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ANALYSIS OF IMPACT OF NAFTA ON THE US AND MEXICO

 

Table of Content

1.0      Introduction. 1

2.0      Methodology. 2

3.0      Literature Review.. 2

4.0      Findings. 5

5.0      Conclusion. 9

 

1.0      Introduction

Eventhough trade agreements and regional trade integration has a long history, the trend has increased within the last two decades (Abo, 2015). In many parts of the world, different forms of regional trade agreements have been established. Some of these have advanced into full economic integration of the countries involved while others are at different levels of integration. Specific examples worthy of mention include the European Union,  Arab Gulf Cooperation Countries, Association of South East Asian States, Economic Community of Western African States, the among  etc. The North America Free Trade Agreement (NAFTA) was established in 1973 between USA, Mexico and Canada. This regional trade bloc was established to ensure reciprocity of benefits from free trade among member countries but there are reports of the benefits of NAFTA has been substantially unequal against the USA (Boz, et al, 2014). This was a key issue in the recently held elections in the United States of America which elected a pro-NAFTA reform candidate Donald Trump. Yet it is not only in US there is some discontent about the benefits of NAFTA. Canada and Mexico also have their own reservations (Bulmer & Paterson, 2014). The report draws on economic literature, data and statistics from the WTO, IMF, World Bank and national agencies to evaluate the growth impact of NAFTA on US and Mexico.

2.0      Methodology

This study draws on existing secondary data to make analysis of the effect of NAFTA on growth in Mexico and the US. Theoretical information is explored based on synthesis of the extant literature. Subsequently, established data, trends and other statistics relating to economic development as a results of NAFTA are analysed using graphs and tables where necessary.

3.0      Literature Review

Ahmed, et al (2015) define a trade bloc as a type of intergovernmental agreement, often part of a regional intergovernmental organization that seeks to remove or reduce trade barriers to stimulate trade among member countries. The term regional trade bloc is a generic term but the exact nature of agreement among the participating countries may take different forms (Moran & Oldenski, 2015). The first form of regional trade bloc is the preferential trade area. This exists where countries with geographical proximity agree to reduce or eliminate tariff barriers on some selected goods that are imported across member countries Almond, et al, 2015).

However, a regional trading bloc can go beyond this first step by adopting a Free Trade Area. The free trade agreement is created when two or more countries within a specified region agree to reduce or eliminate barriers on all goods passing through their borders (Takase, 2015). The third level of integration is the Customs Union and it involves the removal of tarriffs between member countries of the designated bloc. The members also institutionalize, implement and accept common external tarrifs against non member states (Perez Debrand, 2015).

This means that the members may negotiate as a single entity or bloc with any third party on trade issues with other trading blocs or even the World Trade Organization. An advanced form of regional trade bloc is the Common Market in which the participating countries promote a truly free trade regime across borders of member countries without restriction on the type of economic resources (Rahme & Meskin, 2015).). The participating countries completely remove all the existing barriers to trade in goods, services, capital, and labour. The bloc also removes all forms of tariff and non-tariff barriers or at worst reduces them. However, this is possible upon the harmonization of a number of micro-economic policies, and common rules especially those that relates to monopoly power, anti-trust etc (Gupta, 2015).

Finally the trading bloc can take the form of full economic integration where countries within the bloc see their market as one with no form of restriction for entry by member countries.

According to Montemayor & Pirvulescu (2015) despite the peculiarities of regional economic trade agreements, they are fundamentally premised on the David Ricardo’s comparative cost theory. From this theory, it is contended that nations deem trade to be beneficial since it allows them to focus on producing goods and services they have the resources to produce at the lowest cost and sell at the maximum value possible.  They then get the opportunity to buy goods and services from where cost is comparatively less to produce (Rajeswari & Akilandeswari, 2015). Thus in the absence of trade, each country will spend a great deal of resources to cater for their own needs thus depriving it of the maximum utilization of its resources.

An evaluation of the trade literature reveals five major benefits from regional trade bloc agreements and these includes, the flow of foreign direct investment, economies of scale, competition, trade effect and market efficiency among the regional groupings.

Regarding foreign direct investments, Woolcock (2014) trade bloc eliminates barriers to business establishment and this allows reciprocal establishments of companies in each other’s territories to serve the local need (Haseeb & Makdisi, 2014). This creates larger markets resulting in lower cost to manufacture products locally which benefits the economy in term of GDP growth and employment. On the other hand it is the contention of Salem (2014) that regional economic blocs create economic of scale for business organization. Since a large market is created through trading bloc, companies produces more thus sharing fixed cost over many outputs to reduce the average cost of production. This may led to a reduction in prices or increase in revenue for the organization and eventually the economy.

The competition induced by regional trade blocs is also discussed by Rousselet (2014) as an important advantage of the system. Since regional trade blocs usually bring manufacturers in the countries that forms the bloc together, it stimulates competition which promotes greater efficiency within firms. It is not only firm efficiency that regional trade blocs engender, Sharma (2014) contends that such bloc has a potential to stimulate greater market efficiency. This is because an increased in consumption experienced with changes in demand, combines with a higher level of products being manufactured leading to an efficient market.

Finally another major benefits of regional trade blocs is the fact that it eliminates, tarrifs, drive down the cost of imports which changes demand   as consumers make purchases based on the lowest prices. This allows firms with competitive advantage to thrive. Despite these benefits regional economic blocs are fraught with many difficulties including, high dependency, loss of sovereignty and dumping.

 

4.0      Findings

Figure 1: Effect of FDI on Economic Growth

The most prominent measure of economic growth is the GDP and NAFTA has had different effects on GDP growth rates in both Mexico and the US. Figure 1 reveals that effectively, the real growth in Mexico as a result of NAFTA outweighs the real growth in America from 2006 to 2015. The only difference was between 2013 and 2014. The reason why Mexico has gained significantly is because through NAFTA many FDIs from US relocated to set up production in Mexico or outsourced from cheaper Mexican suppliers. Between 1993 and 2015, there was rapid increase in export from Mexico to US and nominal gross domestic product grew by 50 percent in the US and 46 percent in Mexico due to the effect of NAFTA.

The negative effect of NAFTA on real growth in US is not supported by all researchers. For example the 2015 Congressional Research Service dismissed the perceived huge job losses in US as a result of NAFAT. The report rather noted a moderate effect because trade with Mexico and Canada accounts for just a small fraction of the total U.S. GDP. However, there were worker and firm adjustment costs as the three countries adjusted to more open trade and investment among their economies (Congressional Research Report on Trade and Development, 2013).

The limited negative effect of NAFAT on US economy is further disclosed by the 2013 Congressional Budget Office  which said estimated the increase in trade as a results of NAFTA has rather improved  U.S.GDP eventhough the improvement is small. Specifically, NAFTA was estimated to have contributed $10.3 billion to exports and $9.4 billion to imports in 2001 alone.

 

Figure 2: Effect of NAFTA on Employment (US Bureau of Economic Analysis, 2012)

Employment generation and loss is a key measure of the impact of the NAFTA on growth of the participating countries. The volume of NAFTA induced employment and unemployment and very contentious issue in both the US and Mexico. American opponents of NAFTA think that the US has lost too many jobs to Mexico in particular (Bulmer & Paterson, 2014) but this notion is said to be erroneous (Galiani, et al, 2014). The reason for the possible job loss is that a number of US manufacturing companies relocated their production facilities to Mexico in order to access cheap raw materials, labour and other factors production.

The final products are then sent back to the US market under the free trade arrangement to sell. Figure 2, gives an idea of the employment dynamics as a result of NAFTA. The figure shows that indeed the number of US foreign direct investments in Mexico employs more and more people over the years IN Mexico. On the contrary the levels of employment in their parent companies in the US are rather declining. However some researchers such as Li & Beghin (2014) think that this is a misconception because the transfer of employment to Mexico relates to only a sector and not in general. This is because the job losses to the US under NAFTA are balanced by other jobs that are created in more productive sectors as a result of NAFTA. Most of the time, these new jobs usually pay more than the lost ones.

Thus eventhough there are NAFTA related employment losses to US and benefits to Mexico, the overall US employment level increased from 110.8 million in 1993 to 137 million in 2007 representing 24 percentage point increase. Conversely, the level of unemployment in the US WAS nearly 5.1 percent for the first 13 years after NAFAT compared to the 7.1 percent before the agreement. Moreover eventhough Mexico is benefiting from the increase employment; the increase in openness to trade through NAFTA has been accompanied by rapid wage rise. For example from 1979 to 1993 U.S. business-sector real hourly compensation increased from an annual rate of 0.7% per annum and 11% on average.

Similarly, from 1993 to 2007 real wages rose 1.5% per annum. The overall case of employment in Mexico is rather volatile since the implementation of NAFTA. For example eventhough US FDIs in Mexico employed about 840,000 people who contributed 3.3 percent to Mexico’s GDP, the wage levels have not seen significant change relative to wage rate in America eventhough the FDIs pay salaries 37 percent higher than those that don’t export.

Figure 3: Effect of NAFTA on Balance of Trade Deficit (US International Trade Commission, 2010)

 

Balance of trade (difference between import and export) is probably the aspect of economic impact where NAFTA has negatively impacted on the US. This is because a large number of US companies have relocated or outsourced their manufacturing to Mexican territories to take advantage of the low cost of production. These companies then resell the manufactured products back to the US since there is no trade barrier per the requirement of NAFTA.

Thus figure 3 shows that since 1980, the balance of trade between US and Mexico favours Mexico leading to a trade deficit between the two countries with its potential growth implications. This means that the economic benefits of balance of trade surplus will inure to the benefit of Mexico while disadvantages affect the US. However, it must be noted that this kind of trade relationship is just one of the many that determines the overall trade surplus and deficits of both the US and Mexico since there are other trading partners

5.0      Conclusion

Overall, the analysis shows that in Mexico seems to enjoy a substantial positive impact from NAFTA relative to the US. This many probably be the reason for the importance of this issue in the quest for political office during the election. That notwithstanding, it is also possible to agree that some of the weaknesses of NAFTA as far as US is concerned is overhyped. This is the same with the benefits accruing to Mexico. There is the need to take a holistic look at the both the tangible and intangible benefits to know the total contribution of NAFTA to both economies.

 

 

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