Benefits of NAFTA: How NAFTA Has Elevated Mexico’s Economic Health and Status
February 15, 2020
Since the U.S., Mexico, and Canada agreed upon the new USMCA economic treaty in early 2020, NAFTA has been in the news again. USMCA, in effect, replaces the former international trade agreement, which has transformed the economies of the three countries in the past two and a half decades.
While the effects of USMCA remain to be seen, at the end of the NAFTA era, it is clear that the former free trade agreement boosted not only the global economy, but Mexico’s economy in particular. To understand the effects of NAFTA on manufacturing in Mexico, it’s important to look back at its inception in 1994. NAFTA, which stands for North American Free Trade Agreement, created the world’s largest tariff-free zone, allowing for free trade between the three countries and modernizing Mexico’s economy in the process. Section 321 de minimis is one example of how NAFTA continues to positively impact Mexico’s trade economy. This 2015 trade provision built on NAFTA’s foundation by raising the de minimis duty-free value of goods entering the U.S. from Mexico from $200 to $800.
This guide explains the ways NAFTA has elevated Mexico’s economy, giving a clearer idea of the factors that will continue to drive North America’s economic growth in 2020 and beyond.
NAFTA 101: What is NAFTA?
NAFTA marked the first trade agreement between two developed nations and an emerging market. The three countries’ reasons for signing the free trade agreement were multifaceted. NAFTA allowed the U.S. and Canada to compete with other surging markets, including China and the European Union. The motivations for Mexico, however, were different—for this nation, the free trade agreement served as an opportunity to modernize its economy. NAFTA built on the trans-pacific partnership and shares many key goals, including free trade. The Trump Administration pulled out of the trans-pacific partnership but remains a member of NAFTA.
Mexico’s Economy Before the NAFTA Era
Prior to the 1990s, Mexico had a protectionist economic model that promoted local industry. Then, the Latin American Debt Crisis came to its head in the years before NAFTA’s signing. Since the 1970s, Latin American countries, including Mexico, have borrowed heavily from foreign banks, including U.S. banks, in the face of fluctuating oil prices
By 1982, Mexico had $80 billion in foreign debt, and could no longer afford making its agreed-upon payments. In the late 80s and early 90s, Mexican politicians, including former President Carlos Salinas de Gortari, began to embrace free trade, partially in exchange for debt forgiveness, and also to boost economic growth. Economic growth blossomed as Mexican products benefitted from a lack of trade barriers.
The reforms and changes brought about by NAFTA would shift Mexico’s economy in the decades to come.
The NAFTA Agreement
When the U.S., Mexico, and Canada signed the NAFTA agreement, the three countries agreed to:
- Grant each other “most-favored-nation” status in trading
- Eliminate tariffs on imports and exports
- Respect each other’s trademarks and copyrights
- Use a set of agreed upon rules and procedures to settle trade disputes
All of these stipulations were intended to create free trade between the three nations, as well as create more cross-national and multinational investment opportunities through direct foreign investment. This cross-national trade also has led to new laws regarding regulations including entry type 86 customs regulations.
Case Study: The Auto Industry
Now we know how NAFTA worked in theory—its vision and its goals. How did NAFTA affect Mexico in practice? What were the benefits of NAFTA for Mexico?
In order to see some of the overarching impacts of NAFTA, we can look at the auto industry in particular. After NAFTA, Mexico:
- Tripled its vehicle production
- Quadrupled its vehicle exports
- Began to employ close to a million workers in the auto manufacturing sector.
Companies in the auto sector including Ford, Chrysler, GM, Volvo, Toyota, Nissan, Mazda, and Honda began to host part or all of their production process in Mexico, and now, the automotive industry is on-track to become the largest industry within the country. Foreign investment in Mexico for these manufacturing plants led to numerous manufacturing jobs for Mexican citizens.
As we can see, the auto industry’s dramatic growth and transformation had three main effects on Mexico’s economy:
- Increased exports
- Diversified exports and increased investment from multinational companies
- Job creation
Next, we’ll take a deeper look into the way these three transformations came about through the NAFTA trade deal and have continued to transform the economy.
Reduced Tariffs Lead to Increased Exports from Mexico
As we can see from the example of the auto industry, NAFTA helped increase Mexico’s exports. To understand why let’s take a look at the effect of tariffs on trade.
The Basics of Tariffs
Tariffs are essentially taxes that a government imposes on imports and exports. As you may have seen in recent discussions of the ongoing trade war with China, who pays a tariff can be complicated: if a U.S. retailer like Target imports goods from China that are subject to tariffs, they may ask the Chinese supplier to lower the price, or they may pass the price onto the consumer. These decisions on how to handle tariffs can change the way trading partners consider each other and can alter supply chains.
Before NAFTA, goods from Mexico could be subject to tariffs of up to 30% upon entering the U.S. NAFTA eliminated these tariffs on goods imported from Mexico, as long as they originated in North America. This trade deal allowed Mexican products to enter the U.S. while keeping costs low and gave Mexican exports a competitive edge in the U.S.
Mexico’s Growing Export Economy
While Mexico also placed tariffs on goods imported from the U.S. and Canada, the elimination of tariffs between the three countries had a larger impact on Mexico than on the other two NAFTA nations.
Manufacturing costs in Mexico were (and still are) low, and U.S. tariffs on goods manufactured in Mexico fell from 2% to 0.2% between 1993 and 2001. In turn, Mexico became an exporting powerhouse: the dollar value of its exports to its NAFTA trading partners doubled within this period.
Mexico’s trade (imports and exports) went from making up 25% of its GDP in the 1990s to 51% just a decade later. This was almost entirely because of trade with its NAFTA partners, considering 90% of its exports went to the U.S. and Canada.
Diversified Exports and Manufactured Goods
The Latin American debt crisis was strongly tied to the high volatility in global oil prices. Following the NAFTA agreement, preferential trading with Mexico made it profitable for U.S. and multinational companies to manufacture goods in America, as these could then be exported throughout North America without tariffs. This allowed Mexico to diversify its export economy and shift away from oil significantly.
In the pre-NAFTA era, Mexico predominantly exported:
- Agricultural products (avocados, tomatoes, etc.)
- Fuel and ore (petroleum)
In the post-NAFTA era, Mexico’s exports have become increasingly diverse. However, there has been tremendous growth in the export of manufactured goods including:
- Auto parts
The Rise of Maquiladora Manufacturing
The close ties between the U.S. and Mexico have made maquiladora firms especially successful. Under NAFTA, products must be 62.5% produced in North America to remain exempt from tariffs.
Maquiladoras specialize in assembling these goods.
During the NAFTA era, U.S. and multinational companies looking to save money on production costs increasingly began to produce inputs within the U.S., process them in Mexico, and import them back. This way, they met the 62.5% threshold for North American production, while taking advantage of the low cost in labor in Mexico to finish up the production process.
These kinds of exports now make up 50% of total exports from Mexico.
The benefits of NAFTA for Mexico also include new jobs. The increased demand for products manufactured in Mexico has created thousands of jobs across the manufacturing industry and in other sectors of the economy.
While NAFTA has boosted Mexico’s economy and status in the global market, it was controversial throughout its duration. The regeneration of NAFTA led to USCMA, which will impact North America anew. In particular, it expands the protections for workers in Mexico, as well as provides new environmental impact guidelines.
As the workforce in Mexico continues to grow and the country invests significantly in transportation for commercial goods, Mexico’s manufacturing industry isn’t going anywhere. With an increased impetus to build and manufacture goods in North America, the economic ties between the three USMCA nations are only getting stronger. In fact, NAFTA countries have increased their trade volume with one another by 300% and NAFTA renegotiation is currently a priority. The impact of NAFTA will continue to reveal itself in Mexico’s manufacturing process and Mexico’s economy for years to come.
Over 150 companies have used NAPS to reach their goals of successfully manufacturing in Mexico to remain competitive in the global markets and achieve long-term success. Contact us today for a manufacturing solution that will be unique to your business and it’s success.