Issue 2, 1999
Federal Reserve Bank of Dallas
El Paso Branch

NAFTA's First Five Years
(Part 1)

The North American Free Trade Agreement turned 5 years old at the end of 1998 and completed a third of its 15-year implementation schedule. At this juncture it is appropriate, then, to ask if NAFTA's primary objective—increasing trade between the United States, Mexico and Canada—has been met thus far. This article, the first in a three-part series, looks at the North American economy and evaluates NAFTA's trilateral impact on trade during the agreement's first five years.

More than 68 percent of North America's population in 1998 lived in the United States. Mexico had more than 24 percent of the region's population, and Canada contributed nearly 8 percent. Mexico has a much younger population than its developed-country counterparts. In 1998, more than half of the country's population—55 percent—was under the age of 25. The equivalent figures for the United States and Canada were 35 percent and 33 percent, respectively.

The North American labor force was close to 193 million in 1998. Both the United States and Canada have very similar labor-force profiles. For example, in 1998, the share between the ages of 15 and 24 in Canada and between 16 and 24 in the United States equaled 15.9 percent in each country. The share of Mexico's labor force between 15 and 24 was higher, at 26.2 percent. The greater availability of a younger workforce in Mexico is a reflection of its sizable young population.

Mexico's developing-country status is graphically captured by its GDP per capita, which contrasts dramatically with those of its North American counterparts. As shown in Table 1, Mexico's GDP per capita in 1998 was $4,337, while Canada's and the United States' were $19,925 and $31,487, respectively. Overall, North American GDP per capita, on a weighted average basis, was $24,048.[1] Similarly, on wages, Mexico stands in sharp contrast to its developed-country regional partners. According to the latest available data from the U.S. Bureau of Labor Statistics, Mexico's hourly compensation in manufacturing for 1997 was $1.75 per hour. The corresponding figures for Canada and the United States were $16.55 and $18.24, respectively.

Certainly, NAFTA is only one of the factors that have impacted the region's economies since the agreement's inception in January 1994. For example, in 1995 Mexico experienced a severe economic crisis as a result of an unexpected peso devaluation in December 1994.[2] Likewise, a number of factors have affected the U.S. and Canadian economies. Yet, when the focus is trade, NAFTA clearly has had a positive impact on the three economies during the agreement's first five years.

Canada is the United States' No. 1 trading partner, a position it held even before NAFTA. Last year, Canada was the destination of 23 percent of U.S. exports and the source of 19 percent of U.S. imports. Before NAFTA, Mexico was already the United States' third-largest trading partner. However, four years into the agreement—in 1997—Mexico displaced Japan as the second-largest market for U.S. exports. Moreover, Mexico's share in U.S. total imports grew steadily during NAFTA's first five years, allowing the country to retain its position, behind Japan, as the third-largest source of U.S. imports. Exports to Mexico represented 11.5 percent of the U.S. total in 1998, up from 8.9 percent in 1993. Imports from Mexico were 10.4 percent of U.S. imports, up from 6.9 percent. Considering total trade though—both exports and imports combined—Mexico in 1999 replaced Japan as the United States' second-largest trading partner.

Trade with the United States is a more significant share of total trade for both Canada and Mexico than what each of these countries represents in total U.S. trade. Moreover, the United States gained greater ground in Canada's and Mexico's total trade during NAFTA's first five years. In 1998, exports to the United States were 83.6 percent of Canada's total, up from 78.4 percent in 1993; imports from the United States were 77 percent of Canada's total, up from 73.5 percent. Similarly, a considerable majority of Mexico's trade is with the United States. Exports to the United States represented 87.6 percent of Mexico's total in 1998, up from 82.7 percent in 1993. Imports from the United States were 74.3 percent of the country's total, up from 69.3 percent.

Canadian–Mexican Trade
Trade between Canada and Mexico was not significant before NAFTA, but it increased considerably after the agreement's implementation. In 1998, Canada's imports from Mexico (Mexico's exports to Canada) reached $5.2 billion, up almost 79 percent from their 1993 level of $2.9 billion. Canada's exports to Mexico (Mexico's imports from Canada) rose to $876 million, an increase of almost 37 percent from $640 million. Despite these noteworthy increases, however, Canada represented only about 2 percent of Mexico's world trade in 1993 and throughout NAFTA's first five years. Similarly, Canada's imports from Mexico represented 2.1 percent of the country's total imports before NAFTA in 1993; by 1998, this share had grown only slightly, to 2.5 percent. Canada's exports to Mexico remained at 0.4 percent of the country's total during NAFTA's first five years. Table 3 provides a breakdown of the top products traded between Mexico and Canada.

Tariff Reductions
Trade among the United States, Canada and Mexico has grown essentially because of the elimination of tariffs dictated by NAFTA. The agreement specifies a 15-year tariff-elimination schedule on trilateral trade. Chart 3 shows this schedule for U.S.–Mexican trade. As can be seen, within the agreement's first five years, 76.2 percent of U.S. imports from Mexico and 66.3 percent of U.S. exports to Mexico were slated to become duty-free. The corresponding shares prior to NAFTA were 13.9 percent and 17.9 percent, respectively.

The actual trade shares that are currently duty-free are higher, however, than what this original tariff-elimination schedule shows. This is because the NAFTA countries have taken advantage of a provision of the agreement that allows for tariff reductions ahead of schedule. The first of these rounds of accelerated tariff eliminations became effective July 1, 1997; the second round took effect August 1, 1998. A third round was initiated in July 1999 and has yet to conclude.[3]

Moreover, as overall duties on U.S.–Mexican trade have dropped, this has lowered the average tariff each country applies to goods from the other country. Thus, the average Mexican tariff on U.S. products dropped to less than 2 percent (1.68 percent) in 1998, down from 10 percent in 1993. The average U.S. tariff on Mexican goods—which, at 4 percent, was low even before NAFTA—dropped to less than 1 percent (0.46 percent) in 1998.[4] Because the reduction in the average Mexican tariff on U.S. goods was greater than the reduction in the average U.S. tariff on Mexican goods, the United States has especially benefited from NAFTA.

Trade Disputes
NAFTA has not prevented trade disputes among the three countries. But the agreement provides a mechanism to address and resolve any trade disputes that surface between the NAFTA parties (see box titled "NAFTA Trade Disputes."). Given that trade among all three countries advanced considerably during the agreement's first five years, trade disputes have been the exception rather than the rule.

—Lucinda Vargas

About the Author Vargas is a senior economist at the El Paso Branch of the Federal Reserve Bank of Dallas. Notes Jesus Cañas contributed to this article. North American GDP per capita was derived from the weighted average of the three countries' GDP per capita, using the population of each country as the weights. For a look at the different effects of NAFTA and the peso devaluation on the Mexican economy, see David Gould, 'Distinguishing NAFTA from the Peso Crisis,' Southwest Economy, Federal Reserve Bank of Dallas, Issue 5, September/October 1996, pp. 6–10. See Grace Victoria Chomo, 'NAFTA Accelerated Tariff Eliminations,' forthcoming in International Economic Review, U.S. International Trade Commission. See 1999 Trade Policy Agenda and 1998 Annual Report of the President of the United States on the Trade Agreements Program, Office of the U.S. Representative, March 1999, p. 159. About Business Frontier Business Frontier is published by the El Paso Branch of the Federal Reserve Bank of Dallas. The views expressed are those of the author and do not necessarily reflect the positions of the Federal Reserve Bank of Dallas or the Federal Reserve System. Subscriptions are available free of charge. Please direct requests for subscriptions, back issues and address changes to the Public Affairs Department, El Paso Branch, Federal Reserve Bank of Dallas, 301 E. Main St., El Paso, TX 79901-1326; call 915-521-5235 or 915-521-5233; fax 915-521-5228; or subscribe via the Internet at www.dallasfed.org. Articles may be reprinted on the condition that the source is credited and a copy of the publication containing the reprinted material is provided to the Research Department, El Paso Branch, Federal Reserve Bank of Dallas. Editor: Lucinda Vargas Publications Director: Kay Champagne Copy Editors: Jennifer Afflerbach and Monica Reeves Design: Gene Autry Layout & Production: Laura J. Bell