North American Free Trade Agreement ; International trade ; European Union ; Competition ; Maquiladora

William C. Gruben

English

Research Papers in Economics

fourth to a fifth of Mexico’s million-
plus maquiladora workers once produced
textiles and apparel, many of them in fac-
tories near the U.S. border. Employment
peaked at nearly 300,000 workers in early
2001. Since then, widespread layoffs have
slashed jobs. By December 2005, they’d
fallen to 174,000, a 41 percent drop in five
years (Chart 1).
The industry’s massive downsizing has
evoked great concern on both sides of the
border, with hand-wringing about unbeat-
able Chinese competition and the imminent
demise of Mexican apparel operations. The
situation isn’t that grim, though. 
Mexico’s textile and apparel export
industry isn’t going to disappear, although
it has shrunk in response to market reali-
ties related to trade policy changes. What’s
happened reflects a facet of trade liberal-
ization little understood by the general
public: trade diversion. Coined by econo-
mist Jacob Viner, the term describes how
discriminatory tariff policies can undermine
the benefits of free trade, leading to ineffi-
cient allocation of resources and higher
costs for consumers.1
Before joining the European Union,
for example, Britain  imported most of its
lamb from New Zealand, the cheapest pro-
ducer. Adopting the common EU tariffs
made New Zealand lamb more expensive
in Britain, opening the door for producers
in member countries, particularly the
French. For exporting nations, trade diver-
sion can lead to dramatic ups and downs
in sales—which is just what occurred with
Mexico’s textiles and apparel.
When the North American Free Trade
Agreement took effect in 1994, its propo-
nents emphasized the pact’s efficiency and
growth effects. Their arguments rested on
the findings of long-dead economists
whose writings still ring true. Adam Smith,
David Ricardo and others had shown that
increased international trade would allow
economies to direct resources toward what
they produced relatively efficiently, export-
ing what they didn’t consume at home and
importing what their trading partners
could produce more effectively. World
efficiency would increase. Products
would be cheaper. Everyone would be
better off.
To achieve these mutual gains from
trade requires a world in which all
economies are open and each nation
treats all others the same. While regional
free trade agreements like NAFTA do
lower prices for their members, they are
quite different from universal free trade.
By their very nature, regional accords
lower tariffs and regulatory burdens for
members, giving them an edge over non-
members. Trade diversion occurs when
these preferential trade agreements
encourage higher-cost imports of member
countries to replace the lower-cost
imports of nonmembers. 
Where trade diversion exists, eco-
nomic theory suggests that all good
things must end—at least for those that
have benefited from the trade preferences.
As an industry’s imports increase under a
regional trade deal, resistance to opening
markets falls off. At the same time, those
excluded from the preferential arrangement
lobby for the same benefits. More countries
receive such deals and then even more do.
This result suggests that a little bit of trade
opening can lead to a lot.
When the importing countries extend
preferential trade benefits to more nations,
the boom from the original diversion may
be followed by a bust as new trading pat-
terns emerge and the world’s low-cost pro-
ducer regains its advantage. This may not
always occur, but it’s exactly what hap-
pened with Mexico’s textiles and apparel.
With the erosion of Mexico’s NAFTA edge,
China increased U.S. sales. Mexico lost
market share—and as a result, employment
fell in the textile and apparel maquiladoras. 
Mexico’s Experience  
Comparing the trends in U.S. apparel
imports from Mexico, China and countries
that eventually became part of the Domini-
NAFTA, Trade Diversion and Mexico’s
Textiles and Apparel Boom and Bust
By William C. Gruben
A
FEDERAL RESERVE BANK OF DALLAS • SEPTEMBER/OCTOBER 2006    SouthwestEconomy 11
Mexico’s textile and
apparel export industry
isn’t going to disappear,
although it has shrunk
in response to market
realities related to trade
policy changes.
2005 2004 2003 2002 2001 2000
150
175
200
225
250
275
300
325
350
Chart 1
Jobs in Mexico’s Textile and
Apparel Maquiladoras Plunge
Thousands of jobs 
SOURCE: Instituto Nacional de Estadística, Geografía e
Informática.can Republic–Central American Free Trade
Agreement suggests that trade diversion
was behind the boom-and-bust cycle in
Mexico’s textile and apparel maquiladoras. 
In the early 1990s, China topped
Mexico in apparel exports to the U.S.
(Chart 2). A shift toward Mexico began
with NAFTA’s signing in 1993 and acceler-
ated with implementation in 1994. 
Under NAFTA, Mexican apparel enters
the United States duty-free, provided all its
components from the thread forward are
made in the United States, Canada or
Mexico. This provision was included in the
agreement to benefit not only Mexican
apparel manufacturers but also U.S. textile
and fiber companies.
When NAFTA lowered U.S. barriers,
Mexican producers could compete in the
huge market north of the border, even
though other countries could produce tex-
tiles and apparel more cheaply. By the late
1990s, Mexico was picking up market
share so rapidly against China that it
briefly became the No. 1 apparel supplier
to the U.S. 
With NAFTA in place, Mexico also
began to increase its U.S. sales more rapid-
ly than the Central American nations. The
gains continued until 2000, when the U.S.
offered low-wage Caribbean and African
countries some of the same benefits it had
bestowed on higher-wage Mexico under
NAFTA. Last year, the United States signed
a broader preferential trade agreement
with DR-CAFTA.
Meanwhile, China had developed
highly competitive apparel export indus-
tries, helping it become the world’s low-
cost producer. In 2001, China joined the
World Trade Organization, just as the
group was dismantling the Multifiber
Arrangement, the textile and apparel quo-
tas rich countries had maintained to pro-
tect their industries from imports. On a
leveled playing field, China regained mar-
ket share at the expense of both Mexico
and Central America. 
Maquiladora Jobs
The NAFTA-created trade diversion
benefited Mexican textile and apparel
workers. Comparing employment indexes
SouthwestEconomy FEDERAL RESERVE BANK OF DALLAS • SEPTEMBER/OCTOBER 2006 12
for textiles and apparel and other
maquiladora industries since 1990 shows
jobs surged when Mexico had a NAFTA
edge and increased its U.S. market share
(Chart 3). As the U.S. economy gained
momentum after July 2003, employment in
all other maquiladoras climbed steadily.
Textile and apparel job growth, however,
has faltered (see box). 
But the sector’s employment since
NAFTA belies fears of an industry on the
brink of demise. The early NAFTA-driven
boom gave the industry a big lift, but the
gains could not be sustained. Even with
the recent declines, however, the number
of textile and apparel jobs remains much
further above its pre-pact level than other
maquiladora employment.   
NAFTA no longer provides Mexican
textiles and apparel much benefit. The
trade diversion has ended. To show this,
we created an economic model that com-
pares how the industry’s employment
would fare in two scenarios—one assum-
ing NAFTA continued to give Mexico the
same edge it had before 2001, the other
assuming NAFTA didn’t exist.
We needed to control for other vari-
ables that can affect apparel trade. The first
is manufacturing wages in Mexico, the U.S.
and a sample of Asian countries. If
Mexican pay fell relative to U.S. or Asian
wages, the country’s textile and apparel
maquiladora employment would likely rise.
In a global world, when the cost of doing
0
2
4
6
8
10
12
14
16
18
20
China
Mexico
DR-CAFTA
’04 ’02 ’00 ’98 ’96 ’94 ’92
Chart 2
China Gains as Trade
Diversion Unwinds
Percent
SOURCE: Organization for Economic Cooperation and
Development.
0
50
100
150
200
250
300
350
400
450
500
’05 ’03 ’01 ’99 ’97 ’95 ’93 ’91
Maquiladora index minus
textiles and apparel
Textiles and
apparel index
Chart 3
Textiles and Apparel Lead
Maquiladora Job Growth
Index, January 1994 = 100
SOURCE: Instituto Nacional de Estadística, Geografía e
Informática.
Without NAFTA
Actual
Continued NAFTA edge
’80 ’84 ’88 ’92 ’96 ’00 ’04
0
50
100
150
200
250
300
350
Chart 4
No-NAFTA Scenario Predicts Actual
Textile and Apparel Employment
Thousands of jobs
SOURCES: Instituto Nacional de Estadística, Geografía e
Informática; Federal Reserve Bank of Dallas.
On a leveled playing
field, China regained
market share at the
expense of both 
Mexico and 
Central America.business in one place becomes cheaper
than in another, producers migrate. The
second variable is U.S. apparel output. As
production increases in the U.S., it will also
go up in Mexico. This occurs whether
Mexican apparel factories are suppliers to
U.S. producers or Mexico’s industry is
swept higher by the same retail demand
that boosts U.S. apparel employment.
Using our model for 1980–2000, we
can estimate what happened in 2001–03
under two scenarios. We find that Mexico’s
textile and apparel manufacturing employ-
ment would have continued to rise sharply
if other trade agreements hadn’t eroded
Mexico’s preferred position in the U.S.
market (Chart 4). Taking away NAFTA,
however, produces an estimate of textile
and apparel maquiladora employment that
nearly matches the actual experience of
2001–03.
The same supply, cost and demand
variables that once explained fluctuations
in Mexico’s maquiladora employment still
seem to pick up much of what happens.
Mexico’s export industries will continue to
benefit from being on the doorstep of the
greatest consumer market on earth. But for
textiles and apparel, NAFTA isn’t what it
used to be.
It’s hard to predict what will happen
to Mexico’s textile and apparel maquila-
doras now that China and the Caribbean
countries have increasingly open routes to
the U.S. market. Many analysts argue that
Mexico maintains a competitive advantage
based on its ability to deliver products to
the U.S. quicker than China can. Because
both countries stitch garments under con-
tract with U.S. labels, it may be that the
more trendy clothes will be made in
Mexico. Any way you look at it, competi-
tion will be intense. 
Gruben is a vice president and senior 
economist at the Federal Reserve Bank of Dallas.
Note
1 The Customs Union Issue, by Jacob Viner, New York:
Carnegie Endowment for International Peace; London:
Stevens & Sons, 1950.
FEDERAL RESERVE BANK OF DALLAS • SEPTEMBER/OCTOBER 2006 SouthwestEconomy 13
Textiles Aside, Maquiladoras 
Back on Growth Path
Textile and apparel maquiladora employment has continued to decline
at a time when the rest of the industry is expanding. Overall, Mexico’s
assembly-for-export sector has been adding jobs since it bottomed out at a
seasonally adjusted 1,042,085 workers in July 2003. The most recent
employment count stood at 1,213,841 in June.
The strongest sector has been chemicals, up 67.8 percent since
January 2003, followed by services at 45.1 percent, electronics at 25.4 per-
cent, machinery at 21 percent, furniture at 17 percent and transportation at
14.9 percent. By contrast, textiles and apparel declined 15.6 percent over the
same time span.
The maquiladora sectors’ varying fortunes have geographic implica-
tions. The industry is growing in Mexican border cities that cater to main-
stream U.S. manufacturers. Since January 2003, for example, maquiladora
employment is up 40.9 percent in Reynosa and 25.8 percent in Ciudad
Juárez. Elsewhere, border cities’ maquiladora industries have been held back
by various impediments, such as infrastructure difficiencies. Matamoros’ job
gains were 2.8 percent. Employment fell by 30.8 percent in Piedras Negras
and 13.6 percent in Ciudad Acuña.
Because maquiladoras supply U.S. companies, their employment ebbs
and flows with industrial production in the United States. The 1990s boom
helped propel jobs to a record 1,332,147 in October 2000, right before the
U.S. economy tumbled into recession. Maquiladoras resumed hiring as U.S.
industrial production picked up in 2003.
60
70
80
90
100
110
120
130
140
150
160
170
Machinery
Chemicals
Services
Furniture
Textiles
Transportation
Electronics
2006 2005 2004 2003
Maquiladora Employment by Sector
Index, January 2003 = 100*
*Seasonally adjusted.
SOURCE: Instituto Nacional de Estadística, Geografía e Informática; seasonal adjustment by 
Federal Reserve Bank of Dallas.

NAFTA, trade diversion and Mexico's textiles and apparel boom and bust

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NAFTA, trade diversion and Mexico's textiles and apparel boom and bust

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