L. Gruber

Chapter 7 NAFTA and Beyond: Is Free Trade Contagious?

A Summary 

In a Nutshell

The developing world may be ambivalent about free trade but they have little room for maneuver, in that they have to join certain institutions in order not to be excluded from certain agreements. A hegemon does not need to coerce as it has go-it-alone power. Potential partners have to on the inside of a deal in order to avoid the costs of being outside it.

 The argument is that Mexico in making overtures to the USA to sign the NAFTA was not doing so because it was clearly pursuing its own advantage. Indeed there were many opponents to the plan within Mexico, and it provoked much violent opposition. Neither was Mexico forced into the deal as they were the ones that initiated talks. Rather, Mexico saw that it was the lesser of two evils given that Canada and the US had signed the FTA a few years previously. Mexico saw that if it was not included in the process it would become economically marginalized, and this would have had severe consequences as the US was by far and away its largest trading partner. This then was a “scramble for inclusion”. The cost of mitigating this economic marginalization was that they were forced to liberalize much more rapidly than they might otherwise have done meaning that structural adjustment repercussions were much more severe than had they pursued the process of gradual liberalization that had begun in the 80s.

 Likewise Canada had no real interest in signing NAFTA as the liberal government of the time (successors to the conservative government that signed the FTA) were not pro-fee traders and were critics of the FTA. Rather they saw that the US would use its “go-it-alone” power to make a bilateral agreement with Mexico which would threaten their economic position in the region.

 Thus a cooperative agreement signed between A and B alters the strategic calculus of player C in deciding whether he wants to be part of the union. Likewise the decision of C to enter into A and B’s union alters the strategic calculus of D, another natural trading partner. This is why we have seen in recent history the formation of the American, EU and Asian trading blocs. Gruber particularly draws attention to the subsequent calls by LA states for trade integration: MERCOSUR etc. As painful as the deepening of north south integration will be for the LA economies, the alternative marginalization would be even worse.

 Background to NAFTA

  • PRI had been slowly liberalizing since mid-1980s, lowering tariffs and import licenses etc. Domestic response was ambivalent: ISI industries depended on protection, and agriculture was fragile. To remove agro support was to risk a mass migration from countryside to city. Inequality was serious and growing and trade liberalization was blamed.
  • The PRI was losing its grip on power, so increased liberalization was not predicted given the domestic climate and lack of strong government.
  • However, in 1990 the NAFTA was agreed and it went way beyond previous liberalizations. Why did this happen?

 Decision to implement NAFTA

  • An agreement with the US would mitigate the negative trade and investment discrimination that Mexico might otherwise experience as a result of its exclusion from the trading blocs. A desire “not to be shut out”. Mexico’s ties to US and Canada were very important – over 50% FDI came from US and profitability of export business dependent on US customers
  • The FTA agreement reduced Mexico’s access to the US market. Head to head competition with Canadian imports to the US was strong so they would lose from lowered tariffs between Canada and US.
  • The agreement was voluntary – no US coercion. It wasn’t needed. Although trade with US very important to Mex, trade with Mex accounted for 1% GDP for the US
  • The consideration were thus more defensive – the desire to mitigate losses from the FTA – rather than proactive on the part of the US (as suggested by realist interpretations).

 Assessing the Effects of NAFTA

  • Tariff removal increases trade – consumers benefit from lower priced goods, and comparative advantage generates productivity and efficiency gains.
  • There could be costs as consumers in Mex switch to low cost US/Canadian goods which they previously got from Japan, thus reducing revenues of government which would be made up by direct taxes on citizens. The overall effect depends on sign of TRADE CREATION – ADJUSTMENT COSTS – TRADE DIVERSION.
  • This was overwhelmingly +ve for Mex. Mex concentrates on labour intensive, US/Canada on research intensive. Mex already getting over 50% imports from US/Canada. Mex as smallest economy stood to gain the most.
  • However, side agreements such as harmonized labour and environmental standards could hurt Mex’s comparative advantage in the long run. Businesses may now set up in US to service larger US domestic market.
  • All else equal there would have been less political and economic upheaval had Mexico not been forced into NAFTA. A gradual transition as it was already doing would have been possible.


  • Strong response from fragile industries (textiles, trucking, procurement).
  • FDI did not increase due to continued domestic instability (Zapatista uprising in Chiapas).
  • Little protection for Mexico against US reneging (small opportunity cost of reneging for the US, whereas huge for Mex).
  • Much more aggressive liberalization.
  • Nearly all tariffs to be reduced in 10 years.
  • US showed little regard in helping to minimize transition costs which it knew would be huge as Mex was a developing county – higher initial barriers so more radical adjustment; low factor mobility; poor infrastructure; people living on subsistence cannot bear even small disruptions.


  • Political climate not favourable to more free trade.
  • US would have signed anyway regardless of Canadian involvement. Canada would have been worse off had it not signed so it was effectively forced to do so.
  • Mex would have got same special treatment and access to US markets and this would dilute the Canadian advantage. The US would have been a hub of trade, and Canada merely a spoke so Canadian exports would have become less competitive and capital would flow to the US. Mex industry would have been able to get parts duty free from US and this could have made Canadian exports less competitive. So it would have all the disadvantages and no access to Mexican consumers.

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