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References

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1

This paper was prepared for the Monetary Policy and Macroeconomic Stabilization in Latin America conference organized by the Kiel Institute for World Economics in September 2003 and will be published in Weltwirtschaftliches Archiv (Review of World Economics). We thank Don Clark, Jorge Braga de Macedo, Paula De Masi, Ebrima Faal, Marcel Fratzscher, Tom Fullerton, Hideaki Hirata, Reva Krieger, Rolf Langhammer, Enrique Mendoza, Martin Mühleisen, Marco Terrones, Alberto Torres, Kei-Mu Yi, conference participants, and especially our discussant, Lúcio Vinhas de Souza, for helpful comments and suggestions. We thank Gustavo Ramirez and Andrew Swiston for superb research assistance.

2

The roots of trade integration in the region go back to the mid-1960s. In 1965, Canada and the United States signed the Canada-U.S. Auto Pact, which freed cross border trade in the sector (Cardarelli and Kose, 2004). Mexico and the United States initiated the maquiladora program in 1965. The program allowed maquiladora plants to import intermediate inputs, such as parts and equipment, duty-free as long as manufactured product was exported back to the United States, which, in turn, imposed tariffs only on the value-added portion of the product (Canas and Coronado, 2002).

3

In 2002, total GDP of NAFTA members was more than 25 percent larger than that of the European Union. Exports (imports) of the European Union constituted roughly 38 (35) percent of world exports (imports) while exports (imports) of NAFTA accounted for about 18 (25) percent (DFAIT, 2003).

4

Fernández (1997) argues that since NAFTA did not include any provisions about domestic reform programs, it is not clear how it provided a commitment device. Some argue that a major consideration for the United States was that economic growth in Mexico could help slow down illegal immigration (World Bank, 2000). Hufbauer and Schott (1992) provide an extensive analysis of various objectives of the member countries.

5

USITC (1997, 2003) provide detailed information about the provisions of NAFTA. Kowalczyk and Davis (1998) analyze NAFTA tariff phase-outs between Mexico and the United States.

6

Loser and Kalter (1992) provide a review of the reform programs implemented in Mexico since the early 1980s.

7

Gil-Diaz and Carstens (1996) analyze various reasons that are used to the explain the 1994–95 crisis. Sachs, Tornell, and Velasco (1995) examine various domestic factors which contributed to the 1994–95 crisis. Kalter, Ribas, and Armando (1999) analyze the fiscal problems associated with the crisis. Krueger and Tornell (1999) study the problems in the banking sector and the effects of bank structuring on the recovery.

8

USTR (1997) examines Mexico’s policy responses after the two crises (1982 and 1994–95) and concludes that NAFTA membership was an important factor in the relatively rapid recovery from the 1994–95 crisis.

9

The agreements included those with Chile, the European Union, the European Free Trade Association, Israel, Bolivia, Colombia, Venezuela, Nicaragua, El Salvador, Guatemala, Honduras, Costa Rica, and Uruguay. Ibarra-Yunez (2003) studies Mexico’s trade policy initiatives after NAFTA and concludes that Mexico’s use of NAFTA parity in other free trade agreements dampened these agreements’ potentially negative welfare effects stemming from trade diversion.

10

NAFTA has also affected the growth of trade and financial flows between Canada and the United States (Cardarelli and Kose, 2004). U.S. exports to NAFTA partners climbed nearly 90 percent, twice the increase in its exports to the rest of the world (Kose, 2003). DFAIT (2003) documents the increase in trade and financial flows between Canada and Mexico after the inception of NAFTA.

11

The emerging market countries in the sample undertook trade and financial liberalization programs at around the same time as Mexico did. Tornell, Westermann and Martinez (2003) document the dates of financial and trade liberalizations for several emerging market economies.

12

A recent paper by Kehoe (2003) argues that CGE models severely underestimated the impact of NAFTA on the volume of regional trade. For example, a static CGE model by Brown, Deardorff, and Stern (1992) estimates that Mexico’s exports (imports) relative to its GDP would increase roughly 51 (34) percent during the period 1988–99 while the data suggest that the relative increase in exports (imports) was larger than 140 (50) percent in the same period. Kehoe also finds that the models were unable to account for much of the increase in sectoral trade flows. He argues that these models fail to explain the dramatic increase in trade flows because they do not capture the impact of productivity changes associated with NAFTA and they do not allow endogenous formation of specialization patterns implying that the largest increase in trade would take place in those sectors which have already had intensive trade linkages.

13

During the same period, the share of intra-industry trade in total manufacturing trade of the United States (Canada) increased from 63.5 (73.5) percent to 68.5 (76.2) percent (OECD, 2002). Chen and Yi (2003) provide a detailed account of the changes in the nature of global trade flows during the past thirty years.

14

Rivera-Batiz (2000) provides a brief review of how restrictions on FDI flows were relaxed over time since the 1930s in Mexico.

15

Kose, Prasad, and Terrones (2004b) provide a review of this literature, which also shows that macroeconomic instability has a negative impact on investment growth.

16

De Ferranti, Perry, Gill, and Serven (2000) study the sources of macroeconomic volatility in Latin American countries. Santos (2002) finds that recessions in Mexico are deeper and shorter than expansions.

17

Volatility is measured as the standard deviation of the Hodrick-Prescott filtered quarterly series.

18

Prasad, Rogoff, Wei, and Kose (2003) show that welfare gains associated with international consumption risk sharing are quite large in emerging market economies including Mexico. They find that emerging market economies could, on average, increase their consumption by roughly 3.5 percent. Since its consumption stream is less volatile than that of most other emerging market countries, consumption in Mexico could increase by 1.8 percent through the diversification of its consumption risk.

19

Comovement is measured as the cross-country correlation of the Hodrick-Prescott filtered quarterly series of main macroeconomic aggregates (output, consumption, investment, exports, and imports) of Mexico, Canada, and the United States.

20

In several cases, the changes in correlations are statistically significant. The correlations between Mexico and a NAFTA aggregate are also studied and found to be consistent with the results reported here. The results are also robust to alternative detrending methods, such as first-differencing.

21

Kose, Otrok, and Whiteman (2003) provide a detailed discussion about these models. Using various factor models, Lumsdaine and Prasad (2002), Helbling and Bayoumi (2003) and Kose, Otrok, and Whiteman (2003, 2004) document that there is a significant common component explaining business cycles in industrialized countries.

22

Baldwin and Venables (1995) provides a survey of theoretical studies on the growth and welfare implications of regional trade agreements. Kose and Riezman (2000) employ a general equilibrium framework to analyze the welfare implications of different types of preferential trade agreements, such as customs unions and free trade areas, and conclude that these agreements could lead to large welfare gains in member countries. Krueger (1997) argues that trade-creating custom unions are superior to free trade areas on welfare grounds since a free trade area imposes a variety of rules-of-origin requirements and could potentially result in more trade diversion than does a customs union.

23

Berg and Krueger (2003) and Baldwin (2003) provide extensive surveys of the literature on trade and growth. Overwhelming majority of empirical studies in the literature find that trade openness has a positive impact on economic growth. Rodrik and Rodriquez (2001) present a critical review of some of these empirical studies.

24

Baldwin and Venables (1995) provide a summary of the studies using CGE models to evaluate the impact of NAFTA. Manchester and McKibbin (1995) conclude that the decrease in Mexico’s country risk premium associated with NAFTA could lead to very large growth gains.

25

Nevertheless, unlike previous recessions in Mexico, which carried the seeds of major financial and economic crises, the latest downturn appears to be of a more normal cyclical nature (Federal Reserve Bank of Dallas, 2002).

26

Mexico stood 55th in the 2002 World Economic Forum’s ranking of country’s microeconomic competitiveness.

27

Cuevas, Messmacher, and Werner (2002b) argue that one of the potential explanations of the growth slowdown in Mexico was the halt of economic reforms since the mid-1990s. Tornell, Westermann, and Martinez (2003) also conclude that the slowdown in GDP and exports since 2001 was associated with the lack of structural reforms.

28

NAFTA partners have recently decided to establish study groups to analyze avenues for harmonization of MFN tariffs and rules of origin requirements, and to improve rules governing investment flows. In addition, recognizing the importance of secure and continuous access to each other’s markets, NAFTA members have recently placed an emphasis on border security (Cardarelli and Kose, 2004).

How Has Nafta Affected the Mexican Economy? Review and Evidence
Author: Mr. Ayhan Kose, Mr. Christopher M Towe, and Mr. Guy M Meredith