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

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.