The Economic Impact of NAFTA on Mexico

by: Dennis Pohlmann

TABLE OF CONTENTS

1. About NAFTA 1

2. Opinions For and Against NAFTA 2

3. The Economic Impact of Reducing Tariffs 3

4. Mexico’s Winners and Losers from the U.S.-Mexican Trade Pattern 5

The Heckscher-Ohlin Theory 5
The Expected Gainers and Losers from Free Trade in Mexico 8
The Trade Pattern between Mexico and the United States 11
Who in Mexico gains and loses from NAFTA? 13
Low-Skilled Workers 14
Skilled Workers 18
Farmers 19

5. Conclusions 20

References 26

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.

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