The Heritage Foundation

Backgrounder Update #133

April 9, 1990

April 9, 1990 | Backgrounder Update on

A U.S. -Mexico Free Trade Area: Promoting Bilateral Prosperity

(Archived document, may contain errors)

4/9/90 133


(Updating B=1Vvwuiff No. 694, "U.S.-Mexico Economic Ties," March 6,1989.) Throughout this century, Mexico has been a very poor country compared to the United States. Since its default on its foreign debts in 198Z Mexico has suffered through a period of increased economic instability and decline. Now the governments of the U.S. and Mexico are discussing a plan that could revitalize Mexico's economy and at the same time make the U.S. more competitive. This plan is to establish a Free Trade Area (FIA), similar to that created between the U.S. and Canada in 1988 and between the U.S. and Israel in 1985. An FTA requires both countries to drop all tariffs and -many non-tariff barriers to bilateral trade. Such an arrangement with Mexico would build on that country's significant progress in recent years toward trade liberalization and would offer the best hope for Mexico to join the ranks of the world's prosperous countries. The Bush Ad- ministration should give this project top priority by beginning a study on its benefits to U.S. busi- nesses and briefing Congress regularly on FTA progress. . A U.S.-Mexico FTA makes enormous economic sense.The U.S. is Mexico's principal trading partner, last year absorbing S25 billion, or around 60 percent, of Mexico's exports and providing S272 billion, or. 65 percent, of Mexico's imports. Mexico, America!s third largest trading partner, behind Canada and Japan, receives 6 percent of U.S. exports and sells America 6 percent of its =- ports. Bilateral trade between the two countries should be even greater. But Mexico's severe restric- tions on imports and foreign direct investments, added to government overregulation of the economy and ownership of many enterprises, have created tremendous economic waste, with resources allocated to inefficient industries.71iis has kept productivity, job opportunities and, there- fore, real purchasing power and living standards low. This system, of course, has been a major con- tributor to Mexico's debt problem. Mcdcan Progress. In recent years the government of Mexico has tried to reverse these policies. In 1986 Mexico joined the General Agreement onTariffs and Trade (GATI), the international ar- rangement designed to open markets. As a result of me . Mexico has cut import tariffs and eliminated most import licenses. A special framework agreement signed with the U.S. in 1987 al- lows the two countries to deal more quiddy with bilateral trade disputes. Ile U.S. and Mexico began their preliminary talks this January on establishing an FrA. But negotiating an FTA is a long, cumbersome, contentious process. Washington and Ottawa worked on the US.-Canada FTA for two years, Canada already haviiig spent several years in research. Since Mexico is poorer than the US, it has more to gain from an FTA. Greater Mexican imports of cer- tain American food products would benefit Mexican consumers directly. The competition from US. firms would create incentives for the Mexican government to privatize inefficient state-owned enterprises and for Mexican businessmin to channel capital and labor into more productive in- dustries. If an FrA substantially liberalized U.S. direct investment opportunities in Mexico, Mexico

would obtain much needed capital for its businesses. Finally, greater access to the U.S. market for Mexico business would provide greater business opportunities for Mexicans and a greater selec- tion of affordable goods for American consumers. Special Breaks. A preview of the FTA benefits is found in the special U.S.-Mexico arrangement popularly known as the maquiladora system. Under this program, which gained momentum in the last decade, U.S. firms can establish wholly owned factories in Mexico, typically near the U.S.- Mexican border. Permitting Americans to own factories outright is an exception to the usual Mexican limit of 49 percent foreign ownership. The owners can import, duty free, capital equip- ment, components and raw materials for their operations. The final products must be exported. The U.S. for its part, gives special tariff breaks to imports manufactured from American-made com- ponents. This maquiladora system employs an estimated 350,000 Mexicans. Some 100,000 Americans work at jobs in the U.S. to supply these facilities. Many U.S. companies have transferred parts of the manufacturing process to Mexico, making U.S. companies more competitive. Some opponents of an FIFA argue that while such an arrangement might work well for countries at similar stages of economic development, for example, between the U.S. and Canada, an FTA be- tween a poor country and the U.S. would not work. Yet arguments from critics on both sides of the Rio Grande betray fundamental misunderstanding of the issue. Some Mexicans fear that their country, with a Gross National Product only 3 percent the size of America's, will not be able to com- pete with the rich and technologically sophisticated U.S. Some Americans fear just the opposite, that American enterprises will be unable to complete with low Mexican wages. Both fears are un- founded. History shows that each economy would be helped by freer access to the other. An FTA also would address another concern of many Americans: illegal immigration. It is under- standable that Mexicans who are denied economic opportunities in their own country seek their for- tunes in the North. As an FTA provides greater employment opportunities for Mexicans in their own country, it removes some of the incentive for Mexicans to go North illegally and would be a magnet to attract back home many Mexicans now working in America illegally. Economic Powerhouse. A Mexican FI7A would be another step in creating the North American FTA, stretching first from Canada to Mexico and then eventually including the democratic countries of the Caribbean and Central America. This would create the world's economic power- house, dwarfing Japan and towering over even a united European market. The Mexican economy continues slowly to overcome the economic difficulties of the last decade. And a U.S.-Mexican FTA will take some years to negotiate and implement. Because of its protec- tionist past, many Mexicans do not understand fully the benefits to their country of an FTA and are suspicious of such an arrangement. The Bush Administration therefore has proceeded quietly and cautiously in its discussions with Mexican officials; it should continue in this manner. The White House also, however, should begin preparing the ground for future formal negotiations. It should instruct the Department of Commerce or the U.S. Trade Representative's Office to begin a study of the benefits to American firms of an FIFA. In addition, it should begin regular discussions and brief- ings with key Members of Congress on progress in trade talks with Mexico, so that Congress will be well informed when the issue comes before it.

In an FIFA there are not winners and losers. Both countries win. Therefore the leaders of both countries should be congratulated for entertaining this bold and mutually beneficial initiative and encouraged to continue to secure open markets for both countries. Edward L Hudgins, Ph. D. Director, Center for International Economic Growth

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