APPENDIX: Mexico: Numerical Example, Exports Model
|P = .4|
|r* = .1|
|δ = .08|
|rH = .08|
|rF = .12|
|P = .4|
|r* = .1|
|δ = .08|
|rH = .08|
|rF = .12|
Baldwin, Richard, “Hysteresis in Import Prices: The Beachhead Effect,” American Economic Review, Vol. 78, No. 4 (September 1988), pp. 773-85.
Blejer, Mario I., and Alain Ize, “Adjustment Uncertainty, Confidence, and Growth,” IMF Working Paper, WP/89/105 (Washington: International Monetary Fund, 1989).
Calvo, Guillermo, “On the Costs of Temporary Policy,” Journal of Development Economics (Amsterdam), Vol. 27 (October 1987), pp. 245-61.
Cohen, Asian, “Effects of Trade Liberalization on Exports: The Case of Mexico” (mimeographed, University of California, Berkeley, June 1989).
Dixit, Avinash, Irreversible Investment with Price Ceilings, International Monetary Fund Seminar Series, No. 1989-9 (July 1989), pp. 1-13.
Dornbusch, Rudiger, and Alejandro Reynoso, “Financial Factors in Economic Development,” NBER Working Paper, No. 2889 (Cambridge, Massachusetts: National Bureau of Economic Research, 1989).
Edwards, Sebastian, “Structural Adjustment Policies in Highly Indebted Countries,” NBER Working Paper, No. 2502 (Cambridge, Massachusetts: National Bureau of Economic Research, 1988).
Gomez-Oliver, Antonio, “Private Consumption and Saving: The Cases of Mexico and Chile,” IMF Working Paper, WP/89/51 (Washington: International Monetary Fund, 1989).
Helpman, Elhanan, and Assaf Razin, “Exchange Rate Management: Intertemporal Tradeoffs,” American Economic Review (Nashville), Vol. 77 (March 1987), pp. 107-23.
Ize, Alain, “Savings, Investment, and Growth in Mexico: Five Years After the Crisis,” IMF Working Paper, WP/89/18 (Washington: International Monetary Fund, 1989).
Kiguel, Miguel A., and Nissan Liviatan, “The Business Cycle Associated with Exchange Rate Based Stabilizations” (mimeographed, The World Bank, October 1989).
Krugman, Paul, “Pricing to Market when the Exchange Rate Changes,” in Real-Financial Linkages Among Open Economies, ed. by Sven W. Arndt and J. David Richardson (MIT Press, 1987), pp. 49-70.
Lizondo, J. Saul, and Peter J. Montiel, “Contractionary Devaluation in Developing Countries: An Analytical Overview,” Staff Papers, International Monetary Fund (Washington), Vol. 36 (March 1989), pp. 182-227.
Michaely, Michael, Armeane Choksi, and Demetris Papageorgiou, “The Design of Trade Liberalization,” Finance and Development, International Monetary Fund (Washington), Vol. 26, No. 1 (March 1989).
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Rodrik, Dani, “Liberalization, Sustainability, and the Design of Structural Adjustment Programs” (mimeographed, Howard University, 1987).
Rodrik, Dani, “Closing the Technology Gap: Does Trade Liberalization Really Help?,” NBER Working Paper, No. 2654 (Cambridge, Massachusetts: National Bureau of Economic Research, 1988).
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Prepared for a roundtable discussion on Trade Liberalization and Growth organized by CIEMEX-WEFA in Monterrey, Mexico, October 6, 1989. Research on this paper was initiated while the author was visiting El Colegio de Mexico during the summer of 1989. Comments and suggestions from Eliot Kalter, Antonio Gomez Oliver, and Nora Lustig, and valuable research assistance from Chris Wu are gratefully acknowledged. The views expressed here are the author’s exclusive responsibility and do not necessarily reflect those of the International Monetary Fund.
One such sector is livestock and meat products, which has often exerted significant inflationary pressures in other heterodox stabilization attempts. In Mexico, the price of meat relative to the overall consumer price index rose significantly from May to August 1988, but remained at that level thereafter, under pressure from substantial imports. See Figure 4.
Profit margins were computed using Banco de Mexico data on the cost of intermediate inputs and labor in each sector, weighted by their respective value in the 1980 input-output tables.
Some industries that fall in this category are cookies, beer, and cement.
Higher margins could be seen as an option value factor. See the literature on investment and pricing under uncertainty, in particular Dixit (1989).
Mexican laws protect tenants’ rights extensively and prohibit the use of indexed contracts.
Since most of the goods and services with long contracts are by essence nontradables, it is clear that their relative price must rise in relation to the overall consumer price index when the real exchange rate appreciates. The causality of this relationship seems to run from lower inflation to higher nontradable prices, and from higher nontradable prices to a lower real exchange rate, rather than the other way around.
Increasing demand, linked to an overall consumption boom after the freeze, may also be partly responsible for the rise in food prices. This issue is discussed in the next section.
Trade liberalization would not have always prevented substantial price increases, however, as domestic prices were below international prices in many cases.
This argument needs, however, a qualification, as interest payments that appear in Table 5 incorporate the inflation tax on money balances. This explains why interest payments were so negative in 1986 and 1987. Lower income households, who are likely to be liquidity constrained, probably spent the proceeds from the lower inflation tax on their money balances, even though they might not have perceived this income gain to be permanent.
The limited supply response of stocks and housing should have led, in turn, to an increase in their prices, which could have contributed, by raising private wealth, to a further increase in consumption.
If one looks at past values of the exchange rate, this comparison involves more the state of psychological expectations than true market fundamentals. Faced with substantial uncertainty on market fundamentals and the possibility of self-fulfilling equilibria, the public may, however, end up forming its expectations adaptively. This seems to have occurred in Mexico since the crisis.
Helpman and Razin (1987) show that distribution effects can also arise intertemporally, as a result of fixing the exchange rate. Wages have increased, in terms of foreign prices, by at least 25 percent from 1987 to 1988, and this could provide a significant base for such intertemporal distribution effects.
Given the limited size of the tradables sector in Mexico, a real appreciation raises the demand for capital if the higher returns obtained in the nontradable sector dominate the decline in returns to capital in the tradable sector. See Lizondo and Montiel (1989).
See Ize (1989) for a growth programming exercise which is based on some incremental capital output ratio estimates that are consistent with this order of magnitude.
There are strong indications that large Mexican exporting firms currently face a very elastic supply of foreign credit.
Recessionary pressures have been observed to develop in many heterodox stabilization experiences after the initial demand boom, as reported for example by Kiguel and Liviatan (1989). This could also occur in Mexico. If so, it could further depress output, savings, and growth.
Some recent contributions include Sachs (1987), Edwards (1988), Rodrik (1988), Michaely, Choksi, and Papageorgiou (1989), and Whalley (1989). Cohen (1989) analyzes the effects of trade liberalization on exports in Mexico.
Financial strengthening of indebted firms may also have played an important role in the recovery of exports after 1985.
The distinction between ex post and ex ante real interest rates, which should also be made for a correct assessment of private behavior, but which is generally not made, owing in particular to data limitations, is another argument in favor of a constant real interest rate proposal.