Three-way agreement: Reassessing NAFTA 20 years on

The year 2014 marks the 20th anniversary of the North American Free Trade Agreement (NAFTA), a comprehensive deal establishing the terms of trade and investment between Mexico, Canada and the US. With a $19trn market, NAFTA is one of the largest trading blocs in the world, encompassing some 500m people and a wealth of natural resources. Two decades on, proponents and critics continue to disagree on the impact of NAFTA, while shifting trade patterns and redefinition of regional borders via free trade agreements (FTAs) seem to favour a redefinition of NAFTA.

NAFTA Promise

NAFTA came into effect in January 1994. Among other things, it eliminated tariffs on industrial goods, opened a range of service sectors and guaranteed national treatment for service providers across borders, and established an investor protection framework as well as protections in the field of intellectual property. The trilateral agreement promised a significant boost to intraregional trade, as well as liberalising manufacturing and foreign investment and creating hundreds of thousands of new jobs. For Mexico specifically, the agreement promised to increase economic growth, raising the standard of living, which in turn was expected to reduce emigration to the US. NAFTA would also cement the liberal approach the country had begun to implement in the mid-1980s.

At the time it came into effect, critics warned that NAFTA would result in significant job losses for the US, as companies moved production to Mexico to take advantage of lower wages and weaker environmental protection, depressing US wages. Twenty years on, it seems the wins and losses were overstated by both sides.

Two Decades

Since NAFTA came into effect, intra-regional trade flows have increased some 300%, from $290bn in 1993 to more than $1.1trn in 2012. In 2013 trade between the US and Canada, the US’s largest trading partner, reached $632bn, while trade between the US and Mexico, the US’s third-largest trading partner after Canada and China, reached $507bn. Investment flows among the three partners grew significantly. Since NAFTA was signed, the US has invested more than $310bn in it northern neighbour, while Canada has invested more than $200bn in the US. In Mexico, US investment has also grown, with about half going to the manufacturing sector, particularly automotives. Mexico has also made investments in Canada and the US, especially in the retail, cement and dairy sectors.

Major Gains

The US in particular has benefitted from investments made in its neighbours, as a large percentage of their output is imported to the US as intermediate goods, leaving American industries to assemble high-end finished products. It is estimated that roughly 40% of the contents of US imports from Mexico and 25% of US imports from Canada are of US origin. NAFTA has also made possible the development of cross-border supply chains, enabling makers of electronics, machinery and appliances to spread production, reduce costs and boost productivity.

While economists disagree on whether NAFTA has generated more jobs in the US, they seem to agree that it has contributed to the creation of export-related jobs, which are estimated to pay on average 15-20% more than those focused only on domestic consumption. Even though some economists claim NAFTA has depressed wages in the US, a 2012 study by Yale University and the Federal Reserve found that wages have risen in all three countries as a result of NAFTA. However, critics often cite the US post-NAFTA trade deficit to show how NAFTA has hurt the US. The US went from a $29.1bn trade deficit with Canada and a $2.5bn surplus with Mexico in 1993 to a combined trade deficit of $181bn by 2012 , though this ignores the contribution of supply chains and the extent of US input in Mexican and Canadian exports to the US.

Some economists claim Mexico has benefitted the most from NAFTA. At the time NAFTA was under negotiation, Mexico was the smallest of the three economies. Today, its economy is about the same size as Canada’s. Mexico’s auto and manufacturing industries have greatly benefitted from the agreement, in part at the expense of Canada. Mexico is now an important manufacturer and exporter of cars, having recently surpassed Canada in automotive production. Mexican auto exports to the US quadrupled from 1993 to 2013. Meanwhile, Canada’s heavy truck shipments fell 75% between 2006 and 2011. Mexico is expected to continue attracting manufacturing investment and is starting to develop important clusters for aerospace and other industries.

Downsides

However, other sectors were negatively affected. Integration of US and Mexican agricultural markets exposed Mexico’s fragmented food sector to more competition from heavily-subsidised segments in the US, like corn and wheat. This had a major impact on subsistence farmers and the labour market. According to a 2014 study by the Centre for Economic and Policy Research in Washington, from 1991 to 2007, 4.9m family farmers were displaced and seasonal labour in agro-export industries increased by around 3m.

The same study also points to what NAFTA critics often cite to show the limited benefit to Mexico: poverty rates. According to Mexican national statistics, the poverty rate in 2012 was 52.3%, almost identical to the 1994 figure. Given the increase in population, this means that 14.3m more Mexicans live in poverty today than in 1994. Moreover, real (inflation-adjusted) wages in Mexico grew only marginally from 1994 to 2012, by 2.3%. Meanwhile, real GDP grew at an average annual rate of just 0.9%, around half the growth registered by the rest of the region, which in the same period averaged 1.6%, placing Mexico 18th of 20 Latin American economies in growth of real GDP per person, above only Venezuela (0.8%) and Guatemala (0.6%).

Flow Of People

As for emigration, from 1994 to 2000, the study shows that the number of Mexicans emigrating to the US increased nearly 79%, while the number of Mexican-born residents living in the US doubled from 1990 to 2000, from 4.5m to 9.4m, and reached a high of 12.6m in 2009. However, in recent years economic growth in Mexico has helped to reduce the flow of illegal and legal immigration from Mexico to the US.

While the study ultimately concludes that NAFTA failed to deliver on its promises to Mexico, these indicators ignore the effect that the 1995 peso crisis and Mexico’s trade liberalisation efforts, which began before NAFTA, have had on economic growth, per capita GDP and real wages. Isolating the effects of NAFTA on the Mexican economy from other factors like economic cycles in the US and currency devaluations is difficult.

Crossroads

For the first six years of NAFTA, North America became a more integrated and competitive region, reaching a combined share of global production of 36% by 2001. However, some of that progress seems to have been lost in the following years. By 2011 North America’s share of global production dropped to 26%, at level with Asia and Europe. Since 2001 the war on terrorism has increased security along the US border, but is a source of many inefficiencies, while the recent economic recession in the US started a chain of protectionist measures such as buy American incentives and new labelling requirements. Once China joined the World Trade Organisation in 2001, several US firms left Mexico to take advantage of cheaper wages there. Although trade in North America has been on the rise, trade with China has increased at much faster rates. Mexico competes directly with China for US imports. According to the International Monetary Fund, China enjoys a 23% share, while Mexico has 12%.

There is a strong case for further North American integration to increase the region’s productivity and rival the Chinese factory hub, particularly in the energy sector. The US’s shale gas revolution, the development of Canadian oil sands and Mexico’s recent energy policy reforms, expected to attracted significant amounts of foreign investment, could lower energy costs and give North American industries a competitive edge. Moreover, as wages in China increase, Mexico is once again looking attractive in terms of labour costs, particularly given the difference in labour skills and productivity levels between the two countries. However, integrating energy markets and harmonising regulatory standards would be a difficult task. Oil remains a controversial issue in Mexico and the US’s failure to approve Canada’s Keystone XL pipeline, a $5.4bn pipeline that would carry oil from Alberta to American refineries along the Gulf Coast of Texas and Louisiana, has Canada looking at oil markets across the Pacific. The three partners are now negotiating to join the Trans-Pacific Partnership individually. The US is also in talks with the Transatlantic Trade and Investment Partnership. Since both Canada and Mexico already have an FTA with the EU, negotiating as a bloc would increase coherence.

In the US, further integration has often been overshadowed by fears of job losses, narco-traffic and uncontrolled immigration from Mexico. Canada naturally sees Mexico as a competitor rather than a trade partner in its relationship with the US, and now especially in the context of Mexico’s recent economic growth. The Canadian government confirmed in early 2014 that it would not be lifting the visa requirements on Mexican citizens in 2009. For now, it seems that further North American integration remains elusive.