Free Trade Area or Common Capital Market? Notes on Mexico-US Economic Integration and Current NAFTA Negotiations

Free Trade Area or Common Capital Market? Notes on Mexico-US Economic Integration andCurrent NAFTA NegotiationsAuthor(s): Jaime RosSource: Journal of Interamerican Studies and World Affairs, Vol. 34, No. 2 (Summer, 1992),pp. 53-91Published by: Center for Latin American Studies at the University of MiamiStable URL: http://www.jstor.org/stable/166029 .

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Free Trade Area or Common Capital Market?

Notes on Mexico-US Economic Integration and Current

NAFTA Negotiations Jaime Ros

TuHIS ARTICLE addresses some of the key issues involved in i understanding current trade negotiations between Mexico

and the United States, as well as their significance for the

process of economic integration in North America. These issues derive from the new setting produced by (a) Mexico's trade and investment liberalization in the 1980s, (b) the incentives which underlie the drive towards integration, as well as (c) those factors which will condition the final content of the current negotiating process.

Jaime Ros is Associate Professor of Economics and Departmental Fellow at the Kellogg Institute of International Studies, University of Notre Dame. He has been a visiting scholar at Cambridge, Oxford University, the World Institute for Development Economic Research (WIDER), and the Kellogg Institute for International Studies. He is former director of the Department of Economics at the Centro de Investigaci6n y Docencia Economicas (CIDE) in Mexico, senior economist at the Secretariat of the South Commission (Geneva), and consultant for several international agencies (ECLA, ILO, WIDER, ILET). He is a graduate of the Universidad Aut6noma de Mexico (UNAM) and of Cambridge University. He is co-author of LA ORGANIZACION INDUSTRIAL EN MEXICO (Siglo XXI, 1990) and editor of MODEM: UN MODELO MACROECONOMICA PARA MEXICO (CIDE, 1984). He is the author of many articles in Mexican and international economic journals.

Parts of this article have been presented, in different versions, at various conferences and workshops. The author wishes to acknowledge, in particular, comments received from participants in the WIDER conference on "Trade and Industrialization Reconsidered," as well as those in the workshop held by the Brookings Institution on "NAFTA: An Assessment of the Research." The author is also indebted to Roberto Bouzas for a number of suggestions on the present version.

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54 JOURNAL OF INTERAMERICAN STUDIES AND WORLD AFFAIRS

A free trade agreement (FTA) with the United States could be seen as the logical conclusion of the process of trade and investment liberalization carried out by the Mexican government ever since the mid-1980s. At the same time, it also represents a shift in Mexico's initial trade strategy, from multilateralism to bilateralism, or from globalization to regionalization, as a consequence of the global trend, toward the end of the 20th century, to create large regional economic blocs.' Just a few years ago, such a denouement was far from being considered the only possible, and logical, outcome. This article emphasizes precisely those aspects of Mexico's economic reform dynamics which led its government, in the Spring of 1990, to seek full access to the North American market. One of the main arguments presented here is that this initiative was motivated by the quest for a higher degree of capital mobility rather than by the pursuit of trade gains. Hence the title of this article.2

Although the focus of attention will be the immediate background, and current context, of the negotiations for a North American Free Trade Area (NAFTA), these aspects represent only the tip of the iceberg. They are but the most visible point of a deeper process of integration - both social and economic - which has been going on, at an ever- accelerating pace, since the early 1960s. Some of the more significant aspects of this process of "silent integration" are the following:3

(1) the increasing demographic and economic density along Mexico's northern border, where the main economic activity since the mid-1960s, the maquiladora export-processing plants, today account for about a fifth of Mexico's overall industrial employment and non-oil exports;4

(2) the fast expansion, since the 1970s, of intra-firm and intra-industry trade in a number of industrial sectors, including, most prominently, the automobile industry; and

(3) Mexico's transformation, since the early 1980s, into the



ROS: FREE TRADE AREA OR COMMON CAPITAL MARKET?

third largest trading partner of the United States.

The strengthening of economic ties was accompanied by broader trends, which have increasingly brought the two societies closer together: since 1960, a growing population mobility has led more than two and a half million Mexicans to migrate legally to the United States, several million more to migrate illegally, and a much greater number to cross the border more than once. Not surprisingly, half of the Mexicans interviewed in 1986 - i.e., 40 million Mexicans, if the poll was a representative one - admitted to having a family member in the United States.5

This article is divided into four sections. The first section examines Mexico's reform of its external sector since the mid- 1980s, its initial effects, and the dynamics of the reform process which were to lead to the free trade agreement initiative. Using Mexico's experience with trade liberalization as background, the second section then focuses on the likely economic effects of NAFTA and reviews the large body of recent research on the subject. The findings of this research form the basis for a critique, in the third section, of the conventional analysis of Mexico-US trade negotiations. The fourth, and concluding, section summarizes the main findings.

1. MEXICO'S EXPERIENCE WITH TRADE AND IN- VESTMENT LIBERAIATION SINCE THE MID-1980s

t HE 1980s HAVE witnessed an overhaul of Mexico's trade and industrial policy, which was established during the

postwar period and has prevailed for most of the time since. The recent history of the changes in trade policy is summarized in Table 1. In 1984, moderate import-liberalization measures were undertaken as part of the de la Madrid administration's strategy of structural change. The requirements for licensing imports, which had been fully re-established in mid-1981, were relaxed and replaced, at least partially, by tariffs. Thus, the percentage of import-value subject to permits fell (from 100% to 83.5%), while the number and dispersion of tariffs was

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reduced. Additional steps were announced in early 1985. In the context of a medium-term plan drawn up by the Ministry of Industry and Trade, a program was launched which allowed for the gradual elimination of import licenses between 1985 and 1989, and which established, via a series of steps, a more uniform structure of effective protection. At the same time, Mexico and the United States signed a bilateral trade agreement, re-affirming the commitment to liberalization and pledging to eliminate export subsidies. In exchange, Mexico obtained from the United States some of the advantages normally reserved for members of the General Agreement on Tariffs and Trade (GATI).

Table 1. Changes in the Import Regime, 1982-1990

1982 1984 1986 1988 1990 Import license coverage (1) 100 83 27 22 18 Number of tariff items 16 10 11 5 5 Maximum tariff 100 na na 20 20 Tariff mean 27.0 23.3 22.6 10.4 13.1 Weighted average tariff (2) 16.4 8.6 13.1 6.1 10.4

(1) As percent of import value (2) Weighted by import value Sources: Zabludovsky (1990), Garcia Rocha y Kehoe (1991), USITC (1990).

The July 1985 and December 1987 Trade Reforms In mid-1985, additional, more radical, policy reforms

were instituted in response to two developments: (1) a disappointing performance of non-oil exports during the first half of 1985, and (2) the view, increasingly influential in government circles, which attributed failure to meet 1983-85 inflation targets to the sluggishness of import liberalization. As part of the devaluation and fiscal correction package in mid- 1985, the removal of import licenses and the reform of the tariff system were accelerated further (see Table 1). In August 1985,




licensing requirements fell to 37.5% as a percentage of import value and were lifted for most imports of intermediate and capital goods along with certain selected consumer goods. The share of capital-goods imports, as a percentage of the licensed- import bundle, fell from 19% to only 10% (from a high of 31% in 1982, according to Zabludovsky, 1990). At the same time, tariff rates were increased, with the trade-weighted average rising from 8.6% in 1984 to 13.1% in 1986. Further steps towards reducing tariff dispersion were also adopted. By 1986, 90% of the dutiable-import bundle was subject to 3 rates: 10%, 22.5%, and 37% (Zabludovsky, 1990).

Late in 1987, additional major steps were undertaken under the aegis ofthe"EconomicSolidarityPact"-the government stabilization plan, which was adopted at the time with the cooperation of labor unions and business organizations. Li- censing requirements dropped even further, to 22% (as percentage of import value), with the removal this time involving most consumer manufactures. Tariff dispersion was reduced to the 0-20% range, made up of only 5 categories: 0%, 5%, 10%, 15%, and 20%. The average tariff rate fell to 10.4% (unweighted) and 6.1% (import-weighted). Practically all the remaining reference prices, which had traditionally been the basis for establishing the actual tariffs to be paid, were removed. These policy changes went far beyond the schedule of the 1986 reform program. After their introduction, the sectors that remained protected by import licenses accounted for around 25% of tradable output and was made up primarily of agricultural goods plus a few manufacturing industries under industrial promotion programs.

Subsequent tariff reforms included both the elimination, in 1988, of the 5% surcharge on imports (which had been introduced, in stages, since 1985) and the reduction of import tariffs, in support of the stabilization program, with a view to increasing, on a selective basis, the competitive pressure on those goods which had been experiencing above-average increases in price after the counterinflation program had been introduced in December 1987. InJanuary and March 1989, new

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concerns - about the 1988 surge in consumer goods imports, as well as the problem of making effective protection more uniform - led the new Salinas administration to close the dispersion in nominal tariffs by adjusting upwards the tariff rates for most goods which had either previously been exempt or had been subject to a 5% rate. Thus, by 1990, the average tariff rate (import-weighted) had been raised to 10.4%.

The discussion so far has summarized the main changes in import policy. It is also worth highlighting three other aspects. InJuly 1986, the government signed an agreement for membership in the GATT. Mexico pledged to continue replac- ing direct controls with tariffs (a program then well-advanced), to be followed by reductions in tariffs.6 At the same time, a system was introduced by which to assess anti-dumping and countervailing duties, and Mexico maintained the right, at least temporarily, to exclude license removal from certain agricultural and manufacturing sectors, such as automobiles, pharma- ceuticals, and electronics, under specific industrial-promotion programs. In addition to gaining the advantages of GATT membership, the Mexican administration viewed the agreement as a way to strengthen the confidence of the private sector in the government's long-term commitment to liberalization. Membership in GATT was followed by establishing a Frame- work Agreement with the United States in 1987, and by the renewal (in 1988, and again in 1991) of the 1985 bilateral agreement on subsidies and countervailing duties.

Significant changes have also taken place in the export- promotion policy (over and above those experienced as fallout from changes in the import and exchange-rate policies). Export restrictions are now less important than in 1982, and those that remain are determined largely by the presence of domestic price controls and international and bilateral trade agreements. Export licenses affect agricultural goods with controlled prices and products subject to international agreements (such as coffee, sugar, steel, textiles), accounting, altogether, for 24.4% of non-oil exports (or 242 tariff items). Export tariffs (of up to 5.5%) affect largely a number of




agricultural products subject to export licensing, and repre- senting 6.7% of non-oil exports. At the same time, traditional export subsidies (through tax refunds to exporters) have been eliminated. The present export incentive plan is based mainly on a program exempting tariffs on "temporary" imports and on a program which exempts exporting firms from import licenses on inputs.7

The shift towards a more outward-oriented industrial strategy has also been accompanied by a sharp reduction in the number of industrial programs by firm or sector - which had become, in effect, the major industrial policy instrument during the second, and more difficult, state of import-substitution industrialization (ISI) since the mid-1960s - as the replace- ment of import licenses by tariffs freed up importing the products covered by the programs themselves. Meanwhile, this shift led to greater selectivity in industrial promotion, so the programs established (or reformed) during the 1980s focussed on a small number of priority industries, essentially those in the automobile, microcomputer, and pharmaceutical sectors.8 Their main objectives continued to include import substitution and the development of national firms (as in the auto parts industry, for example), but greater emphasis was increasingly given to promotion of exports, price competitiveness, and the improvement of technological and product standards. The major promotional measures have continued to be trade protection (through import licenses and domestic content requirements [DCRs]) and "foreign exchange balances" which, in the case of the auto industry, has led, since 1977, to greater flexibility in the use of DCRs and other regulatory measures, provided that growing exports compensate for additional imports (beyond the levels established in the content requirements). Even in these sectors, however, continuing reforms- including greater flexibility in the use of industrial policy and the removal of import licenses - are currently taking place.

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The Foreign Investment Regime

In contrast to the radical process of trade liberalization, Mexico's policy reform regarding foreign investment should be seen as one of cautious gradualism. The 1973 law - which defined the areas for foreign participation in the economy and established, as a "general rule," a 49% maximum for foreign capital - is still in place and remains the fundamental legal framework regulating foreign participation.9 Moreover, the policy changes introduced since 1984 to deregulate foreign investment flows have been oriented to facilitate portfolio investments in the local stock market, as well as direct investments by small and medium-sized firms, while preserv- ing a more cautious approach towards large investments by multinational corporations.

Although the 1973 law continues in force, both the de la Madrid administration (since 1984) and the Salinas administration (since 1989) have moved away from giving it a restrictive interpretation. Consequently, by simplifying and clarifying foreign investment procedures and opening up new areas of activity to foreign investors, these reforms represent a significant break with the past.10 The most comprehensive change to date has been the May 1989 decree ("Regulations of the Law to Promote Mexican Investment and Regulate Foreign Invest- ment") which repealed all existing administrative regulations and resolutions and gave a more liberal interpretation to the 1973 law. With the implicit goal of increasing direct foreign investment as a share of total investment from the 10% prevailing in 1988 to 20%, the new regulations established automatic approval of 100% foreign investment in projects under US$100 million which also meet a number of conditions.'1 When those conditions are met, automatic approval applies to the "unclassified activities" (i.e., those activities not listed in the decree and which fall outside the areas reserved by the 1973 Law to the State and Mexicans, or which are subject to specific percentages of foreign ownership). These unclassified activities account for 547 (or 73%) of the 754 activities which make up the economy according to the Mexican Catalog




of Economic and Productive Activities. Included are certain industries for which administrative regulations had previously restricted majority foreign participation, such as glass, cement, cellulose, iron and steel (i.e., sectors which have traditionally been dominated by domestic private and state firms). Of the remaining 207 classified activities, the decree lists 40 for which 100% foreign ownership is allowed, provided there is prior authorization by the National Foreign Investment Commission (NFIC).

It is also worth mentioning recent policy reforms in the areas of technology transfer regulations and protection of intellectual property rights, which, in the case of multinational corporations, could turn out to be more decisive than changes to general regulations on the participation of foreign capital. After a long process that involved changing the patent law in 1987, a new decree was issued in January 1990 which covered both technology transfer and the use of patents and trade- marks. The explicit goal of the decree is to foster economic modernization through the elimination of administrative procedures that, according to the government, prevented the transfer of technology to small firms, placed obstacles in the way of all types of transfers from abroad, and hindered the transfer of high technology to production areas. In essence, the new regulations remove government controls on the transfer of technology, leaving such transfers to the decision of the contracting firm, and they eliminate the regulatory powers of the National Registry of Technology Transfer, converting it into a promotional agency and data bank on technology (see Peres, 1990; US-ITC, 1990). The following points deserve mention: (1) there will be no limits on royalties, (2) there will be more protection of industrial secrecy and patents; (3) franchise contracts will be promoted; (4) there will be no more technological or economic performance requirements imposed on firms wanting to register contracts; (5) red tape involved in registering software contracts will be reduced; and (6) manda- tory registration of most contracts that involve operation services will be eliminated.

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External Sector Reform, Economic Efficiency, and Capital Flows

What have been the main effects of these policy reforms? Though any attempt to answer this question at this stage must be considered tentative and preliminary, analysis of this subject may prove useful for understanding, later, the likely consequences of a free trade agreement, as well as for clarifying the incentives that reform of the external sector has itself generated in the pursuit of increased economic integration with North America.

Mexico's transition towards a liberalized trade regime, especially when compared with similar efforts by other Latin American countries, has been strikingly smooth, both in terms of the micro-economic re-allocation of resources and of the macro-economic adjustments dependent upon overall industrial competitiveness. The absence of massive re-allocation processes is revealed by the fact that current trends in the trade pattern and industrial structure are, with no major exceptions, an extrapolation of the past. Beyond the growing export shares of a few traditional industries (wood, textiles, and apparel), the 1980s have witnessed an extrapolation of past trends, marked by the increasing importance of capital-intensive industries in the heavy intermediate, and consumer durable, sectors (the auto and petrochemical industries in particular) to which most of the mid-1980s boom should be attributed. Since 1985, the first year of radical trade reform, these trends have continued unabated and, in the case of consumer durables, have, if anything, accelerated.

The second feature, the smoothness of macro-economic adjustments to trade reform, can be illustrated by the evolution of industrial employment and plants in the post-trade-liberalization period. The latest industrial census data shows that, from mid- 1985 to mid-1988, the country's traditional industrial centers-the metropolitan area of Mexico City in the Federal District and Estado de M(xico, and Monterrey in the Estado de Nuevo Le6n - suffered severe job losses (almost a quarter of a million) and plant closures. At




the same time, however, new jobs and industrial plants were rapidly being created in the rest of the country: the central and eastern regions of Puebla and Veracruz, and, especially, in the northern border states of Chihuahua, Coahuila, and Nuevo Leon (excluding Monterrey). The result of these opposing trends was a net increase in the number of industrial establish- ments (by 4.5%), together with a reduction of industrial employment on the order of 4%, which can be largely explained by the severity of the contraction in industrial demand in 1986 and first half of 1987.12

The counterpart of this smoothness and continuity in the direction of structural change in manufacturing is, however, that the classic gains in efficiency expected from liberalizing trade cannot possibly have been very important. In fact, for those expecting a large, painful - but very beneficial - re-allocation of resources in favor of traditional exportable goods, labor- and natural-resource-intensive, the experience with trade liberalization should have been highly disappointing thus far.13 The major factors which could explain this transition are probably the following.

First, and perhaps paradoxically, the adjustment to the debt crisis and declining terms of trade during the 1980s forced macro-economic policy to provide unprecedented levels of "exchange rate protection" (see de Mateo, 1988; Ten Kate and de Mateo, 1989). This facilitated the adjustment of industrial frms to a more open economy and subsumed the specific dislocation costs of trade liberalization into the broader, and more apparent, costs of overall macro-economic adjustment. A second fact is simply Mexico's successful import-substitution experience in the past, and the advanced stage that intra-industry (and intra-firm) processes of specialization and trade had already reached by 1980, precisely in those capital-intensive, large-scale manufacturing industries which have been responsible for most of the export boom of the decade.14 The industrial policy reforms of the late 1970s, especially in the automobile industry, had given further impulse to those processes. The incentives provided later by a very attractive exchange rate and by the trade reforms of the

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mid-1980s fell, therefore, on already fertile ground. The outstanding export performance of Mexico's manufacturing in the 1980s is, thus, to a large degree, a legacy of the import-substitution period and highlights, in a very real sense, its success. Indeed, it led to an irreversible change in the economy's structure of comparative advantage.

What can be said now about the dynamic effects of trade liberalization on productivity performance? Let us first examine the behavior of labor productivity (for a more detailed analysis, see Ros, 1992b). Overall labor productivity growth in the 1980s, at 1.4% per year, has been clearly below historical trends (on the order of 3.5% per year), and this applies to both halves of the decade, both before and after the 1985 trade reform. At the same time, growth in manufacturing productivity, as a whole, shows a recovery in the post-trade-liberalization period after 1985, when compared to the first half of the decade. A closer look reveals that this acceleration is concen- trated largely in the automobile industry, basic metals, and in food processing. In the first two, the evolution of import and export rations suggests that gains in productivity are most likely the result of an increasing intra-industry (and intra-firm) specialization in foreign trade, associated, in the case of automobiles, to its special policy regime and the international developments since the late 1970s.15 In food processing, the fact that productivity increases have taken place here in the midst of a slowdown of the industry's growth in output also suggests a process of industry rationalization, but of a different nature altogether. In this case, industry rationalization is probably associated with the rapid import penetration in the industry in the recent period (in fact, only since 1988), by which the import ratio had, by 1989, more than doubled when compared to its 1985 level. This rapid expansion of imports in the domestic market has probably led to the shakeout of some parts of the industry, with the elimination of less efficient producers explaining its rising average productivity levels, while, at the same time, accounting for the deceleration of output growth in the midst of an overall economic recovery in manufacturing.




Since 1988, the benefits of import penetration, in terms of productivity performance, become much more doubtful when we look at the rest of manufacturing. Despite the overall improvement in productivity growth, 5 out of the 9 broad component sectors of manufacturing have, in fact, recorded a decline in productivity growth rates after 1985, compared to the first half of the decade.16 Two of them - textiles and other manufacturing industries - show, in addition, negative rates in the more recent period. Moreover, the 3 worst performers (the 2 just mentioned plus the wood industry) all have had declining levels of output since 1985, reflecting a displacement of domestic production by imports, which more than offset the effects on output of a quite outstanding export expansion. Indeed, they show, together with food processing, the fastest rates of import penetration within manufacturing; the almost 4- fold increase in the textile import ratio standing out as the most remarkable.

The evidence on the growth of total factor productivity (TFP) is even less encouraging despite some claims to the contrary.17 The two studies available show a deceleration of TFP growth in the post-trade-liberalization period (i.e., after 1985 as compared to the 1982-85 period): from 4% per year to 2% in 1985-87 (Hemandez Laos, 1990), and from 4% to 3.7% in 1985-89 (Kessel and Samaniego, 1991).18 This deceleration in TFP growth is, of course, unlikely to have been brought about by trade policy reforms. It is, rather, the consequence of the steady increase, since 1982, in the capital-output ratio which took place as a result (a) of the aging of the capital stock and the change in its composition towards residential investment, as well as (b) of Kaldorian effects, by which the rate of productivity growth has been affected by the slow process of capital accumulation (and, thus, of embodied technical change) and a low rate of output growth leading to the relative expansion of underemployment and low-productivity, infor- mal activities (see Ros, 1992a). The increase in the capital- output ratio is the piece of evidence which reconciles the trends to which we have alluded: (1) the slight acceleration of labor productivity growth after 1985, and (2) the decline in TFP

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66 JOURNAL OF INTRMERICAN STUDIES AND WORLD AFFAIRS

growth during this same period. If we add to these the decline in social investment during the 1980s, with their likely effects on long-term productivity growth, the decline in the latter, compared to historical rates, should not be surprising.

The surge in imports that followed the 1987-88 acceleration of the trade-liberalization program had other impacts of doubtful value. Recent import trends - by which imports at current dollars have been growing at an annual rate of 32% since 1988 - have left the country's current account balance in a very vulnerable position. Combined with the export slowdown in recent years, it has led to a declining trade surplus which turned later into a widening deficit. These developments are also partly explained by real appreciation of the peso in recent years, the decline of domestic savings rate throughout the decade, and the recent recovery of aggregate demand and private investment. But the fact that the import boom appears to be clearly linked to the trade liberalization measures of late 1987, and given that those measures have not substantially improved overall export performance, provides a strong indi- cation that trade liberalization since then has, in fact, had a negative impact on the structural trade balance (i.e., the trade balance at constant utilization and exchange rates). By tighten- ing foreign exchange constraints, its overall effects on medium- term economic growth could well turn out to be negative. In the longer term, these macro-economic effects become more uncertain to the extent that the initially dominant and negative effects on import functions could be gradually offset by a spurt of productivity growth and a change in the structure of investment and productive capacity toward exportable goods, with its positive sequel on export functions.

In any case, it seems very unlikely that the Mexican economy will be able to resume and sustain its historical rates of growth unless substantial capital inflows, well above historical levels, can permanently finance a current account deficit that, by now, appears to be on the order of 4-5% of the gross domestic product (GDP). It is precisely the reappearance of the macro-economic costs of trade liberalization, as the real



ROS: FREE TRADE AREA OR COMMON CAPITAL MARKEP?

exchange rate returns to historical levels, together with the fall in domestic savings that the adjustment process of the 1980s left as a legacy, which explains the acceleration of economic reforms in other areas. Indeed, the sequence of events clearly suggests that, besides the progress made on the inflation front since 1988 and the debt relief agreement of 1989, the massive privatization of public enterprises and deregulation of foreign investment flows have been some of the main measures instituted as a means to alleviate, through capital inflows, a balance of payments position that was otherwise unsustainable as a result of recent trade and exchange rate policies.

The impact of recent economic reforms on business confidence and capital inflows has clearly been positive. However, those capital inflows of a more permanent nature still appear to be only a small fraction of the total. The government expected to attract US$3.5 billion in new foreign direct investment (FDI) in 1990, and another US$25 billion in the 4 years following (approximately a fifth of total investment). Although largely compensated by spectacular amounts of portfolio investment and capital repatriation, recent flows of foreign direct investment have been well below those projections. It is in this context of resilient macro-economic fragility that the initiative for a North American Free Trade Area took place. Its enthusiastic adoption by the Mexican government is thus not only a result of a long process of "silent integration," coupled with global trends towards the forma- tion of regional trade blocs in the world economy, but it is also a consequence of the new economic problems brought about by the adjustment and reform processes of the 1980s.

2. TRADE GAINS AND CAPITAL MOBILITY: A REVIEW OF RECENT STUDIES ON THE EFFECTS OF NAFTA

'THE SUBJECT WITH which we concluded the previous section refers to the incentives behind the establishment of

a free trade agreement and is closely linked to the benefits that

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Mexico can derive from greater economic integration with the United States. It is worth pausing now to consider the results from the large body of research on the subject and see what we can learn from it.

Table 2 summarizes the research findings of some of the main quantitative studies on the likely effects of the NAFTA.'9 The studies are classified in a 3 by 2 matrix. The two columns refer to (1) those studies (or scenarios within a study) that assess the size of trade gains under the assumption that no additional investment will flow to Mexico as a result of NAFTA; and (2) those studies which aim to evaluate both the trade effects and those which would arise from additional capital flows, whether assumed exogenously (in which case the authors imply speculate on the likely path of these flows), or endogenously as determined by the model used, simulta- neously with other economic variables. The three rows refer to the type of model used. The first two rows represent computable general equilibrium (CGE) models which make different assumptions about technology: either (1) models with constant returns to scale (CRS); or (2) increasing returns to scale (IRS) and dynamic models. The third row refers to macro-economic models with a high degree of sectoral disaggregation.

Table 2.

Summary of Recent Findings on the Economic Effects of NAFTA

No capital mobility Capital mobility CGE-CRS(1) <0.5% 4.6-6.4%

CGE-IRS and dynamic (2) 1.6-2.6% 5-8.1%

Macroeconomic small interindustry employment models (3) losses (1) Peat Marwick (1991), Hinojosaand Robinson (1991), Roland- Hoist, Reinert, and Shiells (1992); (2) Brown, Deardorff and Stem (1991), Sobarzo (1991), Young and Romero (1992); (3) INFORUM Report (1991).




Each entry in the matrix can then be seen as referring to different types of gains or economic effects. For example, in the first column the first entry focuses on classical gains from inter-industry trade and specialization; the second entry on "new trade theory" effects from economies of scale and intra- industry trade (IRS models), as well as on investment effects arising from lower prices of capital goods (dynamic models); and the third entry refers to dynamic macro-economic effects.

There are two major lacunae to point out, of which the first is the absence of dynamic models with endogenous productivity growth effects. On these effects, all we have are good theoretical reasons to expect that they can be very important (especially when interacting with capital flows), both from the findings of "new growth theories" and the older insights of Allyn Young and Nicholas Kaldor, among others.20 The second is that no research has been conducted on macro- economic dynamics with endogenous capital inflows. The only macro-economic model in the matrix (that of INFORUM Report, 1991) has no additional investment flows as a result of NAFTA.

Trade Gains

By looking across the rows in the first column, one can draw the following conclusions about the trade effects of NAFTA in the absence of increased flows of investment:21

1. Very small trade gains from resource re-allocation and specialization in foreign trade (first entry in first column). The welfare gains resulting from these classical processes of resource re-allocation according to the economy's current comparative advantages turn out to be less 0.5% of Mexico's GDP (approximately 0.3% in the first two studies quoted and even less in the third).

2. Larger, but still small, gains from economies of scale, industry rationalization, and lower prices of investment goods (1.6-2.6% of GDP in the scenarios of Brown et al. [19911, Sobarzo [1991], and Young and Romero [1992] without capital mobility).

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3. Small, but negative, macro-economic adjustment effects in Mexico. These are reflected in a fall of employment levels of less than 1% over the base scenario in the INFORUM Report (and somewhat larger when the agreement in- cludes a full liberalization of agricultural trade), so that the United States turns out to be the main beneficiary of the agreement. Since the Report's methodology (unlike the rest of the studies) does not clearly separate the "Ricardian" static trade gains from the macro-economic effects arising from the "Keynesian" processes of adjustment, which depend on initial absolute advantages, the interesting conclusion that emerges from this study is, indeed, that the latter (taking for granted that the former are positive) would, in the absence of additional flows of foreign investment, be clearly adverse for Mexico.

These results, which many have found disappointing, are hardly surprising in the light of Mexico's recent experience with trade liberalization, an experience which has involved even more drastic trade policy changes than those expected from NAFTA. As discussed in the previous section, the micro- economic processes of resource re-allocation have been re- markably smooth and, for this reason, have not generated but small welfare gains.22 The effects on technical efficiency and efficiencies of scale have been more significant (though not always positive) as a result of processes of industry rationalization in some manufacturing sectors. Finally, macro-economic effects have been negative, though so far hardly visible, since they have been concealed, since 1989, by the turnaround of the capital account. It is worthwhile emphasizing the last result in the context of a free trade agreement. The presence of negative macro-economic effects arising from a NAFTA is, after all, highly plausible. As pointed out by the INFORUM Report (1991), Mexico's trade concessions will be larger than those made by the United States, a factor which modifies the initial advantages determining the dynamics of adjustment in favor of the latter country.23 Moreover, the size of these negative effects is likely to be larger today than at the time of the INFORUM Report simulations since the present real exchange rate is much




less favorable than in 1989 to mitigate the macro-economic adjustments resulting from greater integration.

This experience also tells us something about one of the major lacunae noted in recent research. This is, essentially, that endogenous productivity effects arising from virtuous circles between exports, investment, and productivity growth have been largely absent so far. In fact, the only spectacular change that took place in Mexican industry in the 1980s was the export and investment boom in the auto industry which, however, had little to do with trade liberalization and which is likely to continue, with or without a free trade agreement.24

The Effects of Increased Capital Mobility If trade gains are marginal, what are the real benefits that

Mexico can expect from the agreement? The answer to this question can be found by looking across rows of the matrix. When the same models are simulated with additional capital flows, one can see the gains from NAFTA multiplied by at least a factor of 4: in the studies mentioned (Brown et al., 1991; Sobarzo, 1991; Young and Romero, 1992) for example, one moves from the 1.6-2.6% range to the 5-8.1% range, as a percent of Mexico's GDP. Increased capital mobility is, of course, what both the public and the trade negotiators have in mind when talking about NAFTA.

The difficulty here, however, is that one also moves on to shaky ground. The specific effects of NAFTA (including those arising from the accompanying measures of investment liberalization) refer to those incremental capital flows that will result from reduced uncertainty (the effects of locking in current policies) and the ensuing reduction of risk differentials between Mexico and the United States. And these consequences are, by their very nature, very difficult to measure. This is so, quite independently of whether one models investment flows as exogenous or endogenous, because, in the latter case, one can only speculate about how much interest rates and risk differentials are likely to fall, and about how investment will

71




respond to these reductions in a context which represents a completely new situation for investors.

One way of addressing the problem is to speculate on the basis of the experiences of other countries, as well as of Mexico's own recent experience, with investment liberalization (the "historical method" favored by Hufbauer and Schott, 1992). Spain's recent experience of massive capital inflows is often alluded to in this regard. However, I find this analogy unconvincing for at least two reasons. First, I share the reservations of the authors of the INFORUM Report:

In Spain, the low-wage country was soon to gain access to the well-protected markets of Europe. Moreover, with the prospect of "Fortress Europe" after 1992, many American firms were eager to get a toehold inside the Community. By contrast, Mexico has long had virtually unrestricted access to the US markets outside of the apparel, textile, and steel industries. Foreign investment in Mexico for producing for export has been almost unrestricted since 1972. Further, there is no prospect of a "Fortress USA" looming ahead. At most, an FTA would remove the prohibitions on majority foreign ownership for firms investing in Mexico to sell in Mexico. In fact, there seem to have been important exceptions to the present prohibitions. For example, all of the six major automobile companies operating in Mexico have over 900/o foreign ownership. While an FTA would, we believe, improve the atmosphere for foreign capital in Mexico, there seems little reason to believe that the inflow would be massive (INFORUM, 1991).

It could be argued that, despite these differences, recent capital inflows into Mexico have been, after all, comparable in size to those of Spain. However, there are some other differences in this respect. A substantial fraction of the recent capital inflows into Mexico (repatriation of capital and foreign portfolio investment) are of a one-time nature. They are mostly related not to investment liberalization (as we have seen, the




performance of foreign direct investment has been, in reality, disappointing) but, rather, to privatizations of public enterprises and state banks since 1989. The time pattern of capital inflows and privatization revenues- increasing slowly in 1989-90, accelerating sharply in 199 - dearly suggests this conclusion. Privatization revenues will begin to decline this year (down to around US$7 billion in 1992 from about US$12 billion in 1991), and, under current plans, they will practically disappear by 1993-94. Paradoxically, even though NAFTA is likely to improve Mexico's capital account surplus (compared to what would happen otherwise), it should not be surprising, provided an agreement is reached sometime in 1993, to see its conclusion followed by a decline, rather than an increase, in Mexico's capital account surplus.

Even if a free trade agreement were to bring about substantial additional foreign investment, such a scenario raises a number of issues which have been neglected by recent research. What would be the time pattern of these flows and the associated macro-economic dynamics? Would these inflows come at a steady pace of, say, an additional US$5 billion a year, or, even better, at a gradually increasing rate year after year? Or would foreign capital come in massively during the initial stages (say, an additional 30 billion in 3 years) only to be followed by a sharp slowdown? If that should be the case, would the capital inflows lead to a strong appreciation of the peso, causing severe damage to whole parts of Mexican industry, followed by a period of acute balance of payments difficulties as capital inflows subsequently decline sharply? Or, on the contrary, would they put more gentle pressure on the exchange rate which, combined with the abundance of investment finance, would give an impetus to the technical modernization of Mexican industry?

The lack of answers to these questions is closely related to the lacunae mentioned at the beginning of this section. For the uncertainty that surrounds them follows from the fact that the interactions between endogenous productivity growth effects and macro-economic dynamics can cut both ways and

73




broaden the range of possible outcomes enormously. This is especially the case when the process of economic integration involves two countries at such disparate levels of economic and technological development as Mexico and the United States.25 The experience and future development of the south- ern European countries in the new European Community (EC) is relevant in this respect. As the authors of a recent book on the subject put it:

It was difficult to foresee which of the two divergent paths the new members would take. The double shock of accession and 1992 might drive their economies into depression or accelerate their modernization. Unfortu- nately, economic principles do not point to a predeter- mined outcome. In fact, the degree of indeterminacy is so great that the outcomes may range between brilliant achievements and big difficulties (Bliss and Macedo in CEPR Bulletin, 1990: 7; quoted in Helleiner, 1991).

However, together with these cumulative and uncertain processes, there are stabilizing forces that will operate with particular strength in the case of economies which are also very different in size: capital mobility will tend to stabilize any increases in technological and wage gaps that could occur if initial adjustments are detrimental to Mexico, while Mexico's limited capacity to absorb foreign capital (relative to the size of the US economy) would tend to slow down any processes of technological convergence that could take place in the opposite scenario. In any case, the set of forces operating is so complex, and the uncertainty about their potential interaction is so great, that economic analysis by itself if insufficient. This points to the need for giving much more attention to problems of macro-economic dynamics and management during the transition and, more generally, to the role of the state and social institutions in the integration process.




3. THE BARGAINING PROCESS AND THE ISSUE OF MEXICO'S "SIDE PAYMENT"

REACHING an agreement involves a negotiation process whose parties face different costs and incentives. The

analysis of this process, as in the case of other experiences of economic integration between a large and a small country, has been inspired by the well-known neoclassical proposition by which the gains resulting from trade flow disproportionately to the small country. The reason is that the large country's domestic price structure will dominate in the determination of post-trade prices; it is only in the small country that significant changes will take place in the pre-trade price structure. Since the static gains from trade flow from the re-allocation of resources resulting from the expanded opportunities for specialization associated with the new structure of relative prices, those benefits will accrue largely to the small economy. Adjustment costs derived from resource re-allocation (temporary unemployment of capital and labor in losing sectors) will also be greater in the small country. But these are short-run costs which should be more than offset by the long-term gains of the new, and more efficient, allocation of resources.

In any case, the large country has not much to gain since its pre-trade price structure remains largely unaffected, and no new opportunities for specialization arise from the opening of trade. The conclusion that follows, then, is that there is nothing significant for the large country in the agreement (Dixit, 1987). From this perspective, the next step would be to ask what concessions would Mexico have to make to reach an agreement, and then to examine the non-trade incentives, or even non-economic incentives, that could lead the United States into a free trade agreement. Some interesting analyses along these lines can be found in, for example, Helleiner (1991) and Cameron (1991).26

Nevertheless, it is clear from our review of recent research on the effects of NAFTA that this approach puts too much emphasis on the trade gains that Mexico can derive from

75




greater integration with the United States. Ultimately, the basic reason why the premises of the conventional approach are

openly at variance with the findings of recent research is quite simple: the theoretical proposition, from which the issue of a "side payment" arises, refers to the opening of trade between two previously non-trading economies. It becomes much less relevant if the status quo ante involves two economies already engaged in trade with another to the point that they are, respectively, the first and third trading partners of the other and, furthermore, have rather uniform tariff structures, average tariffs on the order of 4% (US) and 9% (Mexico), and non-tariff barriers for only a few products. Under these circumstances, the gains from additional trade opportunities are likely to be small - the price structure of the large country already dominates that of the small country - and need not necessar- ily flow disproportionately to the small economy. The latter's market is certainly smaller, but it is also more protected initially and, in a free trade agreement, its trade concessions will therefore be greater: its initial average tariff is higher, and quantitative restrictions affect a larger percentage of its tradable output.

As discussed in Section 2, the most significant benefits that Mexico can expect from NAFTA arise from the higher degree of capital mobility that it is likely to produce. More precisely, the most important incentive is avoiding the costs which Mexico would otherwise have to support in the absence of the external capital inflows it needs to sustain its recent, and still fragile, economic recovery. Starting from this premise has, in turn, important implications for the analysis of the bargaining process. Contrary to the conventional approach, it means that NAFTA provides an equally important economic incentive for the United States. This is simply the counterpart of the inflows of additional capital Mexico is expecting: the relocation by US industry of some productive processes, especially in those sectors most seriously threatened by foreign competition in the domestic market, into a low-wage country with locational advantages, in order to face the intensification of international competition that has taken place over the last two decades.27



ROS: FREE TRADE AREA OR COMMON CAPITAL MARKE'P

Does this mean that there is a basic symmetry - rather than the asymmetry assumed by the conventional approach - in the bargaining position ofthe two parties?The answer to this question is negative, but the reasons are very. different from the conventional ones. The first reason has to do with the distribution of gains within each country. In Mexico, the distribution of these gains is more or less uniform, or at least is perceived to be so. Labor benefits from the creation of new jobs and/or higherwages resulting from flows of additional investment, while local capital benefits indirectly from the faster pace of economic expansion that those investments make possible without, at the same time, being threatened by them, since they will flow primarily into activities that complement those of local capital.

These conclusions are violated in only a few areas which are, precisely for this reason, areas of conflict in the trade negotiations: (a) the agricultural sector that produces basic foodstuffs, where rapid liberalization would have a negative effect on rural employment, and (b) financial services, where foreign investment would compete directly with local capital.

In contrast, the benefits from NAFTA are far from being distributed uniformly in the United States: precisely because they have to do with mobility of capital rather than trade, the gains flow disproportionately to capital, up to the point where labor could actually lose from the agreement. Although it can be argued, as some studies have done, that labor would benefit in the long run (compared to what would happen otherwise, which may be of cold comfort to those affected), the transi- tional adjustments introduce an element of conflict between the short-run and long-run interests of US labor - a factor not present in the Mexican case.

The resulting asymmetry is reinforced by another factor which, to put it bluntly, can be stated as follows: In the United States, the eventual losers can put their case more loudly, have it taken more seriously, and have their votes counted more fairly than is true in Mexico. This second difference carries important implications. The very strength of the Mexican executive and the lack of democracy in Mexico's political and

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social system have the paradoxical effect of weakening its position at the bargaining table. The US negotiators are, in fact, strengthened by a divided government at home and a more open and vigilant society. In facing a difficult issue, they can always reject the Mexican position as politically inviable and unacceptable by the US Congress. An analogous threat by Mexico's negotiators would totally lack credibility because, among other reasons, it is the Mexican Senate (whose members, with few exceptions, all belong to the government party) which has to ratify the agreement.

The conclusion that follows from analyzing these asymmetries is that, after all, and as expected by the conventional approach to the bargaining process, Mexico may find itself in the position of making non-trade and unilateral concessions in order to reach an agreement. The same conclusion follows from a rather more formal analysis, which will allow us to clarify some features of the bargaining process.

Consider the following game, in which each of the negotiating parties has the option of making, or not making, some non-trade concessions. The different possible outcomes are illustrated in the following schema:

Mexico Concessions No Concessions

Concessions

United States

No Concessions

Mutual concessions US unilateral concessions

Mexico's unilateral No concessions concessions

Each entry in the table describes a different type of agreement. The second entry in the second row can be seen as the status quo or as an agreement without non-trade concessions (something similar to the 1987 bilateral agreement with some trade innovations).

The outcome of the bargaining process depends on each party's structure of preferences with respect to the different



ROS: FREE TRADE AREA OR COMMON CAPITAL MARKET? 79

possible outcomes, and this structure, in turn, depends upon the nature of the concessions. To give an example, consider the case of "minimum concessions," defined as follows. On the part of Mexico, this would amount to the inclusion in the agreement of GATTs new issues, i.e., the opening of the services sector, the alignment of intellectual property laws, and the liberalization oftrade-related investment measures (TRIMs), such as domestic content requirements, which are still present in some Mexican industries. On the part of the United States, this would imply eliminating from the agenda such issues as those relating to environmental regulations and labor standards, which, if included, would tend to increase the costs of relocating plants or of shifting new investments to Mexico.2 Thus defined, the most likely structure of preferences would be:

Mexico United States Mutual concessions (4) Mexico's unilateral concessions (4) US unilateral concessions (3 No concessions (3) Mexico's unilateral concessions (2) Mutual Concessions (2) No concessions (1) US unilateral concessions (1)

Where, to simplify, we have assigned values of 1 to 4 to each of the possible outcomes. The payoff matrix corresponding to the preference orderings would then be as follows:

Mexico Concessions No Concessions

Concessions United States

No Concessions

2,4 1,3

4,2 3,1 X I . . ..1 -. .

The US has a dominant strategy (no concessions) and Mexico too (concessions). The outcome of the bargaining process is clear: Mexico makes unilateral concessions. The assumed preference orderings are a basic reason behind this




outcome: the assumption, in particular, that Mexican negotiators value highly an agreement based on mutual concessions and very little the status quo (no concessions), an assumption which is related precisely to the non-trade nature of the benefits from NAFTA (arising from the investment liberalization which negotiators would be willing to undertake in any case) and a powerful executive which does not face a strong domestic opposition to making unilateral concessions. This contrasts with the more traditional preference structure being assumed for US negotiators, yielding decreasing values as the outcomes involve higher net concessions and a relatively high value assigned to the status quo resulting from a stronger domestic opposition, the uneven distribution of gains within the country, and a divided government.

The other basic reason for this result, of course, is the way in which "concessions" have been defined. Depending on their exact content, the result could have been "mutual concessions" or even "no concessions" (if, for example, unilateral concessions had been defined as free labor mobility in one case, and a complete opening of the energy sector on the other).29 It is beyond the scope of this discussion to explore the exact content of the side payment that the US could exact from Mexico in order to reach an agreement which is signifi- cantly different from the status quo.3 The purpose of the exercise has been to illustrate the real asymmetries that condition the bargaining process and the source of the weakness of the Mexican negotiating party.31

4. CONCLUSIONS

THE CURRENT drive towards greater economic integration L in North America can only be fully understood in the

context of powerful regional and global trends: (a) the long process of "silent integration" which has increasingly interwo- ven the economies and societies of Mexico and the United States for several decades; (b) the shift in the ideological climate in the 1980s, with its broad repercussions for economic




policymaking and the thinking on development strategies; and (c) the end-of-century trend toward creating regional trading blocs in an increasingly competitive international economy. With this background in mind, this discussion focussed on the more proximate determinants of the current NAFTA negotiations, as well as on its likely economic consequences for Mexico.

The first section examined Mexico's recent experience with liberalization of trade and foreign investment. Special attention was paid to the dynamics of the reform process, showing how the highly adverse external macro-economic conditions (the debt crisis and the oil price collapse) in which the liberalization was undertaken contributed, perhaps paradoxically, to lessen the resistance to change while, at the same time, generating overly optimistic perceptions about the role that trade liberalization was playing in the boom in manufacturing exports which took place during the decade. In turn, this contributed to a further radicalization of the reform process. As the macro-economic costs of trade liberalization, in the context of an appreciating real peso, from 1988 onwards, became more visible, the process was pushed towards its eventual conclusion - full and formal integration into the North American economic space.

This was so because one way of addressing the legacy of macro-economic fragility and diminished growth potential bequeathed by the "lost decade" of the 1980s is to mobilize, as fully as possible, the potential of external financial resources that greater economic integration with the United States would provide. As discussed in the second section, it is here, in the domain of capital movements, that one should look for the real levers behind the integration movement. The fact that traditional trade gains are clearly of a second order should not lead, however, to an overestimation of the benefits to be derived from a higher degree of capital mobility in North America, and thus to neglect a number of important and difficult questions on this subject that much recent research has failed to ask. This discussion has not attempted to answer these questions but has tried to identify the sources of our uncertainty. These have to

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do with the difficult issues of macro-economic dynamics in a context which has hardly any historical precedent, involving, as it does, two economies so different in size, technological and economic development.

Finally, the third section examined the bargaining process, modifying the premises which have inspired previous analyses. Indeed, the conventional approach to the bargaining process appears to be seriously flawed. Its exclusive emphasis on traditional trade gains, and their appropriation by the smaller country, is clearly contradicted by much recent research on the economic effects of a NAFTA. At the same time, it neglects other important asymmetries between the two countries that are very relevant to an understanding of the current bargaining process: the distribution of gains within each country and their very different political systems. Yet the alternative analysis presented herein suggests that the conclusions of this conventional approach - that an agreement may require unilateral concessions by Mexico - is essentially correct. This curious denouement follows from the fact that the focus of attention of the conventional approach to the bargaining process is that it involves asymmetrical players, even though it does not correctly identify the nature of the relevant asymmetries.

NOTES

1. On this second aspect, see Peres (1990a) and Ojeda (1991).

2. Although a North American Free Trade Area (NAFTA) involves a trilateral negotiation, the analysis of this article is limited to the bilateral relationship between Mexico and the United States. Mexico's links to Canada are weak and bear no comparison to those with the United States. Moreover, as Robert Pastor has pointed out, rather than a major actor in a trilateral process, Canada has been defending the interests it acquired in its previous bilateral agreement with the United States (Pastor, 1992). On the relationship between Mexico and Canada, see Cameron et al. (1992).

3. For an analysis that places NAFTA at the center of this broader integration process, see Pastor (1992).




4. Maquiladora exports refer to exports net of imported inputs (i.e., equal, roughly, to the maquiladora's value added). The gross exports from maquiladoras account for a fraction of total exports, well beyond 200/o.

5. Data on both migration and the result of the interviews (conducted by the New York Times in the Fall of 1986) are quoted by Pastor (1992).

6. This involved tariff concessions on approximately 16% of the 1985 bundle of imports, a reduction of the maximum tariff to 50%, and the elimination of official import reference prices (de Mateo, 1988; Zabludovsky, 1990).

7. These are, respectively, the Programa de Importaci6n Tem- poralpara la Produccion de Articulos de Exportaci6n (PITEX) and Derechos de Importaci6n para la Exportaci6n (DIMEX), both of which were established in 1985.

8. See Moreno (1988) and Peres (1990b) for a detailed analysis of these programs. A program for the petrochemicals industry was also issued in 1986, but this was essentially intended to regulate the increasing privatization of this sector.

9. The 1973 Law to Promote Mexican Investment and to Regulate Foreign Investment classified economic activities into 4 categories: (1) activities reserved to the state (such as oil, basic petrochemicals, electricity, and railroads), (2) activities reserved exclusively for Mexicans (in the communications and transport sectors, exploitation of forestry resources, radio and television); (3) activities in which foreign investment was subject to specific percentage limitations (such as a 40% limit in secondary petrochemicals and auto parts, and any other activities for which percentages are specified by law); and (4) all remaining activities, in which foreign participation was limited to no more than 49/o. The National Foreign Investment Commission (NFIC), a regulatory agency established by the 1973 Law, was empowered, however, to modify this general rule in all remaining activities and to grant authorization for a higher percentage when such an investment was considered beneficial for the economy. In practice, the 1973 Law was to apply to new investment projects, since the NFIC allowed those businesses that were wholly foreign-owned prior to the law's adoption to retain their existing capital structure.

10. In approving new investment projects and waiving the 49%0 limit, the NFIC traditionally took into consideration a number of criteria, including their complementarity with national capital, tech-

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nology transfer, balance of payments, and effect upon employment. The liberalization process began with the 1984 Guidelines from the NFIC which endorsed majority foreign participation in 33 selected activities (capital-intensive, high technology, and export sectors) and thus marked a shift towards a policy of selective promotion of foreign investment in specific areas. Subsequently, a series of General Resolutions by the NFIC, from 1984-1988, reduced red tape for majority foreign investments (especially in the export assembly plants, or maquiladoras, located largely along Mexico's northern border), allowed unlimited investment by international development organizations ("neutral capital"), and removed the need for NFIC approval for foreign acquisitions of up to 49%/ of the shares of an established Mexican company, or of up to 100% in companies where foreign investors already controlled more than 490/o of the stock. At the same time, a number of reforms to sector-specific decrees and laws relaxed, or lifted limitations on, foreign investment in several areas, like petrochemicals, banking, insurance, telecom- munication services, and tourism (see Peres, 1990b).

11. These conditions, besides the one that total assets be less than US$100 million, refer to balance of payments criteria (that all funds originate abroad and that anticipated foreign-exchange flows are in balance during the first 3 years the project is in operation), regional policy (production plants should be located outside the most populated urban areas, like Mexico City, Guadalajara, and Monterrey), employment and training (the investment projects are anticipated to create permanent jobs, establish worker training and personnel development programs), and the use of adequate technologies to satisfy environmental requirements.

12. This, in turn, was the result of the fiscal austerity package that followed the early 1986 oil price collapse, rather than a consequence of import penetration in the domestic market. As discussed below, the additional liberalization measures since 1988, combined with an appreciating real peso, have had a stronger impact on import penetration, especially in some light manufacturing industries (wood, textiles) and the capital goods sector. However, since then, the adverse effects of these developments on industrial employment have been partially offset by more favorable domestic demand as the success of the counterinflation program (ate in 1987) was accompanied by a moderate recovery of economic activity and private investment.

13. For a detailed discussion of resource re-allocation, see Ros (1992b) and, in particular, Moreno (1988) for an analysis of the most important aspect of this process, the restructuring of the automobile




industry and its role in the boom of manufacturing exports of the 1980s.

14. Paradoxically, the fastest growing exports during the 1980s came from sectors under specific industrial programs: the automobile industry - which, alone, accounts for 28%/ of the total increase in non-oil exports between 1982 and 1988 (and for 35% of the total increase in non-maquiladora exports) - and the computer industry. These are the two industries where liberalization measures were temporarily waived, and whose finished products have been fully protected by import licenses during the entire period under consideration. The other major contribution to export increases (14% of the whole) has its origin in the maquiladora assembly plans in the region along the northern border - a sector which has traditionally been subject to a free-trade regime for the processing of imported materials and the re-export of the finished products abroad and which, therefore, did not record a change in trade regime during the period. Here, the role of the real exchange rate has been decisive. The very dynamic and improved performance of this sector in the 1980s (compared to previous periods) can be explained by the abnormally low dollar value of domestic wages, the result of depreciations of the peso, together with its advantage of location, a function of its proximity to the large, expanding US market, during a period of increased global competition.

15. In particular, the export-oriented investments of the late 1970s and early 1980s, following the 1977 reform of the automotive decree, must have made a significant contribution to the technical modernization of the industry, whose effects were only fully felt well into the 1980s as the new plants created by those investments came into operation and rapidly expanded their share in the industry's output (see Moreno, 1988). In the basic metals sector, the industry's rationalization is also perhaps related to a government program with precisely that goal, and which included the shutdown and privatization of many public enterprises in a sector where the latter have traditionally shown a relatively high share of the industry's output (29.5% compared to 7.2%, on average, for manufacturing).

16. The other 4 components are made up of the 3 just discussed plus that of non-metallic minerals, which has shown a more moderate growth of productivity and, unlike food processing, done so in the context of improved output.

17. Two studies on total factor productivity (TFP) growth in manufacturing during the 1980s are available (Hernandez Laos, 1990; Kessel and Samaniego, 1991). The claims alluded to come from inferences made by Kessel and Samaniego and are scrutinized by

85




Moreno (1992). Tybout and Westbrook (1992) have also examined changes in technology and efficiencies of scale in a number of manufacturing industries for 1984-89. Their results are broadly consistent with the picture presented above on trends in industry rationalization and labor productivity. However, their data base does not allow for a comparison of recent changes in technical efficiency with historical performance.

18. The studies also show very high TFP growth rates for the 1980s as a whole, which is one of the reasons why Kessel and Samaniego were misled in their conclusions on the effects of trade liberalization. However, the reason for these high growth rates is highly implausible: the measured declines in capital stock from 1982 to 1987, at a rate of 5.8% per year! (Hernandez Laos) and at a rate of 3% per year from 1982 to 1989 in the study by Kessel and Samaniego (which basically updated the Hernandez Laos estimates). In updating those estimates, Kessel and Samaniego failed to adjust the 1988-89 capital stock figures for capacity utilization (as Hernandez Laos had done for the 1982-87 years). This introduced an upward bias in capital productivity growth in 1988-89, and this is the other reason they were misled in their conclusions.

19. For broader, more detailed surveys, on which Table 2 relies, see Brown (1992) and Weintraub (1992).

20. An effort in this direction is the work by Kehoe (1991). However, the basic reference scenario (with which the free-trade simulation is being compared) does not appear to be clearly defined.

21. In what follows, the discussion focuses on Mexico. In most ,studies, the gains for the US are much smaller, roughly 10 times less than for Mexico as a percentage of the corresponding GDP.

22. This is even more so in reality than in the simulations of the models. The latter tend to ignore the very different degrees of international capital mobility between industries (the old issue of the multinational corporations) and, thus, often fail to capture the actual direction of structural change. Very frequently, indeed, the processes of re-allocation of resources in the post-liberalization period have gone in the opposite direction of the one expects by traditional trade theory (see Section 1).

23. Because the INFORUM Report does not consider the possible interactions between changing market shares and productivity levels, it is silent with respect to the possible dynamic processes that could result from them.




24. This boom followed from a fortunate combination of international factors and the industrial policy reforms of the late 1970s and early 1980s. The rapid advances of the Japanese automobile industry in international competition - particularly at the expense of US corporations- forced the latter to redefine its productive strategies, including a shift of new investments towards lower-cost countries. Mexico's advantages in terms of proximity to the US market, experience in automobile production, costs, and subsidies make it an attractive location for the new, export-oriented investments. By relaxing the requirements on domestic content, the 1977 regulatory changes facilitated this process by reducing the disadvantages that might have arisen from the use of less efficient, locally produced parts, thus allowing firms to take full advantage of Mexico's advantages of cost and location. Ten years later, after decades of being a huge burden in the balance of payments, the auto industry had become a major source (second only to oil) of foreign exchange earnings (on this subject, see Moreno, 1988). Peres (1990b) emphasizes similar factors in explaining the rapid growth of exports in the micro-computer industry.

25. The possibility in such circumstances of unstable paths of convergence or cumulative divergence in technological and wage gaps is precisely the source of fears expressed by public opinion in both countries: the US fear that low wages give Mexico an absolute advantage in most industries, and the analogous fear in Mexico that the technological lead of US industry could mean Mexico's industrial ruin.

26. In the case of the free trade agreement between the US and Canada, Helleiner (1991) mentions that Canada's concessions had to do with access for US foreign investors and an agreement on services.

27. It can be argued that this option also exists without a free trade agreement. But the same can be said about Mexico: it is its wage and location advantages that, with or without a free trade agreement, make it attractive to foreign investors. By strengthening the guaran- tee of access to the US market and of stable rules for foreign investment, what NAFTA does, in essence, is to reinforce trends that have been present, on both sides of the border, for many years now.

28. Pastor (1992) has argued - quite correctly - that the environmental and labor issues are not only part of the US agenda, but also of that of Mexican society. However, what is most relevant for the analysis of the bargaining process is that these issues are clearly not part of the agenda of the Mexican negotiators, who, on the contrary, tend to view them as external political pressures.

29. In this case, "no concessions" would probably have been

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a dominant strategy for both parties, with the status quo as the final outcome.

30. On this subject, see Cameron (1991) and Helleiner (1991). Besides the GAIT's "new issues," the areas of conflict in the bargaining process clearly include the following potential candidates: a liberalization of agricultural trade at a faster pace than is desirable, rules of origin in the auto industry that are too biased in favor of US multinational, and greater access of US investors in the energy sector.

31. It is obvious that the analysis has other implications which this article does not pursue. Among them, that a democratic state would be in a better position to maximize the benefits of the agreement for Mexico.

REFERENCES

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Free Trade Area or Common Capital Market? Notes on Mexico-US Economic Integration and Current NAFTA Negotiations