NAFTA, Mexican Trade Policy, and U.S.-Mexico Trade: A Longer Term Perspective

NAFTA, Mexican Trade Policy, and U.S.-Mexico Trade: A Longer Term Perspective

Order Code 97-811 E
CRS Report for Congress
Received through the CRS Web
NAFTA, Mexican Trade Policy, andU.S.-Mexico
Trade: A LongerTerm Perspective
Updated September 2, 1997
(name redacted)
Specialist in International Trade and Finance
Economics Division
Congressional Research Service ˜ The Library of Congress

NAFTA, Mexican Trade Policy, andU.S.-Mexico Trade: A
LongerTerm Perspective
Summary
The North American Free Trade Agreement (NAFTA) has been in place for over
three years, and Congress continues to evaluate it as part of the trade policy process.
“Free trade” is a contentious debate and has become even more complicated in the
NAFTA context because of Mexico’s 1995 economic crisis. Many critics consider
the sudden shift from surplus to deficit in the U.S. trade balance with Mexico a clear
indication of NAFTA’s failure. Others see NAFTA as a positive force supporting
U.S. exports. To sort out the effects of trade agreements, this report evaluates the
U.S.-Mexico trade relationship over the past two decades to place recent events and
NAFTA in a broader economic context.
Over time, U.S.-Mexico trade has grown and diversified as the two economies
have become increasingly integrated. Yet, trade patterns have been volatile at times
for many reasons, including economic downturns in Mexico. To understand the role
of trade policy and agreements on trade flows, it is instructive to compare Mexico’s
1982 and 1995 economic crises because in the first Mexico operated under a closed
trade policy and in the second it had recently acceded to NAFTA as part of a long-
term transition to an open trade policy. Both downturns had similar antecedents: an
overvalued peso, a balance of payments crisis, large capital outflows, and a currency
devaluation. Both were also severe, but the trade effects on the United States proved
much worse in the first instance.
With Mexico’s 1995 balance of payments crisis, the United States saw its
bilateral trade balance fall into a large deficit position, as it did in 1982. However,
U.S. exports to Mexico declined by only 11% in 1995, compared to 34% in 1982 and
23% in 1983. Yet, in 1995, Mexico’s economy had contracted more severely than
earlier, with GDP falling 6.2% compared to 0.6% and 4.3% in 1982 and 1983. A
critical difference in the trade effects between the two periods was Mexico’s change
in trade policy, particularly adopting NAFTA, which kept Mexico from raising
barriers to U.S. trade in response to the crisis.
The 1995 decline in U.S. exports to Mexico was due to the recession-induced
fall in demand and the price effects of the peso devaluation. What the decline does
not reflect is a trade policy bent to restricting the flow of imports from the United
States, which was in place in 1982, but absent in 1995. NAFTA solidified Mexican
commitments to an open trade policy and actually cushioned U.S. exports from a
more serious fall. Further, the trade deficit with Mexico has not been a major
economic problem for the United States as a whole given its global trading position.
Finally, under freer trade conditions, economists generally have expected U.S. exports
to Mexico to recover more quickly from the 1995 decline than they did from the 1982
crisis under a closed Mexican trade policy, which so far seems to be the case.

Contents
United States-Mexico Trade: 1977-1996 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Economic Factors Affecting Trade . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Macroeconomic Performance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Exchange Rate Policy and Capital Flows . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Economic Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Mexican Trade Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Closed Trade Policy and the 1982 Crisis . . . . . . . . . . . . . . . . . . . . . . . . . 10
Trade Reform in the 1980s . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Open Trade Policy and the 1995 Crisis . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Conclusions and Outlook . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Appendix 2. Top 25 U.S. Imports From Mexico . . . . . . . . . . . . . . . . . . . . . . . 16
Appendix 3. Top 25 U.S. Exports To Mexico . . . . . . . . . . . . . . . . . . . . . . . . . 18
List of Figures
FIGURE 1. U.S.-Mexico Merchandise Trade (1977-1996) . . . . . . . . . . . . . . . . 2
FIGURE 2. Real Growth in Mexican GDP and
U.S. Exports to Mexico (1978-1996) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
List of Tables
Table 1. Structural Changes in Mexican
Merchandise Exports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Table 2. Net Capital Flows into Mexico, 1989-95 . . . . . . . . . . . . . . . . . . . . . . . 7
Table 3. U.S.-Mexico Trade Turnover and U.S. Exports To
Mexico as a Percent of Mexican GDP,
1982-1996 (Selected Years) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Appendix 1. U.S. Merchandise Trade with
Mexico, 1977-1997 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

NAFTA, Mexican Trade Policy, andU.S.-Mexico
Trade: A LongerTerm Perspective
The North American Free Trade Agreement (NAFTA) has been operating for
over three years and Congress continues to evaluate its effects as part of the trade
policy process. Many hold NAFTA responsible for the dramatic events that unfolded
in 1994-95: the peso devaluation, Mexico’s economic collapse, and shift from surplus
to deficit in the U.S. balance of trade with Mexico. On the other hand, others cite
NAFTA as a major factor in opening Mexican markets to U.S. goods, thereby
contributing significantly to continued growth and prosperity of the U.S. economy.
As is frequently the case in polarized debates, neither extreme is fully vindicated by
economic theory or evidence.
In evaluating extreme changes in trade balances between two countries, it is
important to understand the fundamental economic forces at work. In the case of the
most recent U.S. trade deficit with Mexico, two major economic questions are
frequently posed. First, what role did trade policy and particularly NAFTA play in
causing the sudden shift in the U.S. trade balance with Mexico? Second, does a
bilateral trade deficit with Mexico present a major economic problem for the United
States?
This report considers trends in U.S.-Mexico merchandise trade over two decades
to evaluate how NAFTA may have affected the economic situation in Mexico and
U.S. trade. To gauge the effects of the agreement, it is instructive to revisit the “debt
crisis” period of 1982-83, when Mexico had a closed trade policy, and contrast it with
the repercussions of the 1994 peso devaluation, when Mexico operated under a more
open trade policy. What shall be seen is that trade agreements can affect the long-
term level of trade, but do not cause sharp fluctuations in the balance of trade, which
are largely defined by domestic economic conditions and policies.1 Finally, it is worth
repeating that the benefits of freer trade are not measured in terms of annual trade
balances, but by broader economic changes that unfold over longer periods of time.2
1 This report does not delve into employment issues. See: U.S. Library of Congress.
Congressional Research Service. NAFTA: Economic Effects on the United States After Three
Years. Report No. 97-612 E, by Arlene Wilson. June 13, 1997, NAFTA: Estimated U.S. Job
“Gains” and “Losses” by State. Report No. 96-788 E, by (name redacted). September 25,
1996, and Weintraub, Sidney. NAFTA at Three: A Progress Report. Washington, D.C.,
Center for Strategic and International Studies, pp. 5 and 11-15.
2 For an economic discussion of the “gains from trade” see: U.S. Library of Congress.
Congressional Research Service. Trade Policy in an Economic Perspective. Report No. 95-
529 E, by (name redacted). March 9, 1995.

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United States-Mexico Trade: 1977-1996
The United States and Mexico have had a long and sometimes stormy economic
relationship, and so the movement toward freer trade with Mexico continues to raise
concerns in the United States. Mexicans also have expressed reservations about being
overwhelmed by the “economic colossus” to their north. Because trade occurs
between a comparatively large and small economy, there is a disproportional aspect
to the relationship that should be recognized.
The United States is by far Mexico’s most important trading partner, accounting
for approximately 83 percent of Mexico’s exports and 77 percent of its imports in
1996. By contrast, Mexico is the United States’ third largest trading partner, but
accounted for only 9 percent of U.S. exports and imports in 1996.3 This is an
important distinction because despite ongoing interest in the level of U.S. exports to
Mexico, the U.S. economy is not greatly affected overall by the economic fortunes of
Mexico. To the contrary, because Mexico is dependent on the large U.S. economy
as its primary export market, it is far more vulnerable to changes in U.S. economic
trends.
FIGURE 1. U.S.-Mexico Merchandise Trade (1977-1996)
Despite this discrepancy in relative trade importance, bilateral trade for the most
part expanded evenly, if not briskly at times, over the past two decades. Between
1977 and 1996, trade turnover (exports plus imports) between the United States and
Mexico grew from $9.5 billion to $130 billion (see figure 1 and appendix 1.) The
U.S. balance of trade shifted back and forth from surplus to deficit, reflecting
changing economic fundamentals in both countries.
3 International Monetary Fund, Direction of Trade Statistics, June 1997. p. 135 and U.S.
Department of Commerce trade data.

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At least four distinct periods can be seen in figure 1. First, the late seventies
show a pattern of balanced trade growth, supported in Mexico by the oil boom. A
second period followed in the 1980s characterized by a decline and stagnation of trade
following the global recession, collapse of world oil prices, and increase in world
interest rates that triggered Mexico’s 1982 debt crisis. U.S. exports fell substantially
after 1981, requiring seven years to recover. Beginning in 1986, a third period of
nearly balanced trade growth resumed largely, as shall be seen, because of Mexico’s
trade reforms. Finally, 1995-96 reflect Mexico’s most recent recession and incipient
recovery. Although U.S. exports to Mexico plunged in 1995, they actually grew
faster than U.S. imports from Mexico in 1996 and the first half of 1997.
In addition to the shifting fortunes in U.S.-Mexico trade over the past two
decades, the composition of trade between the two countries has changed rather
dramatically, particularly for Mexican exports. In the early 1980s, Mexico was, above
all else, an oil exporter, with oil accounting for nearly 60 percent of total export
revenue (see table 1). Half of all oil exports went to the United States at that time.
A major goal of Mexico’s trade liberalization was to diversify production and exports
away from such heavy dependence on oil. By 1996, although still an important
sector, oil production had not increased much from 1984 levels and accounted for
only 12 percent of total Mexican exports and 9 percent of exports to the United
States (see appendix 2.)4
Table 1. Structural Changes in Mexican
Merchandise Exports
(in percent)
Export Type
1984
1987
1990
1993
1996
Agriculture, Livestock, and
Fishing
5.0
5.5
5.3
4.8
3.8
Oil and Minerals
58.9
33.4
26.3
14.8
12.6
Manufactures
36.1
61.1
68.4
80.4
83.6
Source: Banco de Mexico. The Mexican Economy 1997. Table 47.
Interestingly, despite Mexico’s once heavy dependence on oil exports to the
United States, as it diversified its export base away from petroleum toward
manufacturing, the United States became an even more important trading partner. In
the early 1980s, the United States accounted for 55 percent of Mexico’s exports.
This ratio rose to 65 percent in 1987 and 83 percent by 1996. Some 84 percent of
Mexico’s exports are now manufactured goods, 70 percent of which end up in the
United States.5
4 Weintraub, Sidney. A Marriage of Convenience: Relations Between Mexico and the United
States. New York, Oxford University Press, 1990. pp. 86 and 119, and Banco de Mexico,
The Mexican Economy 1997, tables 13 and 47.
5 Weintraub, ibid, pp. 73-75, Banco de Mexico, The Mexican Economy 1997, table 47, and
Vargas, Lucinda. The Maquiladora Industry: Still Going Strong (Part 2). Business Frontier,
(continued...)

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Maquiladoras, through joint production operations, play an important role in this
trade, with half of all Mexican manufacturing exports coming from these firms.
Maquiladoras are domestic- or foreign-owned assembly plants in Mexico, which
produce for export (mostly to the United States). U.S. and Mexican trade laws
provided preferential treatment for imported inputs and capital goods related to
maquiladora production even prior to NAFTA. The three largest maquiladora
industry sectors are electric and electronics equipment, transportation equipment, and
textiles/apparel.6
On Mexico’s import side, between 70 and 80 percent tend to be intermediate
goods, or goods that are further processed. Capital goods, used to manufacture other
goods, account for approximately 15-25 percent of Mexico’s imports, with consumer
goods ranging from 5 percent during recessions to 15-20 percent during periods of
economic growth.7 The dominance of intermediate goods again points to the
importance of the intra-industry maquiladora relationship as partially manufactured
goods are sent across the border for further assembly and then returned to the United
States. Intermediate goods support non-maquiladora manufacturing as well. The
largest categories of imports from the United States are various types of
tractor/automotive and electrical parts. Imports from the United States are highly
diversified with the top 25 import commodity groups accounting for only one-third
of the total (see appendix 3).
Economic Factors Affecting Trade
As seen above, U.S.-Mexico trade changed considerably over the past two
decades. The long-term trend has been one of growth and diversification as the two
economies have become increasingly integrated. Yet, trade has not always expanded
in a smooth upward direction, and to discern NAFTA’s possible role in Mexico’s
recent economic problems, it is essential to understand some of the factors that affect
short-term fluctuations in trade including economic growth, exchange rate policy, and
capital flows. Because events causing the collapse of the 1994 peso are reminiscent
of those in 1982, and because Mexico was operating under different trade policies,
the two periods are contrasted.
Macroeconomic Performance
Trade between two countries can fluctuate over the short-term as their
economies move through their respective business cycles, which is particularly evident
among major trading partners where economies are more highly integrated, such as
the United States and Mexico. When economies are growing, demand increases,
including the demand for imports. When economies enter recessions, demand falls,
5 (...continued)
Issue 4, 1996. Federal Reserve Bank of Dallas, El Paso Branch.
6 Ibid.
7 Banco de Mexico, The Mexican Economy 1997, table 47.

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often abruptly, which also diminishes demand for imports. These short-term swings
can affect trade balances irrespective of trade policy or agreements.
FIGURE 2. Real Growth in Mexican GDP and
U.S. Exports to Mexico (1978-1996)
To highlight the relationship between trade and short-term economic
performance, figure 2 contrasts real annual growth of Mexico’s gross domestic
product (GDP) with real annual growth of U.S. exports to Mexico from 1978 to
1996. Figure 2 shows the potential for volatility in annual bilateral trade balances
based on the vagaries of the Mexican business cycle. In particular, growth in U.S.
exports to Mexico was highest in the late 1970s during a period of strong economic
growth (8-9 percent annually) and decidedly negative when the economy fell on hard
times in 1982-83, 1986, and 1995. The 1996 recovery shows expected return to
growth of U.S. exports to Mexico.
Sudden declines in U.S. exports to Mexico are clearly evident for the 1982-83
and 1995 recessions. In 1982 and 1983, Mexico’s GDP dipped by 0.6 and 4.2
percent, respectively, for a total fall in GDP of nearly 5 percent over the two years.
At the same time, U.S. exports to Mexico fell by 34 and 23 percent for a total decline
of approximately 50 percent. In the wake of the 1994 peso devaluation, Mexican
GDP fell 6.2 percent in 1995 alone, the largest single year decline since the Great
Depression and 50 percent more than in 1983. Yet, U.S. exports to Mexico fell only
11 percent in 1995 or about half of the decline witnessed in 1983. This suggests that
in both cases the recession was an important factor affecting U.S.-Mexico trade, but
raises an interesting question (to be explored in the next section) of why U.S. exports
to Mexico declined much less in 1995 than might have been expected given such a
sharp contraction in the Mexican economy and the previous experience of 1982-83?

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Exchange Rate Policy and Capital Flows
Exchange rate policy and capital flows can exert a major influence on trade
balances. Over the long run, stable and predictable exchange rates promote
confidence in the future value of a country’s currency, which in turn encourages trade
and investment and discourages speculation and the potential for sudden large shifts
in the flow of capital. Exchange rate stability, however, is not always easy to achieve.
In a floating exchange rate system, market forces determine the exchange rate. In a
fixed exchange rate system, policy sets the value of a country’s currency in keeping
with broader economic goals. Both can generate stability, but in Mexico’s case, its
fixed exchange rate policy became suspect in 1994 when very large inflows of foreign
capital caused the peso to become overvalued and Mexican economic policy did not
make the necessary adjustments.8
In 1987, as part of a long-term anti-inflation policy, Mexico pegged the
“nominal” or current market value of the peso to the dollar and then in 1989 adopted
a “crawling peg” exchange rate. The “crawling” aspect of this concept refers to what
amounts to a constant nominal mini-devaluation of the currency, ideally at a rate that
would be equal to the inflation differential with the country to which the peso is
pegged (the United States.) In 1991, Mexico employed a band or defined trading
range within which the peso could be traded, while continuing the regular mini-
devaluation by widening the band.
When a country pegs its currency, exchange rate credibility rests on adopting
macroeconomic policies similar to those of the country to which the currency is
pegged (the United States) to avoid currency misalignments. Policy coordination is
all the more critical in Mexico’s case because the United States is both its primary
trading partner and a much larger economy. Two problems often emerge when a
country adopts a fixed exchange rate, both of which can raise the specter of
devaluation. First, when the difference in inflation rates is not fully closed, the “real
value” (adjusted for inflation) of the pegged currency tends to appreciate. As the real
value of the peso appreciates, the “nominal value” becomes increasingly less credible,
raising concerns about a possible devaluation.9
8 Because of the similarities between 1982 and 1994, emphasis is placed on the latter period.
Prior to 1982, Mexico had a fixed exchange rate compared to a “crawling peg” used prior to
the 1994 devaluation. For all practical purposes, the crawling peg became a fixed exchange
rate by 1994 (if not earlier) so these technical differences did not affect the final outcome,
which was devaluation in both cases.
9 Not adjusting fully for the inflation difference was a matter of broader and deliberate
Mexican policy involving wage and price controls. On the pitfalls see: Dornbusch, Rudiger
and Alejandro Werner. Mexico: Stabilization, Reform and No Growth. Brookings Papers
on Economic Activity. No. 1, 1994. p. 271-76 and Dornbusch, Rudiger, Ilan Goldfajn, and
Rodrigo O. Valdes. Currency Crises and Collapses. Brookings Papers on Economic Activity.
No. 2, 1995. p. 250-53.

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The second and related problem arises when domestic economic policy diverges
from that of the country to which the peso is pegged, which, as mentioned above,
raises questions about the credibility of maintaining the fixed nominal exchange rate.
In 1982, Mexico’s economic policies were overtly expansionary, contributing to
inflation, the peso appreciation, and impending crisis. Similarly, in mid-1994 the
Mexican government adopted looser fiscal and monetary policies, albeit rather subtly,
as a matter of presidential politics. If macroeconomic policy becomes expansionary
and relatively more expansionary than in the United States, which was actually
moving in the opposite direction with the Federal Reserve raising interest rates
throughout 1994, then the inflationary gap between the United States and Mexico
discussed above grows and the nominal fixed exchange rate becomes suspect.10
Capital flows into Mexico were also a driving force that led to the overvalued
currency, rising current account deficit, and Mexico’s financial problems within the
context of a pegged exchange rate system. As Mexico recovered from the debt crisis
of the 1980s and adopted market-based economic reforms, investors came to believe
that long-term stable growth might once again be possible. With rising interest in the
potential for large returns in so-called “emerging markets,” investors committed
capital generously. Capital investment began to trickle into Mexico in 1989, and as
documented in table 2, rushed in thereafter until 1994.11
Table 2. Net Capital Flows into Mexico, 1989-95
($ billions)
Invest
Type
1989
1990
1991
1992
1993
1994
1995
Direct
2.8
2.6
4.7
4.4
4.4
11.0
7.0
Portfolio
0.3
-4.0
12.1
19.2
28.4
7.6
-10.8
Other
-2.0
9.9
8.3
3.4
1.0
-2.8
-7.9
Total
1.1
8.5
25.2
27.0
33.8
15.8
-11.7
Source: IMF, International Financial Statistics, August 1997, p. 474.
Other = currency and deposits, loans, and trade credits.
When capital moves into a country that maintains fixed exchange rates, the
domestic money supply increases, prices tend to rise, and the exchange rate tends to
appreciate. The real appreciation of the peso lowered the price of imports and raised
the price of exports, so Mexico began to run large trade and current account deficits
that matched the capital inflows. When circumstances change, capital flows can
suddenly slow or reverse themselves, particularly portfolio capital (stocks and bonds),
10 Dornbusch, Goldfajn, and Valdes, ibid, p. 240. It has been argued that had Mexico been
able to retain international credibility in its anti-inflationary policy, it might have avoided this
latest crisis. See: Obstfeld, Maurice and Kenneth Rogoff. The Mirage of Fixed Exchange
Rates. Journal of Economic Perspectives, v. 9, Fall 1995. p. 84.
11 1994 was the turnaround year. The $7.6 billion in portfolio capital is deceptive because it
reflects an inflow of capital at the beginning of the year followed by a large capital outflow
the rest of the year.

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which is highly liquid compared to direct foreign investment (plant and equipment).
The sudden reversal of capital flows in 1994 presented serious problems for Mexico
because it then had a large current account deficit, an overvalued exchange rate, and
insufficient foreign exchange reserves to defend the exchange rate, which was under
downward pressure from the massive capital outflows.12
In addition to exchange rate policy and capital flows, noneconomic factors
sparked capital flight from Mexico. Concern over political stability was a key issue
leading to investor uneasiness. In January 1994, a peasant revolt occurred in the state
of Chiapas. March proved to be an even more unsteady month with the assassination
of a presidential candidate. These events triggered a major speculative attack on the
peso in late March, which Mexico defended by selling its foreign exchange reserves.
Further political turmoil led to a final run on the peso in November 1994 as the fear
of devaluation spread.13
Economic Policy
Although changing economic and political events (shocks) encouraged capital
flight, it was Mexico’s economic policy that doomed the peso to devaluation. Rising
U.S. interest rates were responsible, in part, for the initial decline in capital inflows.
Mexico would have had to tighten its monetary policy in like manner to continue to
attract capital, but during an election year Mexico found it difficult to raise interest
rates to maintain its relative competitiveness in the international capital market. In
effect, it no longer subordinated domestic monetary and fiscal policy to the
maintenance of a fixed exchange rate with the United States.14 This decision was
tantamount to allowing higher inflation relative to the United States, which, with a
pegged exchange rate, meant that the real appreciation of the peso would accelerate
to potentially untenable levels, further exacerbating the current account deficit.
At this point, Mexico faced three unattractive options: (1) raise interest rates to
match U.S. policy and continue to attract (or slow the retreat of) foreign capital; (2)
devalue the peso; or (3) do nothing to buy time, but risk more severe financial
difficulty in the future. Option one proved unacceptable because it risked almost a
sure recession prior to a presidential election. Option two was apparently debated,
but discarded because Mexico staked its economic reputation on defending the peso.15
Option three unfolded by default.
12 One view argues that an extremely high level of capital inflows, particularly in a small
economy, is simply not a realistic equilibrium level over the long run and should be treated as
a short-term phenomenon at the outset. See: Edwards, Sebastian. Comments and Discussion.
Brookings Papers on Economic Activity. No. 2, 1995. p. 277.
13 For a summary of events see: U.S. Library of Congress. Congressional Research Service.
Mexico: Chronology of a Financial Crisis. Report No. 95-1007 E, by (name redacted).
September 27, 1995.
14 Dornbusch, Goldfajn, and Valdes, Currency Crises and Collapses, p. 240-41.
15 Ibid, p. 241.

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Investors, both foreign and domestic, actually realized the tenuous nature of the
peso in 1994 and began abandoning it when given the opportunity to move toward
a short-term, dollar-indexed investment instrument known as the tesobono.16 This
amounted to “currency flight” prior to the final capital flight that occurred in
November and December. When investors finally fled in late 1994, Mexico defended
its currency with foreign reserves as long as it could before devaluing and eventually
floating the peso. Mexico’s refusal to face the inconsistency of its macroeconomic
and exchange rate policies helped cause the peso’s undoing. Under adverse
conditions, Mexico could not continue to peg the peso to the dollar and follow a
divergent macroeconomic policy from the United States. When an adjustment did not
occur, it was only time before markets forced the peso’s devaluation.
The unresolved debate over the proper Mexican response continues and the two
main camps are: Mexico should have tightened fiscal and monetary policies to avoid
devaluation, or it should have devalued the peso much earlier and accepted the
consequences before they became so severe. In any event, as Mexico was forced to
adjust to dwindling capital, its trade deficit had to correct, so exports rose and imports
fell. Accordingly, the balance of trade with the United States went from a surplus to
a deficit. The key points are that the seeds of this broad problem were planted years
before NAFTA was contemplated and that the final collapse of the peso resulted more
from domestic economic rather than trade policy reasons.17 In fact, Mexico faced this
problem in 1982 under a closed trade policy and again in 1994 under a more open
trade policy.
Mexican Trade Policy
The preceding discussion points to many interconnected economic factors that
can disrupt long-term trade patterns. The effect of Mexican trade reform, by contrast,
should be evident over longer periods of time and promote stability in trade relations.
To recap, in 1982-83 and 1995, Mexico experienced severe recessions (see figure 2.)
Both were similar in that they were preceded by an overvalued peso, balance of
payments crisis, capital outflows, and a major devaluation, causing U.S. exports to
fall.18 One of the critical variables that differed between the two setbacks was trade
policy. As will be shown, a more open policy in 1995, solidified by NAFTA (and
GATT), had no significant effect on the macroeconomic situation given other factors,
but had a noticeable trade effect by keeping Mexico from imposing import restrictions
on the United States as it did in 1982.
16 Tesobonos grew from 6 percent of total public sector internal debt in April 1994 to 55
percent by the time the peso was devalued in December. They proved to be only a stopgap
measure in the attempt to halt capital flight.
17 Anticipation of NAFTA, however, may have contributed to the high expectations that drove
large capital flows into Mexico after 1989.
18 U.S. Library of Congress. Congressional Research Service. Mexican Financial Crises,
1982 and 1995: Similarities and Differences. Report No. 95-239 E, by (name redacted).
6 p.

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Closed Trade Policy and the 1982 Crisis
Prior to the 1982 crisis, the Mexican economy was considerably more closed to
trade than it was in 1995. Mexico had long followed an import substitution approach
to development, which by maintaining high tariffs and other barriers to imports,
protected domestic industry from foreign competition. In 1981, the average tariff rate
was 27 percent, 83 percent of imports required licenses, and domestic content
requirements covered key industries such as automobile and computer manufacturing.
The sole purpose of these policies was to restrict imports in order to facilitate
domestic industrial development in Mexico. Given the wealth effect of new found oil
reserves in the late 1970s, there was little financial or political pressure to change
policies.19
As the 1980s approached, Mexico’s economy continued to grow based on heavy
external borrowing backed by seemingly unlimited oil revenues, resulting in large
current account deficits. The 1982 balance of payments crisis occurred because
Mexico overborrowed and could not meet growing international debt service
payments when world interest rates rose and oil prices plummeted. Mexico devalued
the peso twice in 1982 and immediately faced economic decline: inflation climbed to
nearly 100 percent and economic growth fell by nearly 5 percent over two years.20
To resume meeting its debt obligations, Mexico raised barriers to imports in
order to earn foreign exchange. The primary tool was the import license (permiso
previo), which in 1982 was extended to 100 percent of imports. Exchange rate
controls were also introduced and tariffs raised, but as one experienced observer has
pointed out, “Under this import structure, it was fatuous to speak of average tariffs
levels in Mexico. Denial of a permiso previo was the equivalent of an infinite tariff.”21
The result for the United States was a huge fall in exports to Mexico, as seen in figure
2.
Trade Reform in the 1980s
Despite the initial strengthening of import barriers, one outcome of the debt
crisis was reform in Mexican trade policy. Mexico began gradual unilateral reductions
in trade barriers after 1982. These accelerated after 1985 when Mexico made overt
moves to integrate itself more completely with the world economic system by
becoming a member of the General Agreement on Tariffs and Trade (GATT) in 1986
and the Organization for Economic Cooperation and Development in 1994.
Becoming a party to NAFTA was also a logical step in this progression.22
19 Lustig, Nora. Mexico: The Remaking of an Economy. Washington, D.C., The Brookings
Institution, 1992. pp. 114-15.
20 The details can be found in chapter 1 of Lustig, ibid.
21 Weintraub, Sidney. The Promise of United States-Mexican Free Trade. Texas
International Law Journal, v. 27, Summer 1992. p. 555.
22 Lustig, Mexico: The Remaking of an Economy, p. 39. It should be noted that trade
liberalization affected primarily manufactured goods; agriculture, services, and other
(continued...)

CRS-11
Mexico’s specific trade reform policies included reducing licenses from 100
percent of imports in 1982 to 36 percent in 1985, 27 percent in 1986, and 22 percent
by the end of 1988. Mexico also simplified its tariff schedules, with maximum tariffs
falling from 100 percent in 1982 to 20 percent in 1988. The trade-weighted average
tariff rate continued downward and today stands at approximately 10 percent (5
percent under NAFTA). By 1987, these and other policy changes “transformed
Mexico from an extremely closed economy into one of the most open ones in the
world.”23 All this transpired seven years before NAFTA took effect.
Because Mexico instituted major trade policy reform before entry into NAFTA,
the trade agreement may be seen as the continuation of a long-term process, at least
as it affects the United States and Canada. Under NAFTA, Mexico’s few remaining
import license requirements were converted to a system of tariff-rate quotas that will
be phased out. Tariff rates remain low and will also disappear as the free trade
agreement is fully implemented. Importantly, as shall be seen, NAFTA consolidated
Mexico’s position on free trade with the United States.
The effect of Mexico’s trade liberalization on its trade volume with the world is
easily documented. From 1982 to 1996, Mexican exports grew from $24.1 to $96.0
billion or nearly 300 percent. Perhaps most telling is that oil, as a percent of total
exports, fell from 77.6 to 12.6 percent. Over the same time period, Mexican imports
rose over 400 percent from $17.0 to $89.5 billion.24
Because the United States is Mexico’s most important trading partner, shifts in
trade policy are particularly noticeable in the bilateral trade data. As seen in figure 1,
the level of trade between the United States and Mexico experienced steady growth
between 1983 (the beginning of Mexican trade policy reform) and 1994 (NAFTA);
both imports and exports rose dramatically, at a time when the Mexican economy
grew at an average annual rate of only 2 percent. In fact, real GDP per capita had not
grown at all.25
22 (...continued)
important areas are still protected and will be opened up under NAFTA.
23 Tornell, Aaron. Are Economic Crises Necessary for Trade Liberalization and Fiscal
Reform? The Mexican Experience. In Dornbusch, Rudiger and Sebastian Edwards, eds.
Reform, Recovery, and Growth: Latin American and the Middle East. Chicago, University
of Chicago Press, 1995. p. 53. See also: U.S. International Trade Commission. Review of
Trade and Investment Liberalization Measures by Mexico and Prospects for Future United
States-Mexican Relations. Publication 2275. April 1990. pp. 4-1 to 4-5 and USITC. 1995
National Trade Estimate Report on Foreign Trade Barriers. pp. 229-236.
24 International Monetary Fund. International Financial Statistics Yearbook 1996, p. 543 and
Banco de Mexico, The Mexican Economy 1997, table 47.
25 In 1990 dollars, Mexico’s per capita GDP was $3,090 in 1985 and only $3,041 in 1994.
Inter-American Development Bank. Economic and Social Progress in Latin America: 1995
Report. Washington, D.C., The Johns Hopkins University Press, October 1995. p. 263.

CRS-12
Table 3. U.S.-Mexico Trade Turnover and U.S. Exports To
Mexico as a Percent of Mexican GDP,
1982-1996 (Selected Years)
1982
1987
1992
1994
1996
Trade Turnover/Mexican GDP
15.7
25.3
22.7
26.8
44.7
U.S. Exports/Mexican GDP
6.7
10.6
12.2
13.6
19.6
Source: IMF, International Financial Statistics Yearbook, 1996 and U.S.
Department of Commerce. TPIS.
Data in table 3 also show the growing importance of U.S. trade to Mexico’s
economy. In 1982, total trade between the United States and Mexico, or trade
turnover (imports plus exports), equaled 15.7 percent of Mexico’s GDP and U.S.
exports to Mexico alone amounted to 6.7 percent of its GDP. By 1994, these ratios
rose to 26.8 and 13.6 percent, respectively. Clearly, trade with the United States has
become a more important part of Mexico’s economy. This growth in the level and
importance of trade is what would be expected of freer trade policies and it is no
coincidence that this growth occurred precisely at the same time that Mexican trade
policy reforms were implemented.26 (The large jump in these ratios for 1996 reflect
these same trends, but also the effect of the 1995 recession on GDP, which served to
lower the ratio’s denominator.)
Open Trade Policy and the 1995 Crisis
The details of the economic crisis in 1995 differed from 1982 in some respects,
but Mexico faced the same fundamental problem: the inability to cover its
international obligations. By 1995 the large trade and current account deficits had to
be corrected and as Mexico’s largest trading partner, the United States saw its
bilateral trade balance reverse to a large deficit position. Mexican imports to the
United States continued to climb as U.S. exports to Mexico fell. However, U.S.
exports declined by only about 11 percent in 1995. As mentioned above this was a
much smaller decrease than experienced in 1982 (34 percent) and 1983 (23 percent)
despite a much larger contraction in Mexico’s economy.
The difference points to Mexico’s more open trade policy, including acceding
to NAFTA, which kept Mexico from raising barriers to U.S. trade in response to the
crisis. Hence, the decline in exports represents the fall in demand that accompanied
the deep recession and the effects of the peso devaluation, as would be expected.
What the decline does not reflect is a formal policy to restrict the flow of imports
from the United States, which was in place in 1982, but absent in 1995. NAFTA, for
its part, helped solidify Mexican commitments to an open trade policy and actually
cushion United States exports from tariff increases ranging from 20 to 35 percent that
Mexico imposed on many goods from countries with which it had no equivalent
26 Exchange rate policy and capital flows, as discussed earlier, were contributing factors.

CRS-13
agreement. The U.S. trade deficit therefore, was smaller than it might have been
under a less open trade regime.27
In fact, it has been argued that this is one of the more important achievements
of NAFTA. Not only could Mexico not fall back on a protectionist trade regime, but
it is committed to continuing liberalization of trade policies in agriculture, services,
and other areas.28 Although this is scant comfort to those who are concerned with a
trade deficit with Mexico, a bilateral deficit is not a major economic problem for the
United States given its broad global trade relationships.29 Additionally, under freer
trade conditions economists generally expected U.S. exports to Mexico to recover
more quickly than they did from the 1982 crisis under a closed Mexican trade policy,
which figure 1 and appendix 1 suggest has so far been the case.
Conclusions and Outlook
Mexico remains a natural, and over the long run, growing market for U.S.
goods, which will become more evident as the Mexican economy recovers and the
long-term trend of trade and investment growth reemerges, as it appears to be doing.
This is a trend that has been evident for decades and one that is dependent on
Mexico’s economic stability and its willingness to maintain an open trade policy, an
option for which NAFTA may serve as an insurance policy. The Mexican case
supports the contention that trade liberalization, relative to a closed trade policy,
supports growth in trade and provides greater stability during times of economic
setbacks, other things being equal.
One problem is that other things are not always equal and it is these other things
(economic and political shocks) that often cause short-term disruptions to long-term
trade trends. Mexico periodically experiences macroeconomic problems that are
common among developing economies, and in 1994 Mexico repeated many mistakes
made in 1982, except for trade policy. Its primary economic policies focus on
resolving such basic problems as tempering runaway inflation, maintaining a stable
exchange rate, managing current account balances, and attempting to achieve long-
term savings rates necessary for development. Mexico, like most developing
countries, looks abroad for resources to take up any slack in domestic savings. Given
Mexico’s tendencies toward exchange-rate and indebtedness problems, often
exacerbated by policy decisions, balance of payment or liquidity problems can arise
periodically that eventually disrupt trade and investment flows. Importantly, these
problems can arise under either an open or closed trade regime.
27 United States Trade Representative. 1996 Foreign Trade Barriers. Washington, D.C. p.
239.
28 Tornell, Aaron and Gerardo Esquivel. The Political Economy of Mexico’s Entry to
NAFTA. Working Paper 5322. Cambridge, National Bureau of Economic Research, October
1995. p. 27.
29 For a discussion of the significance of the entire U.S. trade deficit, see: U.S. Library of
Congress. Congressional Research Service. U.S. Trade Performance: Recent Trends and
Policy Options. Report No. 97-487 E, by (name redacted). April 24, 1997.

CRS-14
Although trade policy can encourage trade growth over the long run, it is only
one economic policy tool and not the most influential in managing macroeconomic
problems. In this case, a trade agreement such as NAFTA was not the cause of
Mexico’s 1995 recession, but it was able to reduce, although not eliminate, the
recession’s negative trade effects on the United States. Only with Mexico’s recovery,
which depends more on Mexico than a trade agreement, will U.S. export growth
continue its upward climb.
Finally, it is worth reiterating the limitations of trade agreements. They are
intended to reduce barriers to trade and encourage growth in trade between countries.
This has occurred with Mexico and the United States. Trade agreements, however,
cannot guarantee any particular balance of trade between countries, nor can they
guarantee that all businesses will prosper. They do hold out the promise that business
and trade success or failure will be less affected by deliberate policies to block
imports, as was evident in Mexico in 1982, but not 1995. Despite the doubts voiced
by many over NAFTA, moving back to a more closed trade posture with Mexico not
only would risk losing broader gains from freer trade, but also would not guarantee
the United States of being insulated from Mexican economic problems, as a
comparison of the 1982 and 1994 crises demonstrates.

CRS-15
Appendix 1. U.S. Merchandise Trade with
Mexico, 1977-1997
($ millions)
% Growth
% Growth
U.S.
U.S.
Trade
Trade
Year
in U.S.
in U.S.
Exports
Imports
Balance
Turnover
Exports
Imports
1977
4,733
4,769
-36
9,502
––-
––-
1978
6,678
6,100
578
12,778
41.1
27.9
1979
9,843
8,829
1,014
18,672
47.4
44.7
1980
15,141
12,573
2,568
27,714
53.8
42.4
1981
17,780
13,799
3,981
31,579
17.4
9.8
1982
11,739
15,566
-3,827
27,305
-34.0
12.8
1983
9,079
16,776
-7,697
25,855
-22.7
7.8
1984
11,978
18,020
-6,042
29,998
31.9
7.4
1985
13,628
19,132
-5,504
32,760
13.8
6.2
1986
12,379
17,302
-4,923
29,681
-9.2
-9.6
1987
14,570
20,271
-5,701
34,841
17.7
17.2
1988
20,633
23,277
-2,644
43,910
41.6
14.8
1989
24,969
27,186
-2,217
52,155
21.0
16.8
1990
28,375
30,172
-1,797
58,547
13.6
11.0
1991
33,276
31,194
2,082
64,470
17.3
3.4
1992
40,597
35,184
5,413
75,781
22.0
12.8
1993
41,635
39,930
1,705
81,565
2.6
13.5
1994
50,840
49,493
1,347
100,333
22.1
23.9
1995
46,401
61,705
-15,304
108,106
-8.7
24.7
1996
56,761
72,963
-16,202
129,724
22.3
18.2
1997(P)
65,430
81,846
-16,416
147,276
15.3
12.2
P = preliminary numbers annualized from 1997 mid-year (six month) trade data.
Note: Figures are in current dollars so growth rate calculations vary some from those
adjusted for inflation in figure 2.
Source: U.S. Department of Commerce. TPIS. Exports measured F.a.s; Imports measured
on customs basis.

CRS-16
Appendix 2. Top 25 U.S. Imports From Mexico
($ millions)
1984
1987
1990
1993
1996
Total all commodities
18,020 20,271 30,172 39,930 72,963
78120–Motor vehicles/transport of persons, nes
34 1,176 2,164
3,084
7,902
33300–Crude oil petroleum/bituminous 6,700 3,520 4,822
4,245
6,356
minerals
78219–Motor vehicles/transport of goods,
59
90
229
543
3,052
n.e.s.
77313–Ignition wirng sts, etc, used in vehicls
312
731 1,216
1,878
3,014
76110–Television receivers, color
179
338
916
1,589
2,749
93100–Special transactions & commod not
326
622 1,008
1,335
2,241
classif by kind
71322–Reciprocatng pist engs, cyl cap
533
823
543
749
1,626
exceedng 1000 cc
75230–Digital processng units
0
68
151
54
1,263
78439–Pts & access of tractor, mtr veh, spec
212
317
582
957
1,187
purpse, nes
78432–Oth pts & access of motor veh bodies
93
226
507
1,155
1,143
(includ cabs)
76431–Transmission apparatus, tv, radio etc.
117
152
199
183
1,095
76211–Radiobroadcast receivers com sound,
137
437
520
601
1,079
extern power
82119–Parts of seats nes
70
137
115
532
938
75997–Parts of auto data proc mach & optical
93
86
265
485
924
readers etc
76493–Pts of tv rec, radiobroad rec, sound
486
487
672
806
844
record
84140–Trousers, overalls, shorts etc, men/boys,
45
120
154
335
833
not knit
71631–Electric motors exceeding 37.5 w, ac
73
131
209
355
612
75260–Input or output units for data processing
39
99
120
209
604
systems
05440–Tomatoes, fresh or chilled
169
159
371
304
580
84260–Trousers etc, women/girls, textile fab,
41
35
88
162
507
not knit
98400–Estimate of low valued import
139
127
292
359
498
transactions

CRS-17
1984 1987
1990
1993
1996
84540–T-shirts, singlets & oth vests, knit or
3
7
6
65
495
chrochet
77121–Static converters (e.g., rectifiers)
116
177
130
160
480
74159–Parts for air conditioning machines of hd
14
55
60
133
479
741.5
77315–Elec conductrs, exc 80 v nt exc 1000 v
15
187
325
269
476
Total of Items Shown
10,005 10,307 15,664 20,547 40,977
Total Other
8,015 9,964 14,508 19,383 31,986
Source: U.S. Department of Commerce. TPIS. Imports reported customs value SITC 5 digit
level.

CRS-18
Appendix 3. Top 25 U.S. Exports To Mexico
($ millions)
1984
1987
1990
1993
1996
Total all commodities
11,978 14,570 28,375 41,635 56,761
78439–Pts & access of tractor, mtr veh, spec
356
511 1,812 1,779
2,343
purpse
99400–Est. low val shp; can low value & n.i.k.
97
339 1,110 1,412
1,952
(exports)
78432–Oth pts & access of motor veh bodies
152
231
807 1,574
1,188
(includ cabs)
04490–Maize (not including sweet corn)
402
275
402
43
1,014
unmilled, no seed
75997–Parts of auto data proc mach & optical
255
340
403
656
933
readers etc
77611–Television picture tubes, color
0
16
142
360
927
89399–Articles of plastics nes
27
38
214
399
891
78120–Motor vehicles for the transport of
5
11
183
122
865
persons
22220–Soybeans
485
220
211
421
859
77282–Pts of elec app for switchng, protectng
59
66
349
372
703
elec circt
77313–Ignition wirng sts, etc, knd used in
179
401
374
815
701
vehicls
75230–Digital processng units
21
24
99
189
628
77643–Nondigital monolithic integrated units
17
20
12
17
576
77259–Electrcl app for switch/protect nes nt ex
41
43
83
182
545
1000
77220–Printed circuits
66
84
103
102
541
69969–Articles of iron or steel, n.e.s.
5
13
88
132
539
33411–Gasoline including aviation (except jet)
2
33
197
457
530
fuel
77645–Hybrid integrated circuits
13
20
117
167
503
69421–Screws, bolts, nuts, threaded, iron or
13
23
63
130
476
steel
64211–Cartons, boxes, cases, corrugated
44
60
170
271
476
paper/board
77129–Pts of elec pwr machry (oth rotating ele
37
68
305
437
446
plnt)
82119–Parts of seats nes
13
6
181
458
443
77641–Digital monolithic integrated units
81
103
123
212
419

CRS-19
1984
1987
1990
1993
1996
71391–Parts, n.e.s. suitbl for spk-ig int com eng
207
151
199
242
405
76493–Pts of tv rec, radiobroad rec, sound
133
170
623
750
401
record
Total of Items Shown
2,710 3,266 8,370 11,699 19,304
Total Other
9,268 11,304 20,005 29,936 37,457
Source: U.S. Department of Commerce. TPIS. Exports reported F.a.s. SITC 5 digit level

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