Lessons from NAFTA for Latin America & the Caribbean
|A Summary of Research Findings
Washington, December 17, 2003 – The North American Free Trade Agreement (NAFTA) has spurred economic development in Mexico, but is not enough to achieve economic convergence with Canada and the United States even in the long run without investment in innovation, infrastructure and adequate institutions, a new World Bank study says.
Lessons from NAFTA for Latin America and the Caribbean Countries: A Summary of Research Findings, co-authored by World Bank economists Daniel Lederman, William F. Maloney and Luis Servén, was released today in advance of the ten year anniversary of the implementation of the agreement on January 1, 2004. It was prepared to help acquaint countries of the region with possible effects of the Free Trade Area of the Americas (FTAA), which is being negotiated by Western Hemisphere nations.
"NAFTA has had positive effects in Mexico but they could have been better," said David de Ferranti, World Bank Vice President for Latin America and the Caribbean. "Free trade definitely brings new economic opportunities, but the lessons from NAFTA for other countries negotiating with the U.S. are that free trade alone is not enough without significant policy and institutional reforms."
In preparing the report, the authors acknowledged the difficulty of separating the impact of NAFTA from the peso crisis experienced by Mexico in 1994-95 --also known as the Tequila crisis-- and from the dramatic liberalizations of trade barriers that began in the 1980s. Through the use of various statistical methods they were able to identify successfully the specific effects of the agreement.
The 346-page report estimates that without NAFTA, global exports would have been roughly 25 percent lower; Foreign Direct Investment (FDI), which was exceptionally high in 1994-95, around 40 percent less, and Mexico's $5,920 per capita income in 2002 would have been about 4 percent lower.
However, the study argues that NAFTA is not enough. Hopes that Mexico would make bigger strides in catching up to the U.S. were diminished by under-investment in education, innovation and infrastructure, as well as low institutional quality -- a term covering accountability, regulatory effectiveness, control of corruption and related issues.
Further, the report stresses that the benefits of NAFTA, and of trade more generally have been unequal across regions and sectors.
"NAFTA definitely further plugged Mexico into the most dynamic economy in the world, but the country's development across the 1990s, including the NAFTA period, was unequal" said Guillermo Perry, World Bank Chief Economist for Latin America and the Caribbean. "The most developed and competitive regions and sectors have clearly benefited from the trade liberalization, while those lagging behind have not. Extending the benefits of greater integration all society remains the challenge."
Some of the unequal effects included in the report are:
Workers, wages and jobs
- The rise in the wages of those with higher levels of education, relative to those with less that began with unilateral liberalization of the 1980s, largely remained after NAFTA.
- Northern and Central States grew faster across the 1990s modestly reducing income gaps with the Federal District, while poorer Southern States grew slower due to low levels of education, infrastructure and quality of local institutions.
- Large Mexican firms increased their access to northern capital markets as domestic credit dried up after the tequila crisis, while credit remained constrained for small and medium enterprises.
- In the countryside, the productivity of the irrigated lands increased, but non-export, non-irrigated agriculture didn't benefit.
The report concludes there is little evidence of adverse impacts of NAFTA on workers. The labor market recovered relatively quickly after the tragic adjustments of the 1994-95 Tequila crisis, and unemployment and real wages returned to 1994 levels. Wages and employment tend to be higher in states with higher FDI and trade, and out migration from those states is lower. Wages are also higher in sectors with more exposure to imports or exports.
"Overall, there is little evidence that increased trade liberalization has led to greater risk faced by workers, or an increase in the size of the informal sector," said William F. Maloney, co-author of the report and World Bank lead economist at the Office of the Chief Economist for Latin America and the Caribbean. "More generally, free trade has increased the demand for a more skilled Mexican workforce, a challenge the educational system must be prepared to meet."
Due to NAFTA, productivity growth jumped, as the amount of time for adoption of foreign technologies was cut in half relative to the pre-agreement period. In addition, the national innovation effort also rose modestly after NAFTA, possibly due to the strengthening of intellectual property rights.
The biggest surprise to researchers was the farm sector's resilience in the face of changes that included NAFTA, the elimination of some price supports in the 1980s, the severe impacts of the 1995 crisis, and long term declines in the agricultural relative prices. Although not necessarily NAFTA driven, domestic production and trade in agricultural goods rose across the late 1990s, the productivity of the irrigated lands increased, and subsidies and income supports for traditional agriculture became more efficient.
The report says that Mexican farmers, including those at the subsistence level, were not adversely impacted by NAFTA as had been widely feared, although better policies for the non-export, non-irrigated agriculture, particularly in the southern states, are needed.
"NAFTA has been quite positive for export agriculture, but it has probably had little impact on small farmers in the Southern states who have suffered a long history of social, political and economic neglect," said Daniel Lederman, co-author of the report and World Bank senior economist at the Office of the Chief Economist for Latin America and the Caribbean. "There should be improvements in rural education, infrastructure, institutions and in rural development policies in general."
Overall, the study concludes that Mexico's deficiencies in education and research and development (R&D) limit the power of NAFTA to enable the country to reach the level of technological progress of the United States or even of countries such as Korea.
The lesson applies to the rest of the region as well. "The international evidence suggests that the region's R&D investment effort should be more than doubled" said Luis Servén, co-author of the report and World Bank lead specialist of Poverty Reduction and Economic Management in Latin America and the Caribbean. "The region needs to improve the efficiency of its innovation effort."
Therefore, the experts recommend reforms that would promote macroeconomic stability, improve institutions and investment climate, and build educational and innovation systems that foster technological and productivity growth. Finally, the report argues that NAFTA would be more effective with certain modifications --allowed by the agreement itself-- in the areas of rules of origin to allow certain Mexican industries, like textiles and apparel, to enter the U.S. easier, as well as certain changes to unfair trade practices related to antidumping and countervailing duties.