3

Even if one accepts the most conservative estimates, Mexico's reserves are sufficient to produce, consume, and export at projected levels for the next 40 years. Mexico's oil is high quality "light" and commands at present a premium price, $23.60 per barrel. Mexico's earnings from oil sales should be between $4.5 and $5.5 billion in 1979 and twice that (at 1979 prices) by 1982.

P. D. Warner
Head, Latin American Research
Economics Department
Bank of America

July 13, 1979

MEMORANDUM FOR MEXICO GROUP

Subject: Meeting with President Lopez Portillo, August 13, 1979 and Proposed Work Program

This memorandum summarizes the discussion with President Lopez Portillo, identifies the topics for further work which emerged from that discussion and suggests an agenda and work program for the Group.

## Mexico City Meeting

The meeting with President Lopez Portillo revealed a high degree of commonality in the perspective and approach of the President and that of the Group. Referring to the Group, the President concluded the meeting with the observation that "this exercise can be of extraordinary importance". He noted that the value of our exercise lies in its concern for the nature of the future relationship between our two countries rather than in its preoccupation with specific issues and, in this sense, it has a unique role to play. There is a need for a formalized framework to define the relationship between the United States and Mexico that will serve to orient that relationship in the future; it is necessary to visualize and anticipate future problems so that they can be dealt with constructively. At the moment, the United States and Mexico are dealing with traditional and specific problems (e.g., migration, winter vegetables, the gas deal), but these are not the most important matters. We are preoccupied with crises and not looking to the opportunities. The President observed at the beginning of the meeting that geography unites us while history separates us. While this is unchangeable, we must deal with problems and opportunities in the context of rules and with a view

to the future. The U.S.-Mexico relationship constitutes the most specific repre-
sentation of the north-south relationship, that between a highly developed country
and a lesser developed one with acute economic and social problems; between a
powerful country and a weak one.

Developing the relationship is all the more important against the back-
ground of a history of distrust and Mexico's sensitivity and need to retain its
sense of independence. There is a need to exercise political will and in a
manner that is respectful of the interests of both countries. The relationship
between the U.S. and Mexico is hampered by "emotional discharges" as in the case
of energy. It is necessary to rationalize the processes of our relationship in
order to find solutions that are respectful of the interests and needs of both
countries. This is what interests the President most; he is confident that
there are solutions to be arrived at.

These views of President Lopez Portillo were consistent with those put
forward by Messrs. Kissinger and Shultz. In their interventions, they expressed
the need to identify a framework and strategy for U.S.-Mexican relations that
is at one and the same time visionary and bold ("dream some dreams") and specific
and realistic. Only in such a context can we overcome historical legacies and
specific difficulties. The Mexico Group sees as its task that of undertaking a
serious study of the content and meaning of the idea of a community of interest
between our two countries and to examine specific areas of policy in direct
cooperation with President Lopez Portillo.

The discussion served to identify a number of areas that would consti-
tute the agenda for the Mexico Group. (These correspond to the topics identi-
fied in the background memorandum, dated August 3.) These are listed with the
comments made by the President noted in each case:

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1. Trade

Mexico is taking a new approach to trade policy, replacing the old approach of import substitution with one that is export oriented and reflects Mexico's industrial development program which is based on competitiveness. This program focuses on the development of capacity to produce and export capital goods and steel as well as to meet the consumption requirements of the lower income groups. Because of Mexico's interest in expanding exports, Mexico has to subscribe to rules for international trade relations and this explains her interest in joining the GATT for which discussions are already under way.

2. Employment-Migration

Mexico hopes to solve her unemployment problem by the end of the century with the use of oil revenues to finance economic development. Mexico hopes that the United States will maintain an open door to immigration.

3. Energy

The issue of energy in a global context will be discussed in the address to the United Nations in late September. Energy is a world responsibility since it affects all mankind. It is especially a problem for the less-developed countries who are caught between two blades of

a scissors: higher oil prices and reduced export markets
in the developed countries because of oil-induced re-
cession. This cuts off the possibility for the
economic development of the less-developed countries.
There is need for order and rationality in world commodity
markets in order to deal with these problems. In his
speech to the United Nations the emphasis will be on the
need to establish order in the exploration, production,
consumption, and distribution of oil including the need
to develop all alternative sources of energy not currently
being adequately exploited. No one country has sufficient
financial resources, however. Regional commitments con-
stitute an approach. The United States is Mexico's
natural customer, but the current gas issue is poisoning
the atmosphere. Mexico's energy production policy is not
solely a function of its reserves because Mexico must
avoid the deformation of its economy and society. Un-
like the Arab oil producers, Mexico can not just open the
valves; increased production requires investment and
borrowing and the threat of inflation must be avoided.

"Mexico must avoid an enormous banquet that can not be digested.") As to the current gas controversy with the United States, the two countries are currently negotiating over price. Mexico is not interested in the price *per se*, but in the principle to be applied in determining price. The price of gas should be linked

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to that of fuel already on the market and for which gas is a
substitute; since prices change over time, provision must be
made for changes in any agreed price. Since there is need for
a rational energy market with the United States, there is need
for a rational principle for energy pricing.

4. Canada

The Canadians don't appear to be interested in a trilateral
arrangement. Mexico does not know what form a relationship
with Canada would take although it does not rule out the
idea.

5. Finance

Despite the marked improvements in the position of the
Mexican economy, inflation is the toughest problem (apart
from Mexico's social problems) and constitutes the "chronic
ailment of democracies". In the less-developed countries, in-
flation can lead to social unrest and that to totalitarianism.
It is a particular problem for Mexico because Mexico can not
concentrate all its efforts on inflation at the risk of
sacrificing its economic growth and development.

V

August 13, 1979

MEMORANDUM

TO: PRESIDENT JOSE LOPEZ PORTILLO

FROM: U.S. MEXICO GROUP

SUBJECT: An Approach to a Joint U.S.-Mexico Economic Strategy

Interest in the subject of US-Mexican relations has been assumed the characteristics of a fad. In the US, four putative presidential candidates (Brown, Connally, Kennedy, Reagan) have in various ways alluded to the need to devise a special relationship with Mexico, especially in the field of energy. At the instance of the Senate Finance Committee, the Trade Agreements Act of 1979 (implementing the results of the Multilateral Trade Negotiations) calls on the President to submit a report within two years on possible trade agreements with countries in the northern portion of the western hemisphere covering energy and other sectors, and Senator Baucus of that committee conducted a day of hearings on June 6 on the possibilities of freer trade between the United States, Canada and Mexico. Similarly, a subcommittee of the House Science and Technology Committee held hearings on July 31 on technology transfers in exchange for oil exports from Mexico, and the Trade Subcommittee of the Committee on Ways and Means has hearings planned on Mexico-US trade in September.

Most of the proposals and ideas that have been bruited are at a high level of generality and tend, in the main, to focus on "a common market for energy" between the United States-Mexico-Canada, although some have addressed the question of trade relations in terms of some kind of preferential arrangement between the three countries. Neither approach appears to be very promising; an energy common market or an arrangement confined to energy is responsive to United States interests, but is not likely to be responsive to Mexico's perceptions of its needs and

interests vis a vis the United States. Various kinds of special trade arrangements
between the large and open economy of the United States and the relatively protected
and vulnerable economies of Mexico and Canada can encounter serious problems of
balance and symmetry in the undertakings of the parties.

At the same time, the interest manifested in both the US and Mexico in
constructing a relationship between the two countries clearly reflects the
existence of both a real need as well as an unusual opportunity. Despite a history
of friction and neglect, as well as a long agenda of problems in the relations
between the two countries--and perhaps because of them--the Mexican authorities
are committed to a constructive evolution of US-Mexican relations as is the US
government. For Mexico, this is an essential adjunct of her policy of reform and
renovation of the Mexican economy. The discovery and development of large reserves
of hydrocarbons in Mexico makes it possible for Mexico to address both issues,
that is, US-Mexican relations and internal reform, from a position of greater
confidence and enhanced negotiating power. The remaining three and a half years of
your term of office may present a unique opportunity to redefine the US-Mexican
relationship given your commitment and disposition to set Mexico on a course whose
evolution will take place over a number of years to come.

Problems and difficulties abound. Treating these problems and issues on
a case by case or category by category basis is not likely to yield the best
solutions. Unless the negotiations between the United States and Mexico are in-
formed by a sense of design and a frame of reference, negotiations on particular
issues are likely to become difficult and protracted, opportunities will be
missed, and frictions and difficulties multiplied.

Moreover, if the architecture of US-Mexican relations is sufficiently
bold and comprehensive, it will be easier to overcome individual problems and

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offset parochial concerns. The existing machinery of government in both Mexico
and the United States is probably incapable of devising and carrying forward such
a design owing to the fragmentation of bureaucratic responsibilities, the particu-
laristic concerns to which various components of the governmental establishments
are responsive, and the inability to negotiate trade-offs between unrelated areas.
The consultative arrangements between the two countries which emerged from the
Carter-Lopez Portillo meeting in February reflect such a fragmented approach.

Clearly any design must be perceived as balanced in both conception and
execution in terms of the interests of the two parties. Hard and protracted
bargaining is inevitable and any balance that may emerge will very likely have to
be weighed over a period of many years.

THE NATURE OF A DESIGN

US and Mexican economies are already closely intertwined for reasons of geographic propinquity and economic complementarity. This is particularly evident in the case of Mexico: approximately two-thirds of its external trade is with the United States; the United States is a major source of financing and direct investment; it is the destination for large numbers of Mexican emigrants. Because of this high degree of dependence and integration Mexico quite naturally looks to the United States as its principal interlocutor over a wide range of economic issues. Until recently, US interest in Mexico was largely confined to specific problem areas: migration, direct investment access, trade protectionism in Mexico, farm products trade, border industries.

Energy has clearly altered the scale and nature of the US interest aided by concerns about political stability in the area. Energy has also altered Mexico's perception. It offers the promise of resources to address Mexico's "national project" while, at the same time, converting Mexico's relationship with the United States from one that cannot be avoided to one that can positively and materially advance Mexico's goal of renewal. For the first time, there is a perception of balance and the possibility of reciprocity in the economic relationship.

In its simplest terms, the basis for a design consists of two parts:

(1) Mexico's interest in an assured and stable access to the American product and labor markets;

(2) the United States interest in access--on a secure, regular and quantitatively significant basis--to Mexico's energy resources.

The agenda would thus include such rubrics as trade, energy, migration, and economic development issues (including direct investment, financing, technical assistance, and rural development).

-4-

Any arrangement would have to meet certain tests in order to succeed:

it must reflect the balanced interests of both parties;

it must, particularly, be responsive to Mexico's needs
and respectful of her independence;

it must be consistent with and in the context of a
larger world order;

it must be ambitious in scope, but capable of achievement.

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TRADE

Background

The United States is Mexico's leading trading partner accounting for about two-thirds of Mexico's external trade; US-Mexico trade is in rough balance at a level of $6 billion each way. External trade accounts for about 10 percent of Mexico's GNP.

The US and Mexico clearly present contrasting cases in trade policy, differences which are accounted for by the different states of economic development, size of market, position in world affairs, etc. Mexico has in the past pursued an autarchic trade policy characterized by quantitative import restrictions, licensing, high tariffs, domestic content requirements, etc. This external policy reflected the internal industrialization policy of import substitution which necessitated protection at the border but has left Mexico with a significant component of its industrial plant vulnerable to competition. The present Mexican government intends to effect a significant change in industrial policy. The new policy emphasizes efficiency and competitiveness and looks increasingly to export markets. Mexico did participate in the Multilateral Trade Negotiations although a very modest bilateral negotiation with the United States has not yet been completed. Mexico has expressed an interest in becoming a contracting party to the GATT and may announce its intention to negotiate for accession to GATT before the end of the year. As a major advanced developing country, it has become akward for Mexico to be a "free rider" on past trade negotiations and, more significantly, membership in GATT would serve to exercise an external discipline for trade liberalization by Mexico.

The US market is not only important to Mexico today, but with the development of efficient industries capable of export, Mexico naturally will look to the

United States. In general, the United States market is today quite open to Mexican imports and, with the tariff reduction agreed to in the Multilateral Trade Negotiations which Mexico will benefit from under the most-favored-nation rule, import duties will be further reduced over the next eight years. The United States provides duty free MFN treatment representing 24 percent of Mexico's exports to the United States. In addition, about 10 percent of Mexico's non-petroleum exports enter the United States free of duty under GSP (Generalized System of Preferences). The average rate of duty on Mexican imports will be no more than 5 percent after the duty reductions agreed to in the Multilateral Trade Negotiations are completed. (It is 7 percent today). In addition, Mexico has been a major beneficiary of provisions 806.30 and 807 of the Tariff Schedules of the United States (covering 25% of its exports to the US) which provide for the assessment of duty on value added outside of the United States (instead of the total value of the imported article) and which has been a significant incentive to the development of Mexico's border industries.

Mexico's interest in United States trade policy and access to the US market has perhaps less to do with the general liberality of treatment in terms of the volume of trade covered than with the question of continuity and stability of access to the US market. With successful industrial development dependent upon access to export markets and particularly that of the United States, Mexico is concerned about having that access curtailed or limited by virtue of the operation of various provisions of US trade laws. A number of categories of trade important to Mexico are excluded from GSP (textiles and apparel, tobacco, tomatoes, steel, electronics, footwear). Others are in danger of being removed from the GSP list by virtue of a general decision that they are import-sensitive items or because Mexico's shipments under GSP have exceeded the "competitive need" standards (i.e., imports of $37.2 million per annum or imports in excess of 50 percent of

-7-

total US imports of the article in question). Railroad cars recently became a victim of the "competitive need" standard. Mexico's textile exports are limited by bilateral agreement between the US and Mexico under the Multi-Fiber Arrangement. Items entering under 806 and 807 are not eligible for GSP because they do not meet the rules of origin required for GSP eligibility. The example of winter vegetables under the antidumping act has been a particularly irritating case in point.

Both the subject of expanding access to the US market as well as the stabilization of that access, and particularly the latter, involve difficult issues. Liberalization or elimination of restrictions on exports of textiles and apparel engage the sensitivities of the textile industry and unions in the US. The items excluded from GSP involve import-sensitive industries. The application of dumping or countervailing duties requires a determination of injury and is not open to presidential discretion so that failure to apply such duties could invite judicial appeal and subsequent application. Thus, most of the specific issues that have arisen from Mexico's point of view in trade with the United States tend to involve hard cases which are difficult, if not impossible, of resolution within the confines of the individual cases themselves. Thus, for example, if the United States would wish to exempt Mexico from the application of the antidumping and countervailing duty laws or to provide for some special treatment under these laws, it would be necessary to construct a special legal regime for Mexico. Such a construction is likely to be feasible only as part of a larger, more comprehensive arrangement with Mexico.

## Options

Against this background, it is possible to identify a number of alternative approaches to a trade agreement with Mexico:

-8-

1. MFN Agreement

The United States could enter into a bilateral agreement with MFN for the
reciprocal reduction of import restrictions on an MFN basis, that is to say, where
reductions in import restrictions would be accorded to imports from all countries
entitled to MFN. Such an agreement is not likely to be very comprehensive as the
experience with the bilateral agreement in the Tokyo Round has shown since it is
likely to be confined to those products for which each party is the principal
supplier to the other. Nor would an MFN agreement permit a preferential treatment
for Mexico which would assure her of the stability of access to the US market which
she desires.

2. Common Market

A common market is a preferential zone with zero internal duties and a
common external tariff for the participants. It is consistent with the GATT
requirement of a common external tariff would itself condemn this approach.

3. Free Trade Area

A free trade area is comparable to a common market except that the indi-
vidual parties retain their own external trade regime and a lesser degree of
economic integration is implied. To be consistent with the GATT, there would
have to be a timetable for the dismantling of all import restrictions between the
United States and Mexico although a different timetable for the lesser-developed
partner is feasible. Special and preferential rules with regard to import re-
strictions for various purposes such as dumping, etc., could be provided.

4. Sectoral or Limited Free Trade

Any sectoral arrangement or arrangement that provides for free trade with
significant exclusions would by its nature be discriminatory and inconsistent with
the GATT. In addition, should Mexico accord preferential treatment to imports from
the United States this would violate a cardinal rule of US trade policy against

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"reverse preferences" accorded by less-developed countries to developed countries, an issue which became a <u>cause celebre</u> in connection with the reverse preferences which the African-Caribbean-Pacific countries accorded the European Community under the Lome convention. Nonetheless, it may be useful to study some hard cases involving sectoral arrangements in such sectors as petrochemicals, electronics, pharmaceuticals, and automotive vehicles and parts to see what light they offer for the general question of what kind of trade regime and agreement might be developed between the two countries.

## A Possible Approach

Because of the constraint against reverse preferences as well as Mexico's inability to dismantle its import restrictions (except, perhaps, on a timetable that reaches into the next century), a US-Mexican trade arrangement will necessarily fall short of a full free trade area. What is possible is:

(a) preferential duty-free access for Mexican imports into the US with assurances of security of access;

(b) gradual liberalization of Mexican import restrictions on an MFN basis;

(c) limited sectoral free trade between the US and Mexico in certain selected sectors.

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ENERGY

## Background

Trade and energy are linked through economic development. Mexico's principal task is to set in train an accelerated process of economic development financed by energy and sustained by access to world markets, especially that of the United States.

There is no doubt that Mexico has enormous energy resources although estimates vary widely as to the size of these reserves when fully proven. Proved reserves of oil and gas amount to 40 billion barrels which makes Mexico the equal of the United States, half the size of Iran and one-sixth the size of Saudi Arabia. Pemex has estimated the size of its potential hydrocarbon reserves at 200 billion barrels. Current production is 1.35 mbd of which 80 percent is consumed in Mexico; the United States imports 80 percent of Mexico's current exports of oil.

The official position of the Mexican government is that in 1982 Mexico will produce 2.2 - 2.5 mbd of which 1.0 mbd will be available for export. Of this 1 mbd only about 60 percent will be available for the US market, an increase of about 400,000 mbd above current levels. A number of observers have suggested that, in terms of the efficient exploitation of its oil fields, a much higher rate of production is feasible perhaps 4-8 mbd by 1990.

The United States clearly has an interest in a significant expansion of Mexican oil production destined for the US market. Mexico presents a secure source of supply and the United States is Mexico's natural market for oil, one which yields the highest net price because of low transportation costs. A measure of United States interest in Mexican oil can be seen from President Carter's synthetic fuels proposal. The proposal calls for the expenditure of $88 billion by 1990 on domestic development of synthetic fuels to yield an increment of 2.5 mbd of oil by 1990.

-11-

A comparable increment in US oil supply is well within Mexico's physical capacity to produce. The cost to the United States economy and environment would be considerably less than the proposed synthetic fuels program. Some part of the $88 billion financing if applied to expanding Mexico's production of oil would without doubt yield higher returns than the same amount applied to synthetic fuels production within the United States.

## A Possible Approach

The elements of a US-Mexico agreement on oil could consist of the following:

1. a "lifting" agreement under which the United States government undertakes to purchase certain quantities of oil for a certain period of time and at a stipulated price. In practice, the US government would actually purchase any amount not acquired by private US companies.

2. Mexico would be exempt from all import duties and fees and any import quotas which may be applied in the future.

3. The United States would be prepared to finance or guarantee loans for capital investment and other costs associated with the expansion of petroleum production (perhaps from the resources of the Energy Security Corporation).

## Mexico's Requirements

Clearly the root of Mexico's interest in a bilateral arrangement with the United States on energy (as part of a larger package) is firmly planted in Mexico's perception of her development requirements. How much oil does Mexico have to produce and export to support its growing domestic requirements as well as to generate required foreign exchange and over what period of time? How much external borrowing capacity does Mexico have? What debt service can Mexico reasonably sustain?

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A major constraint on the expansion of petroleum production and exportation comes from a desire to avoid what you have described as "monetary indigestion". The models of Venezuela and Iran are not those which Mexico wishes to emulate. Of course, the Mexican economy and Mexican society are not those of Venezuela and Iran and Mexico has a relatively high capacity to absorb incremental revenue in its economic development without generating accelerated inflation and social unrest. Are there any techniques or instruments that can be devised for insulating the increment of revenue from additional oil exports to the United States which the Mexican government would not wish to see enter the Mexican income stream? Should any such financial arrangement be made an explicit part of a US-Mexican agreement?

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MIGRATION

Background

The question of undocumented workers has been an old and festering issue
in bilateral relations. It grows out of Mexico's demographic condition and con-
stitutes a safety valve important to Mexico. Mexico's population is 65 million,
growing at an annual rate of 3.5 percent and calculated to reach 120 million by
the year 2000. 45 percent of its population is under 16 years of age so that
the increase in the prospective labor force by the end of this century has already
been born. Mexico has a work force of 18 million workers estimated to increase
to 35 million by the end of the century. Approximately 40 percent of the Mexican
labor force is estimated to be unemployed or underemployed.

The lure of the United States job market is evident from the differential
in minimum wages between the two countries: from a high of $7 a day in Mexico to
a US minimum of $23. Per capita income in Mexico is $1300 a year. Given these
facts, it is understandable why so many Mexicans have sought to leave Mexico.
The internal migration problem within Mexico from rural to urban areas is even
more severe.

The number of undocumented Mexican workers in the United States is a
matter of controversy since no reliable data are available. Estimates range from
2 to 8 million; a Mexican official has suggested 4 million.

The issue of migration has become acute whenever the US has threatened
or acted to cut off immigration or to undertake roundups and deportations. The
US has conducted four deportation campaigns: after World War 1; during the early
30s; in 1947; and in 1954-55 as "Operation Wetback". The pressure for deportation
and limitation on immigration rises as the US economy weakens.

President Carter submitted a legislative program in 1977 which would have provided for (a) amnesty for about 750,000 undocumented workers who entered before January 1, 1970, (b) a limited amnesty for those who arrived between January 1, 1970 and January 1977, providing for five-year work permits with their status to be determined after the expiration of the five years, and, (c) provision for civil penalties on employers hiring workers without permits. This legislation was not reported by the congressional committees and was not pursued aggressively by the Carter administration.

## A Possible Approach

From the US point of view it seems clear that some degree of regulation is necessary if only to control the rate of increase of immigration which has been increasing. Some combination of the following measures has been suggested:

(1) an amnesty program with some limitations perhaps patterned on those of the Carter 1977 legislative proposal;

(2) a significant expansion in the Mexican immigration quota which stands at 20,000 a year;

(3) the issuance of work permits combined with penalties on employers who hire undocumented workers.

Severe restriction on undocumented workers from Mexico would not only inflame US-Mexican relations, but may very well not be in the interest of the United States. Our own demographic developments, marked by an inverted population pyramid, may very well require additions to the US labor force such that there exists a degree of complementarity between US and Mexican requirements.

A TRIPARTITE ARRANGEMENT?

Some form of continental or tripartite cooperation among the USA, Mexico and Canada has been suggested. Most of these have emanated from the United States although Mexican officials have mentioned the possibility of a joint summit meeting of the three heads of state. The Canadian government does not appear to be interested in a tripartite arrangement. Canada is satisfied with its present bilateral arrangements with both the United States and Mexico. The Canadian ambassador in Washington recently noted that regional free trade agreements "failed to reflect adequately either the political or economic realities in Canada and in particular our deeply felt concern with the issue of national sovereignty". Access to Mexican energy resources is however, a subject of interest for Canada which is a net importer of oil; Canada has contracted to buy Mexican oil.

Beyond Canada, the question has also been raised as to whether any arrangements devised for the northern tier of the western hemisphere should not include the Caribbean countries as well as those of Central America.

How should the prospect of Canadian participation on a tripartite basis be viewed? Would it facilitate or complicate any arrangements?

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SOME MODALITIES

1. Should the Mexican and US governments feel that a major initiative is desirable, some consideration will have to be given to how the preparatory work might best be undertaken. Apart from normal government to government discussions, it has been suggested that it might be useful either to (1) give the assignment to Mexican and US "wisemen" (after the seminal role that Jean Monnet played in the construction of the European Community) and/or (2) establish a joint commission of mixed government and private representation to define the framework for such an agreement.

2. It may be useful as a point of information to note that, from the US point of view, the instrument which may be negotiated to embody any major agreement that may be concluded is not limited to either a treaty or conventional implementing legislation. The Trade Act of 1974 provided an innovative procedure which was used to implement the agreements concluded in the Multilateral Trade Negotiations. This procedure is continued in the Trade Agreements Act of 1979 and is available for use in the future and would apply to a US-Mexican agreement which had a significant trade component. Involved is a privileged procedure for the consideration by the Congress of legislation to implement trade agreements. The privileged character derives from the fact that such legislation, once introduced by the President, is not subject to amendment, must be discharged from committee within a stipulated number of days and must come up for a vote in each House within a stipulated number of days. This procedure worked remarkably well for the MTN agreements owing to the fact that there was close and continuous consultation as the agreements were negotiated between the executive and legislative branches and with the advice of an elaborate private advisory committee structure.

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# Summary

This paper is divided into two sections. Section I establishes the basis for economic integration, setting the stage by analysing the present state of integration with respect to trade, capital markets and monetary policy, and factors of production. Section II addresses the relevant issues to be studied before further plans for integration can be pursued. It is important to note that this study is directed mainly toward Mexico.

## The Present State of Integration

The United States is by far the largest market for Mexico's exports (70% in 1978) and is the largest supplier (about 60%) of imports. Furthermore, 90% of Mexico's tourist recipies are provided by the U. S. and Canada. At first glance this might imply that Mexico has fully utilized the North American market to its advantage, but this is clearly not so. By comparison with the EC countries, Canada, Korea, and even the U. S., Mexico derives little of its Gross Domestic Product from exports (for 1975 Mexico's export to GDP ratio was only 3.5% compared to Korea's 27%). Mexico has not utilized the U. S. market for several reasons; the most important of which is that Mexico pursued an import substitution development policy directed at replacing its imports of industrialized consumer goods by domestic production. This policy has been followed since World War II at the expense of traditional export industries and agriculture. Thus, Mexico has not emphasised export industries in the past, and some of the new manufacturing industries that have been created during the import substitution drive are too inefficient to now face exposure to U. S. competition. The auto industry is a case in point. To promote import substitution, tariff and non-tariff barriers to trade had to be created (Mexico is not a member of GATT). These barriers protect everything from food manufactures, intermediate goods, and toys, to autos. On the non-tariff barrier side, state agencies (such as CANASUPO) effectively decrease the level of international competition. To open industries to international competition at this time might endanger some, while others could compete. The unevenness of import substitution led growth is all too apparent in the Mexican economy with the efficient steel industry next to a weak agricultural sector; indeed, the agricultural sector desperately needs new investment. One final note on trade: Mexico is now in a position of strength in its bargaining for new economic relations with the U. S., due to its new oil wealth. Since PEMEX, the state oil company, has been slow in developing this resource, and it has been only in the past four years that significant export revenues have been earned from oil, Mexico is just beginning to benefit from oil. With the oil wealth comes the problem of how to use it to further develop its other resources. That is, does Mexico follow the Venezuelan, Iranian, or Texas model of development? Mexican officials are very conscious of the difficulty in planning properly the use of oil wealth for development purposes. They certainly want to use this wealth to build a complete economy, not an economy anchored on one export.

With trade integration in the North American market, there would be greater potential for capital and financial market integration. Mexican financial markets expanded rapidly during the fifties and sixties. Only in the middle seventies (the peso crisis) did this growth show signs of subsiding. Today the Mexican financial market is once again growing rapidly, providing the savings upon which the authorities have traditionally relied to make larger infrastructure investment. At present these markets are already reasonably integrated into the North American capital market, with financial flows between Mexico and the U. S. open and free. And, from the Mexican point of view direct and indirect investment presently pouring into Mexico are under control. Indeed, with its new found oil wealth, Mexico finds itself in the enviable position of being able to pick-and-choose the investment it desires.

Any integration program would have to consider free mobility of factors of production, both labor and capital. Presently, the border industries, which import goods from the U. S., finish the products and ship them back to the U. S., offer the basis for fixed factors of production integration. This has been a tool utilized to attract investment to relative labor abundance, without necessitating the opening of the Mexican economy to full competition. On the other side, human factors of production already flow into the U. S. from Mexico in the form of legal and illegal immigrants. Indeed, Mexico sees the U. S. as the safety value for their burgeoning population. At present, since many of the immigrants are illegal, the U. S. does not have to provide the social services which it would otherwise have to extend to these "guest" workers, and the U. S. is provided relatively inexpensive labor. By the same token, many of the workers return to Mexico with some new skills, and in doing so, repatriate experience and foreign exchange. The worry, for Mexico, over integration is whether the next wave of immigrants, if integration legalized movements in human factors of production, would be skilled or unskilled. The former would not be beneficial for the long run development of Mexico.

## Issues to be Address

There are several questions which must be addressed before further action, from an economic point of view, is taken on the issue of North American integration:

1. If the Mexican officials decide they want to liberalize trade, geared toward eventual unification into a common market framework with the U. S. and Canada, they must consider how soon this is to take place since there will be economic disruptions associated with integration.

2. Many of Mexican's protected industries (almost all are protected) will be faced with competition for the first time. Which will be most effected, and can they stand the competition?

3) Will the freer exchange of goods and services actually lead to a more rapid path of development? If we answer yes to the long term, what will be the cost in the near term? One might consider that Mexico would possibly favor selective reductions in barriers from the U. S. and give up selective barriers to U. S. goods as an alternative which would cause less short run disruption to the status quo.

4) The real question in the minds of most policymakers is whether or not Mexico can best utilize its new oil wealth in a free market, a closed market, or some combination of the two extremes. At present Mexico benefits from OPEC but has none of the responsibility of enforcing the cartel, and with the captive U. S. market it can decide how and at what pace it desires to exploit this resource.

5) Does Mexico have anything to gain from a closer tie to the U. S. capital market? Although the question can be answered yes it is difficult to place quantitative measures on the benefits from capital market integration. This question will have to be more fully addressed by the relevant planning agencies.

6) Could the concept of the border industries be expanded and would new industries move from the U. S. to Mexico if integration occured? Although it is certain new industries would move to Mexico, it is not certain that these would simply be offset by those Mexican industries closing due to new competition. It is true that the mesh would be better, and investment in areas of relative weakness such as agriculture could occur with the removal of U. S. barriers; however, much study will be needed to evaluate the relative impacts.

7) New capital factors of production most needed are in labor using industry. Mexico must question whether this industrial technology can be gained from integration or not.

8) Mexico must address itself to the issue of whether skilled and semi-skilled labor would leave Mexico. It is quite possible that Mexico, with integrated labor markets, would be exporting the labor it wanted to keep faster than it was exporting the non-skilled labor.

9) Finally, from a moral, political, social point of view, is the mobility of labor desirable for the long run stability of the two economies?

Before any further study of the issues is pursued a larger, "macro" question must be addresed. That is, where does the U. S., Canada, and Mexico want to be in the next century? Will economic integration help us attain our goals?

Following the economic disruptions of the 1974 -1975 world slump and the Peso devaluation of 1976, Mexico has seemingly bounced back stronger than ever. Real growth in 1978 was back up to 6.6%, inflation is being battled, the current account has improved sharply, and financial stability appears to have returned to Mexico. And with the oil crisis of 1979, Mexico finds itself in the enviable position of being compared to Saudia Arabia as a potential world oil supplier.

This enviable position, especially in the face of the large energy demands from the U.S. (the U.S. on a Census basis is estimated to be importing between $51-$54 billion dollars worth of petroleum and petroleum related products in 1979), raises the question of how can Mexico, the U.S., and Canada best utilize this confluence of events to promote the general economic growth of the hemisphere. Just as oil is in great demand in the U.S., Mexico has a need for more jobs for a relatively underemployed population. The economic power of the U.S., in tandem with the human and mineral resources of Mexico and Canada, offers great potential to its peoples. But before one charges into the assumption that economic intergration is the obvious way to fulfill this potential future, let us remind ourselves that the hemisphere already has a well developed flow of goods, services, capital, as well as both fixed and human factors of production. Seventy percent of Mexico's exports and 66% of Canada's exports go to the U.S. Mexico attracted $1.1 billion in tourism from the U.S. and Canada, which represented 90% of total tourist expenditure in Mexico during 1978. Canada and Mexico claimed, respectively, $1.5 billion and $200 million in direct foreign investment from the U.S. in 1977, bringing the totals at year-end 1977 to $35.4

2.

billion in Canada and $3.2 billion in Mexico, or about 30% of all U.S. direct investment abroad. By the same token the U.S. has traditionally been a haven for Canadian and Mexican investors alike. Finally, Mexican labor has traditionally played a large role in the development of many industries in the U.S. Indeed, the U.S. "outlet" is seen by many Mexicans as the "safety valve" of the domestic population explosion (presently growing between 3% and 3.4% annually). And, through the border industries for Mexico and the auto pact for Canada, the fixed factors of production have flowed to labor when labor could not flow to the capital. Thus, at first glance it appears that there is already an established infrastructure for economic integration.

This paper is divided into two sections. Section I establishes the basis for economic integration, setting the stage by analyzing the present state of integration with respect to trade, capital markets and monetary policy, and factors of production. Section II addresses the relevant issues to be studied before further plans for integration are pursued.

It is important to note that this study is geared mainly to Mexico and considerations relevant to it. Facts and questions with respect to the U.S. and Canada are not raised with respect to their individual perspectives, but only to complement the analysis with respect to Mexico.

# I. The Present State of Integration

## Mexican Trade

As mentioned above, Mexico and the United States already share a great deal of economic integration. Figure 1 shows Mexican exports in billions of dollars for 1978. It is obvious that the U.S. is by far the

3.

dominant market for Mexican exports, with 70% of the total going to the U.S. in 1978. If the U.S. and Mexico can come to an understanding with respect to oil and natural gas, a relatively new export for Mexico, then the U.S. will begin to take an even larger share of Mexico's export flow. Add this to tourism from the U.S., which is also growing, and it becomes clear that exports to the U.S. are becoming an even more important factor for Mexico's future development.

This may be somewhat misleading, in that it implies that Mexico is fully utilizing the largest single export market in the world, the United States. However, if we look at Figure 2 it is evident that (for 1975) Mexico is not really an export orientated country. By comparison with what is considered the best example of a closed economy, the U.S., Mexico earns very little of its gross domestic product (GDP) from exports. This fact becomes increasingly obvious when we compare Mexico to another developing economy, Korea. Mexico has an export to GDP ratio of only 3.5% while Korea's ratio is almost 8 times as great at 27%. Export oriented industrialized economies such as Canada, Italy, and Germany all have higher export to GDP ratios than Mexico. From these data it is evident that Mexico has not utilized the North American export market to the fullest possible extent. Indeed, in much of the period following World War II, Mexico has become an increasingly closed economy.

Referring to Figure 3 we note that until 1973 Mexican exports were growing relatively slower than GDP (all countries are indexed on 100 in 1975). This was just opposite the developed countries' case, and in comparison to Korea, Mexico was clearly on a different growth path.

One of the central reasons that Mexico has not yet experienced massive growth in its exports, and looks to this sector for sustained

4.

growth, is that it adopted, along with many of the Latin American countries, an import substitution development program following World War II. As a result, traditional Mexican export industries were made to suffer, as resources were necessarily siphoned off into other developing sectors. Furthermore, these new industries were mainly directed toward providing substitutes for imports, not necessarily toward export markets. Although the authorities have to some extent abandoned these development policies, several sectors of the Mexican economy still feel past neglect. Agriculture, which should be a labor absorbing, growth oriented export sector, is still in a relatively weak position vis-a-vis the position it was in during the 1930s and 1940s. Also, traditional mineral exploitation industries have been suppliers rather than recipients of investment. And finally, the set of barriers and counter-barriers placed upon the Mexican economy has done little to force the bulk of the industrialized sector to become internationally competitive.* Thus, Mexico finds that it has successfully made itself less dependent upon the rest of the world, but by the same token, it has lost many years of possible exploitation of the United States market.

Creating a more open atmosphere for the economy has now become increasingly important. Mexico is attempting to remove some of the non-tariff barriers such as licensing. Traditionally, Mexican industry not only enjoyed high tariffs but quota and other non-tariff barriers as well. For example, autos were heavily protected with actual restrictions on imports, besides huge tariff barriers. Intermediate goods

*Even with these barriers the percentage of exports classified as manufactured rose from 6.7% in 1950 to 36.7% in 1978. This reflects less the growth of manufactures for export than it does the slow growth of traditional export industries such as minerals and agriculture.

5.

manufactures are protected in many ways, with effective tax rates as high as 100% in many areas. Foods manufacturing, consumer durables, drinks, and tobaccos enjoy high tariff walls while, as would be anticipated, capital imports are fairly free of tariff restrictions. But of course Mexico does not have exclusive control over tariffs. The U. S. has tariffs and several non-tariff barriers on Mexican exports of agricultural products. And naturally, Mexican manufactures do face some tariffs although Mexico does enjoy several special relations with the U. S. due to its classification as an LDC.

In the early 1970s some of the policies aimed at import substitution growth were turned around and more emphasis was placed upon labor absorbing industries, such as agriculture. However, many of the economic reforms were short sighted or not allowed to be fulfilled because of macroeconomic considerations. President Echeverria's administration, in attempting to bring about economic and social reforms, actually may have led Mexico down a blind alley. The goals of the administration to break with some of the "old" ways by redistributing jobs and income could not be fully realized. Thus the end of his administration saw few economic gains, higher rates of inflation (indeed stagflation), political turmoil, and a rapid deterioration of the balance of payments. However, he did accomplish two very important things from this paper's perspective. First he began a turnaround in Mexican investment by providing outlays for agriculture, a heretofore under-utilized engine for export led growth; and second, he laid the groundwork for Lopez Portillo to bring the economy onto a more export oriented growth path, especially in the face of the world's increasing appetite for energy.

6.

As we look to the 1980s then, Mexico should begin to see a
growing proportion of its overall income derived from export oriented
industries, even under the present set of laws governing its trade.
Oil will certainly dominate this growth, but other infant industries
are becoming competitors in world markets, (for example, the steel
industry). And with better development of the agricultural sector,
combined with selective lowering of barriers in the U.S., Mexico could
be in position to gain from Echeverria's investment in this sector.

The real concern as to whether this development will be the
most beneficial path for Mexico lies in its ability to diversify away
from oil as an export. Looking at Figure 4 we note that oil has not
been a major source of revenue for the Mexican authorities in the
past. Indeed, export earnings from oil were only 22% of total
merchandise export earnings in 1977 and 33% of total exports in 1978.
Of course this will grow over time, but Mexico could soon be faced
with the Dutch dilemma. That is, if the currency is propped up by oil
alone, how can other export industries develop? This problem, in the
context of Mexico, might better be analysed with an eye toward what
has happened in an energy rich section of the U.S., rather than what
has happened in Holland or Saudia Arabia or Venezuela. The states of
Louisiana and Texas have found energy resources to be the foundation
upon which related industries are being developed, both manufacturing
and service industries. This is just the opposite of what happened in
Holland. And, instead of being priced out of the market more
industries are clamouring to move to these areas. Given a stable
currency, excess labor, a stable source of energy, and sufficient
incentive, Mexico should also be able, with reasonable planning, to
follow the Texas model rather than the Venezuelan model.

7.

Mexico has already gone a long way toward developing an export sector geared mainly to the U.S. These industries, commonly called border industries, import component products from the U.S., convert them to finished goods, and then reexport these goods to the U.S. They are located along a stretch of the border which acts similar to a free trade zone for certain products. These industries, which developed because of normally large barriers to trade, already lay the basis for future integration. They also set the stage for what Mexico needs to obtain from trade -- jobs and a market for its products, not only a buyer for its oil.

In summary, Mexico's export capability is not in the same position it would have been in had policies of import substitution not been implemented following World War II. But some of the barriers to efficient export production are being discarded with the realities of the 1970s, and heretofore neglected sectors are again gaining the attention of policymakers. With the discovery of huge potential oil supplies, Mexico now faces the problem of how best to utilize these revenues for growth, and how to avoid becoming a one product exporter. Certainly, the incorrect way to avoid this problem is by abandoning the present efforts to tear down some of its domestic trade barriers. And, by the same token, Mexico must make renewed efforts to make gains in the world's largest single market, the United States.

Finally, one other factor in Mexico's overall trade picture, which cannot be ignored, is tourism. This industry, which absorbs enormous amounts of semi- and unskilled labor, is one of Mexico's major exports. Tourism accounted for $1.2 billion in export revenues in 1978, equal to 67% of revenues from oil exports. Tourism is an

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area upon which Mexico intends to place even more emphasis since it
has the dual role of absorbing more labor while producing extra dollar
revenues.

Financial and Capital Markets: The Mexican Position

With the maturation of Mexican financial markets in the 1970s, Mexico is in much better position to fully utilize this sector to create growth. During the 1950s and 1960s, real growth in Mexican financial markets was at a rate of about double that of real GDP growth. Even though this growth decelerated sharply in the early 1970s as the market began to anticipate the economic turmoil of 1975 through 1977 (and as a result its resources were no longer sufficient to pay for an increasingly larger government deficit) financial markets are once again in position to aid development. Since 1977 the Mexican stock market has hit new highs, new forms of financial intermediation have been introduced, and a greater sophistication on the part of the Mexican investor has been developed.

The proximity of Mexico to the United States has long been a
driving force in the development of capital markets in Mexico. This
force, for the most part, has been positive. Financial stability,
during the 1960s and early 1970s was perceived as a necessary
condition to attract direct and indirect investment from the U.S. into
Mexico; Mexicans liked to refer to themselves as the Switzerland for
Latin America during the period. By safely being pegged to the
dollar, Mexico was in a position to attract the capital it needed to
fund the development of its many resources, while maintaining control
over this investment. Except for the 1975-77 period of financial
turmoil, Mexico was able to fulfill this desire and utilize its

9.

growing market as a source of funding for government investment. The substitutable nature of the two currencies allowed investments and capital to circulate in Mexico as if it were part of a unified North American capital market. Only the policies of fiscal and monetary expansion, inconsistent with the rest of the world during the middle seventies disrupted this steady flow of funds. Of course, the rebound by the economy and the stability of the peso, along with Mexico's compliance with the IMF's guidelines, are now history. But it must be noted that the present environment of large supplies of funds being lent or directly invested in Mexico is a result of sound economic and financial management. As long as Mexico, given the present integration of the capital markets, maintains a monetary and fiscal policy stance reasonably similar to that of the United States, there should be no problem in Mexico attracting funds for investment and development. The question most Mexicans have today is not if they will receive the funds, but on what terms can they obtain them. At present, it is usually on a pick-and-choose basis for the Mexicans. From their perspective they have access to the most sophisticated capital markets of the world and already belong to an optimal currency area around the dollar.

## Factors of Production

### A. Capital

From the perspective if a labor rich country one of the most obvious rationales for joining a common market, where the other participants are more industrially advanced, is to use this "cheap" labor as an incentive to attract new industry. Creating new industries, along with the concept of import substitution, has been a

10.

goal of the Mexican government for some time. Industrial development, rightfully or wrongfully, is the goal of import substitution development. Development of the infrastructure needed to attract new industry, tax havens for industry, and direct government investment in industry (such as PEMEX) have all played a role in the recent industrialization of Mexico. Presently, Mexico has 24% of its GDP contributed by manufacturing. Manufacturing now ranges from relatively labor using, traditional cottage industries, to the most modern steel making processes (6.7 million tons produced in 1978). Mexico is the 12th largest passenger car producer in the world and the 9th largest commercial auto producer. High technology, chemical, petrochemical, textile and shoe industries as well as border area assembly plants have all contributed to the rapid growth in manufactures. In many respects, following the crisis of the mid-seventies, and in the face of larger oil reserves, Mexico is in the position of choosing what industrial groups, firms, and investments it desires to pursue. Attracting new industry is not now an overwhelming problem for the Mexican officials; locating it to more fully utilize the underemployed population is of much greater concern.

On the negative side, import substitution policies have created several inefficient industries which are not yet ready (and probably never will be ready) to face outside competition. The automobile industry may be a case in point. For this reason, Mexico is seeking selective measures to make many of these import substitution industries more competitive with the rest of the world.

During the period of industrialization certain sectors, again one must note agriculture as an example, have been bled of resources by unfavorable tax and credit treatment. It is now the problem of the

11.

present administration to address these misallocations of resources.
Some progress has been made on this front, but much more effort is
needed; further economic integration could allow market forces to work
to restructure industry by forcing resources from inefficient,
protected industries into other, more efficient areas. With respect
to agriculture, and especially with respect to labor intensive forms
of agriculture, efforts could help alleviate many of the distortions
in the demand for skilled versus unskilled labor.

B. Labor

On the human side, these factors of production are not
homogeneous. This is true in Mexico as well as between Mexico and the
U. S. Presently, there is some scarcity of skilled labor, and wages
and standards of living of employed blue collar workers reflect this.
The problem lies with how Mexico is to educate and employ its
abundance of new entrants into the labor force who are relatively
unskilled. This problem is multiplied by an ever expanding population
and age distributional distortions. Mexico is expected to have six
million new entrants into the labor force during the next 10 years;
and the labor force (counting unskilled and underemployed workers) is
estimated to presently be 20% to 40% unemployed. Further, this labor
force is growing most rapidly in the population centers, which must
somehow offer the basic services necessary for even modest survival.
Because of the wide variance in the productivity of Mexican labor,
extremely skewed income distributions are now present in most cities.
In fact, Mexico has one of the poorest records on income distribution
among the developing nations. It is not anticipated that this problem
can be cured overnight, since many of the programs of the last
administration aimed at curing the problem actually have been seen, in
retrospect, to have aggravated the situation.

12.

Given this uneven productivity of labor, spot shortages of skilled labor appear in a country with labor abundance. Skilled jobs go wanting and unskilled labor migrates to the already overburdened cities in hope of landing some type of job which might later lead to a skill. The problem with this type of development model, which is all too apparent to the planners in Mexico, is that advanced technology production techniques cannot absorb this labor force. Only investment in labor using technology -- something which cannot be purchased from the U.S. -- can lead to quick utilization of this labor. Heretofore investment in those sectors which would absorb this labor, has not been forthcoming, with the exception of the development of the tourist industry. Mexico is now attempting to solve some of these old problems aggravated by import substitution development.

At present, what Mexico needs from the U.S. is not new investment in industry, but an actual outlet for some of its excess labor. This is now occurring through migration of labor to the U.S., both legally and illegally. One problem for Mexico with this migration is that much of the legal migration takes needed skills out of the country. On the other hand, illegals leaving Mexico for temporary employment in the U.S. (it is estimated 1/2-1 million illegals enter the U.S. annually) often return with some newly obtained skills -- though most work in agriculture -- and repatriate needed foreign exchange. One need only look at the size of the errors and omissions in the Balance of Payments section of the National Accounts to see how large undocumented transactions really are. Mexican labor migration to the U.S. has traditionally been seen as a safety valve for unemployed Mexican workers.

It is not clear that removing barriers to movements in factors of production which would be a part of any comprehensive common

13.

marketplan, would solve Mexico's excess labor problems; indeed, it
could cause a problem of draining from Mexico the more skilled
(relatively scarce) human factors of production. From the U.S.
perspective, having to pay for the social services surrounding the
then legal migrating labor (which is not now officially necessary) may
make this labor less attractive, even if one ignores the moral and
political questions involved with free labor migration. Thus, at
present Mexico has somewhat of a safety valve for excess supplies of
labor while at the same time it has not fully given up control of it.
And by the same token, Mexico is now turning investment toward those
sectors which may eventually be able to absorb more of this labor and
is in the process of attempting to bring jobs and opportunity to these
people without further aggravating the problems of urban poverty.
This will be a difficult task and will not be solved overnight. It is
hoped that with the long run planning of the present administration
(in attempting to break out of the Presidential cycle problem Mexico
has traditionally faced), and the new found oil wealth, the Mexican
government will have the resources needed to start alleviating many of
the distortions left over from past development models.

II. Issues To Be Addressed

In consideration of the present path of the Mexican economy,
with respect to trade, capital market development, and factor of
production development, it is necessary to ask some questions before
further efforts toward integration can be undertaken. These questions
deal directly with the three areas mentioned above, as well as the
more nebulous frontiers, such as, what situation do we want to face in
the year 2000? Again we will restrict our discussion to questions
relevant to Mexico.

14.

Trade Integration

1) Mexico must consider whether or not it wants to adopt a more aggressive export oriented development model. As noted above, during the 1950s and 1960s it chose not to push export sectors, and in fact hindered export growth with import substitution subsidization. Now, Mexico is turning more toward export promotion, but on its own terms, which are not geared toward completely opening its economy to the world market. The first question, then, is how aggressively do the Mexican officials want to pursue this type of development policy, and how quickly? Clearly, if the adjustment is too slow or too quick, consideration must be given to the allocation problems associated with each alternative.

2) A second question closely related to that above, which can only be answered after long research is, can Mexico's fledgling industries stand up to international competition? Or more specifically, at what time in the future and under what circumstances can they compete in world or U.S. markets? These questions cannot be answered easily, as they require involved research and discussion.

3) Will the freer exchange of goods and services lead to a more rapid path of development? If we answer yes to the long term what will be the costs in the near term and the medium term?

4) Is full economic integration -- in terms of goods trade -- more beneficial than selective bargaining for a lowering of certain tariffs in the U.S. to Mexican goods such as agricultural exports? That is, can Mexico have concessions from the U.S. without placing its own less competitive industries in jeopardy? With the oil lever the answer may be yes, but again, this is open to debate.

5) Before any undertaking is begun the authorities will need to question what industries will be impacted, and thereafter ask if these are vital to social order or the present political stability.

15.

6) Can the new found oil wealth be best utilized in a framework of protection -- note that Mexico derives monopoly power from OPEC without being responsible for its power -- or in a framework of an integrated economy? Will too much dependence upon the U.S. lead to less than optimal pricing and production decisions for PEMEX? By te same token, will integration assure the U.S. of a cheaper or more uncertain supply of oil?

7) This last question leads to one final rather obvious question on trade; do the Mexican people desire to be more closely associated with their North American neighbors?

## Capital Market Integration

1) Does Mexico have anything to gain from a closer tie to the United States capital market? This question can be easily answered with a resounding yes. But to place quantitative measures on these benefits is extremely difficult, especially given the present state of market integration. Certainly one could argue that technology could be transferred to the Mexicans and the two countries could better cooperate on policy decisions, but this is already happening through education in U.S. institutions, as well as relationships between monetary authorities, international banks, and international authorities.

2) Similarly, one could ask if Mexico would obtain larger flows of investment through further integration? This is more difficult to answer. But one result of capital market integration is certain -- Mexico would have less government control over how and where investment is utilized. The freer the market, *ceteris paribus*, the more difficult it will be to control targets of investment.

16.

3) Will Mexico give up any freedom of monetary policy action if integration takes place? The answer is yes, but again the extent to which policy integration now takes place suggests that these losses would be small. And, there could be benefits derived from further coordination of policy given the present levels of currency integration.

Factors of Production

1) If markets were further integrated would Mexico gain plants and equipment? Yes, most analysis would agree that new firms would locate in Mexico if they were assured that the U.S. market would be receptive to their products. The border industries are a vehicle already being utilized by Mexico to take adantage of lower relative labor costs. However, the extent to which such investment would be an improvement to Mexico over the situation presently existing -- or a possible situation developed around selective reduction in trade barriers -- must be analyzed in depth.

2) Would Mexico be able to obtain the type of fixed factors of production which would help alleviate its present unemployment problems? This is the key question which rests at the heart of any Mexican decision to open its economy, and is the answer most needed.

3) Would fixed factors of production leave Mexico under integration? Some no doubt would, as their markets were opened to U.S. competition. However, whether these losses would be offset by gains from new plants moving into Mexico or not is a difficult question to answer.

4) Will the fixed factors of production move to relatively cheaper labor, or will Mexico find itself exporting skilled and

17.

semi-skilled labor to the U.S.? This question can be posed in
reference to the migration of fixed factors of production as well as
labor. If not now, then would this be the case later, when the
demographics of the U.S. labor force move in a way that larger demands
will be placed on a (relatively) shrinking labor force?

5) A question which must also be raised here from the U.S.
point of view is, does the U.S. want to take the responsibilities for
providing the social services for all of the present, much less the
potential, "guest" workers now in the country illegally? Furthermore
if the U.S. does open its doors to Mexican labor, will only the
unskilled farm and menial labor leave Mexico, or will Mexico find
itself short of more skilled labor? Can Mexico afford to take this
chance or is the present situation better?

6) Finally, from a moral, political, social point of view, is
free mobility of labor desirable for the long run stability of the two
economies?

These are just a portion of the many questions which will have
to be addressed by economists, sociologists, and political analysts
before one begins to undertake plans for further integration of the
economies. In our mind, the key question from Mexico's point of view
is, Is it possible for them to obtain the inputs into their economy
and the market for their goods without full integration? Presently,
their policies suggest that they think answer may be yes, especially
in light of the energy leverage they presently have.

Concluding Comments
---

Before one attempts to answer the above questions or draw up
plans for study of these questions, several more "macro" questions
will need to be answered. First, where does the U.S. want to be in

18.

the twenty first century? Does economic integration of the North American continent help the country to obtain this goal or does it place constraints upon the U.S. reaching this goal? The same question must be asked of Canada and Mexico. For these countries, the question is doubly important because the pre-eminent country in any community will be the U.S. This means that the lesser participants might be giving up something which has in the past been observed to be very important to them -- national economic independence, even if it is in name only. Certainly for Mexico it may choose that it does not want the "Americanization" which could go along with complete economic integration. This is a socio-political question which cannot be ignored.

# I. SUMMARY

This paper develops estimates for the period 1978-88 concerning:

* The potential number of new entrants into Mexico's labor force.

* The potential number of new jobs that will be created under two different levels of petroleum production (called Case I and Case II).

* The potential number of new jobs that will be created in Mexico as a result of increased U.S. investment, assuming: (1) continuation of present conditions, and (2) a more wide-open policy toward foreign investment.

* The ability of the U.S. to absorb any surplus of Mexican labor that might be generated.

The analysis indicates that new entrants into Mexico's labor force will average about 800,000 per year in the period 1978-82, and 972,000 per year in the period 1983-88.

i

In Case I (see Table A), the direct employment impact of the Pemex Plan (Appendix A) generates only 60,000 new jobs per year during the period 1978-1988. However, secondary and indirect investment activities will stimulate employment growth in petroleum and non-petroleum areas:

* The oil revenue surplus will spin off investment in other industries and generate 151,000 new jobs per year during the period 1978-82 and 251,000 new jobs per year during the period 1983-88.

* In addition to oil related jobs, there will be an increase in non-oil related employment based on a general increase in economic activity and on Mexico's National Plan for Industrial Development (Appendix B). The net impact will be the creation of 317,000 new jobs per year during 1978-82, and 467,000 annual jobs during 1983-88.

* Another source of job creation will be U.S. direct investment in Mexico. Higher investment activity of firms currently investing in Mexico coupled with enterprises seeking new ventures will generate 20,000 additional jobs per year in 1978-82 and 30,000 new jobs per year in 1983-88.

When jobs created by investment in the petroleum industry are added to the jobs created by oil revenues in other

ii

sectors of the economy, to non-oil related job increases and to
the jobs generated by U.S. investment activity, the total number
of new jobs available is 548,000 annually for the period 1978-82
and 808,000 per year in 1983-88. These results leave an employ-
ment gap of 256,000 jobs per year in 1978-82 and 164,000 jobs
per year in 1983-88.

TABLE A

Case I

Job Creation
(000, Average Annual)

<table><thead><tr><th rowspan="2">Period</th><th colspan="2">Oil Related Sources</th><th colspan="2">Other Sources</th><th rowspan="2">Total<br>Jobs Created</th></tr><tr><th>Invest in<br>Petroleum<br>Industry</th><th>Investment<br>in Other<br>Industries</th><th>Non-Oil<br>Related</th><th>U.S.<br>Invest.<br>Related</th></tr></thead><tbody><tr><td>1978-82</td><td>60</td><td>151</td><td>317</td><td>20</td><td>548</td></tr><tr><td>1983-88</td><td>60</td><td>251</td><td>467</td><td>30</td><td>808</td></tr></tbody></table>

Employment/Unemployment Balance
(000, Average Annual Flows)

<table><thead><tr><th>Period</th><th>Jobs Created</th><th>Jobs Needed</th><th>Employment Gap</th></tr></thead><tbody><tr><td>1978-82</td><td>548</td><td>804</td><td>(256)</td></tr><tr><td>1983-88</td><td>808</td><td>972</td><td>(164)</td></tr></tbody></table>

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Pemex revenues and the amount of money available for Mexican government investment in oil and non-oil related projects. The impact on employment in the 1983-88 time period is the following:

* Higher investment in the petroleum industry generates 100,000 new jobs per year.

* The investment spin off made possible by higher oil revenues generates 304,000 new jobs per year in other industries.

* The multiplier effect of faster economic growth creates 606,000 new jobs per year.

* Greater cooperation between the U.S. and Mexico, accompanied by a wide open investment policy, generates 75,000 additional jobs per year.

The increased level of jobs created by petroleum investment added to non-oil related jobs from other sectors of the economy and to the jobs created by higher U.S. investment in Mexico produce 1,085,000 new jobs per year during 1983-88. This would afford Mexico an opportunity to meet its annual flow of new workers and to reduce the pool of unemployed and under-employed, currently estimated at 9 million persons, by 113,000 a year.

v

A slowing of growth of the U.S. labor force in the next decade provides the U.S. with the ability to absorb the "worst case" (Case I) Mexican employment gap of 256,000 annually in 1978-82 and 164,000 annually in 1983-88. The rates of U.S. employment growth (see Table C) required to absorb any of the three growth projections of the U.S. labor force plus Mexico's surplus are, with one minor exception in 1978-82, below the 2.2 percent average rate of employment growth recorded in the U.S. over the past decade.

TABLE C

U.S. Labor Force and Employment Growth Projections
(Annual % Change)

<table><thead><tr><th rowspan="2">Bls Rates</th><th colspan="2">U.S. Labor Force<br>Bls Projections</th><th colspan="2">U.S. Labor Force<br>Plus Mexico's<br>Annual Surplus</th></tr><tr><th>1978-82</th><th>1983-88</th><th>1978-82</th><th>1983-88</th></tr></thead><tbody><tr><td>Low</td><td>1.2%</td><td>1.0%</td><td>1.4%</td><td>1.1%</td></tr><tr><td>Intermediate</td><td>1.7</td><td>1.4</td><td>1.9</td><td>1.5</td></tr><tr><td>High</td><td>2.2</td><td>1.8</td><td>2.4</td><td>1.9</td></tr></tbody></table>

If the future unfolds as in Case II, the U.S. ability to absorb a surplus 256,000 annually could complement Mexico's 113,000 annual reduction of its pool of unemployed during the period 1983-88. This would more than triple the rate of reduction.

vi

The Connally Plan, a six-month on, six-month off work permit policy, could leverage the U.S. effort by a factor of two. This would increase Mexico's 113,000 rate of reduction by a factor greater than five.

Based on an analysis of minimum wage and family maintenance cost differentials between Mexico and the U.S., the Connally Plan could be extended to a six-month on, twelve-month off plan. This would leverage the base U.S. effort by a factor of three. The U.S. would absorb no more than 256,000 annually, but the potential effective impact on Mexico's pool of unemployed would be 768,000 jobs. Added to Mexico's 113,000, the total annual effective reduction would be on the order of 881,000, or larger by a factor of eight. Cooperative efforts along these lines between Mexico and the U.S. offer the potential to eliminate a pool of 9 million in ten years rather than eighty.

Finally, the reported Mexican government plan to reduce population growth to 2.5 percent by 1982 and even further by the end of the century would cause the annual new entrants to the labor force to peak in the mid-1990s at an estimated level of 1.2 million. Subsequent annual declines in new entrants would minimize future unemployment problems. This, of course, is the long term solution.

vii

II. MEXICO'S EMPLOYMENT POTENTIAL

The petroleum patrimony has afforded Mexico an
opportunity to rectify its excessive external debt position and
its chronic balance of payments situation. Yet, in the critical
area of employment opportunities, the problem is of such
enormous magnitude that significant unemployment will continue
well into the next century unless (1) the U.S. can absorb
Mexico's excess labor and/or (2) the country's birth-rate
decelerates sharply from the current 3.5 percent per year.

Population

Mexico's estimated population at mid-year 1979 is
approximately 68 million persons. Using the demographic
distribution of the population as reported by the Economist
(Table 1), nearly 27 million, or roughly 40 percent of the
population, are under 14 years of age.

Employment in Mexico was reported at 17.1 million in
1977¹. Assuming an unemployment rate of 20 percent², the labor
force in 1977 would have been about 21.3 million. Based on past

¹ DIETMEX/WHARTON Mexican Econometric Model, WHARTON, 1979.

² While there is no officially tabulated unemployment rate, the consensus appears to be that, when underemployment is added, the rate could be as high as 40 percent (<u>Business Latin America</u>, July 19, 1978, p. 230).

-1-

TABLE 1

population growth, the labor force will increase by 3.5 percent annually for the next decade. This would imply about 750,000 new entrants into the labor force in 1978, and an average annual number of new jobs necessary to achieve absorption of 804,000 for 1978-82 and 972,000 during 1983-88.

In addition to the overwhelming number of new entrants into the job market, about 9 million Mexicans are currently estimated to be unemployed or underemployed³. The absorption of this pool of potential workers represents a formidable problem for the Mexican economy quite apart from and in addition to the annual flow of new workers.

³ Includes undocumented workers in the U.S.

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Employment

Past efforts to quantify the number of new jobs created annually by Mexico's oil wealth fall into two camps: optimistic and pessimistic. The pessimistic camp concludes that the Mexican economy will be generating between 150,000 to 300,000 jobs annually, dramatically short of the increment needed to close the employment gap. The primary advocate of this pessimistic view is David Gordon, author of a recent survey on the Mexican economy. Gordon estimated that:

"If the Mexican economy were to return to the growth rate of 6-7 percent a year that is the official target, industry could provide at the outside 150,000 new jobs a year. Even if a further 150,000 were provided elsewhere, over half the new entrants coming into the work force each year would not find a job."⁴

These two sentences are the most often quoted estimates of the
job creating capacity of the Mexican economy.

⁴ *The Economist*, April 22, 1978

The optimistic view of the employment growth in the
Mexican economy is suggesting annual increases ranging from
600,000 to 1,300,000 jobs⁵.

In order to provide additional evidence on these issues,
this study simulates two different levels of oil production by
Pemex and attempts to determine the likely impact of this
development on job creation in the Mexican economy.

## Case I

The massive expansion program to develop Mexico's
petroleum resources began shortly after the Lopez Portillo
Administration came to power in 1976. According to the Pemex
Plan, petroleum production will average 2.02 mmb/d during the
period 1978-82, rising to 2.4 mmb/d in 1982. Subsequently,
according to extrapolations of the Pemex Plan by the
Congressional Research Service of the Library of Congress, oil
production will average 3.20 mmb/d in the period 1983-88, rising
to 3.8 mmb/d by 1988.

⁵ WHARTON projects average new jobs created equal to 690,000 per year over the 1978-82 period. The newly released National Plan for Industrial Development predicts annual increases of approximately 600,000 between 1978-82 and 1.3 million in 1983-88 (Appendix B).

-4-

Each aspect of the Pemex development plan - exploration, crude oil production, refining, gas production, gas distribution, pipeline construction and petrochemical manufacture - is very capital intensive. For U.S. oil companies, investment in each of these categories exceeds $100,000 per production worker. For Pemex, the consensus capital/labor ratio appears to be about one-half that of U.S. companies, or about $50,000 per production worker.

During the current Pemex Plan, which extends through 1982, the average annual investment expenditure for energy development will be approximately $2.7 billion. Add to this the annual investment of $.3 billion in secondary petrochemicals by the private sector, bringing the total annual investment of the Pemex Plan to $3 billion during 1978-82. Therefore, assuming that Pemex's investments will be apportioned equally over the period 1978-1982 and that each $50,000 of new investment will generate a new job, the Pemex development investments will likely generate about 60,000 new jobs annually.

During the period 1983-88, the Congressional Research Service forecasts an equal rate of expenditures ($3 billion annually) to raise average annual oil production to 3.28 mmb/d from 2.02 mmb/d in the period 1978-82. Consequently, the annual increment to employment for this period is also 60,000 jobs.

However, oil revenues will spin off investments in other industries. Table 2, which develops the contribution of petroleum development to job creation under Case I, indicates that Pemex is expected to generate revenues close to $10 billion (constant 1979 dollars) annually in the time period 1978-82⁶. Assuming an operating cost⁷ ratio of 70 percent of total revenues, these levels should provide a surplus of about $3.01 billion annually for investment by the Mexican government in other industries. During the 1983-88 period, revenues rise to an average $16.7 billion annually (constant 1979 dollars) and generate about $5.01 yearly for investment purposes⁸.

If manufacturing investment activity in Mexico will generate employment at a rate more than twice that of the United

⁶ These results and the results that follow are based on an oil price of $19/barrel, in real terms, through 1988.

⁷ Operating costs are assumed to include investment flow expenditures.

⁸ This calculation assumes a constant 70 percent operating cost ratio throughout the period. (See Appendix C for an explanation of all the assumptions underlying Case I).

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States (that is, $20,000 per worker versus $40,000 per worker), this proposed level of investment activity would create 151,000 new jobs per year during 1978-82 and 251,000 new jobs per year during 1983-88. When added to the 60,000 new jobs created by the direct investments of Pemex, oil related jobs increase by 211,000 annually between 1978-82 and by 311,000 annually from 1983 to 1988.

In addition to oil related jobs, there will be an increase in non-oil related employment based on a general increase in economic activity and on Mexico's National Plan for Industrial Development. According to the National Plan, job creation in non-oil related sectors will increase by a multiple of 1.8 times the oil-related job increases. This ratio appears high since investment expenditures to replace depreciated capital stock have not been considered. A more conservative 1.5 ratio generates 317,000 non-oil related jobs per year in the period 1978-82 and 467,000 new jobs per year for 1983-88.

-8-

A fourth source with job creation potential is U.S. direct investment in Mexico. Of the total 1975 stock of $4.45 billion of direct foreign investment in Mexico, United States' firms accounted for 72.2 percent of the total with West Germany accounting for 5.8 percent, United Kingdom 4.5 percent and Switzerland 4.2 percent. As noted in Table 3, capital expenditures by majority-owned U.S. affiliates fell dramatically during 1977, began recovering in 1978, and are expected to reach the previous peak in the current year.

TABLE 3

Capital Expenditures by U.S. Firms in Mexico
(U.S. $ millions)

<table><thead><tr><td>YEAR</td><td>AMOUNT</td></tr></thead><tbody><tr><td>1976</td><td>$ 424</td></tr><tr><td>1977</td><td>339</td></tr><tr><td>1978</td><td>386</td></tr><tr><td>1979 est.</td><td>427</td></tr></tbody></table>

SOURCE: Survey of Current Business, Department of Commerce

The major successes of U.S. investment in Mexico have been the in-bond manufacturing and assembly plants located primarily along the Mexico-U.S. border. In September 1978, there were 412 maquiladora plants scattered along Mexico's

-9-

northern border plus 33 in-bond plants located in various parts
of Mexico (particularly in Chihuahua and Guadalajara). Employ-
ment at these plants is estimated to be 92,000 workers with
another 20,000 jobs having been created nation-wide by
businesses related to the in-bond operations.

U.S. investment in Mexico will likely generate an average of 20,000 new jobs annually during 1978-82⁹. Higher investment activity by U.S. firms currently operating in Mexico coupled with enterprises seeking new ventures will generate about 30,000 additional jobs per year in 1983-88. These levels of job creation are based on $400 million and $600 million expenditure level averages for the respective time periods.

Foreign investment by the U.S. and other nations will rise in the near future, primarily because Mexico has become a much better investment opportunity. Closer cooperation between Mexico and its investment partners will lead to a lessening of the historical tension between Mexican society and foreign investment. Mexican authorities must resist the tendency to create roadblocks to direct foreign investment if they are to avoid choking off the flow of foreign technology. Some

⁹ U.S. Department of Commerce Mexican specialist's estimate.

-10-

potential obstacles to foreign capital and technology are:

- continued stringent regulation of foreign investment as exemplified by the Foreign Investment Law of 1973;

- skewed distribution of skilled labor and managers due to the higher salaries and benefits by government agencies and corporations (notably Pemex);

- increased reliance on labor-training legislation mandating complicated and confusing guidelines for training employees, the expense and time of which is to be borne by firms doing business in Mexico without government assistance;

- and finally, a continuation of the historical mistrust by the people of Mexico and their government of foreign investment in general, and direct U.S. investment in particular.

While the political incentives (and historical precedents) for curbing direct foreign investment in Mexico are many, the costs of doing so are high for Mexico and its investment partners. For our part, the U.S. must have greater respect for its southern neighbors and show a greater sensitivity to

-11-

[L.C.]

Mexico's problems. On the other hand, the Mexicans must not inhibit wholly-owned American companies from setting up operations in Mexico by favoring (or insisting upon) American minority joint ventures between U.S. and Mexican enterprises.

When jobs created by U.S. direct investment in Mexico are added to oil related job increases and to jobs created in other sectors (both public and private) of the Mexican economy, the total number of new jobs available is 548,000 annually for the period 1978-82 and 808,000 annually for the period 1983-88. Neither rate is sufficient to absorb the inflow of new entrants into the work force during these periods, thus leaving an employment gap of 256,000 jobs annually for 1978-82 and 164,000 during 1983-88.

## Case II

This scenario retains most of the assumptions used for Case I in the 1978-82 time frame, but it assumes:

* significantly higher oil production levels in the years 1983-88, and

* "wide open" U.S. investment activity in Mexico, particularly in the late 1980s.

-12-

The alternative level of petroleum development (see Table 4) assumes that Mexican oil production averages 2.02 mmb/d during 1978-82 (as in Case I) but then rises to an average of 3.76 mmb/d during 1983-88, a 17.5 percent increase over Case I. The sharply higher rate of development of the petroleum resources raises the daily average number of barrels available for export during 1983-88 to 2.08 mmb/d, up from the 1.62 forecasted in Case I. Pemex's annual revenues average $20.28 billion during 1983-88 and produce about $6.1 billion annually for investment purposes.

Pemex's higher investment activity will create 100,000 additional jobs per year during 1983-88¹⁰. Furthermore, investment in other industries, made possible by higher oil revenues, will produce 304,000 new jobs per year. Therefore, oil related job creation will average 404,000 annually during the period 1983-88. This is an increase of 30 percent over Case I levels.

¹⁰ Investment levels of Pemex average $5 billion annually during 1983-88 to increase oil production above Case I levels.

-13-

[LJ]

Assuming, once again, a 1.5 multiplier between the jobs created by petroleum and the non-oil related jobs, newly created jobs in non-oil related sectors of the economy would equal 606,000 per year in the period 1983-88.

If, in addition, the U.S. cooperated more closely with Mexico and if the Mexican government opened its borders to U.S. direct investment on what might be termed a "wide open" policy, capital investments by U.S. majority owned firms could average approximately $1.5 billion annually in 1983-88 (vs $600,000 in Case I). This level is about equal to the current investment levels by U.S. firms in Brazil (see Appendix C). Investments of $1.5 billion would generate about 75,000 jobs annually for 1983-88.

In summary, the increased level of jobs created by petroleum investment added to non-oil related jobs from other sectors of the economy and to the jobs created by a more wide open rate of U.S. investment in Mexico raise the total to 1,085,000 annually for 1983-88 (see Figure 1 for a graphical summary of Case I and II). The increased level of oil production would afford Mexico an opportunity to create sufficient jobs to meet its annual flow of new workers, and to make a dent into the pool of unemployed workers.

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[w]

### III. INTERRELATIONSHIP OF MEXICO'S SURPLUS LABOR WITH THE INTERNAL LABOR NEEDS OF THE U.S.

Growth of the U.S. labor force will be slowing in the next decade, which might provide the opportunity or perhaps even the need to utilize foreign labor. This could be mutually advantageous to the U.S. and Mexico. Without attempting to address the political and social questions involved, a key question to be answered concerns the capability of the U.S. to absorb the annual new entrant labor surplus generated by Mexico. For purposes of analysis, we have used the "worst case"; i.e., Mexico's employment gaps derived in Case I. These averaged 256,000 annually for the period 1978-82 and 164,000 for the period 1983-88.

A preliminary test of that capability can be made by employing the Bureau of Labor Statistics' latest U.S. labor force projections. High, low, and intermediate growth rates were developed for those projections. All three are used in this brief analysis in order to place the conclusion within reasonable boundaries.

The results of the analysis are shown in Figure 2. They are expressed in terms of the average annual percentage growth of U.S. employment required to: (1) absorb Mexico's

-17-

"worst case" annual surplus workers, and (2) hold the U.S. unemployment rate constant at 6 percent.

The BLS projections of annual U.S. labor force growth range from a low of 1.2 percent to a high of 2.2 percent for the period 1978-82. Comparable values for 1983-88 are 1.0 percent and 1.8 percent, a marked deceleration of growth in the last half of the decade. The addition of Mexico's estimated annual surplus of new entrants to the labor force would push each of these rates up by approximately 0.2 percentage point in the 1978-82 time period and 0.1 percentage point in the period 1983-88.

Given the assumption of a constant rate of unemployment, the required rates of employment growth are obviously identical to those projected for the combined total of the U.S. labor force plus Mexico's annual surplus. Employment in the U.S. grew at 3.6 percent annually during the past three years and 3.9 percent annually during the past two. Indeed, in 1978 it even grew by 4.2 percent, slightly exceeding the real growth of GNP in that year. But these rates are clearly above the norm. More reasonable long-term standards are the annual rates of 2.2 percent over the past decade and 2.0 percent over the past two.

-19-

During the period 1978-82, the required rate of employment
growth could range from 1.4 percent to 2.4 percent, with an
intermediate rate of 1.9 percent. This intermediate rate is
less than the 2.2 percent actual rate experienced over the past
decade and appears, therefore, to be quite feasible. If the
growth of the U.S. labor force is nearer BLS' "high growth"
projection, however, the accommodation of Mexico's labor surplus
in the early period might pose some difficulty. The latter
period of 1983-88 would appear to present no problem in this
regard, since the required rate of employment growth would fall
within the range of 1.1 percent to 1.9 percent, well below the
historical rate.

The apparent ability of the U.S. to absorb annually about
256,000 additional workers during the next decade could provide
Mexico with the increment believed necessary to employ all new
entrants to its labor force. But more needs to be done. The
employment of all new entrants to the labor force gradually
reduces the rate of unemployment, but it does not reduce the level
of unemployment.

More can be done. As demonstrated in Case II, an average
17.5 percent increase in planned oil production and the adoption
of a more relaxed policy on foreign investment is estimated to
increase the number of new jobs in Mexico by an amount sufficient
to enable the country to not only hire all of its new entrants,

-20-

but to reduce its pool of unemployed and underemployed by an
estimated 113,000 annually during the period 1983-88. Given the
official estimate of a 20 percent rate of unemployment, the
current pool of unemployed would amount to about 4.5 million
persons. Inclusion of those believed to be underemployed would
probably double this figure to a total of 9 million. But whether
the pool is 4.5 million or 9 million, it is obvious that a 113,000
annual reduction -- albeit a significant and singular Mexican
accomplishment -- would be painfully slow.

There are other steps which could be taken to speed the
process.

* First, the U.S. ability to absorb 256,000 annually need not be restricted to new entrants, and this cooperative effort could complement Mexico's 113,000, thus more than tripling the annual rate of reduction.

* Second, the U.S. effort could be leveraged by a factor of two under a cooperative effort of rotating employment, such as that suggested by John Connally, former Governor of Texas. His suggestion was to issue work permits which would allow the bearer to enter the U.S. every six months for a six-month period of employment.

-21-

* Third, an analysis suggests that the Connally plan could be further leveraged by a factor of 1.5, or a total leverage of 3 relative to the U.S. base effort of 256,000 annually. Using the assumption noted in Appendix D, the analysis indicates that, because of the minimum wage and cost-of-living differentials between Mexico and the U.S., a Mexican worker in the U.S. can pay taxes, living expenses, maintain his family in Mexico, and yet save enough in six months to support both the worker and his family in Mexico for roughly twelve months. In short, the six-month on, six-month off plan could be extended to a six-month on, twelve-month off plan. The U.S. would absorb no more than 256,000 annually, but the potential effective impact on Mexico's pool of unemployed would be greater by a factor of 3, or increased to 768,000. Added to Mexico's 113,000, the total annual effective reduction would be on the order of 881,000. Cooperative efforts along these lines between Mexico and the U.S. offer the potential to reduce the time required for problem solution by a factor of 8. A pool of 9 million could be employed in ten years rather than eighty.

* Finally, the reported Mexican government plan to reduce population growth to 2.5 percent by 1982 and even further by the end of the century¹¹ would cause the annual new entrants to the labor force to peak in the mid-1990s at an estimated

¹¹ Mexican Survey, *Economist*, April 22, 1978, p.4

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Appendix A

PEMEX DEVELOPMENT PLAN

Soon after the Lopez Portillo Administration assumed power in 1976, it authorized a massive expansion program from PEMEX to begin development of Mexico's oil and gas resources over the period 1977 to 1982. The cost of the plan is to be $16 billion, approximately three times the amount of PEMEX's investment during the previous six years. Mexico's private sector is also committed to an investment of about $2 billion in secondary petrochemicals, bringing the grand total to about $18 billion, or almost a quarter of Mexico's gross investment over the period.

The main objectives of the PEMEX oil and gas development plan are as follows:

* Exploration - Drill 1,300 new wells or 10 times as many as in the prior 6 years. Cost: $1 billion.

* Crude Oil Production - Increase production from 1.0 million b/d in 1977 to 2.2 million b/d by 1980. Cost: $7 billion.

* Refining - Double capacity to 1.7 million b/d. Cost: $2 billion.

* Gas Production - Increase gas production from 2.2 bcf/d to 4.0 bcf/d. Cost: difficult to estimate because most of the gas will be associated with oil.

* Gas Distribution - Build gas processing plants to extract gas impurities making it a marketable product. Also included is a project to build a gas pipeline from Cactus to Monterrey, linking up with the main gas pipeline system of Mexico. Initial output of the new pipeline would be 847 million cubic feet per day (mmcf/d), but with added compressors its capacity would rise to 2.2 bcf/d. Cost: $2 billion.

SOURCE: Congressional Research Service, "Mexico's Oil and Gas Policy: an Analysis," GPO, December 1979

A-1

* Other Oil and Gas Transportation - Cost of other pipelines, tankers, and transportation: $2 billion.

* Petrochemicals - Triple capacity to 18.6 million tons by 1982. About 500 mmcf/d will be used to make 10,000 tons a day of fertilizer. Ethylene production will go to 1.3 million tons a year. Cost: $2 billion.

* Planned Exports - Exports of crude oil are to go up from 200,000 b/d in 1977 to 1.1 million b/d in 1980. Exports of gas were to approach 2 bcf/d in 1984, but that estimate is dependent on the U.S. buying the gas for at least $2.60 per mcf.

The development plan is consistent with Mexico's official energy policy of first satisfying its immediate and future domestic needs, second, making rational use of all hydrocarbons, and third, exporting any surplus in order to build an economic development fund. The economic logic behind the development strategy is to reach the crude export goal as soon as possible to help finance the bulk of the plan's scheduled outlays which occur early in the 6-year program. Also important is construction of a gas transportation system capable of delivering gas from the Cactus area to either the U.S. markets or to central Mexico's industrial and power plant markets. This would enable Mexico to reach its crude oil production goal in the Cactus area without wasting valuable gas, which is associated with oil in that region.

The PEMEX plan is the Mexican Administration's main hope in getting the Mexican economy up to historical annual growth rates, and reducing the country's balance of payments problems. The initial assumptions, based on a constant $13.50 per barrel of oil in 1978 U.S. dollars, indicated revenues from exporting 1.1 million b/d would total $5.4 billion in 1982 alone. Overall, PEMEX director Jorge Diaz Serrano has said that for the duration of the present administration (1977-1982) the company's total gross revenues will reach $59.6 billion. The PEMEX

A-2

budget would have the following expenditures:

(1) operating expenses, including Federal taxes, of $32.5 billion;

(2) reduction of PEMEX debt by $1 billion and

(3) capital investment of $16 billion as called for in the plan's development.

This would leave close to $10 billion from the gross $59.6 billion as revenues which the Lopez Portillo Administration could spend in development of the Mexican economy.

## Domestic Oil Demand

Petroleum demand in Mexico has been strong since the beginning of the 1940's. Since that time, demand has been doubling approximately every ten years. Mexico, however, started from a relatively small industrial base, and as such these gains are not unusual for a developing country. As revenues from oil sales is used to further develop the Mexican economy, energy demand, particularly for oil and gas, should continue to rise to near historic rates through the 1980's.

Table 1 shows that between 1940 and 1976, domestic demand grew at a much more rapid rate than supply. This was partially due to the social goal of PEMEX to provide low-cost energy to its consumers, a goal that was reflected in low product prices. Low product prices meant profit margins were compressed, and PEMEX did not have the revenues needed for exploration and development. Consequently, production declined and failed to match the rapidly growing demand. Even as late as 1974, Mexico was a net importer with an annual expenditure of $290 million, which reduced the cash flow of PEMEX even further. The development of the Reforma field, however, has permitted Mexico to once again become an exporter. Exports have exceeded imports since 1976 and will remain so for the foreseeable future, even

A-3

TABLE 1
MEXICAN OIL EXPORT/IMPORT BALANCE
(In thousands of barrels per day)

<table><thead><tr><th>Year</th><th>1940</th><th>1950</th><th>1955</th><th>1960</th><th>1965</th><th>1968</th><th>1969</th><th>1970</th><th>1971</th><th>1972</th><th>1973</th><th>1974</th><th>1975</th><th>1976</th></tr></thead><tbody><tr><td>Consumption¹</td><td>64</td><td>139</td><td>180</td><td>298</td><td>341</td><td>416</td><td>452</td><td>593</td><td>518</td><td>610</td><td>625</td><td>645</td><td>650</td><td>765</td></tr><tr><td>Production</td><td>120</td><td>199</td><td>271</td><td>323</td><td>368</td><td>388</td><td>412</td><td>430</td><td>436</td><td>441</td><td>465</td><td>551</td><td>705</td><td>850</td></tr><tr><td>Balance</td><td>+56</td><td>+60</td><td>+91</td><td>+25</td><td>+27</td><td>-28</td><td>-40</td><td>-73</td><td>-82</td><td>-169</td><td>-160</td><td>-94</td><td>-55</td><td>+175</td></tr></tbody></table>

¹ Does not include oil used in the commercial generation of electricity.

Source: 1976 International Petroleum Encyclopedia, vol. 10.

A-4

Appendix B

# Summary of
NATIONAL PLAN FOR INDUSTRIAL DEVELOPMENT

Mexico has recently revealed its blue-print for industrial development for the next decade and by doing so has indicated its commitment to the development of the business infrastructure necessary to dent the growth in unemployment that plagues the country.

The National Plan for Industrial Development is one section of a yet-specified and forthcoming National Development Plan that will enumerate development plans for the 1980's. Yet, the industrial sector weighs heavily in any development plan and Mexico's program represents an ambitious industrial strategy. Key provisions of the plan are a major push for decentralization, a bid for strong private-sector involvement and sharply increased governmently investment expenditures. The basic strategy concentrates on a sustained high growth rate, which will be necessary to combat Mexico's unemployment. Five steps are outlined in the plan:

(1) to establish new targets for the production of basic consumer goods;

(2) to develop high industrial priority areas that translate into exports and efficient import substitution;

(3) to widen the industrial structure geographically and make better use of the country's natural resources;

(4) to decentralize industry--this step is closely linked to the previous one--and lure it to selected coastal and border areas; and

(5) to strike a balance among various market structures by curbing certain "oligopolistic" tendencies in the more dynamic industries and by linking large, medium and small industry in joint production efforts.

SOURCE: *Business Latin America, 1979*. A full version of the National Plan is available upon request.

B-1

rate of 20.4% in 1980-85 and 25.6% in 1985-90. The public sector companies, led by Pemex and the electricity commission, CFE, are awarded less vigorous growth expectations. Their participation in capital formation will be up 10.5% in 1979 and 15.3% in 1980, falling to an average growth of 4.8% per annum through 1990. The private sector plays an intermediate growth role, with its share of capital generation to rise 6.5% this year and 9% in 1980. For the balance of the plan period, companies are expected to continue vigorous investment growth at annual rates of 12.6% in 1980-85 and 8.9% in 1985-90, although they will steadily lose their weight in overall fixed capital formation to the government.

If the plan performs on schedule, and if its various components--particularly private investment--respond to the restructuring effort, Mexico should achieve some impressive macro-economic results over the next 12 years. The first would be a sustained annual growth rate of 9-10%. This level is considered by planners necessary to answer the growth demanded in employment. Assuming that the country's work force will continue to grow at the rate of 3.4% over the next 12 years, by 1990 unemployment and underemployment is assumed by the Plan to disappear through the creation of 12.6 million new jobs.

B-3

Appendix C

The assumptions used to derive Cases I and II are:

Case I

O Average annual jobs needed is an extrapolation of a 1978 level of 750,000 at a 3.5% annual rate of increase.

O Oil production is assumed to average 2.02 million barrels per day in the period 1978-82 (Pemex Plan) and then rise to 3.2 million barrels per day in the period 1983-88. This forecast is based on an extrapolation by the Congressional Research Service, a division of the Library of Congress.

O Mexican domestic demand is estimated by the Congressional Research Service.

O Pemex total revenues are expressed in 1979 constant dollars and were derived by using an average price of $19/bbl (in real terms) from 1979 through 1988 for exports. Domestic sales were transacted at a price equal to 50% of the export price.

O The petroleum surplus is obtained by subtracting operating costs (including investment flow expenditures) at a 70% ratio. According to Pemex director Jorge Diaz Serrano, the Pemex budget, which includes operating costs, debt reduction and capital investment, is expected to absorb about 83% of gross revenues (CRS study, p. 20). We have adjusted this percentage down to 70% because of the recent increase in the price of oil. The constant 1979 dollar oil export price used in our analysis is $19 per barrel, which is about 18% above the average nominal price believed used by Pemex in their estimation noted above. Assuming that the price increase will raise gross revenues by 18% without raising budget expenses, the 83% reduces to 70% as follows: .83/1.00 x 1/1.18 = .83/1.18 = .70/1.00 = 70%.

O Job creation from direct petroleum investment is assumed to occur at a rate of $50,000 of investment per employee at a planned investment rate of $3 billion annually.

O Indirect investment represents the government's expenditures of petroleum surplus revenues outside petroleum industry. Job creation is assumed at a rate of one job per $20,000 of invested capital.

O Increases in non-oil related employment are based on a ratio of 1.5 times the gains in oil related jobs. This was judged down from a 1.8 ratio that was derived from a comparison of oil related annual employment gains, separately estimated in this

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paper, with the total annual employment gains contained in the abridged version of the National Industrial Development Plan (p. 36). The negative judgment was applied because of the belief that the total employment estimates were based on gross rather than net investment. For the period 1978-82, average annual employment gains for oil related and for the NIDP total are 211,000 and 593,000, respectively, for a ratio of 2.8. Comparable gains for the period 1983-88 are 311,000 and 873,000, respectively, also for a ratio of 2.8. Subtraction of 1.0 from the total ratio (the oil-related gains from total gains) yields a non-oil-related to oil-related employment gains ratio of 1.8.

**Case II Same as Case I except:**

O Oil production averages 2.02 million barrels per day between 1978-82 as in Case I but rises to an average of 3.76 million barrels per day in the period 1983-88.

O Mexican domestic demand for oil rises 5% above Case I levels during 1983-88 period because of increased economic activity.

O An investigation of the investment expenditures by U.S. firms in Latin America reveals a forecast level in 1979 of $4.077 billion. Mexico currently ranks third behind Brazil at $1.685 billion and Venezuela with $.519 billion. Mexico is at a stage of economic development roughly comparable to Brazil's and it has the political stability and infrastructure necessary to handle investments of a magnitude close to Brazil's $1.7 billion.

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Appendix D

MIGRANT WORKERS IN U.S. FROM MEXICO

<table><thead><tr><th></th><th>U. S. $</th><th></th><th>Mexico - Pesos</th></tr></thead><tbody><tr><td>Wages</td><td>1508</td><td>Wages</td><td>7500</td></tr><tr><td></td><td></td><td>Social Charges</td><td>412</td></tr><tr><td>Living costs, taxes, etc.</td><td>904</td><td>Living costs</td><td>7088</td></tr><tr><td>Savings</td><td>604</td><td>Savings</td><td>0</td></tr></tbody></table>

$604 = 13,288 pesos saved in 3 months.

2362 pesos per month living costs.

5.6 months additional living in Mexico possible as result of working 3 months in U.S.

Assumptions

* No income tax paid in Mexico

* Minimum wage both locations, i.e., 2.90 per hour U. S., 100 pesos per day in Mexico

* No overtime - 173.3 hours per month in U. S., 25 days per month in Mexico

* The U. S. numbers include living costs, cost of maintaining family in Mexico, taxes, etc for total of 60% of earnings ($904).

* Returns to same standard of living in Mexico

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BACKGROUND MEMORANDUM
FOR MEETING OF MEXICO GROUP
MEXICO CITY

AUGUST 13, 1979

Introduction

For reasons that do not have to be detailed, interest in the subject of US-Mexican relations has virtually assumed the characteristics of a fad. In the US, four putative presidential candidates (Brown, Connally, Kennedy, Reagan) have in various ways alluded to the need to devise a special relationship with Mexico, especially in the field of energy. At the instance of the Senate Finance Committee, the Trade Agreements Act of 1979 (implementing the results of the Multilateral Trade Negotiations) calls on the President to submit a report within two years on possible trade agreements with countries in the northern portion of the western hemisphere covering energy and other sectors and Senator Baucus of that committee conducted a day of hearings on June 6 on the possibilities of freer trade between the United States, Canada and Mexico. Similarly a subcommittee of the House Science and Technology Committee held hearings on July 31 on technology transfers in exchange for oil exports from Mexico and the Trade Subcommittee of the Committee on Ways and Means has hearings planned on Mexico-US trade in September.

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At the same time, the interest manifested in both the US and Mexico (and especially on the part of President Lopez Portillo) in constructing a relationship between the two countries clearly reflects the existence of both a real need as well as an unusual opportunity. Despite a history of friction and perceived neglect as well as a long agenda of problems in the relations between the two countries-- and perhaps because of them--Lopez Portillo has committed himself to a constructive evolution of US-Mexican relations as an essential adjunct of his policy of reform and renovation of the Mexican economy. The discovery and development of large reserves of hydrocarbons in Mexico makes it possible for Lopez Portillo to address both issues, that is, US-Mexican relations and internal reform, from a position of greater confidence and enhanced negotiating power. The remaining three and a half years of Lopez Portillo's term of office (until the end of 1982) may present a unique opportunity to redefine the US-Mexican relationship given Lopez Portillo's commitment and his apparent disposition to set Mexico on a course whose evolution will take place beyond his term of office, a disposition which has been uncharacteristic of previous Mexican presidents.

Problems and difficulties abound. Lopez Portillo evidently feels, as do others in the United States, that treating these problems and issues on a case by case or category by category basis is not likely to yield the best solutions. Unless the negotiations between the United States and Mexico are informed by a sense of design and a frame of reference, negotiations on particular issues are likely to become difficult and protracted, opportunities will be missed, and frictions and difficulties multiplied.

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Moreover, if the architecture of US-Mexican relations is sufficiently
bold and comprehensive, it will be easier to overcome individual problems and offset
parochial concerns. Both Lopez Portillo and a number of Americans share a concern
that the existing machinery of government in both Mexico and the United States is
incapable of devising and carrying forward such a design owing to the fragmentation
of bureaucratic responsibilities, the particularistic concerns to which various
components of the governmental establishments are responsive, and the inability
to negotiate trade-offs between unrelated areas. The consultative arrangements
between the two countries which emerged from the Carter-Lopez Portillo meeting
in February reflect such a fragmented approach.

The Nature of a Design

Energy has clearly altered the scale and nature of our interest aided by concerns about political stability in the area. Energy has also altered Mexico's perception. It offers the promise of resources to address Mexico's "national project" while, at the same time, converting Mexico's relationship with the United States from one that cannot be avoided to one that can positively and materially advance Mexico's goal of renewal. For the first time, there is a perception of balance and the possibility of reciprocity in the economic relationship.

In its simplest terms, the basis for a design consists of two parts: (1) Mexico's interest in an assured and stable access to the American product and labor markets and (2) the United States interest in access--on a secure, regular and quantitatively significant basis--to Mexico's energy resources. There are of course a number of ancillary issues, such as US direct investment in Mexico, possible financial arrangements, and Mexico's commercial trade policy.

The agenda would include such rubrics as trade, energy, migration, and economic development issues (including investment, financing, technical assistance, and rural development). Some of the issues and approaches to an energy vs. markets agreement are discussed below. At this point, one can ask whether the concept of a large scale agreement between the United States and Mexico is seen to be in the best interest of both countries.

Is it possible to devise an arrangement that has important substance to it but that does not involve a significant preferential dimension, especially in the trade area?

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If a preferential arrangement is agreed to, as may
very well be the case, how does that comport with
a global, non-discriminatory trade policy of the
United States? With the GATT?

Would a preferential arrangement of a far reaching
character be acceptable to Mexico, given the sus-
picions about the United States and the greater
degree of dependence on the United States that
would be entailed and which would require a political
decision on the part of the Mexican authorities?

How would a preferential arrangement with the United
States, particularly one involving a commitment to
supply oil and gas to the United States fit with
Mexico's global energy policy to be elaborated by
Lopez Portillo at the UN in late September?

Would a preferential arrangement be seen as a rebuff
to other countries of Latin America or a possible
model for them?

Would a large scale, comprehensive agreement between
the two countries be seen in Mexico as an exercise
in US hegemony and a threat to Mexico's independence?

Would an ambitious proposal constitute a leap of
faith with a high potential for disappointment?

Trade

The US and Mexico clearly present contrasting cases in trade policy, differences which are accounted for by the different states of economic development, size of market, position in world affairs, etc. Mexico has pursued a highly autarchic trade policy characterized by quantitative import restrictions, licensing, high tariffs, domestic content requirements, etc. This external policy reflected the internal industrialization policy of import substitution which necessitated protection at the border but has left Mexico with a significant component of its industrial plant vulnerable to competition. The present Mexican government intends to effect a significant change in industrial policy. The new policy emphasizes efficiency and competitiveness and looks increasingly to export markets. Mexico did participate in the Multilateral Trade Negotiations although a very modest bilateral negotiation with the United States has not yet been completed. Mexico has expressed an interest in becoming a contracting party to the GATT and will probably announce its intention to negotiate for accession to GATT in September. As a major advanced developing country, it has become akward for Mexico to be a "free rider" on past trade negotiations and, more significantly, membership in GATT would serve to exercise an external discipline for trade liberalization by Mexico.

The US market is not only important to Mexico today, but with the development of efficient industries capable of export, Mexico naturally will look to the United States. The fact is that the United States market is today quite open to Mexican imports and, with the tariff reduction agreed to in the Multilateral Trade

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Mexico's interest in United States trade policy and access to the US market has perhaps less to do with the general liberality of treatment in terms of the volume of trade covered than with the question of continuity and stability of access. With successful industrial development dependent upon access to export markets and particularly that of the United States, Mexico is concerned about having that access curtailed or limited by virtue of the operation of various provisions of US trade laws. Of course, Mexico would like to have duty-free unencumbered access to the US market for the full range of its exports. A number of categories of trade important to Mexico are excluded from GSP (textiles and apparel, tobacco, tomatoes, steel, electronics, footwear). Others are in danger of being removed from the GSP list by virtue of a general decision that they are import-sensitive items or because Mexico's shipments under GSP have exceeded the "competitive need" standards (i.e., imports of $37.2 million per annum or imports in excess of

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50 percent of total US imports of the article in question). Railroad cars recently became a victim of the "competitive need" standard. Mexico's textile exports are limited by bilateral agreement between the US and Mexico under the multi-fiber arrangement. Items entering under 806 and 807 are not eligible for GSP because they do not meet the rules of origin required for GSP eligibility. The example of winter vegetables under the antidumping act has been a particularly irritating case in point.

Both the issue of expanding access to the US market as well as the stability of that access, and particularly the latter, involve difficult issues. Liberalization or elimination of restrictions on exports of textiles and apparel engage the sensitivities of the textile industry and unions in the US. The items excluded from GSP involve import-sensitive industries. The application of dumping or countervailing duties requires a determination of injury and is not open to presidential discretion so that failure to apply such duties could invite judicial appeal and subsequent application. Thus, most of the specific issues that have arisen from Mexico's point of view in trade with the United States tend to involve hard cases which are difficult, if not impossible, of resolution within the confines of the individual cases themselves. Thus, for example, if the United States would wish to exempt Mexico from the application of the antidumping and countervailing duty laws or to provide for some special treatment under these laws, it would be necessary to construct a special legal regime for Mexico. Such a construction is likely to be feasible only as part of a larger, more comprehensive special trade arrangement with Mexico.

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1. MFN Agreement

2. Common Market

A common market is a preferential zone with zero internal duties and a
common external tariff for the participants. It is consistent with the GATT. The
requirement of a common external tariff would itself condemn this approach from
Mexico's point of view.

3. Free Trade Area

A free trade area is comparable to a common market except that the indi-
vidual parties retain their own external trade regime and a lesser degree of economic
integration is implied. To be consistent with the GATT, there would have to be
a timetable for the dismantling of all import restrictions between the United States
and Mexico although a different timetable for the lesser developed partner is
feasible. Special and preferential rules with regard to import restrictions for
various purposes such as dumping, etc., could be provided.

Any sectoral arrangement or arrangements that provides for free trade with
significant exclusions would by its nature be discriminatory and inconsistent with
the GATT. In addition, should Mexico accord preferential treatment to imports from
the United States this would violate a cardinal rule of US trade policy against

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"reverse preferences" accorded by less developed countries to developed countries, an issue which became a <u>cause celebre</u> in connection with the reverse preferences which the African-Caribbean-Pacific countries accorded the European Community under the Lome convention. Nonetheless, it may be useful to study some hard cases involving sectoral arrangements in such sectors as petrochemicals, electronics, pharmaceuticals, and automotive vehicles and parts to see what light they offer for the general question of what kind of trade regime and agreement might be developed between the two countries.

Because of the constraint against reverse preferences as well as Mexico's inability to dismantle its import restrictions (except, perhaps, on a timetable that reaches into the next century), a US-Mexican trade arrangement will necessarily fall short of a full free trade area. What is possible is: (a) preferential duty-free access for Mexican imports into the US with assurances of security of access; (b) gradual liberalization of Mexican import restrictions on an MFN basis; and (c) limited sectoral free trade between the US and Mexico in certain selected sectors.

Such a construction would not be consistent with GATT because of its preferential aspects but this is not a fatal flaw. The movement would be toward freer trade and the preferential features would primarily involve concessions by a developed country to a less-developed one. Sectoral free trade could be patterned after the US-Canada automotive agreement for which a GATT waiver was obtained.

What are Mexico's intentions with regard to trade liberalization and GATT membership?

Has the Mexican government identified particular sectors of export interest? of import vulnerability?

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## Energy

Trade and energy are linked through economic development. Mexico's principal task and Lopez Portillo's prime commitment is to set in train a process of economic development financed by energy and sustained by access to world markets, especially that of the United States. Mexico perceives itself as having entered upon a period of testing of its own capacity to complete its revolution and to solve its obdurate problems of high unemployment, highly skewed patterns of income distribution and rural poverty. The Lopez Portillo government has ambitious plans --a planned annual growth rate of 10 percent--for which energy is the key. Energy is regarded as the patrimony or natural endowment to be employed to meet Mexico's own requirements.

The official position of the Mexican government is that in 1982 Mexico will produce 2.2-2.5 mbd of which 1.0 mbd will be available for export. Of this 1 mbd only about 60 percent will be available for the US market, an increase of about 400,000 mbd above current levels. In terms of the efficient exploitation of its oil fields, it appears that a much higher rate of production is feasible by efficient engineering production standards; indeed a number of observers expect Mexican production to reach the 4-8 mbd level by 1990 despite lower official forecasts.

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The United States clearly has an interest in a significant expansion of Mexican oil production destined for the US market. Mexico presents a secure source of supply and the United States is Mexico's natural market for oil, one which yields the highest net price because of low transportation costs. A measure of United States interest in Mexican oil can be seen from President Carter's synthetic fuels proposal. The proposal calls for the expenditure of $88 billion by 1990 on domestic development of synthetic fuels to yield an increment of 2.5 mbd of oil by 1990. A comparable increment in US oil supply is well within Mexico's physical capacity to produce. The cost to the United States economy and environment would be considerably less than the proposed synthetic fuels program. Some part of the $88 billion financing if applied to expanding Mexico's production of oil would without doubt yield higher returns than the same amount applied to synthetic fuels production within the United States.

While Mexico has insisted her energy resources are a national patrimony to be used for economic development they clearly have no value unless they are used.

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Moreover, unless Mexico is prepared to produce and export oil in greater quantities
than currently planned, it cannot have the negotiating leverage either with the
United States or other countries that it presumably wants and needs if only to
assure itself market access. The guaranteed market for its oil in the United
States at favorable prices should have some appeal for Mexico. The world market
has elements of uncertainty and the potential for significant new finds is not
completely absent. The United States could in the future work out special arrange-
ments with Canada and Venezuela both of whom have huge reserves of heavy oil and
the US could even become substantially more self sufficient in energy.

But whatever Mexico's interest, the root of that interest in a bilateral
arrangement with the United States on energy (as part of a larger package) must
be firmly planted in Mexico's perception of her internal requirements for development.
How much oil does Mexico have to produce and export to support its growing domestic
requirements as well as to generate foreign exchange? As to domestic consumption
requirements, her per capita consumption is big and growing. Mexico does subsidize
oil and gas consumption substantially and a moderation or removal of such price
subsidization would clearly economize in the use of energy. Furthermore, Mexico
has substantial coal reserves and is very interested in nuclear power generation.
As to foreign exchange earnings, Mexico does have substantial borrowing capacity
despite its $30 billion of external indebtedness and is planning on running a current
account deficit for a number of years ahead.

Perhaps the principal constraint on Mexico's willingness to expand petro-
leum production comes from its concern about what Lopez Portillo has described
as "monetary indigestion". The models of Venezuela and Iran are not those which
Mexico wishes to emulate. Of course, the Mexican economy and Mexican society are
not those of Venezuela and Iran and the World Bank has estimated that Mexico has

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a very high capacity to absorb incremental revenue in its economic development
without generating accelerated inflation and social unrest. But the Mexicans are
clearly the best judge of this. It may be very useful, therefore, to explore the
possibility of techniques and instruments for insulating the increment of revenue
from oil exports to the United States which the Mexican government would not wish
to see enter the Mexican income stream. Such financial arrangement could be made
an explicit part of the US-Mexican bilateral deal.

There are other ancillary issues that could be covered by a bilateral
energy agreement including refinery location and construction and petrochemical
production, etc.

How much oil can Mexico produce efficiently over what
time? How much to the US on what timetable?

What are Mexico's requirements for oil production in
terms of its economic development and income objectives?

To what extent can it rely on external debt financing?

What problems (e.g. insufficient equipment, crews) stand
in the way of an acceleration of Mexican oil production?

How serious is Mexico's concern for internal inflation
resulting from aggressive development of oil production?

Are there any techniques that can be devised, in which
the US might participate, to insulate the Mexican
economy from such inflationary effects?

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Migration

Illegal immigration or, to use the preferred term "undocumented workers",
has been an old and festering problem in bilateral relations. It grows out of
Mexico's demographic problem and constitutes a safety valve important to Mexico.
Mexico's population is 65 million, growing at an annual rate of 3.5 percent and
calculated to reach 120 million by the year 2000. 45 percent of its population
is under 16 years of age so that the increase in the prospective labor force by
the end of this century has already been born. Mexico has a work force of 18
million workers estimated to increase to 35 million by the end of the century.
At least 40 percent of the Mexican labor force is unemployed or under employed.

Given these facts, it is understandable why so many Mexicans have sought
to leave Mexico. (The internal migration problem within Mexico from rural to
urban areas is even more severe). The lure of the United States job market is
evident from the differential in minimum wages between the two countries: from
a high of $7 a day in Mexico to a US minimum of $23. Per capita income in Mexico
is $1300 a year.

The number of "undocumented Mexican workers" in the United States is a
matter of controversy since no reliable data are available. Estimates range from
2 to 8 million; a Mexican official suggested 4 million.

President Carter submitted a legislative program in 1977 which would have
provided for (a) amnesty for about 750,000 illegal immigrants who arrived before

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January 1, 1970, (b) a limited amnesty for those who arrived between January 1, 1970 and January 1977, providing for five-year work permits with their status to be determined after the expiration of the five years, and, (c) provision for civil penalties on employers hiring illegal immigrants. This legislation was not reported by the committees and was not pursued aggressively by the Carter administration. As a result of the Carter-Lopez Portillo meeting in February, a select commission was established under the chairmanship of Gov. Reuben Askew to review US immigration policy and to report in September 1980.

The Mexican administration has not offered any proposals for resolving the problem; a few weeks ago, Foreign Minister Castaneda suggested the possibility of a work permit plan provided that a significant number were issued. Lopez Portillo indicated in a recent interview that there was no problem in the United States with "undocumented workers" since all have been able to find employment in the United States.

From a US point of view it seems clear that some degree of regulation is necessary if only to control the rate of increase of illegal immigration which has been increasing. Some combination of the following measures would seem to be reasonable: (1) an amnesty program with some limitations perhaps patterned on those of the Carter 1977 legislative proposal; (2) a significant expansion in the Mexican immigration quota which stands at 20,000 a year; and (3) the issuance of work permits ("guest workers" in the European sense) combined with penalties on employers who hire illegal immigrants without work permits. Severe restriction on "undocumented workers" from Mexico would not only inflame US-Mexican relations, but may very well not be in the interest of the United States. Our own demographic developments, marked by an inverted population pyramid, may very well require additions to the labor force particularly for those types of employment which attract people with fewer educational and technical qualifications.

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The Role of Canada

Some form of continental or tripartite cooperation among the USA, Mexico and Canada has been suggested. Most of these have emanated from the United States although Mexican officials have talked of the possibility of a joint summit meeting of the three heads of state. The Canadian government does not appear to be interested in a tripartite arrangement. Canada is satisfied with its present bilateral arrangements with both the United States and Mexico. The Canadian ambassador in Washington recently noted that regional free trade agreements "failed to reflect adequately either the political or economic realities in Canada and in particular our deeply felt concern with the issue of national sovereignty". This attitude is at least in part motivated by a desire on Canada's part to avoid getting in the middle of US-Mexico squabbles. Access to Mexican energy resources is however, a subject of interest for Canada which is a net importer of oil. Canada has contracted to buy Mexican oil.

The operative question in the context of a US-Mexican discussion is how the Mexicans view the prospect of Canadian participation on a tripartite basis in any negotiations which may evolve.

Would the Mexicans feel more at ease if the Canadians were involved?

Do they see any special advantages in terms of trade or otherwise from Canadian participation?

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## Additional Considerations

While the subject is clearly premature in terms of the discussion on August 13, should the Mexican and US governments feel that a major initiative is desirable, some considerations will have to be given as to how the preparatory work might best be undertaken. Apart from normal government to government discussions, it has been suggested that it might be useful either to (1) give the assignment to Mexican and US "wisemen" (after the seminal role that Jean Monnet played in the construction of the European Community) and/or (2) establish a joint commission of mixed government and private representation to define the framework for such an agreement.

Again looking well ahead, it may be useful as a point of information to note that the instrument which may be negotiated to embody any major agreement that may be concluded is not limited to either a treaty or conventional implementing legislation. The Trade Act of 1974 provided an innovative procedure which was used to implement the agreements concluded in the Multilateral Trade Negotiations. This procedure is continued in the Trade Agreements Act of 1979 and is available for use in the future and would apply to a US-Mexican agreement which had a significant trade component. Involved is a privileged procedure for the consideration by the Congress of legislation to implement trade agreements. The privileged character derives from the fact that such legislation, once introduced by the President, is not subject to amendment, must be discharged from committee within a stipulated number of days and must come up for a vote in each House within a stipulated number of days. This procedure worked remarkably well for the MTN agreements owing to the fact that there was close and continuous consultation as the agreements were negotiated between the executive and legislative branches and with the advice of an elaborate private advisory committee structure.

M. Rashish
8.3.79

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