Global Economy Journal

Volume 7, Issue 1 2007 Article 1

Economic Effects of NAFTA on Mexico
Dominick Salvatore∗

Fordham University, New York, salvatore@fordham.edu

Copyright c 2007 The Berkeley Electronic Press. All rights reserved.

Program in Economics at Fordham University in New York. I will first discuss the theoretically correct method of evaluating the economic effects of the formation of a free trade area in general and then apply this method to correctly measure the effects of NAFTA on Mexico.D. . In this paper. These are the wrong ways to measure the effects of a free trade area on a member state. Mexico ∗ Dominick Salvatore is Distinguished Professor of Economics and Director of the Ph.Economic Effects of NAFTA on Mexico∗ Dominick Salvatore Abstract The economic effects of NAFTA on Mexico have been discussed and measured mostly in terms of its effect on employment on both sides of the border and by the increase in Mexico-US trade and investments before and after NAFTA. KEYWORDS: NAFTA.

trying to satisfy as many of the conditions as possible (partial trade liberalization) is not necessarily or usually second best. This is an application of the theory of the second best. R. in terms of its effect on employment on both sides of the border and by the increase in Mexico-US trade and investments before and after NAFTA. growth is affected by many other factors. as we know.G. measuring the economic effects of NAFTA on Mexico based on the net number of jobs created or destroyed or by comparing Mexican growth before and after NAFTA is not appropriate. This also is wrong because. by removing trade restrictions among member states. MEASURING THE ECONOMIC EFFECTS OF FREE TRADE AREAS AND NAFTA Until Jacob Viner wrote his classic work The Customs Union Issue in 1953. both predictions were wrong.Salvatore: Economic Effects of NAFTA on Mexico INTRODUCTION The economic effects of NAFTA on Mexico have been discussed and measured. however. but what is more important is that measuring the effect of NAFTA based on its effect on employment and comparing trade before and after the Agreement is incorrect. for the most part. independently of NAFTA.S. 1992). and on world markets (and also leading to the diversion of some foreign investments from Mexico to China). such as Ross Perot (the third party candidate in the 1992 US Presidential election). More reasonable economists attempted to measure the effects of NAFTA by comparing Mexican growth before NAFTA and with NAFTA. believed instead that the United States would lose thousand of jobs to Mexico as US firms migrated south attracted by much lower wages and fewer labor and environmental regulations (the “giant sucking sound”). thus becoming a more powerful competitor of Mexico on the U. 2007 1 . which postulates that if all the conditions for first best or maximum social welfare (free trade) are not satisfied. some economists predicted that NAFTA would create hundred of thousand of new jobs on both sides of the border. reduce wage inequalities between the United States and Mexico. Lipsey Published by The Berkeley Electronic Press. economists believed that a free trade area (FTA). the United States faced slow growth in 2000 and recession in 2001. Of course. showed that this was not necessarily the case. For example. Member nations and the rest of the world would benefit only if the FTA created rather than diverted trade. Hufbauer and Schott. and China joined the WTO in December 2001. Thus. Measured in this way. Mexico faced a serious financial and economic crisis in 1994-1995 (just when NAFTA took effect). Viner. for example. and sharply reduce the migration of Mexicans to the United States (see. increased specialization in production and invariably benefited the member countries and also had positive spillover effects on the rest of the world. Others.

and the generally better utilization of economic resources. this would involve estimating how high trade and growth would have been among the FTA members without the FTA. I will begin. 2004. trade. This increased efficiency will certainly affect wages. is by the increased efficiency and productivity resulting from specialization in production. 1. 7 [2007]. as long as it increases efficiency and productivity in the nation. The correct way to measure the effects of a FTA on member nations. Although important. Performing valid counterfactual simulations are fraught with difficulties. on the one hand. James Meade (1955) extended Viner’s analysis showing that by considering not only the production effects of FTA (as Viner did) but also the consumption effects of a FTA. is by counterfactual simulation of its effect on intra-FTA trade and growth. Iss. and others). however. 1992 and 2005. by its effect on employment and on growth before and after the formation of the FTA (see. for example.2202/1524-5861. stimulus to investment. Meredith. investments. Hufbauer and Schott. then even a trade-diverting FTA could improve members’ and world’s welfare. with a more down-to-earth and less elegant but still legitimate method of estimating the economic effects of NAFTA on Mexico by comparing (1) the growth of intra-Mexico-US trade. therefore.bepress. on the other. during the past dozen years of NAFTA’s operation and (2) by comparing the flow foreign direct investment http://www. it is impossible to identify the specific effects of a FTA by comparing its growth before and after its formation. and competition. employment and growth. Vol.Global Economy Journal. and then used for counterfactual simulation. the appropriate method of measuring the effects of a FTA. by how much intra-FTA trade and growth is higher with the FTA as compared with the situation without the FTA. But this is exactly how the effects of FTAs in general and of NAFTA in particular have been mostly measured – that is. this method of measuring the economic effects of a FTA concentrates on the static effects of economic integration without considering its more significant dynamic effects. Art. and Towe. instead. such as the increased competition. Meade pointed out that the smaller the relative inefficiency of FTA members in relation to non-members. In our case. But welfare can increase in a member nation even if the FTA creates few or no jobs. the model would have to be validated by in-sample dynamic simulation. such as NAFTA.1244 2 .com/gej/vol7/iss1/1 DOI: 10. 1 (1961) then specified the conditions under which a FTA was more likely to be trade creating and thus welfare enhancing. economies of scale. A general equilibrium model of trade and growth would have to be constructed. That is. Such an increase in efficiency and productivity will stimulate growth in member nations but since growth also depends on other crucial concomitant factors. According to theory. Kose. to the growth of total Mexican trade. however. the greater was the probability that even a trade-diverting FTA or customs union could lead to net benefits to members and non-member nations.

The pattern of the trade increase as a result of NAFTA also seems somewhat different from that arising in the European Union.6 percent. FDI.5 percent. total exports from Mexico increased at about the same rate as Mexican exports to the United States.Salvatore: Economic Effects of NAFTA on Mexico (FDI) from the United States to Mexico to total FDI to Mexico. but over the entire 1994-2005 period they grew at about the same rate as total Mexican exports. In the dozen years of NAFTA’s operation. Thus. from 1984 to 1993 (i. Thus. I will then present the results of a counterfactual simulation of the effect of NAFTA on trade.4 billion in 1984 to $51. but intra-RTA declined for the Published by The Berkeley Electronic Press. total Mexican exports grew from $29. THE EFFECTS OF NAFTA ON MEXICAN TRADE Table 1 shows the level and growth of Mexican exports to the United States as well as total Mexican exports to the rest of the world from 1984 to 1993 (i. and intraRTA exports as a percentage of the total RTA exports of the European Union (EU) and NAFTA in 1990. The table shows that from 1984 to 1993. inflation. or at a yearly average rate of 7. NAFTA seem to have benefited Mexico (and the United States) by leading to a more rapid expansion of trade in general for the three years preceding and for the seven years following NAFTA as a result of the general liberalization of trade (and the signaling of Mexico’s commitment to further liberalization and reform) rather than by a more rapid increase of Mexican-U. and 2005. on the other hand.. during the decade before the formation of NAFTA) and the dozen years since the creation of NAFTA. Actually.9 billion in 1993.0 percent for total Mexican exports over the same period.S.3 percent per year from 1991 to 1993 in anticipation of NAFTA. the increase in Mexican exports to the United States jumped by an average of 28. intra-regional-trade-agreement (RTA) exports. But Mexican exports to the United States had been growing faster than the total exports of Mexico from 1984. The table shows that the EU has a larger percentage of intra-RTA trade than NAFTA.1 billion in 1984 to $40. Table 2 shows the value of total exports.e. We would have expected instead that intra-FTA trade would grow faster than extra-FTA trade because of the elimination of trade barriers among member countries but not with respect to nonmembers. growth. 2000. Mexican exports to the United States grew more rapidly that total Mexican exports. trade as such in relation to total Mexican trade. Mexican exports to the United States grew much faster from 1994 to 2000 than from 2001 to 2005. Mexican exports to the United States grew from $18. and other economic and financial variables. as compared with an average increase of 21.e.4 billion in 1993. or at an average yearly rate of 5. 2007 3 . in the decade before NAFTA). On the other hand. Similarly.. 1995.

5 166.5 96.9 31. 1 Table 1: Mexico’s Exports.2% 117. http://www.com/gej/vol7/iss1/1 DOI: 10.S. Art.5 160.5 139.0 30.5 1991 42.7 95.1 27. GROWTH 5.0 20.2 35.8 23.1 Source: WTO and U.8 75.1 79.1 172. GROWTH 9.5% 7. Iss.1 1990 41.4 188. 1984-1993 and 1994-2005 (in Billions of Dollars) AVER. 7 [2007].9 50.4 158.8 132. 1.6 1993 51.1244 4 .bepress.4 18.3% 9.2 135.5 1992 46.1 2000 2001 2002 2003 2004 2005 AVER.0 157.0 17. Department of Commerce.7 165.0 62.7 28.6% YEAR 1984 1985 1986 1987 Total To US 29.4 YEAR 1994 1995 1996 1998 Total To US 60.1 22.4 136.3 1989 35.2 19.3 1988 30.3 27.9 40.2202/1524-5861.Global Economy Journal. Vol.0 213.

THE EFFECTS OF NAFTA ON THE INFLOW OF FDI TO MEXICO Another way by which a FTA can benefit a member nation is by encouraging an inflow of FDI. Note.8 46. thereby stimulating growth in the nation. while for NAFTA it increased significantly.392 2.1 66.251 2. occurred during the first five years of NAFTA. total FDI into Mexico averaged $2. that there seems to have been no similar increase in intra-EU trade in anticipation of and immediately after the EU-expansion from 15 to 25 members in 2004. Intra-EU trade also increased in the years immediately after its creation.6 55.482 1. 2006.437 $ 980 1. however. The table shows that from 1984 to 1993.1 billion.523 2. 2005 (in billion dollars and percentages) _______________________________________________________________ NAFTA Exports (in billion dollars)__________________ Intra-NAFTA as Year Total Intra-NAFTA Percentage of Total___ 1990 1995 2000 2005 $ 562 857 1. however.001 Source: WTO.0 55. or 39 Published by The Berkeley Electronic Press. Table 3 compares the inflow of FDI to Mexico in total and from the United States before and since the creation of NAFTA.8___________ 2005 (EU-25) 4.9 67. 1995. 2007 5 . EU from 1990 to 2005.5 66.8 billion per year as compared to $1.295 1.673 66.478 $240 394 682 824 42.9 61.225 1.8__________ ______________________________________________________________ EU (15/25) Exports in Billions of Dollars)_________________ Intra-EU as Year Total Intra-EU Percentage of Total___ 1990 (EU-15) 1995 (EU-15) 2000 (EU-15) 2000 (EU-25) $1. but afterwards intra-EU trade expanded at slower rate than total EU trade. The big jump in intra-NAFTA trade.937 2.Salvatore: Economic Effects of NAFTA on Mexico Table 2 Total and Intra-EU and Intra-NAFTA Trade: 1990. 2000.

4 12.2 27.7 13.4 AVER.6 1. Art.0 0.2 2.3 4.1 1.S.8 1.3 2. 1 Table 3: Foreign Direct Investments Inflows to Mexico.5 9.2202/1524-5861.1 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 11. 1. 2.bepress. Vol.4 4.9 4.8 2.8 5.6 4.3 4.1 5.com/gej/vol7/iss1/1 DOI: 10.3 2. Department of Commerce.7 6.7 18.5 2. http://www.2 0. 1984-1993 and 1994-2005 (Billion $) YEAR Total From US YEAR Total From US 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1.Global Economy Journal.0 9.2 14.8 1. Iss.7 Source: IMF and U.4 2.4 2.2 14.6 12.8 AVER 15.5 3.0 0. 7 [2007].4 18.2 3.0 4.3 5.2 17.6 2.6 8.2 18.5 0.1244 6 .1 6.4 1.0 -0.

Mexican real GDP was estimated to grow at a rate of 5.3 to 10. Form 1994 to 2005.2 billion per year and the growth of exports from 8. That can only be measured by counterfactual simulation.0 percent. Table 4 shows that the growth of real GDP averaged 2. perhaps in anticipation of NAFTA. can only be measured by estimating what growth in Mexico would have been without NAFTA and comparing that with its actual growth (i.7 percent per year and the short-term interest rate from 18.e. before NAFTA) and 2. But we cannot tell how much. FDI to Mexico seemed to have increased as the general result of the liberalization of foreign trade and investments that accompanied the creation of NAFTA and not as a direct and specific results of NAFTA itself (since US DFI to Mexico did not increase more rapidly that total FDI to Mexico during the NAFTA period).4 percent.. therefore. During the 1995–2005 period. Table 5 shows long-run simulations results of NAFTA’s impact on Mexico to the year 2005 and compares these to the actual outcome using the United Nations LINK Model of the world economy.0 billion to $9. by counterfactual simulation). As pointed out earlier. and (3) raise Published by The Berkeley Electronic Press.2 percent per year with NAFTA. of the higher Mexican growth since 1994 can be attributed to NAFTA. the reason for this is that growth depends on many other factors besides NAFTA and comparing actual growth before and after NAFTA simply cannot identify NAFTA’s contribution. The big jump in FDI to Mexico in total and from the United States occurred in 1994 (the first year of NAFTA’s operation) and then again in 2001 (eight years after the start of NAFTA).1 billion per year as compared with $5. The specific effect of NAFTA on Mexico’s growth.. a FTA would increase specialization in production and efficiency in general throughout the economy of a member nation. As in the case of trade. If we eliminate the 1995-1996 period of the Mexican crisis. NAFTA’S EFFECTS ON GROWTH IN MEXICO Table 4 shows the growth of real GDP in Mexico before and after the formation of NAFTA. For example.7 percent. The big jump in DFI to Mexico during this period occurred in 1991.e. after the creation of NAFTA).8 percent without NAFTA. or 38 percent of the total coming from the United States.Salvatore: Economic Effects of NAFTA on Mexico percent of the total coming from the United States.9 percent per year from 1994 to 2005 (i.. The expectation is that by stimulating the flow of trade and investments. yearly growth averaged 3. (2) increase the inflow of foreign direct investments (FDI) from $6.5 percent to 9. as compared with 3.5 percent per year in Mexico from 1984 to 1983 (i. and thus speed up its rate of growth. total FDI to Mexico averaged $15. however. NAFTA was also expected to (1) reduce the Mexican inflation rate from 14. if any. 2007 7 .3 percent to 13.7 billion.e.

9 AVERAGE YEAR 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 94-05.3 4. http://www.2 0.com/gej/vol7/iss1/1 DOI: 10.7% Source: OECD.1 4.9%.5 -6.6 -0.4 4. 2006.1 6. 1984-1993 and 1994-2005 (% per year) AVERAGE 1984-1993 2.5 -3.Global Economy Journal.2 3.6 1. 3.2202/1524-5861.8 1.5% YEAR 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 GDP 3. 1. 7 [2007].2 5.2 5.bepress.2 3.8 1. Iss.5 2.1244 8 . Vol.9 6. Art.9 3.0 2.8 4. 1 Table 4 Growth of Real GDP.6 1. 96-05 GDP 4.

5 8.0 9. because of weak economic institutions and inadequate structural reforms which limited its international competitiveness (according to the 2006 World Competitiveness Report.6 1.5 percent. The actual results. an inflow of FDI $14. $) 5. OECD (2006).1 2. were as follows: a growth rate of real GDP of 2.9 percent per year. a growth of exports of 9. and.8 14.4 -4.8 billion. Published by The Berkeley Electronic Press.5 18. and net financial capital inflows of $12.7 10.6 percent. Table 5 Simulation of NAFTA’s Impact on the Mexican Economy.8 -5. Yearly averages.8 billion.1 5.6 percent. 2007 9 .7 billion to $14.8 9.4 14.4 14.9 13.7 billion per year.0 8. IMF (2006).7 3. If we removed the years 1995 and 2001-2202 from the data.Salvatore: Economic Effects of NAFTA on Mexico the trade deficit from $9.2 10. the average annual growth of real GDP in Mexico was 4.3 6.2 4. which was hardly adequate to achieve a rapid increase in standards of living in the nation (and less than half of China’s growth rate over the past decade).7 13.9 billion and the capital inflows from $10. more importantly.4 percent.3 9. as yearly averages from 1994 to 2005.6 billion to $14.6 12. a rate of inflation of 13.3 3. Mexico did not realize more of the expected benefits from NAFTA because of its deep economic crisis in 1994-1995. 1994-2005 ________________________________________________________________________ Estimates Without Actual With NAFTA NAFTA Difference Results Growth of real GDP (%) Inflation rate (%) Short-term interest rate (%) Inflow of FDI (billion $) Growth of exports (%) Trade Deficit (billion $) Net financial K inflows (bill.9 14. Mexico ranked 53 out of 61 economies evaluated) in the face of increased competition from China.2 2. the slow growth in the United States in 2001-2002. Hufbauer and Schott (2005).6 16.8 ________________________________________________________________________ Source: Klein and Salvatore (1995). a short-term interest rate of 16.2 9.

S. Free trade access to Mexico allows U. concluded that net gain in U. Iss. consumers. 2002). Perhaps more significant than the change in the total volume of trade was the change in the composition of Mexican trade. The implementation of NAFTA benefited the United States by increasing competition in product and resource markets. Because the U. but with a 15-year phase-in period and about $3 billion assistance to displaced workers. As we have seen. With time. States (such as Alabama and Arkansas) suffered while high-wage areas gained.S. market and by increasing inward foreign direct investments – all of which increased production efficiency and competition. where wages are now roughly equal to Mexico’s. 1.S.S.1244 10 . such as Malaysia. NAFTA benefited Mexico by indirectly leading to greater export-led growth resulting from increased access to the huge U. industries to import laborintensive components from Mexico and keep other operations in the United States rather than possibly losing all jobs in the industry to low-wage countries. Mexico suffered a net loss of jobs and incomes in agriculture. InterAmerican Development Bank. with wages more than six times higher in the United States than in Mexico. economy is more than 15 times larger than Mexico’s economy. Furthermore. jobs as a result of NAFTA may have been much smaller (and may even have resulted in a small net loss). however. but an increase of skilled jobs.2202/1524-5861. Mexican trade shifted much more toward intra-industry and intra-firm trade with the United States and Canada. NAFTA led to a loss of unskilled jobs.Global Economy Journal. however.com/gej/vol7/iss1/1 DOI: 10. Art. As a result of vertical integration.bepress. by weak economic institutions and inadequate structural reforms of the economy.S. the United States also negotiated a series of supplemental agreements with Mexico governing workplace and environmental standards (to prevent U. 7 [2007]. 1 GENERAL EFFECTS OF NAFTA ON MEMBER NATIONS We now examine in more general terms the effect of NAFTA on Mexico. A more recent study by Hufbauer and Schott (2005). the Untied States and Canada.000 (see. gains from NAFTA as a proportion of its GDP were much smaller than Mexico’s.S.000 and 160. however. Vol. for an overall net increase in employment in the United States of between 90. the U. but these losses were more than matched by net increases in industry. increasing employment opportunities and rising wages in industry are expected to reduce the pressure for Mexicans to emigrate to the United States.S. firms from moving their operations to Mexico to take advantage of much more lax labor and http://www. Some of the jobs that Mexico gained during the years immediately preceding and following the creation of NAFTA did not in fact come from the United States but from other countries. the harm to workers in low-income areas in the United States was minimized. as well as by lowering the prices of many commodities to U. Mexico’s ability to benefit from NAFTA has been limited. As a condition for congressional approval of NAFTA.

comparing trade.Salvatore: Economic Effects of NAFTA on Mexico environmental regulations). investments. Japan is second. investments. These are not the appropriate ways to measure the effects of a free trade area on a member state. productivity and efficiency in Mexico. their effect growth and employment in the nation. Mexico was unable to capture more of the potential benefits from NAFTA or for a longer period of time because of the economic crisis that afflicted Mexico in 1994-1995. most of the (indirect) benefits that Mexico received from NAFTA occurred in the years immediately preceding the creation of NAFTA rather than in the years soon after its creation. SUMMARY AND CONCUSIONS The economic effects of NAFTA on Mexico have been discussed and measured mostly in terms of their effect on employment on both sides of the border and by the increase in Mexico-US trade and investments. To measure the direct effects of a FTA on member nations requires using a counterfactual simulation. That is. That is. the slowdown of U. competition. and so most of its economic effects on the two countries had already taken place by the time NAFTA came into effect in 1994. the benefits flowing to Mexico seem to have resulted more from the general liberalization of trade and investments than directly from NAFTA. In the case of NAFTA. through them. as such. It is though these effects that the growth and employment in the nation are affected. Furthermore. the general liberalization of trade and investments that accompanied NAFTA led to a general increase in Mexican exports and inflows of FDI.S. and efficiency in general and. before and after NAFTA. 2007 11 . But the increase in total Mexican exports and FDI inflows from the rest of the world was as large or larger than that from the United States. The theoretically correct way of measuring the economic effects of a FTA on a member nation is through its effects on trade. growth in 2000 and recession in 2001. one could say that that the primary reason for Canada joining in the NAFTA negotiations was to protect its trade interests with the United States. increased competition from China. which increased specialization. as well as to protect some American industries against import surges that might threaten them. Canada was and remains the largest trade partner of the United States. Published by The Berkeley Electronic Press. but most importantly because Mexico failed to adequately restructure and liberalize its economy and improve the education and training of its labor force. and Mexico is third (but it may soon be displaced by China). Indeed. NAFTA did not directly affect Canada in a significant way because Canada had already negotiated a free trade agreement with the United States in 1988. competition. competition and efficiency. with and without the FTA.

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