North American Free Trade Agreement ; Economic development

Lucinda Vargas

English

Research Papers in Economics

U.S.–Mexico trade has been on the rise since the
beginning of the North American Free Trade Agreement.
1
This article, the second in a three-part series on NAFTA,
looks at key aspects of the U.S.–Mexico trade and invest-
ment relationship since the agreement took effect in
January 1994.
TOTAL BILATERAL TRADE
Total U.S.–Mexico trade reached $196.6 billion in
1999, up more than 141 percent from its 1993 pre-
NAFTA level of $81.5 billion (Chart 1). Because trade
between two countries is influenced by more than just
whether they have a free trade agreement, how do we
determine how much of this increased trade is attribut-
able to NAFTA? 
Two important factors that affect trade are each
country’s income (ability to purchase goods from the
other country) and the price at which the goods are
traded, expressed in the other country’s currency (the
exchange rate). When a country’s income, or gross
domestic product (GDP), falls, its ability to purchase
goods from another country also falls. The opposite
also holds true: if a country’s GDP rises, purchases of
goods from another country are likely to rise as well. 
Chart 2 shows Mexico’s GDP growth and the
growth of U.S. exports to Mexico (or growth in the vol-
ume of goods Mexico buys from the United States).
When Mexico’s GDP goes up, so do U.S. exports to
Mexico. When Mexico’s GDP falls, as it did sharply in
1995, U.S. exports to Mexico also decline. 
The price at which goods are traded, as expressed
in another country’s currency, impacts trade in a simi-
lar fashion. A country’s goods become more expensive
if its currency appreciates, that is, when the price of the
country’s goods as expressed in another country’s cur-
rency goes up. When this happens, foreign demand for
that country’s goods tends to go down. Conversely, a
country’s goods become less expensive when its cur-
rency depreciates or when their price as expressed in
U.S.–Mexico
Trade and
Investment
Under NAFTA
E l      P a   s   o
FEDERAL RESERVE BANK OF DALLAS     EL PASO BRANCH     ISSUE 1 • 2000
NAFTA’s
First Five Years
(Part 2)
BusinessFrontieranother country’s currency falls, raising demand
for them abroad. 
Chart 3 displays the performance of U.S.
exports to Mexico and U.S. imports from Mexico
alongside the peso/dollar exchange rate. When
the exchange rate fell in December 1994, U.S.
exports to Mexico also fell, while U.S. imports
from Mexico rose. The exchange rate drop meant
the peso had depreciated in relation to the dollar
and, conversely, the U.S. dollar had appreciated
against the peso. This made Mexican goods less
expensive to acquire in the United States, raising
the demand for them. But it also made U.S. goods
more expensive in Mexico, thereby lowering demand.
A free trade agreement’s reason for being is
to boost trade between the countries involved 
by eliminating trade barriers. Thus, NAFTA would
be expected to increase trade between the United
States, Mexico and Canada. Yet, because other
factors such as those outlined above act simulta-
neously either to raise or lower trade, it is not 
easy to distinguish each specific factor’s impact.
However, econometric analysis can help isolate
the individual influence of different factors on
trade. 
Such work has been conducted at the Dallas
Fed to discern the specific impact of NAFTA on
trade between the United States, Mexico and
Canada.
2 The findings show that when controlling
for other factors that affect trade—such as the
December 1994 peso devaluation and the ensuing
Mexican recession, which pushed U.S. exports to
Mexico downward—overall U.S.–Mexico trade is
significantly higher with NAFTA than would have
occurred without it. Without NAFTA, U.S. exports
to Mexico would have declined by 3.4 percent per
year on average during 1994–98, rather than
growing by 13.8 percent per year, as occurred
with NAFTA. Moreover, U.S. imports from Mexico
would have recorded an average annual increase
of only 1.5 percent without NAFTA, rather than
18.5 percent with NAFTA. In terms of dollar
amounts, without the agreement U.S. exports to
Mexico in 1998 would have been $44 billion
lower than the $79 billion reached that year; U.S.
imports from Mexico would have been $43 bil-
lion, or $51.7 billion less than their 1998 level.
3
Clearly, NAFTA has been an important stimu-
lus to U.S.–Mexico trade. 
BILATERAL INVESTMENT
In addition to opening trade, free trade agree-
ments usually also ease foreign investment rules.
Indeed, although NAFTA’s main aim is trade liber-
alization, the agreement includes four other objec-
tives that complement the trade provisions:
4
Chart 1
U.S.–Mexico Trade, 1993–99
Billions of U.S. dollars
0
50
100
150
200
250
1999 1998 1997 1996 1995 1994 1993
U.S. imports from Mexico
U.S. exports to Mexico
39.9 49.5 61.7 73
85.8 94.7 109.7 41.6
50.8
46.3
56.8
71.4
79
86.9
81.5
100.3 108
129.8
157.2
173.7
196.6
SOURCE: U.S. Bureau of the Census, Foreign Trade Division.
2 Business Frontier
Chart 2
U.S. Exports to Mexico and Mexican GDP
Annual growth Annual growth
(Percent) (Percent)
–8
–6
–4
–2
0
2
4
6
8
–15
–10
–5
0
5
10
15
20
25
30
1999 1998 1997 1996 1995 1994 1993 1992 1991 1990
U.S. exports GDP
SOURCE: Instituto Nacional de Estadística, Geografía e Informática and
MISER.
Chart 3
U.S. Trade with Mexico and the Exchange Rate,
1994–95
Exports and imports Exchange rate
(Billions of U.S. dollars) (Pesos per U.S. dollar)
12/95 10/95 8/95 6/95 4/95 2/95 12/94 10/94 8/94 6/94 4/94 2/94
Imports from Mexico
Exchange rate
0
1
2
3
4
5
6
7
8
Exports to Mexico
0
1
2
3
4
5
6
SOURCE: U.S. International Trade Commission and Banco de México.• Promote fair competition;
• Substantially increase investment opportu-
nities;
• Protect and enforce intellectual property
rights; and
• Create effective procedures for the agree-
ment’s implementation and application, 
joint administration and dispute resolution.
Each of these objectives is covered in a chap-
ter of the NAFTA document. The investment 
provisions (chapter 11) are aimed at creating
greater opportunities on this front. The provisions
on fair competition (chapter 15) and protection 
of intellectual property (chapter 17) add certainty to
investors in the NAFTA region. In essence, then,
NAFTA’s “rules of the game” foster a more market-
oriented, internationallycompetitive North Ameri-
can economic environment. The favorable invest-
ment conditions draw investors to the region. The
agreement also attracts investment from interna-
tional companies that seek to penetrate the
region’s open markets. Hence, NAFTA promotes
investment flows not only among the United
States, Mexico and Canada but from other coun-
tries as well. 
An important outcome of NAFTA’s investment
provisions was an overhaul of Mexico’s foreign
investment law to reconcile it with the agreement.
Mexico’s foreign investment law had been on the
books since 1973 and reflected the country’s
nationalism during that time. Even its title—Law
for the Promotion of Mexican Investment and the
Regulation of Foreign Investment—conveyed the
priority given to national investment and the reg-
ulatory approach to foreign investment. The law
stipulated that foreign investments must be held in
a minority position (up to 49 percent). In other
words, all investments in Mexico had to be major-
ity-owned by Mexicans.
5
Although 1989 rules opened up more invest-
ment opportunities to foreigners, the law remained
unchanged until 1993—20 years after it was enact-
ed—when it was replaced with the current one, sim-
ply called Law on Foreign Investment. The new law
allows foreigners up to 100 percent ownership of
their investments, with exceptions in only a few sec-
tors (basic petrochemicals, for example). Thanks to
NAFTA, the entire institutional framework behind for-
eign investment in Mexico is now much more open
to conform with the liberalized investment rules stip-
ulated in the agreement for the three participating
countries.
Foreign investors responded positively to
Mexico’s more favorable investment climate, as
evidenced by the increased foreign direct invest-
ment (FDI) the country received in 1994, when
NAFTA (and Mexico’s new foreign investment
law) took effect. While annual FDI flows in
Mexico during 1990–93 averaged $3.7 billion, they
jumped to an annual average of $11.4 billion dur-
ing 1994–98.
NAFTA also positively impacted FDI flows to
Mexico from the United States (Chart 4). U.S. FDI
in Mexico equaled $1.3 billion in 1992. The fol-
lowing year FDI jumped to $2.5 billion, very like-
ly in anticipation of NAFTA, and in 1994—
NAFTA’s first year—U.S. FDI increased further, to
$4.4 billion. U.S. FDI flows averaged $3.6 billion
per year during 1994–98, up almost 64 percent
from an average annual level of $2.2 billion dur-
ing 1990–93.
Some important examples of U.S. direct
investment in Mexico since the mid-1990s are
found in the telecommunications and insurance
industries. After privatizing the huge telephone
monopoly Teléfonos de México (TELMEX) in
1990, Mexico in 1997 opened its telecommunica-
tions sector to greater foreign investment. Thus,
AT&T Corp., MCI WorldCom and other U.S. long-
distance carriers are now part of the Mexican
telecommunications landscape. Also, major U.S.
insurance companies have increased their pres-
ence in Mexico.
6 Recently, for example, the over-
seas division of New York Life Insurance Co. pur-
chased Mexico’s third-largest insurance company,
Seguros Monterrey Aetna. 
As a developing country, Mexico does not
have an abundance of capital; thus, it has tradi-
tionally not been a big player in direct investment
abroad. There are, however, several notable
examples of such investments, some in the United
States. CEMEX, the third-largest cement company
in the world and Mexico’s most multinational cor-
poration, has U.S. operations in California, Texas
and Arizona. Grupo Bimbo, Mexico’s leading
3 Issue 1 • 2000
Chart 4
U.S. Foreign Direct Investment in Mexico, 1990–98
Billions of U.S. dollars
0
1
2
3
4
5
6
1998 1997 1996 1995 1994 1993 1992 1991 1990
SOURCE: Bureau of Economic Analysis International Investment Data.bread maker and another important multinational
corporation, has about 30 operations in the United
States. In 1998, it acquired Texas-based Mrs
Baird’s Bakeries. Grupo Vitro is yet another exam-
ple. The largest glass producer in Mexico, it has
been active in the United States through acquisi-
tions and joint ventures, including joint ventures
with Libbey and General Electric Co.
Chart 5 shows Mexican FDI in the United
States. Although Mexican FDI flows were at a neg-
ative $110 million in 1993, they jumped to $1.1 bil-
lion in 1994, NAFTA’s first year. Mexican FDI was
negative in 1995 and 1996—a reflection of crisis
conditions in Mexico’s economy—but turned pos-
itive again in 1997 and increased further in 1998,
to $864 million. When taking into account the his-
torical cost
7 of total Mexican FDI in the United
States before and after NAFTA, Mexican FDI grew
from $1.2 billion in 1993 to over $4 billion in 1998. 
CONCLUSION
NAFTA has definitely worked to increase
trade between the United States and Mexico.
Trade between the two countries is higher today
because of NAFTA than it would have been with-
out the agreement. In addition to trade liberaliza-
tion, NAFTA’s objectives include opening up
investment opportunities as well as providing
more certainty for these investments through rules
on fair competition and protection of intellectual
property. These conditions, combined with the
open markets NAFTA encompasses, have drawn
investors worldwide to the North American
region. Clearly, NAFTA has been a positive force
in trade and investment growth for both the
Mexican and U.S. economies.
—Lucinda Vargas
NOTES
1 For a review of trade performance among the United States,
Mexico and Canada since NAFTA’s implementation, see
“NAFTA’s First Five Years (Part 1),” Federal Reserve Bank of
Dallas El Paso Branch Business Frontier, Issue 2, 1999.
2 See David M. Gould, “Distinguishing NAFTA from the Peso
Crisis,” Federal Reserve Bank of Dallas Southwest Economy,
Issue 5, September/October 1996, pp. 6–10, and “Has NAFTA
Changed North American Trade?” Federal Reserve Bank of
Dallas Economic Review, First Quarter 1998, pp. 12–23. An
updated version of Gould’s work that summed up NAFTA’s
impact on trilateral trade during the agreement’s first five
years was presented by William C. Gruben at the fourth inter-
national economic conference of the Federal Reserve Bank
of Dallas El Paso Branch, NAFTA: The First Five Years,
November 4–5, 1999, El Paso, Texas.
3 The average annual growth rates pertinent to the scenario of
U.S.–Mexico trade without NAFTA were applied to non-sea-
sonally-adjusted trade levels.
4 See The North American Free Trade Agreement Between the
Government of the United States of America, the Government
of Canada and the Government of the United Mexican States,
vol. 1, art. 102, p. 1-1.
5 Mexico allowed 100 percent foreign ownership of an invest-
ment only through its maquiladora industry program.
However, this program, launched in 1965, stipulated that all
maquiladora production be exported from Mexico to keep
this industry from competing with domestic producers in the
Mexican market.
6 Although NAFTA did liberalize Mexico’s financial sector 
from its pre-NAFTA conditions, Mexico kept the sector some-
what restricted to foreign investment even within the agree-
ment. However, in February 1995—outside of NAFTA 
and more than a year after the agreement started—Mexico
enacted laws that opened the sector much more to foreign
investment. Also, in 1998 Mexico further liberalized the for-
eign investment rules that applied specifically to the banking
industry.
7 Historical cost is a measure of a foreign direct investment
position according to the values carried on the books of affil-
iates. Therefore, this valuation reflects price levels of earlier
time periods.
4 Business Frontier
Chart 5
Mexican Foreign Direct Investment in the 
United States
Billions of U.S. dollars
–.5
0
.5
1
1.5
2
2.5
3
3.5
4
4.5
1998 1997 1996 1995 1994 1993 1992 1991 1990
Annual flows
Historical cost
SOURCE: Bureau of Economic Analysis International Investment Data.
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Editor: Lucinda Vargas, Senior Economist
Publications Director: Kay Champagne
Design: Gene Autry
Layout & Production: Ellah Piña

NAFTA's first five years (part 2): U.S. - Mexico trade and investment under NAFTA

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NAFTA's first five years (part 2): U.S. - Mexico trade and investment under NAFTA

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