ONLY THEN DID THEY MOVE TO THE CAPITAL-INTENSIVE INVESTMENTS BEING MADE TODAY. THROUGHOUT, THEY HAVE AGGRESSIVELY DEVELOPED THEIR INTELLECTUAL INFRASTRUCTURE BY EMPHASIZING EDUCATION AT ALL LEVELS.

MEXICO'S DEVELOPMENT EXPERIENCE HAS BEEN QUITE DIFFERENT. THE GROWTH IN OUTPUT OF THEIR AGRICULTURAL SECTOR HAS BEEN UNIMPRESSIVE AND CRITICALLY SHORT OF THEIR SOCIO-POLITICAL GOALS OF SELF-SUFFICIENCY AND AGRARIAN REFORM. WHILE LIGHT AND HEAVY MANUFACTURING INDUSTRIES HAVE MADE SIGNIFICANT GAINS, TWO MOST IMPORTANT FACTORS HAVE HINDERED THE DEVELOPMENT PROCESS. THEY ARE: THE GOVERNMENT'S RESTRICTIVE ATTITUDE TOWARD THE ACQUISITION OF TECHNOLOGY AND THE LIMITED ABILITY OF ITS WORKFORCE TO ABSORB AND MAKE USE OF IT.

RECENTLY, MEXICO HAS SOLICITED DIRECT FOREIGN INVESTMENT - BUT ONLY WHEN IT MEETS CERTAIN CRITERIA. ACCESS TO TECHNOLOGY NOT OTHERWISE AVAILABLE IS ONE CRITERION. THEY ARE EAGER TO OBTAIN TECHNOLOGY THAT ENABLES THEM TO PRODUCE GOODS LOCALLY THAT WERE PREVIOUSLY IMPORTED, OR THAT INCREASES THE COUNTRY'S EXPORTS, OR THAT PROVIDES NEW EMPLOYMENT.

12

A FACTOR THAT IS THE KEYSTONE IN MEXICO'S ATTEMPT TO CONTROL AND ACCELERATE THE TRANSFER OF PRIVATELY OWNED TECHNOLOGY INTO MEXICO IS THE 1973 "LAW TO PROMOTE MEXICAN INVESTMENT AND REGULATE FOREIGN INVESTMENT." THIS LAW STIPULATES THAT NEW FOREIGN EQUITY INVESTMENTS WILL NOT EXCEED 49 PERCENT OF A FIRM'S TOTAL EQUITY (THOUGH EXCEPTIONS TO THE 49 PERCENT RULE MAY BE GRANTED BY MEXICO'S FOREIGN INVESTMENT COMMISSION).

ON THE SURFACE, THIS COMPULSORY MEXICAN EQUITY CONTROL LOOKS LIKE AN EASY WAY TO GET CONTROL OVER FOREIGN TECHNOLOGY, TO CONTROL ITS AVAILABILITY AND ITS PRICE AND TO BUILD A LOCAL TECHNOLOGICAL BASE.

IN FACT, IT DISCOURAGES WHAT IT DOES IS DETERMINE MANY INVESTORS FROM COMING TO MEXICO AT ALL, TO THE DETRIMENT OF MEXICO'S PRODUCTION, INCOME, EMPLOYMENT, AND ULTIMATELY ITS RATE OF INFLATION. FOR THOSE WHO DO COME, SEVERE RESTRICTIONS ON THE TRANSFER OF SENSITIVE TECHNOLOGY TO THE MEXICAN ENTITY ARE LIKELY TO BE IMPOSED BY THE INVESTOR.

IT IS THE ONLY WAY TO PREVENT THIS BASIC RESOURCE FROM BEING DIFFUSED TO THE BENEFIT OF OTHERS WITHOUT ADEQUATE COMPENSATION FOR THE INVESTMENT AND THE RISK BEHIND ITS DEVELOPMENT.

THE MEXICAN GOVERNMENT'S ATTITUDE REGARDING OWNERSHIP CONTRASTS SHARPLY WITH TAIWAN'S IN THIS RESPECT. TAIWAN PERMITS 100% FOREIGN OWNERSHIP OF AN ENTERPRISE, AND OFFICIAL LIMITATIONS ON STARTING OR EXPANDING AN OPERATION ARE FEW.

FURTHERMORE, IN MEXICO, FOREIGN INVESTMENT IN CERTAIN INDUSTRIES IS LIMITED, AND IN OTHERS IT IS PROHIBITED. FOR EXAMPLE, FOREIGN OWNERSHIP IS LIMITED TO 34 PERCENT IN COMPANIES EXPLOITING NATIONAL MINERAL RESERVES AND TO 40 PERCENT IN COMPANIES MANUFACTURING AUTOMOTIVE PARTS AND SECONDARY PETROCHEMICAL PRODUCTS. PETROLEUM AND COMMUNICATIONS ARE ENTIRELY OFF-LIMITS TO FOREIGN INVESTMENT. AGAIN, THE RESULT OF THESE RESTRICTIONS ON OWNERSHIP IS TO DETER THE VERY TRANSFER OF TECHNOLOGY THAT MEXICO DESIRES.

14

THE 1973 LAW ALSO REQUIRES ANY INVESTMENT IN "NEW FIELDS OF ACTIVITY" OR "NEW PRODUCT LINES" BY EXISTING FOREIGN-OWNED FIRMS IN MEXICO TO BE APPROVED BY THE GOVERNMENT, WITH THE PRICE OF EXPANSION USUALLY BEING THE ACCEPTANCE OF LOCAL EQUITY AND CONTROLS. AGAIN, THE FOREIGN INVESTOR TENDS TO VEER AWAY FROM FURTHER INVESTMENT IN SUCH A SITUATION.

MEXICO HAS TWO OTHER LAWS WITH FAR-REACHING EFFECTS ON FOREIGN INVESTMENT AND TECHNOLOGY. ONE IS THE "LAW ON THE REGISTRATION OF THE TRANSFER OF TECHNOLOGY AND THE USE AND EXPLOITATION OF PATENTS AND TRADEMARKS." IT MAKES COMPULSORY THE REGISTRATION OF ALL CONTRACTS INVOLVING THE TRANSFER OF TECHNOLOGY, INCLUDING PATENTS. UNDER THIS LAW, CONTRACTS CAN BE VOIDED IN MANY CIRCUMSTANCES, ON SUCH GROUNDS AS EXCESSIVE COST, LOCAL AVAILABILITY OF THE TECHNOLOGY IN QUESTION, OR ATTEMPTS TO USE SUCH CONTRACTS TO CONTROL MEXICAN FIRMS. SUCH INTERVENTION BY THE GOVERNMENT IN THE ESTABLISHMENT OF PRIVATE LICENSING AND RELATED COMMERCIAL ARRANGEMENTS EFFECTIVELY SHARES TECHNOLOGY WITHOUT MARKET-COMPENSATION.

15

THE "LAW ON INVENTIONS AND TRADEMARKS" GRANTS THE GOVERNMENT TIGHT CONTROL OVER PATENTS AND TRADEMARKS AND LIMITS INDUSTRIAL PROPERTY RIGHTS. IT PROVIDES FOR COMPULSORY LICENSING OF PATENTS AND TERMINATION OF TRADEMARK PROTECTION IN CERTAIN CIRCUMSTANCES. FOR AN OBLIGATION TO UTILIZE A LOCAL MEXICAN-ORIGIN TRADEMARK IN CONJUNCTION WITH THE USE OF FOREIGN-ORIGIN TRADEMARKS, AMOUNTING TO A COMPULSORY TRANSFER OF GOODWILL. PENALTIES FOR NON-COMPLIANCE WITH THE ACT INCLUDE CANCELLATION OF TRADEMARK REGISTRATION, FINES, ARREST, AND A SHUTDOWN OF THE BUSINESS. LAWS LIKE THESE ARE MAJOR STUMBLING BLOCKS TO THE TRANSFER OF BOTH INVESTMENT CAPITAL AND TECHNOLOGY.

MEXICO IS ONE OF THE MOST ADVANCED OF THE THIRD WORLD NATIONS, YET THE ABILITY OF HER LABOR FORCE TO ACCOMMODATE AND MAKE USE OF NEW TECHNOLOGY IS LIMITED BY UNDERDEVELOPMENT. ONLY 26 PERCENT OF MEXICO'S POPULATION IS IN THE LABOR FORCE, COMPARED WITH 37 PERCENT FOR TAIWAN, AND ABOUT 46 PERCENT FOR THE U.S.

16

[w]

FURTHER, ABOUT A THIRD OF MEXICO'S 26 PERCENT REMAINS IN THE TRADITIONAL AGRICULTURAL SECTOR, COMPARED TO ABOUT A FOURTH OF THE MORE-INDUSTRIALIZED TAIWANESE LABOR FORCE. MEXICO'S PROBLEM IS WORSENED BY THE STEADY LOSS OF MANY OF HER MOST ABLE WORKERS TO THE U.S.

MUCH OF MEXICO'S INDUSTRIAL IMPROVEMENT HAS OCCURRED IN THE LAST TWO DECADES. OUTPUT PER WORKER IS ABOUT EQUAL TO THAT OF THE U.S. AT THE TURN OF THE CENTURY. THIS IS HARDLY SURPRISING, SINCE MEXICO BEGAN INDUSTRIALIZING ABOUT A CENTURY LATER THAN THE U.S.

SINCE 1960, REAL GNP GROWTH HAS AVERAGED 6.0 PERCENT PER YEAR. MEXICO'S ANNUAL GNP GROWTH, THOUGH HIGH BY WORLD STANDARDS, HAS NOT MATCHED TAIWAN'S 8.7 PERCENT RATE SINCE 1960.

THE EDUCATIONAL ATTAINMENTS OF MEXICAN WORKERS ARE IMPROVING. ABOUT NINE PERCENT OF HER 20 TO 24 YEAR OLDS ARE ENROLLED IN HIGHER EDUCATION, UP FROM 5.7 PERCENT IN 1969. IN FACT, MEXICO'S ENTIRE YOUTH POPULATION IS MARKEDLY BETTER EDUCATED THAN IT WAS 20 YEARS AGO.

17

THE PERCENTAGE OF CHILDREN FROM 6 TO 14 ATTENDING SCHOOL HAS INCREASED FROM 37.5 PERCENT TO 64.4 PERCENT. WHILE MEXICO HAS IMPROVED THE EDUCATIONAL ACHIEVEMENT OF HER POPULATION MARKEDLY, AND HAS ACHIEVED A LITERACY RATE OF 65 PERCENT, TAIWAN'S ATTAINMENT OF A 90 PERCENT LITERACY RATE, AND HER ENROLMENT OF 99.6 PERCENT OF SCHOOL-AGE CHILDREN IN SCHOOL, WILL TAKE A LONG TIME TO MATCH.

IN SUMMARY, EACH DEVELOPING NATION MUST SET ITS OWN GOALS AND DEFINE ITS OWN STRATEGIES FOR ACHIEVING THE DESIRED LEVEL OF SOCIAL AND ECONOMIC DEVELOPMENT. THIS IS NOT AN EASY PROCESS. BUT IF TECHNOLOGY ACQUISITION IS TO CONTINUE TO COME FROM THE MARKET ECONOMIES OF INDUSTRIAL COUNTRIES, DEVELOPING NATIONS MUST FACE UP TO THE REAL ISSUES. IF THEY PERSIST IN THEIR PRESENT POLICIES, TECHNOLOGY WILL NOT BE TRANSFERRED, PRIVATE CORPORATE INVESTMENT IN DEVELOPING NATIONS WILL BE RETARDED, AND THE ATTAINMENT OF BOTH THE MODERNIZATION GOALS OF DEVELOPING NATIONS AND CORPORATIONS' GROWTH GOALS WILL BE CONSTRAINED -- IN OTHER WORDS, A "NO-WIN" SITUATION FOR EVERYONE INVOLVED.

18

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 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.

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

-2-

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 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.

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-

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 away. 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 develop-
ment, 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, member-
ship in GATT would serve to exercise an external discipline for trade liberali-
zation by Mexico.

The US market is not only important to Mexico today, but with the develop-
ment 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-

[vi]

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 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 a 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. The 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 individual 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.

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

-9-

[il]

"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.

-10-

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 21.35 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?

-12-

A major constraint on the expansion of petroleum production and exporta-
tion 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 in an explicit part of a US-Mexican
agreement?

-13-

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.

-15-

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?

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.

-17-

# 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.

[cc]

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

2

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.

5

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.

6

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 main-
tenance 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.

7

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 oentury 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 DIEMEX/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 (Business Latin America, July 19, 1978, p. 230).

-8-

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 underemployed. 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.

-9-

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."

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

The Economist, April 22, 1978

-10-

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

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.

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).

-11-

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.

-12-

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 1978-82. Assuming an operating cost 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 purposes.

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).

-13-

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.

-15-

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

-16-

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 1978-82. 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.

-17-

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

-18-

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.

-19-

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 1983-88. 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.

-20-

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.

-22-

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

-24-

"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.

-26-

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,

-27-

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.

o 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.

-28-

* 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 century 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

-29-

Comparison between TI's Results and C.W. Reynolds Results

In a study commissioned by Texas Instruments, Inc., Professor Clark W. Reynolds of Stanford University projected employment creation in the Mexican economy based on an average 6% GNP compound growth rate between 1980 and 2000. He also advanced employment projections based on three other economic growth rates ranging from a low of 4% to a high of 7%. Although Professor Reynolds' analysis utilized different data and assumptions based on economic growth (as opposed to the oil output basis of this study), his results were not dissimilar from those of Texas Instruments.

Figure 3 summarizes the findings of the two studies by displaying the ability of the Mexican economy to produce jobs on an annual basis using five different fundamental assumptions: Reynolds' four GNP growth rates and Texas Instruments' Case 1 oil output and investment assumptions. The left vertical axis records annual job creation in millions; the right axis records the number of unemployed in the year 2000 in addition to the current pool of unemployed and underemployed estimated at 9 million. The lower graph gives the oil output projections from Case I extrapolated to a ceiling of 5.5 mmb/day attained after 1993.

-31-

These figures indicate the following:

At any GNP growth rate below 7%, Mexico's labor surplus will continue to increase throughout the forecast period. At a GNP growth rate of 4%, 10.5 to 11.5 million unemployed will be added to the ranks of the current unemployed and under-employed. At Reynolds' projected figure of 6%, the range is 3.3 to 4.3. Only at 7%, a sustained growth rate Reynolds considers highly unlikely, does the economy start to eliminate its existing pool of unemployed toward the end of the century. His conclusion: Mexico's economy cannot deal with the country's unemployment problem alone.

Oil production will fuel the economy's growth during the next fifteen years, leading to sharp increases in employment in the petroleum and other sectors of the economy. But assuming a ceiling in Mexican oil production (about 5.5 mmb/day), the growing domestic economy will compete with and eventually begin to supplant foreign purchases of oil by the mid-1990s. At that point, the petroleum industry will decline, relative to other sectors of the Mexican economy, as a source for needed capital and jobs.

Eventually, as the domestic market becomes the dominant customer for Mexican petroleum products, the employment-creation capability of the petroleum industry will decline in absolute terms as well.

-33-

Although statistical consolidation is impossible due to
the unrelated data employed in each study, the job
creation figures and employment gap of Texas Instruments'
Case I scenario strongly suggest a figure close to Reynolds'
6% GNP growth projection.

-34-

CONCLUSIONS

Although the estimates contained in this analysis are
dependent on several key assumptions subject to considerable
variation and debate (i.e. the size of the Mexican labor force
and oil production growth rates), various conclusions can be
advanced which remain valid even if their base assumptions are
altered:

(1) Increased oil production and revenues will alleviate but not eliminate Mexico's chronic labor surplus between 1980 and 2000. At best, the oil boom will lead to economic growth which will absorb the flow of new entrants to the labor market, but do little to contract the existing army of unemployed and under-employed.

In the next decade, revenues from oil exports will be a
major source of capital for the national development plan. But
after 1990, two trends will diminish the employment impact of
oil on the Mexico economy: (a) a ceiling of daily oil
production will be reached (assumed herein at about 5.5 mmb/day)
and (b) growing internal demand will reduce lucrative Mexican
petroleum exports. In relative and absolute terms, the
contribution of oil to total employment creation in the Mexican
economy will decline and reliance on petroleum alone will not
solve Mexico's labor surplus problem.

-35-

(2) The U.S. economy, on the other hand, will be able to absorb the Mexican labor surplus; it may even need to do so to maintain economic growth as a labor shortage develops in the U.S. during the late 1980's. Obtaining the benefits of the Mexican labor pool with a minimum of social disruption on both sides of the Rio Grande will be a major challenge for Mexican and American leaders in the coming years.

(3) The growing labor surplus in Mexico and a developing labor and energy shortage in the U.S. indicate the need for closer Mexican-American cooperation on problems of mutual concern, and a sense of equality not always evident in the past. Over the long haul, serious thought should be given to the creation of a North American Economic Union, meshing the economies of the U.S., Mexico and Canada more closely together thus maximizing the natural compatibility of the three economies.

-36-

* 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

with the continued high domestic demand expected from additional emphasis
or industrialization in Mexico.

PEMEX has estimated that the demand for petroleum products (1976-1985) in Mexico will rise at an annual rate of 6.0 percent, a lower rate than the 6.9 percent that prevailed in the years 1965-1975 (Table 2). This lower growth rate is a national consequence of the larger base on which the projection is made; national growth rates for energy demand usually drop in such circumstances.

The largest increase in demand is projected to be in jet and aviation fuel (8.4 percent), followed by diesel (7.4), industrial (6.6), LP gas (5.5), gasoline (3.2), and kerosene (1.1).

Table 3 gives the estimates by the Library of Congress, U.S. Congressional Research Service (CRS) of oil demand in Mexico for the years 1986-1988.
PEMEX's projections extended to only 1985.

## Case A: Oil Exports Assuming Gas Exports

The PEMEX demand projections assume significant quantities of natural gas exports. If Mexico did not export natural gas, then not only would Mexican demand for oil change, but Mexico oil exports would also change.

Assuming that Mexico's natural gas exports can be maximized, the CRS projections for Mexican oil exports for 1978 to 1988 are summarized in Table 4.

PEMEX has stated that Mexican oil exports would reach 1.1 million b/d in 1980 and remain at that level for two years, and Mexican Petroleum Institute (IMP) has projected oil demand for the same time period. Production levels, therefore, can be estimated from the two data sources. For the period 1983 to 1988, it is more difficult to arrive at estimates.

A-5

## Case B: Oil Exports Assuming No Gas Exports

Production of oil is affected significantly in a "no gas export" case because much of Mexico's oil is associated with large volumes of natural gas. Secondly, there is a change in Mexico's demand for oil because of natural gas' substitution for oil products, particularly fuel oil. Table 5 indicates the CRS projections of Mexican oil export potential based on the "no gas export" case.

Mexico has stated on several occasions that its first export priority in determining recipients of its oil would be the developing countries of Latin America. With only Venezuela and Equador self-sufficient, the potential market for Mexican exports is high. Mexico is already exporting to Cuba, Israel, Spain, the United States, and recently to Japan.

## Domestic Demand for Natural Gas

Since 1965, Mexican demand for natural gas domestically has decreased in comparison to all its other energy sources (Table 6). In 1965, natural gas made up 30 percent of Mexico's total energy demand, and over the years it has gradually decreased in relative importance to the point where it meets only 22 percent of total demand in 1975. The table shows that almost all of the slack in natural gas demand was filled by oil which increased in usage during the same ten year period from 54 percent to 60 percent of Mexico's total demand.

In 1975, Mexican gas production was 790 billion cubic feet (bcf). Of that amount 247 bcf (45 percent) was used in the industrial sector, particularly in the following industries: steel, chemical, cement, glass, and mining and minerals. PEMEX used 195 bcf (36 percent), and power plants used 84 bcf (15 percent) to generate electricity. The residential and

A-9

commercial sectors consumed the rest, 14 bcf (4 percent). Most of the balance, 250 bcf, was lost in distribution or flared.

Future gas demand in Mexico is difficult to project primarily because the Mexican Government is in a transition phase of possibly moving back towards greater dependence on natural gas. The main factor which has forced the Mexican Government to make new policy decisions on natural gas is that prolific areas in Mexico have a large concentration of natural gas which would have to be produced if Mexico is to meet its announced oil production goals.

Initially, in 1976 Mexico has made the decision to continue to rely on an oil-based domestic development plan and to sell the excess associated gas to the United States. Towards this end, Mexico announced it would build an 847 mile, 48-inch pipeline from Cactus to Reynosa, about 100 miles from McAllen, Texas, where there was already in place a gas transportation system to the rest of the United States. The plan called for initial deliveries to be about 800 million cubic feet a day (mcf/d), gradually increasing to 2 bcf/d after processing facilities and compressors were installed and operating. On August 3, 1977, six U.S. gas pipeline companies agreed with PEMEX, officials to a Letter of Intent on the project. This agreement expired on December 31, 1977 primarily because of U.S. intransigence on the price of $2.60 per mcf.

## Potential Mexican Domestic Demand for Gas

Two cases have been considered by the Congressional Research Service in order to assess Mexico's future demand for its gas: (1) the case of gas exports, and (2) the case of no gas exports with Mexico substituting gas for as much of its energy needs as possible and exporting instead the crude oil saved. The CRS projections for gas demand in Mexico during the period 1975 to 1988 are summarized in Table 7.

A-12

The Plan establishes as priorities for growth the food industries and machinery and equipment manufacturing. The regions which will receive more support are four industrial harbors: Coatzacoalos, Lazaro Cardenas-Las Truchas, Salinas Cruz and Tampico, along with other areas along the coasts, borders and selected points in the interior. The incentives offered discourage investments in the valley of Mexico and emphasize locations where exports are easier to realize, or areas where energy and other natural resources are available.

The incentives include discounts in the price of energy of up to 30%, tax credits of up to 25% or new investments and 20% of new payrolls. Additionally, the growing source of financial resources derived from oil exports will make it much easier for business to gain access to credit.

In the period 1979-90, the use of the resources generated by the exports of oil is estimated in the National Plan for Industrial Development to increase the employment by 5% per year. Comermex estimates that GNP will increase by an average of 7.25% in 1979 and 1980, and private investment should grow 26.1% per year in the same period.

Huge investments, in which the government will play an increasingly dominant role, underpin the plan, although Mexican officials are also counting heavily on the multiplier effect of private investment, as well as increased consumption, to provide additional stimulation. The plan kicks off anticipating gross fixed capital formation of P262.6 billion ($11.55 billion) for 1978 (at 1975 prices--roughly one half current values), about 60% of which will be generated by the private sector. In 1979 and 1980, the federal government expects its contribution to capital formation to grow at rates of 9.1% and 10%, respectively. It takes off sharply thereafter, increasing at an annual

B-2

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

C-1

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.

C-2

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

D-1

OVERSEAS DEVELOPMENT COUNCIL

1717 Massachusetts Ave., N.W. / Washington, D. C. 20006 / (202) 234-8701

June 18, 1979

Mr. William D. Rogers
Arnold and Porter
1229 Nineteenth Street NW
Washington, DC 20036

Dear Bill:

As you are aware, the Overseas Development Council has been in the planning stage of a proposed project on Mexican-American relations in the context of a changing international economy and world order. Work on the project began slightly over a year ago with the preparation of the initial background papers and project proposal. It has intensified in recent months and has involved two trips to Mexico by Council staff, one by ODC Senior Fellow Robert Ayres and me in February, 1979, and another by Ayres and me (in connection with the meeting of the UNICEF Executive Board) in May, 1979. A copy of the latest project proposal is attached (April, 1979). The proposal is now being revised to take into account the inputs from our latest trip to Mexico. The basic thrust of the proposal is unchanged; greater attention will be paid, however, to more specificity in the area of research topics.

ODC has also been vigorously pursuing funding for the proposed project. An early decision was taken to concentrate upon foundation funding and to eschew corporate and governmental funding for the project, at least in its initial stages. Meetings in New York on April 23 and 24 with representatives of the Ford, Mellon, Rockefeller, Rockefeller Brothers, and Tinker Foundations were very encouraging. Particular interest was expressed by Ford, Mellon, and Tinker. Within the past several days, we have been informed of an initial grant from the Tinker Foundation (in the amount of $50,000) which will permit us to launch the project. We expect two additional and larger grants this fall from other foundations.

You will note in the attached project proposal document the section entitled "operational format." It is in this connection that I am writing you now. ODC proposes to convene an initial joint Mexican-American planning group meeting in Mexico in early- or mid-fall for the purpose of planning subsequent phases of the project. The proposal is to bring together a small but distinguished group of 6 to 8 Mexican academicians, representatives of the private sector, and governmental representatives to meet with American counterparts. Among its other concerns, the planning group would assist ODC in planning a major symposium on Mexican-American relations to be held in the spring of 1980 and would

JUN 27 1979

Mr. William D. Rogers

June 18, 1979

Page Two

also advise on the proposed establishment of several task forces or
working groups on various aspects of our bilateral relations (see the
attached proposal).

ODC has received verbal commitments of attendance on the Mexican end from Professors Mario Ojeda and Samuel I. del Villar of the Colegio de Mexico, Professor Carlos Rico of the Centro de Investagaciones y Docencia Economicas (the Center for Research and Training in Economics, CIDE), and Leopoldo Solis, Deputy Director of the Bank of Mexico. In the next several weeks we will be following up with additional Mexican governmental representatives as well as with several prominent Mexican businessmen concerning their participation in the proposed fall planning meeting.

In advance of that meeting, ODC would like to hold a meeting of a
distinguished group of Americans knowledgable about Mexico and
Mexican-American relations. Such a meeting would provide ODC with
valuable input as it prepares for the first joint meeting of the project.
In addition, we hope that American participants in the fall meeting in
Mexico would come from among the members of the preliminary group
we propose to assemble.

Accordingly, we propose a day-long session at ODC headquarters sometime
during the last week of July or the first week in August. This will be a
"brainstorming" session on proposed research topics, modalities of
research, the procedural format of the project, pitfalls and problems,
opportunities and potentialities. In advance of the meeting, we would
distribute a brief agenda.

Since your name has repeatedly emerged in connection with our discussions
of people to involve in the early stages of the project, we are hopeful
that you will be able to join us for a day in mid-summer in which we
prepare for subsequent phases of the project. Bob Ayres, John Sewell,
or I will shortly be in touch with you by phone to explore the possibility of
your participation in our first meeting in connection with this important
new country-specific venture of ODC.

April 1979

Overseas Development Council: A Proposal for Policy Research and Dialogues on Mexican-American Interdependence

**General Statement.** The Overseas Development Council proposes to initiate an integrated program of policy research and dialogues on the general subject of Mexican-American interdependence. Toward this end, it is currently involved in active efforts to engage Mexican academicians, representatives of the private sector, and governmental representatives in a binational undertaking. (These efforts are detailed below.) The aim is to investigate in a concrete country setting the interaction of three sets of issues: global issues, including proposals for a "new international economic order" (NIEO) and greater equity between nations, and involving such issues as trade, food, and energy; issues concerning distributional aspects of development, i.e., proposals for greater equity within nations; and more traditional bilateral economic and political issues.

Underlying the entire proposed program are three basic considerations:

(1) that there is a need to consider U.S. development problems and policies as well as Mexican development problems and policies, in order to avoid seeing the "solutions" to problems in the Mexican-American relationship as residing only at the Mexican end;

(2) that, therefore, the notion of interdependence (in the broadest and most constructive sense) must be taken seriously; and

(3) that the issues in Mexican-American relations can be fruitfully addressed from the global perspective of a changing international environment and that addressing them in such a way can provide a "window" on North-South issues between other advanced industrial and developing countries. (See the discussion of the "Comparative Advantage of ODC" for further adumbration of this argument.)

These general principles having been stated, it should be noted that few subjects are of more importance for American foreign policy than our future relations with Mexico. Examples of interdependence are legion. Mexico is the fourth largest trading partner of the U.S. Approximately 70 percent of the value of Mexican exports, for example, go to the United States. Approximately 60 percent of Mexican imports come from the United States. The United States accounts for approximately 75 percent of all private foreign direct investment in Mexico. The U.S. may well come to depend upon Mexico for meeting much of its energy requirements. By the most conservative estimate, at least four million Mexican "undocumented aliens" are presently in the United States. Mexico and the United States are connected; they are interdependent. Relevant, policy-focused, and recommendatory research and dialogue need to be directed to the elements of this interdependence.

-2-

At the same time, future economic and political developments in the U.S. will have a clear impact upon developments in Mexico. The United States has its own development problems requiring attention--problems of energy and other resource constraints (such as water), problems of determining its dynamic comparative advantage in future world trade, questions of optimal resource allocation in the future productive structure of the American economy, and so forth. Mexico and the United States share many problems; many of the problems of each spill over into the economy and society of the other; many of the solutions to common problems must thus be jointly developed.

By the same token, few subjects are of more importance to Mexico than the current apparent issues of the country's development strategy. That strategy has produced some notable achievements. Economic growth rates have been impressive (until the last several years); so has the growth of infrastructure. A large and prosperous middle class has been spawned as the consequence of commercial and industrial development. But social performance has trailed economic performance; "basic human needs" have not been met for a great many Mexicans. How Mexico chooses to deal (or not deal) with these problems will have a clear impact upon economic and political developments in the United States.

What needs to be urgently explored, therefore, are the many ways in which future Mexican development and future American development can be structured in a _mutually accommodative_ fashion and thus lead to a situation of _constructive interdependence_, rather than the imposition of simplistic "solutions" on either side of the border.

It is highly likely that we are witnessing a critical juncture on these aspects of interdependence and their relationship to Mexican development. Decisions taken (or not taken) on both the inter-national and intra-national problems, and on the points of interconnection between the two, will affect Mexican development, U.S. development, and Mexican-American relations for years to come.

Examples of general approach in specific substantive areas. Accordingly, ODC envisions a multi-phase program on the theme of _Mexican-American interdependence_, and on the interaction of Mexican problems and policies with _American problems and policies_. Examples of topical areas to be addressed include:

(1) **Trade.** A systematic examination of Mexican-American trade and of its future prospects is required. Considerable attention needs to be given to the determination of the future pattern of Mexican comparative advantage and of how, for example, this relates to the likely evolution of industrial structure in the United States. Research is also required on the future evolution of American agricultural production and the "policy space" this might (or might not) provide for an increase in agricultural exports from Mexico (assuming agreement that this would be a good thing, a matter of some contention).

There is considerable scope for examining, _inter alia_, the following: Mexican commercial policies in the post-import-substitution period; the extent to which Mexico is (or is not) taking advantage of tariff preferences; policies for the promotion of labor-intensive exportables; American tariff and non-tariff barriers affecting Mexican exports; and the range of likely American (i.e., business, farm, labor, and governmental) responses to increased importation from Mexico.

-3-

(2) **Investment.** Total American direct investment in Mexico is approximately $3 billion. Seventy-five percent of U.S. direct investments in Mexico are in the manufacturing sector, particularly in the more "modern," technologically advanced subsectors. During the Echeverria administration, Mexico adopted several pieces of legislation affecting a range of investment issues--including "Mexicanization" of direct investment, greater scrutiny of foreign technology, efforts to assist Mexican entrepreneurs on royalty issues, and so forth. The salience of such investment issues in U.S. relations with developing countries scarcely needs emphasis.

A particularly open question concerns the future of U.S. investment in a Mexi-
can development strategy that might be revised to give greater attention to
rural development. What would be the role, if any, of foreign investment in
a nationwide program of integrated rural development (such as the current
PIDER program funded by the Inter-American Development Bank, the World Bank,
and the Mexican government)? What would be the role, if any, of foreign invest-
ment in a program to assist small- and medium-scale Mexican industry, which
together account for 45 percent of Mexican manufacturing production and 60
percent of manufacturing employment? In short: What is the future develop-
mental role of American capital in Mexico? How do the Mexicans themselves see
that role? What innovative investment formats might be devised between the
two countries in order to channel American investment into sectors of the
Mexican economy where it is likely not only to stimulate Mexican growth, but,
perhaps more importantly, contribute to significant employment generation?

(3) **Energy.** This is a subject with great implications, and the issues in the Mexican case are complex and important. On the one hand, there are questions about how the increased investment program for PEMEX (the state oil monopoly) will be financed, whether Mexico might eventually join OPEC, the price at which Mexico will sell its oil and gas to the United States, whether there might be diversification of Mexican petroleum exports to other than the U.S. market, and so forth. On the other hand, there are questions about how the proceeds from oil will be used. Will petroleum revenues be employed to facilitate the integration of marginal socioeconomic strata into the mainstream of Mexican life? The examination of what energy and energy-related policies might be, on the part of both Mexico and the United States, is an important component of the proposed program. The United States as well as Mexico needs an energy policy. What policies, for example, will the United States adopt to guarantee that increased importation of petroleum from Mexico, should it be forthcoming, will not simply lead to increased profligacy of consumption on the part of American consumers?

(4) **Migration.** The policies adopted (or not adopted) with regard to each of the above areas have clear implications for the future of the migration problem. Successful policies of rural development and assistance to the small- and medium-scale industrial sector, for example, should be expected to have a beneficial impact upon the "push" factors promoting migration to the United States. Attention needs to be given to a whole range of policy options, both Mexican and American, for dealing with the structural causes of migration. The future of the American labor market needs to be systematically examined. Mexican population policies clearly require attention. So also does the question of migrants' remittances; if these really total $3-4 billion annually, as has been estimated, then they exceed the total value of Mexican exports to the United States in typical recent years. In addition, the Carter Administration proposals dealing with the manifold problems of illegal immigration

-4-

(revealed in August, 1977) require thorough scrutiny. Here again the point is to explore these matters taking seriously the notion of interdependence. Again, this is not only a Mexican problem with a Mexican solution. On the migration issue as on other issues, the two economies need one another. The question is how to structure these mutual needs, how to manage their interdependence.

(5) "Mexamerica" Questions. We use this appellation (borrowed from a recent series in the *Washington Post* on the future of the Mexican community in the United States) to denote a range of cultural-political as well as socio-economic issues related to the "Mexicanization" of large parts of the United States (especially in California and the Southwest, but elsewhere as well). (Consider, for example, that the percentage of Hispanic students in the Los Angeles Unified School District is now 34.9; consider that Los Angeles now has the country's second-largest garment industry, largely staffed by immigrant workers; consider the important question of Hispanic voting behavior in such key states as California and Texas; consider the increased interest of the Mexican government in the Mexican-American community resident in the United States.) The concerns in this area are many and varied, including employment questions, Mexican immigrants' access to social welfare services, public educational questions, criminal justice questions, and so forth. Each of these areas poses significant policy questions involving a complex interrelation of foreign and domestic concerns (what has aptly been called "intermesticity").

To summarize: The future of Mexican development strategy and policies will impinge upon the United States in numerous and variegated ways. Conversely, U.S. policies will have considerable impact on Mexican development. The Mexican impact will be felt at the most general level of a challenge to the American "melting pot" ideology and at the level of specific issues posed for American business, labor, and farm groups as well as the American government. The private and public sectors in the United States need to evolve new ways of relating to a Mexico whose development strategy greatly affects U.S. concerns. The United States as well as Mexico must prepare for the changes, tensions, and antagonisms which the forging of new development options for both countries will inevitably entail. This preparation must devote attention to the diplomacy of U.S.-Mexican relations. This means, in addition, a concern with both Mexican and U.S. policy formulation hurdles to a more fruitful U.S.-Mexican attack on common development problems and a concern with the diplomacy of "managing interdependence" (i.e., new forms--procedures, styles, institutions--for conducting Mexican-American relations). How can/will/should Mexico change? How can/will/should the United States change so as to accommodate a changing Mexico? These are perhaps the overarching questions for the proposed ODC program of policy-related research and dialogues.

**Operational Format.** How does the Overseas Development Council propose to address these matters? We propose to address them through a diversified program of policy-related meetings and research.

In keeping with ODC's basic orientation, we are not proposing academic research for the sake of academic research. An integral part of the project would entail the creation of a procedural format which would communicate research results to a broad spectrum of policy-makers and interested publics in both countries, and which would in turn provide feedback from such publics into the design and implementation of subsequent research.

-5-

ODC proposes, therefore, to bring together both Mexicans and Americans from the academic community, the private sector, and the governmental sector. ODC is well experienced with such tripartite convocations on the American side, having sponsored innumerable meetings and projects during the course of its existence which have done exactly this. Indeed, we have already identified many of the individuals whom we wish to involve in this effort on the American side.

The organizational locus of the proposed project on the Mexican side presents problems which ODC is going to great lengths to overcome. It is obvious that there is no clear analog to ODC in Mexico. Further, expertise on these questions is scattered among Mexican institutions (including, prominently, government institutions), so that it does not appear feasible to have only one institution in Mexico act as an institutional co-sponsor with ODC of the project. Further, while the convening of such tripartite groups in liberal, pluralistic America may be relatively easy, it may be by no means easy in Mexico.

Nevertheless, we are greatly encouraged by the preliminary response in Mexico to our proposal for a steering group of Mexicans and Americans who would jointly plan and implement the remainder of the project. Such a steering group would be composed of from six (6) to ten (10) Mexicans and from six (6) to ten (10) Americans (composed, in accordance with project design, of academic, private sector, and government representatives). We broached this idea with the Mexicans on our recent trip to Mexico (see attached "Report on Trip to Mexico"). We are following up on it in current correspondence, and we will re-emphasize it on a second trip to Mexico planned for late May.

If things proceed according to schedule, we would extend formal invitations to potential steering group participants following the conclusion of our second trip to Mexico (i.e., in June, 1979). We would hope to convene the initial steering group meeting in Mexico in late July or August, 1979. The major task of this first steering group meeting would be to engage in preliminary planning for a major symposium on Mexican-American relations, to be held in early 1980 at a site still to be determined. Such a symposium would be attended by 30-40 Mexicans and Americans. It would meet to consider a number of original commissioned papers, written by both Mexicans and Americans and disseminated in both English and Spanish, on the subject of "Mexican-American Relations in the Context of a Changing Global Economy." The symposium's deliberation would also serve to provide a framework for the proposed post-symposium phase of the project.

Of what would such a post-symposium phase consist? The proposal for the post-symposium phase entails the creation of a number of task forces or working groups on those functional topics which were deemed most salient at the symposium. There could be such working groups, for example, on Mexican-American trade, the complex relationships between Mexican and American agriculture, migration, and so forth. The task forces or working groups would also have tripartite, binational representation and would be composed of perhaps 12-15 members. A small research secretariat would be established for each such group. Research carried out under the project, either by ODC staff itself or by commissioned researchers, would feed into the working groups in a regularized fashion. Initially, the number of such task forces or working groups would be kept small (two or three) to enable us to monitor the usefulness of this particular modality for addressing Mexican-American relations.

-6-

Members of the working groups would be expected to offer written inputs in the form of brief policy proposals, statements of issues in their areas of expertise, and so forth. The working groups would then consider research results, policy proposals, and the like. Depending upon the evolution of the project, it might be desirable to convoke a Commission on Mexican-American Relations to give emphasis and visibility to the findings and proposals of the various task forces. Alternatively, one could envision the institutionalization of the Mexican-American dialogues on an informal pattern similar, perhaps, to the "Dartmouth" meetings between a core group of Russians and Americans that have continued for more than a decade.

As noted previously, the project would be eminently binational. Mexicans and Mexican institutions would be involved from the start; participation in the steering groups, the symposium, and the working groups would be divided roughly equally between Mexicans and Americans; the papers to be considered by the initial conference would be prepared by both Mexicans and Americans; and so forth.

The basic aim of this procedural format is to overcome the all-too-frequent bifurcation of "academic" and "policy-oriented" research. Academicians, representatives of the private sector, and governmental representatives in the two countries would relate to one another in an ongoing dialogue process. Systematic academic research would inform whatever proposals might emerge; at the same time, the insights of the non-academic participants should serve to sharpen the policy relevance of the proposed research.

At the conclusion of the major symposium, and throughout the course of the working group meetings, it is important that there be a major dissemination effort. At a minimum, this would include the publication of a major book composed of the papers (with appropriate commentary) presented at the symposium. It would also include the publication of some shorter, more popular renditions of the major themes of the symposium. A series of follow-up "public education" meetings should be planned. With regard to the task force phase, consideration should be given to the on-going publication of working papers prior to the full-scale dissemination of task force findings and proposals.

**Comparative Advantage of ODC.** There are several reasons why ODC may be better qualified to manage such a project than other institutions in the United States. First, ODC has an almost unique ability to see where Mexican-American relations fit into a global context because of our other work, particularly in the area of global interdependence with special reference to the involvement of developing countries. Some examples may be offered. Agriculture, for example, is a crucial issue both for Mexico and the United States. For the United States, food production is important for several reasons, including notably the major role that food exports play in our trade situation and the likelihood that a continuation of the present pattern of increasing food exports is likely to exert significant inflationary pressures on the U.S. economy by the mid-1980s if not earlier. For Mexico, of course, increased food production is necessary to feed a growing population, as a major source of employment and in some areas--such as fruits and vegetables--as an important export earner. Yet, the policies that both Mexico and the United States formulate separately and together must be evaluated in the context of a world food situation in which increasing scarcity and much higher prices are a virtual certainty unless global cooperative measures are taken to increase food production, particularly in

-7-

in the developing countries. Therefore, what both countries do about food pro-
duction must be considered in the context of global policies to increase food
production between now and the end of the century.

Energy policy is another example. Energy policy will be a major issue in U.S.-Mexican relations because of our need for Mexico's oil and gas for the balance of this century and beyond. Yet both countries need to consider how to make the transition to the post-petroleum society.

So, too, Mexican-American bilateral trade relations must be seen in a global context because they are part of a continuing set of issues in contention between developed and developing countries and because, by its nature, the world trading situation is an international system. The rapidly increasing exports of the newly industrializing countries, notably Mexico, Brazil, South Korea, Taiwan, Hong Kong, and Singapore, confront the OECD countries with the need to absorb the equivalent of "another Japan" in the 1980s; many U.S. trade issues with Mexico must be seen in this broader context.

Second, ODC has a considerable experience drawn from its studies and other acti-
vities about what works elsewhere in the world for the problems confronting
Mexico. Consider, for example, the importance of increasing the productivity
of the small farmer for a variety of economic and social reasons. Experience in
Asia indicated that in labor-plentiful, land-short countries, farms of only two
acres can be even more productive per acre than the large agribusiness farms if
the farmers have the right support systems which give them equivalent ease of
access to credit, fertilizer, water, etc.; and that such small farms are many
more times as labor-intensive. Yet, the experiences of countries which have
dealt successfully with a small-farmer-based agricultural development strategy,
particularly in East and Southeast Asia, have been hardly applied in Latin America.
For Mexico, with its interest in keeping more people on the land while increasing
food production, and for the United States, which must face the fact that immigra-
tion will not slow down until more Mexicans are able to earn a decent living with-
in their own country, the transfer of labor-intensive development lessons from
other parts of the world to the Latin American environment is particularly impor-
tant. ODC's pioneering work in this field has received worldwide recognition in
the 1970s.

Third, ODC has considerable experience in contributing to the translation of new ideas and concepts into action. This is one of the reasons for which the Council was established, and it is accurate to say that we have pioneered a number of techniques which enable us first to develop new ideas and concepts and then to give them general circulation within the policy community and to a broader audience. The most recent of these is the "Physical Quality of Life Index, (PQLI)," an index of social well-being developed at ODC. The PQLI engendered considerable controversy at first, but it has now come to the point where it has been used by *Time* in a major centerfold story and has been adopted by the Development Assistance Committee of the Organization for Economic Cooperation and Development as part of its statistical series. We have had a similar success in the recent past with spreading the concept that the development of the poor countries is as much in the interest of the rich countries as the developing countries themselves. Our work in this area has received a great deal of circulation and discussion over the past year, and is now a generally accepted part of the policy debate.

-8-

Fourth, ODC has a growing capacity to involve Congress and congressional staff people in policy discussions. It will be important for future Mexican-U.S. relations to develop a broader Congressional constituency. ODC is in a position to tap its expanding Congressional network both at the staff and member level, and in so doing enhance both the input into the project and the dissemination of its output.

Finally, it should be pointed out that ODC will involve a great many Latin American experts as well as those knowledgeable about the changing North-South relations in the project itself. Roger Hansen, Professor at the Johns Hopkins School of Advanced International Studies and author of *The Politics of Mexican Development* and the recent *Beyond the North-South Stalemate*, is a former Senior Fellow at ODC and currently a member of its Consulting Staff. Robert L. Ayres, currently a Senior Fellow at ODC, has taught Latin American politics at the University of California in Berkeley and has written widely on Argentine politics, Chilean politics, and Latin American development policy. He has been turning his attention toward Mexico for the past year. In addition, he has met with a range of Mexican and American social scientists to explore their potential involvement in the project. Ayres and James P. Grant, President of ODC, will be traveling to Mexico again in May, 1979, to continue the exploration of the outlines of the project with Mexican businessmen, academicians, and government officials.

If major financial support for the project is forthcoming, ODC will then move to strengthen its own in-house research capabilities on Mexican-American relations, direct some of the time of its current staff toward these issues, and establish close liaison with academic and non-academic personnel outside ODC who possess expertise on these questions. Indeed, ODC intends to convene a research advisory group (8-10 individuals) which would assist us on the research side of the proposed project. It is anticipated that this advisory group would meet once in advance of the first steering group meeting and again in the interim between the steering group meeting and the convocation of the major symposium.

## Tentative Work Plan for Project.

We may schematize the proposed work plan for the project as follows:

(1) Hiring of research assistants (??), administrative person; research assistants to work with ODC Senior Fellow on ODC contribution to basic research.

(2) Convening of a research advisory group under ODC auspices to advise on research input for the project (late spring? summer?).

(3) Convening of steering group meeting in Mexico (summer) to plan proposed symposium and to orient the general project (five or six Mexicans, five or six Americans); travel of participants; possible renting of meeting site; etc.

(4) Commissioning of papers for initial symposium--at least two overviews of the issues, one by a Mexican and one by an American; commissioning of additional papers after the two overview papers.

-9-

(5) Convening of a major symposium on Mexican-American Relations in the Context of a Changing Global Economy, involving about 15-20 participants from each country; 2-3 days; site and time undecided; publication of papers and commentaries (book).

(6) Meetings program at ODC (e.g., on Mexican-U.S. energy relations), in advance of the convening of the major symposium.

(7) (Depending on outcome and sentiment of symposium) Formation of several task forces or working groups on different functional aspects (e.g., trade, agriculture, migration) of the relationship between the two countries; such task forces or working groups to meet on an on-going basis over approximately a two-year period; travel of participants; commissioning of additional papers; publications.

(8) (Possible) convening of a second symposium to summarize and highlight the work, findings, and proposals of the various task forces; possible publication of a book-length volume on Mexican-American Relations in the 1980s.

(9) Follow-up: dissemination, outreach, public education, etc.

A proposed budget incorporating the elements of this work plan is attached.

Further information about the proposed project may be obtained from the Overseas Development Council, 1717 Massachusetts Avenue, NW, Washington, D.C. 20036.

MYER RASHISH
CONSULTING ECONOMIST

818 CONNECTICUT AVENUE, N. W.
WASHINGTON, D. C. 20006
(202) 466-6700

June 20, 1980

FOR: Robert O. Anderson
Donald M. Kendall
Henry A. Kissinger
William D. Rogers

The interim report dated May 30, 1980 having been received by the members of the Mexico Study Group, I felt it was timely to raise with you the questions of program and finances.

PROGRAM

It is essential that the Group decide whether and how it wishes to proceed. The nature of the May 30 report is such that we believe that it can be transmitted to President Lopez Portillo to serve as a working document for any meeting that may be agreed to. I understand from Bob Anderson that he has raised the question of a seminar meeting with Lopez Portillo which would include, on the Mexican side, a number of people selected by the President. Should such a meeting be arranged, it would be useful to have a preparatory meeting between me and whomever the President designates.

JUN 24 1980

[L.C.]

FINANCES

Aside from the contribution of $50,000 by ARCO in early March, no other monies have been received to defray the expenses of the project or in payment of fees for my work. I have advanced my own funds for rent, salaries of staff and other expenses. As of the end of June, estimated total unreimbursed expenses will amount to $25,000. In addition, fees due me for the period July 18, 1979 - July 1, 1980 will amount to $135,000 for a total of $160,000.

In considering the question of what the future of the project should be, it is worth noting that I have assumed obligations for rent of space and salaries to the end of this calendar year. I have detailed all the expenses and budgetary information in a packet of materials which I sent to Messrs. Kissinger, Kendall and Rogers on March 17, 1980 and have supplemented that in a letter to Don Kendall of May 28, 1980.

In the more recent letter to Don, I suggested that consideration be given to soliciting contributions from the 6 corporate members who have not made any contribution. Assuming that the project were to continue to the end of the year, my estimate was that the total amount to be funded (beyond ARCO's contribution and including the $160,000 incurred to date) would be $300,000. This yields $50,000 each for the 6 corporate members (Chase, Texas Instruments, PepsiCo, General Motors, Bank of America and Bechtel).

May I close on the urgent note that some immediate monetary infusion is needed?