According to President Donald Trump, Mexico is “beating the US badly on trade” and a big part of the reason is Nafta. In truth, however, the real question is not why Mexico has benefited so much from Nafta, but rather why the economic benefits have been so small.
Of course, as President Trump likes to point out, it is certainly the case that Mexico’s trade surplus with the US has ballooned under Nafta. When the treaty came into force in 1994, Mexico actually ran a small annual trade deficit with the US of $1.3bn. But by 2015, this had shifted to a surplus of $67bn. What’s more, while the US runs a surplus in services and also earns significant sums on its investments in Mexico, these are more than offset by the outflow of remittances from Mexicans working north of the border. All told, Mexico’s current account surplus with the US was around $75bn in 2015.
Yet the tendency to view the gains and losses from trade through the narrow prism of balance sheet transactions is bad economics. According to this view, exports (and surpluses) are good, while imports (and deficits) are bad. In reality, however, the gains from trade derive not from exports, but from the better allocation of resources permitted by the exchange of goods and services. In other words, the success (or otherwise) of Nafta should be measured not by its effect on trade balances but by its effect on productivity growth. Viewed this way, the benefits for Mexico have been less overwhelming than President Trump’s rhetoric suggests.
In the 20 years prior to Nafta, intermittent crises meant that labour productivity in Mexico actually fell by an average of 0.3 per cent a year. In the 20 years since, annual productivity growth has been positive, but only just. It has averaged 0.7 per cent since 1995 – the worst performance of any major emerging market. To put this into perspective, EMs at similar stages of development have typically recorded annual productivity growth of around 2-3 per cent. Even Brazil has managed productivity growth of around 1 per cent y/y in the past 20 years.
The underlying question, then, is why Nafta has failed to deliver a substantial improvement in Mexican productivity. The answer lies in broader policy failures.
By enabling integration within US supply chains, Nafta has created pockets of high-productivity production in Mexico’s economy. Mexico is now the world’s fourth largest exporter of vehicles, second largest exporter of computer monitors and second largest exporter of wire cabling. But Nafta failed to act as a spur for wider reforms to Mexico’s economy.
Indeed, for much of the past 25 years, Mexico has suffered from competition laws that create monopolistic markets, labour laws that entrench informality, and a thicket of red tape (not to mention drug violence) that deters investment and weighs on productivity. To make matters worse, a legacy of under-investment at Pemex has meant that oil production is in long-run decline. It has fallen by more than 30 per cent over the past decade, cutting into government revenues and thus squeezing public investment.
The result is a two-speed economy comprising a relatively small number of high-productivity, high-income sectors that are integrated in US supply chains alongside low-productivity, low-income sectors that dominate in large swathes of the country. Incomes in Nuevo Leon, a state on the north-east border with the US, are four times higher than those in Chiapas on the border with Guatemala. Workers in the auto industry earn around $8-10 per hour; Mexico’s national minimum wage is less than $1 per hour.
The irony is that Mexico’s government has finally started to tackle some of the structural constraints that have hitherto prevented a broader pick-up in productivity growth. Since President Pena Nieto was elected in 2012, competition laws have been liberalised, labour market regulations loosened and the oil industry has been opened up to foreign investment. Yet all of this has come at a price. The short-term pain caused by these reforms has contributed to a collapse in President Peña Nieto’s approval rating, even before Mexico’s economy is hit by any Trump effect.
Yet there is a silver lining to all of this. If Nafta has failed to deliver a substantial boost to Mexico’s economy then threats to tear it up may not inflict the huge damage that many fear. While Mexico would certainly be the big loser from any efforts to restrict trade, economic growth over the next 5-10 years will be determined more by whether President Peña Nieto’s reforms endure. In this regard, the outcome of 2018 elections in Mexico will be just as important as the outcome of any renegotiation of Nafta.
Neil Shearing is chief emerging markets economist at Capital Economics.