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

Congressional research reportSep 2, 1997

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NAFTA, Mexican Trade Policy, andU.S.-Mexico

Trade: A LongerTerm Perspective

Updated September 2, 1997

(name redacted)

Specialist in International Trade and Finance

Economics Division

Congressional Research Service ˜ The Library of Congress

NAFTA, Mexican Trade Policy, andU.S.-Mexico Trade: A

LongerTerm Perspective

Summary

The North American Free Trade Agreement (NAFTA) has been in place for over

three years, and Congress continues to evaluate it as part of the trade policy process.

“Free trade” is a contentious debate and has become even more complicated in the

NAFTA context because of Mexico’s 1995 economic crisis. Many critics consider

the sudden shift from surplus to deficit in the U.S. trade balance with Mexico a clear

indication of NAFTA’s failure. Others see NAFTA as a positive force supporting

U.S. exports. To sort out the effects of trade agreements, this report evaluates the

U.S.-Mexico trade relationship over the past two decades to place recent events and

NAFTA in a broader economic context.

Over time, U.S.-Mexico trade has grown and diversified as the two economies

have become increasingly integrated. Yet, trade patterns have been volatile at times

for many reasons, including economic downturns in Mexico. To understand the role

of trade policy and agreements on trade flows, it is instructive to compare Mexico’s

1982 and 1995 economic crises because in the first Mexico operated under a closed

trade policy and in the second it had recently acceded to NAFTA as part of a longterm transition to an open trade policy. Both downturns had similar antecedents: an

overvalued peso, a balance of payments crisis, large capital outflows, and a currency

devaluation. Both were also severe, but the trade effects on the United States proved

much worse in the first instance.

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 34% in 1982 and

23% in 1983. Yet, in 1995, Mexico’s economy had contracted more severely than

earlier, with GDP falling 6.2% compared to 0.6% and 4.3% in 1982 and 1983. A

critical difference in the trade effects between the two periods was Mexico’s change

in trade policy, particularly adopting NAFTA, which kept Mexico from raising

barriers to U.S. trade in response to the crisis.

The 1995 decline in U.S. exports to Mexico was due to the recession-induced

fall in demand and the price effects of the peso devaluation. What the decline does

not reflect is a trade policy bent to restricting 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 a

more serious fall. Further, the trade deficit with Mexico has not been a major

economic problem for the United States as a whole given its global trading position.

Finally, under freer trade conditions, economists generally have expected U.S. exports

to Mexico to recover more quickly from the 1995 decline than they did from the 1982

crisis under a closed Mexican trade policy, which so far seems to be the case.

Contents

United States-Mexico Trade: 1977-1996 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

Economic Factors Affecting Trade . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

Macroeconomic Performance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

Exchange Rate Policy and Capital Flows . . . . . . . . . . . . . . . . . . . . . . . . . . 6

Economic Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

Mexican Trade Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Closed Trade Policy and the 1982 Crisis . . . . . . . . . . . . . . . . . . . . . . . . . 10

Trade Reform in the 1980s . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

Open Trade Policy and the 1995 Crisis . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

Conclusions and Outlook . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

Appendix 2. Top 25 U.S. Imports From Mexico . . . . . . . . . . . . . . . . . . . . . . . 16

Appendix 3. Top 25 U.S. Exports To Mexico . . . . . . . . . . . . . . . . . . . . . . . . . 18

List of Figures

FIGURE 1. U.S.-Mexico Merchandise Trade (1977-1996) . . . . . . . . . . . . . . . . 2

FIGURE 2. Real Growth in Mexican GDP and

U.S. Exports to Mexico (1978-1996) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

List of Tables

Table 1. Structural Changes in Mexican

Merchandise Exports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

Table 2. Net Capital Flows into Mexico, 1989-95 . . . . . . . . . . . . . . . . . . . . . . . 7

Table 3. U.S.-Mexico Trade Turnover and U.S. Exports To

Mexico as a Percent of Mexican GDP,

1982-1996 (Selected Years) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

Appendix 1. U.S. Merchandise Trade with

Mexico, 1977-1997 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

NAFTA, Mexican Trade Policy, andU.S.-Mexico

Trade: A LongerTerm Perspective

The North American Free Trade Agreement (NAFTA) has been operating for

over three years and Congress continues to evaluate its effects as part of the trade

policy process. Many hold NAFTA responsible for the dramatic events that unfolded

in 1994-95: the peso devaluation, Mexico’s economic collapse, and shift from surplus

to deficit in the U.S. balance of trade with Mexico. On the other hand, others cite

NAFTA as a major factor in opening Mexican markets to U.S. goods, thereby

contributing significantly to continued growth and prosperity of the U.S. economy.

As is frequently the case in polarized debates, neither extreme is fully vindicated by

economic theory or evidence.

In evaluating extreme changes in trade balances between two countries, it is

important to understand the fundamental economic forces at work. In the case of the

most recent U.S. trade deficit with Mexico, two major economic questions are

frequently posed. First, what role did trade policy and particularly NAFTA play in

causing the sudden shift in the U.S. trade balance with Mexico? Second, does a

bilateral trade deficit with Mexico present a major economic problem for the United

States?

This report considers trends in U.S.-Mexico merchandise trade over two decades

to evaluate how NAFTA may have affected the economic situation in Mexico and

U.S. trade. To gauge the effects of the agreement, it is instructive to revisit the “debt

crisis” period of 1982-83, when Mexico had a closed trade policy, and contrast it with

the repercussions of the 1994 peso devaluation, when Mexico operated under a more

open trade policy. What shall be seen is that trade agreements can affect the longterm level of trade, but do not cause sharp fluctuations in the balance of trade, which

are largely defined by domestic economic conditions and policies.1 Finally, it is worth

repeating that the benefits of freer trade are not measured in terms of annual trade

balances, but by broader economic changes that unfold over longer periods of time.2

This report does not delve into employment issues. See: U.S. Library of Congress.

Congressional Research Service. NAFTA: Economic Effects on the United States After Three

Years. Report No. 97-612 E, by Arlene Wilson. June 13, 1997, NAFTA: Estimated U.S. Job

“Gains” and “Losses” by State. Report No. 96-788 E, by (name redacted). September 25,

1996, and Weintraub, Sidney. NAFTA at Three: A Progress Report. Washington, D.C.,

Center for Strategic and International Studies, pp. 5 and 11-15.

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. 95529 E, by (name redacted). March 9, 1995.

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United States-Mexico Trade: 1977-1996

The United States and Mexico have had a long and sometimes stormy economic

relationship, and so the movement toward freer trade with Mexico continues to raise

concerns in the United States. Mexicans also have expressed reservations about being

overwhelmed by the “economic colossus” to their north. Because trade occurs

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

to the relationship that should be recognized.

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

for approximately 83 percent of Mexico’s exports and 77 percent of its imports in

1996. By contrast, Mexico is the United States’ third largest trading partner, but

accounted for only 9 percent of U.S. exports and imports in 1996.3 This is an

important distinction because despite ongoing interest in the level of U.S. exports to

Mexico, the U.S. economy is not greatly affected overall by the economic fortunes of

Mexico. To the contrary, because Mexico is dependent on the large U.S. economy

as its primary export market, it is far more vulnerable to changes in U.S. economic

trends.

FIGURE 1. U.S.-Mexico Merchandise Trade (1977-1996)

Despite this discrepancy in relative trade importance, bilateral trade for the most

part expanded evenly, if not briskly at times, over the past two decades. Between

1977 and 1996, trade turnover (exports plus imports) between the United States and

Mexico grew from $9.5 billion to $130 billion (see figure 1 and appendix 1.) The

U.S. balance of trade shifted back and forth from surplus to deficit, reflecting

changing economic fundamentals in both countries.

International Monetary Fund, Direction of Trade Statistics, June 1997. p. 135 and U.S.

Department of Commerce trade data.

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At least four 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, and 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, 1995-96 reflect Mexico’s most recent recession and incipient

recovery. Although U.S. exports to Mexico plunged in 1995, they actually grew

faster than U.S. imports from Mexico in 1996 and the first half of 1997.

In addition to the shifting fortunes in U.S.-Mexico trade over the past two

decades, the composition of trade between the two countries has changed rather

dramatically, particularly for Mexican exports. In the early 1980s, Mexico was, above

all else, an oil exporter, with oil accounting for nearly 60 percent of total export

revenue (see table 1). Half of all oil exports went to the United States at that time.

A major goal of Mexico’s trade liberalization was to diversify production and exports

away from such heavy dependence on oil. By 1996, although still an important

sector, oil production had not increased much from 1984 levels and accounted for

only 12 percent of total Mexican exports and 9 percent of exports to the United

States (see appendix 2.)4

Table 1. Structural Changes in Mexican

Merchandise Exports

Export Type

(in percent)

1984

1987

1990

1993

1996

Agriculture, Livestock, and

Fishing

Oil and Minerals

Manufactures

5.0

58.9

36.1

5.3

26.3

68.4

4.8

14.8

80.4

3.8

12.6

83.6

5.5

33.4

61.1

Source: Banco de Mexico. The Mexican Economy 1997. Table 47.

Interestingly, despite Mexico’s once heavy dependence on oil exports to the

United States, as it diversified its export base away from petroleum 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 83 percent by 1996. Some 84 percent of

Mexico’s exports are now manufactured goods, 70 percent of which end up in the

United States.5

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

States. New York, Oxford University Press, 1990. pp. 86 and 119, and Banco de Mexico,

The Mexican Economy 1997, tables 13 and 47.

Weintraub, ibid, pp. 73-75, Banco de Mexico, The Mexican Economy 1997, table 47, and

Vargas, Lucinda. The Maquiladora Industry: Still Going Strong (Part 2). Business Frontier,

(continued...)

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Maquiladoras, through joint production operations, play an important role in this

trade, with half of all Mexican manufacturing exports coming from these firms.

Maquiladoras are domestic- or 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 imported inputs and capital goods related to

maquiladora production even prior to NAFTA. The three largest maquiladora

industry sectors are electric and electronics equipment, transportation equipment, and

textiles/apparel. 6

On Mexico’s import side, between 70 and 80 percent tend to be intermediate

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

goods, account for approximately 15-25 percent of Mexico’s imports, with consumer

goods ranging from 5 percent during recessions to 15-20 percent during periods of

economic growth. 7 The dominance of intermediate goods again points to the

importance of the intra-industry 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 has been one of growth and diversification as the two

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

in a smooth upward direction, and to discern NAFTA’s possible role in Mexico’s

recent economic problems, it is essential to understand some of the factors that affect

short-term fluctuations in trade including economic growth, exchange rate policy, and

capital flows. Because events causing the collapse of the 1994 peso are reminiscent

of those in 1982, and because Mexico was operating under different trade policies,

the two periods are contrasted.

Macroeconomic Performance

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

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,

(...continued)

Issue 4, 1996. Federal Reserve Bank of Dallas, El Paso Branch.

Ibid.

Banco de Mexico, The Mexican Economy 1997, table 47.

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often abruptly, which also diminishes demand for imports. These short-term swings

can affect trade balances irrespective of trade policy or agreements.

FIGURE 2. Real Growth in Mexican GDP and

U.S. Exports to Mexico (1978-1996)

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

1996. Figure 2 shows the potential for volatility in annual bilateral 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 1996 recovery shows expected return to

growth of U.S. exports to Mexico.

Sudden declines in U.S. exports to Mexico are clearly 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 34 and 23 percent for a total decline

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

GDP fell 6.2 percent in 1995 alone, the largest single year decline since the Great

Depression and 50 percent more than in 1983. Yet, U.S. exports to Mexico fell only

11 percent in 1995 or about half of the decline witnessed in 1983. This suggests that

in both cases the recession was an important factor affecting U.S.-Mexico trade, but

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?

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Exchange Rate Policy and Capital Flows

Exchange rate policy and capital flows can exert a major influence on 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 in 1994 when very large inflows of foreign

capital caused the peso to become overvalued and Mexican economic policy did not

make the necessary adjustments.8

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 minidevaluation 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) 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 tends to appreciate. As the real

value of the peso appreciates, the “nominal value” becomes increasingly less credible,

raising concerns about a possible devaluation.9

Because of the similarities between 1982 and 1994, emphasis is placed on the latter period.

Prior to 1982, Mexico had a fixed exchange rate compared to a “crawling peg” used prior to

the 1994 devaluation. For all practical purposes, the crawling peg became a fixed exchange

rate by 1994 (if not earlier) 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.

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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 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.10

Capital flows into Mexico were also 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 adopted 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 generously. Capital investment began to trickle into Mexico in 1989, and as

documented in table 2, rushed in thereafter until 1994.11

Table 2. Net Capital Flows into Mexico, 1989-95

($ billions)

Invest

Type

1989

1990

1991

1992

1993

1994

1995

Direct

Portfolio

Other

2.8

0.3

-2.0

2.6

-4.0

9.9

4.7

12.1

8.3

4.4

19.2

3.4

4.4

28.4

1.0

11.0

7.6

-2.8

7.0

-10.8

-7.9

Total

1.1

8.5

25.2

27.0

33.8

15.8

-11.7

Source: IMF, International Financial Statistics, August 1997, p. 474.

Other = currency and deposits, loans, and trade credits.

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 lowered the price of imports and raised

the price of exports, so Mexico began to run large trade and current account deficits

that matched the capital inflows. When circumstances change, capital flows can

suddenly slow or reverse themselves, particularly portfolio capital (stocks and bonds),

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.

1994 was the turnaround year. The $7.6 billion in portfolio capital is deceptive because it

reflects an inflow of capital at the beginning of the year followed by a large capital outflow

the rest of the year.

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which is highly liquid compared to direct foreign investment (plant and equipment).

The sudden reversal of capital flows in 1994 presented serious problems for Mexico

because it then had a large current account deficit, an overvalued exchange rate, and

insufficient foreign exchange reserves to defend the exchange rate, which was under

downward pressure from the massive capital outflows.12

In addition to exchange rate policy and capital flows, 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.

Further political turmoil led to a final run on the peso in November 1994 as the fear

of devaluation spread.13

Economic Policy

Although changing economic and political events (shocks) encouraged capital

flight, it was Mexico’s economic policy that doomed the peso to devaluation. Rising

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

Mexico would have had to tighten its monetary policy in like manner to continue to

attract capital, but during an election year Mexico found it difficult to raise interest

rates to maintain its relative competitiveness in the international capital market. In

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

maintenance of a fixed exchange rate with the United States.14 This decision was

tantamount to allowing 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.

At this point, Mexico faced three unattractive options: (1) raise interest rates to

match U.S. policy and continue to attract (or slow the retreat of) foreign capital; (2)

devalue the peso; or (3) do nothing to buy time, but risk more severe financial

difficulty in the future. Option one proved unacceptable because it risked almost a

sure recession prior to a presidential election. Option two was apparently debated,

but discarded because Mexico staked its economic reputation on defending the peso.15

Option three unfolded by default.

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. 277.

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 (name redacted).

September 27, 1995.

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

Ibid, p. 241.

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

peso in 1994 and began abandoning it when given the opportunity to move toward

a short-term, dollar-indexed investment instrument known as the tesobono.16 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 helped cause the peso’s undoing. Under adverse

conditions, Mexico could not continue to peg the peso to the dollar and follow a

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 unresolved debate over the proper Mexican response continues and the two

main camps are: Mexico should have tightened fiscal and monetary policies to avoid

devaluation, or it should have devalued the peso much earlier and accepted the

consequences before they became so severe. In any event, as Mexico was forced to

adjust to dwindling capital, its trade deficit had to correct, so exports rose and imports

fell. Accordingly, the balance of trade with the United States went from a surplus to

a deficit. The key points are that the seeds of this broad problem were planted years

before NAFTA was contemplated and that the final collapse of the peso resulted more

from domestic economic rather than trade policy reasons.17 In fact, Mexico faced this

problem in 1982 under a closed trade policy and again in 1994 under a more open

trade policy.

Mexican Trade Policy

The preceding discussion points to many interconnected economic factors 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 in that they were preceded by an overvalued peso, balance of

payments crisis, capital outflows, and a major devaluation, causing U.S. exports to

fall.18 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), had no significant effect on the macroeconomic situation given other factors,

but had a noticeable trade effect by keeping Mexico from imposing import restrictions

on the United States as it did in 1982.

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.

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 (name redacted).

6 p.

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Closed Trade Policy and the 1982 Crisis

Prior to the 1982 crisis, 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.19

As the 1980s approached, Mexico’s economy continued to grow based on heavy

external borrowing backed by seemingly unlimited oil revenues, resulting in large

current account deficits. The 1982 balance of payments crisis occurred because

Mexico overborrowed and could not meet growing international debt service

payments when world interest rates rose and oil prices plummeted. 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.20

To resume meeting its debt obligations, Mexico raised 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 experienced observer has

pointed 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.”21

The result for the United States was a huge fall in exports to Mexico, as seen in figure

Trade Reform in the 1980s

Despite the initial strengthening 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 also a logical step in this progression.22

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

Institution, 1992. pp. 114-15.

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

Weintraub, Sidney. The Promise of United States-Mexican Free Trade.

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

Texas

Lustig, Mexico: The Remaking of an Economy, p. 39. It should be noted that trade

liberalization affected primarily manufactured goods; agriculture, services, and other

(continued...)

CRS-11

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 (5

percent under NAFTA). By 1987, these and other policy changes “transformed

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

world.”23 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 its trade volume with the world is

easily documented. From 1982 to 1996, Mexican exports grew from $24.1 to $96.0

billion or nearly 300 percent. Perhaps most telling is that oil, as a percent of total

exports, fell from 77.6 to 12.6 percent. Over the same time period, Mexican imports

rose over 400 percent from $17.0 to $89.5 billion.24

Because the United States is Mexico’s most important trading partner, shifts in

trade policy are particularly noticeable in the bilateral trade data. 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 had not

grown at all. 25

(...continued)

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.

International Monetary Fund. International Financial Statistics Yearbook 1996, p. 543 and

Banco de Mexico, The Mexican Economy 1997, table 47.

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.

CRS-12

Table 3. U.S.-Mexico Trade Turnover and U.S. Exports To

Mexico as a Percent of Mexican GDP,

1982-1996 (Selected Years)

Trade Turnover/Mexican GDP

U.S. Exports/Mexican GDP

1982

1987

1992

1994

1996

15.7

6.7

25.3

10.6

22.7

12.2

26.8

13.6

44.7

19.6

Source: IMF, International Financial Statistics Yearbook, 1996 and U.S.

Department of Commerce. TPIS.

Data in table 3 also show the growing importance of U.S. trade to Mexico’s

economy. In 1982, total trade between the United States and Mexico, or trade

turnover (imports plus exports), equaled 15.7 percent of Mexico’s GDP and U.S.

exports to Mexico alone amounted to 6.7 percent of its GDP. By 1994, these ratios

rose to 26.8 and 13.6 percent, respectively. Clearly, trade with the United States has

become a more important part of 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.26 (The large jump in these ratios for 1996 reflect

these same trends, but also the effect of the 1995 recession on GDP, which served to

lower the ratio’s denominator.)

Open Trade Policy and the 1995 Crisis

The details of the economic crisis in 1995 differed from 1982 in some respects,

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

international obligations. By 1995 the large trade and current account deficits had to

be corrected and as Mexico’s largest trading partner, the United States saw its

bilateral trade balance reverse to 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 smaller decrease than experienced in 1982 (34 percent) and 1983 (23 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 tariff increases ranging from 20 to 35 percent that

Mexico imposed on many goods from countries with which it had no equivalent

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

CRS-13

agreement. The U.S. trade deficit therefore, was smaller than it might have been

under a less open trade regime.27

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.28 Although this is scant comfort to those who are concerned with a

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

United States given its broad global trade relationships.29 Additionally, under freer

trade conditions economists generally expected U.S. exports to Mexico to recover

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

which figure 1 and appendix 1 suggest has so far been the case.

Conclusions and Outlook

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

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

long-term trend of trade and investment growth reemerges, as it appears to be doing.

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

(economic and political shocks) 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 longterm 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, often

exacerbated by policy decisions, balance of payment or liquidity problems can arise

periodically that eventually disrupt trade and investment flows. Importantly, these

problems can arise under either an open or closed trade regime.

United States Trade Representative. 1996 Foreign Trade Barriers. Washington, D.C. p.

239.

Tornell, Aaron and Gerardo Esquivel. The Political Economy of Mexico’s Entry to

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

1995. p. 27.

For a discussion of the significance of the entire U.S. trade deficit, see: U.S. Library of

Congress. Congressional Research Service. U.S. Trade Performance: Recent Trends and

Policy Options. Report No. 97-487 E, by (name redacted). April 24, 1997.

CRS-14

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, a trade agreement such as NAFTA was not the cause of

Mexico’s 1995 recession, but it was able to reduce, although not eliminate, the

recession’s negative trade effects on the United States. Only with Mexico’s recovery,

which depends more on Mexico than a trade agreement, will U.S. export growth

continue its upward climb.

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

intended to reduce barriers to trade and encourage growth in trade between countries.

This has occurred with Mexico and the United States. Trade agreements, however,

cannot guarantee any particular balance of trade between 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 doubts 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, 1977-1997

($ millions)

Year

U.S.

Exports

U.S.

Imports

Trade

Balance

Trade

Turnover

% Growth

in U.S.

Exports

% Growth

in U.S.

Imports

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997(P)

4,733

6,678

9,843

15,141

17,780

11,739

9,079

11,978

13,628

12,379

14,570

20,633

24,969

28,375

33,276

40,597

41,635

50,840

46,401

56,761

65,430

4,769

6,100

8,829

12,573

13,799

15,566

16,776

18,020

19,132

17,302

20,271

23,277

27,186

30,172

31,194

35,184

39,930

49,493

61,705

72,963

81,846

-36

578

1,014

2,568

3,981

-3,827

-7,697

-6,042

-5,504

-4,923

-5,701

-2,644

-2,217

-1,797

2,082

5,413

1,705

1,347

-15,304

-16,202

-16,416

9,502

12,778

18,672

27,714

31,579

27,305

25,855

29,998

32,760

29,681

34,841

43,910

52,155

58,547

64,470

75,781

81,565

100,333

108,106

129,724

147,276

––41.1

47.4

53.8

17.4

-34.0

-22.7

31.9

13.8

-9.2

17.7

41.6

21.0

13.6

17.3

22.0

2.6

22.1

-8.7

22.3

15.3

––27.9

44.7

42.4

9.8

12.8

7.8

7.4

6.2

-9.6

17.2

14.8

16.8

11.0

3.4

12.8

13.5

23.9

24.7

18.2

12.2

P = preliminary numbers annualized from 1997 mid-year (six month) trade data.

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

adjusted for inflation in figure 2.

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

on customs basis.

CRS-16

Appendix 2. Top 25 U.S. Imports From Mexico

($ millions)

1984

Total all commodities

oil

1990

1993

1996

18,020 20,271 30,172 39,930 72,963

78120–Motor vehicles/transport of persons, nes

33300–Crude

minerals

1987

34 1,176 2,164

3,084

7,902

petroleum/bituminous 6,700 3,520 4,822

4,245

6,356

78219–Motor vehicles/transport of goods,

n.e.s.

229

543

3,052

77313–Ignition wirng sts, etc, used in vehicls

312

731 1,216

1,878

3,014

76110–Television receivers, color

179

338

916

1,589

2,749

93100–Special transactions & commod not

classif by kind

326

622 1,008

1,335

2,241

71322–Reciprocatng pist engs, cyl cap

exceedng

1000 cc

533

823

543

749

1,626

151

1,263

78439–Pts & access of tractor, mtr veh, spec

purpse, nes

212

317

582

957

1,187

78432–Oth pts & access of motor veh bodies

(includ cabs)

226

507

1,155

1,143

76431–Transmission apparatus, tv, radio etc.

117

152

199

183

1,095

76211–Radiobroadcast receivers com sound,

extern

power

137

437

520

601

1,079

82119–Parts of seats nes

137

115

532

938

75997–Parts of auto data proc mach & optical

readers etc

265

485

924

76493–Pts of tv rec, radiobroad rec, sound

record

486

487

672

806

844

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

not

knit

120

154

335

833

71631–Electric motors exceeding 37.5 w, ac

131

209

355

612

75260–Input or output units for data processing

systems

120

209

604

05440–Tomatoes, fresh or chilled

169

159

371

304

580

84260–Trousers etc, women/girls, textile fab,

not

knit

162

507

98400–Estimate of low valued import

transactions

139

127

292

359

498

75230–Digital processng units

CRS-17

1984

1987

1990

495

77121–Static converters (e.g., rectifiers)

116

177

130

160

480

74159–Parts for air conditioning machines of hd

741.5

133

479

77315–Elec conductrs, exc 80 v nt exc 1000 v

187

325

269

476

84540–T-shirts, singlets & oth vests, knit or

chrochet

1993

1996

Total of Items Shown

10,005 10,307 15,664 20,547 40,977

Total Other

8,015 9,964 14,508 19,383 31,986

Source: U.S. Department of Commerce. TPIS. Imports reported customs value SITC 5 digit

level.

CRS-18

Appendix 3. Top 25 U.S. Exports To Mexico

($ millions)

1984

1987

1990

1993

1996

Total all commodities

11,978 14,570 28,375 41,635 56,761

78439–Pts & access of tractor, mtr veh, spec

356

511 1,812 1,779 2,343

purpse

99400–Est. low val shp; can low value & n.i.k.

339 1,110 1,412 1,952

(exports)

78432–Oth pts & access of motor veh bodies

152

231

807 1,574 1,188

(includ cabs)

04490–Maize (not including sweet corn)

402

275

402

43 1,014

unmilled,

no seed

75997–Parts of auto data proc mach & optical 255

340

403

656

933

readers etc

77611–Television picture tubes, color

142

360

927

89399–Articles of plastics nes

214

399

891

78120–Motor vehicles for the transport of

183

122

865

persons

22220–Soybeans

485

220

211

421

859

77282–Pts of elec app for switchng, protectng

349

372

703

elec

circt

77313–Ignition wirng sts, etc, knd used in

179

401

374

815

701

vehicls

75230–Digital processng units

189

628

77643–Nondigital monolithic integrated units

576

77259–Electrcl app for switch/protect nes nt ex

182

545

1000

77220–Printed circuits

103

102

541

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

132

539

33411–Gasoline including aviation (except jet)

197

457

530

fuel

77645–Hybrid integrated circuits

117

167

503

69421–Screws, bolts, nuts, threaded, iron or

130

476

steel

64211–Cartons, boxes, cases, corrugated

170

271

476

paper/board

77129–Pts of elec pwr machry (oth rotating ele

305

437

446

plnt)

82119–Parts of seats nes

181

458

443

77641–Digital monolithic integrated units

103

123

212

419

CRS-19

71391–Parts, n.e.s. suitbl for spk-ig int com eng

76493–Pts of tv rec, radiobroad rec, sound

record

Total of Items Shown

Total Other

1984

1987

1990

1993

1996

207

133

151

170

199

623

242

750

405

401

2,710 3,266 8,370 11,699 19,304

9,268 11,304 20,005 29,936 37,457

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

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