Trade Liberalization and NAFTA

Following the crisis of 1982, the Mexican economy received praise for having “adjusted well”, but failed to achieve any significant momentum due to renewed struggles in 1985-86. Mexico’s response has been to implement a policy of labor “flexibilizacion”, or weakening collective labor bargaining, and widespread trade liberalization to take advantage of newly awakened international competitiveness. Since the 1994 implementation of NAFTA or the North American Free Trade Agreement, Mexico has signed twelve free trade agreements with such diverse nations as Japan, Israel, and Chile.

NAFTA is by far the most important trade agreement Mexico has signed both in the magnitude of reciprocal trade with its partners as well as in its scope. Unlike the rest of the free trade agreements that Mexico has signed, NAFTA is more comprehensive in its scope and was complemented by the North American Agreement for Environmental Cooperation (NAAEC) and the North American Agreement on Labor Cooperation (NAALC). Given the overall size of trade between Mexico and the United States, there are remarkably few trade disputes, and even those few involve relatively small dollar amounts. These disputes are generally settled in World Trade Organization (WTO) or NAFTA panels or through negotiations between the two countries.

While the trade agreement has not synchronized employment or productivity across North America, it has resulted in an enormous interdependence between Mexico and the United States. Even as the United States has been shifting much of its dependence for imports to other nations such as China, Mexico remains firmly dependent on the state of the United States’ economy. Exports now represent 30 percent of Mexico’s GDP, up from 10 percent 20 years ago. The great majority of Mexico’s exports are manufactured goods, and almost 90 percent of them are shipped to the United States.

While Mexico has undoubtedly benefited from trade liberalization, a history of bilateral trade agreements which Mexico has historically been able to join that other nations have been unable to access has resulted in a preferential place in world trade. Unfortunately for Mexico, the entrance of many nations such as China into the WTO and the United States’ aggressive moves to increase free trade worldwide is already working to erode that preferential trade status. While the economic case for free trade suggests that Mexico will ultimately benefit from reduced trade restrictions with other nations, Mexico is already beginning to suffer the early price of dislocation of many of its people. In particular, Mexico’s maquiladora industries face competition from China and Mexico’s rural poor face stiff competition from American agri-business.

One disturbing impact of increased integration into the global economy has been Mexico’s increasing wage inequality. The new economic reality of globalization has resulted in a substantial increase in the wage premium for skilled labor, which when coupled with an unequal distribution of skills has created higher inequality in the distribution of labor incomes that is closely associated to disparities in schooling.

As each of the Asian tigers achieves greater market penetration in the United States, Mexico’s export-dependent growth becomes more threatened. In particular, as tariffs against textiles from China expire, Mexico can expect to suffer financially. Yet Mexico’s real problem with trade liberalization is that it exposes an uncomfortable truth – that Mexico is no longer a relatively “poor” nation, but its institutions and human capital nonetheless remain unable to compete with “wealthy” nations.

The Washington Consensus and Asymmetric Growth

According to the program of economic reform known as the “Washington Consensus”, one of the expected effects of trade liberalization is a rapid expansion of exports from lesser developed countries (LDCs), including labor-intensive manufactures. The idea is that this will improve micro- and macroeconomic performance and stimulate overall growth, since the economy-wide behavior in LDCs tends to depend quite critically on what happens in the export sector. Yet for Mexico from 1981 to 2004 a remarkably dynamic growth of exports—non-oil exports grew, on average, at 13.4% per year—has been associated with a surprisingly poor growth performance of gross domestic product (GDP)—an annual average rate of just 2.1%. Furthermore, as population grew at 1.6% during this period, GDP growth became negligible in per capita terms. The resulting "asymmetric" or "unbalanced" growth has relegated the economic masterminds behind the Washington Consensus to the popular status of "peddlers of dreams".

The failure of Mexico to cultivate widespread economic growth in an environment of explosive export growth is the most unexpected outcome of the reform process begun by President De la Madrid. This failure is best explained by the growth of the “maquiladora” industry. The term "maquiladora" is used for firms that are highly labor intensive and end-of-value chain assembly-type operations. Proximity to the US and trade liberalization opened up opportunities to develop these type of activities, particularly in the frontier states with the US. The maquiladora industry is so dangerous as a model of economic development because there is no incentive to invest in increased labor productivity. By virtue of the nature of the industry itself and the characteristics of the labor market, capital can grow by simply adding more cheap labor. Between 1982 and 2000, the sector was able to absorb more than 1 million workers while not only successfully resisting upward pressure on wages, but actually pulling off a significant cut in real wages. Indeed, the industry also seems designed to minimize the creation of production linkages (forward and backward) with the rest of the economy. Since so many maquiladora companies are owned by foreign corporations, a large degree of “transfer pricing” or pricing with the intent of producing no profit for the local company probably occurs in spite of substantial tax concessions from the state. The lack of domestic linkages ensures easy international mobility, and anecdotal evidence abounds suggesting that Mexico has lost hundreds of thousands of maquiladora industry jobs to China in the past decade.

In 2000, South Korea had a manufacturing industry with a level of exports similar to that of Mexico ("maquiladora" and "non-maquiladora" manufacturing exports together)—about $150 billion; however, Korea had a manufacturing industry generating twice the level of value added and only using half the level of imports of Mexico. Furthermore, Korea had relatively low levels of manufacturing imports despite a substantially higher level of investment in machinery and equipment, which traditionally have a high import component. Considering South Korea’s disadvantages to Mexico with regard to the Washington Consensus Model, this is a startling outcome. Yet it is also explicable in terms of the comparative absence of the maquiladora industry in South Korea. Because capital in South Korea can only consistently grow in an environment of rising productivity, significant investments in worker productivity are encouraged. In contrast, Mexico provides the paradigm case for the failure of the neoliberal model advocated by the Washington Consensus.

One of the main reasons why investment performed badly after the reforms is precisely that capital could easily end up having little incentive to invest. In this new investor framework, as capital (domestic or foreign) can increase its accumulation rate (at least for a long period of time) either via stagnant wages (in sectors with productivity growth) or via shrinking ones (where there is none), why should it make a significant investment effort? Furthermore, if in the new equilibrium of the labor market, labor loses the property rights it had over the benefits that may derive from the use of this additional capital (increased productivity), labor also can end up having little incentive to acquire human capital. If all the benefits that might accrue from human capital accumulation go to capital, workers actually have a lesser incentive to invest in themselves.