Introduction
The North American Free Trade Agreement (NAFTA) stands as the textbook example for an ideal regional trade agreement. Fundamentally, regional trade agreements like NAFTA benefit all participating countries by increasing the inflow of foreign investment and the significance of global value chains of participating countries. Additionally, regional integration, like the case of NAFTA, softens physical borders between countries. NAFTA is recognized by many as the most significant regional trade agreement for inspiring other regions to create preferential trade agreements in the 21st century. For Mexico individually, the ratification of NAFTA in 1994 was its breakthrough into the international trading system. Additionally, NAFTA integrated Mexico's developing economy with the two developed economies of the United States and Canada. While on the one hand, NAFTA signaled Mexico's breakthrough into the international trading system, on the other, it placed pressure on Mexico to implement liberal trade policies to maintain the efficiency of the trade agreement.
For Mexico, after 25 years, NAFTA does not yield the same impacts it did when first ratified.
The changing effects of NAFTA on the Mexican economy stem from a combination of factors Mexico can and cannot influence. For example, the emerging significance of new global powers in the international trading system impacted the amount of trade entering Mexico. Take the example of China emerging as a dominant trading partner. What made China an attractive trading partner to multiple countries was its low cost of production and labor. Since these characteristics of low production are the same characteristics that made Mexico an attractive trading partner to countries, trade ultimately was diverted away from Mexico to China. Although Mexico cannot influence or determine an event like China rising in the international system, they can, however, control national economic policies that can mitigate the impact of unexpected events.
To determine whether NAFTA is a useful trade agreement, it is significant to observe Mexico's economy before ratification, the early years after ratification, and, in recent years, considering the ramifications for the new United States-Mexico-Canada trade agreement (USMCA). Analyzing the economic impact of high trade barriers will be one deciding factor as to whether Mexico benefits from free trade or not. This analysis, including the differences between NAFTA and USMCA, will indicate reforms Mexico will need to implement to yield higher benefits from the nearly ratified USMCA.
Origins and Justification of NAFTA
NAFTA operates similarly to other preferential trade agreements with special exceptions. Firstly, NAFTA eliminated all tariffs on imported goods that were not in the agriculture, textile, or automobile industry. For all countries, these three industries are volatile to international trade, so maintaining some form of barrier will attempt to ensure minimal externalities on these three industries arising from international trade. Another significant operation of the NAFTA agreement is the treatment of most-favored-nation status to all members. The definition and practice stemming from the World Trade Organization (WTO), the most-favored-nation status, means that no country in this agreement could treat another member-state any differently.
The operations mentioned are some of the critical elements to the NAFTA agreement, while other mechanisms not mentioned ensure these regulations are met. By having these guidelines in place for bordering countries, movement of factories and goods between each country is made smoother. The special treatment established in this agreement also encourages more trade to be done between the agreed countries. Overall, NAFTA integrates the three countries that would stand against more significant integrated regions such as the European Union (EU) while still maintaining the sovereignty to implement different economic policies.
The United States and Canada created NAFTA with the hopes of mitigating large flows of migration into the United States and Canada. An objective of NAFTA for these two countries was that the inflow of foreign investments into Mexico would increase the number of economic opportunities in the country, which would ultimately decrease the flow of migration. We later see that while NAFTA did bring forth more economic opportunities and developments into Mexico, it did not evenly distribute benefits throughout the country due to select industries benefiting more than others.
A Pre-NAFTA Mexican Economy
Before ratifying NAFTA in 1994, Mexico engaged in minimal trade. The little trade Mexico did engage in consisted of a high tariff and other forms of non-trade barriers such as import licenses. Import licenses are licenses administered by the national government that permit the importation of certain goods. This practice decreases the average rate of imports, and the revenue generated from these licenses is used to invest in different industries. For an extended period, the high level of investments contributed to the development of capital-based industries. The development of these industries increased their significance in the Mexican government that ultimately influenced economic policies during times of economic shocks. Between 1970-1981, Mexico suffered an extreme debt crisis that required the government to implement liberal trade policies to gain an alternative form of revenue. These policies were short-lived, however, once individual industries noticed harmful effects such as increased imports and high consumer prices. Industries' influence caused these liberal trade policies to be repealed. Industries also influenced economic policy in 1982 when Mexico transitioned into a business-orientated government, which began a four-step approach to transition Mexico into an open economy. Parallel to this four-step approach, discussions for a bilateral trade agreement between the United States and Mexico were underway.
Due to the discussion of a possible trade agreement with the United States coinciding with Mexico's massive wave of liberal trade policies, many trade policies implemented at this time appeased the interest of the United States. More specifically, policies that incentivized foreign investments are among some of the policies which appeased the United States to further negotiate the possibilities of a trade agreement.
Before NAFTA, economic shocks were driving factors for Mexico to become more open to international trade. The influence of specific industries, however, prevented at times the government from implementing specific economic policies. When the discussions for a bilateral trade agreement between the United States and China were underway, Mexico's agenda shifted to implementing strings of liberal trade policies to appease the United States. By crafting trade policies that molded the interest of the United States, it ultimately influenced Mexico's economic relationship with the United States. We see these policies play a significant role later as it ultimately influences how Mexico conducts future trade agreements with other countries.
The Early Impacts of NAFTA
Research shows that the net effects of NAFTA on the Mexican economy were generally positive. Although economic shocks could skew any economic fluctuation at this time, even with these events considered, the total net effects of NAFTA are still positive. First and arguably most significant is Mexico's convergence to the development of Canada and the United States. The net inflow of foreign investments to Mexico introduced new technological innovations in the country. New technological innovations caused Mexican national firms to reform their structure to match the rigid standards of the United States and Canada. Reforms made many national Mexican firms increase the quality of jobs in Mexico and contributed to an increase in the national average wage. These structural reforms led to economic and policy reforms that made Mexico better equipped for surprise economic events.
Although NAFTA is credited for the overall development of Mexico, the effects, however, did create different inequalities. For example, the technological innovations that were introduced in select industries, which ultimately branched out to the overall development of individual states. The concentration of innovative development in only select industries meant that wage increases were only distributed to a specific group of individuals. On the same note, since the creation of jobs was concentrated in select industries, there is no substantial change in the unemployment and poverty rate made by NAFTA.
While NAFTA did increase the overall development of Mexico, the concentrated development of different states caused little societal improvement. Because of this little improvement, issues such as poverty and migration remained prevalent throughout all years NAFTA has been implemented.
Differences between USMCA and NAFTA
Newly devised provisions in USMCA mostly surround the automobile and agriculture industry. Seeing that the automobile industry is one of the largest integrated industries within the agreement, new regulations and standards in the automobile industry are proposed in USMCA to better concentrate car manufacturing in North America. Additionally, for automobiles to receive no tariff a minimum of 75% of the car must be produced either in the United States, Mexico or Canada. USMCA provisions regarding the automobile industry help ensure that the automobile industry remains as a unified industry in North America and prevents large portions of manufacturing from being outsourced. Agriculture based provisions mostly pertain to the market access between the United States and Canada. Besides granting the United States more access to Canada’s agriculture sector, other agriculture provisions include increasing transparency in sanitary and biotechnology changes.
The Mexican agriculture industry has experienced both the positive and negative effects of NAFTA. While NAFTA increased Mexican exports to both the United States and Mexico, there were still some level of trade barriers which lessened Mexico’s benefit in exporting agriculture products.
Policy Recommendation: Export Diversification and The Pacific Alliance
Considering the economic integration between Mexico and the United States, diversifying exports will make Mexico’s economy less dependent and reactionary to the United States. Diversifying Mexico’s exports will also allow the country to branch out and strengthen established economic partnerships already in place. Efforts recommended in an attempt to close the gap between what NAFTA was supposed to achieve and what it achieved.
There are current efforts made by the Ministry of Economy to diversify Mexico’s export portfolio. Current efforts prioritize the development of small and medium-sized enterprises (SMEs) as well as increase their financial confidence. Through specific initiatives and forms of investments, the Ministry hopes for an increase in bank investments in SMEs to increase productivity and competition. Due to the uneven development of sectors and states in Mexico, current efforts will ideally close the unemployment rate across sectors and states. By developing under-developed sectors, it will increase productivity in the market, which in turn will increase the total amount of exports. Collaborating with banks, offering forms of financial assistance and consultancy to small businesses will ideally increase economic opportunities for states that did not feel all the benefits from NAFTA.
An economic partnership that can strengthen Mexico’s export diversification is the Pacific Alliance. An economic partnership between Mexico, Colombia, Chile, and Peru, these four countries comprise half the exports that leave Latin America. This partnership originated as a free trade agreement, which has now branched into integrating more aspects of each country’s economy, such as a unified stock market and single passport usage, to name a few. The overarching goal of this partnership is for it to expand to more Latin American countries to strengthen intra-regional trade. Although there is an already established Free Trade Area of the Americas, a trade agreement with the Pacific Alliance and more Latin American countries would be one of the few Pan-American trading agreements that do not include the United States. Despite the challenges which lie ahead for the Pacific Alliance becoming a stronger partnership, Mexico can take initiatives that will allow it to emerge as the leader of the Alliance. Seeing that implementation is the main challenge to further strengthening the Alliance, by implementing policies or standards that are in alignment with the Alliance’s agenda, it will set the model for other countries to follow.