Chapter 13 Economic Integration in North America Copyright © 2011 Pearson Addison-Wesley. All rights reserved. Chapter Objectives • Explore the formation and impact of the Canadian-United States Trade Agreement (CUSTA), the North American Free Trade Agreement (NAFTA), and the Dominican Republic-Central American Free Trade Agreement (DR-CAFTA) • Understand the sources of political controversy surrounding NAFTA’s negotiations and ratification Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 13-2 Introduction: Expanding Economic Relations • The North American Free Trade Agreement (NAFTA) came into effect on January 1, 1994 • For many U.S. economists, it seemed odd that a relatively dry and straightforward agreement would turn into one of the most contentious economic issues of the 1990s • However, there were many aspects of the agreement that were controversial Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 13-3 Economic and Demographic Characteristics of North America • Enormous market: larger than the EU • Vast income differences exist between Mexico on the one hand, and the U.S. and Canada, on the other – However, the purchasing power parity gap is smaller – On average, the North American market is very rich • The North American market is marked by numerous difficult policy questions on migration and environmental and labor standards, for example Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 13-4 TABLE 13.1 Population and GDP for NAFTA Countries, 2007 Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 13-5 TABLE 13.2 Merchandise Trade Within the NAFTA Region, 2007 (Millions of U.S. $) Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 13-6 FIGURE 13.1 Canada–United States Total Trade, 1985-2008 Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 13-7 The Canada-U.S. Trade Relationship: The Canadian–U.S. Trade Agreement (CUSTA) of 1989 • Helped Canada overcome growing U.S. protectionism and Asian competitiveness – However, many Canadians feared competition by U.S. firms, erosion of Canada’s social programs, and U.S. cultural influence • Rather modest impact – In 1989–1994, U.S. exports to Canada grew by 46.6%, and Canadian exports to the U.S. by 55% – Canadian fears were largely unfounded Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 13-8 Recent Mexican Economic History • The decision to seek closer economic ties to the United States was one of many major policy changes that Mexico made between the late 1980s and early 1990s • Mexico’s shift from a closed and inward economic orientation to an open and outward set of policies began in the mid-1980s after a long period of crisis caused by international trends and a series of domestic policy mistakes Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 13-9 The Slowdown in Economic Growth • In the late-1970s, Mexico was prospering due to high revenues from oil production • However, problems emerged in 1981 – World oil prices declined, reducing Mexico´s credit worthiness – A dramatic rise in U.S. interest rates increased the interest charged on Mexico’s debt with commercial banks • In August 1982, the debt crisis began: Mexico suspended payments of the principal of its debts Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 13-10 The Lost Decade of the 1980s • The 1980s was considered the “Lost Decade” in Latin America: GDP growth was nonexistent, foreign capital stopped flowing in, credit became scarce, investment declined • Between the end of World War II and 1980s, Mexico followed inward-oriented import substitution industrialization (ISI) policies: industrial policies targeting the development of manufacturing sectors that can compete against imported goods Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 13-11 Economic Policy Reforms in the Mexican Economy • The economic crisis stemmed from macroeconomic mismanagement: large government expenditures had increased borrowing and indebtedness • Budget cuts and inflation had a social cost: real wages fell by 40–50% in 1983–1988 Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 13-12 The North American Free Trade Agreement (NAFTA) of 1994 • As a result of the agreement, tariffs on about half of the goods traded between U.S. and Mexico were eliminated immediately – Most dramatic changes in Mexico were: average tariffs on U.S. goods fell from 10% to 2.9% between 1993 and 1996, while U.S. tariffs on Mexican goods fell from 2.07% to 0.65% • NAFTA specified content requirements for goods subject to free trade • NAFTA established a system of trade dispute resolution Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 13-13 The NAFTA Debate in the United States: Labor Issues • NAFTA reignited contention on trade policy in the U.S. – Blue collar labor unions feared jobs would migrate to the South given Mexico’s lower labor costs • Political opposition forced Canada, Mexico, and the U.S. to attach a labor-side agreement to NAFTA, which was the North American Agreement on Labor Cooperation Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 13-14 The NAFTA Debate in the United States: Environmental Issues • Environmental groups feared that (1) polluting U.S. and Canadian firms would move to Mexico, and (2) pollution would increase along the U.S.Mexico border • Environmental-side agreements to NAFTA were the North American Agreement on Environmental Cooperation and the North American Development Bank (NADBank) to help finance border cleanup costs Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 13-15 The NAFTA Debate in the United States: Immigration • Illegal immigration is a contentious issue in U.S.Mexico relations – Proponents argue that illegal immigrants support the U.S. economy by buying goods and services and help keep prices low by increasing labor supply – Opponents argue that the U.S. should not ignore illegal behavior and that the increased labor from illegal immigration suppresses wages for legal workers Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 13-16 The NAFTA Debate in the U.S.: Immigration (cont.) • Attempts at stricter border enforcement have been largely unsuccessful at stopping illegal immigration – The border is too long – 2,000 miles – The economic incentive the enter the U.S. is too high – Nearly half of the illegal immigrants entered legal, but did not return home when their visa’s expired Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 13-17 Figure 13.2 Real Value Added and Employment in Manufacturing, 1960-2008 Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 13-18 The Impact of NAFTA on the U.S. Economy • The local effects of NAFTA on trade and economy are dramatic especially in the U.S.-Mexican border • However, Mexico’s economy is 5% of the U.S. economy: NAFTA has had a very modest impact on the overall U.S. trade balance and current account or on jobs and wages Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 13-19 The Impact of NAFTA on U.S.Mexico Trade • Trade flows between U.S. and Mexico have shot up • The growth in trade between all three NAFTA partners indicates increased specialization, economies of scale, and efficiency • However, the exact impact of NAFTA is hard to assess – Bilateral trade has expanded already since 1989 thanks to Mexico’s economic reforms – Mexico’s 1994–1995 peso crisis and recession caused U.S. exports to decline momentarily to Mexico Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 13-20 FIGURE 13.3 United States–Mexico Merchandise Trade, 1989-2005 Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 13-21 The Economic Impact of NAFTA in Summary • Canada: trade with Mexico is growing, but still represents a small part of Canada’s trade • The U.S.: NAFTA has had local effects especially along the border, but had a small impact on the overall U.S economy • Mexico: NAFTA has had an important impact on trade flows and solidified economic reforms Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 13-22 The Expansion of NAFTA • In July 2005, the U.S. ratified the Dominican Republic-Central American Free Trade Agreement (DR-CAFTA) between: – Dominican Republic – Guatemala – Honduras – El Salvador – Nicaragua – Costa Rica Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 13-23 TABLE 13.3 Population and GDP for the DR-CAFTA Countries, 2007 Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 13-24 The Future of NAFTA: A North American Community? • Relative to the European Union, NAFTA is in an early stage of economic integration. • Deeper integration among the members will require: – Increased labor mobility – The establishment of permanent governing bodies – A focus on development to close the economic gap between Mexico and the other members Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 13-25 TABLE 13.4 Doing Business in the NAFTA Countries, 2009 Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 13-26 TABLE 13.4 (continued) Doing Business in the NAFTA Countries, 2009 Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 13-27 Copyright © 2011 Pearson Addison-Wesley. All rights reserved. 13-28