NAFTA's Economic Impact

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Lee Hudson Teslik
Assistant Editor, Council on Foreign Relations
Monday, March 24, 2008; 2:45 PM


The 2008 U.S. presidential elections have brought new attention to the debate over the North American Free Trade Agreement, or NAFTA, the free trade bloc uniting Canada, Mexico, and the United States. Currently, the Canadian, Mexican, and U.S. governments all broadly support NAFTA, but the leading U.S. Democratic presidential candidates, Sens. Hillary Rodham Clinton (NY) and Barack Obama (IL), say they want to renegotiate aspects of the deal. Trade relations have broadened substantially among the three parties to NAFTA since the deal's implementation, and all three have grown economically, Canada at the fastest average rate, Mexico at the slowest. Yet expert opinion varies on NAFTA's direct impact, given the multitude of other economic factors at play and the possibility that trade liberalization might have happened even without a trilateral agreement.

What is NAFTA?

NAFTA is a trilateral free trade deal that came into force in January 1994, signed by Democratic President Bill Clinton. The central thrust of the agreement is to eliminate the vast majority of tariffs on products traded among the United States, Mexico, and Canada. The terms of the agreement called for these tariffs to be phased out gradually, and the final aspects of the deal weren't fully implemented until January 1, 2008. The deal swept away export tariffs in several industries: agriculture has been a major focus, but tariffs have also been reduced on items like textiles and automobiles. NAFTA also implemented intellectual-property protections, established dispute-resolution mechanisms, and put into place regional labor and environmental safeguards, though some critics now lobby for stronger measures on this front.

How do economists assess NAFTA's economic impact?

It is difficult to quantify NAFTA's effect very precisely, given the complexities involved in assigning direct causality between NAFTA's implementation and economic shifts. Further, it is impossible to know the extent to which trade policy might have liberalized even without NAFTA. Gary Clyde Hufbauer and Jeffrey J. Schott, two experts at the Peterson Institute for International Economics and the authors of NAFTA Revisited: Achievements and Challenges, say that on a basic level, NAFTA's impact on North American companies is clear. "NAFTA was designed to promote economic growth by spurring competition in domestic markets and promoting investment from both domestic and foreign sources," they write. "It has worked. North American firms are now more efficient and productive. They have restructured to take advantage of economies of scale in production and intra-industry specialization."

A paper from three prominent trade experts, C. Parr Rosson, III, C. Ford Runge, and Kirby S. Moulton, notes that the idea of trade blocs is relatively new in North America, but argues that similar arrangements elsewhere in the world have shown consistent gains when viewed from a long-term perspective. The report outlines different forms of "preferential trading arrangements," from free trade deals like NAFTA to more limited customs unions and economic unions, which have been successful in parts of Europe. The report notes that preferential trading arrangements can actually divert trade in the short term -- and can cause labor-market disruptions that are painful to some workers -- but also "can be expected to have major long-term benefits."

In May 2003, the Congressional Budget Office attempted a full-scale examination of NAFTA's economic consequences to date, taking care to note the challenges inherent in any effort to assign direct causation to one specific trade agreement. The report came to three main conclusions:

  • U.S. trade with Mexico was growing before NAFTA's implementation, and would likely have continued to grow with or without the deal on a scale that "dwarfs the effects" of NAFTA itself;
  • The direct effect of NAFTA on U.S.-Mexico trade is fairly small, and thus the direct impact on the U.S. labor market is also small; and
  • Overall, the NAFTA deal has expanded U.S. gross domestic product (GDP) "very slightly," and has had a similar effect -- both positive and small -- on the Canadian and Mexican economies.

What impact has it had on trade specifically?

Trade relations among Canada, Mexico, and the United States have broadened substantially since NAFTA's implementation, though experts disagree over the extent to which this expansion is a direct result of the deal. According to data from the office of the U.S. Trade Representative (USTR), the United States' chief negotiator in foreign trade and a major booster of NAFTA and other free trade accords, the overall value of intra-North American trade has more than tripled (PDF) since the agreement's inception. The USTR adds that regional business investment in the United States rose 117 percent between 1993 and 2007, as compared to a 45 percent rise in the fourteen years prior. Trade with NAFTA partners now accounts for more than 80 percent of Canadian and Mexican trade, and more than a third of U.S. trade.

How has NAFTA affected the U.S. labor market?

Measuring the impact of a specific trade deal on a country's labor market is not a straightforward exercise, and analysts disagree on how to gauge NAFTA's effects. The USTR claims a broadly positive influence, citing figures that show an increase in overall U.S. employment of 24 percent since NAFTA's inception, as well as declining unemployment rates over the same period. In addition, the USTR cites data showing that inflation-adjusted U.S. wages rose 19.3 percent between 1993 and 2007, as compared to only 11 percent in the fourteen years prior.

Many economists agree that NAFTA has had some positive impact on overall U.S. employment. But most also agree that gains have been accompanied by some painful side effects. Edward Alden, a senior fellow at the Council on Foreign Relations, notes that wages haven't kept pace with labor productivity and that income inequality has risen in recent years, in part due to pressures on the U.S. manufacturing base. To some extent, he says, trade deals have hastened the pace of these changes in that they have "reinforced the globalization of the American economy."

Opponents of NAFTA take a starker position. Thea M. Lee is policy director for the AFL-CIO, which opposes NAFTA and lobbies against other free trade agreements as unfair to U.S. workers and corporations unless they include provisions that require signatory countries to raise labor and environmental standards. Lee argues one of the main upshots of the deal has been to "force workers into more direct competition with each other, while assuring them fewer rights and protections." The Economic Policy Institute, a left-leaning research organization, says in a policy paper on NAFTA that the deal's trade agenda has served to widen U.S. trade deficits and has indirectly pushed some U.S. workers into lower-paying jobs.

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