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NAFTA's Economic Impact

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

Introduction

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:

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.

But most economists say it's a stretch to blame these shifts on NAFTA. "The problems in Youngstown, Ohio, and other places like that go back decades before NAFTA," says Daniel T. Griswold, the director of the Center for Trade Policy Studies at the libertarian Cato Institute. Griswold says job losses are "part of a structural shift of the U.S. economy" away from a focus on heavy manufacturing and toward a focus on light manufacturing and high-end services. "It's a cruel illusion to say if we just go in and tinker with NAFTA there will be some kind of industrial renaissance," he says. Alden echoes this idea and says that broader economic trends affecting U.S. employment -- the rise of China and skyrocketing energy prices, for instance -- wouldn't be substantially altered by U.S. policy shifts toward NAFTA.

What impact has NAFTA had on Mexico?

Analysts cite economic growth in Mexico since NAFTA was implemented. Attributing this growth directly to the deal is a fuzzy process, however, and some experts say Mexican growth has underperformed expectations. Since 1994, Mexico's GDP has increased at an average annual rate of 2.7 percent, below the average growth rates of 3.3 percent and 3.6 percent in the United States and Canada, respectively. Mexican exports to the United States have quadrupled since NAFTA's implementation, from $60 billion to $280 billion per year. U.S. exports to Mexico have also increased sharply, more than tripling as Mexico's economy has grown. In addition, experts say trade liberalization between Mexico and the United States has brought broad positive consequences for regular Mexicans, not just Mexican business interests. For instance, the deal has led to a dramatic reduction in prices for Mexican consumers. GEA, a Mexico City-based economic consulting firm, estimates that the cost of basic household goods in Mexico has halved since NAFTA's implementation.

But some analysts argue the deal hasn't benefited Mexico much. Alejandro Portes, a Princeton sociology professor, notes stagnation in the country's labor market: "Economic growth has been anemic in Mexico, averaging less than 3.5 percent per year or less than 2 percent on a per capita basis since 2000," Portes writes. "Unemployment is higher than what it was when the treaty was signed; and half of the labor force must eke out a living in invented jobs in the informal economy, a figure ten percent higher than in the pre-NAFTA years." Some critics single out Mexico's farm industry, saying NAFTA has crippled Mexican farming prospects by opening competition to the heavily-subsidized U.S. farm industry. Economists dispute this assessment as flatly incorrect. The Economist notes that despite increased competition, Mexican farm exports to the United States have in fact tripled since NAFTA's implementation, in part because of reduced tariffs on maize.

Yet even some strongly pro-NAFTA experts say they are surprised the deal hasn't done more to boost Mexico's economy. Schott and Hufbauer of the Peterson Institute say Mexican growth rates over the past decade and a half have been "a disappointment." They attribute Mexican economic stagnation not to NAFTA, however, but rather to a lack of liberalization in sectors not covered by NAFTA. "Sectors that were shielded from NAFTA -- particularly energy in Mexico -- have also been shielded from its positive effects."

What impact has it had on Canada?

Like the United States and Mexico, Canada, the leading exporter of goods to the United States, has experienced economic growth since NAFTA's implementation. If anything, Canada has seen the strongest gains, though again it is difficult to attribute direct causation, particularly given that Canada and the United States had a free trade deal that predated NAFTA. Canada's GDP has grown at a faster rate than either Mexico's or the United States' since 1994. Between 1994 and 2003, Canada's economy showed average annual growth rates of 3.6 percent, compared to 3.3 percent in the United States and 2.7 percent in Mexico. Canadian employment levels have also shown steady gains in recent years, with overall employment rising from 14.9 million to 15.7 million in the early 2000s. Even Canadian manufacturing employment held steady, though Schott and Hufbauer note that Canadian economists remain concerned about the "productivity gap" between the Canadian and U.S. economies. U.S. labor productivity has consistently outpaced Canada's, and the gap has broadened since NAFTA was put in place.

One of NAFTA's biggest economic affects on U.S.-Canada trade has been to boost bilateral agricultural flows. Canada is the leading importer of U.S. agricultural products and U.S. agricultural exports to Canada roughly doubled between 1994 and 2003. The U.S. Department of Agriculture offers a sector-by-sector review (PDF) of U.S.-Canada trade since NAFTA's implementation, which shows broad increases in trade in several different sectors.

What changes to NAFTA have been proposed?

Sens. Clinton and Obama, as well as many other leading Democrats, call for the amendment of NAFTA to include additional labor and environmental standards. Clinton says she wants to set up periodic reviews of NAFTA, and both candidates said in a February 26 campaign debate they will use the lever of a U.S. "opt-out" to press Canada and Mexico to renegotiate the terms of the deal. Canadian officials have noted they also hold a major negotiating card in the sense that U.S. economic interests could face severe problems if Canada uses a renegotiation to stiffen conditions on energy exports (GlobeandMail). Mexico has made similar threats (IBT), saying it might not be as accommodating about accepting U.S. agricultural exports the second time around.

Some U.S. politicians, including Sen. John Edwards (D-NC), have called for the more radical step of abolishing NAFTA altogether. Republican candidate Sen. John McCain (AZ) says he supports NAFTA, though like Clinton and Obama he backs efforts to strengthen U.S. Trade Adjustment Assistance, or TAA, a program designed to assist workers negatively affected by trade-related job loss.

Many economists who broadly support NAFTA agree that TAA reforms could prove broadly useful as a way of quelling anger directed at trade liberalization. Experts including Alden note that positive long-term economic change often is accompanied by job-market turbulence. The United States is currently working to reform TAA, which helps retrain and relocate workers who face job loss due to trade. One component of a reformed TAA could be wage insurance, which a recent Council Special Report argues would protect workers who face sustained long-term wage losses.

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