A SIMPLE MACROECONOMIC MODEL OF AN OPEN AND UNDERDEVELOPED ECONOMY: EL SALVADOR 1960-1976

This study represents an attempt to present a macroeconomic model of an economy which typifies the "open and small economy" found in the economics literature. The model is used to examine the external vulnerability which results from the degree of openness and the potentiality of the effectiveness of public policy to ameliorate such vulnerability. The country chosen is El Salvador, not only because of its degree of openness, but also because its exports are based on one agricultural export: coffee. Chapter II presents a descriptive analysis of the economy with particular emphasis on the links between the internal and external sectors. The specification, identification, estimation, and stability conditions of the model are presented in Chapter III. In the first part of Chapter IV we simulate the model in order to establish the level of predictive accuracy. Using Theil's inequality coefficient, it is found that the model performs better than a simple extrapolation model. An ex-post simulation is carried out to determine the quantitative level of predictive accuracy. This simulation established that the model can predict GNP for a future year within an eight per cent difference from the actual value. This level of accuracy was assumed to be satisfactory to simulate the effects of public policy changes and changes in the exogenous coffee price variable. We also investigated the level of built-in stability in the tax structure. It was found that the income-tax structure provides a fifteen per cent stabilization effectiveness and that the coffee export-tax reduces the income change which results from an increase in the price of coffee by 59 per cent. Having examined the structure of internal and external stability, we analyzed the alternatives available to the public authorities in order to further stabilize drastic income changes which result from the changes of world coffee prices. The simulations provide exploratory evidence that the necessary changes in public expenditure to offset the effects of the external sector are beyond the reasonable financial capabilities of the public authorities. This indicates the precarious situation which an agricultural mono-exporting country faces in the world arena.