The economic impact of NAFTA on Mexico

TABLE OF CONTENTS

1. About NAFTA

2. Opinions For and Against NAFTA

3. The Economic Impact of Reducing Tariffs

4. Mexico’s Winners and Losers from the U.S.-Mexican Trade Pattern
The Heckscher-Ohlin Theory
The Expected Gainers and Losers from Free Trade in Mexico
The Trade Pattern between Mexico and the United States
Who in Mexico gains and loses from NAFTA?
Low-Skilled Workers
Skilled Workers
Farmers

5. Conclusions

References

THE ECONOMIC IMPACT OF NAFTA ON MEXICO

1. About NAFTA

Many countries are reducing trade barriers and promoting regional economic integration. A result of this is the rising of free-trade areas in which the belonging countries trade freely among themselves without tariffs or trade restrictions.

One example for a free-trade area is the North American Free Trade Agreement (NAFTA) founded by the U.S., Mexico and Canada. When NAFTA took effect on January 1, 1994 it created the world´s largest free-trade zone with a combined population of over 416 million and a total GDP of $12 trillion. Of course, the U.S., as the world´s largest single market, dominates the North American business environment. The goal of NAFTA is to eliminate all the trade barriers between the three countries over a 15-year period, completed in 2009. NAFTA also substantially reduces, but does not completely eliminate, nontariff trade barriers like import quotas, sanitary regulations, and licensing agreements. Before NAFTA for example, the average Mexican tariff on U.S. imports was about 12 percent in 1993. On the other hand, the tariff on Mexican imports into the U.S. was between two and three percent. As a result of NAFTA, Mexico reduced it´s tariffs to approximately 1.3 percent in 2001. 87 percent of the Mexican imports entered the USA duty free in 2001. Because of an average duty on the remainder of only 1.4 percent the overall average tariff on Mexican imports was about 0.2 percent in 2001 down from 2.1 percent in 1993 (Sarkar & Park, 2001, p. 270; CBO, 2003, p. IX). In general, most of the declines in tariffs have been on the Mexican side due to the fact that Mexico started with higher tariffs than the United States or Canada (Gould, 1998, p. 13).

2. Opinions For and Against NAFTA

From the beginning, NAFTA had a lot of opponents against it. For example, U.S. labor unions feared a loss in jobs because of dislocating production from the USA to Mexico by reason of lower wages. In Mexico, farmers opposed, and are still opposing NAFTA because of the high U.S. subsidies on agricultural products that are imported to Mexico. These subsidies put a great pressure on the prices of agricultural products and forced many Mexican farmers out of business. Also a higher efficiency in production allows U.S. farmers to provide their products at a lower price than their Mexican counterparts. Other voices in Mexico warned that the USA would use NAFTA to influence Mexican policy. For instance, the U.S. could urge Mexico to enact foreign investor friendly laws which harm the Mexican people. U.S. investors would benefit from lower labor rights in order to save costs at the expense of Mexican laborers. There were also beliefs from environmental, social justice, and other advocacy organizations stating that NAFTA has unfavorable impacts on non-economic areas like public health or environment.

Mexican proponents of NAFTA who supported NAFTA´s establishment argued that open trade could reduce migration in the long run from Mexico into the U.S. since NAFTA brings an improvement of the Mexican economy relative to the U.S. economy (Acevedo & Espenshade, 1992, p. 742). Other Mexicans hoped that NAFTA would have some influence on U.S. trade policies like anti-dumping and that more investments would be attracted into Mexico.

Between 1994 and 2003 Mexico´s average annual GDP growth was 2.7 percent (Hufbauer & Schott, 2005, p. 2). At the first sight, NAFTA seems to be a benefit for the Mexican economy at the whole. Nevertheless, there are those that gain and those who lose as a result of free trade. The content of this paper is to take a closer look at the Mexican economy and to answer the following three questions:

1. Can the trade pattern between Mexico and the U.S. be determined by using economic models?
2. Can the winners and losers that are resulting from the trade pattern between the U.S. and Mexico be explained with these models?
3. According to the economic models of international trade, does Mexico benefit like predicted?

3. The Economic Impact of Reducing Tariffs

As mentioned above, an economy benefits from free trade. Reducing tariffs increases a nation´s welfare. Figure 1 illustrates the gains and loses and the resulting net welfare gain.

The effect of NAFTA was reducing tariffs on Mexican imports to the United States and U.S. imports to Mexico. The result of lower or no tariffs is a lower world price. When the world price of a specific good declines from P0 to P1 the domestic producers in the economy lose producer surplus represented by area a. On the other hand, the domestic consumers benefit from the lower world price and gain additional consumer surplus represented by the areas a+b+c+d. The government loses revenue created by the tariff shown by area c. Therefore, the national net gain is represented by b+d.

illustration not visible in this excerpt

Figure 1

Although the national benefits are greater than the national losses it is important to emphasize that the domestic producers are the losers while the domestic consumers are the gainers from free trade. Focusing on the Mexican economy, the gainers are the Mexican consumers and the losers are the Mexican producers of goods which are traded with no tariffs or lower tariffs than before. If producers lose there will be also an impact on the factors used in production. To predict this impact by using economic models, it is necessary to find out which goods are traded between Mexico and the U.S. That again, delivers theoretical indications implying which factors gain and lose in Mexico because of free trade. These predictions can be compared with the real world situation.

Because of the close connection between the trade pattern and the resulting gainers and losers, the first two questions should be answered in context. That will provide the necessary information to answer the third question at the end of this paper which is to assess if Mexico benefit from free trade like economic models predict.

4. Mexico’s Winners and Losers from the U.S.-Mexican Trade Pattern

The Heckscher-Ohlin Theory

The leading theory to explain a nation´s trade pattern is the Heckscher-Ohlin (H-O) theory. Its core idea was developed by the Swedish economic historian Eli Heckscher in 1919. In 1930 his student Bertil Ohlin published a clear overall explanation of this theory.

According to the H-O theory, a country specializes in the production and export of the goods that use the country’s relative abundant factors intensively. Also, the country imports the goods which production uses its relative scarce factors intensively. What means relative abundance of a certain factor in the case of Mexico and the U.S.? Consider, for example, the factor "labor". Mexico has an abundance of labor (Polanski, 2006, p. 3). That means it has a higher ratio of labor to other factors than the U.S.

Economic theory implies a higher national well-being for Mexico as a result of this specialization pattern. Figure 2 illustrates the effect of open trade.

Consider a simplified example. Mexico produces only two goods: engines and corn. Without trade the country has to produce a combination of engines and corn that will maximize the community well-being. The produced quantities of both goods must equal the consumed quantities. The bowed-out production-possibility curve (ppc) reflects the amounts of corn and engines that Mexico can produce, given the country´s available factor resources and maximum feasible productivities.

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Figure 2

The community indifference curves show the various combinations of consumption quantities of corn and engines that lead to the same level of well-being. In this example, I2 reflects a higher level of well-being than I1. With no trade the equilibrium is located at point S0 (or C0). At this tangent point, the highest achievable indifference curve I1 touches Mexico´s ppc. Therefore, Mexico produces and consumes 30 units of engines and 30 units of corn. C0 equals S0. The relative price in Mexico is shown by the shape at the tangent point. Here, one unit of corn equals two units of engines. Thus, the relative price of corn is 2 E/C.

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