Mexico and the World
Vol. 3, No 1 (Winter 1998)
http://www.profmex.org/mexicoandtheworld/volume3/1winter98/nafta_riogrande.html

The Wall Street Journal, May 10, 1996

Nafta Benefits Flow Back and Forth Across the Rio Grande

Mexico has had two economic catastrophes in the last 25 years, one in 1982, labeled the Mexican debt crisis, and another, the latest peso devaluation, in 1994. Both crises resulted in economic chaos for Mexico and great impoverishment for Mexicans.

There is a world of difference, however, between the economic fallout from the most recent Mexican debacle and that of 1982. This time around the U.S. did not experience a dramatic contraction in exports to Mexico and Mexico, for its part, has been ab le to show some, albeit weak, recovery prospects after 14 months. Substantial credit for this good news goes to the North American Free Trade Agreement. A more integrated economy has paid benefits on both sides of the border. To illustrate this, a few trade facts about the two experiences are worth considering.

U.S. merchandise exports to Mexico in 1981 totaled $18 billion. In 1983 they fell to $9 billion. Contrast this with the U.S. merchandise export figures before and after the most recent Mexican crisis: In 1993, the year before Nafta went into effect, U.S. merchandise exports to Mexico were $41.6 billion. They rose in 1994 to $50.8 billion and then fell to $46.3 billion in 1995, when the peso devaluation decimated the Mexican economy, resulting in a 6.9% contraction in gross domestic product. Despite the drop, Mexico was still the third largest U.S. export market in 1995, after Canada and Japan.

U.S. exports to Mexico fell by 50% between 1981 and 1983. U.S. exports to Mexico rose by 11% over the 1993-95 period; and they fell by only 9% in 1995 from the level reached, in 1994. Mexico's imports from Japan and Europe, according to Mexican trade d ata, dropped precipitously from 1994 to 1995.

Why did U.S. exports perform so much better in this latest crisis, compared to both those from other regions and to the post-1982 period? The main reason is Nafta. When the crisis of 1982 erupted, Mexico dealt with its balance-of-payments problem by imposing sharp import restrictions. Not only did tariffs go up, but, more significantly, prior liscensing requirements were imposed on 100% of imports. This was the standard Mexican solution. By contrast, with Nafta in effect in 1994, Mexico did not res ort to any import restrictions against U.S. goods.

For Mexico, Nafta meant an expanded export market during the crisis. But as importantly, Nafta forced Mexico to seek a real remedy in the realm of macroeconomic policy: tightened domestic credit and restrictive public sector spending. While the socia l cost has been high, the correction so far looks more favorable than after the 1982 crisis. Then the economic downturn lasted more than four years; this time, some economic and financial indicators are showing growth after only one year.

High interest rates are clearly impeding industrial growth and recovery, but the indicators of the past few months nevertheless show a definite upward movement in almost all industrial sectors. The first signs of industrial recovery took about three y ears after the 1982 debacle.

Since the 1980s North America has become increasingly integrated. The critics of Nafta argue that it is an agreement made for multinational corporations, and to a large degree it is. World direct investment is increasing more rapidly than trade and t he biggest global direct investors are the multinational corporations. They benefit from operating in an integrated North American market rather than in three compartmentalized countries. The co-production and alliance arrangements that exist among mult inational companies mean that trade increasingly is taking place in intermediate products, like engines and computer chips, rather than final products. Trade between affiliates of the same firms now makes up about 75% of Canada's manufactured exports to the U.S.; Mexican intrafirm and alliance exports, having started later, are approaching this percentage.

Nafta can also benefit small and medium size businesses. Unfortunately the priority necessary to combat inflation in Mexico's current stabilization program favors large over small and medium-sized companies. The latter have no escape from high real i nterest rates because they must borrow in pesos, whereas multinationals and large Mexican companies have access to dollar credits at far lower U.S. interest rates.

It is politically comforting to politicians of both main parties to rail against non-U.S. competition, crying foul at every blip on the trade account. Yet those who would turn back the march of technology or the global reach of production and marketin g are tilting against windmills. U.S.-based companies can't withdraw from the world without imperiling their own competitiveness and, hence, compromising U.S. wages and incomes.

Nafta facilitates a range of activities — production, trade, finance, communications, transportation — required in economic interchange within a single region. It recognizes the need for freer trade as goods produced anywhere in North America are used as inputs for assembly elsewhere, in U.S. cars and computers or Mexican phamaceuticals and apparel.

Nafta, unfortunately, was not promoted with this degree of candor. Instead, supporters hyped the jobs created by U.S. exports, thereby pemitting critics to resort to similar demagoguery by publicizing jobs lost from imports. This has led to silly merc antilistic arguments that should have gone out of fashion with Adam Smith. Proponents of such, arguments say Nafta was good in 1994 because the U.S. had a trade surplus with Mexico, and was bad 1995 because Mexico had a bilateral surplus!

Yet why should a bilateral balance, calculated year by year, matter in a global trading system? Of course, it shouldn't. The Mexican trade surplus in 1995 was two-tenths of 1% of U.S. GDP. Can anybody credibly assert that this af fected the overall U.S. economy, any more than the modest U.S. surplus did in 1994? Can any serious economist really believe that total U.S. job creation, which approximates two million jobs per year and is based on the performance of the economy as a whole, is materially influenced by yearly trade balances with any single country?

The U.S. public is being fed much economic drivel as political agitators trash Mexico and Nafta in this election year. But Nafta is not a burden. In fact, it is helping both Mexico and the U.S. solve the problems created by Mexico's faulty mac roeconomic policy that led to the 1994-95 crisis.

Mr. Weintraub holds the William E. Simon chair in political economy at the Center for Strategic and International Studies in Washington.