NAFTA at Ten: Lessons from Recent Studies
CRS Report for Congress
NAFTA at Ten: Lessons from Recent Studies
J. F. Hornbeck
Specialist in International Trade and Finance
Foreign Affairs, Defense, and Trade Division
Summary
On January 1, 2004, the North American Free Trade Agreement (NAFTA)
completed its tenth year and most of its provisions are now implemented. Its
anniversary sparked numerous evaluations, which are particularly relevant as the United
States pursues free trade agreements with multiple Latin American countries. Most
studies found NAFTA’s effects on the U.S. and Mexican economies to be modest at
most. This report provides an analytical summary of the economic lessons reached in
support of Congress’s role in the trade policy process. It will not be updated.
Introduction
Free trade agreements are supposed to enhance the welfare of participating countries,
so evaluating their effects is important. NAFTA is particularly relevant to the bilateral
trade agreements being considered by the United States today because it was the first trade
agreement between a developing and two developed countries. As such, it is important
to note that this report focuses on U.S.-Mexico issues because the U.S.-Canada free trade
agreement predates NAFTA and is less controversial in the eyes of most trade critics
(because it involves trade between two developed economies), and so is less relevant to
the pending U.S. trade agreements with Latin America. Also, trade between Canada and
Mexico remains very small and the trilateral trade agenda is only beginning to emerge.
This report evaluates multiple studies, whose assessments of NAFTA, by and large,
are analytical in nature, use established methodologies, caveat their own work to reflect1
limitations of the research, and draw on academic rather than special interest research.
1 Weintraub, Sidney, ed. NAFTA’s Impact on North America: The First Decade. Center for
Strategic and International Studies, Washington, D.C. 2004. Kose, M. Ayhan, Guy M. Meredith,
and Christopher M. Towe. How Has NAFTA Affected the Mexican Economy? IMF Working
Paper WP/04/59, Washington, D.C. April 2004. Lederman, Daneil, William F. Maloney, and
Luis Serven. Lessons From NAFTA for Latin America and the Caribbean Countries: A Summary
of Research Findings. The World Bank, Washington, D.C. December 2003. Audley, John J.,
Demetrios G. Papademetriou, Sandra Polaski, and Scott Vaughan. NAFTA’s Promise and
(continued...)
Congressional Research Service ˜ The Library of Congress
The details of their methodologies are not reproduced here, but it is important to note that
they faced similar research challenges. These include 1) isolating the effects of NAFTA
from many other economic policies and forces at play; 2) using sufficiently long time-
frames to separate out pre- and post-NAFTA trends and effects; and 3) comparing
NAFTA over time and across countries to provide relative measures of the importance of
any observed or inferred change. When analyses overlap, agreements and differences are
identified. The discussion provides a sense of NAFTA’s economic effect on trade,
investment, economic growth, productivity, employment, wages, and immigration.
Trade and Investment Effects
NAFTA is a broad agreement, but permanently improved market access was the
major goal. After ten years, most tariffs have gone to zero, except for some very sensitive
(agricultural) goods that have limited protection for up to 15 years. Clearly, U.S.-Mexico
trade and investment have grown sharply over the past decade. From 1994 to 2003, U.S.
exports to Mexico rose 91%, compared to 41% to the world. U.S. imports increased by
so the question is, how much of the post-1994 growth can be attributed to NAFTA?
NAFTA Had a Modest Effect on U.S.-mexico Trade Growth. The CBO,
World Bank, and USITC approached the problem differently, but all found that NAFTA
had a modest effect on U.S.-Mexico trade growth. The CBO model of U.S.-Mexico trade
estimated that 85% of U.S. export growth and 91% of U.S. import growth would have
occurred without NAFTA. Although the effect was modest, it accelerated over time,
accounting for a 2% marginal growth of U.S. exports and imports in1994 up to11% and
8% marginal growth of U.S. exports and imports in 2001. The IMF notes that, as a
percentage of GDP, the increased trade was more pronounced for Mexico than for the
United States, doubling from 25% to 51% from 1993 to 2000. The World Bank makes
the point that NAFTA has reinforced existing trends in trade growth and estimates that2
Mexico’s global exports would have been 25% lower without NAFTA.
The USITC analyzed tariff preferences by sector to isolate the effects of NAFTA on
U.S.-Mexico trade. It estimated that NAFTA tariff preferences accounted for one-third
of the growth in U.S. import shares from Mexico (higher among textile and apparel
goods) and 13% of growth of U.S. exports to Mexico. The remaining growth in trade
would have occurred anyway, and was influenced more by factors such as the 1994 peso
devaluation and existing preferences provided Mexico under the Generalized System of
Preferences (GSP) and production-sharing (maquiladora) programs. Both the IMF and
CSIS studies support the modest trade growth conclusion, but add that the composition
of Mexican exports changed dramatically after NAFTA as they diversified away from oil
1 (...continued)
Reality: Lessons from Mexico for the Hemisphere. Carnegie Endowment for International Peace,
Washington, D.C. 2004. United States International Trade Commission. The Impact of Trade
Agreements: Effect of the Tokyo Round, U.S.-Israel FTA, U.S.-Canada FTA, NAFTA, and the
Uruguay Round on the U.S. Economy. Publication 3621. Washington, D.C. August 2003. The
Congressional Budget Office. The Effects of NAFTA on U.S.-Mexican Trade and GDP.
Washington, D.C. May 2003.
2 CBO, pp. 17-19, World Bank, p. v, 298, and 307, USITC, p. 66. IMF, p. 12 and CSIS, pp. 5-7.
and into higher value-added manufacturing due to increased maquiladora trade. The U.S.
benefit from NAFTA may also be seen in Mexico’s response to the 1994-95 peso crisis,
which was to raise tariffs against non-NAFTA partners.3
There Is Little Evidence of Trade Diversion. A key concern of trade analysts
is whether an FTA results in trade shifting from nonmember countries to members of a
trade agreement because the tariff preferences have allowed them to become the lower-
cost producers. This has the effect of switching trade from more to less efficient trading
partners. The World Bank study found no significant evidence of trade diversion in
NAFTA, particularly with respect to textile and apparel producers in neighboring Central
America and the Caribbean. This is consistent with a majority of studies done earlier and
is reinforced by the IMF and CSIS studies, both of which found NAFTA to be trade4
creating rather than trade diverting.
NAFTA Did Not Cause the Widening U.S. Trade Deficit with Mexico.
From 1994 to 2002, the U.S. trade deficit with Mexico grew from -$1.4 to -$37.1 billion.
These studies found that trade deficits are largely macroeconomic phenomena, in this case
predominantly attributed to the respective business cycles in Mexico and the United
States. Strong U.S. growth in the 1990s combined with Mexico’s deep recession caused
by the December 1994 peso crisis (devaluation) were the main factors cited for the large
deficits. Importantly, none of the studies attributed the peso crisis to NAFTA, but to
structural misalignments in the Mexican economy combined with political events.5
NAFTA Helped Increase Bilateral Foreign Direct Investment (FDI).6 From
Mexican FDI in the U.S. increased 244% to $7.9 billion, albeit from the much smaller
base of $2.3 billion. FDI in Mexico (mostly U.S.) grew on average from 1.1% of GDP
in 1980-93 to 3.0% in 1994-2001. The World Bank noted that NAFTA was one of
numerous factors directing FDI and estimated that it led to a 40% annual increase in FDI
to Mexico, without diverting FDI from other countries. The CBO, USITC, IMF, and
CSIS studies basically agreed, finding that NAFTA’s investment and trade liberalization
provisions helped increase total investment flows to Mexico by increasing investment
opportunities, reducing risk, strengthening investor rights, and improving profitability.
Domestic Economic Effects
The various studies reached different conclusions with respect to the macroeconomic
effects of NAFTA. Choice of methodology and depth of research varied and likely
explain many of the differences.
3 IMF, p. 13-16, CSIS, p. 9, and USITC, pp. 302-04, 308, 313.
4 World Bank, pp. xvii-xviii and 298, IMF, p. 14, and CSIS p. 47.
5 CBO, p. 20 and USITC, p. 49. The Carnegie Endowment study (Polaski, p. 14) does state that
the tariff cuts, “resulted in a shift from a net trade deficit with the United States before NAFTA
to a substantial net trade surplus in 2002” without citing evidence for it.
6 World Bank, p. v, 155, and 366, CBO, p. 4, USITC, p. 158, IMF, pp. 16-17, and CSIS, p. 13.
NAFTA Slightly Increased Growth in Output and Productivity. The CBO
study, which had a limited model for estimating the trade effects on GDP, found that
NAFTA increased annual GDP growth in the United States by no more than .04%, and
for Mexico, no more than .8%. Similarly, the USITC cited other literature suggesting that
U.S. GDP could grow by an additional 0.1% to 0.5% once NAFTA is fully implemented.
The World Bank study, which undertook a more elaborate modeling effort, concluded that
Mexico’s economic performance was similar to the rest of Latin America prior to
NAFTA. After NAFTA went into effect, Mexico’s per capita GDP converged
increasingly toward that of the United States, although a large discrepancy still exists.
Estimates of the rate of convergence suggest that without NAFTA, Mexico’s per capita7
GDP growth would have been 4-5% lower by 2002. Over a decade, however, this is not
a large amount. Growth was hindered by weak economic fundamentals and the 1994-95
peso crisis. The World Bank also suggested that NAFTA contributed to “a substantially
faster rate of productivity convergence than in previous years.” For example, Mexican
manufacturers were able to halve the time needed to adapt U.S. technological innovation.
The Carnegie study also notes that productivity rose dramatically after NAFTA in both
the United States and Mexico and suggests NAFTA “likely played a significant role,”
which was also supported by the IMF paper.8
NAFTA Had Little or No Impact on Aggregate Employment. NAFTA is at
the heart of a long-standing debate over the employment effects of trade because of fears
that trade with developing countries causes U.S. job losses and that trade deficits equate
to higher unemployment. None of the reports attributed changes in aggregate U.S. or
Mexican employment levels to NAFTA, but the author of the first chapter of the Carnegie
study suggests that changing the assumptions of a USITC model would allow for a net
gain in U.S. employment over the past decade of between zero and 270,000 jobs, a small
increase. For Mexico, it concludes that “the sum of the effects of the trade pact to date
has not been a strong net gain in overall employment.” The second chapter (different
author) argues for zero net growth in U.S. jobs. The USITC study demonstrates, contrary
to some popular opinion, that U.S. trade deficits tend to occur during periods of low
unemployment, and “vice versa.” This evidence supports well-established economic
theory that would suggest both the U.S. trade deficit with Mexico and U.S. employment
levels over the past decade were responding to economic growth, not each other.9
NAFTA Contributed to Employment Shifts among Sectors. The Carnegie
report observes a shift in Mexican employment away from agriculture toward services and
manufacturing. It attempts to correlate this shift with NAFTA-induced trade balances in
agriculture (deficit) and manufacturing (surplus) goods, but concludes that it is impossible
to establish precisely how much of the jobs shift can be attributed to NAFTA. The World
Bank points to productivity growth in irrigated agricultural lands and the lack of
opportunity in subsistence agriculture as alternative reasons for these shifts. In the United
States, employees who lost jobs because of NAFTA are eligible for NAFTA trade
adjustment assistance. The Carnegie report notes that at the end of 2003, some 525,000
7 CBO, p. 22, USITC, p. 32, and World Bank, p. 27-28.
8 World Bank, p. 5 and 28, Carnegie Endowment, (Polaski, pp. 24 and 33), USITC pp. 100-13,
IMF, pp. 25-26, and CSIS, pp. 14 and 308.
9 Carnegie Endowment, (Polaski, p. 20 and 28, Papademetriou, p. 39) and USITC, p. 49.
workers have been certified under this program, heavily concentrated in manufacturing,
especially apparel. Over a period of ten years, this represents a small portion of the
aggregate work force, many of whom are already re-employed. Nonetheless, it is among
the most salient adjustment issues related to trade, along with the possible need for a
larger “social safety net.” The USITC and World Bank also show that structural shifts in
both countries had been affecting long-term employment patterns as well.10
NAFTA Has Had a Small Effect on Real Wages. The USITC, in summarizing
the vast literature on the observed rising U.S. income gap between more-skilled and less-
skilled workers, suggests that while estimates varied, trade in general has contributed to
no more than 10-20% of the wage gap. Economists generally consider the wage-gap
problem to be a function of skill-based technological change that causes an employment
bias toward more highly educated or trained workers. Increased trade of intermediate
goods using outsourcing or production-sharing arrangements has also been linked in
recent research. For Mexico, the Carnegie Endowment and the World Bank note that real
wages are lower than when NAFTA began, but conclude that it was not the cause.
Decomposing the trend shows that Mexico experienced a 25% fall in real wages after the
1994 peso devaluation. Real wages began a steady recovery in 1997 and are approaching
exports, and maquiladoras had higher and faster-growing wages than other states.11
Immigration Patterns Were Not Affected by NAFTA. The long-term trend
in legal and unauthorized worker migration from Mexico to the United States continued
and accelerated after NAFTA was implemented. The trade agreement, however, was
found to have little effect. The Carnegie Endowment study points to many factors that
outweigh any effect an FTA can have on migration patterns. Mexican workers have been
drawn to the United States by large wage differentials and the high demand for low-
skilled workers. They have been encouraged to leave Mexico by the burgeoning work
force that cannot be absorbed. Periodic financial crises (1982, 1986, 1994) exacerbate the
problem. These cause huge losses in formal sector jobs, large declines in real wages
relative to those in the United States, and failing confidence in the Mexican economy, all
of which encourage emigration. The World Bank found that Mexican emigrants had
higher levels of education and earned more than non-emigrants and so migration may
have contributed to Mexico’s growing wage gap. The CSIS study concurred with these
conclusions, adding that family and village networks further encouraged immigration.12
Nafta Has a Minor Role in Mexico’s Rural-Urban Migration. The first
chapter of the Carnegie Endowment study argues that the observed trend of migration
from rural areas of Mexico to urban centers, along with the attendant problems of
unemployment, family disruption, and poverty, is directly the result of agricultural
liberalization linked to NAFTA. This is contradicted by a second chapter (different
author) that argues such migration patterns have been in place since 1960 when over 50%
10 Carnegie Endowment, (Polaski, p. 20-28), World Bank, p. xv, xxv, 183-85, and USITC, p. 41-
11 USITC, p. 67-68, 114, 125, World Bank, pp. vi-vii, Carnegie Endowment (Polaski, p. 24-25).
12 Carnegie Endowment, (Papademetriou pp. 40-41and 50-53), World Bank, pp. 174-80, and
CSIS, pp. 264, 271, 278, and 398.
of the workforce was agricultural compared to 36% in 1980 to less than 25% in 1995.
NAFTA appears at most to have affected at the margin an established trend that
economists long have argued is common in the development process of most countries.
The CSIS study notes that rural poverty is not due to NAFTA, but to the structure of
Mexico’s agricultural sector, which lacks skilled workers and investment in education and
infrastructure needed to link the sector better to the formal productive economy.13
Outlook
The studies discussed above point to three broad themes. First, by most aggregate
measurements, NAFTA has had only a modest, but positive, effect on the U.S. and
Mexican economies and tends to reinforce long-term trends already evident by its
inception. This is in keeping with what is widely understood about trade and trade
agreements; they work at the margin of economies and their effect can be easily confused
with much more powerful factors such as long-term structural change and short-term
volatility (e.g. financial crises). Such confusion is seen in the reluctance of many
supporters and opponents of NAFTA to engage in a more nuanced debate on trade.
Second, adjustment problems related to trade liberalization present the greatest
challenge to policy makers. For export firms and sectors, the adjustment is positive and
provides evidence of the winners from trade. For import competing sectors, displacement
can have devastating effects on communities and raises the question of whether to fight
freer trade or attempt to adjust to it as part of the larger global integration process. The
World Bank report argues that trade agreements can do more by improving distorting
rules of origin, taking on the hard tasks of antidumping and countervailing duty measures,
and tackling adjustment problems. The Carnegie Endowment study argues that trade
agreements should address trade-related adjustment issues through longer tariff reduction
schedules, use of special safeguards, removal of agricultural subsidies, and provision for
regionally funded trade adjustment assistance and social safety net programs.14
Third, four studies address a common call for better integration of trade policy into
a country’s overall development program by coordinating and supporting it with domestic
structural reforms. The Carnegie Endowment study argues for more attention to
agricultural, environmental, immigration, tax, and labor rights protection policies. The
World Bank study prioritizes institutional reform (especially rule of law and anti-
corruption efforts), educational development (to promote technology transfer), other
innovation supporting policies, and labor reform that facilitates employment transition
among industries and sectors. The IMF emphasizes reducing labor market and judicial
rigidities. CSIS authors point to investment in education, infrastructure, and transitional
support programs. In the end, these reports do not provide easy answers to trade-related
policy problems, but they do attempt to explain how the gains from trade may be
enhanced by understanding and responding better to the adjustment challenges all
countries face.15
13 Carnegie Endowment, pp. 17-23, 46-47, and 51-52) and CSIS, pp. 18 and 307.
14 Carnegie Endowment, pp. 7-8 and World Bank, pp. v, xiv, xxiv, xxv.
15 Carnegie, pp. 7-8, World Bank, pp. v, viii, ix, xxiv, xxv, IMF, p. 29, and CSIS, pp. 18 and 307.