The North American Free Trade Agreement: The Ties That Bind

By Aguilar, Linda | Chicago Fed Letter, September 1992 | Go to article overview

The North American Free Trade Agreement: The Ties That Bind


Aguilar, Linda, Chicago Fed Letter


In February of 1991, at the request of Mexico's President Salinas, the United States, Mexico, and Canada agreed to begin negotiations for a free trade agreement. An agreement between the three countries is expected to benefit all three, although not equally, by allowing each trading partner more open access to the others' markets. Formal negotiations for the North American Free Trade Agreement (NAFTA) began in June of 1991 and an agreement was announced on August 12, 1992.

The potential benefits to the three nations of forming a regional trading bloc are enormous. The combined GDP of the three countries in 1990 was $6.2 trillion, $221.3 billion larger than the European Economic Community's. All three countries would benefit from reduced costs, more competitive prices, and greater global trading power. Although the benefits at the regional level within the U.S. are difficult to determine at this time, the Seventh District, which covers most of Illinois, Indiana, Michigan, and Wisconsin, and all of Iowa, should benefit from NAFTA through increased exports to Mexico. As a region, the five states have increased their manufacturing exports to Mexico 90% over the 1987-1991 period; U.S. manufacturing exports have increased 130% over the same period. is Mexico develops, so will the demand for the types of goods produced in the Seventh District, namely machinery and transportation equipment.

This Chicago Fed Letter discusses the current trade relationship between the U.S. and Mexico, the potential benefits to the U.S. of future trade with Mexico, and two issues of special concern to the Seventh District states: U.S. jobs and worker retraining, and rules of origin.

TRADE BETWEEN THE U.S. AND MEXICO

Because the United States is Mexico's largest trading partner, Mexico's economic ups and downs are felt by many U.S. industries. The five largest U.S. exporting industries to Mexico in 1991 were electrical machinery, nonelectrical machinery, transportation equipment, chemicals, and primary metals, totaling slightly less than two-thirds of manufacturing exports to Mexico that year. And the interdependence between the two countries is growing. In 1971, the U.S. provided 61% of Mexico's imports and received 62% of its exports. By 1989, both numbers had grown to 70%. As seen in Figure 1, U.S. exports to Mexico rise and fall with the Mexican economy, closely paralleling the economy in the 1970s, but with more pronounced impacts occurring in the latter half of the 1980s, suggesting that as the Mexican economy continues to grow, their need for U.S. goods also grows. (Figure 1 omitted)

Of particular significance to the U.S. and the Seventh District has been the growth of U.S. manufacturing exports to Mexico. Total U.S. manufacturing exports grew $161.9 billion, or 75%, to $377.9 billion over the 1987-1991 period, with exports to Mexico contributing 17.7 billion of the increase. Over this period, roughly half of all manufacturing exports to Mexico were in the capital goods-producing industries, i.e., machinery and transportation equipment.

These two categories of capital goods exports comprised 68% of the District's manufacturing exports to Mexico in 1991. Mexican imports of machine and transportation equipment(1) have comprised anywhere from 50% to 55% of total commodities imports over the last 20 years. It would be safe to assume that this trend will likely continue, particularly in the short run, with or without NAFTA.

The primary benefit of free trade is the nearly complete elimination of tariffs between free trade partners. Therefore, NAFTA will, on net, benefit(2) each nation. The U.S. will benefit through expanded trade with a large and growing market, increased competitiveness in world markets, and more investment opportunities for U.S. firms. Mexico will benefit from more open and secure access to its largest market, the U.S.; increased confidence on the part of foreign firms to invest in Mexico; a more stable economic environment; and the return of Mexican owned capital. …

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