CASE STUDY II: NAFTA
1. Historical Development
- The Canada-US Trade Relationship.
The U.S. and Canada are the major trading partner each other (Canada depends 80% of its imports on the U.S.)
Their trade increased 11-12% annually
The Auto Pact of 1965
CUSTA of 1989
Use of antidumping and countervailing duties and VERs by the U.S. |
Competition coming from Asia | à
Formation of a free trade area in all products
CUSTA was a hot issue in Canada, but low key in the U.S.
Canadian’s concern:
(1) Canadian industries are at comparative advantages.
(2) Canadian’s social program would be curtailed to be competitive.
(3) Cultural dominance by the U.S. à provision in the Agreement to have content requirements for cultural products
It was approved by both congresses (in Canada and US) à no tariffs between two countries
- The NAFTA (North American Free Trade Agreement)
Negotiation began in 1991. An agreement was reached in August 1992. Both Canada and Mexico approved the Agreement by the fall of 1993. Stiff opposition in the US House. It was passed on November 17, 1993 with a last-minute round of lobbying by the President Clinton.
NAFTA’s main contents:
(1) Abolition within 10 years of tariffs on 99 % of products between three countries.
(2) Removal of most barriers on the cross-border flow of services
(3) Protection of intellectual property rights
(4) Removal of most restrictions on foreign direct investment
Exceptions: Mexican energy and railway industries
American airline and radio communications industries
Canadian cultural products
(5) Application of national environmental standards
(6) Establishment of two commissions with the power to impose fines and remove trade privileges when environmental standards or legislation involving health and safety, minimum wages, or child labor are ignored
2. Arguments for and against the NAFTA
Arguments for NAFTA: opportunity to create an enlarged market and more efficient production base for the entire region
Production and employment increase in Mexico (Mexico’s wage - $2.32 per hour, American wages - $14.31 per hour in 1991), low prices for American and Canadian consumers, and increase in demand by Mexicans for the US and Canada products.
Arguments against NAFTA: job security from the American and Canadian views and national sovereignty from the Mexican view
Exodus of American and Canadian jobs to Mexico, dominance of Mexican economy by American firms, deterioration of Mexican environment
3. Effects of the NAFTA
Evidence from the early experience: too early to draw meaningful conclusions
In the first year of the NAFTA implementation, US exports to Mexico grew by 22% while Mexico’s exports to the US grew by 23%. However, The Mexican crisis of 1994-1995 resulted in sharp decline in trades between Mexico and the US. A more recent study indicates that NAFTA has had a little impact on trends already in place.
Job creation in the U.S. has been small but positive.
4. Issues in the NAFTA
a. labor issues (North American Agreement on Labor Cooperation)
Mainly concern of American labor unions. Fear that lax labor standards or lax implementation of the standards in Mexico may take jobs away from the US workers.
Decrease in demand for blue-collar jobs in the US is not due to the NAFTA, but to technological changes in the US.
b. environmental issues (North American Agreement on Environmental Cooperation)
American labor’s concern: Difference in environmental standards may cause American firms moving to Mexico.
Environmentalists’ concern: environmental degradation
c. immigration issues
The most tense issue in US-Mexico relations: illegal immigration (annually 300,000).
Three factors affecting immigration: demand–pull, supply-push, and social networks
The NAFTA will cause immigration to be less than it would have been.
5. Enlargement of the NAFTA
Chile is to be accepted into the NAFTA pending the approval by the US Congress. Potential candidates include some countries in Central and Latin Americas
* Mexican Economic History and the Mexican Crisis
1. Mexican Economic History
a. Import Substitution Industrialization in the 1950s, 60s, and 70s
Inward-orientation
Emphasis on the domestic production of goods that substitute for imports
b. The lost decade of the 1980s
1978 rich reserves of crude oil In Mexico in production and the second oil crisis in 1979-1980 à Increase in Mexican government revenue à Expansion of economic and social program à Mexican government borrowing from abroad (14.1% of GDP in 1982) à fall in crude oil prices and increase in the interest rates à suspension of repayment of the principal à debt crisis and devaluation of peso à debt relief under the Brady plan (10% reduction)
c. Structural reforms in the late 1980s
Privatization, trade liberalization, inflation control, budget deficits reduction,
d. Joining NAFTA in 1993
2. The Mexican Crisis of 1994-1995
Preconditions:
(1) financial liberalization , privatization of banks, and no capitalization rule à over-indebtedness and asset price bubbles
(2) political instability in 1994: the peasant rebellion in Chipas and the assassination of the ruling party’s presidential candidate
Precipitating conditions:
(1) a semi-fixed exchange rate and overvalued pesos
(2) a sizable current account deficit
(3) a substantial rise in US interest rates
Process:
Continuous decrease in foreign reserves due to the current account deficits and decrease in capital inflow (from $30 billion in march 1994 to $5 billion in December 1994) à devaluation of pesos by 15% and issuance of Tesebonos (short-term government securities indexed to the dollar) of $23billion à not enough devaluation and the short-term nature of Tesebonos did not give confidence to foreign investors à continuous outflow of capital and speculative attack on pesos
The U.S. and IMF support package of $50billion in January 1995.
Effects:
Peso depreciated to half of its pre-crisis value. Interest rate in 1995 at 80%, economic growth rate in 1995 of –7%
From a trade deficit of $18.5 billion in 1994 to a trade surplus of $7.4billion
Spreading to Argentina and other Latin American countries. Argentina defended its currency regime (a currency board system) at high costs (-5% economic growth rate for Argentina in 1995).
* Other Regional Economic Integration
1. The Andean Pact
2. MERCOSUR
3. CACM (Central American Common Market)
4. CARICOM (Caribbean Community)
5. Free Trade Area of the Americas