A Quick ‘n Dirty Look at Free Trade Agreements

Are the member countries of free trade agreements better off? With much recent discussion and debate surrounding the current devising of the Trans Pacific Partnership Agreement (TPP), it would seem rather appropriate to pay heed to the momentous 20 year anniversary of the North American Free Trade Agreement (NAFTA). After all, what better way to look into the future than to look at the lessons provided to us by past free trade agreements? As Mark Twain once noted, “History does not repeat itself, but it does rhyme”.

At its inception, NAFTA was credited with becoming the world’s largest free trade zone. Accordingly, this trade zone currently produces $17 trillion worth of goods and services, of which 9.4 percent of that total is traded between the U.S. and its partners. As supported by Heckscher-Ohlin’s trade theory, the U.S. had a goods trade deficit of $41 billion and $95 billion in 2009 and 2010, respectively, whereas it had surpluses in services. Less esoterically, the U.S. exported greater quantities of the product that intensively uses its most abundant factor.

If we examine the graph below of Mexico’s gross domestic product (GDP) composition, the country experienced a notable inflection point in exports between 1994 and 1995. Mexico’s exports as a percentage of GDP increased from 13 percent to 25 percent, an actual increase of 23 percent in exports, according to World Bank data.

MEX_GDP

As of 2010, NAFTA has continued to remain the greatest source of imports for the United States. Imports from Canada totaled $276.5 billion, whereas Mexican imports to the U.S. were to the amount of $229.7 billion. As a percentage of total import flows, trade with Mexico and Canada accounted for 9 percent and 10 percent, respectively. Some estimates place this percentage higher at approximately 26 percent. Exports reveal a similar story as NAFTA export flows from the United States were roughly 22 percent of total exports. One can thus argue that NAFTA has provided mutually beneficial economic value.

With regards to Mexico’s foreign direct investment in the 10 years subsequent to the signing of NAFTA, we have seen a shift in the upward acceleration of FDI net inflows while placing long-run downward pressure on the country’s significant level of poverty (though we can not solely attribute this reduction in poverty to NAFTA). These inflows appear to have exhibited a similar trend pattern as that of the U.S. and Canada. Perhaps interestingly, and contrary to fundamental trade theory models, these inflows have been relatively smaller than that of the United States. Such a phenomenon is not explained under Heckscher-Ohlin’s theory regarding relative abundant factors for production in trade.

NAFTA_FDI

Due to a failed attempt to account for negative externalities, imperfect information, and principles of power distribution, traditional trade models cannot accurately explain reality. The role of power seems to have been surprisingly lost in modern economics, but is still rather prevalent in the political economy literature. Many models are also without explanation of what occurs to production in the transition period in shifting to a new equilibrium.

Shifting to a new production possibilities frontier (PPF) instantaneously, for example, would only be possible in a perfectly competitive factor model. In the case of the United States and Mexico, the PPF curve would likely fall to the inside of the U.S. PPF when we also consider the free movement of capital. In other words, we must also account for the period in which a country’s factors of production shift away from the import-competing industry along with the lost income of those made temporarily or permanently unemployed. This is, of course, dismissed since such models tend to take a long-run purview. However, we must then ask why it is that we employ discounting methods in our costs and benefits analysis if we do not in fact weigh the value more on a short to medium-term basis.

And so we arrive where we began: are the member countries of the free trade agreements better off? Well, it depends on who you ask. Theoretically, Mexico should be the country to reap the largest gains. However, since NAFTA grants legal personality to corporations, companies, such as Dow AgriSciences, can sue countries like Canada for policy changes that potentially impact profits. This dispute involved the banning of certain pesticides, and was considered due to pressure from Canada’s general public. While Dow had lost every individual lawsuit brought up against the Canadian government, the continued expensive legal harassment drove the Canadian government to a negotiated settlement involving large transfers of tariff revenue.

In terms of the benefit to a country’s collective well-being, could we call such agreements a success if only a small increase in collective income has arisen while a smaller fraction of the population has accumulated large detrimental losses? I am not so sure. Furthermore, it is unclear whether the increase to the U.S. collective well being was far more than negligible.

Data Source: World Bank

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