At the recent Asia-Pacific Economic Cooperation forum in Lima, Peru, Mexican President Felipe Calderon voiced his opposition to U.S. President-elect Barack Obama’s prior suggestions to renegotiate some provisions of the North American Free Trade Agreement (NAFTA). A recent report from the Congressional Research Service titled “NAFTA and the Mexican Economy” by M. Angeles Villarreal and Marisabel Cid provides insights on why Calderon took that position. What are often termed as NAFTA related problems for Mexico appear to be economic development issues most nations have in transitioning from an agrarian economy to a more industrial one.

In 1990 when Mexican President Carlos Salinas suggested a free trade agreement (FTA) to U.S. President George H.W. Bush his main goal was to stabilize the Mexican economy by increasing foreign direct investment (FDI) and trade as a percent of the nation’s GDP. The 1980s had been a period of inflation and a decline in the standard of living. Mexico began reversing its 50 years of protectionist trade policies and joined the General Agreement on Tariffs and Trade (GATT) in 1986. In November 1987 the U.S. and Mexico agreed to a bilateral understanding on trade and investment including an agenda to reduce trade barriers. Progress at opening markets under that understanding resulted to a second one in October of 1989 which led to the June 1990 announcement that the U.S. and Mexico would negotiate an FTA. The U.S.-Canada FTA had taken effect in 1989.

At a fundamental level NAFTA and other market opening efforts accomplished their objectives. Beginning with implementation of NAFTA 70 percent of Mexican exports to the U.S. were tariff free and as were 50 percent of U.S. exports to Mexico. In 1987 exports accounted for 10 percent of Mexico’s GDP; in 2007 that had increased to 33 percent. Those exports are one dimensional with over 80 percent going to the U.S leaving the Mexican economy subject to U.S. economic declines as occurred in 2001-02 and currently. According to a 2005 World Bank study, FDI in Mexico would be 40 percent lower without NAFTA. It has allowed Mexican manufacturers to quickly adopt U.S. technological innovations. In 1987 GDP growth had declined to one percent per year and labor productivity growth had gone negative. By the late 1990s the Mexican economy was growing 4-6 percent per year and has recently grown 3-4 percent per year. While those are decent growth rates, they are half of that of China and India in recent years.

NAFTA started in 1994 and Mexico was hit with a financial crisis late that year partly caused by an outflow of foreign exchange due to concerns about currency devaluation. In December 1994 the government abandoned its fixed exchange rate and the peso declined 50 percent in six weeks. Assistance from the U.S. and the International Monetary Fund helped Mexico pursue sounder monetary and fiscal policies. The government honored its commitments made under NAFTA and recovered more rapidly than if it had reverted to previous protectionist policies. Mexico made the shift to a more export oriented economy, but incomes still suffered from the economic turmoil. Overall macroeconomic variability year-to-year has declined.

Despite NAFTA and other trade related efforts, poverty remains a top issue for President Calderon. According to World Bank estimates, in 2005 18.6 percent of the population lived in extreme poverty (less than $1 per person per day on a purchasing power parity basis) and 47.8 percent in moderate poverty (less than $2 per person per day). More money will be needed for education, infrastructure and national institutions if the poverty rate is to be reduced. Wage rates have increased in Mexican states where FDI has increased the greatest, but the wage rate spread has increased for the country as a whole. States with the best infrastructure and skilled workers before the market openings have had the largest gains under NAFTA. Northern and central state have grown the most, while the southern states with lower levels of education and infrastructure have fallen further behind.

While much has been made about the impact of NAFTA on Mexican agriculture, the report explains that it is difficult to separate NAFTA from internal reforms that began in the 1980s. Some community lands were privatized, state enterprises that bought and sold agricultural products eliminated and subsidies removed. Partly in preparation for NAFTA in 1992 the government established the Program for Direct Support of the Countryside. While competition from U.S. corn increased, domestic production increased by 40 percent from the average of 1983-90 to the average of 1994-2001. Production of fruits and vegetables also increased, but production of other staples declined. Most of the increased trade in agriculture occurred in the first 10 years as two-way trade more than doubled from $6.3 billion in 1993 to $14.3 billion in 2003. U.S. FDI in Mexico’s food processing industry increased from $2.3 billion in 1993 to $5.7 billion in 2000. Employment in agriculture declined as would be expected in any country that pursued economic growth in non-agricultural industries and where people can migrate to urban areas. In 2002 the government created a program to provide micro-credit to small farmers to buy machinery, equipment and technology to help keep people in rural areas.

According to non-partisan public opinion polls Mexicans have a positive view of NAFTA and international trade in general, but people are split over the idea of renegotiating NAFTA and negotiating more trade agreements. Agriculture continues to be the area of greatest disagreement about NAFTA.

Based on the information in the report, President Calderon has little choice but to push ahead on NAFTA and other trade policies. Reducing the income gap can occur only when lower income regions are more prepared to participate in globalization and new opportunities for trade become available.