1. Alternatives for Economic Growth, Employment, and Poverty Reduction in Paraguay. Macro and Micro simulations Results. José R. Molinas Institute Desarrollo Asuncion, Paraguay www.desarrollo.edu.py International Poverty Center Conference on Employment Brasilia, 11-12 January, 2005

2. 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.

3. Increasing Poverty –1990-1995: 3.2% –1995-2000: 0.7% –2000-2003: 0.1% YearPovertyRural Poverty 199530%37% 1997/9832%42% 199934%42% 2000/0134%41% Central Problems Decreasing Growth Average Population Growth: 2.6%

4. Share of Main Crops in Agriculture GDP (%) Crops 1990199520002003 Labor Intensive: Cotton Sugar Cane Vegetables Fruits Sub-total: 14.5 4.1 4.0 12.7 35.3 11.3 4.1 4.8 10.9 31.1 5.9 3.3 4.8 11.4 25.4 3.0 3.6 4.3 10.2 21.1 Capital Intensive: Soybean Wheat Sub-total: 18.8 7.4 26.2 28.7 3.8 32.5 37.6 4.1 41.7 38.8 6.9 45.7 Mixed Technologies: Corn Manioc Sub-total: 5.2 14.3 19.5 9.2 15.8 25.0 7.1 13.7 20.8 8.5 17.2 25.7 Fast Falling Labor Absorption in Agriculture

5. AreaYear Unemployment Rate (%)Underemployment Rate (%) OpenHiddenTotalOpenHiddenTotal 19953.42.65.9--- 1997/985.49.514.36.526.532.9 19996.89.715.96.128.134.1 2000/017.68.315.37.729.236.9 Urban 19955.32.77.8--- 1997/986.97.613.95.917.323.2 19999.47.916.65.319.224.5 2000/0110.37.417.07.721.929.6 Rural 19951.42.53.9--- 1997/983.212.014.97.339.346.6 19993.412.015.07.139.646.7 2000/014.19.513.27.638.646.2 Increasing Unemployment and Underemployment

6. Context: Increasing Economic Liberalization 1989-1994 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.

7. The Searching for Alternatives Policies 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.

8. Econometric models of total factor productivity (growth accounting models)

9. Selected Results Basic 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.

10. Selected Results Within 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.

11. Selected Results Technological change positively depends on: (i) FDI/Total Private Investment, (ii) Exports/GDP, and (iii) Industry Valued Added/GDP.

12. 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.

13. …Aggregate Estimations 2) 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.

14. The Computable General Equilibrium Model

15. 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.

16. 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.

17. Activities and Goods A 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 Water 5. Transport, Warehousing, and Communications 6. Commerce, Restaurants and Hotels 7. Financial Services. 8. Government Services.

18. 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.

19. Macro Simulations: Reported Information GDP Absorption Expenditure Components Nominal and real exchange rates Private, Government and Foreign Savings, Domestic activity by sector Employment by type of worker Consumption by type of household Prices: Import, Export and Non-tradable Terms of trade Fiscal Revenues: Tariffs and Direct Taxes

20. Household survey based Micro-simulation Models

21. 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.

22. 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.

23. 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%)

24. 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%)

25. Micro Simulations: Reported Information Poverty: Headcount (P0), Gap (P1) and Severity (P2) Gini Income per capita Gini Labor income Sequence of effects on Poverty by changes in: Unemployment Employment by sectors Types of jobs (formal and informal) Skill Levels Sequence of effects on Inequality (Idem Poverty)

26. Results (Percentage change with respect to the base year) Tariff +50% Sub X 10 FTAAWTO Dev 10% GDP-1.11.30.30.5-3.7 Exports-0.112.00.04.011.3 Imports-2.10.11.0-0.6-11.2 Foreign Saving-1.2-2.60.61.0-9.3 Labor Market Winner (1) FFU FIU MF FIU MF Labor Market LoserFIU FFU FIS, IU FFU MIS Winner Household (2) US RG RS Loser HouseholdRG UG USRG Poverty (P0)1.3-4.00.70.14.8 Inequality (Gini)0.32-1.10.4-0.31.4 (1): F=Female, M=Male, F=Forma, I=Informal, U=Unskilled, S=Skilled (2): U=Urban, R=Rural, G=Guarani Speaking, S=Spanish Speaking

27. Results (Percentage change with respect to the base year) TFPG5TFPP10 MP +10% EP (– 10%) +Tariff500, -TFPTG5 GDP8.71.9-5.0-1.3-15.9 Exports8.11.7-0.7-11.6-8.7 Imports8.71.8-11.4-0.1-20.6 Foreign Saving2.50.6-0.54.7 -11.0 Labor Market Winner FIUFFU Labor Market LoserFFUFISFIU Winner HouseholdRGUS Loser HouseholdRSRRG Poverty (P0)-10.5-2.87.33.09.0 Inequality (Gini)-3.0-0.62.10.21.2 (1): F=Female, M=Male, F=Forma, I=Informal, U=Unskilled, S=Skilled (2): U=Urban, R=Rural, G=Guarani Speaking, S=Spanish Speaking

28. 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)

29. 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.