NAFTA, Mexican Trade Policy, and U.S .-Mexico Trade : A LongerTerm Perspective

Congressional research reportMar 11, 1996

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96-225 E

NAFTA, Mexican Trade Policy, and

U.S .-Mexico Trade : A LongerTerm Perspective

J. F . Hornbeck

Specialist in International Trade and Finance

Economics Division

March 11, 1996

OEM

CRS

NAFTA, MEXICAN TRADE POLICY, AND

U.S :MEXICO TRADE : A LONGERTERM PERSPECTIVE

SUMMARY

After two years of the North American Free Trade Agreement (NAFTA),

the debate over liberalizing trade with Mexico continues .

Because of

congressional interest over the dramatic turnaround in the U .S. balance of trade

with Mexico in 1995, this report considers trends in U .S.-Mexico merchandise

trade in a longer term context . It does not address employment issues, which

are the subject of other CRS reports . What becomes evident is that an open

trade policy can facilitate trade, but macroeconomic problems can destabilize

trade flows independently of trade policy or agreements .

U.S.-Mexico trade has grown and diversified as the two economies have

become increasingly integrated . Yet, trade has not always expanded in a smooth

upward direction . Many economic variables affect trade : economic performance

of trading partners, capital flows, domestic economic policies, exchange rate

policy, and trade policy . In 1982-83 and 1995, Mexico experienced severe

recessions . Both were similar in that they were preceded by an overvalued peso,

balance of payments crises, large capital outflows, and major peso devaluations .

A critical variable that differed between the two setbacks was trade policy, which

caused Mexico to act much differently in 1995 than it did in 1982 .

Mexico was essentially a closed economy in 1982, but the debt crisis led the

way to Mexican trade policy reform. Mexico began serious unilateral reductions

in trade barriers after 1985 and made overt moves to integrate itself more

completely with the world economic system by becoming a member of the

General Agreement on Tariffs and Trade (GATT) in 1986 and the Organization

for Economic Cooperation and Development in 1994 . NAFTA, in this context,

is the continuation of a long-term trade-opening process .

With Mexico's 1995 balance of payments crisis, the United States saw its

bilateral trade balance fall into a large deficit position, as it did in 1982 .

However, U .S. exports to Mexico declined by only 11% in 1995, compared to 35%

in 1982 and 25% in 1983 . Yet, in 1995, Mexico's economy contracted much

more, with GDP falling 6 .9% compared to 0 .6% and 4.3% in 1982 and 1983 .

The difference points to Mexico's open trade policy, including NAFTA,

which kept it from raising barriers to U .S . trade in response to the crisis . The

decline in exports represents the fall in demand that accompanied the recession

and the effects of the peso devaluation . What the decline does not reflect is a

formal policy to restrict the flow of imports from the United States, which was in

place in 1982, but absent in 1995 . NAFTA solidified Mexican commitments to

an open trade policy and actually cushioned U .S . exports from more serious

effects . Although this is scant comfort to those who are concerned with the

1995 trade deficit with Mexico, the deficit is not a major economic problem for

the United States and is smaller than it might have been without NAFTA . Also,

under freer trade economists generally expect U .S. exports to Mexico to recover

more quickly than they did from the 1982 crisis under a closed trade policy .

CONTENTS

UNITED STATES-MEXICO TRADE : 1977-1995

ECONOMIC FACTORS AFFECTING TRADE

TRADE AND ECONOMIC PERFORMANCE

EXCHANGE RATES, CAPITAL FLOWS, AND TRADE BALANCES . 6

MEXICAN TRADE POLICY

CLOSED TRADE POLICY AND THE 1982 CRISIS

TRADE REFORM IN THE 1980s

OPEN TRADE POLICY AND THE 1995 CRISIS

CONCLUSIONS AND OUTLOOK

APPENDIX 1 . U .S . MERCHANDISE TRADE WITH

MEXICO, 1977-1995

APPENDIX 2 . TOP 25 U .S . IMPORTS FROM MEXICO

APPENDIX 3 . TOP 25 U .S . EXPORTS TO MEXICO

NAFTA, MEXICAN TRADE POLICY, AND

U.S :MEXICO TRADE: A LONGERTERM PERSPECTIVE

After two years of the North American Free Trade Agreement (NAFTA),

the debate over liberalizing trade with Mexico continues . Many hold NAFTA

responsible for both Mexico's sudden economic collapse and the resulting

bilateral U.S. trade deficit, concluding that NAFTA was a bad deal for the U .S.

economy.'

Economists generally dispute this position based on two

fundamental propositions . First, a bilateral trade deficit with Mexico does not

present a major economic problem for the United States, and second, trade

policies and particularly trade agreements do not cause trade deficits . In short,

free trade agreements can affect the long-term level of trade, but not sharp

fluctuations in the balance of trade . Finally, it is worth reiterating that the

benefits of freer trade are not measured by annual trade balances, but by

broader economic changes that unfold over longer periods of time 2

Nonetheless, the public policy debate continues over short-term movements

in U.S: Mexico trade . This report considers trends in U.S: Mexico merchandise

trade over two decades to help place recent events into a historical economic

context. To evaluate the role NAFTA may have had on the current economic

and trade situation in Mexico, it is instructive to revisit the "debt crisis" period

of 1982-83, when Mexico had a closed trade policy, and contrast it with the 1994

peso devaluation, when Mexico operated under an open trade policy . As shall

be seen, rather than trade policy or agreements, politics, macroeconomic

problems, and policy responses proved to be the short-term destabilizing forces

of long-term trade trends in both cases . By contrast, changes in Mexican trade

policy, including adopting NAFTA, may have actually cushioned U .S. exports

from even steeper declines in 1995, given Mexico's worst recession since the

1930s .

The major criticisms revolve around loss of jobs and U .S . exports . For example see :

Buchanan, Patrick J . Mexico: Who Was Right? The New York Times . August 25, 1995 and

Public Citizen. NAFTA's Broken Promises . September 4, 1995 .

2 For an economic discussion of the "gains from trade" see : U.S . Library of Congress .

Congressional Research Service . Trade Policy in an Economic Perspective . Report No . 95-529 E,

by Craig K. Elwell . March 9, 1995 .

3 This report will not delve into employment issues ; for a discussion of the employment effects

see : U .S . Library of Congress . Congressional Research Service . NAFTA. U.S . Job Effects and

Industry Trends After Two Years . Report No . 96-176 E, by Mary Jane Bolls . February 27, 1996

and United States-Mexico Economic Relations : Has NAFTA Made a Difference? Report No . 95398 E, by J . F . Hornbeck . March 15, 1995.

CRS-2

UNITED STATES-MEXICO TRADE : 1977-1995

The United States and Mexico have had a long and sometimes tempestuous

economic relationship . Although freer trade with Mexico raises concerns in the

United States, Mexicans have also expressed reservations about being

overwhelmed by the economic colossus to its north . Because trade occurs

between a comparatively large and small economy, there is a disproportional

aspect to the relationship .

The United States is by far Mexico's most important trading partner,

accounting for approximately 85 percent of Mexico's exports and 72 percent of

its imports in 1995 . Although Mexico is the United States' third largest trading

partner, it accounted for only 10 percent of U .S . exports and 7 .5 percent of

imports in 1995 . This is an important distinction because despite concerns over

U .S . exports to Mexico, the U .S . economy is not greatly affected overall by the

economic fortunes of Mexico . To the contrary, Mexico's economy is much more

vulnerable to U .S . economic trends .

Despite this discrepancy in relative trade importance, bilateral trade

expanded briskly and for the most part evenly over the past two decades .

Between 1977 and 1995, trade turnover (exports plus imports) between the

United States and Mexico grew over ten fold from $9 .5 billion to $107 billion

(see figure 1 and appendix 1 .) The U .S . balance of trade shifted from surplus

to deficit, reflecting changing economic fundamentals in both countries .

At least three distinct periods can be seen in figure 1 . First, the late

seventies show a pattern of balanced trade growth, supported in Mexico by the

oil boom. A second period followed in the 1980s characterized by a decline and

stagnation of trade following the global recession, collapse of world oil prices,

increase in world interest rates that triggered Mexico's 1982 debt crisis .

U .S exports fell substantially after 1981, requiring seven years to recover .

Beginning in 1986, a third period of nearly balanced trade growth resumed

largely, as shall be seen, because of Mexico's trade reforms . Finally, 1995 may

or may not portend the beginning of a fourth period, perhaps similar to 1982,

in which Mexico's balance of payments problems result in a severe decline in

U .S . exports .

In addition to the volatility in U .S .-Mexico trade over the past two decades,

the composition of trade between the two countries changed rather dramatically,

particularly Mexican exports . In the early 1980s, Mexico was, above all else, an

oil exporter, with oil accounting for over two-thirds of total export revenue .

Some 40 percent of exports to the United States consisted of oil at that time .

By 1995, although still an important sector, oil production had not increased

from 1983 levels and accounted for only 12 percent of total Mexican exports and

9 percent of exports to the United States (see appendix 2 .) 4

4 Weintraub, Sidney . A Marriage of Convenience: Relations Between Mexico and the United

States . New York, Oxford University Press, 1990 . pp . 86 and 119 and U.S . Department of State.

U .S . Embassy, Mexico . Mexico, Economic and Financial Report . Fall 1995. p . 80.

CRS-3

FIGURE 1

. U .S .-Mexico Merchandise Trade (1977-1995)

$ billions (current)

-e- U .S . Exports

-+- U .S . Imports

.. . . . . . . .. .. .. . . . . .. .. .. . . . . . . .

® U .S . Trade Balance

-20

77 78 79 80 81 82 83 84 85 88 87 88 89 90 91 92 93 94 95

Year

Source: U .S. Department of Commerce .

As Mexico diversified its export base away from oil toward manufacturing,

the United States became an even more important trading partner . In the early

1980s, the United States accounted for 55 percent of Mexico's exports . This

ratio rose to 65 percent in 1987 and 85 percent by 1995 . Approximately 80

percent of Mexico's exports are now manufactured goods, 70 percent of which

end up in the United States .

Maquiladoras, through joint production

operations, play an important role in this trade, with half of all manufacturing

exports coming from these firms . Motor vehicles, electrical instruments, and

electrical appliances constitute most of the maquiladora exports .'

As important as the maquiladora relationship is to Mexico, the fundamental

changes in Mexico's export composition also reflect shifts in non-maquiladora

production . As seen in table 1, the ratio of manufactured exports to total

manufacturing output tripled from 1982 to 1994 (column 3) and the ratio of

manufactured exports to total non-maquiladora exports quadrupled (column 4) .

Also evident in this table is the growing importance of exports to the economy

(column 2) and the declining relative importance of petroleum (column 5) .

5 Weintraub, Ibid, pp . 73-75 and U .S . Embassy Mexico, Ibid, pp. 80 and 83 . Maquiladoras are

foreign-owned assembly plants in Mexico, which produce for export (mostly to the United States) .

U.S . and Mexican trade laws provided preferential treatment for inputs and finished goods related

to maquiladora production even prior to NAFTA . U .S . Library of Congress . Congressional

Research Service. Mexico's Maquiladora Industry . Report No . 93-1050 E, by M. Angeles

Villarreal . December 14, 1993 .

CRS-4

Table 1 . Structural Changes in Mexican Exports (in percent)

Mfg.

Petroleum

Year

Total

Mfg.

Exports/Total

Exports/GDP Exports/Mfg.

Exports*

GDP

Exports*

17.5

74.5

1982-83

14.7

10 .5

50.9#

17.3

23.6

37.7#

1986-87

21.2

32.0

68.9

1994

20.6

Total exports excluding maquiladora production . # 1985-87

Jorge Mattar, El Indicador Bursatil, in U .S . Department of State .

Source :

Economic and Financial Report, Fall 1995. p . 80 .

Mexico:

Between 60 and 70 percent of Mexico's imports tend to be intermediate

goods, or goods that are further processed . Capital goods, used to manufacture

other goods, account for approximately 20-25 percent of Mexico's imports, with

consumer goods ranging from 5 percent during recessions to 15-20 percent

during periods of economic growth . The dominance of intermediate goods again

points to the importance of the maquiladora relationship as partially

manufactured goods are sent across the border for further assembly and then

returned to the United States . Intermediate goods support non-maquiladora

manufacturing as well . The largest categories of imports from the United States

are various types of tractor/automotive and electrical parts . Imports from the

United States are highly diversified with the top 25 import commodity groups

accounting for only one-third of the total (see appendix 3) .

ECONOMIC FACTORS AFFECTING TRADE

As seen above, U .S .-Mexico trade changed considerably over the past two

decades . The long-term trend is one of growth and diversification as the two

economies become increasingly integrated . Yet, trade has not always expanded

in a smooth upward direction, and in an effort to discern NAFTA's possible role

in Mexico's economic problems, it is essential to understand some of the factors

that affect short-term fluctuations in trade including economic performance,

exchange rate policy, and capital flows . Because events causing the collapse of

the 1994 peso are reminiscent of those in 1982, the two periods are contrasted .

TRADE AND ECONOMIC PERFORMANCE

Trade between two countries can fluctuate over the short-term as the

economies move through their respective business cycles, which is particularly

evident among major trading partners where economies are more highly

integrated, such as the United States and Mexico . When economies are growing

demand increases, including the demand for imports . When economies enter

recessions, demand falls, often abruptly, which also diminishes demand for

imports. These short-term swings can affect trade balances irrespective of trade

policy or agreements .

CRS-5

FIGURE 2 . Real Growth in Mexican GDP and

U .S . Exports to Mexico (1978-1995)

Percent

35 . . . . .. .. .. . . . . .. .. .. . . . . . . ... .. . . .

30-2500 . . . . . . . .....

20F1

Is.

10.. .

~I a it

. . ._~I

5-~1 h /,I -/,

-5 -10 -16 . . . . .... .. . . . . . . .. .. .. . . . . .. .. . . . . . . ... .. . . . . .. .. .. .. . . . . .. .. .. . . . . . . ..... . . . . .. .. .. . . . . . . .... . . . . . . . .... .. . . . . ..

-20 -25 ... .. . . . . .. .. .. . . . . .. .... . . . . . . . ...... . . . . . . .. .. . . . . .. .... . . . . . . . . ..... . . . . . . .... . . . . .. .... . . . . . . . .. .. . . . . . . .... .. . . . . .. ... .

-30 -35 -40

78 79 80 81 82 83 84 86 86 87 88 89 90 91 92 93 94 96

Year

Mexico GDP Growth

U .S . Export Growth

CRS calculations, Dept of Commerce data .

To highlight the relationship between trade and short-term economic

performance, figure 2 contrasts real annual growth of Mexico's gross domestic

product (GDP) with real annual growth of U .S . exports to Mexico from 1978 to

1995 . Figure 2 shows the potential for volatility in annual trade balances based

on the vagaries of the Mexican business cycle . In particular, growth in U .S .

exports to Mexico was highest in the late 1970s during a period of strong

economic growth (8-9 percent annually) and decidedly negative when the

economy fell on hard times in 1982-83, 1986, and 1995 .

The decline in U .S . exports to Mexico is most evident for the 1982-83 and

1995 recessions . In 1982 and 1983, Mexico's GDP dipped by 0 .6 and 4 .2 percent,

respectively, for a total fall in GDP of nearly 5 percent over the two years . At

the same time, U .S . exports to Mexico fell by 35 and 25 percent for a total

decline of approximately 50 percent . In the wake of the 1994 peso devaluation,

Mexican GDP fell 6 .9 percent in 1995 alone, the largest single year decline since

the Great Depression and fully two-thirds more than in 1983 . Yet, U.S . exports

to Mexico fell only 11 percent or only about half the decline witnessed in 1983 .

This raises an interesting question (to be explored in the next section) of why

U .S . exports to Mexico declined much less in 1995 than might have been

expected given such a sharp contraction in the Mexican economy and the

previous experience of 1982-83 .

CRS-6

EXCHANGE RATES, CAPITAL FLOWS, AND TRADE BALANCES

Exchange rate policy and capital flows can also affect trade balances . Over

the long run, stable and predictable exchange rates promote confidence in the

future value of a country's currency, which in turn encourages trade and

investment and discourages speculation and the potential for sudden large shifts

in the flow of capital . Exchange rate stability, however, is not always easy to

achieve . In a floating exchange rate system, market forces determine the

exchange rate . In a fixed exchange rate system, policy sets the value of a

country's currency in keeping with broader economic goals . Both can generate

stability, but in Mexico's case, its fixed exchange rate policy became suspect

when very large inflows of foreign capital caused the peso to become overvalued

and Mexican economic policy did not make the necessary adjustments .

In 1987, as part of a long-term anti-inflation policy, Mexico pegged the

"nominal" or current market value of the peso to the dollar and then in 1989

adopted a "crawling peg" exchange rate . The "crawling' aspect of this concept

refers to what amounts to a constant nominal mini-devaluation of the currency,

ideally at a rate that would be equal to the inflation differential with the

country to which the peso is pegged (the United States .) In 1991, Mexico

employed a band or defined trading range within which the peso could be traded,

while continuing the regular mini-devaluation by widening the band .'

When a country pegs its currency, exchange rate credibility rests on

adopting macroeconomic policies similar to those of the country to which the

currency is pegged (the United States in this case) to avoid currency

misalignments . Policy coordination is all the more critical in Mexico's case

because the United States is both its primary trading partner and a much larger

economy . Two problems often emerge when a country adopts a fixed exchange

rate, both of which can raise the specter of devaluation . First, when the

difference in inflation rates is not fully closed, the "real value" (adjusted for

inflation) of the pegged currency (the peso in this case) tends to appreciate . As

the real value of the peso appreciates, the "nominal value" becomes increasingly

less credible, raising concerns about a possible devaluation .7

The second and related problem arises when domestic economic policy

diverges from that of the country to which the peso is pegged, which, as

mentioned above, raises questions about the credibility of maintaining the fixed

6 Because of the similarities between 1982 and 1994, only the latter period is discussed . Prior

to 1982, Mexico had a fixed exchange rate compared to a "crawling peg ." For all practical

purposes, the crawling peg became a fixed exchange rate by 1994 so these technical differences did

not affect the final outcome, which was devaluation in both cases .

Not adjusting fully for the inflation difference was a matter of broader and deliberate

Mexican policy involving wage and price controls . On the pitfalls see : Dornbusch, Rudiger and

Alejandro Werner . Mexico : Stabilization, Reform and No Growth . Brookings Papers on

Economic Activity . No . 1, 1994 . p . 271-76 and Dornbusch, Rudiger, Ilan Goldfajn, and Rodrigo

O. Valdes . Currency Crises and Collapses . Brookings Papers on Economic Activity . No . 2, 1995,

p. 250-53 .

CRS-7

nominal exchange rate . In 1982, Mexico's economic policies were overtly

expansionary, contributing to inflation, the peso appreciation, and impending

crisis . Similarly, in mid-1994 the Mexican government adopted looser fiscal and

monetary policies, albeit rather subtly, as a matter of presidential politics . If

macroeconomic policy becomes expansionary and relatively more expansionary

than in the United States, which was actually moving in the opposite direction

with the Federal Reserve raising interest rates throughout 1994, then the

inflationary gap between the United States and Mexico discussed above grows

and the nominal fixed exchange rate becomes suspect . 8

Capital inflows into Mexico were a driving force that led to the overvalued

currency, rising current account deficit, and Mexico's financial problems within

the context of a pegged exchange rate system . As Mexico recovered from the

debt crisis of the 1980s and achieved market-based economic reforms, investors

came to believe that long-term stable growth might once again be possible . With

rising interest in the potential for large returns in so-called "emerging markets,"

investors committed capital accordingly . Capital began to trickle into Mexico in

1989, and as documented in table 2, rushed in thereafter until 1994 .

Table 2 . Net Capital Inflows into Mexico,

1989-95 ($ billions)

Investment

Type

1989

1990

1991

1992

1993

1994

1995

1/2 year

Portfolio

0 .4

3 .4

12 .7

18 .0

28 .9

8 .2

-11 .5

Direct

2 .8

2 .6

4 .7

4.4

4 .4

8 .0

2 .6

Total

3 .2

6 .0

17 .4

22 .4

33 .3

16 .2

-8 .9

Source : IMF, International Financial Statistics, February 1996.

When capital moves into a country that maintains fixed exchange rates, the

domestic money supply increases, prices tend to rise, and the exchange rate

tends to appreciate .' The real appreciation of the peso lowers the price of

imports and raises the price of exports, so Mexico began to run large trade and

current account deficits that matched the capital inflows ." When these capital

Dornbusch, Goldfajn, and Valdes, Ibid, p . 240 . It has been argued that had Mexico been able

to retain international credibility in its anti-inflationary policy, it might have avoided this latest

crisis . See : Obstfeld, Maurice and Kenneth Rogoff . The Mirage of Fixed Exchange Rates .

Journal of Economic Perspectives, v . 9, Fall 1995, p . 84 .

9 One view argues that an extremely high level of capital inflows, particularly in a small

economy, is simply not a realistic equilibrium level over the long run and should be treated as a

short-term phenomenon at the outset . See : Edwards, Sebastian . Comments and Discussion .

Brookings Papers on Economic Activity . No . 2, 1995 . p. 27710

Another indication of the growing deficit may be seen by comparing table 2 with figure 1 .

Growth in foreign capital investment in Mexico from 1991 to 1994 coincided with Mexico's trade

balance with its major trading partner, the United States, turning from a surplus to a deficit .

CRS-8

flows suddenly slow or reverse themselves, they can present serious problems for

the recipient countries . This occurs because the country then has a large

current account deficit, an overvalued exchange rate, and often insufficient

foreign exchange reserves relative to possible capital outflows . This happened

to Mexico during 1994 .

Rising U .S . interest rates were responsible, in part, for the initial decline

in capital inflows . Mexico would have had to adjust its economic policy in like

manner to continue to attract capital, but Mexico found it difficult during an

election year to change policy in response to the change in capital flows . In

effect, it no longer subordinated domestic monetary and fiscal policy to the

maintenance of a fixed exchange rate with the United States . In fact, as Mexico

lost foreign exchange reserves, they were replaced by central bank purchases of

Mexican government debt so that the economy would not have to deflate or

allow the money supply to contract, which would slow growth and risk

recession."

In addition to higher U .S . interest rates, noneconomic factors sparked

capital flight from Mexico . Concern over political stability was a key issue

leading to investor uneasiness . In January 1994, a peasant revolt occurred in

the state of Chiapas . March proved to be an even more unsteady month with

the assassination of a presidential candidate . These events triggered a major

speculative attack on the peso in late March, which Mexico defended by selling

its foreign exchange reserves . Other political disturbances and tighter monetary

policy in the United States continued throughout 1994 and in November Mexico

faced another run on the peso as the fear of devaluation spread ."

Although changing political and external economic events encouraged

investor withdrawal, it was Mexico's economic policy that doomed the peso to

devaluation . In the absence of political and economic uncertainty, Mexico's

impending financial crisis would probably have occurred in any event, although

the timing might have been different . By mid-1994, Mexico loosened both its

fiscal and monetary policies precisely when the United States was tightening its

monetary policy . This decision was tantamount to encouraging higher inflation

relative to the United States, which, with a pegged exchange rate, meant that

the real appreciation of the peso would accelerate to potentially untenable levels,

further exacerbating the current account deficit .

Mexico faced one of three unattractive options : (1) raise interest rates to

match U .S . policy and continue to attract foreign capital ; (2) devalue the peso ;

or (3) do nothing and head toward more serious financial difficulty . Option one

proved unacceptable because it risked almost a sure recession prior to a

presidential election . Option two was apparently debated, but discarded because

Dornbusch, Goldfajn, and Valdes, Currency Crises and Collapses, p . 240-41 .

For a summary of events see : U.S . Library of Congress . Congressional Research Service .

Mexico: Chronology of a Financial Crisis . Report No . 95-1007 E, by Patricia A. Wertman .

September 27, 1995 .

CRS-9

Mexico staked its economic reputation on defending the peso ." Option three

unfolded by default .

Investors, both foreign and domestic, actually realized the tenuous nature

of the peso throughout much of 1994 and abandoned it by moving toward a

dollar-indexed investment instrument known as the tesobono . 14 This amounted

to "currency flight" prior to the final capital flight that occurred in November

and December . When investors finally fled in late 1994, Mexico defended its

currency with foreign reserves as long as it could before devaluing and

eventually floating the peso . Mexico's refusal to face the inconsistency of its

macroeconomic and exchange rate policies ultimately set events into motion .

Mexico could not continue to peg the peso to the dollar and follow divergent

macroeconomic policy from the United States . When an adjustment did not

occur, it was only time before markets forced the peso's devaluation .

The debate over the proper Mexican response continues today ." For this

report, it is sufficient to note that a fixed exchange rate policy combined with

large capital inflows and Mexico's unwillingness to adopt necessary adjustment

policies led to an overvalued peso and large current account deficits . As the peso

lost credibility and capital fled Mexico, a devaluation became inevitable with

dramatic and predictable effects on trade balances : Mexican exports increased,

imports fell, and the balance of trade with the United States went from a

surplus to a deficit . The key points are that the seeds of this problem were

planted years before NAFTA was contemplated and that the final collapse of the

peso occurred irrespective of trade policy ." Mexico faced this problem in 1982

under a closed trade policy and again in 1994 under a highly open trade policy .

MEXICAN TRADE POLICY

The preceding discussion points to many interconnected economic problems

that can disrupt long-term trade patterns . The effect of Mexican trade reform,

by contrast, should be evident over longer periods of time and promote stability

in trade relations. To recap, in 1982-83 and 1995, Mexico experienced severe

recessions (see figure 2 .) Both were similar 17 in that they were preceded by an

Dornbusch, Goldfajn, and Valdes, Currency Crises and Collapses, p . 241 .

Tesobonos grew from 6 percent of total public sector internal debt in April 1994 to 55

percent by the time the peso was devalued in December . They proved to be only a stopgap

measure in the attempt to halt capital flight.

The two main camps are : (1) Mexico should have tightened fiscal and monetary policies

to avoid devaluation, and (2) Mexico should have devalued the peso much earlier .

Anticipation of NAFTA, however, may have contributed to the high expectations that drove

large capital flows into Mexico after 1989.

U.S . Library of Congress . Congressional Research Service . Mexican Financial Crises, 1982

and 1995: Similarities and Differences . Report No . 95-239 E, by Patricia A. Wertman . 6 p.

CRS-10

overvalued peso, balance of payments crises, capital outflows, and major

devaluations, causing U .S. exports to fall . One of the critical variables that

differed between the two setbacks was trade policy . As will be shown, a more

open policy in 1995, solidified by NAFTA (and GATT), kept Mexico from

reverting to import restrictions that were so prevalent in 1982 . This policy

change actually protected U .S . exports from worse declines when faced with a

severe economic setback in Mexico .

CLOSED TRADE POLICY AND THE 1982 CRISIS

In 1982, the Mexican economy was considerably more closed to trade than

it was in 1995 . Mexico had long followed an import substitution approach to

development, which by maintaining high tariffs and other barriers to imports,

protected domestic industry from foreign competition . In 1981, the average

tariff rate was 27 percent, 83 percent of imports required licenses, and domestic

content requirements covered key industries such as automobile and computer

manufacturing .

The sole purpose of these policies was to restrict imports in order to

facilitate domestic industrial development in Mexico . Given the wealth effect of

new found oil reserves in the late 1970s, there was little financial or political

pressure to change policies ." As the 1980s approached, Mexico's economy

continued to grow based on heavy external borrowing backed by seemingly

unlimited oil revenues . This trend gave way to large current account deficits .

The 1982 balance of payments crisis occurred because Mexico overborrowed

and could not meet growing international debt service payments given rising

world interest rates and falling world oil prices . Mexico devalued the peso twice

in 1982 and immediately faced economic decline : inflation climbed to nearly 100

percent and economic growth fell by nearly 5 percent over two years . 19

To resume meeting its debt obligations, Mexico increased barriers to

imports in order to earn foreign exchange . The primary tool was the import

license (permiso previo), which in 1982 was extended to 100 percent of imports .

Exchange rate controls were also introduced and tariffs raised, but as one

observer points out, "Under this import structure, it was fatuous to speak of

average tariffs levels in Mexico . Denial of a permiso previo was the equivalent

of an infinite tariff."20 The result for the United States was a dramatic fall in

exports to Mexico, as seen in figure 2 .

Lustig, Nora. Mexico : The Remaking of an Economy. Washington, D .C., The Brookings

Institution, 1992 . pp. 114-15 .

19 The details can be found in chapter 1 of Lustig, Ibid .

20 Weintraub, Sidney .

The Promise of United States-Mexican Free Trade .

International Law Journal, v. 27, Summer 1992 . p. 555 .

Texas

CRS-11

TRADE REFORM IN THE 1980s

Despite the initial raising of import barriers, one outcome of the debt crisis

was reform in Mexican trade policy . Mexico began gradual unilateral reductions

in trade barriers after 1982 . These accelerated after 1985 when Mexico made

overt moves to integrate itself more completely with the world economic system

by becoming a member of the General Agreement on Tariffs and Trade (GATT)

in 1986 and the Organization for Economic Cooperation and Development in

1994 . Becoming a party to NAFTA was a logical step in this progression 21

Mexico's specific trade reform policies included reducing licenses from 100

percent of imports in 1982 to 36 percent in 1985, 27 percent in 1986, and 22

percent by the end of 1988 . Mexico also simplified its tariff schedules, with

maximum tariffs falling from 100 percent in 1982 to 20 percent in 1988 . The

trade-weighted average tariff rate continued downward and today stands at

approximately 10 percent . By 1987, these and other policy changes "transformed

Mexico from an extremely closed economy into one of the most open ones in the

world ."" All this transpired seven years before NAFTA took effect .

Because Mexico instituted major trade policy reform before entry into

NAFTA, the trade agreement may be seen as the continuation of a long-term

process, at least as it affects the United States and Canada . Under NAFTA,

Mexico's few remaining import license requirements were converted to a system

of tariff-rate quotas that will be phased out . Tariff rates remain low and will

also disappear as the free trade agreement is fully implemented . Importantly,

as shall be seen, NAFTA consolidated Mexico's position on free trade with the

United States . The effect of Mexico's trade liberalization on trade volume with

the world is well documented . From 1982 to 1994, Mexican exports grew over

150 percent to $60 .9 billion . Perhaps most telling is that oil, as a percent of

total exports, fell from 77 .6 to 21 .4 percent. Over the same time period non-oil

export revenues (mostly manufactured goods) increased by over 450 percent .

Mexican imports also rose dramatically from 1982 to 1994, rising over 360

percent to $79 .4 billion ."

Lustig, Mexico : The Remaking of an Economy, p . 39 and CRS, United States-Mexico

Economic Relations, p . 4 . It should be noted that trade liberalization affected primarily

manufactured goods ; agriculture, services, and other important areas are still protected and will

be opened up under NAFTA .

Tornell, Aaron . Are Economic Crises Necessary for Trade Liberalization and Fiscal

Reform? The Mexican Experience . In Dornbusch, Rudiger and Sebastian Edwards, eds . Reform,

Recovery, and Growth: Latin American and the Middle East. Chicago, University of Chicago

Press, 1995. p . 53. See also : U .S . International Trade Commission . Review of Trade and

Investment Liberalization Measures by Mexico and Prospects for Future United States-Mexican

Relations . Publication 2275 . April 1990 . pp . 4-1 to 4-5 and USITC . 1995 National Trade

Estimate Report on Foreign Trade Barriers . pp . 229-236 .

Tornell, Aaron and Gerardo Esquivel . The Political Economy ofMexico's Entry to NAFTA .

Working Paper 5322 . Cambridge, National Bureau of Economic Research, October 1995 . Tables

2-3. International Monetary Fund . International Financial Statistics Yearbook, 1995, p . 541 .

CRS-12

Because the United States is Mexico's most important trading partner,

shifts in trade policy are particularly noticeable . As seen in figure 1, the level

of trade between the United States and Mexico experienced steady growth

between 1983 (the beginning of Mexican trade policy reform) and 1994

(NAFTA) ; both imports and exports rose dramatically, at a time when the

Mexican economy grew at an average annual rate of only 2 percent . In fact, real

GDP per capita did not grow at all ."

Table 3 . U.S: Mexico Trade Turnover and

U.S. Exports To Mexico as a Percent

of Mexican GDP, 1982 and 1994

1982

1994

Trade Turnover/Mexican GDP

15.8

28 .3

U.S. Exports/Mexican GDP

6.8

14 .4

Source : IMF, International Financial Statistics Yearbook, 1995.

The ratios of total bilateral trade and U .S. exports to Mexico's GDP also

provide a indication of trade openness . As seen in table 3, in 1982, U .S.-Mexican

trade turnover (imports plus exports) was 15 .8 percent of GDP and U.S. exports

alone amounted to 6 .8 percent of GDP . By 1994, these ratios rose to 28 .3 and

14.4 percent respectively . Clearly, trade with the United States has become a

more important factor in Mexico's economy . This growth in the level and

importance of trade is what would be expected of freer trade policies and it is no

coincidence that this growth occurred precisely at the same time that Mexican

trade policy reforms were implemented ."

OPEN TRADE POLICY AND THE 1995 CRISIS

The economic crisis in 1995 differed from 1982 in some technical aspects,

but Mexico faced the same fundamental problem : the inability to cover its

international obligations . Political events, higher U .S . interest rates, speculative

attacks on the peso, and Mexico's deteriorating economy eventually eroded

investor confidence . By 1995 the large current account deficit became a liquidity

crisis . Dollars fled north (held by both Mexicans and foreigners), foreign

reserves dwindled, and Mexico was forced to devalue and then float its currency .

As Mexico's largest trading partner, the United States saw its bilateral trade

balance fall into a large deficit position . Mexican imports to the United States

continued to climb as U .S . exports to Mexico fell . However, U .S . exports

declined by only about 11 percent in 1995 . As mentioned above this was a much

24 In 1990 dollars, Mexico's per capita GDP was $3,090 in 1985 and only $3,041 in 1994

Inter-American Development Bank . Economic and Social Progress in Latin America : 1995

Report . Washington, D .C ., The Johns Hopkins University Press, October 1995 . p. 263 .

25 Exchange rate policy and capital flows, as discussed earlier, were contributing factors .

CRS-13

smaller decrease than experienced in 1982 (35 percent) and 1983 (25 percent)

despite a much larger contraction in Mexico's economy .

The difference points to Mexico's more open trade policy, including acceding

to NAFTA, which kept Mexico from raising barriers to U .S . trade in response

to the crisis . Hence, the decline in exports represents the fall in demand that

accompanied the deep recession and the effects of the peso devaluation, as would

be expected. What the decline does not reflect is a formal policy to restrict the

flow of imports from the United States, which was in place in 1982, but absent

in 1995 . NAFTA, for its part, helped solidify Mexican commitments to an open

trade policy and actually cushion United States exports from more serious

repercussions .

In fact, it has been argued that this is one of the more important

achievements of NAFTA . Not only could Mexico not fall back on a protectionist

trade regime, but it is committed to continuing liberalization of trade policies in

agriculture, services, and other areas ." Although this is scant comfort to those

who are concerned with the 1995 trade deficit with Mexico, a bilateral trade

deficit is not a major economic problem for the United States and in any case,

the deficit is smaller than it might have been under a less open trade regime .

Additionally, under freer trade economists generally expect U .S. exports to

Mexico to recover more quickly than they did from the 1982 crisis under a closed

Mexican trade policy .

CONCLUSIONS AND OUTLOOK

Mexico remains a natural, and over the long run, growing market for U .S.

goods, which will become more evident when the Mexican economy recovers and

the long-term trend of trade and investment growth reemerges . This is a trend

that has been evident for decades and one that is dependent on Mexico's

economic stability and its willingness to maintain an open trade policy, an

option for which NAFTA may serve as an insurance policy . The Mexican case

supports the contention that trade liberalization, relative to a closed trade

policy, supports growth in trade and provides greater stability during times of

economic setbacks, other things being equal.

One problem is that other things are not always equal and it is these other

things that often cause short-term disruptions to long-term trade trends .

Mexico periodically experiences macroeconomic problems that are common

among developing economies, and in 1994 Mexico repeated many mistakes made

in 1982, except for trade policy . Its primary economic policies focus on resolving

such basic problems as tempering runaway inflation, maintaining a stable

exchange rate, managing current account balances, and attempting to achieve

long-term savings rates necessary for development . Mexico, like most developing

countries, looks abroad for resources to take up any slack in domestic savings .

Given Mexico's tendencies toward exchange-rate and indebtedness problems,

Tornell and Esquivel, The Political Economy of Mexico's Entry to NAFTA, p . 27.

CRS-14

often induced by policy decisions, balance of payment or liquidity problems can

arise periodically that eventually disrupt trade and investment flows .

Importantly, these problems can exist under either an open or closed trade

regime .

Although trade policy can encourage trade growth over the long run, it is

only one economic policy tool and not the most influential in managing

macroeconomic problems . In this case, trade agreements such as NAFTA are not

the cause of Mexico's current recession . Additionally, long-run policy goals

might consider the fact that Mexico's recovery and the continuation of U .S .

export growth to Mexico would be complementary events .

Finally, it is worth reiterating the limitations of trade agreements . They

are intended to reduce barriers to trade . They cannot guarantee any particular

level of trade flows among countries, nor can they guarantee that all businesses

will prosper . They do hold out the promise that business and trade success or

failure will be less affected by deliberate policies to block imports, as was evident

in Mexico in 1982, but not 1995 . Despite the unhappiness voiced by many over

NAFTA, moving back to a more closed trade posture with Mexico not only would

risk losing broader gains from freer trade, but also would not guarantee the

United States of being insulated from Mexican economic problems, as a

comparison of the 1982 and 1994 crises demonstrates .

CRS-15

APPENDIX 1 . U.S . MERCHANDISE TRADE WITH

MEXICO, 1977-1995

($ millions)

Year

U.S.

Trade

% Growth in

Exports

Imports

Balance

Turnover U.S. Exports

U.S. Imports

1977

4,733

4,769

-36

9,502

----1978

6,542

6,197

345

12,739

38 .2

29.9

1979

9,667

8,983

684

18,650

47 .8

45.0

1980

15,145

12,774

2,371

27,919

56 .7

42.2

1981

17,789

14,013

3,776

31,802

17 .5

9 .7

1982

11,817

15,770

-3,953

27,587

-33 .6

12 .5

1983

9,082

16,776

-7,694

25,858

-23 .1

6.4

1984

11,992

18,020

-6,028

30,012

32 .0

7.4

1985

13,635

19,132

-5,497

32,767

13.7

6.2

1986

12,392

17,302

-4,910

29,694

-9.1

-9.6

1987

14,582

20,271

-5,689

34,853

17 .7

17 .2

1988

20,628

23,260

-2,632

43,888

41 .5

14 .7

1989

24,982

27,162

-2,180

52,144

21 .1

16 .8

1990

28,279

30,157

-1,878

58,436

13 .2

11 .0

1991

33,277

31,130

2,147

64,407

17.7

3.2

1992

40,592

35,211

5,381

75,803

22 .0

13 .1

1993

41,581

39,917

1,664

81,498

2.4

13.4

1994

50,844

49,494

1,350

100,338

22 .3

24 .0

1995

45,401

61,705

-16,304

107,106

-10.7

24 .7

Source: U.S. Department of Commerce . Exports measured F .a.s ; Imports measured on customs

basis.

Note: Figures are in current dollars so growth rate calculations vary slightly from those adjusted

for inflation in figures 2.

CRS-16

APPENDIX 2. TOP 25 U.S. IMPORTS FROM MEXICO

($ millions)

1983

1986

1989

1992

1995

Total all commodities

17,302

78120--Motor vehicles, transport of persons, nes

®=®==

61,705

33300--Crude oil from petroleum/bituminous

minerals

7,521

3,262

4,014

4,362

5,417

77313--Ignition wirng sts, used in vehicle, etc

207

560

1,148

1,620

2,718

76110--Televisio eceivers, color

183

222

853

1,281

2,493

93100--Special transactions & commod

283

500

1,020

1,166

2,072

78219--Motor vehicles for the transport of gds

151

119

442

1,772

71322--Recip pist engs, cyl cap exceedng 1000 cc

441

756

660

671

1,557

78439--Pts, access : tractor, mtr veh, spec purpse

127

248

565

896

1,053

76211--Radiobroadcast receivers com sound,

extern power

270

531

543

1,010

78432--Brakes, servo-brakes, pts for motor

vehicles

179

398

862

953

75997--Parts :auto data proc mach/opticalreaders

76431--Transmission apparatus, tv, radio etc

105

82119--Parts of seats nes

50 =®

84140--Trousers, overalls, shorts etc, men/boys

278

129

®~

149

155

807

458

®'

168

650

75260--Input/output units : data processing sys

103

214

557

00119--Bov animals not pb breeding animals,live

139

282

284

341

546

71631--Electric motors exceeding 37 .5 w, ac

106

207

299

529

87325--Speedometers, tachometers, stroboscopes

525

07111--Coffee, not roasted, not decaffeinated

251

540

434

224

508

77259--Electrcl app for switch or protect

176

212

490

98400--Est of low valued import transactions

131

213

320

425

260

418

05440--Tomatoes, fresh or chilled

225

324

222

133

406

77641--Digital monolithic integrated units

106

133

385

Total of items shown

10,533

9,117

13,719

18,682

33,629

Total other

6,243

8,185

13,467

16,502

28,076

87465--Regulating & controlling inst & appts nes

U .S . Department of Commerce. Tradenet . Imports reported customs value. SITC 5 digit level .

CRS-17

APPENDIX 3. TOP 25 U .S. EXPORTS TO MEXICO

($ millions)

1983

Total all commodities

78439--Pts&access : tractor and motor vehicle

99400--Est . low value shp ; canadian low value

78432--Brakes & pts for motor vehicles

75997--Parts : auto data proc mach & optical

readers

9,079

205

142

1986

12,379

417

1989

24,969

1,116

1992

40,598

1,802

1995

45,401

1,636

178

189

676

611

1,375

1,542

1,625

1,389

263

392

447

740

669

629

89399--Articles of plastics

76493--Pts of tv rec, radiobroad rec, sound

record

184

142

594

342

823

77611--Television picture tubes, color

77313--Ignition

g sets, for vehicles, etc

77129--Pts of elec pwr machry (not rotating

ele pint)

33411--Gasoline ind aviation (except jet) fuel

114

333

103

247

570

490

238

660

374

560

547

573

516

143

507

501

450

485

77649--Elec integratd circts & microassemblies

77259--Electrcl app for switch or protect nes

at ex 1000

®®®

22220--So e

239

179

309

77282--Pts of elec a fo s

h g, protec g

lec circt

64211--C o s,

es &cases o uga ed

paper or board

M®

77220--Printed circuits

82119--Parts of seats nes

71322--Reciprocatng pist engs, cyl cap

exceedng 1000 cc

77643--Nondigital monolithic integrated units

69969--Articles of iron or steel, n .e .s.

04490--Maize (not including sweet corn)

unmilled, no seed

77867--Fixed capacitors, n.e .s.

71391--Parts, for use wt spk-ig int com eng

89319--Articles for conveyance/packing of

goods nes, plat

75260--Input or output units for data

processing systems

398

101

439

426

418

399

372

644

122

®®®®

342

184

252

®M

267

179

324

315

189

Total of items shown

1,984

2,484

6,559

11,241

14,986

Total other

7,095

9,895

18,410

29,357

30,415

Source : U .S. Department of Commerce . Tradenet. Exports reported F .a.s . SITC 5 digit level

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