percent, and a large reduction In products who" trade was regulated by quantitative restrictlons (from akmost 100 percent to about 50 percent).<sup>7</sup>

The severity of the Impact of the debt and structural adjustment crlsis on Moxican welfare needs emphasis. Durlng the four years after 1982, Mexico transferred abroad resources equivaltent to US$31 billon (In 1987 prices), amounting to 4 percent of GDP and nearly 25 percent of export earnings. To place them In historical context, they were 1.6 times larger In relation to national Income than the reparations paid by Germany after World War I. To achlove this transfer reoukred a cumulative trade surplus of US$48 billion (1987 prices) over five years, amounting to 8.3 percent of GDP. In human terms, this effort required a reduction of 15 percent In per capita consumption between 1981 and 1984. To date, per capita consumption has yet to regain the level of 1981.8 The adjustment process In agriculture has featured the gradual eliminatIon of a system of quantative controls on Imports and exports that up to 1985 had limited
8

**ipr4xtation** of **key** agriultural commoditles to public enterprks (in order to control the Impact of trade on the cost of producer and consumer subsidies), mavement of of producer support prices toward border prices, reduction of Input subsidies, closure of Inefficient governme,.it processing plants and lberalIzation of price ceilings on basic consumer foods.

# Il The Strate Role of Aaricufturo in Mexican Economic Polcy

For almost forty years, the major thrust of Mexican pollcy toward agriculture has been to keep the terms at which agriculture trades wlth the rest of the economy favorable to urban consumers. rhis policy of cheap food to city dwellers was essentially aimed at stabilizing the real wage cost of bluo collar workers and civil servants at a relatively low level. Such a policy facilltated Import substituting industrializatlon and promoted peaceful Industrial labor relations. However, as already noted, a sustained Import substituting pollcy Insulates the economy from external competition, losing the stimulus toward cost reduc ion and market diversification that trade provudes. Similarly, a sustained pro-urban bias tends to Induce excessive urbanizatlon, as the bloated size and heavy pollutlon of Mexico City attest. The cornerstone of the pollcy creating the urban-Industrlal complex In Mexico has been the use of pricing of food commodities to stabilize the real Incomes of urban workers. The major safety not for the small farmer and rural workers has been migration (to the citles or the U.S.) and emigrant remittances to relatives left behind. 9 The system of essentially fixed producer and cr.nsumer prices for baslc foods Imposed tho necessity of government supply adjustment as quantity control Instrument to manage disequilibria In food and feed grain markets. The system works as follows: In the fall when major crops are harvested, the predominant public agency In food supply
9 operations, CONASUPO, can estimate with some accuracy the aupply available from domestic production over the next year. Combining this Information with estimates of food demand at exlsting prices produces an estimate of excess supply or demand, and hence an Indication of the _ov'_ ,;ltlos to offer for export or to order for Import. Any errors In the Initlal estimates of surplus or shortage (at existing prices) can be met by varying the level of government held Inventories. Since the system provides no Incentve for private Investments In storage facillties or the holding of Inventories, and even though trade In basic foods Is no longer a government monopoly, the government supply adJustment mechanism Is still an essential part of the food distribution sytem.
10 IV Fool* - StrUctire of kEXA3ITS Model The objective of this model Is to provide a shnulatlon tool at the disaggregated lvel of Individual agricultural commodity markets that will permit experiments explorig the effect on those markets of policies at the donestic macroeconomlc or International (i.e., tradig partner) macroeconomic and sectoral levels. The effects are A. be transmitted by changes In variables that are specilled as exogenous deteminants of quantities der .anded or supplied, In turn, the values of these Ihkago variables are dtormhod In upstream models In an experental framework of rocursive causation. The structure of this framework Is given In Figure _1._ Note that MEXAGMKTS receives values of ik*ago variables from both the Mexian macroeconomic and the US (and rest of the world) agricultural markets models.

Model design specifies the Interaction of markets for several kportant food/feed crops with markets for representative livestock commodities. iputs are the prknary factors of labor and capital and the Intermedlate Inputs of fortIlizer and food crop commodities. Land Is omitted from the specification through the use of supply functions whose key arguments are price varlables. ThIs approach Is taken since the set of markets modeled does not Include sno markets for all agricultural conunodltles and knportant substItution relatlonships between factor Inputs, especlally land, exist between the markets modeled and those omltted. In additlon, the supply of agricultural labor Is linked to markets for unskillod labor nationwido (and even intortionally). Thus, the wage of labor Is a key linkage variable whose value Is determinod In the Mexican, macroeconomic model.
# F ur 1: Schematic of Pattern of Major Interactions Hypothesized **an** Analycical Framwork

<!-- Start of picture text --> MACROECONOMIC MACROECONOMIC<br>MOVEL MODEL<br>OF OF<br>mSCO UNITED STATES<br>AGRICULTURkL AGRICULTURAL<br>COMMODITY AND COMMODITY<br>FACTOR MAETS MAlRlTS<br>; ~OF EXCO OF US<br>DISACGUGATD<br>AGICULTURAL<br>COOODITY<br>wARTs.<br>REST OF THE VORLD<br><!-- End of picture text -->
12

# V **Functional speomation of IEXAGQKTS Model**

This section presents a functlonal specificatlon of the model. A detailed specification of Individual equations complete with parameter esthuates Is given in Appendix A. The specification starts with baslc Index sets and continues with descriptions of va' ibles and equations:

# **kdex** Sets

Symbol Description Set Members c Food/Feed Crops /malze, sorghum, soybeans/ I Factor Inputs /capital, labor, fertlilzer/ a Anknal Stocks /cattle, pigs, broliers, layers/ Livestock Comm. /beef, pork, poultry, eggs, milk/

# **Variable**

Name Description PR(c) Production of crop c FD(c) Anknal feed demand, crop c HD(c) Human food demand, crop c GSADJ(c) Goverrvnent supply adJustment, crop c RPG(c) Real price guarantee, crop c RBP(c) Real border price, crop c PCC(c) Per capita human consumption, crop c P(l) Real price of factor I
13

- PCON Per capita human consumption, all commoditles POF Index of the relative price of food POP Population of Mexico INV(a) Stocks In Mexico of animal type a INVUS(a) Stocks In US of animal type a QP(I) Productlon of Ilvestock commodity I PCL(I) Per capita consumption, livestock commodity I NEXP(I) Net exports, livestock commodity I PP(I) Real producer price, Mexico, livestock comm. I PPUS(I) Real producer price In US, livestock comm. I RP(l) Real consumer price, Mexico, livestock comm. I PTORT Real consumer price, Mexico, maize tortillas

The variables P(i), PCON and POF are linkage varlables from the Mexican macroeconomic model; and the variables RBP(c), INVUS(a) and PPUS(I) are linkage variables from the US (and rest of the world) agricultural markets model. The variables RPG(c) are agricultural policy variables, while the variables P(l) and NEXP(I) may also be policy variables. The variable POP Is exogenous. All other varlables are ondogenous.

# Equatkn

Number Typo Functlonal Specificatlon

- 3 Crop production PR(c) - PR(RPG(c), P(l))

- 3 Aninal foed demand FD(c) - FD(RPG(c), INV(a)) 1 Human food demand HD(c) - HDEPOP*PCC(PTORT,PCON,POF)] 3 Gov't supply adJ. OSADJ(c) - FD(c) + HD(c) - LtPR(c)]
14

- 4 Anklial Stock Demand INV(a) - INV(RPG(c),P(I),PP(I), LEINV(a)])

- 5 Livestock comm. prod QP(I) - QPIPP(l),RPG(c),P(I), INV(a),L[QP(l)J,TIma)

- S Per cap cons, Ivstk PCL(I) - PCL(RP(I),POF,PCON, commodity I LCPCL(I)])

- 1 Not exports, lvstk NEXP(I) - NEXP(PPUS(l),INVUS(I)) commodity I

- 2 Consumer Price,Ivstk RP(I) * RP(PP(l), L[RP(l)]) commodity I

- S Market clearlng, QP(I) - NEXP(l) - POP*PCL(I) 'vstk commodity I

- I Consumer price of PTORT - PTORT[RPG("malze")] tortillas

The thirty-three equations ilsted solve for thirty-three endogenous variables. Consumer prices are determined as a function of producer prices for only two livestock commodities, beef and pork. For all other livestock commodities, a thue serles of producer prices was not available. In these cases, the market clearing equation solves for a consumer price. The notatlon Lt.] Indicates a lagged value of the variable shown Inside the brackets.

Model parameters wore estUmated using multivarlate linear regresslon methods (OLS and 2SLS) using data from the Mexican MinIstry of Agriculture and Water Resources (on crop and livestock production, prices. stocks, hnports e.id exports), the Mexican Central Bank (price Indices), Ministry of Programming and Budgetig
15 (natbnal accounts), the Mexcan National Institute ot Statistics and Geography, and the Foreign Agricultural Service of the US Department of Agriculture. Parameter esthiates are given with the exact llsting of model equatlons presented In Appendix A.
# IS

The economic ntrpretatlon of model equations Is straightforward. The crop production equatons are econometric supply functions which specify crop supply as a functlon of output and Input prices. The feed demand equations specify food demands as a function of crop price guarantees and anknal stocks. Human crop demand (for maize) Is specified as the product of population and per capita demand, where the latter Is determined by total per capita consumptlon, relative price Index for food, and the retail prico of tortillas, which Is a function of the price guarantee for maize. The supply adjustment equations determine the quantities of borts or exports required to sustain the fixed guarantee. In brief, the equatlons relating to field crops embody the government supply adjustment process for market equilibration described above.

The livestock oriented equations are direct applications of microeconomic theory. Anknal stocks are specifled as a functlon of producer prices for livestock commoditles, crop price guarantees, Input prices and lagged stocks. Production of livestock commoditles Is specified as a function of producer prices, feed crop price guarantees, ankial stocks and lagged production. Per capita consumption of livestock commoditles Is determined by consumer prices for livestock commodities, total per capita consumption, relative price for food and lagged per capita consumption of the livestock commodity. Net exports of livestock commoditles are specified as a function of producer prices and ankial stocks In the US. Market clearhg for livestock commodities Is accompllshed by determining the price which equates quantity demanded with quantity supplied.
17 Model Validation The aim of validatlon Is to demonstrate that the model can acceptably reproduce historically observed outcomes. Since the objective of model construction was to deveiop a tool for simulating policy Interaction effects, the period for validation should be the periods over which these effects are to be studled. This requirement effectively limits the validation period to the relatively recent past given that the data base used In model estimatlon contains some time series that go back only to 1972. For this reason, and because avallable Information Is as yet Incomplete for the most recent years, the 1974-85 period was selected for model validatlon.

Given that the ultimate objective Is counterfactual simulations of pollcy Interactions, the model should be capable of simulation over a number of years with only Initial historical values for endogenous varlables as Input data to the model. Of course, the behavioral relatlonships defined by the parameterized model equations will embody the expectatlons of economic agents as conditloned by historical experience and rational expectations based on that experience. Hence, the validation test selected was sinultaneous solution of model equations over the twelve years 197485, with only Initial historical values for 1972-73 used to provide data for predetermined lagged ondogenous variables. Hlstorical values were used for pollcy and exogenous varlables In the validatlon test.

The simulated values of endogenous variables and their actual historical values are pioted together over 1974-85 In Figures 1 to 33 of Appendix B. In general. simulated values track historical values quite well. Of course, the parameterized equations do make use of dummy variables (that temporarily shift Intercepts) to explaln
18 shocks that are outside both the deterministic functional relationshIps specified in model equations and the asymptotic normality posited for stochastic error torms. Where the simulated values track history less well, there Is Invariably an explanation. A case In polnt Is the government supply adjustment varlables which represent pollcy variables that are assumed to be set to validate the real price guarantees to farmers by the government. Yet It Is evident that these variables are adjusted discontinuously not only In response to agricultural policy but also to cope with government fiscal constraints and concerns over the effect of food prices on the welfare of key groups. That Is, market clearing prices may diverge from the price guarantees by means of ad hoc supply channels or queuing may emerge temporarily. The same arguments apply to the prices for beef, pork and milk, which on occaslon are tomporarily manipulated by government officials acting to affect the prices of foods Important to the welfare of favored urban groups. Thus, temporary quotas on beef exports have been Imposed to damp expected beef price Increases. Similarly, an kmportant fraction of milk consumption Is supplied by Imports of powdered milk, which are under the control of government; and varlations In milk knports can be used to manipulate milk prices. Such discontinuous and poorly documented government actions are difficult to formally Incorporate In model equations, and yet they do have real effects on prices and quantities In livestock commodity markets. Finally, there Is the possibility of errors In the data sources. For example, the sharp drop of over 50 percent between 1983 and 1984 In stocks of broilers In conjunction with a reported Increase In poultry production Is hlghly unlikely.
19

# **VI** AvPatlon **of MEXAGICTS** to Counterfactual Trade Lberafation Scearb

As an initlal application, MEXAGMKTS will be used to shnulate a trade liberalization scenarlo that has been urged upon Mexico<sup>by multilateral and bilateral</sup> lenders. This experklent consists of dropping the<sup>system of guarantee prices for the</sup> field crops malze,sorghum and soybeans and<sup>letting the world market determine the</sup> domestic prices for these commodities. Conceptually,<sup>this experknent envisions the o'nd</sup> of internatlonal trading and storage operatlons<sup>by CONASUPO</sup> to validate the politically determined guarantee prices. Of course, there would<sup>still be International trading In</sup> maize, sorghum and soybeans; but It would be by private<sup>fIrms or even by CONASUPO</sup> at International prices and without subsidy. Since<sup>the experkment Is counterfactual,</sup> shaulation over the entire 1974-85 period Is of Interest<sup>as a test of the alternative</sup> policy under a variety of economic conditions. Operationally, the experuiennt Is kmplemented by skuply substituting the real border<sup>price (RBP) variables for the real</sup> price guarantee (RPG) variables; and Interpreting the<sup>supply adjustment varlables as</sup> profit maxhlizing trade at world prices by private<sup>traders or even by CONASUPO.</sup>

# Experknental Results

The results from the experkinent are most easily<sup>Interpreted by noting that only</sup> three exogenous variables are changed, the prices<sup>of malze, sorghum and soybeans.</sup> Since the changed variables are prices, the resource<sup>a'locatlonkIpactIs determined</sup> by the change hI two relative prices, using<sup>one commodity as numeraire. This</sup> comparison Is given in Table 1. Thus, the maize<sup>price decreases from 1.51 to 1.06</sup> sorghum units; and the soybeans prico drops from<sup>2.67 to 2.23 sorghum units when</sup> averaged over the period 1974-85. That Is, the<sup>guarantee prices over the period</sup>
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# have on average overvalued maize and soybeans In torms of social opportunity costs.

Table 1: Comparison of Relative Guarantee and Border Price of Maize and Soybeans In Sorghum Units, 1974-85

||Maize|Soybeans|
|---|---|---|
|Guarantee Price|1.509|2.670|
|Border PrIce|1.056|2.229|

# Rate are average values of varlables over 1974-85 period.

For this reason, It Is no surprlse that the experkmental results presented In Table 2 show on average that maize production decreases by 28%, soybeans production Is down by 4% and sorghum production Increases by 9%. Skuilarly, on average maize and soybeans food demands Increase by 13.5% and 1.5% respectively, while sorghum feed demand decreases bY 1.4%. On average, the decrease In malze prIce Increases per capita human consumption by 3.8% and total maize consumption by 7.6%. All of these changes knply on average a iarge Increase In maize Imports of 3.7 millon metric tons annually or 349%, and a decrease of 0.4 million metric tons annually or -31% In sorghum knports, with very little change In soybean Imports.

Since all three crops are Important sources of animal feed, and can be substituted at the margin, It Is not surprising that large changes In thelr relative prices induce only small changes In livestock production and consumption. Annual average roeWts for beef and pork are given In Table 3. Note that on average production and per capita consumption of both beef and pork change by loss than 1X. Beef exports are unchanged year by year since these are largely driven by prices and stock levels In the U.S.
21 Table 2: Comparison of Trade Liberalization Case With Base Case, Fleld Crops, 1974-85

|VARIABLE|UNITS|BASE<br>CASE|TRADE<br>LIBERALIZATIO|PERCENT<br>N CHANGE|
|---|---|---|---|---|
|Maize Price|pesos/KG|4.671|3.843|-17.7|
|Sorghum Price|pesos/KG|3.144|3.640|15.8|
|Soybeans Price|pesos/KG|8.394|8.112|-3.4|
|Malze Feod<br>Demand|1000 MT|4297|4876|13.5|
|Sorghum Feed<br>Demand|1000 MT|5626|5547|-1.4|
|Soybeans Feed<br>Demand|1000 MT|1021|1036|1.5|
|Maize Production|1000 UT|11115|7953|-28.4|
|Sorghum<br>Production|1000 MT|4583|4989|8.9|
|Soybeans<br>Production|1000 MT|579|558|-3.6|
|Per Capita Food<br>Cons. of Maize|KG|109.3|i13.5|3.8|
|Total Maize<br>Consumptlon|1000 MT|11,792|12,686|7.6|
|Maize Supply<br>AdJustment|1000 MT|1072|4816|349.3|
|Sorghum Supply<br>AdJustment|1000 MT|1269|877|-30.9|
|Soybeans Supply<br>Adjustment|1000 MT|625|649|3.8|

* Data are average values of variables shown over 1974-85 perlod. MT Indicates metric ton(s). Price variables are In 1980 prices.
22 Table 3 Comparion of Trade Liberalization Ease With Base Case, Beef and Pork. 1974-85

|VARIABLE|UNITS|BASE<br>CASE|TRADE<br>LIBERALIZATO|PERCENT<br>N CHANGE|
|---|---|---|---|---|
|Beef Productlon|1000 MT|1193.8|1189.3|-0.4|
|Beet Export|1000 MT|64.0|64.0|0|
|Beet Producer<br>Price|Pesos/KG|50.2|54.2|8.0|
|Per Capita Beef<br>Consumption|KG|16.4|16.3|-0.6|
|Cattle Stocks|millon head|29.487|31.180|5.7|
|Pork Productlon|1000 MT|1169|1172|0.3|
|Pork Producer<br>Price|Pesos/KG|62.1|57.1|-8.1|
|Per Capita Pork<br>Consumption|KG|16.9|16.9|0|
|Pig Stocks|millon head|16.425|16.453|0.2|

S Data are average values of variables shown over 1974-85 perlod. MT denotes metric tonts(). Price variables are In 1980 prices.
23 Of course, the averages over the period 1 P74-85 Include<sup>several policy</sup> regknes as well as significant rise and fall In overall per<sup>capita consumption, which</sup> Increased by 20.B8 from 1974 to 1981 and then decreased<sup>by 15.3X from 1981 to</sup> 1985, wlth consumption In 1985 ending at virtually the same level<sup>as In 1974. Thus,</sup> It Is Instructive to examino tine series results for key varlables<sup>over the period.</sup> Charts 1 to 6 prosent such tikn series comparlng a base case<sup>(historically given prico</sup> guarantees) with the counterfactual trade liberalizatlon for maize<sup>prices, production,</sup> food demand, per capita diroct human consumption, total demand<sup>and crop supply</sup> adjustment. Clearly the border price for malze has fluctuated<sup>more than the maize</sup> price guarantee. This difference Induces similar variatlon In production, consumption and crop supply adJustment. Under trade llberalization, maize<sup>imports reach a peak</sup> level of 13.4 million metric tons In 1983, owing to low productin<sup>the previous year</sup> and high demand In 1983. Thus, under trade liberalization, maize<sup>Imports could be</sup> expected to show significantly greater varlance Charts 7 to 10 present tine serles comparisons of the<sup>two cases for sorghum</sup> prices, production, feed demand and crop supply adJustment. Once again, significant variatlon In the border price for sorghum Induces corresponding<sup>variatlons In sorghum</sup> production; but foed demand shows less variation owing to high<sup>correlation between</sup> the border prices for maize and sorghum. Sorghum crop supply<sup>adjustment Is highly</sup> variable, but due to greater domestic productlon at border prices,<sup>the reduced</sup> sorghum Imports do not reach peak levels as large as under price<sup>guarantees. Charts</sup> 11 to 14 present tine serles data for soybeans analogous to<sup>the tine series for</sup> sorghum. While soybeans prices are more variable (but<sup>iower on average), soybeans</sup> productlon, feed demand and crop supply adjustment under<sup>border prices show quite</sup> similar patterns and levels as under price guarantees.
24

# Assessment of Results

If human consumption Is the welfare criterlon, then trade llberalization results In knproved consumption possibIlltls on average for the Mexican people. This result Is essentially due to iower prices for maize and soybeans directly and Indirectly shifting consumptlon possibilities outward, with the effect of an Increased price for sorghum offset by officient nput substitution In livestock production. The cost of this knprovement Is significantly loss domestic production of maize and Increased varlabluty In producer prices for maize and sorghum. In consequence, maize Imports may reach very high levels on occasion. This can be viewed as high cost on the part of a liovernment that prefers to produce domestically all or at least most of the domestic demand for a major food grain such as maize. However, over the longer term, when per capita Incomes are growing slgnificantly and substitution against maize In favor of preferred foods by a predominantly urban Mexican population has reduced direct maize consumption to much lower levels, the food security cost of malze knports would appear to be much lower.
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# 1:Price Incentives Maize

<!-- Start of picture text --> Trade liberolization vs Price Guorcntee<br><!-- End of picture text --> <!-- Start of picture text --> 6-<br>5.5"'<br>5~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~<br>45<br>4<br>3 5<br>25- \' I \<br>3<br>2 5- l :<br>1974 75 76 77 78 79 80 81 82 83 84 85<br>Years<br>3 = price guarantee + = trode lib<br>2: Production Maize<br>Trode liberoliZation vs Price Guarantee<br>15<br>13 -i 2~~ //\<br>12<br>°~ i/ / \ _<br>4!<br>1S~74 75 76 7, 78 79 80 81 82 83 84 85<br>tears<br>a pr,ce guarantee = traOe liL<br><!-- End of picture text -->
26 <!-- Start of picture text --> 3: Feed demand Maize<br><!-- End of picture text --> Trode liberaitzation vs Price Guarontee <!-- Start of picture text --> 10 .<br>9<br>8<br>lo/T<br>6<br>c 5<br>0<br>1974 75 76 7, 78 79 80 81 82 83 84 8S<br>fears<br>a price guarontee + = trode lib<br><!-- End of picture text -->

# 4: Per Capita consuumption Maize

Ttuva iioeralizaticon .s Price Guorontee <!-- Start of picture text --> 4w1<br>__<br>35 1 1<br>130<br>125<br>I '5<br>100<br>1974 75 76 77 78 79 80 81 82 83 64 *35<br>T eors<br>= W p'.l ~. eiuaiincee ...... + = trade lb<br><!-- End of picture text -->
27

# 5: Total Demand Maize

Trade liberalization vs Price Guorontee <!-- Start of picture text --> I71<br>1 5<br>- 1 4<br>3 71<br>19 74 75 76 7 7 -78 79 so 8 1 8° 83 34 85<br>Ii o - price guorantee / -teors + =trade lib-<br>9~~~~~~~~~~~~~<br><!-- End of picture text -->

# 6-: Gov. supply adjustment Maize

Tradelibefalizotion vs Price Guorontee <!-- Start of picture text --> 4<br>7<br>12<br>14<br>1974 75 76 77 78 79 80 81 =5 82 83 84<br>Yeors<br>a - prize quarontee + trade lib.<br><!-- End of picture text -->
**28**

# .7: Price incentives Sorghum

<!-- Start of picture text --> Trade liberalization<br><!-- End of picture text -->

**vs** **_Price_** Guorantee

<!-- Start of picture text --> 5.8 -<br>5.6<br>54<br>52<br>5<br>48<br>4 4<br>3?<br>34<br>36<br>:3<br>.36<br>24<br>1974 75 76 77 78 79 80 81 82 83 84 85<br>fears<br>0 price -guarantee + traoe IbD<br><!-- End of picture text -->

# 8: Production Sorghum

<!-- Start of picture text --> TvZae *.,teroi:oat,on ,s Price . .,.rantee<br>65<br>7~~~~~~~~~~~~~~~~~~~<br>E. 5 5;<br>6 /<br>5.5<br>I ~ ;<br>4.5<br>4 X<br>3-0 , ,<br>* 1,<br>19 74 75 76 77/ 78 79 80 Sl 8' 83 84 as<br>.eors<br>C a price guarantee + = trade lit<br><!-- End of picture text -->
**29**

# 9: Feed demand Sorghum

<!-- Start of picture text --> Trade liberalization vs Price Guarontee<br><!-- End of picture text --> <!-- Start of picture text --> 9.<br>8 /<br>7 /<br>4-<br>6/ > 6 j ~ ~~~//'<br>5 /<br>4<br>3i<br>I- - I I I<br>1?4 5 G 8 79 80 81 8 2 S3 84 85<br>(ears<br>= price guarantee + = trode lib<br><!-- End of picture text --> <!-- Start of picture text --> 10: Gov. supply adjustment Sorghum<br>Trade liberalization vs Price Guorantee<br>4-<br>3.5<br>'-.5<br>O.5<br>0 5~~~~~.<br>05 ..... .'~~.<br>is~~~~~~~~~~~er<br>-0.5/<br>1974 715 76 77 78 79 80 81 82 83 4 85<br>Years<br>- price guarontee + -trode fib.<br><!-- End of picture text -->
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# 11: Price incentives Soybeans

<!-- Start of picture text --> Trade liberolization vs Price Guarantee<br><!-- End of picture text --> <!-- Start of picture text --> 12<br>Ii~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~I<br>8<br>:194 7 716 717 7'8 79 80 811 812 8 4<br>08 0 price guarantee ' + tradje lib. ///\<br>0~~ 1:Production Soybeans \<br>Trade liberalization vs Price Guorantee<br>0 7 /J1<br>06<br>0.5 -<br>04<br>0 3<br>197t4 75 7 6 77 78 79 80 81 82 83 84 85<br>fears<br>0 = price guarantee + trode lib<br><!-- End of picture text -->
**31**

# 13: Feed demand Soybeans

Trade liberolization ,s Price Guarontee

1.8 -.

<!-- Start of picture text --> i.7I<br>1 6- ,<br>~u4/ 1<br>v 5 i : i>1<br>.,,<br>09<br>7A<br>06<br>1974 75 76 77 78 79 80 81 82 83 84 85<br>Years<br>q - price guarontee t trade lb<br><!-- End of picture text -->

# 14: Gov. supply adjustment

# Soybeanis

<!-- Start of picture text --> Trade liberaiizot;vr ws Pr-ce Guarantee<br>4<br>3~~~~~~~~~~~~~~~~<br>09<br>0.8 /<br>c<br>- 0.7<br>0.6-<br>05-<br>0)4<br>0.3<br>0.2<br>1974 75 7d 77 78 73) 80 81 82 8 6<br>Teors<br>a price )ua3rantee 4- trade lib<br><!-- End of picture text -->
32

# Footnotes

1. This paragraph Is based largely on Villa Issa.

2. World Bank 1989a, pp. 4-5.

3. Shwedel, pg. 12.

4. Gil Diaz, pg. 255.

5. World Bank 1989b, pg. 3.

- O. Gll Dlaz, pg. 256.

7. World Bank 1989b, pp. 3-4.

8. World Bank 1989b, pp. 4-5.

- O. Flshlow, pp. 243-44.