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Thoughts on a Free Trade Agreement with Mexico

By

Jock O'Connell

(This article originally appeared in the Sacramento Bee Forum section on Sunday, June 3, 1990.)

In a politically risky departure from traditional policy, Mexico's President Carlos Salinas de Gortari revealed in March his interest in negotiating a free trade agreement with the United States. It is a highly controversial step which will certainly bear close watching by border states like California and by industries such as agriculture, where the impact of any agreement is apt to be especially pervasive.

A U.S.-Mexico accord would likely resemble a limited version of the Free Trade Agreement (FTA) signed by the United States and Canada in 1988. Under that agreement, tariffs and most non-tariff barriers (such as import quotas) are being gradually phased out so that trade between the two nations will eventually move freely across the border.

Although the U.S. has a keen interest in Mexico's economic and political stability, the official U.S. reaction to the Salinas overture has been ambiguous at best. The White House indicated in late March that the two governments had begun what were termed "preliminary discussions" that could lead to a free trade pact. But other officials in the Bush Administration, notably U.S. Trade Representative Carla Hills and Commerce Secretary Robert Mosbacher, have been quick to emphasize that a formal agreement with Mexico is unlikely in the near future.

To some extent, the administration's ambivalence toward a bilateral trade pact with Mexico reflects its commitment to the multilateral approach to international trade enshrined in the General Agreement on Tariffs and Trade (GATT). Yet even if the White House genuinely wanted to expedite talks with Mexican authorities, the U.S. Congress seems hardly in the right mood. If anything, Congress appears more inclined to impose trade sanctions against Mexico as a means of punishing that nation for a host of sins, both real and imagined.

Efforts to expand commercial relations with Mexico also run into vocal opposition in the U.S. from organized labor and segments of the business community. Labor union leaders contend that tens of thousands of well-paying U.S. manufacturing jobs literally went south during the past decade as employers moved their operations to Mexico to avail themselves of lower labor costs and a less stringent regulatory environment. Unions representing workers in some of the more mature industries of the Rust Belt states are especially fearful that a U.S.-Mexico FTA, by eliminating most existing trade barriers, would only encourage more U.S. companies to seek the less costly manufacturing environment Mexico affords. In some cases, organized labor's concerns are echoed by financially harassed U.S. companies worried that low-cost competition from Mexican may put them out of business.

Given such resistance to even initiating serious negotiations, why did the Mexican government raise the issue of a U.S.-Mexico FTA? After all, generations of Mexican leaders have defined their nation's sovereignty in terms of its independence from the presumably covetous power to the north. For more than a half century after coming to power in 1929, the Institutional Revolutionary Party (PRI) adhered to economic strategies designed to keep foreign interests at bay while nurturing the development of a strong domestic industrial base.

For many years, those strategies appeared to pay off. From the early 1930s through 1982, Mexico's economy expanded at an average annual rate of six percent. But all economic models eventually lose their vitality, and Mexico's was no exception. While structural inefficiencies had already taken their toll, what Mexico's inward-looking industrial policies ultimately choked was on a massive wad of foreign debt.

As with many other developing countries, Mexico had borrowed heavily during the 1970s when banks in industrialized nations were eager to re-cycle billions of petro-dollars they had taken in deposit from OPEC nations. Mexican authorities took the loans offered them and embarked on a debt-led strategy to accelerate development of the nation's industries. Had world oil prices stayed high, the gamble may have worked.

But as luck would have it, oil prices collapsed in 1981, leaving Mexico gravely over- extended and facing interest payments on its $100 billion external debt that amounted to about 5-6 percent of the nation's gross domestic product.

Since 1982, Mexico's economic fortunes have sunk steadily. Per capita real income declined by some 15 percent between 1982 and 1988, while working class Mexicans saw their purchasing power fall by half. And they were the lucky ones. Unemployment soared to over 15 percent after the oil bubble burst, while underemployment affected another 30-40 percent of the economically active population.

Mired in debt, the Mexican economy was further saddled with a largely inefficient industrial complex of protected industries, a cats-cradle of government subsidies and an unwieldy public sector deficit. By mid-decade, it was obvious that major changes in the management of the nation's economic affairs were imperative.

Adding to the impetus for thorough economic reform was the growing political fall- out of economic malaise. Popular discontent was undermining the PRI's political strength, as was evident in the outcomes of the elections of 1986 and 1988. In both instances, several of the PRI's chosen candidates suffered embarrassment but generally averted outright defeat by resorting to the expedient of election fraud. In the 1988 presidential contest, Salinas, the PRI's anointed candidate won a bitterly contested race with a shocking 50.4% of the vote, considerably less than the usual margin of victory for the party's standardbearer in previous presidential elections.

Salinas' predecessor, Miguel de la Madrid, was the first to begin jettisoning the economic doctrines of extreme nationalism. Among other reforms, selected nationalized industries would be privatized, subsidies to the private sector would be slashed, and more liberal policies on trade and foreign investment would be adopted.

An important corner was turned in 1986 when Mexico become party to the General Agreement on Tariffs and Trade (GATT), a status it had earlier rejected on the grounds that GATT membership would eventually require Mexico to liberalize its economy and ease its restraints on imports and foreign direct investment.

Yet even then the question of a formal trading relationship with the U.S. remained outside the bounds of non-violent conversation in Mexico. In an interview with The New York Times shortly after his inauguration in December 1988, President Salinas, like his predecessors, shunned the idea of forging closer economic links with the United States. Among the reasons he cited was a concern that, absent barriers, the much larger U.S. economy would likely gobble up large and valuable chunks of Mexico's economy.

What changed Salinas' mind was almost certainly a growing fear that Mexico, having only recently adopted economic policies emphasizing an expanding export trade, might find itself locked out of the world's largest markets.

During a visit to Europe last January, Salinas was reported to have been dismayed by the Common Market nations' preoccupation not only with achieving full economic integration by the end of 1992, but with the historic changes then unfolding in Eastern Europe as well. As with other observers of European economic integration, Salinas was troubled by the prospect that the post-1992 European Community would be resemble an economic Fortress Europe, excluding from its markets goods manufactured or grown elsewhere. He also returned home discouraged about the chances that substantial amounts of European investment would be coming to Mexico in the foreseeable future.

With the opportunity for expanding Mexico's trade with Western Europe clouded by uncertainty, Salinas was also alarmed by developments to the north. Nationalistic rhetoric notwithstanding, Mexico had grown acutely dependent on the U.S., the destination for 60% to 70% of its total exports. (A similar share of Mexico's imports come from the United States.) Even more critically, many of Mexico's most vital industries had become tightly integrated with U.S. industry, with about 90 percent of Mexico's exports of manufactured goods going to the U.S.

This degree of economic intimacy leaves Mexico dangerously vulnerable to economic and political trends in the United States. A slowdown in the U.S. economy or a rise in interest rates can have a devastating impact in Mexico. More ominously, shifts in U.S. trade policies -- such as toward even greater protectionism -- could prove absolutely disastrous to Mexico.

The conjunction of a rising tide of protectionist sentiment in Washington and growing animosity toward Mexico in the wake of the Camarena case posed a very real danger that U.S. policy-makers would single out Mexico for trade sanctions. To prevent this, Salinas had to act quickly and decisively to insure Mexico's continued access to the U.S. market on which it had come to depend.

An intermediate step was taken in October 1989, when President Salinas and U.S. Secretary of States James Baker signed an understanding which provided for bilateral talks to ease trade restrictions in eleven specific economic sectors, including automobiles, telecommunications, chemicals, transportation, and infrastructure. At the same time, Mexico has evidently been successful in petitioning the U.S. to expand the list of Mexican products which may be imported duty-free into the U.S. under the provisions of the Generalized System of Preferences (GSP), a program designed to promotes growth in developing economies by facilitating access for the goods to the massive U.S. market.

Yet the Salinas' Administration's primary objective, a formal free trade agreement remains a long way off. Still, the absence of the comprehensive legal and diplomatic framework that a formal FTA would provide does not mean that the de facto economic integration of Mexico and the United States will not proceed on an ad hoc basis in several vital areas. Indeed, one of the areas most likely to see further economic convergence is of particular interest to California -- agriculture.

Until just a few years ago, Mexican vegetable production took place far from the U.S. border and had a harvesting schedule different than that of California crops. As a result, imports of Mexican vegetables tended to extend the fresh vegetable season for U.S. consumers, without competing directly with California farmers. This is no longer true. In the past decade, cultivation in Mexico has edged closer to the border, and the volume of Mexican fruit and vegetables imported into the U.S. has swelled. There is now much more direct competition between California and Mexican producers.

Between 1982 and 1987, U.S. imports of fresh vegetables from Mexico rose 73 percent. Ironically, the liberalization of Mexican policies on foreign investment contributed to this increase by permitting California and other U.S. agribusiness firms to participate in developing agricultural areas in border areas such as Baja California.

Most large and many medium-sized growers in California have established direct ties with Mexican agricultural production. In many cases, California firms have entered into joint ventures with Mexican companies and are now actively engaged in production south of the border. Increased U.S. investment has also accelerated the transfer of agricultural technology from California to Mexico. As a result, production in some areas of Mexico has advanced to the point that yields are now similar to those achieved in Southern California. In Baja, for example, fresh market tomatoes yields have actually surpassed the yields reaped by California farmers in some recent years.

California growers have responded to the competition from lower-cost production in Mexico by diversifying their own production into Mexico. Labor intensive crops are being moved to Mexico, allocating California farmland to machine-intensive crops. Thus, production of vine- ripened tomatoes, which are picked by hand, has been shifting to Mexico, while hardier machine- picked tomatoes have become the norm in California. In 1982, when Mexico supplied 19 percent of U.S. consumption of hand-picked fresh tomatoes, California held a 24 percent share of this market. By 1987, Mexico had surpassed California's market share and now accounts for one in every four fresh hand-picked tomatoes consumed in this country.

A free trade agreement with Mexico would ultimately lead to an increased flow of Mexican produce to the U.S. market primarily by encouraging greater investment both in Mexican agriculture and in the country's rural transportation system and by lowering U.S. tariffs now levied on most Mexican fruit and vegetable imports. This would of course poses an even greater competitive challenge for California growers. Judging from actions already taken, it seems likely that an FTA would spur further efforts to integrate and rationalize agricultural production in adjacent areas of the two countries. Indeed, By affording greater access to investment opportunities in Mexican agriculture, an FTA could prove to be a boon to the larger players in California agribusiness. Yet, by same token, an FTA may also hasten the demise of the less competitive family farm. That prospect, together with general uncertainty over the full implications of an FTA, fuels the simmering opposition of most California growers to a free trade accord.

Although the instinct for sheer economic survival explains the anxiety most smaller California growers feel when contemplating more liberalized agricultural trade with Mexico, FTA opponents publicly focus on the importance of safeguarding the state's farms, livestock and consumers from agricultural pests, animal diseases and pesticide-tainted produce from Mexico. The need for maintaining strict sanitary requirements is a valid concern, but it is also a subject that will be aggressively addressed in any negotiations to ease U.S. barriers to Mexican livestock and produce.

This state's farming community may draw some solace from the fact that a formal U.S.- Mexico Free Trade Agreement is not imminent. Despite the very considerable economic reforms made in Mexico, much of its industry continues to be less than competitive by U.S., let alone world standards. More importantly, there remains a deep reservoir of ill-feeling on both sides of the border, and there has been little progress in understanding the source of each other's grievances and prejudices.

Under the most favorable circumstances, what is more likely to occur in the near term is a continued gradual expansion of trade and greater integration of selected industries as a result of as both governments remove constraints on private sector initiatives. But short of a formal free trade agreement, stronger commercial links will emerge only so long as the U.S. avoids more exclusionary trade policies and so long as the economic reforms instigated by Presidents de la Madrid and Salinas are allowed to function.

Unfortunately, bilateral economic ties can too easily fall prey to eruptions of the mutual recriminations that have traditionally afflicted between relations the two neighbors. Given the degree to which the two economies are already intertwined, though, more than national egos can be bruised. The fall-out could ultimately be devastating for Mexico's economic and political stability while also producing grave consequences to the north. As a border state whose second largest export market is Mexico, California definitely has a very large stake in the outcome.

Copyright (c) 1990 by J. A. O'Connell


Other Articles by Jock O'Connell