NAFTA and the Mixed Effects of Trade: A Mexican Case Study

In August 2017, the United States, Canada, and Mexico began renegotiations of the North American Free Trade Agreement (NAFTA)—one of President Trump’s top priorities during his electoral campaign. Trump argued that trade with Mexico and Canada had resulted in job losses and trade deficits, particularly with Mexico. Negotiations are scheduled to end in December, however, this deadline is flexible and negotiations could be postponed until January of the following year.

In this context, it is important to assess NAFTA’s consequences on employment and trade. From the Mexican perspective, a recent study by the Central Bank of Mexico analyzes two phenomena: the consequences of the implementation of NAFTA in the 1990s, and the admission of China into the World Trade Organization (WTO) in 2001 on Mexican labor markets.

On the one hand, NAFTA resulted in increased Mexican manufacturing exports to the U.S. After NAFTA’s implementation, Mexico expanded its production-sharing agreements under which the country imported manufacturing components and exported finished goods to the U.S. On the other hand, after China’s admission to the WTO, Chinese exports to the U.S. increased, which implied greater competition and substitution for Mexican exports. Thus, NAFTA initially yielded benefits for Mexico’s labor markets, but as China’s trade liberalization grew, resulted in negative effects on Mexico’s employment rate, particularly in regions more exposed to international trade and heavily reliant on unskilled labor.

To measure this effect, the authors used a statistical method known as “instrumental variables,” a type of instrument that exploits correlation with some factors to explain an intended outcome. The outcome variables are the change from 1993 to 2000 (for NAFTA estimations) or from 2000 to 2008 (for China estimations) in the rates of unemployment, employment, and wages in Mexico. The variable that affects that outcome is the measure of exposure of a certain area to NAFTA integration or Chinese competition in U.S. markets. For estimating the effects of substitution for Chinese goods, the authors used the change in Chinese exports to eight developed countries (Australia, Denmark, Finland, Germany, Japan, New Zealand, Spain and Switzerland) from 2000 to 2008 as the instrumental variable. This variable enables them to capture only the effects of an increase in China’s export capacity.

The results suggest that NAFTA integration reduced unemployment of unskilled workers in manufacturing and increased real wages in Mexico. An increase in the NAFTA exposure measure from the 25^th percentile to the 75^th percentile is associated with a 24 percent decrease in the number of unemployed workers, or a 1.05 percentage point decrease in the unemployment rate. On the other hand, Chinese competition increased the unemployment rate of manufacturing workers and decreased non-manufacturing wages in Mexico. Wages decreased in response to reduced employment in manufacturing, increasing the supply of workers in non-manufacturing sectors. The authors also found that both the positive and negative effects of the implementation of NAFTA and China’s accession to the World Trade Organization were stronger in regions closer to the U.S. border which host large export-oriented industries.

This study supports the idea that the consequences of trade should be studied on a regional basis as some regions are more specialized in certain industries or more exposed to international markets. Moreover, this research reveals that international trade should be approached holistically. A country can benefit from one treaty, but be negatively affected by another treaty or action that does not involve that country. Country A can have significant gains from doing trade with country B and can run a trade deficit with country C. Thus, the negotiators of NAFTA in their forthcoming meeting should emphasize job creation and trade growth rather than creating trade surpluses for all countries that are part of the treaty.

Article source: Chiquiar, D., Covarrubias, E., Salcedo, A. “Labor Market Consequences of Trade Openness and Competition in Foreign Markets.” Banco de México, Working Papers, No. 2017-01. (2017).

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