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Ten Years of the North American Free Trade Agreement

Philip Ginsberg

The North American Free Trade Agreement (NAFTA) began on January 1, 1994. Signed in December 1992 by Canada, Mexico and the United States under the stewardships of Presidents Mulroney, Salinas and Bush, NAFTA broke new ground as “the first major free trade agreement between a developing country and developed countries” (Hufbauer/Goodrich 2004). It is the world's largest free trade agreement (FTA) in terms of GDP and the second largest in terms of trade volume after the EU. NAFTA is also an unusually extensive agreement that includes a dispute settlement mechanism and side-agreements on labour and environmental issues (Kose et al. 2004). It served as a model for the recently signed Central American Free Trade Agreement (CAFTA) between the US, Costa Rica, El Salvador, Honduras and Nicaragua, and was the precedent for the Free Trade Area of the Americas (FTAA) between 31 Latin American, Caribbean and North American countries, envisioned to come into force no later than December 2005 (FTAA Official Website 2004).

Assessing NAFTA’s impact

The first ten years of the agreement – a relatively short timespan upon which to judge an economic agreement of NAFTA’s scale (Lederman et al. 2003) – were marked by several important events. Apart from the terrorist attacks of September 11, 2001 and the first elections generally accepted as free in Mexico in 2000 (Johnson 2003), Mexico experienced the so-called “Peso” or “Tequila” financial crisis of 1994/5. In late 1994, as sudden capital outflows replaced the considerable capital inflows the country had been receiving throughout the 1990s, Mexico was forced to float the Peso, which duly lost almost half its value measured against the dollar. Even today, the country's banks remain weakened by the crisis (The Economist 2004).

Although 'only' a trade agreement, NAFTA nevertheless has considerable implications apart from its formal mission as a boost to North American trade. Beyond a judgement on NAFTA's effect as an economical tool the discussion therefore touches on issues such as employment, migration and the environment. The great majority of views examined here acknowledge its economic success at least to some extent, while simultaneously expressing reservations and occasionally strongly criticising the agreement's wider consequences. NAFTA's impact is subject to a lively debate and the purpose of this paper is to reflect the arguments put forward in that discussion.

1. Impact on trade and investment

It is clear that NAFTA stimulated trade and investment between its members. In this context, the agreement is very widely seen to have been a success: trade and investment between member nations have approximately tripled (Pastor 2004).

i. US trade

US exports to, and imports from, Canada and Mexico made up approximately a quarter of US trade in 1990, but rose to account for approximately a third in 2004. Indeed, from 1993 to 2002, U.S. trade with NAFTA countries increased by 105% while its trade with the rest of the world increased by 67% (The Economist 2004).

ii. Canada's trade

From 1994 until 2002, Canada's trade with the U.S. increased by more than half and Mexico's more than doubled (Hufbauer/Goodrich 2004). Canada's trade with all NAFTA countries increased by 80% compared to a 39% increase in its trade with the rest of the world (The Economist 2004).

iii. Mexico’s trade

Mexico's trade with NAFTA countries went up by 179% and by 188% with the rest of the world – it should be noted, however, that Mexico's trade within NAFTA amounts to more than $255 billion, while its trade with the rest of the world is worth approximately $75 billion dollars (The Economist 2004). In fact, without NAFTA, Mexico's global exports would have been approximately 25% lower and its FDI approximately 40% less (Lederman et al. 2004).

Mexican per capita GDP reportedly also increased by 4 to 5% because of NAFTA by the end of 2002 (Lederman et al. 2004), although this statistic was disputed (Audley et al. 2003).

Finally, most of the various reports cited by the International Monetary Fund in its paper on NAFTA's effect on Mexico, which use different models to investigate trade diversion, show that there was no trade diversion as a result of NAFTA, while only some show that there was relatively little trade diversion (Kose et al. 2004).

iv. Foreign direct investment

From 1994 until 2001, U.S. foreign direct investment (FDI) to Canada almost doubled while its FDI to Mexico more than tripled (Hufbauer/Goodrich 2004).

U.S. direct investment abroad, 1994-2002

Mexico	$58 billion	+approx. 245%
Canada	$153 billion	+approx. 105%
Rest of World	$610 billion	+approx. 125%

Foreign direct investment to the U.S., 1994-2002

Mexico	$8 billion	+approx. 275%
Canada	$92 billion	+approx. 120%
Rest of World	$386 billion	+approx. 110%

Source: Bureau of Economic Analysis (The Economist 2004)

2.      Impact on labour

Trade policy affects the pattern rather than the number of jobs. This is why it should never have been assumed that NAFTA would be a net creator of employment. Although it succeeded in making its member countries' economies more efficient and therefore in raising average income, this was "bound to be a painful process" (The Economist 2004). It is also obvious that the Canadian and U.S. economies, being much greater in size and considerably less dependent on trade with Mexico than Mexico with them, would never have been affected to the extent that Mexico's economy would be.

i. The U.S. perspective: Job losses and job creation

There is a wide consensus that NAFTA did not cause massive job losses in the U.S. The frequently quoted "giant sucking sound" of jobs moving southward, as the presidential candidate at the time, Ross Perot, put it (Perot/Choate 1993), was certainly “never heard” (Hufbauer/Goodrich 2004). In 2000, unemployment in the U.S. had reached record lows (Stiglitz 2004) and it is still lower today than in 1994 (Griswold 2004). However, NAFTA did undoubtedly lead to some direct job losses in the U.S. These amounted to as many as 110,000 according to the most pessimistic estimate (The Economist 2004).

Between 1994 and 2000 more than 2 million new jobs were being created each year (Hufbauer/Goodrich 2004) and the majority of jobs created since 1994 have paid above-median wages (The Economist 2004). The International Institute of Economics' expert Gary Clyde Hufbauer highlighted the complexity of the issue of job losses in an interview with the New York Times: "NAFTA-related job loss and lower income may be small, but the echo is very large because of all the other jobs lost to globalization. NAFTA is the symbol for all of that pain" (Weiner 2003).

ii. The Canadian perspective: Job creation and the welfare state

The situation in Canada is discussed less. However, unemployment in the country decreased significantly from 11% to 7% from 1993 to 2000. Canada’s welfare state was not threatened by NAFTA as Canadian taxpayers were simply prepared to sustain it financially through their taxes (The Economist 2004). Indeed, it was the welfare state that helped contain the impact of NAFTA on the Canadian economy, which has been changed into a more export-oriented economy (Weiner 2003).

iii. The Mexican perspective: Job losses and job displacement

The developments in Mexico must be seen in the context of the financial crisis of  1994/95.

In terms of labour, the agreement has been a double-edged sword for Mexico. Jobs were not created fast enough to keep pace with the job losses in agriculture (Weiner 2003), where farmers were displaced by subsidised US imports such as corn (Stiglitz 2004). Therefore, while the country gained 500,000 jobs in manufacturing from 1994 to 2002, it lost 1,3 million in the agricultural sector – which employs nearly a fifth of the population (Audley et al. 2003).

Mexican per capita average income in 2002 was still only roughly a sixth of U.S. per capita average income, just as in 1993 (Sangmeister/Melchor del Río 2004). Income disparities have grown by 10,6% between the US and Mexico in the last ten years and real wages in Mexico have fallen at an annual rate of 0,2% (Stiglitz 2004). Increases in wages for less qualified or handicapped workers have been limited to the "maquiladoras". It is for this reason that Mexico also has one of the highest concentrations of income in Latin America (Sangmeister/Melchor del Río 2004). Thus, when assessing the importance of NAFTA-related job losses in Mexico, Robert Pastor claims that "NAFTA was silent on the development gap between Mexico and its two northern neighbors, and that gap has widened" (Pastor 2004). Only the most developed areas of Mexico, such as the northern districts that accommodate the "maquiladoras" (factories allowed to import duty free if their output is exported) benefited (Sangmeister/Melchor del Río 2004) – therefore, the divide between the manufacturing north and the agricultural south has been exacerbated. 90% of investment since NAFTA has been received by just four states (of which three are on the northern border) of Mexico's total 31 states. As a result, these three states have since grown ten times as fast as others in the south of the country (Pastor 2004).

3.      Other related issues

i.  The impact on the environment

There was no "race to the bottom" in environmental legislation (Audley et al. 2003). However, NAFTA's environmental side-agreement was "toothless" because the Mexican and Canadian governments would not have accepted it otherwise, as neither country would have wanted to provide funds to clean the border (Hufbauer/Goodrich 2004). Additionally, NAFTA changed Mexico's commercial farming practices by industrialising them to increase production levels. This change put the environment at risk – the damage to the environment is already greater than the economic gains since NAFTA's implementation (Audley et al. 2003).

ii. The impact on migration

NAFTA was oversold in terms of the moderating effect it would have on the flow of migration from Mexico into the U.S (Weiner 2003). After ten years, total illegal immigration into the U.S. from Mexico has risen from an estimated 210,000 to an estimated 270,000 persons a year. The reason for this is that simply not enough jobs were created to accommodate those that chose to leave (Sangmeister/Melchor del Río 2004). However, historical migration patterns, employment opportunities in the U.S. and the financial crisis of 1994/95 must be considered and ultimately provide better explanations than NAFTA on its own (Audley et al. 2003).

iii. The impact on Mexican democracy

NAFTA is also seen by some commentators to have been at least partially responsible for the development of democracy in Mexico. Although Latin America as a whole was more stable and prosperous a decade ago, in July 2000 Mexico elected Vincente Fox, its first opposition president for 71 years (Johnson 2004). NAFTA "set the stage" for this (Griswold 2004). Because FTAs have an impact on domestic regulation, they can also have an important bearing on improving political "fundamentals" in addition to economic ones (Salazar-Xirinachs/Granados 2004). The potential for FTAs to further the political development of their member countries may turn out to be an added incentive for the development of new trade agreements in the region. In Joseph Stiglitz's view even, NAFTA's "potential geopolitical benefits were far more important than the economic benefits" (Stiglitz 2004).

iv. NAFTA's dispute settlement mechanisms

Assessing the dispute settlement mechanisms built into the agreement, Stiglitz goes on to claim that "hidden in NAFTA was a new set of rights – for business – that potentially weakened democracy throughout North America". Businesses may now resort to the intransparent dispute resolution mechanisms (such as closed tribunals) provided by NAFTA, instead of remaining obliged to use normal judicial proceedings. Those affected by the results of companies’ successful claims within NAFTA then have no “comparable protections of appealing [...] and receiving compensation” (Stiglitz 2004).

However, Hufbauer and Goodrich note that NAFTA shows that "bilateral mechanisms designed to solve commercial disputes can succeed" if only "outside the realm of high profile cases", meaning investor-state disputes. Although even in these cases, the U.S. has "learnt [its] lesson" and will ensure that coming agreements are less ambitious (Hufbauer/Goodrich 2004).

4. The impact of foreign competition on Mexico's economy

An increasingly worrying competitor for the Mexican economy is China (Kose et al. 2004). It offers even cheaper labour and is now also a member of the WTO. Asian countries have already absorbed some of the production of central American countries and an estimated 70% of jobs lost in "maquiladoras" went to Asia, predominantly to China (Sangmeister/Melchor del Río 2004). This shows that in the global marketplace, Mexico's advantage of cheap labour is disappearing. Essentially, while Mexico's economy was changing, China’s was changing even faster and now Mexico must try and capitalise on its advantageous geographical position as America's neighbour. Eventually, 85% of the global manufacturing sector may move to China according to US government estimates (Rosen 2003).

5. Conclusion

“Put simply, NAFTA has been neither the disaster its opponents predicted nor the savior hailed by its supporters” (Audley et al. 2003). Taken from the Carnegie Endowment’s paper, this is the quote that perhaps best sums up the plethora of opinions and reports on NAFTA’s tenth anniversary. Especially where Mexico is concerned, the limited scope of a trade agreement as such, which could never improve the lives of each and every inhabitant of its member countries, becomes painfully obvious – “even if all three countries could hope to gain in the aggregate”, as the Economist puts it, “NAFTA was never going to be [...] a winning proposition for all of North America’s citizens”.

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