Is Mexico better off with NAFTA

QUESTION 5

This essay aims to critically evaluate if Mexico is better off as a result of the North American Free Trade Agreement (NAFTA). In reality, NAFTA is an extension of the Free Trade Agreement (FTA) between the United States and Canada which entered force in 1989. FTA expanded to include Mexico and January 1 1994 NAFTA came into effect and was the largest free trade area in the world, comprised of Canada, the United States and Mexico. This made North America the one of the most economically integrated regions of the world. Worth noting in relation to NAFTA; this was the first time industrialised economies, such as the United States and Canada, integrated a non industrialised economy, Mexico, to such extent. According to the governments of the NAFTA signatories; “NAFTA fuels economic growth and dynamic trade, stimulates investment whiles creating productive partnerships, works for small and medium-sized businesses and provides fairness and certainty. NAFTA partners promote environmental protection, and provide greater job opportunities in North America”. With an outset in the latter statement, this essay will first give a short introduction to NAFTA; why would Mexico join in? Its structure and elaborate on its specific main goals. Then, on the basis of statistical analysis of Mexico before and after NAFTA, it will critically compare the main objectives of NAFTA in relation to the actual development in Mexico. This will in turn enable this essay to reach a clear and objective conclusion on whether Mexico is better off as a NAFTA member and also investigate some future potential Mexican trade issues in relation to NAFTA.

NAFTA is not a customs union; it is purely a free trade area, this entails that the aim of the agreement is to eliminate trade barriers between member countries to increase economic activity. The Free Trade Commission (FTC) is the main organ of NAFTA. Composed of the US Trade representative, the Canadian Minister for International Trade and the Mexican Secretary of Commerce and Industrial Development, it monitors the performance and development of NAFTA, and includes a dispute settlement panel. The Secretariat, with national offices in the three capitals serves as an administrative office for the FTC, the dispute panel and the various committees and working groups that runs the organisation day to day. Compared to institutions like the EU, NAFTA is visibly much weaker institutionally. So why enter a regional trade agreement? The answer is twofold, political and economic. “Political reasons include: enhancing security, improving their international bargaining positions, signalling to potential investors the seriousness of their commitment to reforms, to satisfy domestic constituencies’ demands for “reciprocity” and because they perceive regional agreements are easier to negotiate than those within the WTO. Economic motivations for regionalism include access to a larger “domestic market”, possibilities for attracting additional foreign direct investment, the possibility of engaging in “deeper integration” and the opportunity afforded to continue to protect politically sensitive, globally uncompetitive industries”. What specifically did Mexico recognise as their criteria for becoming a NAFTA member? Most important, a deeper integration and guaranteed access to the United States. This would increase FDI and trade with the world’s largest consumer market, and fuel the growth of Mexican trade and provide better opportunities in the Mexican labour market. Membership would also strengthen Mexican democratic reforms and make the economy more stabile and Mexico more secure. This essay will look specifically at the Mexican development in relation to trade, GDP, FDI, job opportunities, wages and migration as the most important features of what NAFTA promised.

This is a preview of the whole essay

Leading up to membership in 1994, Mexico’s economy was undergoing a reform program that started in the late 1980s. This program featured inflation control and market liberalization measures in the financial sector. Mexico also joined GATT in 1986. “However, the challenges of sustaining this program in Mexico increased over time, as the peso became overvalued and external competitiveness declined. In addition, imprudent fiscal policies and excessive reliance on external borrowing contributed to financial fragilities”. This left Mexico with macroeconomic imbalances. The credit dried up and the government shifted towards more hazardous financial instruments. “When the crisis hit hard at end-1994, the impact was amplified by the balance-sheet effects of exchange rate depreciation, which required extensive government intervention in support of financial institutions. The currency depreciated sharply, output plunged, and inflation rose sharply”. The “Tequila Crisis” produced spoilt investor confidence because of their exchange rate and inflation uncertainty combined with severe inconsistency between their domestic financial intermediation and external capital flows. Mexico managed to recover from this quite fast compared to the 1982 crisis and by 1997; it was almost back at pre-crisis levels of GDP and investments. Looking back, this was much due to NAFTA which promoted credibility to the reforms Mexico implemented. Was this the first sign of Mexico gaining what they had been promised previous to January 1 1994?

Trade grew substantially in Mexico after 1994. From 1993 to 2001 trade increased by 225 per cent, with NAFTA members and almost threefold in the same period with non-NAFTA members. Mexican exports grew to the point where it overtook Japan’s place as the second largest exporter to the US thus developing into one of the biggest exporting emerging markets in the world. There is no doubt that the preferential treatment Mexico got through NAFTA had a huge impact on their booming trade. Even so, there may be other factors that led to the increase in Mexican trade; the “Tequila Crisis” resulted in the collapse of the Mexican peso and Mexico signing the GATT agreement in 1986 led to unilateral reduction of tariffs.

As trade obviously increased significantly, how did it this influence Mexican GDP? In the World Bank Report, Lessons from NAFTA for Latin America and the Caribbean Countries: A Summary of Research Findings, it is stated that since Mexico joined NAFTA it has experienced an annual 0.5 to 0.7 per centage growth in GDP. Revised studies have found a smaller but still positive growth. This must be a positive sign of NAFTA? “Following a 6 per cent decline in 1995, the data show annual growth of only 2.1 per cent from 1996 to 2003, driven primarily by a 9.5 per cent jump in 2001. Since NAFTA went into effect in 1994, Mexico has averaged 1.8 per cent real per capita GDP growth. By contrast, through much of the sixties and seventies Mexico had per capita GDP growth that exceeded 4 per cent, and in some years exceeded 7 per cent”. Comparing Mexico to other developing countries such as China, also suggests a weak Mexican post-NAFTA growth in GDP.

The gross FDI flows into Mexico increased severely after NAFTA came into effect. FDI grew from 6 per cent of investments in 1993 to 11 per cent in 2002, mainly as a result of increased FDI flows from NAFTA members. The growth in trade, as a result of increased productivity and a heavy increase in FDI were supposed to keep Mexico up with the growing demand for work. “It is necessary to look at both the elimination of tariffs on exports from Mexico to its northern neighbours and elimination of Mexican tariffs on US and Canadian goods to understand the impact of NAFTA’s tariff cuts on Mexican jobs”. The fact of the matter is that NAFTA has not been able to create a sufficient level of job opportunities in Mexico. In the post NAFTA era Mexico has experienced a shift in export. Traditionally Mexico exported mostly agricultural products to its NAFTA members, but after the cut in tariffs on imports, a growing trade deficit in agricultural trade with the United States is evident. This in turn is offset by a surplus in manufactured goods exported from Mexico. The result of this diversification in Mexican trade; a loss of over one million jobs in the agricultural sector since 1994, while the manufacturing sector has only produced 500,000 new work places.

“The US government reports that even in nominal dollar value terms, Mexican manufacturing wages were no higher in 2000 than in NAFTA’s first year and considerably lower than in 1981, prior to Mexico’s sweeping market reform. Making ends meet in Mexico’s rural areas is even tougher. NAFTA opened floodgates to cheap US corn imports, leading to an 18-fold increase between 1993 and 2000. The devastating impact on Mexican farmers is reflected in the rising rural poverty rate, which climbed from 79 per cent in 1994 to 82 per cent in 1998, according to the World Bank”. The “Tequila Crisis” is obviously one factor to the slow growth in wages, but still increased productivity fails in converging Mexican wages to American wages, which most theory suggests it should do. Why has increased trade and FDI resulted in lower wages and less jobs for the Mexican people? Globalization is one answer. Mobile employers have their methods to fight workers who claim their fair share. What happened when Mexican workers demonstrated for an independent union in June 2000; one pregnant woman in the hospital after police broke off the peaceful demonstration and no union. Another factor is the East-Asian countries that have entered the WTO. The consequence of this is new markets that are even cheaper for American manufacturers than the Maquiladoras. “A fourth to a fifth of Mexico’s million-plus maquiladora workers once produced textiles and apparel, many of them in factories near the US border. Employment peaked at nearly 300,000 workers in early 2001. Since then, widespread layoffs have slashed jobs. By December 2005 they had fallen to 174,000 a 41 per cent drop in five years”. Entering WTO levels the playing field for other developing countries to Mexico’s comparative advantage in North America. The dependence of the US market for Mexican workers is also under threat as US growth has stagnated since 2001, especially in the industrial sector where most Mexican exports end up.

As a result of low wages and few job opportunities, illegal migration from Mexico to the US is still blooming. In 1994 officials from the United States and Mexico argued that the increase in jobs in Mexico would see an end to the flow of illegal immigrants from Mexico. “Illegal immigrants from Mexico has risen sharply since 1994 despite increasingly vigorous border enforcement efforts that commenced at roughly the same time as NAFTA. Indeed, by most estimates, the population of unauthorized Mexican immigrants in the United States more than doubled between 1990 and 2000 (with most of that growth after 1994), and has continued to grow strongly in the new century”. Could increased migration be the best argument to support the failure of NAFTA in creating a better Mexican society?

Having assessed NAFTA’s impact on Mexican economy and society, how does the future look like for Mexico? As other Latin American countries also are gaining market shares in the US through FTAA and CAFTA the competition will only grow stronger. According to the IMF Working Paper; How Has NAFTA Affected the Mexican Economy? Review and Evidence, first of all they have to undergo structural reforms to become more competitive in international markets. The energy sector must get fresh investments. Hopefully this will raise the electrical generation needed to support an expanding industrial base, which is now held back by constitutional provisions. The same is needed in the oil and gas sector, where PEMEX obstruct private participation. Especially the labour market, but also the Telecommunications market must be streamlined and less regulated for them to grow. These markets are now far too rigid. Judicial reforms must be undertaken to enhance the rule of formal law and new fiscal policies must divert Mexico away from oil and gas dependence. “Addressing these challenges will be central to recovering the growth momentum experienced in the latter part of the 1990s from membership in NAFTA. Mexico will need to overcome traditional barriers to action in these areas to keep pace with other developing countries that are undertaking more dynamic reforms, particularly in Asia”.

This essay has argued that the most important areas that NAFTA would strengthen Mexico were: trade, and investments. This would in turn create higher productivity and thus a need for a larger work force and higher wages. This was supposed to fight poverty, migration and ensure growth of GDP. Considering the statistical truth of the NAFTA agreement, the reality seems to be less positive. On the positive side, NAFTA has spurred an increase in trade and financial flows in Mexico and GDP; even if it’s not growing at an optimal rate, it’s not negative. And not forgetting how NAFTA promoted stability and reforms, which was the key to most of the FDI flows from non NAFTA members after the “Tequila Crisis”. Where NAFTA has failed is in the labour market much due to the shift in exports. This has led the Mexican agricultural sector to lose over one million jobs. This has left a gap in the labour market that the manufacturing sector is nowhere near filling. The setback in wages caused by the “Tequila Crisis”, have not either been stimulated by the increased trade post NAFTA. As a result of this, illegal migration to the United States has not stemmed, it has on the contrary grown even more of a problem after 1994. Now Mexico is facing even more competition from East Asia. Considering what US tariffs would be on Mexican products, and considering Mexico would have to compete on a level with China for US exports, without NAFTA Mexico might just be worse off. It is important not to forget that the NAFTA deal was negotiated between hugely unequal partners. Mexico has maybe not done so badly after all, not forgetting that a lot of the concessions have actually benefited them more than either of the two other members. “From the standpoint of manufacturers, labour, agricultural sectors with a comparative advantage, and consumers, once these factors are taken into account it becomes clear that, imperfect though it may be, NAFTA has brought more good than harm to most Mexicans despite the nasty things that are said about it”. Counter facts suggests that Mexican GDP may have been at a higher level without NAFTA, comparing it to earlier statistics. Then at the same time it is hard to believe that trade, FDI or productivity would be at the same level as it has been in the post NAFTA period. The failure of NAFTA has not been in fuelling the economy, but rather to transfer the growth in this area to Mexican society. So in many ways NAFTA has actually come true on their promises. In reality even though NAFTA is a fairly negotiated deal, trade agreements has a tendency to create winners and losers, especially when one part of the deal is obviously so much weaker than the other. Mexico is not a loser in this agreement, but the developments of NAFTA has not come around as quickly as one might had hoped for.

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