Study on the Operation and Effects of the NAFTA: Chapter 1, Part 1

Study on the Operation and Effect
of the North American Free Trade Agreement

From: Reports Issued by the Office of the United States Trade Representative and Related Entities

Chapter 1: The Economic Effects of NAFTA

Under NAFTA, Mexico has reduced its trade barriers on U.S. exports significantly, while the United States -- which started with much lower tariffs -- has made smaller reductions:

In 1993, just prior to NAFTA, the average Mexican tariff applied to all U.S. exports was 10 percent, while the United States applied an average tariff of only 2.07 percent. Moreover, U.S. average tariffs would have declined further because of the U.S. Uruguay Round commitments, thereby increasing the disparity. Mexico's applied rates have actually increased to countries other than the U.S. and Canada.)
As a result of NAFTA, Mexico’s average tariffs on American-made products have dropped from 10 percent to approximately 2.9 percent (a 7.1 percentage point difference); whereas, U.S. tariffs fell from 2.07 percent to 0.65 percent (a 1.4 percentage point difference).
The NAFTA also required Mexico to dismantle a wide variety of protectionist rules and regulations, while the United States made only a few adjustments beyond the 1.4 percentage point reduction in already low U.S. tariffs.

U.S. exports to Canada and Mexico increased since 1993, supporting more higher-paying American jobs:

Exports of U.S. goods to Mexico grew by nearly 37 percent (or $15.2 billion) in the three years after NAFTA went into effect to a record high of $56.8 billion. This large increase came during a three-year period when Mexico experienced a three percent decline in total domestic demand. At the same time, the United States widened its lead over its trade rivals in sales into the Mexican market -- increasing its share of Mexico's imports from 69 percent in 1993 to 75 percent in 1996, and displacing imports, particularly from Asia.
U.S. exports to Mexico in the first four months of 1997 virtually equaled exports to Japan, our second largest export market, even though Japan's economy is 12 times larger than Mexico's. In April of this year, U.S. exports to Mexico actually exceeded those to Japan by nearly $200 million. U.S. sales to its number one export market, Canada, have increased by $33.8 billion since 1993. In the first four months of 1997, U.S. exports to Mexico were up by another 23 percent relative to the same period of 1996, while exports to Canada increased by 12.4 percent. Export growth to Mexico and Canada, combined, during the first four months of 1997 accounted for 53 percent of total U.S. export growth to all countries. Mexico and Canada account for almost one-third of global U.S. trade.
By 1996, goods exports to Mexico and Canada supported an estimated 2.3 million U.S. jobs: 749,000 associated with exports to Mexico and 1.56 million with exports to Canada. Jobs for non-supervisory production workers supported by goods exports pay 13 to 16 percent above the national average wage.
The movement of the U.S. trade balance with Mexico to a deficit in 1995 and 1996 reflected Mexico’s sharp recession and the U.S. economy's strength, as U.S. consumers and firms increased purchases from all sources.

Several outside studies conclude that NAFTA contributed to America's economic expansion. The NAFTA in isolation had a modest positive effect on U.S. exports, income, investment and jobs supported by exports:

The task of isolating the economic effects of NAFTA after little more than three years of operation is challenging; while Mexico's tariff cuts have been substantial, its market-opening rules are not fully phased in (some will take 12 more years) and there are only three years of data to analyze. The challenge is compounded by the several significant events that directly affected trade flows during the first three years of NAFTA's operation. These were: (1) the strong performance of the United States economy; (2) Mexico's balance-of-payments crisis and 1995 recession, its worst since the 1930s; and (3) implementation by the United States beginning in 1995 of MFN tariff cuts agreed to in the Uruguay Round and implemented in the World Trade Organization (WTO).
Nevertheless, a recent study by DRI/McGraw-Hill concludes that NAFTA, controlling for the effects of the peso crisis, increased U.S. exports to Mexico by $12 billion by 1996. This same study concludes that NAFTA increased U.S. imports from Mexico by $5 billion annually, for an increase in net exports of $7 billion. Two other studies reach similar conclusions. A study by the International Trade Commission (ITC) reported that NAFTA caused U.S. export growth to Mexico to exceed import growth from Mexico in 1994, with those results reversing in 1995 and 1996. The ITC characterized 1994 as the "only year in which the NAFTA was in place and the peso devaluation does not confound the estimates... ."
- Based on DRI's estimates, the short-run effect of NAFTA was to increase U.S. GDP by approximately $13 billion by 1996. Also, in the first three years of NAFTA, U.S. GDP may incorporate as much as $3 billion to $14 billion of the expected long-run annual gains (permanent gains from improved efficiency and possibly greater investment in the U.S. economy). Estimates of the long-run annual gains to U.S. GDP when NAFTA is fully implemented -- not just in the first three years -- run as high as $40 billion. None of the studies examined found negative effects from NAFTA on the U.S. economy.
- Based on Commerce Department estimates regarding the link between U.S. exports and employment, the gains in U.S. exports to Mexico associated with NAFTA alone support an estimated 90,000 to 160,000 American export-related jobs.
As noted, Mexico experienced its sharpest recession since the 1930s in 1995; the sudden contraction in the Mexican economy reduced demand for U.S. exports, contributing to the difficulty in isolating the effects of NAFTA.
Trade flows with Mexico were affected much more by the drop in the price of Mexican imports caused by the 50 percent decline in the value of the peso than by price changes caused by the less than 1.4 percentage point drop in U.S. tariffs or the larger drop in Mexican tariffs.
Growth in U.S. imports from Mexico during the period largely reflected the relative strength of the U.S. economy over the last three years, rather than NAFTA. U.S. tariffs were so low when NAFTA took effect that NAFTA lowered U.S. trade barriers very modestly. The shift in trade balance was due to the relatively much stronger U.S. economic performance, the dampening effect of Mexico’s recession on its purchases, and the depreciation of the peso exchange rate. If anything, outside studies (DRI and the Dallas Federal Reserve) suggest that NAFTA on its own worked to increase U.S. net exports to Mexico since 1994.

The NAFTA protected U.S. exports and jobs during Mexico's recession:

Mexico's actions towards U.S. exports were sharply different in its 1995 recession than during its financial and economic crisis in the early 1980s. Then, Mexico imposed quotas and duties of up to 100 percent on American products, prompting U.S. exports to Mexico to plunge by 50 percent. It took nearly seven years for U.S. exports to Mexico to return to their 1981 levels.
Despite its worst recession since the 1930s, Mexico continued to lower its tariffs on U.S. and Canadian imports, as NAFTA required, even though it raised tariffs on products from other countries. Thus, although Mexican GDP contracted by over 6 percent in 1995 when the recession took effect, U.S. exports to Mexico recovered in 18 months to reach record levels. (U.S. exports dropped only 9 percent in 1995, compared to a 25 percent drop for Japanese and European exports to Mexico.)

The Mexican economy recovered more rapidly following Mexico's 1995 financial crisis than it did after the 1982 crisis, in part because of the economic reforms locked in by NAFTA:

Mexico's actions during 1995 -- implementing a strong economic adjustment program and respecting its NAFTA obligations -- helped quickly restore foreign investor confidence. The resulting rapid recovery allowed Mexico to regain its pre-crisis peak by the fourth quarter of 1996. The results for U.S. exports was a nearly 23 percent increase last year, surpassing pre-recession levels.
By all measures, Mexico has recovered from its recent recession more quickly this time than it did during its last crisis in 1982. In both cases, the peso fell by 50 to 60 percent in nominal terms over the first six months of its financial crisis. However, this time the peso stabilized and began to appreciate in real terms after six months. By contrast, in the earlier crisis the peso dropped sharply again after six months. Although Mexican economic output dropped much more quickly in 1995, it then rebounded and reached pre-crisis peaks by the end of 1996. Following its earlier financial crisis, Mexican output drifted down for nearly two years before rising again and reaching pre-crisis levels five years later.
Last time, it took Mexico seven years to return to international capital markets. This time it took seven months.

U.S. foreign direct investment (FDI) in Mexico remained relatively small and did not significantly impact aggregate U.S. investment:

Annual business fixed investment in the U.S. was nearly $800 billion in 1996, and the United States remains the world's largest destination for global foreign direct investment, receiving $77 billion in FDI in 1996 alone.
U.S. FDI flows to Mexico in 1994, 1995, and 1996, at $3.7 billion, $3.0 billion, $2.7 billion, respectively, amounted to just 0.4 percent, 0.3 percent, and 0.2 percent of total investment in the United States. U.S. FDI flows to the world were $69.3 billion in 1994, $86.7 billion in 1995, and $87.8 billion in 1996. In the three years prior to NAFTA, U.S. FDI flows to Mexico averaged $2.8 billion. An ITC study concluded that any fluctuations in U.S. FDI to Mexico, whether or not attributable to NAFTA, have only minimal impact on aggregate investment in the United States.
Mexico accounted for 2 percent of the stock of U.S. FDI abroad in 1996. Mexico's share of U.S. outflows of FDI shifted from 3.3 percent in 1993, prior to the NAFTA, to 5.3 percent in 1994, and dropped to just 3.4 percent in 1995, the year of the peso crisis, and continued to fall to 3.1 percent in 1996. The higher share in 1994 reflected an 11.5 percent fall in U.S. FDI to the world, as well as an increase in U.S. FDI to Mexico from $2.5 billion in 1993 to $3.7 billion in 1994.

Introduction

The NAFTA phases out tariffs among the United States, Canada, and Mexico on goods produced in North America. The NAFTA also calls for the immediate or phased elimination of important non-tariff barriers. The Agreement has resulted in our neighbors, particularly Mexico, reducing their trade barriers more significantly than we did, as our barriers were already relatively low in comparison. This has enabled American companies, workers, and farmers to capitalize on the opportunities presented by trade with our North American neighbors. The NAFTA has resulted in increased trade with what were already our first (Canada) and third (Mexico) largest trading partners, including substantially increased U.S. exports. Indeed, if trends for the first four months of 1997 continue, Mexico will surpass Japan as our second largest trading partner, even though its economy is one-twelfth the size of Japan's and less than one-twentieth the size of ours.

The NAFTA in isolation has made a modest positive contribution to the U.S. economy in terms of net exports, GDP, employment, and investment. As such, NAFTA has contributed to the recent performance of the U.S. economy, which by all measures has been strong. The economy has created 12 million new jobs and unemployment is now 5 percent. Exports have contributed one third of our recent economic growth. The NAFTA also protected our interests during Mexico's financial crisis and deep recession, during which Mexico adhered to its NAFTA commitments thereby safeguarding U.S. exports and the jobs supported by those exports. And it helped Mexico by contributing to a rapid recovery of investor confidence and economic growth in Mexico following its most severe economic crisis in decades.

The NAFTA

The NAFTA is the most comprehensive regional free-trade agreement in the world. It created the world's largest free trade-area, encompassing a region with nearly 400 million people that produces over $8 trillion dollars worth of goods and services. With the Agreement's entry into force, on January 1, 1994, half of all U.S. exports to Mexico immediately became eligible for duty-free treatment. Remaining tariffs were scheduled for elimination on five, ten or fifteen year schedules.

Perhaps its most significant feature, and one that distinguishes NAFTA from other regional free-trade agreements, is its broad scope and level of disciplines it incorporates. In addition to gradually eliminating all tariffs on North American-made goods, NAFTA:

eliminates or imposes strict rules on a range of non-tariff barriers, including technical barriers to trade;

opens government purchasing regimes to firms in all three countries;

eliminates restrictions on foreign investment and ensures non-discriminatory treatment for local companies that are owned by investors in other NAFTA countries;

eliminates barriers that prevent services companies from operating across North American borders, including in such key sectors as financial services;

provides rules preventing governments from using monopolies and state enterprises to restrict trade;

facilitates border-crossing for business persons in all three countries;

provides comprehensive rules to protect intellectual property rights; and

provides three distinct dispute settlement mechanisms.

Moreover, NAFTA is accompanied by additional agreements on labor and environmental cooperation. (These are discussed in Chapters 3 and 4.) The NAFTA and its agreements provide a comprehensive framework of rules that seek to reduce or eliminate trade barriers while promoting worker rights and enhancing environment protection across North America.

Trade Policy Changes Under the NAFTA

The NAFTA phases out tariffs among the three countries on goods produced in North America. The Agreement calls for the United States and Canada to phase-out tariffs on their bilateral trade by 1998, as agreed under the 1988 U.S.-Canada Free Trade Agreement (CFTA). Tariffs on three-way trade including Mexico are to be eliminated by 2008. Some of those tariffs were eliminated on entry into NAFTA; others are being phased out over time. The NAFTA also calls for the immediate or phased elimination of important non-tariff barriers.

Because Mexican tariffs were substantially higher than those imposed by the United States at the time NAFTA entered into force, the effects of mutual reduction of those barriers, considered in isolation from other factors affecting the bilateral trade, could have been expected to cause U.S. exports to Mexico to expand more than imports from Mexico, all other things equal, in the early years of implementation.

When NAFTA went into effect on January 1, 1994, U.S. tariffs on Mexican and Canadian goods were already relatively low. U.S. tariffs had been progressively reduced as a result of multilateral rounds of liberalization under the GATT, the CFTA, and the U.S.-Canada Automotive Agreement. The CFTA was in its sixth year of implementation and had already significantly lowered tariffs between the United States and Canada. The average duty for total U.S. imports from Canada was less than one-half of one percent (0.37 percent) in 1993. Figure 1

The average applied duty for all imports from Mexico was 2.07 percent in 1993. Moreover, at that time many Mexican products entered the United States duty-free under the U.S. Generalized System of Preferences (GSP), a program for which Mexico was the largest beneficiary. In addition, a growing quantity of Mexico’s exports entered the United States at reduced duties under the production sharing provisions of the U.S. tariff schedule (the maquiladora trade). By 1993, over half of U.S. imports from Mexico, in terms of value, entered the United States free of duty. Average U.S. tariffs on those remaining products subject to duty were just over 4 percent.

By contrast, the United States faced considerably higher tariffs -- plus substantial non-tariff barriers -- on its exports to Mexico. In 1993, Mexico's average tariff on all imports from the United States was 10 percent, nearly five times the 2.07 percent level applied by the United States on all Mexican goods. (Canada's average tariff on U.S. goods was 0.37 percent.) In addition to tariff barriers, Mexico had in place a wide variety of non-tariff barriers such as import licensing, local content and trade balancing requirements that restricted U.S. imports. Also, in the auto sector, Mexican restrictions forced U.S. producers who wished to sell in Mexico to invest in Mexico rather than export to the Mexican market.

During the period NAFTA has been in effect, Mexico's average tariff on U.S.-produced goods has fallen by about 7 percentage points to an estimated 2.9 percent. (Figure 1.) Since Mexico raised its average applied tariffs on imports from other countries during this time period, reaching 12.5 percent in 1996, NAFTA actually gave United States an almost 10 percentage point advantage over foreign goods.

Meanwhile, the average U.S. duty collected on all imports from Mexico fell by less than 1.4 percentage points to 0.65 percent in 1996. Even in the absence of NAFTA, U.S. commitments under the Uruguay Round require a 35 percent reduction in U.S. bound tariffs on imports from all WTO members, including Mexico. The first two years of what is generally a five-year tariff phase out period occurred in 1995 and 1996. Three-quarters of U.S. imports from Mexico were actually accorded duty-free treatment in 1996, and average U.S. duties on the remainder were 2.6 percent.

The average rate on all U.S. imports from Canada stood at 0.37 percent in 1993 and by 1997 had declined to 0.22 percent. As noted above, however, implementation of NAFTA had no effect on these reductions, as they would have gone forward under the pre-existing CFTA had NAFTA not taken effect. Other rulemaking aspects of NAFTA did, however, represent new conditions for U.S.-Canadian bilateral trade.

U.S. Trade With the NAFTA Countries

The NAFTA is an agreement between the United States and what were in 1993 its largest (Canada) and third largest (Mexico) trading partners. Shared land borders and geographic proximity make Canada and Mexico our natural trade partners. In 1993, our trade with them was already disproportionately great relative to the size of their economies and compared with our other trade partners. The NAFTA appropriately recognized the immense opportunities that exist naturally with our neighbors in the region and sought not only to ensure a trading environment so that we could capitalize on those opportunities, but also one in which the prosperity and stability in the region would be enhanced. The NAFTA also recognized that competing in the North American marketplace was vital in preparing America to compete in the global market of the 21st century.

Canada and Mexico accounted for nearly one-third of U.S. global two-way trade (exports plus imports) during 1996, or $421 billion. Two-way trade with Canada accounted for more than $290 billion of that amount, while Mexico accounted for nearly $131 billion. U.S. trade with the NAFTA countries has grown by nearly 44 percent during the first three years of NAFTA's implementation (37percent with Canada and 61 percent with Mexico). This is particularly striking since Mexico had a severe recession that brought real total domestic demand down by 3.3 percent over this period. By contrast, U.S. trade with all other countries increased by 33 percent during 1993 to 1996.

Canadian imports of U.S. goods during 1996 amounted to $134 billion, while the United States imported $156 billion from Canada. The United States exported $57 billion of Mexican goods during 1996 and imported $74 billion from Mexico. All these figures are record levels.

U.S. goods exports to Mexico and Canada, combined, were up by 34.5 percent or nearly $49 billion (to $191 billion) between 1993 and 1996. U.S. goods exports to Canada were up by nearly 34 percent to a record $134.2 billion in 1996, while U.S. exports to Mexico increased by nearly 37 percent to a record $56.8 billion in 1996. 1

Trends in 1997 suggest this year's export growth may exceed even the record growth of 1996. If trends from the first four months of 1997 continue, Mexico could surpass Japan this year to become our second largest export market, despite Japan's economy being 12 times larger than Mexico's. Through the first four months of 1997, U.S. exports to the NAFTA countries were up by an additional 15.5 percent as compared to the first four months of 1996 (more than two and one-half times the rate of U.S. export growth to the rest of the world -- i.e., up 5.9 percent). U.S. exports to Canada were up by 12.4 percent for the first four months of 1997 compared to the first four months of 1996 and U.S. exports to Mexico were up by 23.4 percent. 2 Export growth to Mexico and Canada, combined, during the first four months of 1997 accounted for 53 percent of total U.S. export growth to all countries.

U.S. goods imports from Canada and Mexico, combined, were up by 52.3 percent or nearly $79 billion (to $230 billion) between 1993 and 1996. U.S. goods imports from Canada rose to $156 billion in 1996, while U.S. imports from Mexico were up to $74 billion in 1996. This import growth results in part from macroeconomic factors, particularly the strong growth in the U.S. economy and the 50 percent devaluation of the peso. These macroeconomic factors far surpass the significance of the 1.4 percentage point reduction of U.S. tariffs under NAFTA.

Through the first four months of 1997, U.S. imports from the NAFTA countries increased by 12.3 percent, as compared to an increase in U.S. exports to the NAFTA countries of 15.5 percent. U.S. imports from Canada were up by 10.3 percent for the first four months of 1997 compared to the first four months of 1996, and U.S. imports from Mexico were up by 16.8 percent. April 1997 marked the 13th out of 14 months in which U.S. export growth to Mexico has exceeded U.S. import growth from Mexico.

The U.S. goods trade deficit with Mexico and Canada combined increased by $30 billion from 1993 to 1996 due to macroeconomic factors (e.g., strong U.S. growth, Mexico's recession). The goods trade deficit with Canada increased by $11 billion to a level of $22 billion in 1996, while the trade balance with Mexico shifted from a surplus of $1.7 billion to a deficit of $17.5 billion.

With regard to Canada specifically, large U.S. bilateral surpluses in trade other than in goods (services, including investment income) partially offset the deficit on goods trade alone. The U.S. bilateral current account (broadest measure of trade) balance with Canada shifted from a deficit of $0.5 billion in 1993 to a $12 .4 billion surplus in 1996 (preliminary). In recent years the Canadian government has taken actions at the macroeconomic level to help reduce what had become a large Canadian deficit with the world. Canada's current account deficit with the world was the equivalent of 4.2 percent of Canadian GDP in 1993, but had fallen to 0.4 percent of GDP by 1996. 3

Two-way U.S. services trade with Canada and Mexico remained relatively steady, increasing by nearly one percent between 1993 and 1995. (Data on bilateral trade in services is not yet available for 1996.)

U.S. services exports to Canada increased slightly from $17.7 billion in 1993 to $17.9 billion in 1995. Over 70 percent of these exports were travel receipts and other private services (e.g., affiliate transactions, insurance and business, professional and technical services). U.S. services imports from Canada increased from $10.4 billion to $12.4 billion during the period. Nearly all of these imports were concentrated in the travel category, other private services, category (e.g., affiliate transactions, and insurance), and other transportation.

U.S. services exports to Mexico increased from $8.4 billion in 1993 to $8.8 billion in 1994 before declining to $6.2 billion in 1995. Nearly all of the decline was due to decreased travel by Mexican citizens to the United States, down $2.3 billion in 1995. U.S. services imports from Mexico increased by 5 percent between 1993 and 1995. The increase in U.S. travel to Mexico and other private services offered by Mexico accounted for most of the import increase.

With regard to other private services trade with Mexico, U.S. exports were up 5.4 percent to $1.9 billion between 1993 and 1995, while U.S. imports were up 11.3 percent to $2.2 billion. U.S. financial services exports, however, were down 18 percent to $189 million and insurance (net insurance premiums) were down 52 percent to $37 million because of Mexico's financial difficulties. Telecommunication service exports increased 21 percent to $218 million; business professional and technical services increased 12 percent to $553 million; and miscellaneous private services rose 13 percent to $446 million.

U.S. imports of telecommunication services rose by 13 percent to $1 billion. These services imports especially reflect payments to Mexico for telephone calls made from the United States to Mexico. These telecommunications imports from Mexico accounted for 45 percent of all U.S. service imports from Mexico in 1995 and over half of the increase in service imports from Mexico between 1993 and 1995. The U.S. trade deficit with Mexico in telecommunication services was $783 million. Excluding telecommunication services, the U.S. has a $419 million trade surplus in all the remaining "other private services," as compared to a deficit of $364 million when telecommunication services are included.

The United States ran an overall services trade surplus with the NAFTA countries of $3.2 billion in 1995, down from $7.5 billion in 1993. The services surplus with Canada declined from $7.2 billion to $5.6 billion, due mainly to an increase in U.S. services imports. The slight services surplus with Mexico during 1993 and 1994 ($0.2 billion and $0.3 billion) changed into a services deficit of $2.4 billion in 1995, after the peso crisis.

Performance of the U.S. Economy

This Study assesses the impact of NAFTA on various aspects of overall U.S. economic performance. A brief review of that performance during NAFTA's first three years places NAFTA's economic effects in context.

During the period that NAFTA has been in effect, the U.S. economy has exhibited remarkable strength. Over the period, U.S. real GDP grew by 8.1 percent. U.S. domestic demand grew by 16.6 percent. U.S. employment and industrial production also continued to grow strongly. U.S. unemployment, for example, dropped from 6.9 percent in January 1994 to 5 percent in June 1997.

The current recovery, in contrast to previous post-War expansions, has been characterized by strong rates of investment, thus helping extend the U.S. growth cycle with low inflation. Real fixed investment (non-residential) was up 9.9 percent in 1994, 9.5 percent in 1995, and 7.3 percent in 1996. Investment in producers' durable equipment, at 7.6 percent of GDP in 1996, was at its highest level since the 1950s.

U.S. net employment has increased by nearly 8.6 million jobs in NAFTA's first three years. Strong job creation in the United States in recent years has been all the more striking in that job creation has been so weak in other major industrial economies. Over 90 percent of U.S. job creation has also been in the private sector. A recent study by the Council of Economic Advisers (CEA) finds that approximately two-thirds of recent job growth has been in job categories paying above the median wage.

Nearly every real income measure -- real hourly earnings, real weekly earnings and real compensation per hour, for example -- is up moderately since 1993. To the extent inflation is overstated, those gains are understated. And, after a 14-year period in which U.S. income gains were concentrated in the top half of the income distribution, the real incomes of every quintile of the income distribution have increased since 1993, with the largest percentage increase for those in the lowest income quintile.

Exports have been a key driver of US. growth, accounting for one-third of our overall growth since 1993, and growing more than three times faster than the overall U.S. economy. U.S. export growth was robust, with goods and services exports to the world up nearly 32 percent from 1993 to a level of nearly $850 billion in 1996. Goods and services imports, reflecting the strength of the U.S. economy, were up a somewhat greater 34 percent between 1993 and 1996. As a result, the goods and services deficit rose from $72.3 billion in 1993 to $111.0 billion in 1996. 4 The high level of U.S. purchases from all sources reflects the fact that robust economic performance in the United States stimulated import demand.

The NAFTA'S Effect on the U.S. Economy

Measuring NAFTA's Effects

The task of isolating the economic effects of NAFTA after little more than three years of operation is challenging; while Mexico's tariff cuts have been substantial, its market-opening rules are not fully phased in and we have only three years of data. The challenge is compounded by the several significant events that directly affected trade flows during the first three years of NAFTA's operation. These were: (1) the strong performance of the United States economy; (2) Mexico's balance-of-payments crisis and 1995 recession, its worst since the 1930s; and (3) implementation by the United States beginning in 1995 of MFN tariff cuts mandated by the Uruguay Round agreements.

Figure 2 Strong growth in the United States stimulated U.S. demand for imports from Mexico, quite aside from any specific effect of NAFTA. Mexico's recession, which was not caused by NAFTA, depressed its demand for imports from the United States. While the U.S. economy continued to grow, Mexico suffered a balance-of-payments crisis beginning in late 1994 and, in 1995, endured its most severe recession since the 1930s. (Figure 2). Consumption fell by over 17 percent in 1995; more than 1.0 million Mexicans lost their jobs (a year in which the United States added 1.7 million jobs); and, wages fell by more than 20 percent in the year after the crisis began. The related depreciation of the peso acted to shift demand from U.S. to Mexican products.

Finally, some of the 1.4 percentage point tariff reduction the United States has made under NAFTA would have been made in any event pursuant to the recent Uruguay Round agreement. 5 Absent NAFTA, Mexico, on the other hand, would likely have raised its applied tariffs against the United States, as it did against other countries.

The ITC study also found that it is difficult at this stage to sort out NAFTA's economic effects from those of other factors bearing on the U.S. economy and trade. Moreover, the Commission concluded that " . . . it has also become clear that many of NAFTA's most important effects are not easily quantified or observed, and the full effects of the Agreement will take many more years to make themselves known." 6 Public testimony heard by the ITC in preparing its report echoed the view that it will take many years to determine the precise impact of the Agreement. 7 These concerns are especially relevant to sectoral analysis (addressed in Chapter 2) where data are particularly problematic.

While the empirical results should not be viewed as precise measures, the empirical studies that attempted to isolate the effects of NAFTA from other influences found that it increased U.S. exports. Those results are reviewed below with respect to U.S. goods trade, GDP, and employment.

U.S. Goods Trade

Several economic studies have measured the economic effects of NAFTA on the U.S. economy in its first few years. 8 These studies generally conclude that NAFTA in isolation has had a modest positive effect on the U.S. economy, although the precise measurement of the benefit varies. 9 The DRI study is the most recent study that used data over a sufficient period to reach statistically significant results. It examined the effects of NAFTA using disaggregated data from 57 disaggregated industries to estimate a direct NAFTA effect on trade with Mexico, controlling for the effects of Mexico's peso crisis. DRI's disaggregated study found that NAFTA boosted U.S. exports to Mexico by $12 billion and increased U.S. imports from Mexico by $5 billion per year, for a $17 billion increase in two-way trade and a $7 billion net export increase from 1993 to 1996. 10

The Federal Reserve Bank of Dallas (DFR) study reaches similar conclusions, although the magnitude of its estimates differ. DFR estimated a pair of bilateral trade equations, one for U.S. exports to Mexico, the other for U.S. imports from Mexico, using monthly data from January 1980 to January 1996. 11 The two equations were similar to each other, and explained the growth in bilateral trade using information about past trade growth, growth of economic activity in each country, the change in the real peso-dollar exchange rate, and trade with other parts of the world. The equations also included variables to take into account two major changes in Mexico's trade policy. One accounts for the trade liberalization that Mexico initiated in the late 1980s, while the other accounts for the effects of NAFTA beginning in January 1994.

The DFR study concluded that, after taking into account Mexico's recession and the peso's depreciation, the effect of NAFTA through 1995 was to increase the growth of U.S. exports to Mexico by 7 percent per year, for a total boost to U.S. exports by the end of 1995 of $5 billion. Extrapolating that trend to 1996 would imply a total effect of about $7 billion.

The DFR study also found that NAFTA had boosted growth in U.S. imports from Mexico by 2 percent per year, or $2 billion by the end of 1995. If the same trend had continued through 1996, the total effect would have been $3 billion. Thus, applying the results of the study to the first three years of NAFTA's operation would suggest that NAFTA increased total trade between the United States and Mexico by around $10 billion, and trimmed the trade deficit with Mexico by about $4 billion.

The ITC also attempted to isolate the impact of NAFTA 12 on aggregate U.S. bilateral trade flows with Canada and Mexico, but had more difficulty doing so. The ITC used an econometric model, using a shorter time series of monthly aggregate trade data between January 1989 and December 1996. The ITC study found that NAFTA had increased U.S. trade with Mexico and concluded that there was " . . . a strong statistical link between the increase in bilateral trade between the United States and Mexico and the implementation of NAFTA," 13 but indicated that the effects it found ". . . may also reflect other events that occurred concurrently with NAFTA implementation." 14 On that basis, the ITC was unable to draw a link between NAFTA and the levels of U.S. exports to and imports from Canada and Mexico. The ITC study states, "[i]n 1994, the only year in which NAFTA was in place and the peso devaluation does not confound the estimates, the implied increase in the volume of U.S. exports to Mexico outpaced the increased volume of U.S. imports from Mexico." 15

Footnotes:

1. U.S. components shipped to Mexico for assembly and claiming duty exemption upon re-shipment to the United States accounted for 33 percent of the total U.S. export increase to Mexico between 1993 and 1996. Maquiladora exports are playing a decreasing role in total exports from Mexico, having fallen from 42 percent of total exports in 1993 to 38 percent in 1996.

2. In January 1997, the U.S. Census Bureau reported that U.S. goods exports to Mexico (as well as to the rest of the world) had been underestimated. Census estimates that the understatement of U.S. exports to all countries ranges from 3 to 7 percent, and could be as high as 10 percent. From 1991 - 1994, the discrepancy between published U.S. exports and Mexican imports ranged between 8 and 12 percent. However, for 1995 and 1996 (through July), the discrepancy increased to nearly 17 percent. Census doubts that these discrepancies reflect the true degree of under-reporting of U.S. exports and believes that the discrepancies reflect both an understatement of U.S. exports as well as an overstatement of Mexican imports from the United States. Census has been working with several Mexican agencies to review the discrepancy.

3. Mexico's current account deficit moved from $23.4 billion in 1993 (5.8 percent of GDP) to $29.4 billion in 3 1994 (7.0 percent of GDP) to $0.7 billion in 1995 (0.3 percent of GDP). Data are not currently available for 1996. The drop in 1995 reflected the loss of foreign investor confidence and net outflows of foreign capital.

4. The goods and services deficit represented 1.5 percent of GDP, substantially below the 3.3 percent of GDP at its 1987 peak of the previous business cycle.

5. The United States began lowering its MFN tariff rate (the rate that applies to WTO members other than its 5 free-trade partners) by 35 percent over five years beginning in January 1995. That means that in the absence of NAFTA, overall U.S. rates of duty on Mexican imports would have nonetheless begun dropping in 1995. Because the U.S.-Canada tariff reductions would have gone forward under the CFTA had NAFTA not been implemented, neither U.S. nor Canadian MFN tariff cuts under the WTO would have affected their bilateral trade. These potential reductions would have to be factored out of any complete attempt to isolate NAFTA's effects.

6. The Impact of the North American Free Trade Agreement on the U.S. Economy and Industries: A Three-Year Review, June 1997, ITC Investigation No. 332-381, p. XVII ("ITC Study").

7. These observations echo a 1989 Canadian study, which examined when it might be possible to determine the economic impact of the CFTA whose implementation began on January 1, 1989. The study concluded that it would take many years before meaningful results from the CFTA could be seen because of problems of data availability, data reliability, and the difficult task of isolating the effects of the agreement from the effects of other concurrent events. M.C. McCracken, Carl A. Sonnen, Steve Hall, and Paul Jacobson, Assessing the FTA: Design of a Framework, Infometrica Limited, December 1989.

8. These include studies by DRI/McGraw-Hill (a private economic consulting group), the Federal Reserve Bank of Dallas, the ITC, and UCLA economist Raul Hinojosa-Ojeda with others. Unlike the other studies, the Hinojosa-Ojeda study does not provide econometric estimates.

9. The Hinojosa-Ojeda study concluded that the impact of NAFTA on U.S.-Mexico trade flows was negligible. The study found that the overall pattern of U.S.-Mexican trade and investment began to change radically nearly a decade before NAFTA when Mexico unilaterally liberalized its trade and investment policies. This unilateral liberalization ushered in a period of dramatic growth in two-way trade of intermediate goods that has not changed significantly since the start of NAFTA's implementation. The study concluded that the lowering of tariffs through NAFTA has not had a statistically significant impact on the rate of growth or the composition of trade between the United States and Mexico. Hinojosa-Ojeda, R., et al., "North American Integration Three Years After NAFTA," University of California Los Angeles, 1996.

10. The DRI also calculated the effects of NAFTA using a less detailed methodology that employed aggregated data. Under that methodology, it concluded that NAFTA in isolation had added $6 billion to U.S. exports to Mexico by 1996, adjusting for the effects of recession and depreciation. It also concluded that NAFTA's effect on U.S. imports from Mexico was very small, perhaps increasing imports $1 billion by 1996.

11. David M. Gould, "Distinguishing NAFTA from the Peso Crisis," The Southwest Economy, Federal Reserve Bank of Dallas, September/October 1996, pp. 6-10. The study's author notes because of the study is based on just the first two years that NAFTA was in effect, the study's conclusions regarding NAFTA effects in the individual trade equations are not statistically significant by conventional criteria, although NAFTA is significant in explaining the increase in total trade.

12. ITC Study, June 1997.

13. ITC Study, June 1997, pp. 4-13.

14. ITC Study, June 1997, p. 4-1.

15. ITC Study, June 1997, p. xxii

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