After NAFTA:

An Informal Integration without a Foreseeable Monetary Union

Julio Alejandro ESPINOZA ALVAREZ

Baku, March 25, 2010

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Contents

What’s next after NAFTA? 3

Integrationists and Skeptics, between a Partnership and a Community 6

Vision of a Monetary Union in North America 9

America and Mexico do not Need a Monetary Union yet… and Canada neither! 11

After NAFTA: an Informal Integration without a Foreseeable Monetary Union 15

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What’s next after NAFTA?

This work presents elements to debate the direction of the North American economic integration. It aims to offer a synthesis of the American and Mexican standpoints regarding a possible monetary union. The first section analyses the integrationists and skeptical streams of thought to understand how all this debate began in North America after the Mexican crisis of 1994 and the high volatility of the Canadian dollar during the 1990s. The second section deals with a landscape of a hypothetical monetary union in North America. The third part explores the economic and political unfeasibility of a monetary union for the US and Mexico. The Canadian position deserves more than few words, but --for the lack of time-- I have not focused on Canada. I will do it in the future, when there will be more favorable conditions. Definitive conclusions are not sought, because the topic is under debate and complex empirical research for the three countries is required, which exceeds the purpose of this work.

After the entrance in force of the Euro, in North America there was a flow of ideas on the adoption of a common currency, perhaps the American dollar or a new currency. The Mexican crisis (1994) and the Asian crisis (1997) created the atmosphere in North America to debate on the relevance of fixed or floating exchange rates between the US dollar, the Canadian dollar and the Mexican Peso.

The Fox Administration (Mexico, 2000-2006) intended to advance North America beyond a free trade area. President Fox encouraged the idea of a “NAFTA plus”, a deeper economic integration with a limited flow of the factors of production (being capital fully liberalized and labor partially liberalized by means of a hypothetical Mexico-U.S. immigration agreement).

Recently, the Security and Prosperity Partnership and the Merida Initiative add two more regimes to NAFTA and the US-Mexico binational commission, but are not yet enough to consider North America in a formal process of integration, made of a legal framework and institutions that enforce harmonizing policies to America, Canada and Mexico.

In North America, two schools of thinking exist sixteen years after the entrance in force of NAFTA. The integrationists look for a deepening and institutionalizing the interdependence of the three North American countries, mainly the economic interdependence, perhaps throughout a dollarization process, a monetary board or an economic union with a single currency. The skeptics consider impossible to move from a free trade area to an economic union with a single currency for the disparities of the three NAFTA economies and for their necessity of economic autonomy.

The truth is that North America is far from achieving a common currency if we consider that any economic integration is a progressive phenomenon beginning with an area of free trade, continuing with a customs union and a common market, an economic union and ending up with a monetary union.

According to my research and professional experience, I find that if the economic integration is proportional to the political will and economic development of the countries, unless the United States and the elites in Canada and Mexico consider convenient the union to happen and they promote it, hardly will it be to materialize such an idea. In this case, for the mid term, better can we expect a spontaneous integration, being forced by the inertia of the market and the threats to the national security. I would expect that such spontaneous integration could develop into a sui generis common market with a constant and illegal flow of labor and the informal harmonization of macroeconomic policies between the central banks, as is already happening.

The reader will find that I recognize the lack of feasibility for a North American Community with a single currency in the foreseeable future, but I do also recognize myself as an integrationist. I hope that in the long term there will be better chances to think of NAFTA as the foundation of a broader and deeper integration that eventually could lead to the creation of the United States of North America.

In this sense, I do agree with the research of Robert Pastor and some members of the Mexican Council for Foreign Affairs, mainly Rafael Fernandez de Castro. They all propose to start thinking Mexico and the US, North America in general, as a free trade area slowly becoming into a community made of institutions for intraregional cooperation.[1] Over several documents it is Pastor who advises to pursue a multi-stage integration. In the short term, NAFTA can foster harmonization and cooperation to optimize the intraregional performance of the three economies. In the middle term it will be possible to create a North American Community, which might be based on pragmatic solutions favoring multilayer cooperation over sovereignty arguments. In the very long term, the Community might only arrive to a full convergence of macroeconomic policies and close the gaps in development. (See Pastor 2001, among other works of his)

Myself being an integrationist, after doing this research, I would advise to pursue a passive, without the public’s awareness, and spontaneous, led by the market forces, Mexican integration into North America, because pegging the Mexican peso to the American dollar could result into a costly process of convergence and the lack of economic sovereignty to deal with the downturns of the business cycle. Therefore, the Presidency would face difficulties when selling the idea of abandoning the so far successful autonomy of the central Bank of Mexico.

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Integrationists and Skeptics, between a Partnership and a Community

The integrationists are up to a community beyond the market. In the center of the integrationist thought there is the belief that the uncertainty of the exchange rate is the main obstacle for economic development. The integrationists consider that overcoming the volatility of the exchange rates is more valuable than the loss of independence in monetary and exchange policies. They believe that NAFTA is a success, because it has dismantled most restrictions on trade and investment and increased US trade with Canada and Mexico twice as fast as did its trade with the rest of the world. (Sullivan 2009, 31) Therefore, this school recommends that a monetary union (based on dollarization, a monetary board or a common currency) should be established.

The NAFTA economies have similar interests; and on the base of interdependence, they need to meet them in a joint manner. The necessity of security, stability and prosperity motivates NAFTA countries to move towards a convergence of economic, foreign and national security policies. The three countries face common threats such as terrorism, organized crime, environmental degradation and decontrolled immigration flows. Canada, Mexico and the U.S. in face of the rise of other geopolitical regions (Europe, Asia and South America), need to foster intraregional competitiveness to sustain economic growth. For the integrationists, the integration had already taken place well before NAFTA and has gained momentum after NAFTA. For them, the integration could be passive or active.

Passive integration is driven by means of the market forces, unleashed by NAFTA, because implementing macroeconomic harmonization by a binding framework is unfeasible. After all, the three major macroeconomic indicators (interest, exchange and inflation rates) show a more responsible monetary and fiscal policy on the Mexican side, because, along with the business cycle in North America, monetary and fiscal policies in the three countries have being moving together. For example, after the Mexican crisis of 1994-1995 the fundamentals of the Mexican economy have remained stable and moving at the same pace as the American and Canadian ones do. In this regard, the integrationists propose a harmonization of domestic economic policies to foster regional cooperation in strategic sectors of NAFTA, being the most important the labor and the energy markets. (Council on Foreign Relations 2005, 1-32)

Active integration is pursued by means of common policies and institutions leading to some convergence. (Fernández de Castro y Rozental 2006, 90-92) Thanks to the strong economic interdependence, the three countries have the opportunity to create a North American community, which will sit on pragmatic solutions favoring free markets policies and leaving aside arguments on sovereignty and discourses on total integration. On the base of the regional competitiveness, it is needed to advocate for more economic cooperation and institutionalization to reduce the disparity of the GDP per capita between the three nations, improve regional infrastructure, prevent financial crisis and homogenize bordering and customs controls. (Pastor 2004, 124-135)

The skeptics are for a society based on the market and nothing more. In the center of the skeptic thought, in addition to the belief in sovereignty, we can find the economic assumption that flexible exchange rates are compatible with economic growth in an environment of financial volatility. For the skeptics a fixed exchange rate lacks viability and implies economic and social costs in the event of negative external shocks, due to the inability of using the monetary policy to foster growth and employment. (Ibarra and Moreno-Brid 2001, 10-11) The skeptics at some degree believed that NAFTA has paid few gains to Mexico in terms of economic development.

NAFTA was born not as the milestone for a deeper economic integration, but as mechanism of economic liberalization. It is easier to deepen economic interdependence when the concerned parties are relatively homogeneous, like France and Germany, than when the countries are more different like Canada, Mexico and the U.S. The three North American countries have chosen to keep NAFTA membership close to three members and expand free trade by means of bilateral free trade agreements between the NAFTA countries and third parties. Because NAFTA has grown outwards not inwards, it is clear that integration has not been a priority for Canada, Mexico and the U.S. NAFTA countries have subscribed free trade agreements with third parties instead of advancing into a common external tariff or discussing the possibility of working permits for the surplus in the labor market for example.

So far, North America, although trying to increase political dialogue and cooperation, lacks institutional means to deal with economic, political, social and security issues at the highest level. Canada is still skeptic about the concept of a community with the U.S. and Mexico. The Canadian public and leaders have been so proud of its special relationship to the U.S. that hardly may they start thinking in terms of the Mexican national interest. The U.S. after September 11 became more aware of other regions except for the Americas and increased the level of its traditional isolationism. Mexico is in the middle of a domestic struggle against organized crime and its political spectrum is divided between the pro-American rightists in power and the anti-imperialistic leftist in the opposition.

In Canada, Mexico and the US, now there is little political support to a North American Monetary Union. The business sector of America, Canada and Mexico favor more monetary integration to foster stability and growth; however the general public and the Legislative Branches are indifferent in the three countries. The fact that each country is dealing with domestic skepticism about a North American Community hinders advancing the integration.

In the short and middle terms, the creation of a customs union or a common market is not probable, let us not say the instauration of monetary union. Although the private sectors of the three countries agreed on a deeper integration for the sake of reducing the costs of transaction, it would be required political consensus between the ruling elites and their oppositions, which would be very difficult to achieve given the still strong nationalisms in the three countries. (Santillán 2003, 18)

Additionally, looking for escalating NAFTA from a free trade area to a customs union would imply to deal with the complex system of free trade agreements between NAFTA members and third countries and then establishing an agreement between NAFTA and its trading partners. By the same token, a common market is still impossible given the lack of will to allow the free flow of labor in North America, even this flow was given through temporary working permits in specific sectors of the economy.

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Vision of a Monetary Union in North America

Seen from a long term perspective, there are chances of a monetary union to take place along with a Central Bank of North America. Such CBNA might have norms, procedures, officials (appointed and monitored on a tripartite basis that guarantees representativeness and accountability to three bands) and a single objective (to control inflation even at the risk of full employment). After implementing converging monetary and fiscal policies during a certain period, just as it happened in the European Union, there would be a common currency in North America, perhaps called Amero or Americus. Canada and Mexico would change their national currencies to an exchange rate that does not alter the competitiveness and the wealth of each country. In the three countries the prices of the goods and services, wages, assets and liabilities, would be converted simultaneously to Ameros. (see Grubel 2001, he probably is the most outstanding Canadian advocate for a common currency)