NAFTA Is Not Nirvana

MEXICO CITY — The success of the North American Free Trade Agreement has sparked much talk about expanding the accord to include other nations in the hemisphere. President Bill Clinton has embraced the cause and is urging the U.S. Congress to grant him fast-track authority to negotiate hemispheric-wide free-trade deals. Foremost among the countries mentioned as candidates for membership in a bigger NAFTA is Chile. But NAFTA, in its current form, is not a suitable home for Chile, and may offer few significant advantages to other potential members as well.

The trade accord has certainly worked for Mexico, Canada and the United States. But this is because NAFTA was tailor-made to affirm and build upon a pre-existing economic condition. It consolidated what was already free trade between the United States and Canada, and rewarded growing trade in specific industries between America and Mexico. The main players in these industries are multinational corporations investing worldwide but operating in markets where competition is controlled.

It is thus natural that when NAFTA was shaped, these corporations sought not only to validate a regime of free trade and ensure unfettered capital mobility within the region, but also to create specific restrictions on trade with nonmember countries. In short, NAFTA, like most commercial accords, is a restrictive agreement.

Trade flows reflect just how integrated the economies of the NAFTA signatories are. Trade is chiefly driven by investment and this investment, in turn, is influenced by transportation costs and physical proximity. Certain manufacturing plants are interlocked and interdependent, which increases overall efficiency and reduces costs. This is why trade has grown much faster in such industries as automobiles, electronics, office equipment and other high-tech engineering than in nonintegrated sectors, including those with strong comparative advantages like oil or minerals. As long as its trade structure reflects the increasing importance of this integration, Mexico will stand by NAFTA.

For the same reason, NAFTA is an agreement that places a higher premium on ensuring certain investment flows and nontariff restrictions than on reducing tariffs. North American investors, Mexicans included, want to prevent Asian or European producers from assembling their products in, say, Mexico with imported materials, then re-exporting the finished products to the North American market.

Mexico, which has greatly benefited from investments in the car industry, is thus in a position to become a regional producer for NAFTA, but not a global one. This results from the accord’s tough rule-of-origin provisions that discourage imports of key European or Japanese components that would enable these foreign producers to link their Mexican assembly plants to their home companies. In textiles, too, regional protection may enable Mexico someday to displace Asian producers in the NAFTA market. In the case of agriculture and beef, the Mexican market is practically reserved for U.S. and Canadian producers.

Mexico probably had good reasons for accepting these kinds of trade-offs because 70% of its trade is with North America, and 80% of its foreign direct investment is similarly from this region.

This is not an economic situation in which Chile would thrive. Chile liberalized its trade and investment policies long ago. Unlike Mexico’s, its trade is evenly distributed among the world’s major economic blocs. If Chile were to become a member of NAFTA, it would have to accept the agreement’s existing restrictions and most likely the environmental and labor agreements that were tailored to Mexico’s situation.

Still, to some Chileans, NAFTA exerts a strong attraction based on the belief that it is a high-fliers’ club. But surely NAFTA lost some luster following the Mexican peso crisis in late 1994, and why would Chile need to join this club when its structural reforms have been much more thorough than Mexico’s.

At the same time, NAFTA is maturing while Chile and others wait for the green light to enter. After the peso crisis in December 1994, Mexico unilaterally opened up its gas distribution to foreigners and allowed foreigners a much larger percentage of ownership in its banking system. These changes were not formally appended to NAFTA, but since they were sectors in which the Mexicans fought hard to limit foreign participation, they must now be considered a part of the regime that Chile would have to accept. Thus, to new members anxious about linking themselves to a trade bloc that is already in operation, NAFTA has, in fact, become a moving target.

Free trade in the hemisphere has a great future irrespective of NAFTA. Countries should join trading blocs for economic reasons, not political ones. Unless Chile can be assured of a NAFTA free of the restrictions that apply to Mexico, it will be better off staying out. Its best policy would be continuing to remove barriers to free trade without expecting great reciprocity. Chile, furthermore, would be better off attracting foreign direct investment from any country and using it to transform itself into an authentic global producer. The alternative--to redraft the agreement in order to accommodate Chile--is not realistic.

NAFTA is today a freer-trade region than envisioned in January 1994, because an economic crisis forced the Mexican government to liberalize more sectors than it had originally intended. This proves that regional agreements can evolve into larger trading zones, at which point it would be wiser for more liberalized economies to join up. Politicians like Clinton may find many arguments to deny the restrictive nature of NAFTA or to argue that the agreement must be broadened because the politics are now right. They may even waste more time debating fast track as the quickest route to hemispheric nirvana. But, truth be told, the economics of NAFTA do not currently justify its expansion.