Brad DeLong "Afta Thoughts on NAFTA" October 16, 2006

Professor Brad DeLong shares some his reflections on NAFTA, which he helped to craft during his tenure as Deputy Assistant Secretary of the Treasury for Economic Policy.

Download a podcast of this event here (requires iTunes)

- Article on the talk by Professor DeLong
- Professor DeLong's article in the Berkeley Review of Latin American Studies

“I was a true believer in NAFTA--the North American Free Trade Agreement. Now my faith is not gone but shaken.” So states Brad DeLong, economist and creator of one of the net’s most popular weblogs on economics, at www.j-bradford-delong.net.

Afta Thoughts on NAFTA: The Right Way for Mexico?
By Lauge Skovgaard Poulsen

Now more than a decade old, the North American Free Trade Agreement — NAFTA — has not proved to be the developmental building block for Mexico many believed it would be. In order to reap the promised benefits of NAFTA — and free trade in general — Mexico needs to turn its attention to domestic policies and institutions.

Not many years ago Economics Professor J. Bradford DeLong was a strong believer in NAFTA. As late as January 2000, DeLong concluded on his poplar internet blog that even though NAFTA had been associated with yet another peso-crisis, the agreement, “has done its job, has fulfilled its intended task: it has given some extra strength to the forces in favor of Mexican industrialization, modernization and democratization.” By the time of his October CLAS talk, DeLong was no longer so sure.

In theory NAFTA was bound to be a success for Mexico when it came into effect in 1994. The combination of guaranteed tariff-free access to the world’s largest consumer market and a new Mexican government dedicated to enforcing and improving private property laws would mean a massive increase in Mexico’s exports as well as a boost in investment from abroad. In turn, this would lower unemployment in Mexico , increase wages for Mexican workers, establish a broad middle class and “tie in” prudent political reforms. This would not only benefit Mexico; the U.S., too, had an interest in a stable and prosperous southern neighbor.

Some of these benefits actually came through. In important sectors like autos and textiles increased specialization and division of labor have in fact been good for Mexico . Mexican exports have gone from 10 percent of GDP in 1990 to around 28 percent of GDP today. “ Mexico has globalized with a vengeance under NAFTA, ” as DeLong put it. Second, the chapter on investment protection in NAFTA and general adherence to private property rights in Mexico also seem to have brought benefits. Foreign investment has increased significantly since the passage of NAFTA, resulting in a healthy capital-stock growth over the last decade. This is all good news.

On other indicators, NAFTA’s track-record has not been that impressive. Rapidly rising living standards? Not really. The mean income in Mexico today is barely 15 percent above 1994 levels. Mexican real GDP has grown by 3.6 percent per year in the decade since NAFTA, but Mexico ’s population has grown by 2.3 percent per year, leaving only 1.3 percent per year for the growth rate of average incomes and living standards in Mexico . Growth has thus been slower than in Europe and the U.S. , resulting in Mexico now being further behind the U.S. in terms of relative economic prosperity than it was when NAFTA was passed. In this case, free trade has not resulted in a convergence between rich and poor countries. On the contrary — the gap has grown.

Increased living-standards for the poor? Hardly. Having to compete with far more effective (and subsidized) U.S. farm producers, rural Mexicans have seen their living standards fall over the past decade. Relatively poor urban workers may have gained a little from NAFTA, but wages of urban workers have in general lagged behind real GDP. Inequality within Mexico has thus risen over the past decade. NAFTA has therefore not delivered the increases in productivity and working class wages that neoliberals, like DeLong himself, would have confidently predicted at the beginning of the 1990s.

For economists and believers in free trade this is a puzzle. Why has opening up the Mexican economy not brought the benefits that other countries have experienced since the days of Adam Smith and David Hume? DeLong mentioned several possible explanations based on his ongoing research.

Professor DeLong pointed out NAFTA's successes (the growth of the export sector of the Mexican economy, e.g.) but also its shortcomings, including capital outflows from Mexico to the U.S. and its failure to foresee the explosive growth of China and its effect on the Mexican economy.

The first answer could be that NAFTA actually has worked, but things are just taking longer than expected. NAFTA supporters were perhaps a bit too optimistic in their enthusiasm to convince both Mexican and American politicians to support the agreement. They also overlooked one key structural restraint on the Mexican economy: with population growth of 2.3 percent a year, increased economic output is mostly used to feed more mouths and equip more workers rather than actually improving people’s lives. Mexicans may just have to wait until the birthrate drops at which time the benefits of NAFTA may in fact reveal themselves.

Another explanation could be the rise of China . By pursuing export-led development, many thought Mexico would follow the same path as Japan and the four Asian Tigers by capitalizing on competitiveness in low-cost labor. However, NAFTA came into effect just as China began to produce low-cost goods for Western consumers on a scale and at a price Mexico has not been able to compete with. So with a rising China participating in the “export-led development game,” perhaps there is no room for other players.

Even though these are plausible explanations, the simple fact is that the reasons for NAFTA’s lack of success still remain somewhat of a mystery. Nonetheless, DeLong argued that Mexico most likely would have been better off if, in the early 1990s, it had focused on domestic issues such as improving its miserable education system and stamping out widespread corruption rather than spending political capital on free trade with America.

Therefore, in a post-Doha era, with an increasing number of developing countries signing regional trade agreements, the Mexican experience should cause them to reconsider their priorities. At a minimum, it shows that free trade is not a cure-all if domestic institutions and policies are hampering social and economic development.

J. Bradford DeLong is Professor in Economics at U.C. Berkeley and worked on NAFTA under the first Clinton administration. He spoke at the Women’s Faculty Club on October 16.

Lauge Skovgaard Poulsen is a graduate exchange student.

Professor DeLong took questions from the audience on such issues as explaining Latin American support for a Free Trade Agreement for the Americas.