Alternatives for Economic Growth, Employment, and Poverty Reduction in

Paraguay.Macro and Micro simulations Results.

José R. Molinas

Institute DesarrolloAsuncion, Paraguaywww.desarrollo.edu.py

International Poverty Center Conference on Employment Brasilia, 11-12 January, 2005

PRESENTATION OUTLINE

I. Central Problems of the Paraguayan Economy.

II. The Searching for Macro Solutions using three types of economy-wide models.

III. Micro/Sectoral Policy Implications.

Increasing Poverty

– 1990-1995: 3.2% – 1995-2000: 0.7% – 2000-2003: 0.1%

Year Poverty Rural Poverty

1995 30% 37%

1997/98 32% 42%

1999 34% 42%

2000/01 34% 41%

CentralCentral Problems ProblemsDecreasing Growth

Average Population Growth: 2.6%

Share of Main Crops in Agriculture GDP (%)

Crops 1990 1995 2000 2003

Labor Intensive:Cotton

Sugar CaneVegetables

FruitsSub-total:

14.54.14.012.735.3

11.34.14.8

10.931.1

5.93.34.8

11.425.4

3.03.64.3

10.221.1

Capital Intensive:Soybean

WheatSub-total:

18.87.426.2

28.73.8

32.5

37.64.1

41.7

38.86.9

45.7

Mixed Technologies:Corn

ManiocSub-total:

5.214.319.5

9.215.825.0

7.113.720.8

8.517.225.7

Fast Falling Labor Absorption in Agriculture

Area YearUnemployment Rate (%) Underemployment Rate (%)

Open Hidden Total Open Hidden Total

Total

1995 3.4 2.6 5.9 - - -

1997/98 5.4 9.5 14.3 6.5 26.5 32.9

1999 6.8 9.7 15.9 6.1 28.1 34.1

2000/01 7.6 8.3 15.3 7.7 29.2 36.9

Urban

1995 5.3 2.7 7.8 - - -

1997/98 6.9 7.6 13.9 5.9 17.3 23.2

1999 9.4 7.9 16.6 5.3 19.2 24.5

2000/01 10.3 7.4 17.0 7.7 21.9 29.6

Rural

1995 1.4 2.5 3.9 - - -

1997/98 3.2 12.0 14.9 7.3 39.3 46.6

1999 3.4 12.0 15.0 7.1 39.6 46.7

2000/01 4.1 9.5 13.2 7.6 38.6 46.2

Increasing Unemployment and Underemployment

Context: Increasing Economic Liberalization1989-1994

Trade Liberalization:• Significant Tariff Decrease

– 1988: 54% => 1992: 9%

Capital Account Liberalization:• Foreign Investment Promotion Law (1990)

Financial Liberalization:

Increase credit supply=> Increase Private Consumption financing.

The Searching for Alternatives The Searching for Alternatives PoliciesPolicies

• At the Institute Desarrollo, we are working with three types of models :

– A. Econometric models of Total Factor Productivity (Growth Accounting models)

– B. Computable General Equilibrium Models– C. Household survey based Micro-simulation

Models for analyzing welfare changes through labor market conditions.

• These three types of models are complementary among each other.

Econometric models of total factor productivity

(growth accounting models)

Selected ResultsBasic features of the Paraguayan economy in the

last 35 years, according to this model:

Factor contribution to GDP Growth:• Physical capital contributed in 72%

• Land contributed in 11%

• Unskilled labor force contributed 10% • Education per worker (human capital) contributed

only 0.3%

Technological change contributed in 6.5% to GDP growth.

Selected ResultsWithin physical capital, investment on

communication is the most socially profitable, following by investment on transport, and machinery respectively. The least profitable in social terms is the investment on buildings.

To match a similar impact on GDP growth by an investment of US$ 70 million on communication, we need US$ 182 million investment on transport, US$ 303 million on machinery, and US$ 1,092 million on buildings.

Selected Results

Technological change positively depends on:

(i) FDI/Total Private Investment,

(ii) Exports/GDP, and

(iii) Industry Valued Added/GDP.

Aggregate Estimations• In Paraguay, we need four main

conditions for achieving an average GDP growth rate greater than 5% over the next 6 years.

1) A gradual increase on investment share of GDP (from a current average of 21% to 26% of GDP), prioritizing investment on communication, transport and machinery, respectively.

…Aggregate Estimations2) To achieve a larger share of industry on

GDP (from current 14.3 to 16%)

3) Increasing FDI (from 2.3 to 3.3% of GDP)

4) Gradually increase exports (from 35% to 43% of GDP).

• Extreme poverty rates would be reduced in a range from 16% to 23% at the end of the sixth year.

The Computable General Equilibrium Model

CGE Based on the “Standard” IFPRI CGE

• Root on Neoclassical-Structuralist tradition (Dervis, de Melo y Robinson, 1982)

• Data Requirements:– A Social Accounting Matrix (SAM)

• Representing the country main activities, goods, factors, and institutions.

– A set of selected elasticities

• The model is calibrated to the SAM, using the set of defined elasticities.

A CGE for Paraguay• The IFPRI Standard CGE is adjusted to a 1998 SAM of

Paraguay.

• Closure Rules:• Foreign Sector: Fixed exch. rate, flexible foreign savings.• Government: Fixed direct tax rates, flexible govt. savings.• Saving-Investment: Uniform change of the saving

propensity, fixed government investment and consumption proportion.

• Capital is full employed and activity specific.• Labor is under-employed, moves across activities and real

wage is fixed.

Activities and GoodsA Social Accounting Matrix, Base = Year

1998

8 Sectors of Activities and Goods.1. Primary Sector: Agriculture, Cattle-rising, Hunting, Forestry, Fishing and Mining

2. Industry 3. Construction

4. Electricity and Water5. Transport, Warehousing, and Communications6. Commerce, Restaurants and Hotels7. Financial Services.8. Government Services.

Types of Labor and Households

8 Types of Labor. Criteria: (i) Skilled (>9 years of schooling)-Unskilled

(ii) Man-Women(iii) Formal (wage labor)-Informal (self-employment)

4 Types of Households. Criteria:(i) Urban-Rural

(ii) Guarani Speaking-Spanish Speaking.

Macro Simulations: Reported Information

GDPAbsorptionExpenditure Components

Nominal and real exchange ratesPrivate, Government and Foreign Savings, Domestic activity by sectorEmployment by type of workerConsumption by type of householdPrices: Import, Export and Non-tradableTerms of tradeFiscal Revenues: Tariffs and Direct Taxes

Household survey based Micro-simulation Models

Micro-simulations• The micro-simulation exercises use the complete range of

income distribution, as stated in the 1997/98 Paraguayan Household Survey (HS).

• The HS original database is transformed according to the changes in the labor market structure as defined in the different scenarios simulated with the CGE.

• The labor market is defined by the unemployment rates, by the structure of employment by sectors, by types of labor (skilled/unskilled), by earnings, and by the general average of labor income.

Micro-simulations• The basic problem is to determine what would be the

poverty and inequality levels IF the labor market were determined by an unemployment level, an structure of employment by sector, by type of workers different from the one observed in the 1997/98 Household Survey and defined by the CGE simulations results.

• The selection of which individuals (HS observations) will change their labor condition in the original database is undertaken by a random process.

• A Monte Carlo procedure is applied to generate confidence intervals.

• It is reported the average results of 30 runs with different allocations of random numbers.

Macro-Micro Simulations(14 scenarios)

Six Types of Economic Policies in Four Areas:Trade• Change in Tariffs (-50 and +50%)• Export subsidy (+10%)• Full application of trade agreements (WTO and FTAA)

Foreign Exchange • Foreign Exchange Management (Overvaluation and

devaluation of 10%)

Labor• Exogenous increase of nominal labor income (+10%)

Real Sector • Promotion of technological Change (TFP +5% economy-

wide and focalized to the primary sectors +10%)

Macro-Micro Simulations(14 scenarios)

Exogenous Shocks:• Increase in import prices (+10%)• Decrease of export prices (+10%)• Decrease of TFP (-5%)

Combined Simulation: Tariff Increase (500% + decrease in TFP 5%)

Micro Simulations: Reported Information

Poverty: Headcount (P0), Gap (P1) and Severity (P2)Gini Income per capitaGini Labor income

Sequence of effects on Poverty by changes in:UnemploymentEmployment by sectorsTypes of jobs (formal and informal)Skill Levels

Sequence of effects on Inequality(Idem Poverty)

Results(Percentage change with respect to the base year)

Tariff+50%

SubX 10

FTAA WTO Dev 10%

GDP -1.1 1.3 0.3 0.5 -3.7

Exports -0.1 12.0 0.0 4.0 11.3

Imports -2.1 0.1 1.0 -0.6 -11.2

Foreign Saving -1.2 -2.6 0.6 1.0 -9.3

Labor Market Winner (1) FFU FIU MF FIU MF

Labor Market Loser FIU FFU FIS, IU

FFU MIS

Winner Household (2) US RG RG RS

Loser Household RG UG US RG

Poverty (P0) 1.3 -4.0 0.7 0.1 4.8

Inequality (Gini) 0.32 -1.1 0.4 -0.3 1.4(1): F=Female, M=Male, F=Forma, I=Informal, U=Unskilled, S=Skilled(2): U=Urban, R=Rural, G=Guarani Speaking, S=Spanish Speaking

Results(Percentage change with respect to the base year)

TFPG5 TFPP10 MP

+10%

EP (– 10%)

+Tariff500, -TFPTG5

GDP 8.7 1.9 -5.0 -1.3 -15.9

Exports 8.1 1.7 -0.7 -11.6 -8.7

Imports 8.7 1.8 -11.4 -0.1 -20.6

Foreign Saving 2.5 0.6 -0.5 4.7 -11.0

Labor Market Winner

FIU FFU FFU FFU FFU

Labor Market Loser FFU FIS FIU FIU FIU

Winner Household RG US US US US

Loser Household RS R RG RG RG

Poverty (P0) -10.5 -2.8 7.3 3.0 9.0

Inequality (Gini) -3.0 -0.6 2.1 0.2 1.2

(1): F=Female, M=Male, F=Forma, I=Informal, U=Unskilled, S=Skilled(2): U=Urban, R=Rural, G=Guarani Speaking, S=Spanish Speaking

Identifying the more sustainable growth path

Evaluation Criteria:

1) Economic Growth (9 out of 14 analyzed measures)

2) Poverty Reduction (5 out of 9 measures)+TFPG5%, +TFPP10%, Overvaluation, SubX10, -Tariffs.

3) Fiscal Sustainability (3 out of 5 measures)* Overvaluation* +TFPG5%, * +TFP 10% primary sectors

4) Foreign Saving requirements* Overvaluation (very demanding)* +TFPG5% (less demanding)* +TFP 10% primary sectors (no demanding)

What is should be done?What is should be done?We should focus on Rural Development:• Adequate technical assistance for peasant

farms.• Investment on rural communication and

information technology.• Rural roads maintenance with relatively labor

intensive techniques.• Clusters of Agro-industries that process labor

intensive agricultural products• Promote FDI in these agro-industry sectors.• Effective export promotion.