CONGRESS OF THE UNITED STATES

CONGRESSIONAL BUDGET OFFICE

A

CBO

PAPER

MAY 2003

The Effects of

NAFTA on

U.S.-Mexican

Trade and GDP

© Photodisc/GettyImages

CBO

A

P A P E R

The Effects of NAFTA

on U.S.Mexican Trade and GDP

May 2003

The Congress of the United States # Congressional Budget Office 
Notes

Unless otherwise indicated or apparent, all timeseries values in this paper are quarterly and are

seasonally adjusted. Similarly, unless otherwise indicated, all rate series—such as exports in bil

lions of dollars or gross domestic product—are annual rates.

Data series for exports and imports were constructed from three compilations of trade data from

the Bureau of the Census: the Interactive Tariff and Trade Data Web on the Web site of the

International Trade Commission (www.usitc.gov); Direction of Trade Statistics, published by the

International Monetary Fund; and the Haver Analytics database. The export values used are the

free alongside ship (f.a.s.) values of total exports. The import values used are the customs values

of general imports.
Preface

The North American Free Trade Agreement (NAFTA) went into effect on January 1, 1994,

creating a freetrade area encompassing the United States, Canada, and Mexico. Since then,

agreements have been proposed—and, in some cases, negotiations begun or even completed—for

a Free Trade Area of the Americas and freetrade areas with a number of other countries of vary

ing degrees of development. Consequently, assessing the effects of NAFTA is relevant to current

debates about trade policy.

This Congressional Budget Office (CBO) paper—prepared at the request of the Chairman of

the Senate Committee on Finance—examines aggregate U.S.Mexican trade in goods in the first

eight years after NAFTA went into effect and how it has been affected by the agreement and by

other factors. The paper provides quantitative estimates of the effects of NAFTA on that trade

and of the resulting effects on U.S. gross domestic product. (The paper focuses on U.S. trade

with Mexico because U.S. trade with Canada had already been substantially liberalized in accord

ance with the CanadaUnited States Free Trade Agreement before NAFTA went into effect.)

Bruce Arnold of CBO’s Microeconomic and Financial Studies Division prepared the paper under

the direction of Roger Hitchner and David Moore. Charles Capone, Robert Dennis, Tracy

Foertsch, Douglas Hamilton, Juann Hung, Rob McClelland, and Thomas Woodward of CBO

provided valuable comments, as did Gary Hufbauer of the Institute for International Economics

and David Gould of the Institute of International Finance, Inc.

Christian Spoor edited the paper, and Christine Bogusz proofread it. Kathryn Winstead prepared

the paper for publication, Lenny Skutnik produced the printed copies, and Annette Kalicki

prepared the electronic versions for CBO’s Web site.

Douglas HoltzEakin

Director

May 2003

This study and other CBO publications

are available at CBO's Web site:

www.cbo.gov

1

2

3

CONTENTS

Summary ix

Introduction 1

What Is NAFTA? 1

How Should the Success or Failure of a FreeTrade

Agreement Be Measured? 2

How Has U.S.Mexican Trade Changed Over Time? 6

Other Influences on U.S.-Mexican Trade Besides NAFTA 11

Domestic U.S. Factors 11

Mexican Economic Development 12

Imports of Crude Oil from Mexico 12

The Exchange Rate Between the Dollar and the Peso 12

The Mexican Business Cycle 13

The Effects of NAFTA 17

The Effects of NAFTA on U.S.Mexican Trade 17

The Effects of NAFTA on U.S. GDP 21

A Few Notes About the Results 22

Consistency of CBO’s Results with Other Estimates

in the Literature 23

Appendix A

CBO’s Model of U.S.Mexican Trade 27
vi THE EFFECTS OF NAFTA ON U.S.-MEXICAN TRADE AND GDP

Appendix B

Assumptions for the Alternative Scenario

in Chapter Three 37

Appendix C

Results from the Model Estimated Using

Only PreNAFTA Data 39

Appendix D

Effects of the Assumption About the Real Exchange

Rates and Incomes in the Absence of NAFTA 49
CONTENTS vii

Tables

1. Effects of NAFTA on U.S. Goods Trade with Mexico 19

2. Effects of NAFTA on U.S. Gross Domestic Product 22

3. CBO’s Estimates of the Effects of NAFTA Compared with

Others in the Literature 24

A1. Estimates and Statistics for LongTerm Equilibrium

Equations for U.S.Mexican Trade 34

A2. Estimates and Statistics for Dynamic ErrorCorrecting

Equations for U.S.Mexican Trade 35

C1. Effects of NAFTA on U.S. Goods Exports to and Imports

from Mexico by CBO’s Standard and Alternative Methodologies 44

C2. Effects of NAFTA on the U.S. Goods Trade Balance with Mexico

by CBO’s Standard and Alternative Methodologies 46

C3. Effects of NAFTA on U.S. Gross Domestic Product by CBO’s

Standard and Alternative Methodologies 47

Figures

S1. U.S. Trade in Goods with Mexico xi

S2. Real Exchange Rates for U.S. Trade in Goods with Mexico xii

S3. Mexican Industrial Production and Real Gross Domestic Product xii

S4. U.S. Balance of Trade in Goods with Mexico Under

Alternative Scenarios xiv

1. Tariff Rates on U.S.Mexican Trade Before and After NAFTA 3

2. U.S. Goods Trade with Mexico 8

3. Mexico’s Share of U.S. Goods Trade with the World 8

4. U.S. Goods Trade Balance with Mexico 9

5. U.S. Goods Trade Balance with Mexico and with the World 10
viii THE EFFECTS OF NAFTA ON U.S.-MEXICAN TRADE AND GDP

6. U.S. Goods Trade with Mexico as a Share of U.S. Goods

Trade with the World 10

7. Crude Oil as a Share of U.S. Goods Imports from Mexico 12

8. Real Exchange Rates for U.S. Goods Trade with Mexico 13

9. Mexican Industrial Production and Real Gross Domestic Product 13

10. Net Foreign Investment in Mexico 14

11. U.S. Goods Trade with Mexico with and Without NAFTA 18

12. U.S. Goods Trade Balance with Mexico Under Alternative Scenarios 20

B1. Real Exchange Rate for U.S. Goods Exports to Mexico

Under Alternative Scenarios 37

B2. Mexican Industrial Production Index Under Alternative Scenarios 38

B3. Real U.S. GDP Under Alternative Scenarios 38

C1. U.S. Goods Trade with Mexico by CBO’s Alternative Methodology 41

C2. U.S. Goods Trade Balance with Mexico by CBO’s Alternative

Methodology 45

C3. U.S. Goods Trade Balance with Mexico Under Alternative

Scenarios by CBO’s Alternative Methodology 46

C4. Actual U.S. Goods Trade Balance with Mexico Under Alternative

Scenarios by CBO’s Alternative Methodology 47

Boxes

1. NAFTA and Foreign Investment 4

2. The Effects of Trade Creation and Trade Diversion 5

3. Trade Balances with Individual Countries Versus the Balance

with the Entire World 7
Summary

The North American Free Trade Agreement

(NAFTA), which took effect on January 1, 1994, called

for the phasing out of virtually all restrictions on trade

and investment flows among the United States, Canada,

and Mexico over 10 years (with a few of the most sensitive

restrictions eliminated over 15 years). The United States

and Canada were already well into the elimination of the

barriers between themselves in accordance with the

CanadaUnited States Free Trade Agreement, so the main

new feature of NAFTA was the removal of the barriers

between Mexico and those two countries.

Now, more than eight years later, most artificial impedi

ments to trade and investment between the United States

and Mexico have been dismantled. In 2001, 87 percent

of imports from Mexico entered the United States duty

free. The average duty on the remainder was only 1.4 per

cent, for an overall average tariff rate of 0.2 percent, down

from 2.1 percent in 1993. The overall average Mexican

tariff rate in 2001 was only 1.3 percent, down from

12 percent in 1993. Enough time has passed and enough

of NAFTA’s trade and investment liberalization has been

phased in that any substantial effects of the agreement

should be evident by now.

This paper assesses the effects of NAFTA on overall levels

of trade in goods between the United States and Mexico

and on U.S. gross domestic product (GDP).1

 Such an as

sessment is important not only for its own sake but also

because of its relevance to other proposed U.S. freetrade

areas with developing countries. Since NAFTA went into

effect, proposals have been made and, in some cases,

negotiations have begun (or even been completed) for a

Free Trade Area of the Americas and for freetrade areas

with Chile, Central America, Southern Africa, Morocco,

Singapore, and various other countries of the Association

of Southeast Asian Nations.

The challenge in assessing NAFTA is to separate its effects

from the effects of other factors that have influenced trade

between the United States and Mexico. Those factors in

clude the considerable economic and political turmoil that

occurred in Mexico in the early postNAFTA years—

turmoil that, for the most part, was unrelated to the agree

ment—and the long U.S. economic expansion that lasted

throughout most of the 1990s. The Congressional Budget

Office (CBO) used a statistical model of U.S.Mexican

trade to separate out the effects of those factors and

reached the following conclusions:

• U.S. trade with Mexico was growing for many years

before NAFTA went into effect, and it would have con

tinued to do so with or without the agreement. That

growth dwarfs the effects of NAFTA.

• NAFTA has increased both U.S. exports to and im

ports from Mexico by a growing amount each year.

Those increases are small, and consequently, their ef

fects on employment are also small.

• The expanded trade resulting from NAFTA has raised

the United States’ gross domestic product very slightly.

(The effect on Mexican GDP has also been positive

and probably similar in magnitude. Because the Mexi

can economy is much smaller than the U.S. economy,

however, that effect represents a much larger percentage

increase for the Mexican economy.)

1. Lack of data and other considerations make analyzing trade in

services problematic, and as noted earlier, almost all barriers to

U.S.Canadian trade had already been removed (or were scheduled

for removal within a few years) before NAFTA went into effect.
x THE EFFECTS OF NAFTA ON U.S.-MEXICAN TRADE AND GDP

Some observers look at NAFTA’s effects on the U.S.

balance of trade with Mexico (the difference between the

values of exports and imports) as an indication of the

economic benefit or harm of the agreement. The balance

of trade dropped substantially after NAFTA took effect

and has declined further in more recent years, leading

some people to conclude that NAFTA has been bad for

the U.S. economy.

However, changes in the balance of trade with a partner

country are a poor indicator of the economic benefit or

harm of a trade agreement. A better indicator is changes

in the levels of trade. Increases in trade—both exports and

imports—lead to greater economic output because they

allow each nation to concentrate its labor, capital, and

other resources on the economic pursuits at which it is

most productive relative to other countries. Benefits from

the greater output are shared among the countries whose

trade increases, regardless of the effects on the trade bal

ance with any particular country. Such effects do not

translate into corresponding effects on the balance of trade

with the world as a whole; for a country as big as the

United States, that balance is largely unaffected by restric

tions on trade with individual countries the size of Mexico.

Moreover, even declines in a country’s trade balance with

the world have little net effect on that country’s output

and employment because the immediate effects of those

declines are offset by the effects of increased net capital

inflows from abroad that must accompany those declines.2

Furthermore, CBO’s analysis indicates that the decline

in the U.S. trade balance with Mexico was caused by eco

nomic factors other than NAFTA: the crash of the peso

at the end of 1994, the associated recession in Mexico,

the rapid growth of the U.S. economy throughout most

of the 1990s, and another Mexican recession in late 2000

and 2001. NAFTA, by contrast, has had an extremely

small effect on the trade balance with Mexico, and that

effect has been positive in most years.

Besides increasing trade, NAFTA has had a substantial

effect on international investment. It has done so for at

least two reasons. First, it eliminated a number of Mexican

restrictions on foreign investment and ownership of

capital. Second, by abolishing tariffs and quotas, NAFTA

made Mexico a more profitable place to invest, particularly

in plants for final assembly of products destined for the

United States. However, it is difficult—if not impossible

—to separate the increases in foreign investment in

Mexico that resulted from NAFTA from the increases

caused by prior liberalization of Mexico’s trade and other

economic policies. Modeling such investment flows and

their effects on the U.S. economy is similarly difficult.

Consequently, this paper does not examine NAFTA’s

effects on investment in any detail but instead concentrates

on the agreement’s effects on trade.

How Has U.S.-Mexican Trade

Changed Over Time?

For Mexico, the North American Free Trade Agreement

was only part of a much larger program of economic

liberalization extending back to the mid1980s. That

program included joining the General Agreement on

Tariffs and Trade in 1986; lowering the average tariff rate

from 27 percent in 1982 to 12 percent (or 10 percent as

calculated by some sources) in 1993—a larger drop than

remained to be accomplished by NAFTA’s elimination

of tariffs; reducing import licensing requirements and

restrictions on foreign investment; privatizing and dereg

ulating various state enterprises, including banks; and

implementing an inflationreduction program, which

brought inflation down from a peak of 187.8 percent in

1987 to 6.4 percent at about the time that NAFTA went

into effect.

Since Mexico began its program of economic reform and

trade liberalization, its trade with the United States—both

exports and imports—has grown substantially. That

growth started long before NAFTA and has continued

since then. A year after NAFTA went into effect, the U.S.

trade balance with Mexico dropped suddenly from near

zero to a substantial deficit. It recovered partially over the

2. By an accounting identity derivable directly from the definitions

of the economic terms, net capital inflows must increase by the

same amount that the trade balance declines. More precisely,

changes in the net inflow of foreign investment must be equal in

magnitude and opposite in sign to changes in the currentaccount

balance, which is a broad measure of the trade balance that includes

trade in services and income flows on foreign investments in

addition to trade in goods. See Congressional Budget Office, Causes

and Consequences of the Trade Deficit: An Overview (March 2000).
SUMMARY xi

1970 1974 1978 1982 1986 1990 1994 1998

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

U.S. Imports

from Mexico

U.S. Exports

to Mexico

next few years but then began declining again to record

deficits. That decline has continued ever since.

Changes in Exports and Imports

Over the past two decades, U.S. trade with Mexico has

increased dramatically. In dollar terms, exports of goods

to Mexico rose by almost a factor of six between late 1982

and late 1993 (just before NAFTA), and they nearly

tripled again by the third quarter of 2000 before declining

during the recent recession in the United States and

Mexico. That growth was not smooth: a year after NAFTA

took effect, exports dropped by 21.4 percent in just over

two quarters before they resumed their climb. U.S. im

ports of goods from Mexico almost tripled between late

1982 and late 1993 and then more than tripled again by

the third quarter of 2000, at which point they too fell back

during the recession. Even with exports and imports

expressed as percentages of GDP, growth was substantial

(see Summary Figure 1).

The growth was sufficiently large and rapid that Mexico’s

share of U.S. trade with the world rose considerably. At

the end of 1982, exports destined for Mexico represented

Summary Figure 1.

U.S. Trade in Goods with Mexico

(As a percentage of U.S. GDP)

Source: Congressional Budget Office using data on trade from the Bureau of

the Census and data on gross domestic product from the Bureau of

Economic Analysis.

Note: The dashed vertical line marks the beginning of the North American Free

Trade Agreement on January 1, 1994.

3.7 percent of all U.S. exports of goods. In the last quarter

before NAFTA went into effect, that figure stood at 8.8

percent, and it reached 14.2 percent by the end of 2001.

Similarly, imports from Mexico rose from 4.6 percent of

all U.S. imports of goods at the end of 1986 (the end of

a decline resulting from a crash in crude oil prices) to 7.1

percent just prior to NAFTA and then to 11.8 percent

by the end of 2001. Before NAFTA, Mexico was the third

largest market for U.S. exports and the thirdlargest sup

plier of U.S. imports. By 2001, it was second in both

categories.

Changes in the Trade Balance

The balance of trade in goods with Mexico has declined

substantially since NAFTA went into effect. Its descent

actually started almost two years before NAFTA, but the

balance did not decline much until a year after the agree

ment went into force. It recovered slightly from 1995

through 1998 before resuming its descent.

The United States also experienced a growing deficit in

trade in goods with the world as a whole during that

period and for many years beforehand; Mexico’s share of

that deficit has been smaller than might be expected from

the country’s size as a U.S. trading partner. Indeed, for

almost all of the past 17 years, Mexico’s share of the U.S.

trade deficit with the world has been smaller than its shares

of U.S. exports and imports (the only exception being the

seven quarters from the beginning of 1995 through the

third quarter of 1996). Correspondingly, Mexico’s ranking

on the list of trading partners with which the United States

has the largest deficits has been lower than its rankings

on the lists of top U.S. export markets and import sup

pliers. Nevertheless, the large decline in the trade balance

since NAFTA took effect has led critics to suspect that

the agreement significantly worsened, if not caused, the

trade deficit with Mexico.

Other Factors Besides NAFTA That

Have Affected U.S. Trade with Mexico

Numerous factors other than NAFTA have substantially

influenced U.S.Mexican trade. Four events that occurred

after the agreement went into effect are particularly im

portant:
xii THE EFFECTS OF NAFTA ON U.S.-MEXICAN TRADE AND GDP

1970 1974 1978 1982 1986 1990 1994 1998

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

For U.S. Imports

from Mexico

For U.S. Exports

to Mexico

For U.S. Nonoil

Imports from

Mexico

1970 1974 1978 1982 1986 1990 1994 1998

0

20

40

60

80

100

120

140

0

1

2

Industrial Production Index

(Left scale)

Real GDP

(Right scale)

• A sudden major decline in the value of the peso at

the end of 1994 (which reduced U.S. exports to

Mexico and increased U.S. imports from Mexico),

• An associated harsh Mexican recession in 1995

(which lowered Mexico’s demand for all countries’

exports, including those of the United States),

• The long U.S. economic expansion that lasted

through most of the 1990s (which increased U.S.

demand for imports from all countries), and

• Recessions in the United States and Mexico in late

2000 and 2001 (which reduced Mexican demand

for U.S. and other countries’ exports and U.S. de

mand for imports from all countries).

The prolonged U.S. expansion and the U.S. and Mexican

recessions in late 2000 and 2001 are clearly unrelated to

Summary Figure 2.

Real Exchange Rates for U.S. Trade

in Goods with Mexico

(In dollars per peso)

Source: Congressional Budget Office using data on nominal exchange rates

and Mexican prices from International Monetary Fund, International

Financial Statistics, and data on prices and quantities of U.S. traded

goods from the Bureau of the Census, Bureau of Labor Statistics,

Bureau of Economic Analysis, and Energy Information Administration.

Notes: The effects of Mexican inflation over time were removed using the

Mexican wholesale price index. The effects of U.S. inflation over time

were removed using price indices for U.S. exports to and imports from

Mexico that CBO constructed from the data sources cited above.

The dashed vertical line marks the beginning of the North American

Free Trade Agreement on January 1, 1994.

Summary Figure 3.

Mexican Industrial Production and

Real Gross Domestic Product

(Index, 1993 = 100) (Trillions of 1993 Pesos)

Source: International Monetary Fund, International Financial Statistics.

Note: The dashed vertical line marks the beginning of the North American Free

Trade Agreement on January 1, 1994.

NAFTA, and their effects must be removed from the

observed fluctuations in U.S.Mexican trade to isolate the

effects of NAFTA. The peso crash and ensuing Mexican

recession, however, merit further discussion. Both were

severe. From the last quarter of 1994 to the first quarter

of 1995, the real value of the peso (the value adjusted for

inflation in the United States and Mexico) dropped by

onethird (see Summary Figure 2). In the recession, sea

sonally adjusted real Mexican GDP declined by 9.7 per

cent (see Summary Figure 3). Because of their magnitudes,

both of those events could be expected to have had a sub

stantial influence on trade. Their occurrence just a year

after NAFTA went into effect might lead some people to

suspect that the agreement played a role in causing them

or making them worse. However, that is not the case.

A number of factors converged to cause the financial crisis

that led to the peso crash and Mexican recession of the

mid1990s. They include the market’s nervousness about

the historically high real value of the peso; considerable

political turmoil in 1994 (an armed rebellion in the state

of Chiapas, a presidential election and change of admini

stration, two major political assassinations, and the resig

nation of the Deputy Attorney General claiming a coverup

in the investigation of one of the assassinations); rising

interest rates in the United States; wellintended Mexican
SUMMARY xiii

government policies that ended up exacerbating the crisis;

and the market’s memories of past Mexican government

actions in somewhat similar situations that had hurt

investors.

In response to those factors, net foreign investment in

Mexico plummeted in 1994, causing interest rates to rise

and putting severe downward pressure on the value of the

peso. The Mexican central bank ran out of the foreign

exchange reserves required to keep the peso from falling

and was forced first to devalue it and then to let it float.

Interest rates skyrocketed, the government and private

sector were unable to borrow from abroad, and the coun

try went into a severe recession.

NAFTA had little to do with that course of events. Con

sequently, the effects of the peso crash and Mexican reces

sion must be removed from the observed fluctuations in

U.S.Mexican trade along with the effects of the other

factors listed earlier in order to isolate the effects of

NAFTA.

The Effects of NAFTA on U.S. Trade

with Mexico

To disentangle the effects of NAFTA from those of other

influential factors, CBO constructed a statistical model

of U.S. trade with Mexico. Simulations from the model

indicate that NAFTA has slightly increased U.S. exports

to and imports from Mexico of goods and that the vast

bulk of the growth and fluctuation of exports and imports

has occurred for reasons other than the agreement. On

the basis of those simulations, CBO estimates that roughly

85 percent of the increase in U.S. exports of goods to

Mexico between 1993 and 2001, and 91 percent of the

increase in U.S. imports of goods from Mexico over the

same period, would have taken place even if NAFTA had

not been implemented. In addition, the major fluctuations

in exports and imports would have been similar to what

actually occurred.

By CBO’s estimates, NAFTA increased U.S. exports to

Mexico by 2.2 percent ($1.1 billion) in 1994—an effect

that rose gradually, reaching 11.3 percent ($10.3 billion)

in 2001. Similarly, the agreement boosted imports from

Mexico by amounts that rose from 1.9 percent ($0.9 bil

lion) in 1994 to 7.7 percent ($9.4 billion) in 2001.

Relative to the size of the economy, the increases in exports

never exceeded 0.12 percent of U.S. GDP, and the in

creases in imports never exceeded 0.11 percent of U.S.

GDP. The effects were more significant for the much

smaller Mexican economy, however. The increase in U.S.

exports to Mexico represented 1.9 percent of Mexican

GDP in 2001, and the increase in U.S. imports from

Mexico equaled 1.7 percent of Mexican GDP.

Although NAFTA’s effects on the balance of trade with

Mexico are unimportant economically, they are of consid

erable interest politically. The perception that the agree

ment is responsible for the decline in that balance since

1993 has contributed to negative attitudes toward NAFTA

and toward other proposals for trade liberalization. How

ever, simulations from CBO’s model indicate that NAFTA

has had an extremely small effect on the balance of trade

in goods with Mexico in all of the years since the agree

ment went into force—and a positive effect in most of

those years. The largest effects indicated by the simulations

are increases of $0.9 billion, $1.3 billion, and $0.9 billion

in 1999, 2000, and 2001, respectively—the most recent

three years in the simulation. The effects for all years are

less than 0.02 percent of GDP in magnitude.

The reason for the substantial fall in the trade balance with

Mexico since NAFTA took effect lies primarily in fluctua

tions of the U.S. and Mexican business cycles. The balance

went abruptly into substantial deficit at the end of 1994

and the beginning of 1995 because of the severe Mexican

recession and, to a much lesser extent, the peso crash. The

recession significantly reduced Mexican demand for U.S.

exports, and the peso crash further reduced that demand

slightly and increased U.S. imports from Mexico slightly.

Those factors affected Mexico’s trade with other countries

more than its trade with the United States. Mexican

imports from the rest of the world fell by 17.4 percent

between 1994 and 1995, whereas its imports from the

United States declined by 6.3 percent. Likewise, its exports

to the rest of the world rose by 46.2 percent over the same

period, whereas its exports to the United States increased

by 28.0 percent.
xiv THE EFFECTS OF NAFTA ON U.S.-MEXICAN TRADE AND GDP

1989 1993 1997 2001

-40

-30

-20

-10

0

10

20

Projection from CBO's Model

Under Actual-Values Scenario

Projection from CBO's Model

Under Alternative Scenario

Actual

a

b

In 1996, Mexican demand for U.S. exports began to

recover along with the peso and the Mexican economy.

However, U.S. imports from Mexico (as well as from

other countries) began to rise in response to the economic

expansion in the United States. Consequently, the U.S.

trade balance with Mexico did not recover much, and in

fact, it began to decline further in 1998. In 2001, the U.S.

recession caused imports from Mexico to fall, but a co

inciding Mexican recession caused U.S. exports to Mexico

to fall even more, so the trade balance continued to

decline.

Projections from CBO’s model indicate that if the peso

crash, the associated Mexican recession, the prolonged

U.S. economic boom, and the U.S. and Mexican reces

sions in late 2000 and 2001 had not occurred, U.S. trade

with Mexico would have remained near balance through

out the entire postNAFTA period (see Summary Figure 4).

The Effects of NAFTA on U.S. GDP

Precisely estimating the effects of NAFTA on U.S. GDP

involves assessing how much of the increase in imports

from Mexico that was caused by NAFTA merely displaces

imports from other countries rather than adding to them.

Such an assessment is beyond the scope of this paper.

Other studies have tackled that issue, however, and by

combining their results with CBO’s estimates of the effects

of NAFTA on U.S. trade, it is possible to conclude that

NAFTA has increased annual U.S. GDP, but by a very

small amount—probably no more than a few billion dol

lars, or a few hundredths of a percent.

The effect on Mexican GDP has also been positive and

probably similar to the effect on U.S. GDP in dollar terms

Summary Figure 4.

U.S. Balance of Trade in Goods with

Mexico Under Alternative Scenarios

(In billions of dollars)

Source: Congressional Budget Office using data from the Bureau of the Census

for the actual trade balance and projections from CBO’s model for

other trade balances.

Note: The dashed vertical line marks the beginning of the North American Free

Trade Agreement on January 1, 1994.

a. This alternative scenario assumes no peso crash and associated Mexican

recession in 1994 and 1995, no prolonged U.S. economic expansion in the

1990s, and no U.S. or Mexican recession in late 2000 and 2001.

b. The actual-values scenario assumes the values of U.S. gross domestic product, the Mexican industrial production index, and real exchange rates that

actually occurred.

(at least to the same order of magnitude). However, be

cause the Mexican economy is much smaller than the U.S.

economy (Mexican GDP ranged from one16th to one

21st the size of U.S. GDP between 1996 and 2001), that

increase represents much larger percentage growth for the

Mexican economy than for the U.S. economy.
1

Introduction

When the North American Free Trade Agree

ment (NAFTA) was under consideration for approval by

the U.S. Congress, it engendered considerable debate and

concern. It was the first major freetrade accord between

advanced industrialized countries and a large developing

country, and predictions of its effects ranged from substan

tial benefits for the United States to a “giant sucking

sound” of jobs being moved south of the Rio Grande by

firms attracted by lowwage Mexican labor. The vast

majority of trade economists predicted a small positive

effect on U.S. gross domestic product (GDP) and little

effect on employment.1

NAFTA went into force on January 1, 1994, and it has

now been in operation long enough to determine which

of those predictions was most accurate. An assessment of

NAFTA is relevant to current debates about trade policy

because a number of proposals for similar agreements with

other developing countries are on the policy agenda. Since

NAFTA became effective, agreements have been proposed

—and, in many cases, negotiations have been started or

even completed—for a Free Trade Area of the Americas

and for freetrade areas with Chile, Central America (El

Salvador, Guatemala, Honduras, Nicaragua, and Costa

Rica), Southern Africa (Botswana, Lesotho, Namibia,

South Africa, and Swaziland), Morocco, Singapore, and

various other countries of the Association of Southeast

Asian Nations (likely candidates include the Philippines,

Thailand, Indonesia, and Malaysia).

What Is NAFTA?

NAFTA is an agreement by the United States, Canada,

and Mexico to phase out almost all restrictions on inter

national trade and investment among the three countries

over 15 years—with all but a few of the most sensitive re

strictions being eliminated within the first 10 years.2

NAFTA was preceded five years earlier by the Canada

United States Free Trade Agreement, which meant that

the United States and Canada were already well on the

way to eliminating the barriers to trade and investment

between them when NAFTA went into effect. Therefore,

the main new feature of NAFTA was the removal of most

of the barriers between Mexico and those two countries.

In addition, Mexico was a more important trading partner

for the United States than for Canada (the buyer of

9.0 percent of U.S. exports in 1993 versus 0.4 percent of

Canadian exports, and the source of 6.8 percent of U.S.

imports versus 2.0 percent of Canadian imports). For

those reasons—plus the much larger size of U.S.Mexican

trade than CanadianMexican trade in dollar terms and

the greater interest of U.S.Mexican trade to a U.S. audi

ence—this paper concentrates on the effects of NAFTA

on U.S.Mexican trade and largely ignores the effects on

U.S.Canadian and CanadianMexican trade.

For Mexico, NAFTA was a late part of a much larger

program of economic liberalization that extended back

to the mid1980s. In 1982, after Mexico had increased

tariffs and established other restrictions and controls in

response to a balanceofpayments crisis, its average tariff

1. See Congressional Budget Office, Estimating the Effects of NAFTA:

An Assessment of the Economic Models and Other Empirical Studies

(June 1993), for a detailed survey and assessment of 19 modeling

and other empirical studies of the likely effects of NAFTA.

2. There were also side agreements to NAFTA concerning labor and

environmental issues. This paper does not examine the effects of

those agreements.

CHAPTER
2 THE EFFECTS OF NAFTA ON U.S.-MEXICAN TRADE AND GDP

rate stood at 27 percent, and the country required im

porters to obtain permits for all imports. Mexico then

began a series of major economic reforms. It became a

member of the General Agreement on Tariffs and Trade

(GATT) in 1986. It reduced the portion of imports re

quiring licences to 36 percent in 1985, 27 percent in

1986, and 22 percent by the end of 1988. It lowered the

maximum tariff rate from 100 percent in 1982 to 20 per

cent in 1988 and reduced the average tariff rate to 25 per

cent in 1985, 19 percent in 1987, and 10 percent in

1988.3

 According to one source, the average rate subse

quently edged up to 12 percent by 1993 (another source

indicates that it remained at 10 percent).

In addition to trade liberalization, the administration of

President Carlos Salinas, who held office from 1988

through 1994, implemented substantial domestic eco

nomic reforms.4

 It privatized and deregulated a number

of state enterprises, including banks, and it brought infla

tion down from a peak of 187.8 percent in 1987 to

6.4 percent in 1994.5

 It also liberalized restrictions on

foreign investment in Mexico.

By comparison with that program of economic liberaliza

tion, NAFTA was somewhat small in significance. Look

ing just at import tariffs, one may note that the cumulative

net decline in the average tariff rate from 1982 to 1993

was larger than the average rate remaining to be eliminated

by NAFTA. Indeed, when NAFTA was being debated in

the U.S. Congress, a number of analysts argued that the

primary value of the agreement lay not in its removal of

most of the remaining restrictions on trade and investment

flows but in the fact that it would make much of the

previous Mexican liberalization more difficult for future

governments to reverse.

NAFTA has now been in effect for over eight years, and

most trade and investment barriers have been eliminated.

In 1993, just before the agreement went into effect,

51.2 percent of imports from Mexico (by value) entered

the United States duty free, and the average tariff on the

remaining imports was 4.24 percent, for an overall average

tariff rate of 2.07 percent (see Figure 1). By 2001, the per

centage of imports from Mexico entering duty free had

risen to 86.8 percent, and the average duty on the re

mainder had declined to 1.37 percent, for an overall aver

age tariff rate of just 0.18 percent. On the Mexican side,

the average tariff rate, which was roughly 12 percent in

1993, had declined to only 1.3 percent by 2001.6

 Enough

time has elapsed and enough of NAFTA’s provisions have

been phased in to allow a reasonably confident assessment

of the effects of the agreement on the United States.

How Should the Success or Failure of

a Free-Trade Agreement Be Measured?

The economic goal of trade agreements is to increase gross

domestic product (GDP). Increases in both exports and

imports are generally necessary to achieve that goal and

can (with qualification) be used as rough indicators of the

3. The information on import licensing requirements, maximum tariff

rates, and GATT membership is from J.F. Hornbeck, NAFTA,

Mexican Trade Policy, and U.S.Mexico Trade: A LongerTerm

Perspective, CRS Report for Congress 97811 E (Congressional

Research Service, September 2, 1997), pp. 1011.

4. See Manuel Pastor Jr., “Pesos, Policies, and Predictions: Why the

Crisis, Why the Surprise, and Why the Recovery?” in Carol Wise,

ed., The PostNAFTA Political Economy: Mexico and the Western

Hemisphere (University Park, Penn.: Pennsylvania State University

Press, 1998), p. 123.

5. Those inflation rates are the percentage increases in wholesale prices

from the first quarter of 1987 to the first quarter of 1988 and from

the second quarter of 1993 to the second quarter of 1994, respec

tively.

6. Some sources put the average rate for 1993 at 10 percent. The rate

of 12 percent used here is from Raúl HinojosaOjeda and others,

The U.S. Employment Impacts of North American Integration After

NAFTA: A Partial Equilibrium Approach (Los Angeles: North

American Integration and Development Center, School of Public

Policy and Social Research, University of California at Los Angeles,

January 2000), Figure 4.5. The average rate for 2001 is from Office

of the U.S. Trade Representative, 2001 Trade Policy Agenda and

2000 Annual Report of the President of the United States on the Trade

Agreements Program (March 2001), p. 115. Various issues of the

Annual Report are among the sources placing the rate for 1993 at

10 percent. The 12 percent rate is used here for consistency with

Figure 1, which uses rates from HinojosaOjeda and others for

1982 through 1995 and rates from various issues of the Annual

Report for 1996 through 2001. Other than the rate for 1993, the

Annual Reports do not have rates for years before 1996, and

HinojosaOjeda and others does not have rates for years after 1996.
CHAPTER ONE INTRODUCTION 3

1989 1991 1993 1995 1997 1999 2001

0

10

20

30

40

50

60

70

80

90

100

Share of U.S. Goods Imports from

Mexico Entering Duty Free

1989 1991 1993 1995 1997 1999 2001

0

1

2

3

4

5

Average U.S. Tariff Rate on Dutiable

Goods Imports from Mexico

1989 1991 1993 1995 1997 1999 2001

0

1

2

3

4

Average U.S. Tariff Rate on Total

Goods Imports from Mexico Average Mexican Tariff Rate

1982 1985 1988 1991 1994 1997 2000

0

5

10

15

20

25

30

Figure 1.

Tariff Rates on U.S.-Mexican Trade Before and After NAFTA

(In percent)

Source: Congressional Budget Office using data on U.S. imports and tariff revenues from the Bureau of the Census and data on Mexican tariffs from Office of the U.S.

Trade Representative, Trade Policy Agenda and Annual Report of the President of the United States on the Trade Agreements Program (various years),

for 1994 through 2001, and Raúl Hinojosa-Ojeda and others, The U.S. Employment Impacts of North American Integration After NAFTA: A Partial Equilibrium

Approach (Los Angeles: North American Integration and Development Center, School of Public Policy and Social Research, University of California at Los Angeles,

January 2000), for 1982 through 1993.

Note: Average U.S. tariff rates were calculated as the ratio of “calculated duties” to the customs value of imports for consumption.
4 THE EFFECTS OF NAFTA ON U.S.-MEXICAN TRADE AND GDP

Box 1.

NAFTA and Foreign Investment

The North American Free Trade Agreement and the

Mexican economic liberalization that preceded it have

affected the United States through international invest

ment as well as through international trade. They elimi

nated a number of laws and regulations that directly

restricted foreign ownership and investment in Mexico.

In addition, by removing tariffs, import quotas, and

other trade restrictions and generally deregulating busi

ness operations, they made investment in Mexico more

profitable. As a result, international investment in Mex

ico has grown.

That growth has affected the United States in three

ways. First, much of the new investment came from the

United States. It went to Mexico because of higher rates

of return, so the U.S. owners of the capital in question

benefited. Second, some of the investment from the

United States (and even some from other countries)

probably would otherwise have been invested in the

United States. The fact that it went to Mexico instead

has reduced the aggregate capital stock in the United

States and thereby raised U.S. interest rates and rates

of return and reduced U.S. gross domestic product. This

second effect is almost certainly so small as to be un

noticeable, however, because the investment flows from

the United States were small compared with the size of

the U.S. capital market and because any rise in U.S.

interest rates resulting from an outflow to Mexico would

attract an inflow from other countries to replace much

of the outflow. Third, a significant part of the invest

ment undoubtedly went to construct assembly plants

in Mexico for products destined for the U.S. market.

That part led to increased U.S. exports to Mexico of

intermediate goods for those plants and increased U.S.

imports from Mexico of their finished products.

To assess with any precision the effects of NAFTA on

the United States through the first two of those effects

of investment flows would require determining what

proportion of the increased flows resulted from NAFTA

rather than from the preceding Mexican trade and other

economic liberalization. It would also require construct

ing some sort of model (or models) of the U.S. capital

market and the effects of capital flows on the U.S.

economy. The first of those tasks would be extremely

difficult, if not impossible, and the second would be

a substantial undertaking at the very least. This paper

has not attempted those tasks but instead concentrates

on the more manageable task of assessing the effects that

NAFTA has had on the United States through inter

national trade flows. In so doing, it implicitly captures

the third effect of NAFTA through international invest

ment flows—the stimulation of U.S. trade with Mexico.

The analysis also looks briefly at the magnitude and

direction of international investment flows to and from

Mexico over time in connection with the peso crash and

associated Mexican recession in late 1994 and 1995,

which had a substantial impact on trade.

extent to which it has in fact been achieved. Effects on the

balance of trade with other parties to an agreement are

not a good indicator of benefit or harm. Trade agreements

can affect GDP and other aspects of the economy through

foreign investment flows as well as through trade flows

(see Box 1 for more details). However, this paper concen

trates primarily on NAFTA’s effects on trade flows.

Changes in Exports and Imports

The mostdirect economic benefits from international

trade arise from the fact that countries are not all equally

adept at producing the same products. The reasons they

are not lie in differences in natural resources, in education

levels of their workforces, in relative amounts and qualities

of physical capital, in confidential technical knowledge,

and so on. Without trade, each country must make every

thing it needs, including things it is not very efficient at

producing. When trade is allowed, each country can con

centrate its efforts on what it does best relative to other

countries and export some of the output in exchange for

imports of products it is less good at producing. As coun

tries do that, total world output increases. World output

may also grow because of increasing use of economies of

scale, as a factory in one country can serve a market the
CHAPTER ONE INTRODUCTION 5

Box 2.

The Effects of Trade Creation and Trade Diversion

The distinction between trade creation and trade

diversion is important because the former is more likely

to produce a net economic benefit in the aggregate than

the latter is. Although some sectors may be hurt by trade

creation, it is almost always economically beneficial

overall because it occurs only when the price of the im

port in question is lower than the domestic cost of pro

ducing the same good. It therefore allows the domestic

economy to obtain the good at lower cost than would

be possible without trade.

Trade diversion is less likely to be beneficial in the ag

gregate (although some sectors are still likely to be

helped by it) because it results in the import’s being ob

tained at a higher cost to the economy. Using NAFTA

as an illustration, the fact that the import came from

elsewhere before NAFTA went into effect, when tariffs

on imports from Mexico were equal to those on im

ports from other countries, indicates that the competing

country was selling the product for a lower price than

Mexico was. After NAFTA, the competing country’s

price would still be lower, but the domestic purchaser

would choose the Mexican product because (in the case

of trade diversion) the Mexican price would be lower

than the competing country’s price plus the tariff.

Although the cost to the domestic purchaser of the

competingcountry import would be the price plus the

tariff, the cost to the economy would be the price only.

The tariff would be paid by the purchaser to the U.S.

government and therefore would not be a loss to the

economy.

Some exceptional cases exist in which trade creation can

be harmful or trade diversion beneficial, but for the

reasons described above, the reverse is much more often

true.

size of two or more countries rather than one. In either

case, market forces ensure that all countries involved in

the trade share in the benefits from the increased output.

It is the growth in both exports and imports of each coun

try that allows the shift in production that increases world

output. No country would export if it could not import.

Exports constitute the giving away of valuable economic

commodities in exchange for pieces of paper (or additions

to bank accounts) that would be worthless if they could

not be used to purchase imports. In the case of NAFTA,

U.S. exports to Mexico are sold for pesos, which have

value only insofar as they can be used to purchase imports

(now or in the future) from Mexico.

Although increases in exports and imports are necessary

for, and usually indicative of, benefits from a freetrade

agreement, they are not a perfect measure because they

are not always beneficial. Growth in exports is beneficial

in almost all circumstances, but whether growth in im

ports is beneficial depends in part on whether the imports

displace domestic production or imports from other coun

tries not party to the agreement. The displacement of do

mestic production is referred to by economists as trade

creation because it results in a net increase in trade. The

displacement of imports from other countries is referred

to as trade diversion because it does not increase trade

overall but rather amounts to a diversion of existing trade.

Perhaps counterintuitively, trade creation almost always

produces a net economic benefit (although it can create

temporary painful dislocations to some domestic workers

and firms), whereas the net effect of trade diversion is

likely to be detrimental. (For more details, see Box 2.) Con

sequently, the amount and significance of trade diversion

must be considered before one can make confident infer

ences about the benefits of a freetrade agreement from

the increases in trade that result from it. Of course, if the

changes in trade are small, one can conclude confidently

that the net benefit or harm is small regardless of the ex

tent of trade diversion.

Changes in the Trade Balance

Some people gauge the success of a trade agreement by

its effects on the trade balance—the difference between

the value of exports and the value of imports—with the

other party (or parties) to the agreement. However, such
6 THE EFFECTS OF NAFTA ON U.S.-MEXICAN TRADE AND GDP

effects are not a good indicator of the benefit or harm of

an agreement for two reasons.

First, to the extent that trade balances merit any concern,

it is a country’s balance with the world as a whole—not

its balance with any one country—that matters, and the

effects of a trade agreement on the latter do not translate

into effects on the former (see Box 3). By a fundamental

accounting identity, a country’s trade balance with the

world as a whole (specifically, its currentaccount balance)

is equal to the difference between aggregate saving and

gross domestic investment. Neither aggregate saving nor

gross domestic investment in a country as large as the

United States is significantly affected by the elimination

of barriers to trade with another country the size of Mex

ico. Therefore, a trade agreement such as NAFTA cannot

significantly affect the U.S. trade balance with the world.

Second, even if the balance with the world were signifi

cantly affected by a trade agreement, one still could not

validly conclude much about the benefit or harm of the

agreement because the value of that balance is normally

of little significance. Trade deficits with the world are not

generally harmful, and trade surpluses are not generally

beneficial. CBO has examined the U.S. trade deficit with

the world in more detail in a previous publication.7

 Here

it is sufficient to note a few conclusions of that analysis.

Although in some extreme cases not currently applicable

to the United States a country can be harmed by deficits

with the world as a whole, in general such deficits are not

harmful. They normally have a small positive effect on

GDP because of the inflow of foreign investment that

must accompany them (by the aforementioned accounting

identity), which increases the aggregate capital stock. Their

effect on gross national product (GNP, which is GDP

minus the net interest, dividends, and other returns on

capital that must be paid to the owners of the foreign

investment) is even smaller and may be either positive or

negative depending on the circumstances. Even if GNP

declines with a given trade deficit, that does not necessarily

mean that the country’s citizens are worse off. Effectively

what is happening in that case is that people are choosing

current consumption over future consumption, and no

objective criterion exists by which to judge them right or

wrong in that choice.

Trade deficits also have little if any effect on aggregate

employment, and the same is true of trade agreements

such as NAFTA. In the short term, jobs lost in industries

producing tradable goods are offset to a greater or lesser

extent by jobs gained in construction and investment

goods industries because of the inflow of foreign invest

ment that must accompany the trade deficit. Whatever

the net effect, wages adjust over time until demand for

labor again equals supply so that there is no effect on the

aggregate level of employment in the long run (although

some redistribution of employment among industries may

occur).

Notwithstanding the foregoing analysis, many people sus

pect that NAFTA caused or significantly worsened the

substantial decline in the U.S. trade balance with Mexico

that has occurred since the agreement went into effect,

and that suspicion has led to criticism of NAFTA and cast

a negative light on proposals for future trade talks and

agreements. Accordingly, it is worth examining NAFTA’s

effects on the trade balance along with its effects on ex

ports, imports, and GDP to determine whether that suspi

cion is correct. (The agreement’s effects on trade in various

individual products can also be of interest for some pur

poses but are beyond the scope of this analysis.)

How Has U.S.-Mexican Trade

Changed Over Time?

As one would expect from NAFTA and the Mexican

program of economic reform and trade liberalization that

preceded it, U.S. trade with Mexico has grown substan

tially over the past two decades—in absolute dollar terms,

as a percentage of U.S. GDP, and relative to U.S. trade

with other countries. The growth began long before

NAFTA and has continued in the years since the agree

ment. Mexico is now the United States’ second largest ex

port market and second largest supplier of imports.

Almost two years before NAFTA, the U.S. trade balance

with Mexico peaked at a small surplus and began to

decline. A year after NAFTA, it suddenly plunged into 7. Congressional Budget Office, Causes and Consequences of the Trade

Deficit: An Overview (March 2000).
CHAPTER ONE INTRODUCTION 7

Box 3.

Trade Balances with Individual Countries Versus the Balance

with the Entire World

To the extent that any reason for concern about trade

balances exists, that concern relates to the balance with

the world as a whole, not the balance with any particular

country. The experience of an individual person pro

vides a useful analogy. The typical person buys large

quantities of goods over time from the local supermarket

but rarely if ever sells goods to the supermarket, which

means that he (or she) runs a deficit with the super

market. Similarly, he runs deficits with department

stores, his doctors, and any other providers of goods and

services that he purchases. He sells his own labor or

services to his employer but rarely if ever buys anything

in return (aside from payroll deductions for benefits)

and therefore runs a surplus with his employer.

No one would suggest that a person should not run

those individual deficits. The economic harm that

would ensue from such a constraint is evident. Further,

the size of any of the individual deficits is of no impor

tance. What matters is the overall trade balance—the

surplus with the employer minus the sum of all of the

individual deficits. If that overall balance is in deficit,

then the person must borrow or draw down his savings.

If he does neither, then any increase in one of the indi

vidual deficits must be offset by a reduction in one or

more of the others or by an increase in the surplus with

his employer. If a new store opens nearby, creating a

new opportunity for trade, the person may incur a new

deficit with that store. If he has any sense, however, he

will not make his decisions about his overall budget

balance contingent on the opening of a new store.

Rather, he will offset the deficit with the new store by

reducing his deficits with other stores.

Similarly, in the absence of barriers to international

trade, the United States (or any other country) will run

deficits with some countries and surpluses with others.

It will do that for the same reason that people run defi

cits with some entities and surpluses with others in their

daily lives: because different countries produce different

products and have different products that they need to

purchase. If the United States needs more of the par

ticular products that a country produces than that

country needs of the particular products that the United

States produces, the United States will run a trade deficit

with that country. If the opposite is true, it will run a

trade surplus. To insist that trade with each individual

country be in balance makes no more sense than to insist

that people not run individual deficits and surpluses

with their favorite stores or their employers.

For the same reason, the size of the trade deficit with

any one country is unimportant; what matters is the

overall trade balance with the world. By a fundamental

accounting identity, that overall trade balance (actually

a specific measure of the trade balance called the

currentaccount balance) must equal the difference

between aggregate saving and gross domestic invest

ment. Hence, just as an individual running an overall

deficit must be “dissaving,” a country running a current

account deficit must be saving less than is required to

finance the capital investment occurring within the

country, so part of that investment must be financed

by inflows of capital from abroad.

Just as a person will not allow the opening of a new store

to put his budget out of balance so that he dissaves, the

aggregate saving and gross domestic investment of a

country are not significantly affected when barriers to

trade with other individual countries are eliminated,

creating new opportunities for trade. Therefore, if

NAFTA were to cause the United States to incur a trade

deficit with Mexico, there would be offsetting increases

in U.S. trade balances with other countries. The result

would be little—if any—net effect on the U.S. trade

deficit with the world.
8 THE EFFECTS OF NAFTA ON U.S.-MEXICAN TRADE AND GDP

1970 1974 1978 1982 1986 1990 1994 1998

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

U.S. Imports

from Mexico

U.S. Exports

to Mexico

1970 1974 1978 1982 1986 1990 1994 1998

0

20

40

60

80

100

120

140

160

U.S. Imports

from Mexico U.S. Exports

to Mexico

In Billions of Dollars

As a Percentage of U.S. GDP

a large deficit. After recovering only partially over the next

few years, the balance began falling again—this time to

record deficits. The decline continued through the end

of 2001.

Changes in Exports and Imports

U.S. goods trade with Mexico—both exports and imports

—has increased significantly over the past two decades

(see Figure 2). Over the 11year period from the end of

1982 (just after a Mexican balanceofpayments crisis) to

the end of 1993 (just before NAFTA), the dollar value

of quarterly U.S. goods exports to Mexico rose by nearly

Figure 2.

U.S. Goods Trade with Mexico

Source: Congressional Budget Office using data on trade from the Bureau of

the Census and data on gross domestic product from the Bureau of

Economic Analysis.

Note: The dashed vertical lines mark the beginning of the North American Free

Trade Agreement on January 1, 1994.

a factor of six. It almost tripled again by the third quarter

of 2000 before slipping back during the recent recession

in the United States and Mexico. Imports of goods fol

lowed a similar pattern, almost tripling over the same pre

NAFTA period and then more than tripling again before

falling back in the recession.

Expressed as a percentage of GDP—which eliminates the

illusory effects of inflation and of increases that merely

reflect economic growth—exports nearly tripled over the

11 years leading up to NAFTA and almost doubled again

by the third quarter of 2000, at which point they declined

during the recession (see Figure 2). Imports increased by

onethird over the 11 years preceding NAFTA and then

more than doubled before falling back in the recession.

The rise in U.S. trade with Mexico was not smooth. One

year after NAFTA went into effect, exports to Mexico de

clined substantially before resuming their climb. At the

same time, the growth of imports from Mexico accelerated

slightly (at least relative to the growth of imports from

the world as a whole) and then returned to near its original

rate.

U.S. trade with Mexico has grown faster than U.S. trade

with the world as a whole. Of quarterly U.S. goods exports

to the world, the share destined for Mexico rose from

3.7 percent at the end of 1982 to 8.8 percent in the last

quarter before NAFTA and then to 14.2 percent at the

end of 2001 (see Figure 3). Likewise, the share of quarterly

U.S. goods imports coming from Mexico grew from

4.6 percent at the end of 1986 (the end of a decline re

sulting from a crash in crude oil prices) to 7.1 percent just

before NAFTA and then to 11.8 percent by the end of

2001.

Cumulatively, over the 15 years ending with 2001, Mex

ico’s share of U.S. quarterly goods exports rose by a sub

stantial 9.1 percentage points while its share of U.S. goods

imports rose by a smaller but still substantial 7.3 percent

age points. Of those increases, 5.4 percentage points and

4.7 percentage points, respectively, occurred over the eight

years since NAFTA went into effect.

The increase in Mexico’s share of U.S. goods trade caused

Mexico to rise in the rankings of the United States’ main
CHAPTER ONE INTRODUCTION 9

1970 1974 1978 1982 1986 1990 1994 1998

0

2

4

6

8

10

12

14

16

Exports

Imports

1970 1974 1978 1982 1986 1990 1994 1998

-40

-30

-20

-10

0

10

20

In Billions of Dollars

As a Percentage of U.S. GDP

1970 1974 1978 1982 1986 1990 1994 1998

-0.4

-0.3

-0.2

-0.1

0

0.1

0.2

0.3

0.4

trading partners. Before NAFTA, Mexico was the third

largest market for U.S. exports and gaining rapidly on

first and secondplace Canada and Japan. Mexico passed

Japan to become the second largest market in 1997. The

situation with goods imports was similar, but Mexico

started out farther behind and therefore took longer to

catch up. In 1989, it was the third largest supplier of U.S.

imports, behind firstplace Japan and secondplace Can

ada. In 1992, a year before NAFTA, Canada and Japan

switched positions but Mexico remained in third place.

Mexico finally passed Japan in 2001 to rank second as a

source of U.S. imports.

Changes in the Trade Balance

Even though the share of U.S. goods exports destined for

Mexico has increased more than has the share of U.S.

goods imports coming from Mexico, the balance of goods

trade with Mexico has fallen substantially since NAFTA

went into effect (see Figure 4). It actually peaked almost

two years before NAFTA but did not decline much until

a year after the agreement, when it dropped suddenly from

a deficit of $2.5 billion (0.03 percent of U.S. GDP) in

the fourth quarter of 1994 to $17.5 billion (0.24 percent

of GDP) in the second quarter of 1995—an alltime

record in dollar terms and close to a record as a percentage

Figure 3.

Mexico’s Share of U.S. Goods Trade

with the World

(In percent)

Source: Congressional Budget Office using data from the Bureau of the Census.

Note: The dashed vertical line marks the beginning of the North American Free

Trade Agreement on January 1, 1994.

Figure 4.

U.S. Goods Trade Balance with Mexico

Source: Congressional Budget Office using data on trade from the Bureau of

the Census and data on gross domestic product from the Bureau of

Economic Analysis.

Note: The dashed vertical lines mark the beginning of the North American Free

Trade Agreement on January 1, 1994.

of GDP.8 The balance recovered slightly through the last

quarter of 1998 and then resumed its descent, soon reach

ing record deficits even as a percentage of GDP. By the

end of 2001, the U.S. goods trade deficit with Mexico

stood at $31.5 billion (0.30 percent of GDP).

The United States’ goods trade with the world as a whole

also exhibited a growing deficit over that period. The bal

ance of that trade has been in deficit and fluctuating about

a declining trend since the first quarter of 1976. In the

last quarter before NAFTA, the deficit was $117.8 billion

(1.73 percent of GDP), and it reached $454.5 billion

8. The dollar figures given here are seasonally adjusted annual rates.
10 THE EFFECTS OF NAFTA ON U.S.-MEXICAN TRADE AND GDP

1970 1974 1978 1982 1986 1990 1994 1998

-5

-4

-3

-2

-1

0

1

Trade Balance with Mexico

Trade Balance

with the World

1985 1989 1993 1997 2001

-10

-5

0

5

10

15

Imports Trade Balance

Exports

Figure 5.

U.S. Goods Trade Balance with

Mexico and with the World

(As a percentage of U.S. GDP)

Source: Congressional Budget Office using data on trade from the Bureau of

the Census and data on gross domestic product from the Bureau of

Economic Analysis.

Note: The dashed vertical line marks the beginning of the North American Free

Trade Agreement on January 1, 1994.

(4.53 percent of GDP) by the end of 2000 before sub

siding slightly in the recession (see Figure 5). Cumulatively,

the goods trade balance with Mexico underwent a post

NAFTA decline of $31.2 billion through the last quarter

of 2001, while the fall in the balance with the world over

the same period was $284.3 billion.

The U.S. trade deficit with Mexico is smaller than might

be expected given Mexico’s significance in U.S. trade. The

country’s share in the U.S. goods trade deficit with the

world has been smaller than its shares in U.S. exports and

imports for almost all of the past 17 years, the only excep

tion being the comparatively short period from the begin

ning of 1995 through the third quarter of 1996 (see Fig

ure 6). Correspondingly, Mexico’s ranking on the list of

trading partners with which the United States has the

largest deficits has been lower than its rankings on the lists

of top export markets and import suppliers.

Figure 6.

U.S. Goods Trade with Mexico

as a Share of U.S. Goods Trade

with the World

(In percent)

Source: Congressional Budget Office using data from the Bureau of the Census.

Note: The dashed vertical line marks the beginning of the North American Free

Trade Agreement on January 1, 1994.
2

Other Influences on U.S.-Mexican

Trade Besides NAFTA

The onset of the substantial decline in the U.S. bal

ance of trade with Mexico not long after the North Ameri

can Free Trade Agreement went into effect has led some

people to conclude that the latter caused the former. How

ever, numerous other factors besides NAFTA have influ

enced U.S.Mexican trade over time and could explain

some or even most of the changes described in Chapter 1.

Those factors include the U.S. and Mexican business

cycles, saving and investment behavior in the United

States, fluctuations in crude oil imports and prices, Mex

ico’s status as a developing country, its trade and other

economic policies, and fluctuations in the dollar/peso ex

change rate. Of particular importance since NAFTA began

are a sudden major decline in the value of the peso at the

end of 1994, a severe Mexican recession in 1995, the U.S.

economic expansion that lasted throughout most of the

1990s, and recessions in the United States and Mexico

in late 2000 and 2001. Those factors are largely indepen

dent of NAFTA, and their effects must be removed from

the observed fluctuations in trade before valid conclusions

can be drawn about the effects of the agreement.

Domestic U.S. Factors

As discussed in Chapter 1, the U.S. goods trade balance

with the world has been negative and fluctuating about

a declining trend for more than 25 years. The current

account balance with the world, a broader measure of the

balance of trade, has been negative in all except three quar

ters (two quarters for seasonally adjusted data) since the

third quarter of 1982 and similarly fluctuating about a

declining trend.

The major factors influencing those balances are domestic.

They include a long decline in saving as a share of gross

domestic product that began in the mid1950s and ac

celerated in the 1980s, fluctuations in the business cycle,

and relatively attractive investment opportunities in the

United States in the 1990s.1

 Imports and trade deficits

tend to increase during economic expansions and decrease

(or grow more slowly) during recessions. Because of an

accounting identity that equates the currentaccount bal

ance with the difference between gross saving and gross

domestic investment, declines in saving and increases in

investment cause the trade balance to decline. Personal

saving (a component of gross saving) began falling as a

percentage of GDP in the early 1980s and continued to

do so through 2000, with only a small deviation from the

downward trend in the late 1980s and early 1990s. Real

gross private domestic investment trended upward slowly

starting in the 1950s by one measure and was especially

strong in the 1990s.

Those factors have influenced the component of the bal

ances with the world represented by the goods trade bal

ance with Mexico. Like the two balances with the world,

the balance with Mexico has fluctuated about a downward

trend for two decades. Also like the two balances with the

world, it declined in the early 1980s with the onset of a

U.S. economic expansion (although more abruptly and

briefly), rose back to a peak with the recession of the early

1990s, and fell substantially over the rest of the decade

1. For more details, see Congressional Budget Office, Causes and Con

sequences of the Trade Deficit: An Overview (March 2000).

CHAPTER
12 THE EFFECTS OF NAFTA ON U.S.-MEXICAN TRADE AND GDP

1973 1977 1981 1985 1989 1993 1997 2001

0

10

20

30

40

50

as a result of the prolonged U.S. economic expansion of

the period (see Figure 4 in Chapter 1). In 2001, the balance

with Mexico and the balances with the world parted ways,

with the U.S. recession causing the deficit with the world

to decline while the deficit with Mexico continued to in

crease. The timing of those factors is not correct for ex

plaining the sudden large drop in exports and in the trade

balance that occurred in the first quarter of 1995, but the

factors could have contributed substantially to the con

tinuing decline in the balance in subsequent years.

Mexican Economic Development

Mexico has grown rapidly since it began liberalizing its

economy the mid1980s. That growth has required high

levels of investment, which have not been completely

matched by increased saving. (The difference has been

made up by a net increase in inflows of foreign invest

ment.) As a result, Mexico’s saving/investment balance

has been lower than it would otherwise have been, and

in accordance with the aforementioned accounting iden

tity, its balance of trade with the world has been lower

(meaning that other countries have had higher balances

with Mexico).2

 That fact might explain, at least in part,

why Mexico’s share of the U.S. goods trade deficit with

the world has fairly consistently been smaller than would

be expected from its share of U.S. trade for the past 17

years.

Imports of Crude Oil from Mexico

Fluctuations in the value of crude oil imports once domi

nated movements in U.S. imports from Mexico, but they

have not done so since NAFTA went into effect. Largely

because of fluctuations in the amount of oil supplied by

the Middle East, the value of U.S. crude oil imports from

Mexico rose from near zero in the early 1970s to 46.9 per

cent of U.S. imports from Mexico in the second quarter

of 1980 and then declined rather rapidly in the mid

1980s, reaching 13.7 percent of U.S. imports in the third

quarter of 1986 (see Figure 7). Since NAFTA went into

effect, however, crude oil’s share of U.S. imports from

Mexico has never risen much above 10 percent.

Figure 7.

Crude Oil as a Share of U.S. Goods

Imports from Mexico

(In percent)

Source: Congressional Budget Office using data on trade from the Bureau of

the Census and the Energy Information Administration and data on

crude oil prices from the Bureau of Labor Statistics.

Note: The dashed vertical line marks the beginning of the North American Free

Trade Agreement on January 1, 1994.

The Exchange Rate Between

the Dollar and the Peso

The dollar/peso exchange rate has varied substantially over

time—with sudden large declines in the peso in 1982 and

at the end of 1994 being particularly notable (see Fig

ure 8).

3

 By changing the relative prices of U.S. and Mexi

2. That course of events is consistent with a standard model of eco

nomic development in the economics literature. According to that

model, when countries are in early stages of development and grow

ing rapidly, their investment is higher than their saving and they

consequently run trade deficits. Once they become fully developed,

their investment declines relative to GDP and is surpassed by sav

ing, so they begin running trade surpluses. The model accurately

describes the history of the United States through the 1970s, but

it does not always hold true. For the past couple of decades, the

United States has run deficits for the reasons given in the section

on domestic U.S. factors, and Japan in the 1960s ran surpluses

despite its rapid growth rate because it had very high rates of saving.

The case of Japan prompted articles in the economics literature

probing why the Japanese saving rate was so high.

3. The real exchange rate in Figure 8 is expressed as dollars per peso

rather than the pesos per dollar that is more common in the eco

nomics literature because the discussion in the text focuses on the

value of the peso. Movements in the value of the peso are opposite

in direction to movements in the exchange rate expressed in the
CHAPTER TWO OTHER INFLUENCES ON U.S.-MEXICAN TRADE BESIDES NAFTA 13

1970 1974 1978 1982 1986 1990 1994 1998

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

For U.S. Imports

from Mexico

For U.S. Exports

to Mexico

For U.S. Nonoil

Imports from

Mexico

1970 1974 1978 1982 1986 1990 1994 1998

0

20

40

60

80

100

120

140

0

1

2

Industrial Production Index

(Left scale)

Real GDP

(Right scale)

Figure 8.

Real Exchange Rates for U.S. Goods

Trade with Mexico

(In dollars per peso)

Source: Congressional Budget Office using data on nominal exchange rates

and Mexican prices from International Monetary Fund, International

Financial Statistics, and data on prices and quantities of U.S. traded

goods from the Bureau of the Census, Bureau of Labor Statistics,

Bureau of Economic Analysis, and Energy Information Administration.

Notes: The effects of Mexican inflation over time were removed using the

Mexican wholesale price index. The effects of U.S. inflation over time

were removed using price indices for U.S. exports to and imports from

Mexico that CBO constructed from the data sources cited above.

The dashed vertical line marks the beginning of the North American

Free Trade Agreement on January 1, 1994.

can goods, such fluctuations can have large effects on

trade.

Exchange rates can vary for a number of reasons. Not all

of those reasons are independent of the other factors dis

cussed in this chapter, but some of them are. In particular,

rather than let the nominal value of the peso be deter

mined by market forces, the Mexican central bank his

torically (until the end of 1994) intervened in currency

markets to keep the peso at various target levels relative

to the dollar over time. The declines in 1982 and the end

of 1994 occurred when, in the face of downward market

pressure on the peso, the Mexican central bank ran short

of the dollar reserves required to prop it up. On the latter

occasion, the real value of the peso (the value adjusted for

inflation in the United States and Mexico) dropped by

onethird from the last quarter of 1994 to the first quarter

of 1995—coincident with the sharp drop in U.S. exports

to Mexico, the acceleration of import growth, and the

sudden decline in the trade balance that took place a year

after NAFTA went into effect. The fall in the value of the

peso made Mexican goods less expensive relative to U.S.

goods and therefore could partly explain those changes

in trade.

The Mexican Business Cycle

Mexico has experienced substantial fluctuations in aggre

gate economic activity over time, with severe recessions

in 19821983 and 1995 and another recession in 2001

being especially significant (see Figure 9). Just as the U.S.

trade balance with the world is negatively correlated with

the U.S. business cycle, the Mexican trade balance with

the world is negatively correlated with the Mexican busi

ness cycle. As a result, U.S. exports to Mexico tend to in

crease whenever Mexico undergoes an economic expan

sion, and the U.S. trade balance with Mexico rises accord

ingly. Similarly, U.S. exports and the trade balance tend

to decline whenever Mexico goes into a recession.

Figure 9.

Mexican Industrial Production and

Real Gross Domestic Product

(Index, 1993 = 100) (Trillions of 1993 Pesos)

Source: International Monetary Fund, International Financial Statistics.

Note: The dashed vertical line marks the beginning of the North American Free

Trade Agreement on January 1, 1994.

morecommon pesos per dollar. Consequently, the crash of the

peso at the end of 1994 would appear as an upward spike if the

exchange rate were expressed that way, which might confuse some

readers.
14 THE EFFECTS OF NAFTA ON U.S.-MEXICAN TRADE AND GDP

1984 1988 1992 1996 2000

-40

-30

-20

-10

0

10

20

30

40

50

The 1995 recession was marked by a 9.7 percent drop in

seasonally adjusted real GDP, which coincided precisely

with the sudden substantial decline in the U.S. trade bal

ance with Mexico that occurred a year after NAFTA went

into effect. The recession in 2001 coincided with the

continuing decline of the U.S. trade balance with Mexico

even as the U.S. balance with the world recovered some

what because of the U.S. recession.

The peso crash and Mexican recession in late 1994 and

1995 were not independent events. They both resulted

from a severe financial crisis in Mexico that has been dis

cussed at length in the economics literature.4

 Its occur

rence just a year after NAFTA went into force might lead

some people to suspect that NAFTA played a role in caus

ing those events or making them worse, but in fact it did

not.

Over the years leading up to NAFTA, the real value of

the peso relative to the dollar rose substantially. By 1994,

it was at record levels, and some analysts thought the peso

was overvalued. In that year, investors in Mexico were

rattled by considerable political turmoil—including an

armed rebellion in the state of Chiapas, a presidential

election in Mexico, the assassination of the presidential

candidate of the dominant Institutional Revolutionary

Party (PRI), the assassination of the Secretary General of

the PRI, and the resignation of the Secretary General’s

brother as Deputy Attorney General claiming a coverup

in the investigation of the latter assassination. The result

was a substantial decline in (and even a net outflow of)

foreign investment in Mexico, which had previously been

high because of the investment opportunities afforded by

the forthcoming trade agreement and by Mexico’s general

economic liberalization (see Figure 10).

Figure 10.

Net Foreign Investment in Mexico

(In billions of dollars)

Source: International Monetary Fund, International Financial Statistics.

Notes: Data not seasonally adjusted.

The dashed vertical line marks the beginning of the North American Free

Trade Agreement on January 1, 1994.

The investment decline was exacerbated by other factors.

Rising U.S. interest rates made the United States more

attractive to investors relative to Mexico. Investors may

also have feared a repetition of the devaluation that had

occurred at the end of the previous presidential adminis

tration, when some thought the peso was overvalued, or

of the peso/dollar conversion problems that had occurred

during the peso crisis in 1982. It is clear in hindsight that

4. See, for example, the following, on which the discussion of this

section is based: Manuel Pastor Jr., “Pesos, Policies, and Predictions:

Why the Crisis, Why the Surprise, and Why the Recovery?” in

Carol Wise, ed., The PostNAFTA Political Economy: Mexico and

the Western Hemisphere (University Park, Penn.: Pennsylvania State

University Press, 1998), pp. 119147; William C. Gruben, “Policy

Priorities and the Mexican Exchange Rate Crisis,” Economic Review,

Federal Reserve Bank of Dallas (First Quarter 1996), pp. 1929;

Christopher J. Neely, “The Giant Sucking Sound: Did NAFTA

Devour the Mexican Peso?” Review, Federal Reserve Bank of St.

Louis (July/August 1996), pp. 33 47; “Origins and Evolution of

the Current Crisis,” in Organization for Economic Cooperation

and Development, OECD Economic Surveys: Mexico, 1995 (Paris:

OECD, 1995), pp. 340; “Evolution of the Mexican Peso Crisis”

and “Mexican Foreign Exchange Market Crises from the Perspec

tive of the Speculative Attack Literature,” in International Monetary

Fund, International Capital Markets: Developments, Prospects, and

Policy Issues (August 1995), pp. 5379; Francisco GilDiaz and

Agustin Carstens, “One Year of Solitude: Some Pilgrim Tales

About Mexico’s 19941995 Crisis,” American Economic Review:

Papers and Proceedings, vol. 86, no. 2 (May 1996), pp. 164169;

Guillermo A. Calvo and Enrique G. Mendoza, “Petty Crime and

Cruel Punishment: Lessons from the Mexican Debacle,” American

Economic Review: Papers and Proceedings, vol. 86, no. 2 (May 1996),

pp. 170175; Sebastian Edwards, “ExchangeRate Anchors, Cred

ibility, and Inertia: A Tale of Two Crises, Chile and Mexico,”

American Economic Review: Papers and Proceedings, vol. 86, no.

2 (May 1996), pp. 176180; and Anne O. Krueger, “NAFTA’s

Effects: A Preliminary Assessment,” The World Economy, vol. 23,

no. 6 (June 2000), pp. 761775.
CHAPTER TWO OTHER INFLUENCES ON U.S.-MEXICAN TRADE BESIDES NAFTA 15

the resulting crisis was made worse by various well

intended policies of the Mexican government, such as con

tinuing its longstanding policy of maintaining a target

exchange rate after international capital markets had

grown to the point that swings in international investment

flows could dwarf the resources of central banks for deal

ing with currency fluctuations; offsetting the effects on

the money supply of the Banco de Mexico’s intervention

in the foreign exchange market in 1994 to maintain the

peso’s value (what economists refer to as sterilization of

the intervention); and converting much of the govern

ment’s debt to shortterm dollarindexed securities during

that year.5

The decline in investment caused interest rates in Mexico

to rise and put severe downward pressure on the value of

the peso. Ultimately, Mexico’s central bank ran out of the

foreign exchange reserves required to keep the peso from

falling and was forced first to devalue the currency and

then to let it float. Interest rates skyrocketed, the govern

ment and private sector were unable to borrow from

abroad, and the country went into a severe recession.

NAFTA had little to do with that course of events. Con

sequently, the analysis in this paper removes the effects

of the peso crash and Mexican recession from the observed

fluctuations in U.S.Mexican trade—along with the effects

of the other factors discussed earlier—in order to isolate

the effects of the agreement. 5. In defense of the Mexican government, the targeted exchange rate

policy in the years leading up to NAFTA was used as part of a very

successful antiinflation program. Further, not sterilizing its

currencymarket interventions in 1994 would have worsened the

performance of the Mexican economy, which was felt to be subpar

already as the presidential election approached; and the conversion

of its debt to dollarindexed securities reduced the interest rates

it had to pay and served as a signal to investors that it did not in

tend to devalue the peso (since devaluation would make paying

off the debt much more difficult).

3

The Effects of NAFTA

To disentangle the effects of the North American

Free Trade Agreement from those of the other influential

factors discussed in Chapter 2, the Congressional Budget

Office constructed a model of U.S. trade with Mexico.1

Results from the model indicate that:

• Changes in trade between the United States and

Mexico since NAFTA went into effect have been

determined primarily by factors other than the agree

ment.

• Without NAFTA, both U.S. exports to and imports

from Mexico would have grown almost as much as

they did with NAFTA, and they would have fluc

tuated almost identically to the manner in which they

did with NAFTA.

• NAFTA has had a comparatively small, but growing,

positive effect on U.S. exports to Mexico (ranging

from 2.2 percent in 1994 to 11.3 percent in 2001)

and a similar effect on U.S. imports from Mexico

(ranging from 1.9 percent in 1994 to 7.7 percent in

2001).

• The effects of NAFTA on the U.S. balance of trade

in goods with Mexico have been positive in most

years, and very small in all years, since the agreement

began. The decline in the balance since 1993 is com

pletely attributable to the peso crash in late 1994, the

associated Mexican recession, the prolonged U.S.

economic boom from the early 1990s through 2000,

and the Mexican recession in late 2000 and 2001

(with the effect of the peso crash itself—exclusive of

the associated recession—being relatively minor).

CBO estimates that the increased trade resulting from

NAFTA has probably increased U.S. gross domestic prod

uct, but by a very small amount—probably a few billion

dollars or less, or a few hundredths of a percent.

The Effects of NAFTA on

U.S.-Mexican Trade

CBO’s model calculates quarterly real U.S. goods exports

to Mexico as a function of the average Mexican tariff rate,

a socalled dummy variable to capture the effects of

NAFTA’s nontariff provisions, the real exchange rate be

tween the dollar and the peso, and real Mexican economic

activity as measured by the Mexican industrial production

index.2

 Similarly, it calculates quarterly real U.S. goods

imports from Mexico as a function of the average U.S.

1. That model is described in detail in Appendix A.

2. CBO used the Mexican industrial production index for the export

equation because numbers for real Mexican GDP were not available

before 1980, and such early numbers were necessary for a support

ing version of the model discussed in Appendixes A and C. The

availability of data aside, the industrial production index is likely

to be a better variable than real GDP for use in the export equation

because a large portion of U.S. exports are inputs for Mexican

industry, whose level of activity and consequent need for inputs

is measured by the industrial production index. The proportion

of U.S. imports from Mexico that are inputs for U.S. production

is smaller and the proportion destined for final consumption in

the United States is correspondingly larger. Consequently, demand

for imports is likely to be better correlated with a broader measure

of income, such as real GDP, than with industrial production,

making real GDP a better variable for use in the import equation.

CHAPTER
18 THE EFFECTS OF NAFTA ON U.S.-MEXICAN TRADE AND GDP

Exports Imports

Trade Balance

1989 1993 1997 2001

-40

-30

-20

-10

0

10

1989 1993 1997 2001

0

50

100

150

1989 1993 1997 2001

0

50

100

150

Actual

Model

with NAFTA

Model

Without NAFTA Model

Without NAFTA

Model

with NAFTA Actual

Actual

Model

Without NAFTA

Model

with NAFTA

Figure 11.

U.S. Goods Trade with Mexico with and Without NAFTA

(In billions of dollars)

Source: Congressional Budget Office using data from the Bureau of the Census for actual values and projections from CBO’s model for other values.

Note: The dashed lines mark the beginning of the North American Free Trade Agreement on January 1, 1994.
CHAPTER THREE THE EFFECTS OF NAFTA 19

Table 1.

Effects of NAFTA on U.S. Goods Trade with Mexico

Effects in

Billions of Dollars

Effects as a

Percentage of U.S. GDP

Exports Imports

Trade 

Balance

Effects in Percent

Exports Imports

Trade

Exports Imports Balance

1994 1.1 0.9 0.1 2.2 1.9 0.016 0.014 0.002

1995 2.0 2.9 -0.8 4.7 4.9 0.029 0.040 -0.012

1996 3.8 4.2 -0.4 7.2 6.1 0.052 0.057 -0.006

1997 5.6 5.4 0.2 8.6 6.8 0.074 0.071 0.003

1998 6.9 6.4 0.5 9.5 7.2 0.086 0.080 0.006

1999 8.4 7.5 0.9 10.8 7.4 0.101 0.090 0.011

2000 10.4 9.1 1.3 10.3 7.2 0.120 0.105 0.015

2001 10.3 9.4 0.9 11.3 7.7 0.118 0.107 0.010

Source: Congressional Budget Office.

Note: Effects are calculated as the difference, averaged year by year, between the lines labeled “Model with NAFTA” and “Model Without NAFTA” in Figure 11. The

difference between the effect listed for exports and the effect listed for imports in a given year may not precisely equal the effect listed for the trade balance because

of rounding.

tariff rate, a dummy variable for the nontariff provisions

of NAFTA, the real exchange rate between the dollar and

the peso, and real U.S. economic activity as measured by

real GDP.3

 Real trade values calculated by the model were

subsequently converted to nominal values to produce the

numbers presented in this paper. The parameters of the

model were estimated using data extending from the

beginning of 1989 through the end of 2001.4

According to the model, the vast bulk of the growth and

fluctuation of both U.S. goods exports to Mexico and U.S.

goods imports from Mexico has occurred for reasons other

than NAFTA (see Figure 11). Simulations from the model

indicate that 85 percent of the yearoveryear increase in

exports from 1993 to 2001, and 91 percent of the growth

in imports over the same period, would have happened

even if NAFTA had not been implemented. All of the

major fluctuations in goods exports and imports would

have occurred as well.

NAFTA, according to the simulations, has had compara

tively small and smoothly increasing positive effects on

both exports and imports over time (see Table 1). It in

creased U.S. goods exports by 2.2 percent in 1994 and

by gradually growing amounts thereafter, up to 11.3 per

cent in 2001. In dollar terms, the positive effect grew from

$1.1 billion in 1994 to $10.4 billion by 2000 before easing

back very slightly, to $10.3 billion, in 2001. At no time

did the effect on annual exports exceed 0.12 percent of

U.S. GDP. Similarly, NAFTA increased U.S. goods im

ports from Mexico by 1.9 percent (or $0.9 billion) in 1994

and then by gradually growing amounts, up to 7.7 percent

(or $9.4 billion) in 2001. The agreement’s effect on annual

imports remained below 0.11 percent of GDP throughout

the period. (Because the effects on exports and imports

have been relatively small, it follows that disruptions to

employment have been small.)

The increases in trade caused by NAFTA were far more

important for Mexico than for the United States because

of Mexico’s much smaller economy. The estimated value

of U.S. exports to Mexico attributable to NAFTA in 2001

3. Technically, the model calculates nonoil imports as a function of

those variables, and CBO added data on actual oil imports back

into its projections to obtain total imports. That procedure effec

tively assumes oil imports to be the same under all scenarios—in

particular, the same with NAFTA as without it. The error intro

duced by that assumption should be small, and CBO judged it to

be outweighed by the improved fit of the model and resulting im

proved accuracy of predictions. (See Appendix A for more details.)

4. The reasons for the choice of that range, and the implications of

the choice for the results and conclusions, are discussed later in

this chapter.
20 THE EFFECTS OF NAFTA ON U.S.-MEXICAN TRADE AND GDP

1989 1993 1997 2001

-40

-30

-20

-10

0

10

20

Projection from CBO's Model

Under Actual-Values Scenario

Projection from CBO's Model

Under Alternative Scenario

Actual

a

b

equaled 1.9 percent of Mexican GDP, and the correspond

ing value for U.S. imports from Mexico attributable to

NAFTA in that year was 1.7 percent of Mexican GDP.

The substantial decline in the goods trade balance with

Mexico since NAFTA went into effect would have hap

pened even without the agreement, according to the simu

lations (see Figure 11). Moreover, NAFTA’s effects on the

balance have been extremely small in comparison with

the fluctuations of the balance that have occurred and in

most years have been positive rather than negative.

NAFTA is estimated to have reduced the cumulative

decline in the annual trade balance from 1993 through

2001 by 2.5 percent in nominal terms and by 3.9 percent

in real terms. All of the major fluctuations that have oc

curred in the goods trade balance with Mexico since the

beginning of NAFTA would have occurred anyway if the

agreement had not gone into effect, and their magnitudes

would have been almost identical to what they were with

the agreement.

NAFTA’s effect on the trade balance has also been incon

sequential in absolute dollar terms and in comparison with

the size of the U.S. economy. At no time has the effect

been larger than $1.3 billion, or 0.02 percent of GDP,

and it has been positive for the past five years straight.

Those results confirm the conclusion stated at the end of

Chapter 2 that NAFTA had little to do with the course

of events leading to the peso crash in late 1994. In prin

ciple, any NAFTAinduced decline in Mexico’s trade bal

ance would have increased the downward pressure on the

peso. However, the estimated $0.1 billion effect of

NAFTA on the U.S. trade balance with Mexico in 1994

(which means a $0.1 billion decline in Mexico’s balance

with the United States) is tiny in comparison with the

$31.8 billion decline that occurred in the net flow of

foreign investment into Mexico from the third quarter

of 1994 to the fourth quarter. Even if the actual effect of

NAFTA on the trade balance were several times that esti

mated effect, it would still be extremely small in compari

son with the investment decline.

The substantial fall in the goods trade balance with Mexico

since the agreement went into effect is attributable pri

marily to fluctuations in the levels of U.S. and Mexican

economic activity, with the peso crash playing a small role

Figure 12.

U.S. Goods Trade Balance with

Mexico Under Alternative Scenarios

(In billions of dollars)

Source: Congressional Budget Office using data from the Bureau of the Census

for the actual trade balance and projections from CBO’s model for

other trade balances.

Note: The dashed vertical line marks the beginning of the North American Free

Trade Agreement on January 1, 1994.

a. This alternative scenario assumes no peso crash and associated Mexican

recession in 1994 and 1995, no prolonged U.S. economic expansion in the

1990s, and no U.S. or Mexican recession in late 2000 and 2001.

b. The actual-values scenario assumes the values of U.S. gross domestic

product, the Mexican industrial production index, and the real exchange

rates that actually occurred.

in the earlier years. A simulation from the model produced

using actual values for the real exchange rates, the Mexican

industrial production index, and real U.S. GDP follows

the actual decline in the trade balance reasonably closely

(see the line labeled “Projection from CBO’s Model Under

ActualValues Scenario” in Figure 12, which is the same

as the line labeled “Model with NAFTA” in the bottom

panel of Figure 11). However, if the actual values are mod

ified to eliminate the peso crash, the associated Mexican

recession, the prolonged U.S. economic expansion, and

the U.S. and Mexican recessions in late 2000 and 2001,

the resulting simulation shows essentially no decline in

the trade balance (see the line labeled “Projection from

CBO’s Model Under Alternative Scenario” in Figure 12).5

The balance declines to roughly a $10 billion deficit in

5. For moreprecise details about the assumptions used for that simu

lation, see Appendix B.
CHAPTER THREE THE EFFECTS OF NAFTA 21

2000, but other than that it remains fairly near zero

throughout the 19942001 period and ends up in the

fourth quarter of 2001 at almost exactly the level it had

at the end of 1993. Even the $10 billion deficit in 2000

is only about onethird of the deficit calculated using

actual values for the real exchange rates, U.S. GDP, and

the Mexican industrial production index.

Other simulations (not shown) indicate that the peso crash

itself had a comparatively minor effect on the trade bal

ance. The largest role was played by the U.S. and Mexican

business cycles. Initially, the trade balance plunged in 1995

primarily because of the effect that the severe Mexican

recession had on demand for U.S. exports. The peso crash

and Mexican recession affected Mexican trade with other

countries more than it affected U.S.Mexican trade.

Mexico’s imports from the United States declined by

5.3 percent, from a value of $57.0 billion in 1994 to

$54.0 billion in 1995. Over the same period, its imports

from the rest of the world fell proportionately much more

—17.4 percent—from $22.3 billion to $18.5 billion.

Mexico’s exports to the United States rose by 28.0 percent

over the period, from $51.9 billion to $66.5 billion,

whereas its exports to the rest of the world increased by

46.2 percent, from $8.9 billion to $13.1 billion.

In 1996, demand for U.S. exports started to recover along

with the Mexican economy, but the U.S. economic expan

sion began to increase U.S. imports from Mexico (as well

as from other countries). As a result, the balance did not

recover substantially; in fact, in 1998, it began falling

further. In 2001, the U.S. recession caused imports from

Mexico to fall, but the Mexican recession caused U.S.

exports to fall by a larger amount, so the trade balance

continued to decline.

The long U.S. economic expansion of the 1990s is respon

sible for most of the trade deficit in 2001. Even with the

recent recession, U.S. GDP remained higher in 2001 than

it would have been had GDP grown since 1993 at its aver

age growth rate over the previous seven years (see Fig

ure B3 in Appendix B). That addition to GDP improved

the wellbeing of U.S. residents, but according to another

simulation from the model (not shown), it was responsible

for over 70 percent of the deficit with Mexico in 2001

and over half of the deficit in the last quarter of 2001.

That result further illustrates the fallacy of interpreting

the decline in the trade balance as an indicator that

NAFTA has been harmful: not only was the decline not

caused by NAFTA, but most of it was caused by some

thing that was (and remains) clearly beneficial—an in

crease in GDP. Of course, part of the deficit in the last

half of 2001 resulted from the Mexican recession, which

was (and remains) harmful. There simply is no consistent

relationship between the trade balance and economic

benefit or harm.

The Effects of NAFTA on U.S. GDP

NAFTA has had a very small positive effect on U.S. gross

domestic product. Estimating that effect precisely requires

not only an estimate of the effects of NAFTA on trade

with Mexico but also an assessment of the degree of trade

diversion (as discussed in Chapter 1) and a model of the

effects of trade on the U.S. economy. Such an analysis is

beyond the scope of this paper. Trade diversion cannot

be assessed using aggregate trade data, such as that ana

lyzed here; it requires analyzing trade on a productby

product basis. The CBO model does not do that.

It is possible, however, to obtain a rough orderof

magnitude estimate of the effects of NAFTA on U.S. GDP

by piggybacking on the results of other studies. In an

earlier report, CBO concluded from a survey and analysis

of the relevant empirical literature that barriers to trade

with big emerging economies (such as those of China,

Hong Kong, South Korea, Singapore, Taiwan, and Mex

ico) cost the U.S. economy somewhere between 5 cents

and 35 cents for each $1 loss of exports.6

 That estimate

was obtained from studies showing the converse—that

the removal of trade restrictions led to a rise in GDP of

5 cents to 35 cents for each $1 increase in exports—so it

is legitimate to conclude back to that converse. That is,

one can multiply the ratio of 5 cents to 35 cents for each

$1 increase in exports by the estimates from CBO’s model

of how much NAFTA has increased U.S. exports to

Mexico to produce a rough estimate of NAFTA’s effects

on U.S. GDP. Such a method implicitly incorporates the

effects of trade diversion because the empirical literature

6. Congressional Budget Office, The Domestic Costs of Sanctions on

Foreign Commerce (March 1999), p. 42.
22 THE EFFECTS OF NAFTA ON U.S.-MEXICAN TRADE AND GDP

Table 2.

Effects of NAFTA on U.S. Gross

Domestic Product

Effects in

Billions of Dollars

Effects in

Percent

1994 0.1 - 0.4 0.001 - 0.005

1995 0.1 - 0.7 0.001 - 0.010

1996 0.2 - 1.3 0.002 - 0.018

1997 0.3 - 2.0 0.004 - 0.026

1998 0.3 - 2.4 0.004 - 0.030

1999 0.4 - 3.0 0.005 - 0.035

2000 0.5 - 3.6 0.006 - 0.042

2001 0.5 - 3.6 0.006 - 0.041

Source: Congressional Budget Office.

that CBO surveyed to obtain the ratio considered trade

diversion.7

Applying the ratio to the estimates from CBO’s model

leads to the conclusion that NAFTA has increased U.S.

GDP, but by a very small amount—probably no more

than a few billion dollars, or a few hundredths of a percent

(see Table 2). The trade increases wrought by NAFTA

raised Mexican GDP by much larger percentages than they

raised U.S. GDP—quite likely 16 to 21 times the U.S.

percentages—because of the much smaller size of the

Mexican economy.8

A Few Notes About the Results

Several aspects of CBO’s procedure and assumptions—and

their effects on the results presented in this paper—merit

brief discussion. Those aspects are the use of postNAFTA

data in the estimation of the CBO model’s parameters;

the assumption that trade barriers would have remained

at their 1993 levels in the absence of NAFTA; and the

assumption that NAFTA did not affect the real exchange

rates, real U.S. GDP, and Mexican industrial production.

The Use of Post-NAFTA Data

As noted earlier, the parameters of the model that CBO

used to produce the projections and estimates presented

above were estimated using data extending from 1989

through 2001. Those years include the postNAFTA

period, which might be a source of concern for some

people. However, the resulting conclusions are confirmed

and even strengthened by results from another version of

the model with parameters estimated using only pre

NAFTA data (see Appendix C).

The reason for choosing 1989 through 2001 concerns a

change in the behavior of U.S.Mexican trade that oc

curred in the late 1980s. CBO chose to use data from after

that change to ensure that the model would reflect the

behavior of U.S.Mexican trade just before NAFTA went

into effect. The quantity of data between the change and

the beginning of NAFTA was inadequate for estimating

the parameters of the model, necessitating the use of addi

tional data from 1994 and after. Some people might won

der whether using the additional data built the post

NAFTA decline in the trade balance into the model. Per

haps if postNAFTA data containing the decline had not

been used in the estimation, the model would not predict

that decline (or at least not all of it) without the need for

NAFTA. The estimated effects of NAFTA would then

include at least some of the decline. Although economists

might argue that such a result is unlikely, those of a more

skeptical bent could be forgiven for remaining suspicious.

To confirm that this concern and others related to the use

of postNAFTA data are unwarranted, CBO repeated its

analysis using a slightly revised version of its model with

7. Of course, the increase in GDP results from increases in imports

as well as exports, and therefore the ratio of the increase in GDP

to the increase in exports depends on the increase in imports. Thus,

the ratios are valid only if the relative sizes of NAFTA's effects on

exports and imports are similar to the relative sizes of those quanti

ties in the studies that CBO surveyed to obtain the ratio. However,

that is, in fact, the case. Those studies were primarily examinations

of NAFTA produced in the years leading up to the adoption of

the agreement. Most of them assumed no change in the trade

balance, which is close to the results from CBO’s model presented

above.

8. From 1997 through 2001, U.S. GDP ranged between 16 and 21

times Mexican GDP. Therefore, the same dollar increase in GDP

would be between 16 and 21 times the percentage of Mexican GDP

that it would be of U.S. GDP. Although it is probably a good

educated guess that the dollar increase in Mexican GDP resulting

from NAFTAinduced trade growth is similar in size to the dollar

increase in U.S. GDP resulting from that same growth, that guess

depends on a number of assumptions that may or may not hold

true, such as the assumption that Mexican trade diversion resulting

from NAFTA is similar in magnitude to U.S. trade diversion.
CHAPTER THREE THE EFFECTS OF NAFTA 23

parameters estimated using data from 1970 through 1993

(just before NAFTA went into effect). As would be ex

pected, simulations from that version of the model track

postNAFTA trade a little less well than do the simulations

presented here. Nevertheless, they largely support and even

strengthen the conclusions. Of particular interest, they

indicate that if U.S.Mexican trade had behaved the same

way in the mid1990s that it did before the mid to late

1980s, the decline in the trade balance in response to the

peso crash and associated Mexican recession would have

been much more drastic than the decline that actually

occurred.

Trade Restrictions in the Absence of NAFTA

The estimates presented here presume that trade barriers

in the absence of NAFTA would have remained constant

at their 1993 levels. Some people might argue that such

an assumption is not appropriate. Because of NAFTA,

Mexico did not erect new trade barriers against the United

States and Canada during the peso crisis and subsequent

recession in 1994 and 1995 as it did against other coun

tries, and as it had done against all countries in the peso

crash of 1982. Hence, one could argue that the proper

alternative for the “Model Without NAFTA” scenario is

some assumed increase in Mexican trade barriers during

the crash and subsequent recession. With that alternative,

the estimated positive effects of NAFTA on exports would

be larger than those presented here for the time that those

barriers were in place. Consequently, NAFTA’s estimated

negative effect on the trade balance in 1995 and 1996

would be smaller—or possibly even positive (depending

on the magnitude of the tariff increases and the sensitivity

of exports to them).

In addition, some of the reductions in trade barriers agreed

to in NAFTA would eventually have occurred anyway as

a result of the Uruguay Round agreement of the General

Agreement on Tariffs and Trade, which went into effect

on January 1, 1995. If those reductions were included in

the “Model Without NAFTA” scenario, the estimated

effects of NAFTA on exports and imports would be

smaller. The change in the estimated effect on the trade

balance would depend on the relative magnitudes of the

changes in the estimated effects on exports and imports

and therefore cannot be determined without actually col

lecting the relevant tariff data and calculating the effects

on exports and imports.

The Real Exchange Rates, Mexican Industrial

Production, and U.S. GDP in the Absence of NAFTA

Producing simulations of exports and imports in the

absence of NAFTA requires making assumptions about

what the values of the real exchange rates, real U.S. GDP,

and the Mexican industrial production index would have

been without the agreement. The methodology used to

produce the results presented in this paper assumes that

those variables would have had the same values in the

absence of NAFTA that they actually had in the presence

of NAFTA. That assumption is only approximately true.

In general, one would expect NAFTA to have affected the

variables by amounts that are not precisely known. The

effects should be very small, however, and the error intro

duced by ignoring them should also be very small. (For

more details, see Appendix D.) Correcting the error (if

it were possible) would very slightly increase the positive

estimated effects of NAFTA on exports and the trade

balance. The direction of the error for imports is unclear.

Consistency of CBO’s Results with

Other Estimates in the Literature

CBO’s estimates of NAFTA’s effects on U.S.Mexican

trade are generally consistent with estimates from other

papers and studies in the literature, including other regres

sion studies, studies using crosssectional methodologies,

and generalequilibrium modeling studies.

Estimates from Other Regression Studies

Two earlier studies that used statistical regression equa

tions to isolate the effects of NAFTA were published in

1997 and early 1998: one by David M. Gould of the Fed

eral Reserve Bank of Dallas and another by the U.S. Inter

national Trade Commission (ITC).9

 Those studies ex

amined effects up through 1996. Gould estimated that

exports and imports were higher in that year by $21.3 bil

lion and $20.5 billion, respectively, than they would have

been in the absence of NAFTA (see Table 3). CBO’s

9. David M. Gould, "Has NAFTA Changed North American Trade?"

Economic Review, Federal Reserve Bank of Dallas (First Quarter

1998), pp. 1223; and U.S. International Trade Commission, The

Impact of the North American FreeTrade Agreement on the U.S.

Economy and Industries: A ThreeYear Review, Publication No. 3045

(July 1997).
24 THE EFFECTS OF NAFTA ON U.S.-MEXICAN TRADE AND GDP

Table 3.

CBO’s Estimates of the Effects of NAFTA Compared with Others in the Literature

Effects of NAFTA on

U.S. Exports to Mexico

Effects of NAFTA on

U.S. Imports from Mexico

Billions

of Dollars Percent

Billions

of Dollars Percent

CBO Gould CBO ITC GE Modelsa CBO Gould CBO ITC GE Modelsa

1994 1.1 2.2 1.3 0.9 1.9 1.0

1995 2.0 4.7 3.9 2.9 4.9 5.7

1996 3.8 21.3 7.2 2.9 4.2 20.5 6.1 6.4

1997 5.6 8.6 5.4 6.8

1998 6.9 9.5 6.4 7.2

1999 8.4 10.8 7.5 7.4

2000 10.4 10.3 9.1 7.2

2001 10.3 11.3 9.4 7.7

Long Run 5.2 - 27.1 3.4 - 15.4

Sources: Congressional Budget Office; David M. Gould, “Has NAFTA Changed North American Trade?” Economic Review, Federal Reserve Bank of Dallas (First Quarter

1998), pp. 12-23; U.S. International Trade Commission, The Impact of the North American Free-Trade Agreement on the U.S. Economy and Industries:

A Three-Year Review, Publication No. 3045 (July 1997); and U.S. International Trade Commission, Potential Impact on the U.S. Economy and Selected

Industries of the North American Free-Trade Agreement, Publication No. 2596 (January 1993), p. 2-7.

a. The range of estimates made by a number of general-equilibrium modeling studies surveyed by the International Trade Commission (ITC), which were published

in the years before NAFTA went into effect. Those estimates are for a long-run period that probably exceeds the eight years included in this table.

estimates for 1996—a $3.8 billion increase in exports and

a $4.2 billion increase in imports—are only about one

fifth as large as Gould’s estimates, but they are within the

margin of error reported by Gould and thus are not incon

sistent with his results.10

Gould’s export and import estimates imply a positive

effect on the trade balance of $0.8 billion in 1996. Al

though that number is opposite in sign to CBO’s esti

mated effect for that year ($0.4 billion), 1995 and 1996

are the only years for which CBO estimates negative effects

on the trade balance. For all other years, CBO’s model

indicates positive effects on the trade balance of similar

magnitude to the effect implied by Gould’s export and

import estimates. Furthermore, CBO’s estimate is within

the margin of error of the number implied by Gould’s

estimates.

The ITC study estimated that NAFTA increased U.S. ex

ports to Mexico in 1994, 1995, and 1996 by 1.3 percent,

3.9 percent, and 2.9 percent, respectively. The correspond

ing estimates from the CBO model are 2.2 percent,

4.7 percent, and 7.2 percent, respectively. NAFTA in

creased imports from Mexico by 1.0 percent, 5.7 percent,

and 6.4 percent in those years by the ITC’s estimates. The

corresponding CBO estimates are 1.9 percent, 4.9 percent,

and 6.1 percent. The ITC did not report confidence inter

vals for its estimates, but clearly its estimates and CBO’s

are very similar.

Like CBO’s numbers, the ITC’s estimates for exports and

imports imply a positive effect on the trade balance with

Mexico in 1994 and negative effects in 1995 and 1996.

The ITC study notes the implied positive effect on the

balance in 1994; however, rather than make the same

comparison for 1995 and 1996, it indicates that the esti

mates for those two years are less reliable than the esti

10. Gould reported a 90 percent confidence interval for the effect on

exports (that is, an interval in which one can be 90 percent confi

dent that the true effect on exports lies) extending from roughly

zero to roughly $32 billion. (The ends of the ranges cannot be given

precisely because Gould does not report actual numbers but instead

presents rather small graphs from which the numbers can be read

only imprecisely.) His 90 percent confidence interval for the effect

on imports extends from roughly $30 billion to roughly $48

billion.
CHAPTER THREE THE EFFECTS OF NAFTA 25

mates for 1994 because of the confounding effects of the

peso crash and ensuing Mexican recession.

The ITC estimated its model using data from 1989

through 1996—a range over which almost the only fluctu

ation of any of the variables was that associated with the

peso crash and subsequent recession. The result was to

effectively fit the model to the crash and recession. Con

sequently, the ITC was being properly cautious about

whether its model had separated out the effects of the crash

and recession with enough accuracy and reliability to draw

any valid conclusions about NAFTA’s effects on the trade

balance in 1995 and 1996. However, CBO’s model, which

was estimated using a larger range of data that included

more fluctuations of the variables, produced similar re

sults. The effects of NAFTA on exports and imports indi

cated by the two models are very similar in magnitude,

and thus the implied effects on the trade balance indicated

by the two models are roughly similar in magnitude.

Estimates Using Cross-Sectional Methodologies

The small magnitudes of CBO’s export and import esti

mates are also consistent with the results of a paper pub

lished in January 2000 by Raúl HinojosaOjeda and

others.11 That paper used crosssectional methodologies

(that is, methodologies in which the different data points

are different traded products over the same range of time)

rather than the timeseries methodologies used in this

study (in which different data points are the same group

of products at different points in time).

In one exercise, that paper divided the various traded

products into those for which NAFTA had liberalized

trade and those for which it had not (because, for example,

there were no trade restrictions to start with, or scheduled

liberalization had not yet occurred). The analysis found

that U.S. imports of products for which trade had been

liberalized had increased by less, on average, than imports

of products for which trade had not been liberalized.12

That result, which confirmed similar results in earlier

papers using less recent data, suggests that the effects of

NAFTA’s trade liberalization were small in comparison

with the effects of other factors that caused trade in various

products to increase.

In another exercise, the paper estimated an equation in

which the dependent variable was the percentage change

in U.S. imports of a given product from Mexico between

1993 and 1998 and the explanatory variables included

the decline in the tariff rate and a number of other likely

factors. The estimation showed that the decline in the tar

iff rate was a significant determinant of the increase in

U.S. imports but that all of the variables together ex

plained less than 13 percent of the variation in the increase

in imports from product to product.13 Once again, the

implication is that the effects of NAFTA’s tariff reductions

are small compared with the total effects of all of the other

factors that influence U.S.Mexican trade, many of which

evidently were not in the regression.

Estimates from General-Equilibrium

Modeling Studies

Finally, CBO’s estimates are consistent with the predic

tions made by generalequilibrium modeling studies before

NAFTA went into effect. Unlike statistical regression

models, which are based primarily on statistical correla

tions of various aggregate variables in the recent past,

generalequilibrium models explicitly incorporate theo

retical assumptions about how various economic actors

behave, such as the notion that businesses attempt to max

imize their profits and consumers attempt to maximize

their economic wellbeing. Although regression models

are usually informed by the kinds of theoretical notions

incorporated into generalequilibrium models, and gen

eralequilibrium models are informed by what is known

about statistical correlations of the various variables, the

two kinds of models are distinct and have different advan

tages and disadvantages, which CBO has discussed else

where.14

11. Raúl HinojosaOjeda and others, The U.S. Employment Impacts

of North American Integration After NAFTA: A Partial Equilibrium

Approach (Los Angeles: North American Integration and Develop

ment Center, School of Public Policy and Social Research, Univer

sity of California at Los Angeles, January 2000).

12. Ibid., pp. 4648.

13. Ibid., pp. 4850.

14. For more details, see Congressional Budget Office, Estimating the

Effects of NAFTA: An Assessment of the Economic Models and Other

Empirical Studies (June 1993), Appendix A.
26 THE EFFECTS OF NAFTA ON U.S.-MEXICAN TRADE AND GDP

The International Trade Commission surveyed a number

of generalequilibrium modeling studies and concluded

that “[e]stimated increases in U.S. exports to Mexico range

from 5.2 to 27.1 percent. U.S. imports from Mexico are

estimated to increase by 3.4 to 15.4 percent.”15 Those esti

mates were for effects in the very long term, so the most

appropriate CBO estimates to compare with them are

those for 2001. Those estimates—increases of 11.3 percent

for exports and 7.7 percent for imports—are a little lower

than the middles of the ranges stated by the ITC (see

Table 3).

16

In 1993, CBO surveyed generalequilibrium modeling

studies of the likely effects of NAFTA and stated that the

agreement would probably improve the U.S. balance of

trade with Mexico.17 However, that conclusion was based

on NAFTA’s likely effects on aggregate saving and invest

ment in the United States and Mexico in conjunction with

the accounting identity that equates the currentaccount

balance with the difference between aggregate saving and

aggregate investment. Surveying the predictions of the

models, CBO concluded that “[u]nfortunately, most of

the studies improperly handle investment or saving in

Mexico (many assume the trade balance would be unaf

fected by NAFTA), so it is not possible to say much about

the sizes of the effects on the U.S. and world balances of

trade with Mexico.” Thus, the CBO results presented here

are consistent with predictions from simple economic

reasoning, but there is little in the way of sophisticated

predictions from preNAFTA generalequilibrium model

ing with which to compare them.

CBO’s estimates of the effects of NAFTA on U.S. GDP

are consistent with—although in the lower end of—the

range of effects predicted by generalequilibrium modeling

studies produced before NAFTA began. The meaning of

such a comparison is limited, however, by the fact that

the results of some of those studies were used to produce

the range of GDPtoexport ratios that CBO used to

estimate NAFTA’s effects on GDP.

Surveying a number of preNAFTA generalequilibrium

modeling studies, the ITC summarized their predictions

of the likely longterm increases in GDP resulting from

NAFTA as ranging from 0.02 percent to 0.5 percent.18

The summary of predictions in CBO’s 1993 survey, which

covered mostly the same modeling studies, largely con

firms the ITC’s range.19 CBO concluded that many of

the studies that produced the smaller estimates in the range

had left out some of the various mechanisms by which

NAFTA might increase GDP.

One reason that CBO’s own estimates of effects on GDP

are toward the lower end of the range predicted by the

generalequilibrium models may be that most of those

models concentrate on effects in the very long term—

longer than the eight years estimated by CBO. Alterna

tively, the generalequilibrium modeling estimates—pro

duced before NAFTA went into effect and not informed

by postNAFTA data—may be a bit too high. Another

possibility is that CBO’s crude methodology might have

produced underestimates. CBO does not claim that its

estimates of effects on GDP are any more accurate than

a rough order of magnitude. Regardless, one can conclude

that the effects of NAFTA on U.S. GDP have most likely

been positive and very small. 15. U.S. International Trade Commission, Potential Impact on the U.S.

Economy and Selected Industries of the North American FreeTrade

Agreement, Publication No. 2596 (January 1993), p. 27.

16. The equilibria in most of the models surveyed by the ITC are

probably longer term than eight years, so CBO estimates for years

later than 2001 (if they were available) would be even more appro

priate for comparison. CBO’s estimates of the effects of NAFTA

are growing over time, so later estimates would undoubtedly be

even closer to the middles of the ranges cited by the ITC.

17. Congressional Budget Office, Estimating the Effects of NAFTA,

pp. 5961.

18. U.S. International Trade Commission, Potential Impact on the U.S.

Economy and Selected Industries of the North American FreeTrade

Agreement, p. 23, Table 21.

19. Congressional Budget Office, Estimating the Effects of NAFTA,

p. 57, Table 11.
(1) + ln( ) ln( ) ln( ) X TREND CONST81 Y TE NAFTA t

X X

t

X

t

X

t

Mex X

t

X X

t t

X =+ + + + + αα α α α α ε 01 2 3 4 5

Longterm equilibrium equation for exports:

(2) + ∆ ∆ ∆∆ ∆

∆

ln( ) ln( ) ln( ) ln( ) ΣΣΣ

[ln( ) ln( )]

X CONST81 X Y TE

NAFTA X X

t

X X

t ii

X

t i

i

i

X

t i

Mex

i

i

X

t i

X

X

t

X

t tt

X

=+ + +

+ + −+

−− −

− −

ββ β β β

ββ μ

01 2 3 4

5 61 1

Dynamic errorcorrecting equation for exports:

(3) ln( ) ln( ) ln( ) M TREND TREND80 Y TE

NAFTA

t

ExclOil M M

t

M

t

M

t

US M

t

M

M

t t

M

=+ + + +

+ +

αα α α α

α ε

01 2 3 4

5

Longterm equilibrium equation for imports:

A

CBO’s Model of U.S.-Mexican Trade

To isolate the effects of the North American Free

Trade Agreement from the effects of other factors that

have influenced U.S.Mexican trade since the agreement

went into effect, the Congressional Budget Office con

structed and estimated its own model of that trade. The

model and methodology that CBO used were informed

in part by the models, methodologies, and results of two

earlier studies in the literature—by David Gould, then

of the Federal Reserve Bank of Dallas, and by the Inter

national Trade Commission (ITC)—that examined

NAFTA’s effects on U.S.Mexican trade through 1996.1

The Model

CBO used quarterly data extending from 1969 through

2001. Application of the DickeyFuller test to the data

failed to reject the hypothesis that some of the variables

are nonstationary, which is consistent with the results of

the Gould and ITC studies. Application of the augmented

DickeyFuller test rejected the hypothesis that the variables

are not cointegrated, which is consistent with the results

of the ITC study. Therefore, CBO chose an error

correcting specification for its model. The equations of

the model are as follows:

1. David M. Gould, “Has NAFTA Changed North American Trade?” Economic Review, Federal Reserve Bank of Dallas (First Quarter 1998), pp. 1223;

and U.S. International Trade Commission, The Impact of the North American FreeTrade Agreement on the U.S. Economy and Industries: A ThreeYear

Review, Publication No. 3045 (July 1997).

APPENDIX
28 THE EFFECTS OF NAFTA ON U.S.-MEXICAN TRADE AND GDP

(4) + ∆ ∆ ∆ ∆∆

∆

ln( ) ln( ) ln( ) ln( ) Σ ΣΣ

[ln( ) ln( )]

M TREND80 M Y TE

NAFTA M M

t

ExclOil M M

t ii

M

t i

ExclOil

i

i

M

t i

US

i

i

M

t i

M

M

t

M

t

ExclOil

t

ExclOil

t

M

=+ + +

+ + −+

− −−

− −

ββ β β β

ββ μ

01 2 3 4

5 61 1

Dynamic errorcorrecting equation for imports:

where:

= the firstdifference operator;

ln(.) = the natural logarithm of the variable in parentheses;

= real U.S. exports to Mexico;

= real U.S. imports from Mexico excluding crude oil;

 , = the values of and predicted by the longterm equilibrium equations (that is, the

values calculated from those equations with and set equal to zero);

= real U.S. gross domestic product;

= the Mexican industrial production index (used in place of real Mexican GDP, which was not

available for dates before 1980);

 , = the tariffadjusted real exchange rates between the peso and the dollar for exports and imports,

respectively (see the data section below for details);

= a dummy variable (equal to 0 before the beginning of NAFTA and equal to 1 after it) to capture

effects of the nontariff provisions of the agreement;

 , = artificially constructed variables included to partially rectify certain deficiencies in the available

data for 1981 and earlier (see data section below for details);

, , , = random error terms; and

, , , ,

, , , 

= statistically estimated coefficients.

Crude oil imports were excluded from the import equa

tions because their behavior has differed significantly over

time from that of other imports from Mexico. The value

of U.S. crude oil imports from Mexico has varied substan

tially, both in absolute magnitude and in its share of the

value of total U.S. imports from Mexico (see Figure 7 in

Chapter 2). The reasons for that variation—mostly fluc

tuations in the supply of crude oil from the Middle East

and their effects on world oil prices—are captured poorly

by the explanatory variables in the import equation. Equa

tions estimated for imports of all goods (including crude

oil) did not fit the data as well as the same equations esti

mated with crude oil excluded. Therefore, CBO decided

to model only nonoil imports and add the actual historical

crude oil imports back into the predictions made by the

model to obtain predicted total goods imports.

The fact that crude oil imports were not modeled assumes

away any effect of NAFTA on U.S. oil imports. It also

introduces an error into the predictions of total goods

imports (crude oil included) for 1994 through 2001 for

cases in which alternative assumptions are made for the

real exchange rate and U.S. GDP growth. Those alterna

tive assumptions would be expected to affect crude oil im

ports, and those effects are not captured by the method

ology. However, the resulting error should be small, and
APPENDIX A CBO’S MODEL OF U.S.-MEXICAN TRADE 29

including crude oil in the imports that were modeled

would have introduced its own error in the form of a sig

nificantly poorer fit of the model to the data.

The error introduced by CBO’s methodology should be

small for several reasons. First, in only two quarters from

1994 through 2001 did crude oil imports exceed 10 per

cent of total U.S. goods imports from Mexico, and they

did not exceed it by much in those quarters. Second, the

U.S. tariff on crude oil before NAFTA was only 5.25 cents

per barrel. For Standard Industrial Classification (SIC)

13—crude petroleum and natural gas—calculated duties

paid on imports were roughly onehalf percent of the

dutiable value of imports from Mexico in each year from

1989 through 1993.2

 Thus, the effect of NAFTA’s elimi

nation of duties on oil imports from Mexico must accord

ingly be trivial. The agreement’s main effects of signifi

cance to the oil industry related not to U.S. import restric

tions but to elimination of restrictions on U.S. investment

in the Mexican industry. Finally, Saudi Arabia plays a large

swing role in the world oil market, deliberately varying

its output in response to economic conditions in an

attempt to keep the world price at the target level set by

OPEC. The result is that U.S. oil imports from Mexico

do not vary as much with the U.S. business cycle (and

would not vary as much with alternative assumptions

about U.S. growth such as those made in Chapter 3 in

the analysis of the decline of the trade balance) as would

otherwise be the case.

Data Set and Sources

As noted above, CBO used quarterly data extending from

1969 through 2001. All variables except the nominal

exchange rate were seasonally adjusted.3

 In cases in which

the source data series were not seasonally adjusted, CBO

seasonally adjusted them using the Census X11 routine

in SAS.4

Nominal and Real Exports and Imports

Nominal values of total U.S. exports to Mexico (f.a.s.

value) and general U.S. imports from Mexico (customs

value) for various ranges of years were obtained from the

International Trade Commission Web site (www.usitc.

gov), Haver Analytics, and various issues of Direction of

Trade Statistics, published by the International Monetary

Fund. Ultimately, the numbers from all of those sources

come from the Bureau of the Census. The customs value

of general imports under SIC 13 was then subtracted from

total general imports to obtain nominal nonoil imports.

The customs value of SIC 13 imports from Mexico for

1989 through 2001 was obtained from the ITC Web site

(and thus ultimately came from the Bureau of the Census).

Physical quantities of crude oil imports for 1973 through

2001 and “landed cost” prices for those imports from

1975 through 2001 were obtained from the Energy Infor

mation Administration (EIA) of the Department of En

ergy. Prices from 1973 through 1975 were approximated

using the Bureau of Labor Statistics’ (BLS’s) producer

price index for SIC 131—crude petroleum and natural

gas. The values of imports calculated from the EIA data

and BLS price index were multiplied by the necessary

factor to make the average value for 1989 equal to the cus

toms value of general SIC 13 imports for that year. Before

1973, crude oil imports from Mexico were negligible and

were assumed to equal the same percentage of total goods

imports from Mexico that they did in 1973. The final

series consisted of the data from the ITC Web site for

1989 through 2001, the values calculated from the EIA

and BLS data and multiplied by the multiplicative factor

for 1973 through 1988, and the assumed constant propor

tion of total goods imports before 1973.

To obtain the real values of exports and nonoil imports,

the nominal values were divided by price indices that CBO

constructed from chainweighted price indices for aggre

gate goods exports to and imports from the entire world

2. “Calculated duties” are an estimate from the Bureau of the Census

(in this case obtained by CBO from the Web site of the U.S. Inter

national Trade Commission) of the duties paid. They are calculated

on the basis of the applicable rate(s) of duty as shown in the Har

monized Tariff Schedule.

3. For substantial portions of the estimation period the exchange rate

was kept constant by the Banco de Mexico, and for much of the

rest of the period it was set or highly managed by the Banco de

Mexico. Therefore, the nominal exchange rate has reflected policy

decisions more than seasonal factors, and seasonal adjustment was

not deemed appropriate.

4. SAS is a package of statistical analysis software produced by the

SAS Institute, Inc.
30 THE EFFECTS OF NAFTA ON U.S.-MEXICAN TRADE AND GDP

TE

P

P

TE

P

P

t

X t t

Mex

t

Mex

t

USX

t

M t t

US

t

Mex

t

USM

= +

= +

π

τ

π τ

( )

( )

1

1

and

(from the national income and product accounts published

by the Bureau of Economic Analysis, or BEA) and from

price indices for U.S. exports to and imports from the

entire world of various products (from BLS). The import

price index that CBO constructed is an index of the price

of U.S. imports from the world as a whole of the sorts of

products that the United States imports from Mexico. As

such, it is a price index for imports that compete with

Mexican imports. Similarly, the export index is a price

index for U.S. exports to the world of the sorts of goods

that the United States exports to Mexico.

Had BLS import and export price indices existed for all

products, the aggregate indices for Mexico could have been

produced simply by taking the weighted harmonic average

of the BLS series (or, equivalently, the straight weighted

average inflation rates of those series) with the various

component indices weighted by U.S. exports to or imports

from Mexico of the product in question for each compo

nent index. Values of U.S. trade with Mexico by product

at virtually any degree and kind of classification (CBO

used primarily threedigit SIC) from 1989 through 2001

are available from the ITC Web site. Values of U.S. trade

in manufactured goods by fourdigit SIC classification

are available from the National Bureau of Economic Re

search Web site (www.nber.org).5

 CBO merged the NBER

data to the threedigit level for use in creating its indices.

Unfortunately, there are a number of traded products for

which BLS publishes no price indices. Thus, CBO took

the harmonic average of the available BLS indices for any

given date using U.S. exports to or imports from the world

(as appropriate) as weights. That average was then sub

tracted in harmonic fashion from the BEA chainweighted

index of exports or imports (as appropriate), again using

U.S. trade with the world as weights. The residual consti

tuted an aggregate price index for all products for which

there were no BLS price indices. That index was then

averaged harmonically with the BLS indices, using U.S.

trade with Mexico as weights, to obtain the final index.

Other Variables

Values of real U.S. gross domestic product (for )

came from the Bureau of Economic Analysis Web site

(www.bea.gov). The Mexican industrial production index

(for ) was obtained from International Financial

Statistics, published on CDROM and in monthly print

versions by the International Monetary Fund.

The tariffadjusted real exchange rates for exports and

imports ( and ) were calculated by the follow

ing formulas:

where:

= the nominal exchange rate in dol

lars per peso (obtained from Inter

national Financial Statistics),

= the Mexican wholesale price index

(also obtained from International

Financial Statistics),

 , = the dollar price indices that CBO

constructed for U.S. exports to and

imports from Mexico (see the dis

cussion of real trade values above),

and

 , = Mexican and U.S. tariff rates.6

5. The NBER Web page contains a link to the Center for Inter

national Data at the University of California at Davis (http://

data.econ.ucdavis.edu/international/), where the data set is located.

The data set was assembled by Robert Feenstra of the university’s

Department of Economics under a grant from the National Science

Foundation to NBER.

6. Nominal and real exchange rates are expressed here in dollars per

peso rather than the reciprocal pesos per dollar that is more com

mon in the economics literature in order to be consistent with the

usage in the main text of the paper. As noted there, the pesosper

dollar formulation leads to the confusing result that the peso crash

at the end of 1994 appears as an upward spike in a plot of the real

exchange rate and to the similarly confusing result that the gradual

upward trend in the value of the peso before and after the crash

appears as a gradual downward trend in the real exchange rate. To

avoid such confusion, the dollarsperpeso formulation is used

throughout this paper.
APPENDIX A CBO’S MODEL OF U.S.-MEXICAN TRADE 31

Mexican average tariff rates were obtained from a study

by Raúl HinojosaOjeda and others and reports from the

Office of the U.S. Trade Representative.7

 Average U.S.

tariff rates were computed from data for calculated duties

and c.i.f. values of imports obtained from the ITC Web

site (which compiled them from Census Bureau data).

Mexican tariff rates before 1982 were not available, so the

tariff rate for all dates before 1982 was assumed to be con

stant and equal to its value in 1982. To allow for the possi

bility that the actual rate on those dates might have been

different from the value in 1982, was in

cluded in the longterm equilibrium export equation

(which, in turn, required including its first difference in

the dynamic errorcorrecting export equation).

 is equal to 1 for all dates before 1982 and

equal to 0 in that year and thereafter. Its inclusion effec

tively relaxes the assumption made about the tariff rate

before 1982. The rate is still assumed to be constant over

that period but may have a different value from the one

in 1982. If the actual tariff rate was less than the 1982

value, the coefficient on the variable should be positive.

If the actual rate was higher than the 1982 value, the

coefficient should be negative.

 is another variable made necessary by a

limitation of the available data. Many of the BLS price

indices that CBO used to construct the U.S. price indices

for imports and exports begin in or near 1980. Conse

quently, the aggregate indices constructed by CBO are

little different before 1980 from the BEA chainweighted

price indices for U.S. trade with the world as a whole.

That fact is not a problem for the index constructed for

exports to Mexico, because that index ended up being

almost identical to the BEA chainweighted index for U.S.

exports to the world as a whole even in years for which

most BLS price indices were available. That similarity is

not surprising because one would expect the exports of

any country to be determined in large part by what it

produces and therefore to be similar from export market

to export market, and one would further expect a given

exported good to have the same price (in the country from

which it is exported) regardless of its country of destina

tion. (The latter expectation is assumed by the method

ology that CBO used to construct the index.)

The same could not be said for the import price indices,

however. Mexico is a developing country, whereas most

U.S. trade is with industrialized countries. Consequently,

the mix of products that the United States imports from

Mexico is more laborintensive and more skewed toward

agriculture and natural resources (crude oil, for example)

than is the mix of U.S. imports from the world as a whole.

That difference was more pronounced in the 1970s and

early 1980s than in the 1990s and currently. That being

the case, one would expect that the prices of U.S. imports

from Mexico might behave differently over time from the

prices of U.S. imports from the world as a whole and that

the difference would probably be more pronounced in

the 1970s and early 1980s than in the 1990s and currently.

That expectation is backed up by graphical analysis. A

suitably constructed logarithmic plot indicated that CBO’s

price index for imports from Mexico and the BEA chain

weighted price index for imports from the world as a

whole grew at roughly the same rates from 1986 through

2001 and also from 1969 through 1980. However, they

grew at different rates from 1981 through 1985. A reason

able interpretation of those facts is that the respective

inflation rates were similar from 1986 through 2001 be

cause the large increase in Mexican exports of manufac

tured goods resulting from Mexico’s economic liberaliza

tion made the mix of U.S. imports from Mexico more

similar to U.S. imports from the world as a whole. Simi

larity of imports translates to similarity of price behavior.

Before 1986, the mix of U.S. imports from Mexico was

different from that of U.S. imports from the world as a

whole, which translates to different prices and quite likely

different inflation rates. The inflation rates presumably

were different from 1969 through 1980 also, but the index

constructed by CBO could not show that difference be

cause the lack of BLS indices before 1980 means that the

CBO index is nearly identical to the BEA chainweighted

index for those years.

7. Raúl HinojosaOjeda and others, The U.S. Employment Impacts

of North American Integration After NAFTA: A Partial Equilibrium

Approach (Los Angeles: North American Integration and Develop

ment Center, School of Public Policy and Social Research, Univer

sity of California at Los Angeles, January 2000); and Office of the

U.S. Trade Representative, Trade Policy Agenda and Annual Report

of the President of the United States on the Trade Agreements Program

(various years).
32 THE EFFECTS OF NAFTA ON U.S.-MEXICAN TRADE AND GDP

The problem with the CBO import index before 1980

enters the model in two places: the construction of the

tariffadjusted real exchange rates, and the deflation of

nominal imports from Mexico to real imports. Because

the problem relates to a constant rate of change over time,

it has the character of a spurious trend before 1980. To

capture that spurious trend and keep it from affecting the

various coefficient estimates and distorting the fit of the

model, was constructed and included in the

model. That variable consists of an upward time trend

from 1969 through the first quarter of 1980, at which

time its value is equal to zero. From that point on, its value

remains equal to zero.

Estimation of the Model

Because the behavior of U.S.Mexican trade changed in

the late 1980s (as described in Appendix C), CBO esti

mated two versions of its model. The first, or standard,

version was estimated over data from the first quarter of

1989 through the fourth quarter of 2001—entirely after

the change in behavior occurred. The variables

 and were unnecessary in that

version and were therefore excluded. Because the data set

for that version lies entirely after the change in behavior,

the model reflects the behavior of trade at the time

NAFTA went into effect.

The second, or alternative, version of the model was esti

mated over an earlier range: from the first quarter of 1970

through the fourth quarter of 1993. (The need to include

four lags of the first differences, which is discussed below,

prevented the use of observations in 1969.) That range

is entirely before NAFTA, so the alternative version of the

model is not subject to the criticism that major effects of

the agreement might have been built into it. To avoid any

question about effects of NAFTA possibly being built into

the model through the coefficient estimates, the true values

of leads of the first differences extending beyond 1993 into

the postNAFTA time period were replaced with the

average of the first differences of the same variables in

1993. The dummy variable was not needed for

the alternative version and was therefore excluded.

The two longterm equilibrium equations were estimated

by maximum likelihood with correction for firstorder

serial correlation in the error term. The dependent vari

ables and some of the independent variables in the equa

tions are actually determined by a simultaneousequations

system. Unlike the case of stationary time series, standard

singleequation estimation techniques such as ordinary

least squares or maximum likelihood give consistent results

even in simultaneousequations systems when the variables

are cointegrated.8

 That is, in the limit as the data sample

gets infinitely large, the coefficient estimates produced

by the techniques approach the true values of the co

efficients. 

Nevertheless, the estimates can be severely biased for finite

sample sizes, and the bias often declines slowly as the

sample size increases. The bias can be corrected, however,

by including leads and lags of the first differences of the

independent variables as additional independent explana

tory variables in the equations to be estimated.9

 The added

terms are used only during estimation of the longterm

equations; after that, the terms are removed before the

equations are used to produce longterm values for inser

tion into the dynamic errorcorrecting equations.

In accordance with that methodology, CBO included four

leads and four lags of the first differences of and

when estimating the equilibrium export equation

for 1970 through 1993, and it did the same for and

 in the equilibrium import equation for that time

period. The same procedure was tried with the equations

for 1989 through 2001, but the resulting decline in the

degrees of freedom resulted in large error bars and con

sequent nonsensical values for some of the coefficients.

In particular, the coefficient estimate for the real exchange

rate in the export equation had the wrong sign (but was

insignificantly different from zero), and the coefficient

estimates for the dummy variables in both equations were

negative (but insignificantly different from zero).

8. See John Y. Campbell and Pierre Perron, Pitfalls and Opportunities:

What Macroeconomists Should Know About Unit Roots, Technical

Working Paper No. 100 (Cambridge, Mass.: National Bureau of

Economic Research, April 1991), pp. 4748.

9. Ibid., p. 51.
APPENDIX A CBO’S MODEL OF U.S.-MEXICAN TRADE 33

The nonsensical values made it impossible to use the esti

mates in the model to achieve results that made any sense.

Therefore, the equations for 1989 through 2001 were esti

mated without the bias correction procedure. As a result,

the coefficient estimates for the real exchange rate may

be biased upward. The coefficients for the dummy vari

ables appeared to change in such a direction as to at least

partially offset the change in the coefficients for the real

exchange rates, however. Thus, the coefficient on the

tariffadjusted real exchange rate was larger without the

correction, which produced stronger estimated effects for

the tariff provisions of NAFTA; but the coefficients on

the dummy variables were smaller and, hence, produced

smaller estimated effects for the nontariff provisions. Con

sequently, the error in the estimated total effect of NAFTA

—if there is one—may be smaller than the error produced

by the bias in the real exchange rate coefficient.

The coefficient estimates and statistics, excluding those

for the leads and lags of the first differences, are shown

in Table A1. The values of R squared are included in the

tables, but their meaning in the 19701993 equations is

open to question because of the firstdifference variables.

The dynamic errorcorrecting equations were estimated

using ordinary least squares over the same time period

used for the longterm equations. The residuals calculated

from the longterm equations with the first differences

excluded were used for the lagged longterm error variable.

The equations were estimated first with a number of lags

of each variable that exceeded what seemed likely to be

needed, and the most distant lags were successively elimi

nated as dictated by their t statistics and their effects on

the adjusted R squared. The coincident value was similarly

eliminated as dictated. The coefficient estimates and statis

tics are shown in Table A2.
34 THE EFFECTS OF NAFTA ON U.S.-MEXICAN TRADE AND GDP

Table A-1.

Estimates and Statistics for Long-Term Equilibrium Equations 

for U.S.-Mexican Trade

1970-1993 1989-2001

Coefficient

Estimate

Standard

Error

t

Statistic

Probability

>|t|

Coefficient

Estimate

Standard

Error

t

Statistic

Probability

>|t|

U.S. Goods Exports to Mexico

Intercept 5.6541 1.5369 3.68 0.0004 3.8522 1.1571 3.33 0.0017

TREND 0.0259 0.0188 1.38 0.1730 0.0535 0.0102 5.24 <0.0001

CONST81 0.1207 0.0909 1.33 0.1886

ln(YMEX) 1.3662 0.3458 3.95 0.0002 1.5453 0.2411 6.41 <0.0001

ln(TEX

) 1.0254 0.1808 5.67 <0.0001 0.2691 0.0818 3.29 0.0019

NAFTA 0.0756 0.0370 2.04 0.0468

Serial Correlation of Error 0.7763 0.0769 10.10 <0.0001 0.6873 0.1230 5.59 <0.0001

Memorandum:

Degrees of Freedom 74 46

Regression R Squared 0.9126 0.9618

Total R Squared 0.9935 0.9951

Durbin-Watson 2.1523 2.0045

Probability >DurbinWatson 0.2849 0.6138

U.S. Goods Imports from Mexico (Excluding crude oil)

Intercept -15.4408 5.5635 -2.78 0.0070 -18.2128 5.6264 -3.24 0.0022

TREND 0.0805 0.0195 4.12 <0.0001 0.0585 0.0204 2.86 0.0063

TREND80 -0.1591 0.0163 -9.74 <0.0001

ln(YUS) 2.8774 0.6286 4.58 <0.0001 3.2464 0.6362 5.10 <0.0001

ln(TEM) -0.5303 0.1461 -3.63 0.0005 -0.1211 0.0705 -1.72 0.0925

NAFTA 0.0710 0.0348 2.04 0.0471

Serial Correlation of Error 0.3902 0.1078 -3.62 0.0005 0.6582 0.1337 4.92 <0.0001

Memorandum:

Degrees of Freedom 74 46

Regression R Squared 0.9852 0.9806

Total R Squared 0.9942 0.9973

Durbin-Watson 1.9880 1.7687

Probability >DurbinWatson 0.6627 0.8756

Source: Congressional Budget Office.
APPENDIX A CBO’S MODEL OF U.S.-MEXICAN TRADE 35

Table A-2.

Estimates and Statistics for Dynamic Error-Correcting Equations 

for U.S.-Mexican Trade

1970-1993 1989-2001

Coefficient

Estimate

Standard

Error

t

Statistic

Probability

>|t|

Coefficient

Estimate

Standard

Error

t

Statistic

Probability

>|t|

U.S. Goods Exports to Mexico

Intercept 0.0118 0.0076 1.57 0.1210 0.0191 0.0072 2.66 0.0110

)CONST81 0.1998 0.0635 3.15 0.0023

)ln(YMEX) Lag0 1.0643 0.2883 3.69 0.0004 1.5068 0.2922 5.16 <0.0001

)ln(YMEX) Lag1 0.4215 0.2837 1.49 0.1410 0.7556 0.2759 2.74 0.0089

)ln(TEX) Lag1 0.3819 0.1210 3.16 0.0022 0.2569 0.0763 3.37 0.0016

)ln(TEX) Lag2 0.3136 0.1164 2.69 0.0085 0.0076 0.0901 0.08 0.9327

)ln(TEX) Lag3 0.0638 0.1118 0.57 0.5697 -0.2766 0.0884 -3.13 0.0031

)ln(TEX) Lag4 -0.3317 0.1107 -3.00 0.0036

)NAFTA 0.0544 0.0353 1.54 0.1306

Lag1 -0.1800 0.0671 -2.68 0.0087 -0.1310 0.0682 -1.92 0.0613

Memorandum:

Degrees of Freedom 86 43

R Squared 0.5246 0.6854

Adjusted R Squared 0.4804 0.6341

Durbin-Watson 2.230 2.075

U.S. Goods Imports from Mexico (Excluding crude oil)

Intercept -0.0023 0.0123 -0.19 0.8535 0.0127 0.0106 1.19 0.2388

)TREND80 -0.0790 0.0584 -1.35 0.1794

)ln(YUS) Lag0 1.4513 0.7673 1.89 0.0619 2.9120 0.9321 3.12 0.0032

)ln(YUS) Lag1 0.7409 0.7876 0.94 0.3495 3.6955 0.8840 4.18 0.0001

)ln(YUS) Lag2 1.0489 0.7832 1.34 0.1840 -0.8290 0.9845 -0.84 0.4044

)ln(YUS) Lag3 0.4212 0.7902 0.53 0.5954 -1.0402 0.9203 -1.13 0.2646

)ln(YUS) Lag4 1.4357 0.7753 1.85 0.0675

)ln(TEM) Lag0 -0.3030 0.1300 -2.39 0.0188

)ln(TEM) Lag1 0.0977 0.0649 1.51 0.1393

)ln(TEM) Lag2 -0.0983 0.0665 -1.48 0.1467

Lag1 -0.6074 0.1031 -5.89 <0.0001 -0.2138 0.1083 -1.97 0.0548

Memorandum:

Degrees of Freedom 86 43

R Squared 0.2999 0.4729

Adjusted R Squared 0.2583 0.3870

Durbin-Watson 2.052 1.812

Source: Congressional Budget Office.

1970 1974 1978 1982 1986 1990 1994 1998

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

Exchange Rate Assuming

No Mexican Financial Crisis

Actual

Exchange

Rate

B

Assumptions for the Alternative Scenario

in Chapter Three

To determine the cause of the substantial decline

in the U.S. trade balance with Mexico since the North

American Free Trade Agreement went into effect, Chap

ter 3 compared two simulations from the Congressional

Budget Office’s model. A simulation produced using

actual historical values for the determinants—that is, for

the real exchange rates, the Mexican industrial production

index, and real U.S. gross domestic product—tracked the

actual decline in the trade balance reasonably closely.

However, when the actual values of the determinants were

modified to eliminate the late1994 peso crash, the associ

ated Mexican recession, the prolonged U.S. economic

expansion, and the U.S. and Mexican recessions in late

2000 and 2001, the resulting simulation showed essen

tially no decline in the trade balance. This appendix gives

the precise details of the assumed values that were used

for the second simulation.

For that simulation, the real value of the peso was assumed

to have remained constant from the fourth quarter of 1993

through the first quarter of 1999 (the last quarter before

the actual rate finally recovered to a level higher than the

value in the fourth quarter of 1993). After that, it was as

sumed to have equalled the real values that actually oc

curred (see Figure B1).1

Figure B-1.

Real Exchange Rate for U.S. Goods

Exports to Mexico Under

Alternative Scenarios

(In dollars per peso)

Source: Congressional Budget Office.

Notes: For information about how CBO calculated the real exchange rate, see

Figure 8 on page 13.

The dashed vertical line marks the beginning of the North American

Free Trade Agreement on January 1, 1994.

The Mexican industrial production index, rather than

taking the values it actually took after the fourth quarter

of 1993, was assumed to have grown over that period at

its average rate of growth from the fourth quarter of 1986

through the fourth quarter of 1993 (see Figure B2). The

starting point for that range was chosen because it was the

trough of the previous Mexican recession. The end of the

range was also close to a recession trough, so the average

1. To be precise, prices were assumed to have the values that they

actually had, and the nominal exchange rate was adjusted so that

the real exchange rate for exports remained constant. The same

nominal exchange rate was then used in the import equations,

which means that the real exchange rate for imports was not exactly

constant but was very close to being constant.

APPENDIX
38 THE EFFECTS OF NAFTA ON U.S.-MEXICAN TRADE AND GDP

1970 1974 1978 1982 1986 1990 1994 1998

0

50

100

150

Production Index Assuming

No Mexican Cyclical Fluctuations

Actual

Production

Index

1970 1974 1978 1982 1986 1990 1994 1998

0

2

4

6

8

10

Actual GDP

GDP

Assuming No

U.S. Cyclical

Fluctuations

Figure B-2.

Mexican Industrial Production

Index Under Alternative Scenarios

(Index, 1993 = 100)

Source: Congressional Budget Office. Actual values for the index come from

International Monetary Fund, International Financial Statistics.

Note: The dashed vertical line marks the beginning of the North American Free

Trade Agreement on January 1, 1994.

over the range gives the average growth rate over a business

cycle from trough to trough. The reasonableness of that

average for the alternative is supported by the fact that it

produces a path for the industrial production index after

1993 that looks very much like a trend about which the

actual index fluctuates.

U.S. GDP was assumed to have grown after 1993 at its

average rate of growth over the same time period used for

the Mexican industrial production index (see Figure B3).

That period includes the U.S. recession of 19901991 as

well as a number of years of economic expansion, so it

should have a reasonable average growth rate. The reason

ableness of the rate is bolstered by the fact that the result

ing assumed values of GDP are similar to the values that

actually occurred for several years after 1993, not deviating

significantly from them until 1997.

Figure B-3.

Real U.S. GDP Under Alternative

Scenarios

(In trillions of dollars)

Source: Congressional Budget Office. Actual values for gross domestic product

come from the Bureau of Economic Analysis.

Note: The dashed vertical line marks the beginning of the North American Free

Trade Agreement on January 1, 1994.
C

Results from the Model Estimated

Using Only Pre-NAFTA Data

The results and conclusions presented in Chapter 3

were produced using the Congressional Budget Office’s

model with parameters estimated over data from the first

quarter of 1989 through the last quarter of 2001 (referred

to in this appendix and in Appendix A as the standard

model or methodology). The 19892001 interval was

chosen for the standard model because of a shift in the

structure of production and trade across the U.S.Mexican

border that occurred in the late 1980s. Before the shift,

Mexico imported primarily intermediate goods for input

into the production of goods for its own domestic con

sumption by domestic manufacturers protected by high

tariffs, import quotas, and restrictions on foreign invest

ment. Its exports were heavily oriented toward mining

and agricultural products and crude oil. The shift con

sisted of a large increase in the importation of intermediate

goods for use in the production of finished goods for ex

port back to the United States.1

 The increase resulted from

U.S. and Mexican tariff preferences granted to such trade

and, more generally, from the Mexican trade and other

economic liberalization that began in the mid1980s, of

which NAFTA was a significant but comparatively small

and late part.2

 In effect, a portion of the production pro

cess for goods destined for U.S. consumers was shifted

to Mexico, creating new trade in the intermediate and final

goods involved.

The shift in production and trade caused significant

changes in the sensitivities of trade to its various determi

nants in the late 1980s. To ensure that the standard model

reflected the sensitivities that were current when NAFTA

went into effect, it was necessary to use only data from

after the shift. Further, the quantity of data between the

time of the shift and the beginning of NAFTA on January

1, 1994, was inadequate for estimating the parameters of

the model, necessitating the use of additional data from

the postNAFTA period.

The results from the standard model should be reasonably

accurate and reliable. However, some people might ques

tion whether the reason that the model accurately tracks

the substantial postNAFTA decline in the trade balance

over time—and thus attributes it to factors other than the

agreement—is that the use in the estimation procedure

of postNAFTA data containing the decline effectively

estimated it into the parameters of the model.3

 Although

1. See Raúl HinojosaOjeda and others, The U.S. Employment Impacts

of North American Integration After NAFTA: A Partial Equilibrium

Approach (Los Angeles: North American Integration and Develop

ment Center, School of Public Policy and Social Research, Uni

versity of California at Los Angeles, January 2000), pp. 4244 and

Figure 4.11.

2. The tariff preferences consisted of Mexico’s waiving of tariffs on

goods imported into Mexico for input into the production of goods

that were reexported, and the United States’ waiving of tariffs on

the percentage of the value of imports represented by components

produced in the United States.

3. More generally, although the effect is not likely to be large, NAFTA

could have changed the sensitivities of trade to its various determi

nants. Most of the data used for estimation being postNAFTA,

the parameter estimates reflect primarily the postNAFTA sensi

tivities. Consequently, to the extent that the effects of NAFTA

APPENDIX
40 THE EFFECTS OF NAFTA ON U.S.-MEXICAN TRADE AND GDP

economists might argue that that is not the reason, the

results would be more convincing if the data set used for

estimating the parameters did not include the decline.

In addition, one socalled dummy variable was used in

the standard methodology to capture the effects of non

tariff provisions of NAFTA over the entire eight years of

postNAFTA data. Because the agreement’s provisions

were phased in over time, there is no reason to expect that

the effects of the nontariff provisions would be unchang

ing throughout those eight years as the use of only one

such variable presumes. In principle, more dummy vari

ables could have been used, such as one for each post

NAFTA year or for each twoyear postNAFTA period.

However, the use of more than one dummy variable

resulted in large statistical error margins for the estimates

for those variables’ coefficients and produced nonsensical

results.4

To preclude any doubts, CBO repeated the analysis des

cribed in Chapter 3 using a slightly revised version of its

model (referred to as the alternative model or methodol

ogy). In that version, the parameters were estimated using

only preNAFTA data—specifically, data extending from

1970 through 1993.5

 The use of only preNAFTA data

eliminates the possibility of the estimation procedure’s

essentially customdesigning the model to predict the post

NAFTA decline in the trade balance and thereby attribute

the decline to factors other than NAFTA. It all but elimi

nates the possibility of any significant effects of NAFTA

being estimated into the model and consequently attrib

uted falsely to other factors.6

 It also eliminates the need

for any dummy variables for the effects of NAFTA’s non

tariff provisions and, in so doing, does away with the

problem that the standard methodology uses only one

dummy variable for the entire eightyear period after

NAFTA.

The alternative model can be used to produce simulations

of what trade would have been in the absence of NAFTA

and of what it would have been with NAFTA’s tariff re

ductions but none of the agreement’s other provisions.

However, because the model has no dummy variables to

capture the effects of nontariff provisions, it cannot pro

duce simulations of trade in the presence of all of

NAFTA’s provisions. Consequently, the method used to

determine the effects of NAFTA with the standard model

must be modified slightly for the alternative model. The

procedure with the standard model was to compare the

model’s prediction of trade in the absence of NAFTA with

take the form of changes in sensitivities of trade to its determinants,

the model will confound some of the effects of NAFTA with the

effects of changes in the exchange rate, prices, or other determinants

of trade that occurred for reasons other than NAFTA.

4. As a matter of theory, the coefficient of each succeeding dummy

variable over time should be as large as or larger than the coefficient

of the dummy variable preceding it to reflect the fact that trade

restrictions are being progressively liberalized over time, resulting

in more trade. Because of the large statistical error in the estimates,

that result was not the case for some of the variables, with notice

able effects on the simulations.

5. The revisions consisted of eliminating the dummy variable, which

is needed only for (and can be estimated only with) postNAFTA

data, and including variables to offset certain problems with the

data prior to 1981.

6. NAFTA could nevertheless affect the estimated coefficients of the

model, but the effects would be extremely small—much too small

to make the model predict the postNAFTA decline in the trade

balance and attribute it to other factors if that decline were indeed

caused by NAFTA. Before the agreement became effective, the

knowledge that it would soon do so undoubtedly led to increased

investment flows between the United States and Mexico. Those

investment flows would have raised the real value of the peso

relative to the dollar and thereby increased Mexican demand for

U.S. exports and reduced U.S. demand for imports from Mexico.

However, that effect would not have significantly altered the sensi

tivities of exports and imports to the real value of the peso or to

the real values of U.S. and Mexican incomes, which are the para

meters of the model estimated from the data. The investment flows

would also have increased Mexican demand for investment goods.

Depending on how much of the higher demand was satisfied by

U.S. exports to Mexico, that effect could have raised slightly the

level of U.S. exports to Mexico estimated into the model for given

levels of the real value of the peso and real Mexican income. That

effect might lead the model to underestimate very slightly NAFTA’s

positive effect on exports. There should be no significant effect

on the sensitivities of trade to the value of the peso and Mexican

income. Whatever slight effects NAFTA might have had on coeffi

cients of the model by any of those mechanisms would be made

even smaller by the fact that expectations of the coming agreement

would have had significant effects on investment flows only in the

last two to four years of the 24year estimation period. Thus, the

coefficients overwhelmingly reflect the behavior of trade before

those expectations became significant.
APPENDIX C RESULTS FROM THE MODEL ESTIMATED USING ONLY PRE-NAFTA DATA 41

1989 1993 1997 2001

0

50

100

150

1989 1993 1997 2001

0

50

100

150

Model with

Only NAFTA's

Tariff Reductions

Actual

Exports

Imports

Model

Without NAFTA

Actual

Model

Without NAFTA

Model with

Only NAFTA's

Tariff Reductions

its prediction of trade in the presence of NAFTA. With

the alternative model, the prediction of trade in the ab

sence of NAFTA must be compared with the actual his

torical trade in the presence of NAFTA.

Built into the standard methodology was the assumption

that NAFTA did not affect the real exchange rates, real

U.S. gross domestic product, and the Mexican industrial

production index. That assumption is not built into the

alternative methodology, but some assumption must be

made about the values of those variables in the absence

of NAFTA in order to make projections of what trade

would have been. CBO chose the same assumption that

was built into the standard methodology. That assumption

has the same implications for the results of the alternative

methodology as it does for the results of the standard

methodology (implications that are discussed in Chapter 3

and Appendix D).

Also like the standard methodology, the alternative

methodology assumes that trade barriers in the absence

of NAFTA would have remained constant at their 1993

levels. The implications of that assumption are the same

for the results presented below as they are for the results

of the standard methodology (also discussed in Chapter 3).

The Effects of NAFTA on

U.S.-Mexican Trade

Most of the years over which the parameters of the alterna

tive model were estimated predate the shift in production

and trade structure, so the model reflects primarily the

preshift sensitivities of U.S.Mexican trade to its various

determinants. Therefore, simulations from that model

track the postNAFTA fluctuations in trade a little less

accurately, and are a little more difficult to interpret, than

those from the standard model. Nevertheless, properly

interpreted, the simulations largely support and strengthen

the conclusions presented in Chapter 3.

Effects on Exports and Imports

Simulations from the alternative model indicate that,

except for imports during a short period from early 1995

to early 1996, both exports and imports have been higher

by increasing amounts over time than the model predicts

Figure C-1.

U.S. Goods Trade with Mexico by

CBO’s Alternative Methodology

(In billions of dollars)

Source: Congressional Budget Office using data from the Bureau of the Census

for actual values and projections from CBO’s model for other values.

Note: The dashed vertical lines mark the beginning of the North American Free

Trade Agreement on January 1, 1994.

they would have been in the absence of NAFTA (see Fig

ure C1). The implied effects of NAFTA are a bit larger

than those indicated by the simulations from the standard

model; nevertheless, the simulations from the alternative

model, like those from the standard model, indicate that

the vast bulk of the increases in trade since NAFTA have

happened for reasons other than the agreement. Eighty

percent of the growth in annual goods exports to Mexico

from 1993 to 2001 and 90 percent of the growth in an

nual goods imports from Mexico over the same period
42 THE EFFECTS OF NAFTA ON U.S.-MEXICAN TRADE AND GDP

would have occurred even if NAFTA had not been imple

mented. The corresponding percentages for the standard

model were 85 percent and 91 percent, respectively.

Although the alternative model does not track the fluc

tuations in trade over time as well as the standard model

does, the fluctuations that have actually happened in the

presence of NAFTA have nevertheless been similar to those

that the alternative model indicates would have occurred

in the absence of NAFTA with two exceptions. The first

exception is that the model indicates a larger decline in

exports with the peso crash and Mexican recession, and

a larger rise in imports, than actually occurred. The second

exception is that the model indicates a less severe drop in

exports in 2001 than actually occurred.

The exceptions can be explained, at least qualitatively, by

the shift in the structure of U.S.Mexican production and

trade in the late 1980s. One would expect the shift to

(among other things) make both U.S. exports to and im

ports from Mexico less sensitive to the exchange rate and

to other price variables such as tariffs. Imports would be

come less sensitive because the exchange rate would affect

the cost of only that portion of the final product price in

the United States that results from the cost of assembly

in Mexico and not the portion that represents the cost of

the components made in the United States and exported

to Mexico.

Exports would become less sensitive because Mexican de

mand for them would become dependent primarily on

U.S. demand for the final product exported back to the

United States rather than on the exchange rate, and as just

stated, U.S. demand for imports of that final product

would become less sensitive to the exchange rate. Further

more, what little effect would arise in that manner would

be in the opposite direction to the previous effect of ex

change rates on Mexican demand for U.S. exports. A rise

in the value of the peso would slightly reduce U.S. de

mand for imports from Mexico, which in turn would

lower Mexico’s demand for U.S. exports. Previously, one

would have expected a rise in the peso to have made U.S.

exports less expensive to Mexico and therefore cause them

to increase. That effect undoubtedly still occurs for the

portion of exports not destined for use in products that

will be exported back to the United States. However, it

is offset to some degree by the negative effect on exports

that are so destined, reducing the sensitivity of exports to

the exchange rate. Both the United States and Mexico give

substantial tariff breaks on trade in which U.S.made

intermediate goods are shipped to Mexico for assembly

and then shipped back to the United States, so the sensi

tivity of trade to tariff changes would also be reduced.

The alternative model reflects mainly the earlier, higher

sensitivities of exports and imports to the real exchange

rate. Those higher sensitivities explain, at least qualita

tively, the two exceptions discussed above. First, the higher

sensitivities of both exports and imports explain why the

model projects a larger decline in exports and increase in

imports than actually occurred in 1995 and 1996 with

the peso crash and associated Mexican recession.7

 Second,

the higher sensitivity of exports explains why the model

underpredicts the downturn of exports resulting from the

Mexican recession of late 2000 and 2001. During that

period, the real exchange rate rose significantly while the

Mexican industrial production index declined. The

model’s overreaction to the rise in the real exchange rate

(which, all else being equal, would make exports rise) off

sets the fall in exports resulting from the decline in the

7. An additional factor that is attributable to NAFTA may contribute

to the model’s prediction of a larger decline in exports than actually

occurred in 1995 and 1996. During that period, Mexico raised

tariffs significantly on imports from other countries but did not

do so for imports from the United States and Canada because of

the agreement. The resulting reduction of international competition

for U.S. and Canadian producers means that U.S. and Canadian

exports probably fell less than they would have otherwise. Had a

good price index for competing goods in the Mexican market been

available to include in the CBO model, that index would likely

have risen because of the reduced competition and thereby led the

model to predict that effect. However, the best Mexican price index

available for use in the model was the wholesale price index, which

probably was not accurate enough to pick up the effect. It is doubt

ful that the effect was very large because the vast bulk of Mexican

imports already came from the United States before the tariff

increase. In principle, the effect should show up in the simulations

from the standard model as well, but in fact it is not noticeable

in them. One reason might be that the effect is too small to be

noticeable. Alternatively, the estimation of the standard model

using data that includes the decline may have served to fit the

model to the smaller net decline that resulted from the super

position of the effect on the larger decline that would otherwise

have happened if Mexico had not raised tariffs on other countries.

If so, even a large effect would not appear as a difference between

actual imports and simulations from the model.
APPENDIX C RESULTS FROM THE MODEL ESTIMATED USING ONLY PRE-NAFTA DATA 43

industrial production index. Consequently, the rise in

exports predicted by the model merely decelerates rather

than reversing into a downturn as exports actually did.

Excluding the exceptions just discussed, exports and im

ports have both been higher by gradually increasing

amounts since NAFTA went into effect than the alterna

tive model predicts they would have been in the absence

of NAFTA, and the amount by which they have been

higher is a bit larger than was the case for the standard

model. Those increments to trade indicated by the alterna

tive model may be only partially attributable to NAFTA,

however. The reason is that they may contain increases

in trade resulting from the shift in the structure of produc

tion and trade in the late 1980s. In addition to changing

the sensitivities of U.S.Mexican trade to its various deter

minants, the shift caused increases in both exports and

imports for given values of those determinants. Most of

the data used to estimate the parameters of the alternative

model preceded the shift in trade structure, so the model

reflects primarily the lower levels of trade for given values

of the determinants that existed before the shift. Therefore,

as an estimate of the effects of NAFTA, the difference be

tween the “Actual” and “Model Without NAFTA” lines

in Figure C1 may tend to be too large.

Further support for the notion that the difference between

those two lines is too large comes from the third line in

the figure, labeled “Model with Only NAFTA’s Tariff

Reductions.” The difference between that line and the one

labeled “Model Without NAFTA” represents the effect

on trade of the tariff reductions. That effect is only a small

part of the difference between “Actual” and “Model With

out NAFTA” in each panel of the figure. The rest—the

difference between “Actual” and “Model with Only

NAFTA’s Tariff Reductions”—represents the changes in

trade resulting from NAFTA’s other provisions (elimina

tion of trade quotas and investment restrictions) and some

portion of the rise resulting from the shift in the produc

tion and trade structure.

It was not possible to determine precisely how much of

the difference between “Actual” and “Model with Only

NAFTA’s Tariff Reductions” results from NAFTA’s elimi

nation of trade quotas and investment restrictions and how

much results from the change in the production and trade

structure or perhaps other causes. However, given the

comparatively small size of the effects of NAFTA’s tariff

reductions, it would seem unlikely that the effects of

NAFTA’s elimination of trade quotas and investment

restrictions would make up very much of the difference.

That possibility would appear even more unlikely when

one considers that the estimated effects of the NAFTA

tariff reductions are probably too large because the model

reflects mainly the earlier, higher sensitivities of trade to

relative price variables such as the real exchange rate and

tariffs. It would be still more unlikely in the case of im

ports because the United States had very little in the way

of trade quotas and investment restrictions for NAFTA

to eliminate.

By the alternative methodology, exports were 10.4 percent

higher in 1994 than they would have been in the absence

of NAFTA, ranged between 26 percent and 34 percent

higher from 1995 through 2000, and were 13.2 percent

higher in 2001 (see Table C1). In dollar terms, they were

$4.8 billion (or 0.07 percent of GDP) higher in 1994 and

rose gradually to $25.4 billion (0.29 percent of GDP)

higher by 2000 before easing back to $11.8 billion (0.13

percent of GDP) higher in 2001.

Correcting for the change in sensitivity of exports to the

real exchange rate would change the pattern of the esti

mates over time to something more like a smooth upward

trend, although there might be some decline in the last

year with the recession. The increases would range from

a little over 10 percent (roughly $5 billion, or 0.07 percent

of GDP) in 1994 to roughly 25 percent to 30 percent

(about $22 billion to $26 billion, or 0.25 percent to

0.30 percent of GDP) in 2001. Those numbers are mostly

in a range of roughly 2.5 to 5 times the size of the effects

estimated by the standard methodology. However, as

noted above, they may include not only the effects of

NAFTA but also some portion of the increases resulting

from the shift in the structure of production and trade

in the late 1980s.

Imports were also generally higher by the alternative

methodology than they would have been without NAFTA,

but by a smaller amount than was the case for exports.

They were 5.2 percent higher in 1994, fell to 4.7 percent

lower in 1995, and then rose gradually to 14.6 percent

higher in 2000 before falling back to 8.6 percent higher

(see Table C1). In dollar terms, they were $2.5 billion (or
44 THE EFFECTS OF NAFTA ON U.S.-MEXICAN TRADE AND GDP

Table C-1.

Effects of NAFTA on U.S. Goods Exports to and Imports from Mexico

by CBO’s Standard and Alternative Methodologies

Effects in Billions of Dollars Effects in Percent

Effects as a Percentage

of U.S. GDP

Exports Imports Exports Imports Exports Imports

Standard Methodology

1994 1.1 0.9 2.2 1.9 0.016 0.014

1995 2.0 2.9 4.7 4.9 0.029 0.040

1996 3.8 4.2 7.2 6.1 0.052 0.057

1997 5.6 5.4 8.6 6.8 0.074 0.071

1998 6.9 6.4 9.5 7.2 0.086 0.080

1999 8.4 7.5 10.8 7.4 0.101 0.090

2000 10.4 9.1 10.3 7.2 0.120 0.105

2001 10.3 9.4 11.3 7.7 0.118 0.107

Alternative Methodologya

1994 4.8 2.5 10.4 5.2 0.069 0.036

1995 10.8 -3.0 31.3 -4.7 0.152 -0.043

1996 14.4 2.7 34.0 3.8 0.196 0.037

1997 17.9 6.4 33.5 8.0 0.233 0.083

1998 18.3 7.7 30.1 8.9 0.228 0.097

1999 17.9 11.5 25.9 11.8 0.215 0.139

2000 25.4 17.4 29.4 14.6 0.293 0.200

2001 11.8 10.4 13.2 8.6 0.135 0.118

Source: Congressional Budget Office.

Note: By the standard methodology, effects are calculated as the difference, averaged year by year, between the lines labeled “Model with NAFTA” and “Model Without

NAFTA” in Figure 11. By the alternative methodology, effects are calculated as the difference, averaged year by year, between the lines labeled “Actual” and “Model

Without NAFTA” in Figure C-1.

a. Not corrected for the production and trade shift that occurred in the late 1980s.

0.04 percent of GDP) higher in 1994, fell to $3.0 billion

(0.04 percent of GDP) lower in 1995, and then climbed

to $17.4 billion (0.20 percent of GDP) higher in 2000

before slackening to $10.4 billion (0.12 percent of GDP)

in 2001.

Correcting for the change in the sensitivity of imports to

the real exchange rate would lead to a more smoothly in

creasing positive effect of NAFTA on imports, although

there might be some decline in 2001 with the recession.

The increases would range from close to 5.2 percent

(roughly $2.5 billion, or 0.04 percent of GDP) in 1994

to roughly 12 percent to 15 percent (about $14 billion

to $18 billion, or 0.16 percent to 0.21 percent of GDP)

in 2001. Those numbers are mostly in a range of roughly

1.5 to 3 times the size of the effects estimated by the

standard methodology. Again, they may reflect not only

the effects of NAFTA but also part of the increases result

ing from the shift in production and trade structure in

the late 1980s.

Effects on the Trade Balance with Mexico

Like the results of the standard methodology, the results

of the alternative methodology indicate that NAFTA has

had a positive effect on the U.S. goods trade balance with

Mexico (as shown by the difference between the “Actual”

and “Model Without NAFTA” lines in Figure C2). The

effect is larger than that indicated by the standard method

ology and positive in every year rather than in six of the

eight postNAFTA years. Nevertheless, the cumulative
APPENDIX C RESULTS FROM THE MODEL ESTIMATED USING ONLY PRE-NAFTA DATA 45

1989 1993 1997 2001

-40

-30

-20

-10

0

10

Actual

Model

Without NAFTA

Model with

Only NAFTA's

Tariff Reductions

Figure C-2.

U.S. Goods Trade Balance with

Mexico by CBO’s Alternative

Methodology

(In billions of dollars)

Source: Congressional Budget Office using data from the Bureau of the Census

for the actual trade balance and projections from CBO’s model for

other trade balances.

Note: The dashed vertical line marks the beginning of the North American Free

Trade Agreement on January 1, 1994.

effect over the eight years is comparatively small. The al

ternative methodology indicates that NAFTA reduced the

cumulative decline in the annual goods trade balance from

1993 through 2001 by 7.4 percent. The comparable figure

by the standard methodology was 2.5 percent.

Other than being higher in all postNAFTA years, the

path of the actual trade balance over time is similar to that

of the balance in the absence of NAFTA as projected by

the alternative model with two exceptions. First, the model

indicates a larger decline in the trade balance in 1995 than

actually occurred, with the indicated balance remaining

substantially lower than the actual balance for several years.

Second, the model indicates an increase in the trade bal

ance in 2001, whereas the trade balance actually continued

to decline.

Those two exceptions correspond to the two exceptions

discussed above in relation to exports and imports; hence,

they are at least qualitatively explainable by the same factor

—the shift in the structure of U.S.Mexican production

and trade. As noted above, the alternative model predicts

a larger decline in exports and larger rise in imports than

actually occurred. It follows that it predicts a larger decline

in the trade balance than actually occurred. The model

indicates only a slowing of the growth of exports in 2001

rather than the decline that actually took place. It follows

that it would also predict a smaller decline in the trade

balance than actually happened, or that it might even

predict an increase. Excluding those two exceptions, one

is left with a gradually increasing positive difference be

tween what the trade balance actually was with NAFTA

and what the model indicates the balance would have been

in the absence of NAFTA.

Although the estimated effects of NAFTA on both exports

and imports may be too high because of the inclusion of

increases resulting from the shift in production and trade

structure, the same is not necessarily the case for the esti

mated effects on the trade balance. When imports are sub

tracted from exports to obtain the balance, the error in

the imports tends to cancel out the error in the exports.

The errors may or may not cancel each other exactly. If

they do, then the trade balance in the absence of NAFTA

as projected by the model is correct, and so are the esti

mated effects of NAFTA as calculated by the standard

methodology. If they do not, then the trade balance pro

jected by the model is somewhat in error in one direction

or the other (depending on the relative magnitudes of the

export and import errors), and so are the estimated effects

of NAFTA on the trade balance by the alternative method

ology.

By the uncorrected alternative methodology, NAFTA in

creased the U.S. goods trade balance with Mexico by

$2.3 billion (0.03 percent of GDP) in 1994; by a much

larger $13.8 billion (0.19 percent of GDP) in 1995; by

smaller amounts declining slowly to $8.1 billion (0.09

percent of GDP) in 2000; and by only $1.4 billion (0.02

percent of GDP) in 2001 (see Table C2). Correcting for

the changes in trade sensitivities resulting from the shift

in production and trade structure would at least partially,

and perhaps completely, smooth out the fluctuations in

the estimates. The result would be an upward and possibly

smooth trend over time from roughly $2 billion (0.03

percent of GDP) in 1994 to roughly $5 billion to $10 bil

lion (in the neighborhood of 0.1 percent of GDP) in

2001. The positive effects from 1995 through 1997 would

be substantially smaller than those in Table C2, and the

decline in 2001, if any, would also be much smaller than
46 THE EFFECTS OF NAFTA ON U.S.-MEXICAN TRADE AND GDP

1989 1993 1997 2001

-40

-30

-20

-10

0

10

20

Actual

Model with Only NAFTA's Tariff Reductions, Excluding

Cyclical Fluctuations and Mexican Financial Crisis

Model with

Only NAFTA's

Tariff Reductions

Table C-2.

Effects of NAFTA on the U.S. Goods Trade Balance with Mexico

by CBO’s Standard and Alternative Methodologies

Standard Methodology Alternative Methodologya

Effects in Billions

of Dollars

Effects as a Percentage

of U.S. GDP

Effects in Billions

of Dollars

Effects as a Percentage

of U.S. GDP

1994 0.1 0.002 2.3 0.033

1995 -0.8 -0.012 13.8 0.195

1996 -0.4 -0.006 11.7 0.159

1997 0.2 0.003 11.5 0.150

1998 0.5 0.006 10.5 0.132

1999 0.9 0.011 6.3 0.076

2000 1.3 0.015 8.1 0.093

2001 0.9 0.010 1.4 0.017

Source: Congressional Budget Office.

Note: By the standard methodology, effects are calculated as the difference, averaged by year, between the lines labeled “Model with NAFTA” and “Model Without NAFTA”

in Figure 11. By the alternative methodology, effects are calculated as the difference, averaged year by year, between the lines labeled “Actual” and “Model Without

NAFTA” in Figure C-2.

a. Not corrected for the production and trade shift that occurred in the late 1980s.

that in the table. The effects in all years (with the possible

exception of 2001) would be larger than those indicated

by the standard methodology.

Simulations from the alternative model support the con

clusion from the standard model that the substantial de

cline in the U.S. goods trade balance with Mexico is

explained by the Mexican financial crisis and U.S. and

Mexican cyclical fluctuations (see Figure C3). As noted

above, the alternative model cannot make projections of

the balance in the presence of all of the provisions of

NAFTA. Therefore, the simulations of the balance with

NAFTA under the two scenarios in Figure 12 in Chapter 3

must be replaced with simulations of the balance with

NAFTA tariff reductions under the two scenarios. That

being the case, the effects of NAFTA’s nontariff provisions

are excluded. Because Mexico had more nontariff trade

barriers to eliminate than did the United States when

NAFTA began, including those effects should increase

the positive effect of NAFTA on the balance and thereby

strengthen the results presented here.

Note that under the scenario with no Mexican financial

crisis and no U.S. or Mexican cyclical fluctuations, the

decline in the trade balance is mostly eliminated and the

balance actually recovers by the end of 2001 to a level

Figure C-3.

U.S. Goods Trade Balance with

Mexico Under Alternative Scenarios

by CBO’s Alternative Methodology

(In billions of dollars)

Source: Congressional Budget Office using data from the Bureau of the Census

for the actual trade balance and projections from CBO’s model for

other trade balances.

Note: The dashed vertical line marks the beginning of the North American Free

Trade Agreement on January 1, 1994.

higher than the one it had just before NAFTA went into

effect. The drastic decline in 1995 is completely elimi
APPENDIX C RESULTS FROM THE MODEL ESTIMATED USING ONLY PRE-NAFTA DATA 47

1989 1993 1997 2001

-40

-30

-20

-10

0

10

20

30

40

Actual

Actual Adjusted to Exclude

Effects of Cyclical

Fluctuations and

Mexican Financial Crisis

Figure C-4.

Actual U.S. Goods Trade Balance with

Mexico Under Alternative Scenarios

by CBO’s Alternative Methodology

(In billions of dollars)

Source: Congressional Budget Office using data from the Bureau of the Census

for the actual balance and calculations based on the census data and

projections from CBO’s model for the adjusted actual balance.

Note: The dashed vertical line marks the beginning of the North American Free

Trade Agreement on January 1, 1994.

nated, and the balance drifts downward only slowly to

roughly a $10 billion deficit by the end of 1998. It re

mains near that level for two years and then recovers to

surpluses in 2001. The $10 billion deficits projected for

1999 and 2000 are roughly onehalf to onethird of the

deficits that actually prevailed in those years and, similarly,

onehalf to onethird of the deficits projected by the model

for the scenario with the actual historical values of the real

exchange rate, U.S. GDP, and the Mexican industrial

production index. Other simulations (not shown), in

which slower growth of U.S. GDP was assumed, produced

higher trade balances than those presented here.

Another way of viewing what the trade balance would have

looked like in the absence of the Mexican financial crisis

and the U.S. and Mexican cyclical fluctuations is to adjust

the actual balance over time by the difference between the

lines for the two model solutions in Figure C3 to create

what could be called “Actual Balance Adjusted to Exclude

Effects of Cyclical Fluctuations and Mexican Financial

Crisis ” (see Figure C4). That measure does not drop into

deficit until mid1998, and even then the deficits that it

indicates remain substantially smaller than those that

actually prevailed in the presence of the Mexican financial

crisis and the U.S. and Mexican cyclical fluctuations.

The substantial rise in the balance in 1995 and 1996 by

that measure is undoubtedly a figment of the fact that the

model reflects the higher sensitivities of trade to the real

exchange rate that prevailed before the shift in production

and trade structure in the late 1980s. As already noted,

those higher sensitivities cause the model to project too

large a decline in the balance in response to the peso crash

and associated Mexican recession. As a result, the differ

ence between the projections with and without the crash

and recession is too large, causing the adjusted actual bal

ance to be too high.

Another effect of the model’s incorporation of the older,

higher sensitivity to the real exchange rate is that other

Table C-3.

Effects of NAFTA on U.S. Gross

Domestic Product by CBO’s Standard

and Alternative Methodologies

Effects in

Billions of Dollars

Effects in

Percent

Standard Methodology

1994 0.1 - 0.4 0.001 - 0.005

1995 0.1 - 0.7 0.001 - 0.010

1996 0.2 - 1.3 0.002 - 0.018

1997 0.3 - 2.0 0.004 - 0.026

1998 0.3 - 2.4 0.004 - 0.030

1999 0.4 - 3.0 0.005 - 0.035

2000 0.5 - 3.6 0.006 - 0.042

2001 0.5 - 3.6 0.006 - 0.041

Alternative Methodologya

1994 0.2 - 1.7 0.003 - 0.024

1995 0.5 - 3.8 0.008 - 0.053

1996 0.7 - 5.0 0.010 - 0.069

1997 0.9 - 6.3 0.012 - 0.082

1998 0.9 - 6.4 0.011 - 0.080

1999 0.9 - 6.3 0.011 - 0.075

2000 1.3 - 8.9 0.015 - 0.103

2001 0.6 - 4.1 0.007 - 0.047

Source: Congressional Budget Office.

a. Not corrected for the production and trade shift that occurred in the late

1980s.
48 THE EFFECTS OF NAFTA ON U.S.-MEXICAN TRADE AND GDP

simulations (not shown) do not indicate that the peso

crash itself had a comparatively minor effect on the trade

balance as it did according to the simulations from the

standard methodology. Rather, they indicate that the real

exchange rate and U.S. and Mexican cyclical fluctuations

all played significant roles in the decline of the trade

balance.

The Effects of NAFTA on U.S. GDP

Even more than was the case for the standard methodol

ogy, a precise estimate of the effects of NAFTA on U.S.

GDP is not possible using the alternative methodology—

only an orderofmagnitude estimate can be obtained.

Applying the range of cost ratios used with the standard

methodology—somewhere between 5 cents and 35 cents

for each $1 loss of exports—to NAFTA’s effects on exports

as estimated by the alternative model gives increases in

annual U.S. GDP of a few billion dollars, or a few hund

redths of a percent (see Table C3 on page 47). Because the

estimates of effects on exports by the alternative method

ology were mostly in a range of roughly 2.5 to 5 times

the estimates by the standard methodology, the same is

true for the estimates of effects on GDP. Excluding the

increases in exports that resulted from the shift in produc

tion and trade structure would most likely lower the esti

mates presented in Table C3.
D

Effects of the Assumption

About the Real Exchange Rates

and Incomes in the Absence of NAFTA

Producing simulations of exports and imports in the

absence of the North American Free Trade Agreement

requires making an assumption about what the values of

the real dollar/peso exchange rates, real U.S. gross domes

tic product, and the Mexican industrial production index

would have been in the absence of the agreement. The as

sumption used in this paper is that those variables would

have had the same values in the absence of NAFTA that

they actually had in the presence of NAFTA. In general,

one would expect NAFTA to have affected the real ex

change rates, U.S. GDP, and Mexican industrial produc

tion by amounts that are not precisely known. However,

the true values of those variables in the absence of NAFTA

should not be far different from the values in the presence

of NAFTA, and the error introduced by using the latter

values in place of the former should be very small. In the

case of exports, the error should be such as to attribute

smaller positive effects to NAFTA than it actually has had.

In the case of the trade balance, the error should cause the

effects attributed to NAFTA to be less positive or more

negative than the agreement’s actual effects. The direction

of the error for imports is unclear.

The effects of the assumption with regard to GDP and

industrial production can be dispensed with fairly quickly.

The effects of NAFTA on the real incomes of the United

States and Mexico are both positive, which means that

the actual effects of NAFTA on both U.S. exports to

Mexico and imports from Mexico are larger than those

indicated by the model with the assumption that NAFTA

had no effect on U.S. GDP and Mexican industrial pro

duction (since increased Mexican industrial production

causes higher Mexican demand for U.S. exports and in

creased U.S. GDP causes higher U.S. demand for im

ports). The increase in U.S. GDP is very small—less than

1 percent. Consequently, the effect of that increase on

U.S.Mexican trade is trivially small and would not even

be visible in the simulation plots in this paper. (Simulation

plots relating to exports would not be affected because

U.S. exports are not a function of U.S. GDP.)

The predicted effect of NAFTA on Mexican income is

larger in percentage terms than is the predicted effect on

U.S. income. Just before NAFTA went into effect, predic

tions from models were that the agreement would increase

Mexican real GDP by amounts ranging from 3 percent

to 121⁄2 percent (excluding cumulative effects on growth

rates of productivity over long periods of time), and

growth of industrial production should not be drastically

different from growth of real GDP.1

 The predictions for

GDP concerned equilibrium effects over a longer period

of time than has yet elapsed, so the actual effects to date

are probably smaller. Nevertheless, the actual effects on

GDP, and hence on industrial production, might in turn

produce effects on U.S. exports to Mexico and therefore

on the trade balance with Mexico that might be visible

1. See Congressional Budget Office, Estimating the Effects of NAFTA:

An Assessment of the Economic Models and Other Empirical Studies

(June 1993), p. 5.

APPENDIX
50 THE EFFECTS OF NAFTA ON U.S.-MEXICAN TRADE AND GDP

in simulation plots in this paper. They should not be large,

however.

Because the NAFTAinduced increase in Mexican indus

trial production has a larger positive effect on U.S. exports

to Mexico than the NAFTAinduced increase in U.S.

GDP has on U.S. imports from Mexico, the net result

of considering those increases would be to project larger

positive effects of NAFTA on the U.S. trade balance with

Mexico than are projected under the assumption used (and

to reduce or eliminate any negative effects projected under

that assumption).

The analysis of the real exchange rates is a little more com

plicated, but the effect of NAFTA on the real value of the

peso is also most likely positive. The increase in the trade

balance indicated by the model as an effect of NAFTA

would cause an increase in the demand for the dollar rela

tive to the peso and therefore put downward pressure on

the real value of the peso. However, NAFTA’s elimination

of Mexican restrictions on foreign investment would mean

more investment flows going into Mexico, which would

increase the demand for the peso relative to the dollar and

therefore put upward pressure on the peso.

Overall, one would expect NAFTA and the preceding

trade and other economic liberalization in Mexico to lead

to morerapid economic development and improve the

attractiveness of Mexico as a place to invest. Developing

countries that begin to grow rapidly usually see their in

vestment rise faster than their saving, leading to increases

in inflowing foreign investment that cause their real ex

change rates to rise and put downward pressure on their

trade balances. Except for the extremely aberrant years of

the peso crash and subsequent Mexican recession, market

pressures have indeed been pushing the real value of the

peso steadily higher over the past 15 years. From 1997

through 2001, it was at record high levels and continuing

to rise.

If NAFTA has indeed increased the real value of the peso,

that increase has caused a rise in U.S. exports to Mexico,

a decline in U.S. imports from Mexico, and an increase

in the U.S. trade balance with Mexico (all three relative

to what they would have been without the real increase

in the peso). Those effects of NAFTA would not be cap

tured by CBO’s methodology.

Since NAFTA’s effects on the real exchange rates and its

combined effects on U.S. GDP and Mexican industrial

production both lead to larger effects on U.S. exports to

Mexico and on the trade balance with Mexico, it can be

said with reasonable confidence that NAFTA’s actual ef

fects on exports and the trade balance are larger (or, in

the case of negative effects on the balance, less negative

or even positive) than those projected by the model with

the assumption of no effects of NAFTA on GDP and the

real exchange rates. Since the effects of NAFTA on GDP

and the real exchange rates have effects on U.S. imports

from Mexico that go in opposite directions, it is unclear

whether the actual effects of NAFTA on imports are larger

than, smaller than, or the same as those projected by the

model with the assumption of no effects on GDP and the

real exchange rates.

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