May 2004
By ROBERT PEGG
This year marks a decade that the North American Free Trade Agreement went into effect. At the time, the debate of its passage centered on whether young Mexicans, given productive lives, would be able to raise their standard of living and buy American products. NAFTA was intended to spur U.S. exports and jobs, suppressing illegal Mexican immigration and cementing a better relationship between Mexico and the U.S. The treaty was seen as a laboratory for regional integration and globalization.
Many American manufacturers, driven by intense competition from Asia, ran to Mexico to take advantages of wages that were 10 percent of those in the U.S. Foreign investment flooded Mexico and it rose to an average of about $12 billion a year Ð approximately three times what India takes in. Mexico's exports tripled and its per capita income rose 24 percent and is now about 10 times China's. Mexico's economy now stands as being the ninth largest in the world, up from number 15 almost a decade ago. More important perhaps, the pact stimulated profound political changes in Mexico, giving them open markets and a more open political system. Moreover, the Mexican experience was supposed to encourage other Latin American countries to open up their political and economic systems too.
Early on, NAFTA was proven a powerful reform. When the peso crisis occurred in 1994, Mexico did not increase its import tariffs. As a result, the U.S. developed a bailout package that helped Mexico stabilize its finances and return to the capital markets in under a year. Although difficult for the Mexican economy, the peso's devaluation lowered the costs of Mexican labor and exports, benefiting the U.S. It enabled the Mexican government to exert fiscal discipline on its economy and ultimately earned Mexico an investment-grade rating on its debt.
On the American side, the worst predictions did not happen, although domestic jobs were lost. Indeed, more American jobs have been lost to China and India than to the NAFTA agreement. Nonetheless, former President Clinton predicted that NAFTA would create 200,000 jobs. However, jobs unquestionably were lost to Mexico. Despite differing assessments by different studies, a U.S. government study concluded that more than 525,000 workers have lost their jobs due to NAFTA. This loss of jobs was masked by the booming U.S. economy, which at the time enjoyed record low unemployment rates.
Nonetheless, critics of the pact have not been silenced, and after 10 years many analysts now see that NAFTA has not come without its shortcomings. While some predicted soaring Mexican salaries, real wages in Mexico are lower today than when NAFTA was approved and has not kept pace with productivity gains, according to a study by the Carnegie Endowment for International Peace. The rural sector has lost 1.3 million jobs and neither poverty nor the flow of undocumented workers has abated at the borders. Government statistics show that while extreme poverty has indeed fallen sharply, the number of people classified as poor or extremely poor has risen from 62 million over the decade to 69 million, out of a population of more than 100 million.
The wild card in the process has been the emergence of China. Since 2000, factories in Chinese export zones have replaced small towns in Mexico as the favorite of U.S. multinational corporations. More than 300,000 Mexican workers have lost their jobs since 2000. Under NAFTA, the number of assembly plants operating in Mexico rose 67 percent in the 1990s. However, since 2000, 850 plants have closed, shifting their venues to cheaper locations. Moreover, Mexico failed to use NAFTA's initial flood of dollars to invest in education and needed infrastructure projects such as power plants, highways and water treatment facilities. A recent report by the Fitch credit rating agency noted that lagging infrastructure was causing Mexico to become less competitive in the world's markets.
The outcome of NAFTA is still open. Mexico's struggle to regain economic momentum, after a recession, is of vital interest to Latin America and the U.S. The U.S. benefits from a prosperous Mexico on its border to stem the flow of illegal immigration and drugs. Mexico's ability to move ahead will test whether low-wage economies around the world will be able to hold their own against China.
About the author: Mr. Pegg is managing director of Tocqueville Asset Management LP, the New York City-based investment advisory firm which serves businesses, institutions and private individuals.