Something I Wrote Six Years Ago That It Is Time to Revisit...

How much of this do I still believe?

NAFTA's (Qualified) Success

J. Bradford DeLong
delong@econ.berkeley.edu
http://www.j-bradford-delong.net/

July 2000

It is time to conclude that NAFTA--the North American Free Trade Agreement--is a success.

It is nearly seven years since the ratification of NAFTA, nearly seven years since then-Treasury Secretary Lloyd Bentsen argued and President Clinton decided that NAFTA should be the second major initiative of his administration. The major argument for NAFTA was that it was the best thing the United States could do to raise the chances for Mexico to become democratic and prosperous, and that the United States had both a strong interest and a neighborly duty to try to help Mexican political and economic development.

By that yardstick NAFTA has been a clear success.

NAFTA has helped Mexico economically. Over the past five years real GDP has grown at 5.5 percent per year. Even including the sharp shock of the 1995 peso crisis, Mexican real GDP has grown at 3.8 percent per year since the ratification of NAFTA. The urban unemployment rate that was 6 percent in 1992 and rose to 8.5 percent in 1995 is now less than 4 percent. The Mexican boom has been led by the manufacturing, construction, transportation, and communications sectors. Most of all, the Mexican boom has been led by exports: next year Mexico's real exports will be more than three times as large as they were at the ratification of NAFTA, and as a share of GDP exports have grown from a little more than 10 to 17 percent.

It is here--in the growing volume of exports and in the building-up of export industries--that NAFTA has made the difference. Four-fifths of Mexico's exports go to the United States. More than two-thirds of Mexico's imports come from the United States. NAFTA guarantees Mexican producers tariff- and quota-free access to the American market. Without this guarantee, a smaller number of Mexican exporters would dare try to develop the strong links with the market north of the Rio Grande that have enabled them to sell their exports. Without this guarantee, few--either in Mexico or from overseas--would have dared to invest in the manufacturing capacity that has allowed Mexico to satisfy United States demand.

Without NAFTA's guarantee of tariff- and quota-free access to the American market, we would not have seen the rise in trade within industries between Mexico and the U.S. over the past half decade. Rising intra-industry trade means that Mexico and the U.S. are moving toward a greater degree of specialization and a finer division of labor in important industries like autos--where labor-intensive portions are more and more done in Mexico--and textiles--where the U.S. increasingly does high-tech spinning and weaving and Mexico increasingly does lower-tech cutting and sewing. As economists Mary Burfisher, Sherman Robinson, and Karen Thierfelder put it, NAFTA has nurtured the growth of productivity through "Smithian" efficiency gains that result from "widen[ing] the exent of the market" and capturing "increasing returns to finer specialization."

Without NAFTA, would Mexican domestic savings have doubled as a share of GDP since the early 1990s? Surely not. Without NAFTA, would the number of telephone lines in Mexico have doubled in the 1990s? Probably not.

Moreover, Mexican exports are by no means low-tech labor- and primary product-intensive goods. More than 20 percent of all Mexican exports are capital goods. More than 70 percent of Mexican manufacturing exports are metal products. Without NAFTA, would U.S. big three auto producers have invested in the Mexican auto industry, and would Mexican exports of autos and auto parts to the U.S. have grown from $10 to $30 billion a year? Surely not.

\More important, NAFTA has helped Mexico politically. Strong economic growth makes political reform much, much easier: reslicing a growing pie is possible under many circumstances where reslicing a static pie is not. AIncreasing economic integration brings with it pressures for increasing political integration as well: the liquidation of the statist-corporatist PRI order, and a shift toward democratic institutions that are more like those of the industrial democracies that Mexico hopes to join (and to which mexico hopes that NAFTA will serve as a passport of admission). The result has been the first peaceful transfer of power in Mexico in more than a lifetime, with the election to the Mexican presidency of Vicente Fox Queseda. Economist Dani Rodrik describes political democracy as a powerful meta-institution for building the political and economic institutions needed for success: thus Mexico's future looks much brighter now than it did back in the late 1980s when the dominant PRI regularly stole elections and held a hammerlock on Mexico's government.

But haven't all these good things for Mexico come at a substantial cost for Americans? In a word, no. Back during the debate over the ratification of NAFTA, commentators like Harley Shaiken predicted that NAFTA would send "high wage American jobs south," especially in the auto industry. Ross Perot and Pat Choate heard a "giant sucking sound" of American firms betraying their country by transferring up to five million American jobs to Mexico. Ralph Nader claimed that NAFTA would gut U.S. environmental regulation--that Americans would be poisoned by polluted Mexican strawberries--and that NAFTA would undermine the sovereign authority of the U.S. government.

Such claims were always incredible. The President and the Congress--not any committee established by NAFTA--continue to make and execute the laws: the U.S. government remains sovereign. The Mexican economy was always too small to have any significant macroeconomic effect on the American economy. Imports from Mexico rank way down on the list of factors affecting the distribution of income in America.

And in retrospect they have proved clearly false. You have to work really, really hard to find any significant effect--positive or negative--of increased economic integration with Mexico. American jobs that have been displaced because of increased imports from Mexico amount to less than two percent of all job elimination--the sum of those who lose their jobs and those who leave their jobs--in America. Far from shrinking, employment in autos and auto parts in America has grown by more than twenty percent since the beginning of NAFTA. Far from falling, hourly earnings of U.S. automotive workers have risen since the beginning of NAFTA.

But by the same token American jobs created by increased exports to Mexico are a very small fraction of job creation. NAFTA's effects are too small to materially influence the overall state of the American labor market for good or ill.

All, however, is not rosy. Mexico's political and economic problems remain enormous. Mexico's destiny continues to hang in the balance.

Mexico's political democracy is very fragile. The Mexican banking system is still in crisis as a result of the collapse of the value of the peso in early 1995. Mexico's distribution of income is deteriorating--in part because of failures under the old regime to adequately finance education and infrastructure, in part because of demographic burdens, and in part because the initial benefits of economic integration with the United States flow to the well-educated and well-prepared.

Improving Mexico's distribution of income requires raising the incomes of the poorest--which means that Mexico's poorest families need to over time be shifted out of low-tech low-productivity near-subsistence corn-centered agriculture and into either fruit- and vegetable-based agriculture or into urban occupations. But will the government be able to fund the infrastructure to support such a potential mass migration? And will rural populations--extremely undereducated--do well in urban labor markets?

Moreover, Mexico's social welfare system is bureaucratically inept. Mexico's safety net is in shreds. Mexico has many problems--corruption, a legacy of past underinvestment, and a legacy of inefficient government-protected and -sponsored enterprises among them. NAFTA has not fixed these problems. NAFTA could not fix these problems: they would exist with or without NAFTA. NAFTA did not turn Mexico into Utopia. And NAFTA does not guarantee that Mexico's economic and political future would be bright.

But NAFTA has done its job, has fulfilled its intended task: it has given some extra strength to the forces in favor of Mexican industrialization, modernization and democratization. It has loaded the dice somewhat in favor of a somewhat better outcome.

Comments

[save_the_rustbelt]

Let's think about this...

500,000 Mexicans came across the border last year looking for a job, any job.

Light manufacturing jobs in the US have been butchered.

I think in Y2000 the tech and stock bubbles were disguising a gathering storm.

And where are those high value service jobs Clinton promised to the displaced American workers? Bangalore!

[jerry]

What does any changing faith in NAFTA say about any change in your opinion of Free Trade, Fair Trade, and Ricardo?

[anne]

The complaint about effects of globalization that are left unattended to and uncompensated for is completely valid, but, without making this a politcal point but a point on policy, we went from an Administration concerned with compensating for workers who are displaced to an Administration that will not use policy for such worker needs. The problem is not globalization, but policy meant to protect and compensate workers through globalization.

[Sonia]

Where is the evidence that NAFTA has resulted in a meaningful loss of American manufacturing jobs or reduced the standard of living of for that matter low and moderate Americans who can buy cheeper goods? Many Mexicans have benefited from NAFTA. Unfortunately many Mexicans particularly in the South have not benefited. Cheep US agricultural products have benefited Mexican consumers but hurt uncompetive farmers. Also to be considered is that high birth rates of twenty years ago in
Mexcico mean that young Mexicans are much more productive in the US in construction and restaurant jobs than they would be in agricultural labor in Mexico or here. No trade agreement is a sufficient condition to reforming the educational system or to reforming the system of private/state monopolies that dominate much of the Mexican economy.

Unfortunately targeted efforts to compensate workers e.g. retraining have not demonstrated much success for a variety of reasons. One factor is that retraining often just delays adjustment or relocation. Another problem is that it very difficult in practice to determine whose job job loss is the result of trade and whose job loss is the result of other market factors. Universal health would reduce the double blow of job loss. Maintaining something like the current structure of Social Security would also help. Some sort of insurance system ( A la Shiller)to alleviate residential property value loss and facilatate relocation when the economic base of a commmunity is undercut by job loss whether by trade or otherwise would also improve economic security.

[andres]

Well for starters, Brad, you may want to rethink of the financial side of NAFTA, as in:

(a) unfettered capital flows between the two countries result in an asymmetrical adjustment burden (Mexico has to keep strict control over its fiscal policy; the US doesn't thanks to China and Japan), and also maintains the potential for another Peso crisis.

(b) since the Brady Plan, which has in retrospect proven to be insufficient, there have been no provisions made to reduce Mexico's external burden, the servicing of which is still a significant portion of Mexico's export earnings.

And then there are some sundry other issues:

(c) for some reason, NAFTA embeds the principle that US firms have the right to outsource labor/jobs to Mexico, and yet everybody seems surprised and horrified that Mexican families believe that they have the right to outsource wages/working conditions to the US. _This is hypocrisy on a grand scale_.

(d) As Sonia pointed out, NAFTA is in the process of substantially wrecking small-scale Mexican agriculture. This is not such a bad thing for middle-class consumers. However, most of the displaced Mexican farmers ended up voting for the PRD. No problem, though, since enough of their votes were stolen so that it didn't make a difference.

(e) Even large-scale Mexican farmers are starting to grumble against US agricultural subsidies. What US Florida fruit farmers lost by way of protection against Mexican crops, I suspect they more than made up for it by way of additional cash from uncle Sam. This is also (indirect) protectionism, though not covered by NAFTA guidelines, I think.

Is this enough to think about, or do you start to wonder if all the Clinton economists' zeal for free trade treaties and the Washington consensus was a bit misplaced from the beginning?