NAFTA: ECONOMIC EFFECTS ON THE UNITED STATES AFTER FIVE YEARS

CRS Report for Congress
NAFTA: Economic Effects on the United States
After Five Years
Arlene Wilson
Specialist in International Trade and Finance
Foreign Affairs, Defense, and Trade Division
Summary
The main economic benefit of the North American Free Trade Agreement (NAFTA)
is that, over time, it is expected to increase productivity and incomes in the United
States, Mexico and Canada. In the near term, some reallocation of resources occurs
within each country, generating gains for some producers and workers and costs for
others. Since the Mexican and Canadian economies are small relative to the U.S.
economy, both the long-term benefits and short-term adjustment costs of the NAFTA to
the United States are expected to be small. The data suggest that NAFTA has had a
positive, but small, effect on U.S. trade with Mexico and that U.S. direct investment in
Mexico remains very small relative to total U.S. investment abroad. The number of
workers displaced by import competition with Canada and Mexico or production shifts
to those countries is estimated to be very small compared with total U.S. employment.
This report will be updated annually.
The NAFTA has been in effect since January 1, 1994. Some anecdotal evidence
suggests that the NAFTA has been highly beneficial to the United States, while other
accounts imply that import competition from Mexico has led to substantial U.S.
unemployment. Neither of these claims are supported by the available evidence. This
report begins with a brief discussion of the benefits and adjustment costs of free trade,
followed by empirical evidence suggesting that, over time, trade is beneficial to all
countries. The discussion then focuses on the NAFTA’s effect on the United States, given
the relatively small size of the Mexican economy and the data which show the NAFTA’s
effects, in the aggregate, to be very small.
Why Trade Matters
The basic economic argument for international trade is that nations can, by producing
more efficiently, expand the amount of goods and services they produce and consume. By
importing goods that are relatively costly to produce domestically and exchanging them
for exports which it can produce most efficiently, it is argued that each country can

Congressional Research Service ˜ The Library of Congress

produce and consume more goods with trade than in isolation. That is, by specializing in
producing those goods and services in which each country has a comparative advantage,
productivity is improved for all countries. Moreover, by providing access to a larger
market, free trade may allow some industries to take advantage of “economies of scale;”
plants can specialize in producing fewer product lines at lower costs. The economy can
be thought of as a pie; trade expands the size of the pie. Importantly, all countries gain;
one country’s gains are not another country’s losses.
Free trade also can enhance the investment climate, improve the rate of technological
development, stimulate firms to become more competitive, and raise the economy’s rate
of growth. Consumers, in particular, benefit considerably from lower prices and a wider
choice of products. These dynamic gains are often of greater long-term significance than
the benefits of comparative advantage.
Nevertheless, as countries engage in trade, labor and capital may have to shift from
one industry to another. As resources are reallocated from an industry whose costs are
relatively high to one whose costs are relatively low, some jobs disappear and others are
created. This process occurs regularly and necessarily in a market economy, with or
without foreign trade, and ultimately results in a rising living standard. Importantly, trade
does not affect the total number of jobs in the economy, but it may affect the composition
of jobs.
Trade may also affect the distribution of income within an economy. By increasing
the demand for those products which are produced most efficiently, wages for workers
and the reward to capital that produce those products tend to rise. Similarly, demand for
the products produced least efficiently falls, reducing wages of workers and the return to
capital in those industries.
Empirical evidence suggests that international trade, when restricted, inhibits
economic growth and, when liberalized, stimulates economic growth. Economists believe,
for example, that the Smoot-Hawley tariff (which raised tariffs to an all-time high in 1930)
led to retaliatory trade restrictions by other countries, which served to deepen and lengthen
the worldwide depression of the 1930s.
In contrast, the post-World War II process of trade liberalization under the auspices
of the General Agreement on Tariffs and Trade (GATT) and its successor, the World
Trade Organization (WTO), has been accompanied by a large increase in world output
(GDP) and an even larger growth of world trade. Recent experience of the developing
countries supports the hypothesis that trade liberalization is associated with higher
economic growth. Those developing countries which liberalized trade, such as Hong
Kong and Singapore, grew much faster than those that restricted trade, such as Nigeria
and Ghana. ¹

The Theory and Practice of Free Trade. Federal Reserve Bank of Dallas Economic Review.¹
Fourth Quarter, 1993. p. 4. Of course, other factors, such as education levels, political stability,
and access to technology, are also important.

Magnitude of NAFTA’s Effect on the United States
Figure 1. Gross Domestic Product 1998There are several reasons
^10,000why NAFTA’s effect on the
^8,511U.S. economy would be
^8,000expected to be small. First, the
U.S. economy is very large
^6,000relative to that of Canada and
^4,000Mexico. Mexico’s GDP in
1998 of $429 billion was only
^2,0005% that of the United States
⁴²⁹⁵⁹⁹(see figure 1). Expressed
^Mexico^Canada^{United States}⁰another way, the Mexican
economy is roughly the size of
the economy of New Jersey or the Los Angeles metropolitan area. Even Canada’s 1998
GDP of $599 billion was only 7% of U.S. GDP.
Another way of looking at it is to examine U.S. trade with Mexico and Canada. Even
though Mexico is the second largest U.S. export market, U.S. exports to Mexico were less
than 1% of U.S. GDP in 1998 (see figure 2). U.S. exports to Canada (the largest U.S.
trading partner) were 1.8% of U.S. GDP. Even if the NAFTA substantially increased
trade flows, they would still be relatively small in relation to U.S. GDP.
Figure 2. U.S. Merchandise Exports as aSecond, tariffs were already
Percent of U.S. GDP, 1998low or nonexistent between the
¹⁰three countries when the NAFTAwent into effect and have
⁸⁸continued to decline. Under the
Canada-U.S. Free Trade
⁶Agreement, which was
⁴superceded by the NAFTA, some
tariffs were eliminated on
^1.8²January 1, 1989, and the rest
^0.9
⁰phased out over 5 or 10 years.By January 1, 1999, virtually all
^{To Mexico}^{To Canada}^{To World}
U.S.-Canadian tariffs had been
eliminated.
When the NAFTA went into force, half of U.S. exports to Mexico became duty-free,
with the remaining half phased out over 5, 10, or 15 years. By January 1, 1999, the
average Mexican tariff on U.S. products had declined from 10% to 1.68%, while the
average U.S. tariff on Mexican products had declined from 4% to 0.46%.²

Office of the United States Trade Representative. 1999 Trade Policy Agenda and 1998 Annual²
Report of the President of the United States on the Trade Agreements Program. Washington,

1999. p. 159.

The Evidence So Far
Figure 3. U.S.-Canada Merchandise TradeTrade. U.S. trade with
²⁰⁰Canada and Mexico has increasedsince 1994, as shown in figures 3
¹⁶⁸¹⁷⁵
¹⁵²¹⁵⁶¹⁴⁴¹⁵⁶¹⁵⁰and 4. Between 1994 and 1998,
¹³⁴¹²⁸U.S. exports to Mexico and
¹¹⁴¹²⁷
¹⁰⁰Canada combined grew by about
42%, while U.S. imports from
⁵⁰both countries increased 51%.
The U.S. trade deficit with
¹⁹⁹⁴¹⁹⁹⁵¹⁹⁹⁶¹⁹⁹⁷¹⁹⁹⁸⁰Mexico and Canada combined
^{U.S. Exports}^{U.S. Imports}fluctuated from $33 billion in 1995
to $39 billion in 1996, $31 billion
in 1997 and $34 billion in 1998. It accounted for 15% of the total U.S. merchandise trade
deficit in 1998.
Figure 4. U.S.-Mexico Merchandise TradeHowever, the trade data
reflect much more than the effects
⁹⁵¹⁰⁰of the NAFTA. Although not
⁸⁶shown in figures 3 and 4, U.S.
⁷¹⁷⁹⁶²⁷⁴⁸⁰trade with Canada and Mexico
⁵¹⁴⁶⁵⁷⁵⁰⁶⁰was increasing before 1994,
⁴⁰suggested that some of the post-
²⁰NAFTA trade increases are acontinuation of an ongoing trend.
¹⁹⁹⁴¹⁹⁹⁵¹⁹⁹⁶¹⁹⁹⁷¹⁹⁹⁸⁰Moreover, in the short-run,
^{U.S. Exports}^{U.S. Imports}exports and imports and the trade
deficit are strongly influenced by
exchange rate changes and the level of economic activity in each country. For example,
in 1998, the robust U.S. economy and the relatively high U.S. dollar vis-a-vis the Canadian
dollar and Mexican peso likely were important causes of the increased U.S. trade deficit
with both countries in 1998.
Section 512 of the NAFTA Implementation Act (P.L.103-182) required the President
to provide a comprehensive assessment of the operation and effects of NAFTA to the
Congress by July 1, 1997. The main findings of this report, which covers the first three
years of NAFTA (1994 through 1996) were: ³
CNAFTA had a modest positive effect on U.S. net exports, income, investment
and jobs supported by exports.
CU.S. suppliers saw their share of Mexico’s import market grow from 69% to

75%. Mexican suppliers increased their share of U.S. imports from 7% to 9%.

President of the United States. Study on the Operation and Effects of the North American Free³
Trade Agreement. July 1997, p. ii, iv, v, and vi.

CThe U.S. share of Mexico’s import market increased the most in the following
sectors: textiles, transport equipment, and electronic goods and appliances.
Under the NAFTA, Mexico’s tariffs declined substantially in these three sectors,
stimulating increased U.S. exports.
CIn apparel, the U.S. share of imports from Mexico (which have a high U.S
content) grew from 4.4% to 9.6%, while the share from China, Hong Kong,
Taiwan and Korea fell. U.S. apparel imports from Mexico apparently displaced
apparel imports from the Far East.
Investment. During the NAFTA debate, much concern was expressed that U.S.
firms might relocate plants to Mexico to take advantage of its low wages. Others argued
that wages are only one factor in the decision to invest abroad. In particular, productivity
in most industries in Mexico is lower than in the United States, and Mexico’s
transportation and infrastructure are not as well developed as those of the United States.
Figure 5. U.S. Direct Investment Abroad,The available data suggest
1990 and 1997that U.S. direct investment in
⁴
^1,000Mexico is currently small
^860.7relative to total U.S. direct
⁸⁰⁰investment abroad. In 1997 (the
⁶⁰⁰latest data available), the U.S.
^424.1⁴⁰⁰direct investment position (the
cumulative amount, or the stock)
in Mexico was $25.4 billion, only
^99.9²⁰⁰3.0% of the U.S. direct
^9.4^25.4⁶⁷⁰
¹⁹⁹⁰¹⁹⁹⁷investment position in all
^{In Mexico}^{In Canada}^{In All Countries}countries of $860.7 billion
(figure 5). Even the U.S. direct
investment position in Canada is only 11.6% of the total U.S. direct investment position
abroad.
Furthermore, the amount of new investment in Mexico is relatively low. Looking at
investment flows, U.S. direct investment in Mexico was $3.0 billion in 1995, $2.7 billion
in 1996, and $5.9 billion in 1997. By comparison, U.S. domestic investment in U.S. plant
and equipment was $864.9 billion in 1997. In other words, U.S. investment in Mexico⁵
was less than 1% of all U.S. domestic investment in plant and equipment in 1997. This
suggests that even if the NAFTA directly caused all these investment flows, the NAFTA’s
effect is very small.

Direct investment is defined as the ownership or control, directly or indirectly, by one person⁴
(individual, partnership, etc.) of 10% or more of the voting securities of an incorporated business
enterprise or an equivalent interest in an unincorporated business enterprise.
U.S. Department of Commerce. Survey of Current Business, Vol. 78, No. 7, July 1998, p. D-2.⁵

Employment. As noted earlier, the NAFTA may cause some workers to gain jobs
and others to lose them as the economy reallocates its resources. Since it takes time to
shift resources, and since some resources are not easily adaptable to other types of
production, some industries and workers will find it difficult to adjust. At the same time,
other industries would benefit from increased demand, creating new jobs.
The implementing legislation for the NAFTA (P.L. 103-182) included a Transitional
Adjustment Assistance (TAA) program, which provides employment services, training,⁶
income support, and job search and relocation allowances to eligible workers. To receive
benefits, workers must be certified by the U.S. Secretary of the Labor as having lost their
jobs (or been threatened with job loss) by increased import competition from Mexico or
Canada or by production shifts to Mexico or Canada.
One by-product of the TAA program is that it provides data on the estimated number
of workers covered by certification. It is important to emphasize that the number of
workers covered by certification is not the same as the number of jobs lost as a result of
NAFTA. Some of the workers covered by certification were never laid off from their jobs,
while some displaced workers may not have applied for assistance. Nevertheless, since the
TAA numbers are the only available data, they provide an indication of the magnitude of
the adjustment costs of NAFTA.
In the 5 years ending December 31, 1998, 350,011 workers were covered by
certification, of which about 34% were in the apparel and electronics industries. The⁷
350,011 workers covered by certification is relatively small — about three-tenths of a
percent of total U.S. employment of 132.5 million at the end of December 1998. From
another perspective, the average number of jobs created per month between March 1991
(when the current economic expansion began) and December 1998 has been about
165,000. Moreover, since mid-1994, the U.S. economy has been near, if not above, what
most economists consider to be full-employment, suggesting that displaced workers may
have found jobs elsewhere or dropped out of the labor force.

For a fuller discussion, see CRS Report 94-52 EPW, Adjustment Assistance for Workers⁶
Dislocated by the North American Free Trade Agreement, by James R. Storey (Updated
September 10, 1998).
U.S. Department of Labor. Office of Trade Adjustment Assistance. See also CRS Report 98-782⁷
E, NAFTA: Estimates of Job Effects and Industry Trade Trends After 4 ½ Years, by Mary Jane
Bolle.