The Reasons For Mexico’s Trade Liberalization*

By

Jorge Sebastian Roberts

Department of Economics University of Washington

Seattle, WA, USA May 2001

Abstract

As part of the current discussion of free trade, this paper provides an understanding of how Mexico’s trade liberalization developed and examines the reasons that motivated policy makers to undertake such reforms.

* This paper was awarded Honorable Mention in the UW Economics Undergraduate Paper Competition.

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“There is probably no area in economics where professional opinion is so united: the vast majority of economists see free trade, warts and all, as superior to protection. The attraction of free trade resides at one level in the theoretical elegance of the principle of comparative advantage. As Paul Samuelson once put it, comparative advantage is the only proposition in economics that is at once true & nontrivial.” –Dani Rodriki

I. Introduction

At the turn of the 21st century, free trade and globalization have been a central

topic in most policy discussions around the globe. As global communication is

becoming readily available and interconnected, more and more people from different

backgrounds and interests are engaging in this discussion. One clear example of this

increasing involvement is the continuous response from groups that have gone to the

streets of Seattle, D.C., Prague, Davos, Cancun, and other cities to protest against the

policies of certain institutions that are involved in redefining the global economy, such as

the World Bank, the International Monetary Fund (IMF), the World Trade Organization

(WTO), and the Organization for Economic Cooperation and Development (OECD). In

this discussion, many nations with closed economies are facing the tough decision of

whether to follow the global trend of liberalization or to wait and see what effects this

liberalization will have on the nations that have decided to open their economies. Other

countries that have liberalized their economies are constantly debating whether they

should continue to liberalize or to revert their policies. The present paper is part of this

discussion of trade in the global economy, and it provides an example of how a country,

in this case Mexico, has engaged in the process of liberalization.

The focus of this paper is mostly on the period that led to Mexico’s trade

liberalization, culminating with the signing of the North American Free Trade Agreement

in 1993. The paper also discusses the post-NAFTA era, though in less detail, showing

some of the preliminary effects of the liberalization process as well as the changes in

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trade policies. The purpose of this paper is to answer certain questions, such as how a

country that was very protectionist at the beginning of 1980 decided to liberalize its trade

in the midst of the debt crisis a couple years later, and why Mexico didn’t start the

process earlier, when it could have sustained the political and economic costs associated

with liberalization.

To answer these questions, I argue that even though there might have been certain

outside pressures, such as the need to compete for Foreign Direct Investment in the world

capital markets and pressures from institutions such as the IMF and World Bank, the

reforms in Mexico had a very strong domestic character. In recognizing this domestic

character, I examine the economic environment at that time, together with the behavior

and motives of the groups in power. We will see that in an attempt to survive, these

groups displaced each other and ultimately caused their own demise. In order to show

how these factors came into play in Mexico’s liberalization process, this paper is divided

into three sections. The first section presents the historical background, which provides

the background for understanding the reasons of the liberalization process. This section

is further divided into two sections, from 1976 to 1983 and then from 1983 to the present.

The second section outlines the reasons for Mexico’s trade liberalization in three sub-

sections: internal economic reasons, internal political reasons, and external reasons. In

the final section, I discuss some of the recent effects and benefits for Mexico from the

liberalization process.

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II. Historical Background

Let’s Liberalize, Let’s Better Not (1976-1982)

Trade liberalization in Mexico officially started after 1983. Previously, however,

during the administration of President José López-Portillo (1976-1982), there were

attempts to liberalize Mexico’s trade. The disequilibrium in the balance of payments

caused by the current import-substitution trade policies led Lopez-Portillo to rethink

these policies. He tried to use a moderate approach in the liberalization process. His new

approach included replacing the existing licenses with tariffs, gradually removing the

official prices for imports and exports, and establishing incentives for foreign countries in

the form of fiscal and trade credits in order to promote Mexico’s exports. At the end of

1979, Lopez-Portillo even toyed with the idea of joining the General Agreement on

Tariffs and Trade (GATT). However, this idea was dismissed the following year when

the prices on Mexico’s oil exports surged and the GATT entry debate became too heated.

Also, at that time, there were many influential people benefiting from the government’s

revenue. Knowing that any reform could jeopardize their economic power, they strongly

opposed any attempts to liberalize (I discuss this further in section III of this paper, under

the political reasons for the liberalization process).

In the end, Lopez-Portillo decided that it was best to leave the liberalization idea

alone. He was confident that as long as the oil money continued to finance the

government’s spending and economic prosperity was in place, there was no need to

pursue the liberalization agenda. In addition, the oil reserves seemed endless and no one

thought that the oil prices would change so drastically. Oil exports continued to boom,

imports surged at a faster rate than exports, and the externa l debt quadrupled as more and

more foreign banks decided to lend to Mexico. The exploitation of the proven oil reserves

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allowed the Mexican government to borrow from abroad and to increase its expenditures

at an increasing rate. The income received by the oil exports and the loans allowed the

government to finance imports and sustain an annual growth of about 7.5% on average

annually.

The economic boom ended in 1981, when, to the surprise of the whole world and

misfortune of Mexico, world oil prices collapsed, taking the whole Mexican economy

into a major recession. Mexico’s revenue, which was almost entirely dependent on oil,

experienced a substantial drop. Oil represented almost 70% of Mexico’s exports, up from

22.3% in 1977. As a result, Mexico was faced with a severe balance of payment

problems.

The expenditures were so excessive that it caused the country to be left insolvent

and unable to meet its obligations by the end of 1981. In four years, the government’s

budget deficit rose from 5.5 percent in 1978 to 16.2 percent in 1982 as a proportion of

GDP (See figure 1). Furthermore, this deficit was the main factor for a current account

deficit, which was also aided by an overvalued peso.

Figure 1. Mexico’s Budget Deficits (1970 -1988)

Source: Banco de México

Budget Deficit (1970-1988)

05

101520

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

% o

f GD

P

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By this time, the financial fragility of the economy became apparent. Real

interest rates became negative as a result of an overvalued peso and a rise in inflation

rates, causing a major capital flight. Bank lending dried out and Mexico could no longer

service its debt commitments. In August 1982, it declared a moratorium on its external

debt. The following month, during the final presidential annual report to Congress, in a

populist move to save his image, Lopez Portillo nationalized the banks in Mexico,

blaming them for the crisis.ii At this point, the government imposed strict exchange

controls, abandoned the trade liberalization program, and reinstated the old trade policies

of import substitution with 100 percent of all imports covered again by licenses. The

year 1982 would not only mark the end of the Lopez-Portillo Administration, but would

also mark the end of the economic model based on oil exports.

The administration that followed had to rethink the current economic policies in

order to recover from the current crisis and bring much-needed economic development

for the country. As we will see in the next section, the administration under Miguel De

La Madrid undertook substantial reforms with the goal of creating a more open economy

and bringing recovery to the nation’s economy.

Let’s Liberalize (1983-2001)

There is a broad misconception of when trade liberalization started in Mexico.

Many people think that Mexico started to liberalize its trade in 1993 when the trilateral

North Free Trade Agreement between Mexico, US, and Canada was signed. Actually, by

the time NAFTA was signed, Mexico had almost completely eliminated its trade barriers

in the manufacturing sector.iii

In the present paper, this period of trade liberalization in Mexico is divided into

four phases. What makes each phase distinct from the other is the speed in which the

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liberalization took place. The first phase starts during Miguel de la Madrid’s

Administration and lasts from 1983 to mid 1985. The second phase starts in 1985, a year

before Mexico’s entry to the General Agreement on Taxes and Tariffs (GATT), and

culminates in 1988 with the end of the De La Madrid’s administration and the beginning

of the Salina’s regime. The third phase ends in 1992, a year before Mexico signs the

NAFTA agreement. The post-NAFTA period is treated as phase four. Since we are still

living in period four and the data available is very limited, this paper will focus mostly on

the first three periods, while still discussing in lesser detail the current period.

Phase one (1983 to mid-1985) of the liberalization started when the

administration of President Miguel de la Madrid decided to loosen the restrictive import

regime that had been adopted the previous year to address the country’s debt and balance

of payment crisis. His administration also signed a bilateral trade agreement with the US

establishing commitments of further trade liberalization and the elimination of export

subsidies. The next year, the import licenses were reduced from 100 to 83 percent and

controls on 44 percent of non-oil exports were relaxed.

Phase two started in the middle of 1985, with Mexico accelerating its

liberalization program by announcing a new four-step tariff reduction program that would

end by 1988 with tariffs ranging between 0 and 30 percent. This new program was an

accelerated version of what De La Madrid’s administration had previously announced.

There were two reasons for this. First, Mexico, by entering the GATT in 1986,

committed itself to getting rid, by the following year, of all the official prices for imports

and exports. Second, in December 1987, in order to combat high inflation, Mexico put

into practice the Pacto de Solidaridad Económica (Economic Solidarity Pact). This pact

included a lower (0-20 percent) tariff target range designed to promote external

competition to keep domestic prices in check. It also included new price and wage

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guidelines. During this period, the administration decided to change its trade policies and

decided to substitute the subsidies with temporary exemptions of tariffs and licenses on

crucial imported industrial inputs. Also, in 1987, Mexico and the US signed an

agreement that included a broader legal framework than the one they had previously

signed during phase one.

When Carlos Salinas de Gortari took office in 1988, most of Mexico’s

commercial liberalization in the manufacturing sector had been completed, while the

agricultural and services sectors remained closed. From 1988 to 1992, the administration

focused mostly on fine-tuning the liberalization, while at the same time liberalizing the

services sector with radical privatizations. This fine-tuning consisted mostly of reducing

the tariffs for goods that were still showing unusually high prices and contributing to

inflationary pressures. On the other hand, it increased the tariffs for consumer goods that

were registering an import surge. As a result of this net increase, it caused a slight

increase in the mean and weighted tariff rates in 1990, as seen in Table 1.

Table 1. Changes in Mexico’s import regime, 1982-1993 (in percentages)

Measure 1982 1984 1986 1988 1990 1993 Import license coverage 100 83 27 22 18 16.5 Number of Tariff items 16 10 11 5 5 5 Maximum tariff 100 100 45 20 20 25 Tariff mean 27 23.3 22.6 10.4 13.1 13.0 Production Weighted Avg. Tariff 22.8 23.5 24 11 12.5 12.5

Source: Secretaría de Economía (SECOFI)

In 1992, Mexico and Chile signed the Economic Complementation Agreement,

which was basically a Free Trade Agreement (FTA). After very positive signs from this

first FTA, such as a sevenfold increase in trade from US$188 million in 1991 to US$1.4

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billion in 1998, and with the prospects of Chile’s possible future addition to NAFTA,

both countries decided to replace the 1992 FTA with a new FTA modeled after NAFTA

in August 1, 1999.

In the early 90’s, as negotiations with Chile took place, Mexico was also initiating

negotiations with Canada and the US on what would be later called the North American

Free Trade Agreement (NAFTA). In 1993, the three countries signed the agreement, and

in 1994, the agreement went into effect. NAFTA would push the liberalization to the

next step (see table 2 for NAFTA’s tariff elimination schedule). This marked the

beginning of phase four of the liberalization process. In this phase, the agricultural sector

has been liberalized gradually, and is expected to be fully liberalized by 2010.

Table 2. NAFTA’S Tariff Elimination Schedule

Elimination on January 1 Dutiable Goods on which Tariffs are eliminated 1994 60% 1998 9% 1999 11% 2002 1% 2003 12% 2008 8%

Source: US Congressional Budget Office

After 1993, the Salinas administration saw that the initial trade reforms were very

closely related to the promotion of foreign investment in Mexico. With this in mind,

Mexico became a member of the OECD in 1994 and a founding member of the WTO in

1995.

Continuing with Salina’s foreign policy, the Zedillo administration (1994-2000)

pursued a policy of signing as many trade agreements as possible (see figure 2). As of

2000, it had signed 10 agreements with 31 countries iv, granting Mexico’s export industry

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access to over 860 million consumers. Most of these agreements were signed with Latin

American Countries. However, the most significant for Mexico were the ones signed

with the two major economic blocs in the world, that is North America (Canada and the

US) and the European Union. The most recent agreement, which will enter into effect as

of July 2001, was signed with the European Free Trade (EFTA), composed of Norway,

Iceland, Liechtenstein, and Switzerland.

Figure 2. Timeline of Mexico’s Free Trade Agreements and adhesions to Organizations

Source: Secretary of Economy (SECOFI)

In addition, Mexico has signed other kinds of cooperation agreements relating to

trade and investment with various countries (including South Korea, Australia, New

Zealand), is currently in talks with Japan, and has set up ad hoc groups to administer

trade relations. Furthermore, as a member of the Asia-Pacific Economic Cooperation

(APEC), Mexico has participated actively in the organization’s goal of creating a free

trade and investment area by the year 2020.

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III. Reasons For The Trade Liberalization

The reasons for Mexico’s decision to liberalize its trade are divided in this paper

into internal & external reasons. The internal reasons are further divided according to

whether they are economic or political in nature. Clearly it was not one sole factor or

reason that influenced Mexico to engage in a free trade policy. Therefore, in this paper, I

try to present an inclusive view of the main factors in Mexico’s decision to liberalize its

trade.

Internal Economic Reasons

The internal reasons that led Mexico to liberalize its trade and engage in trade

agreements with other nations were derived from the fact that the import-substitution

policy was no longer effective and the liberalization after 1983 proved successful in

creating jobs and growth in the export industry. Also, according to economic theory,

open economies might encourage producers to raise their supply volumes and diminish

their marginal revenues, which in turn translates into lower prices for consumers, and in

the long run, a better income distribution.

During the period of the economic model Desarrollo Establizador (Stabilizing

Development), used by the Mexican government in the 70’s, the import-substitution

policy imposed a series of tariffs, permits, and direct subsidies to promote the country’s

industrialization and development. However, this policy created a distorted picture in the

economy and a heavy fiscal deficit. These distortions were based on heavy subsidies

given to industries, such as the transportation, energy, water, and, most importantly, the

credit industry. In addition to this, there were fiscal extensions granted to private and

statev companies, assets depreciated at an accelerated rate, and price controls on food,

which continued to sustain the low nominal salaries. By the end of 1983, according to

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Herminio Blanco, former Minister of Commerce and Industrial Development, all these

different regulation instruments made it almost impossible to determine the duration of

the subsidies, their size, and which industries were receiving them. Investors grew

uneasy of these practices and, as a result, the levels of capital necessary to sustain the

growth disappeared. Therefore, at the end of the period based on the import-substitution

model, the country had few possibilities to continue sustaining a stable economy and

generate new jobs.

In addition to the negative results of the import-substitution model, there was a

sector of the economy that proved that free trade could create economic growth. This

industry was the maquiladoravi industry. Prior to 1993, the maquiladora industry, in

contrast to the rest of the economy, demonstrated that it was a dynamic industry that

could generate new jobs and retain foreign capital. In the first 28 years of its existence,

the number of maquiladora plants grew from 50 in 1965 to over 2000 in 1992. Over this

period of time, such expansion created an annual growth rate of employment of 10

percent, versus the national average of 2 percent. Exports soared from US$2.5 billion in

1980 to US$18.7 billion in 1992. In 1992, this represented a net value added for Mexico

of US$4.7 billion.

Table 3. Maquiladora Industry (1980 – 1993) 1980 1983 1985 1990 1993 1996 1999 2000 Number of plants 620 629 760 1,938 2,692 3,403 4,636 4,762 Employment (thousands) 119 173 212 460 543 n.a. n.a 1,300 Employment change (%) ----- 30.96 18.35 53.94 15.17 n.a. n.a. n.a. Average Wage (US$/hr) 1.08 n.a. 1.38 1.78 2.51 n.a. n.a. n.a. Source: SECOFI, INEGI, Galhardi (1998)

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The growth in the country as a whole, however, did not match the growth of the

maquiladora industry. The main reason for this was that the rest of the economy was

practically closed and the maquiladora industry had been operating under a more

liberalized regime since 1965. Therefore, as a result of the sluggish growth in the early

80’s, and with the imperative of generating one million new jobs to keep up with the

growing population, Salina’s Administration, in 1988, engaged itself in an extensive

modernization program with the objective of promoting economic competitiveness and

economic growth. This program included major constitutional reforms and dozens of

deregulatory measures, such as privatization of the major state companies with the

exception of the oil company, Petróleos Mexicanos (Pemex), and continued with the

liberalization of the economy.

By 1992, the experience with the maquiladora industry and the successful

development of an export industry through the trade liberalization process initiated in

1983 proved to the Salina’s Administration that free trade in Mexico was a viable way of

creating a dynamic growing export industry and more new jobs, and, at the same time, of

training the workforce in modern production processes.

The Salinas administration negotiated trade agreements with other countries,

which remained consistent with the administration’s modernization program. Also, since

Mexico’s trade policies are closely linked to the promotion of foreign investment,

Mexico decided to continue formalizing its commitments to reforms and liberalization

through a permanent framework of trade and investment rules embodied in multilateral

and preferential arrangements. It is important to note that the successes of these

agreements were conditioned by the fact that Mexico had to stabilize its economy. This

stabilization included fiscal reforms and the restructuring of the public debt. Moreover,

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these agreements reinforced Mexico’s commitment to a predictable, sustainable, and

viable trade policy. vii

Reinforcing Mexico’s commitment to continue reforms and continue with the

liberalization process was one of the major goals of the Zedillo Administration. It

seemed that in 1994 the crisis would slow down the liberalization process, but on the

contrary, the liberalization was intensified, which became a major part of Mexico’s

recovery from the crisis. Zedillo’s administration, which lasted from 1994 to the year

2000, pursued the outward model agenda very strongly and reaffirmed Mexico’s

commitment to Free Trade by signing multiple agreements.

The newly elected president Vicente Fox is very unlikely to change Mexico’s

trade policies. He has mentioned that he will try to take the agreements to the next level.

In his first visit as President of Mexico to Washington, D.C., maybe naïvely, but with a

vision of NAFTA’s future, he proposed to the Bush administration the expansion of

NAFTA by adding free movement of labor. The Bush administration immediately

expressed a negative reaction to the proposal and said that it would be prepared to

consider such proposal in twenty years. Fox’s proposal might seem far- fetched, but let’s

not forget that in the early 90’s nobody expected the occurrence of NAFTA. In another

region of the world, for example, no one expected that the developed countries within the

EU would accept countries with lesser developed economies, such as Portugal, Spain,

and Greece, into the Union, much less come to share the same currency with them.

Fox has decided to also continue with Zedillo’s idea of diversifying Mexico’s

access to markets in the world and to lessen its dependence on the US economy. The Fox

administration hopes to offset any effects of economic slowdowns in the US by stepping

up the trade with Europe, Latin America, and Asia. Fox’s goal is to establish a

continental agreement in the Americas within the next five years.

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Internal Political Reasons

While there were obvious economic reasons why Mexico went ahead with

reforming its trade policies, there were political reasons that laid the ground for the

implementation of these reforms. It is perplexing to see that Mexico did not liberalize its

trade in the seventies when it was considered necessary and when economic conditions

could have supported it, but that it was instead in the midst of the economic crisis of the

mid-eighties that the liberalization was implemented. Also, it is important to note that it

was President de la Madrid, who was commonly considered weak and indecisive, who

initiated the change, rather than President López Portillo, who tended to be seen as a

strong leader. From this one can conclude that government actions do not reflect only the

will of an all-powerful authority, nor are they solely determined by the will of a majority

of voters. Therefore, there are other groups that have a considerable influence in

governmental policies. In order to better explain this process, I use a political economy

model developed by Aaron Tornell, a professor at UCLA.

Tornell develops a political economy analysis for the reforms that took place in

the early 1980’s in a two period model.viii In this model, he identifies three powerful

groups, or elitesix, during the 70’s and early 80’s, which played a major role in the

government’s actions. Two of these groups were in the manufacturing sector, comprised

of the private import-competing elite and the statist elite. The statist elite was made up of

managers, union leaders, and suppliers that were part of networks associated with state-

owned enterprises. The other was the rural elite, which was comprised of the regional

bosses who controlled the PRI’s voting machine and distributed government subsidies to

the agricultural sector.

In this two period model, the import competing elite and statist elite both enjoyed

governmental transfers in the form of subsidies during the 70’s. In 1980, when the debt

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crisis developed, both groups were left to compete for the government’s reduced fiscal

revenue. Tornell argues that the reduction in the size of the pie increased the marginal

utility of gaining a greater share of it, and increased the payoff of becoming the “leader”

and displacing the other group. In fact, the statist elite, in their attempts to displace the

private elite, induced the government to expropriate all Mexican private banks.x The

banks channeled much fiscal revenue into the private sector (through subsidized credit

and implicit guarantees of their borrowings from foreign banks), and their owners

comprised one of the strongest groups in the private elite.

In response to the statist elite’s move, the private elite, aware that trade

liberalization could be a way to destroy the power of the statist elite, decided to support

the liberalization of the 80’s instead of opposing it as they did in the 70’s. This time, the

private elite was not choosing between the trade liberalization and the protectionist status

quo, but between trade liberalization and becoming the “follower”. This means that trade

liberalization would reduce the power of the statist elite to further expropriate the private

elite and extract fiscal subsidies.

After the expropriation of the banks and the trade liberalization, both groups

became weaker and worse off. In the early 80’s, as Tornell puts it, even though both

groups knew about the outcome, the payoff of unilaterally deviating from the status quo

at that time by trying to become the leader exceeded the payoff of maintaining the status

quo due to the decrease in the government’s revenue. With both groups becoming

weaker, the administrations of De La Madrid and Salinas gained more autonomy in their

decision-making. Both administrations used this autonomy to implement a tax reform, a

radical privatization program, and a deregulation program that eliminated many

privileges and monopolies conferred in earlier administrations. Two new groups, the

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export elite and the foreign investors, replaced the statist and the private import-

competing elite. The rural elite remained.

The rural elite remained because the manufacturing sector was the only sector

liberalized. Therefore, the agricultural elite continued to enjoy political control in the

rural areas and decided not to interfere with the government’s policies. Tornell and

Esquivel state that liberalizing only the manufacturing sector goes against any economic

logic, but that the administrations at that time realized that it was necessary not to

liberalize the agricultural and services fully in order to ensure that the reform process

would not be blocked.xi In order to ensure this, reformers had to make sure that they

were going to be re-elected and they had to avoid alienating at the same time all-powerful

groups while they waited to build the two new elites to support further reforms.xii

External Reasons: Global Trends

The decision to engage in free trade with other countries is congruent with the

need to take advantage of the globalization process. The technological changes and cost

reduction in information systems, telecommunication, and in transportation have caused

the integration of markets to create global markets in which more and more countries can

participate. The struggle to dominate or even survive in this world market has forced

countries to specialize in the goods or activities in which they pose a comparative

advantage.

The other external reason motivated Mexico to liberalize its trade was the

increasing competition in the world for outside capital and FDI. In 1982, Mexico was

faced with a serious debt crisis. The consolidation of financial markets as well as

production processes, together with the opening of markets like China and Eastern

Europe, have led to an increasing mobility of capital throughout the world. This has

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forced many developing economies to engage in liberalization of their trade and financial

sectors. Also, to a lesser extent, the influence of institutions such as the World Bank and

IMF under the so-called “Washington Consensus” contributed to this liberalization

process. In many instances, the conditions for lending money to countries through these

institutions require that the borrowing countries liberalize their economies or establish

certain macroeconomic policies.

Furthermore, the need to attract FDI and capital for development has forced

many countries to create environments where there is a lower economic and political risk

for investors. Mexico, before the liberalization process, had a very strict regime for

foreign investment. In order to create a stable and predictable economic environment for

investors, it had to engage in radical reforms, allowing it to attract large amounts of

foreign capital in the 1990’s.

Before the 1970’s, many, if not most, of the developing nations pursued the

strategy of import-substituting industrialization (ISI). This strategy came under attack in

the 70’s, when the countries that had pursued the ISI strategy had clearly not shown any

signs of catching up with the more developed and advanced countries. Chile was the first

country in Latin America and one of the first in the world to abandon the ISI strategy in

the 70’s. The move to liberalization and the move to the establishment of an export- led

growth strategy allowed Chile to recover very rapidly from the “debt crisis” in the early

80’s by showing an impressive economic performance in the mid 80’s. Chile’s example,

together with the success of the so-called “high performance Asian economies” (HPAEs),

persuaded countries like Mexico to shift their policies towards an export- led growth

strategy. This strategy involved liberalizing the economy and dropping the ISI strategy.

Today, Mexico is leading the way in regards to liberalization in the world arena.

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IV. Recent Effects and Benefits of the Liberalization Process

Even though it is still early to assess the complete impact that NAFTA or any

trade agreement has had on Mexico, it is possible to observe very good preliminary

results from the liberalization process. The benefits can be seen both in the increase of

FDI and in the amount of traded goods. During the first five years of this administration,

foreign direct investment reached US$54.5 billion dollars compared to US$27 billion

between 1990 and 1994. In matters of trade, as a result of the trade growth between the

US and Mexico since the implementation of NAFTA in 1994, Mexico has displaced

Japan as the US’ second largest trading partner.

The positive effects of the liberalization were seen in the recovery of the Mexican

economy after the 1994 currency crisis. As one can observe in Figure 4, as a result of

having a more open economy, Mexico was able to recover from the 1994 crisis in two

years as opposed to five years after the 1982 crisis.

Figure 4. Mexico’s recovery after the crisis, 1982 vs. 1994

Source: 1997 US Trade Rep. Report on NAFTA

Mexico is no longer dependent strictly on oil. As of 1999, only 8% of Mexico’s

total exports came from oil & mining as opposed to 70% in 1982 (see figure 5). After

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Mexico’s experience in the early 80’s, when the fall in oil prices put Mexico in a serious

debt crisis, Mexico has decided to encourage its exports more through the manufacturing

sector. As we saw earlier, the agricultural and fisheries sectors are still in the

liberalization process, which is why the share of exports in those sectors have not shown

an increase in the share of exports relative to oil and manufacturing exports since 1982.

Reducing the dependency on oil exports has allowed Mexico to be less susceptible to

external oil shocks, such as changes in the oil price.

Figure 5. Diversification of Mexico’s Exports (1982 vs. 1999)

Mexico's Exportsin 1982

Oil & Mining 70%

Agriculture & Fisheries

5%

Manufacturing25%

Mexican Exports Diversified as of 1999

Agriculture & Fisheries

3%

Manufacturing89%

Oil & Mining 8%

Source: Secretary of Economy (SECOFI)

Also, Mexico not only has diversified its exports, but it also has gained a very

strong position as an international trade hub and global market production platform. In

1999, Mexican exports reached over US$136 billion, making Mexico the 8th largest

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exporter in the world. It is not surprising that Mexico is gaining more and more respect

among the international community. Even Japan, which currently has no FTA with any

country in the world, has expressed that in the future it might consider an FTA with

Mexico. Japan’s ambassador to Mexico, Katsuyuki Tanaka, most recently expressed that

an FTA would be very beneficial to both countries, and that the reason they are holding

back on the FTA with Mexico is that Japan has not signed a FTA with any other country

and the Japanese government believes that if it signs one with Mexico, every other nation

will request one as well. However, it has expressed that as a first step towards a FTA

with Mexico, it will sign the Reciprocal Investment Promotion and Protection Agreement

(APPRI), which will open the investment opportunities and encourage Japanese

investment in Mexico.

Mexico is a strategic location for foreign businesses that are looking for top-notch

strategic partnerships, a young and skilled workforce, and preferential access to 870

million consumers in 31 countries.

Maquiladora Industry Today

As of this year, maquiladora exports make up 46% of total Mexican foreign sales.

There are over 4,700 plants operating in Mexico. This means that there are 2,070 more

plants this year than in 1993 (see Table 3). While most are concentrated around the

border, after NAFTA they started to establish themselves in other parts of the country

(see figure 7). This will create a more uniform growth across the country and prevent the

economy from fragmenting and becoming a dual economy. The economic dualism is

apparent with the North being more affluent and industrialized and the South falling

behind in the growth process. Already, we have seen groups in the South, such as the

Zapatista National Liberation Army (EZLN), express their concerns that the south is not

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receiving the benefits of the economy’s growth. This is one example of many of the

disparities in growth between the North and South.

Figure 7. Number of Maquiladoras per State (2001)

Source: Secretary of Economy (SECOFI)

It is important to note that the growth of the maquiladora industry has promoted

the creation of industrial clusters in different regions of the country such as:

• Guadalajara: electric and electronics cluster

• Saltillo-Monterrey industrial corridor: automotive cluster

• Tijuana-Mexicali corridor: world’s largest TV production center

• Puebla, Tlaxcala, and La Laguna: textiles and apparel cluster

• Aguascalientes: automotive and electronics cluster

It would be interesting to see, in future research, if these clusters are a modern

example of Alfred Marshall’s nineteenth century concept of “external economies”,

where the concentration of production for a certain industry in one location reduces the

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industry’s costs, even if the individual firms in the industry remain small. This could

benefit Mexico because companies will find it attractive to establish their production

centers inside those clusters in order to receive the benefits of the external economies. As

more and more companies settle in Mexico, more jobs will be provided and everyone will

benefit as a whole. For the nature of this paper I make this connection very superficially.

It would require a more thorough analysis in order to prove this point and find out if

external economies of scale are actually present in these clusters.

V. Conclusions

The reasons that led Mexico to liberalize its markets had a strong domestic

character. There were undeniably externa l reasons, such as the competition for capital

and FDI in the global market, but as outlined in this paper, domestic reasons are what

ultimately make a country pursue a certain policy. Also, Tornell’s model provides us

with the framework to understand how the two power groups, the statist elite and the

private import-competing elite in Mexico, in an attempt to survive in the midst of the

crisis, decided to displace one another from power. The end result of this game between

these groups led to the demise of both groups and laid the foundations for the deep

reforms carried about by the government at that time. It also led to the creation of new

power groups, such as the export-competing elite and foreign investors.

In general, the reasons for Mexico’s liberalization process can be summarized as

three internal and two external reasons. The first of these reasons was the increasing

incapacity of the import-substitution model used during three decades to create a

sustainable economy with the creation of new jobs. The second was the positive effect

that free trade had on the export sector, as well as in the creation of new jobs, as shown in

the maquiladora industry. The third internal reason for continuing with the liberalization

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process was the positive effects felt in the economy since the process started in 1983.

Finally, the two external reasons were the opportunity to expand to other markets by

forming economic blocks in the world economy and the intense competition for capital,

which obligates countries to have stable economic environments that encourage local and

foreign investment.

In this paper, I showed that Mexico, by signing multiple agreements, has

demonstrated a greater commitment to the liberalization and reform process. This

commitment to other countries has established confidence in the foreign investor,

showing that regardless of the party or group in power, Mexico’s trade policies will be

less likely to experience a reversal. This creates stability and predictability for everyone

involved in the economy. By establishing multiple bilateral agreements, such as the one

signed with the European Union, Mexico gains more leverage power in negotiating trade

matters with the United States. These agreements also allow Mexican producers to

secure access to Mexico’s major trading partners’ markets.

VI. Topics For Future Research

While this paper’s main focus was to show the process and reasons for the trade

liberalization in Mexico, it has also laid the groundwork for future research. Further

areas of interest include assessing the impacts of NAFTA and other FTAs on the Mexican

economy and society, and examining whether the maquiladora clusters exhibit external

economies of scale. Also, it would be interesting to examine the reasons for Mexico’s

pursuit of multiple FTAs and to ask why other countries have not followed Mexico’s

footsteps. Furthermore, there are social policy matters that need to be examined in future

research, such as the causes for income disparity within the country, how the income gap

can be reduced, the benefits of free trade on the lower income population, how far

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Mexico is in creating a common market similar to the European Union with the US and

Canada, and what labor shifts a common market would cause between these three

countries. Finally, it would be interesting to conduct a study to see if regional agreements

have caused an asymmetric concentration of capital in participating countries and capital

shortages in nonparticipating countries.

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NOTES i Rodrik adds that Samuelson was challenged by a mathematician, who disdained economics, to come up with such a proposition; he was confused to being at a loss until he came up with the principle of comparative advantage. That it is true, Samuelson pointed out, need not be explained at great length to a mathematician. That it is nontrivial, he said, was evidenced by the long history of errors committed by individuals who had not understood it. ii Tornell states that the nationalization of Mexican banks together with the crisis set the stage for reforms in Mexico. iii See Aaron Tornell and Gerardo Esquivel, “Political Economy of NAFTA”, pg. 2. By 1993, the manufacturing sector was almost completely liberalized. Because of political reasons as outlined in this paper, the ruling party only liberalized the manufacturing sector and waited to liberalize the agricultural and service industries only after the signing of NAFTA. iv 31 countries if we count all the 15 countries that make up the European Union. v The state owned industries are called in Spanish: Industrias Paraestatales. vi The word “maquiladora” is from colonial Mexico when “maquila” was the charge that millers collected for processing other people’s grain. Today, the term applies to companies that process or assemble components imported into Mexico that are then re-exported. vii Tornell & Esquivel state that NAFTA was a commitment by the Mexican government to eliminate protection in agriculture and services within the next fifteen years and continue to reduce the protection of the already liberalized manufacturing sector. viii For a detailed explanation of this model refer to Tornell, Aaron. “Are Economic Crises Necessary for Trade Liberalization and Fiscal Reform? The Mexican Experience.” ix A Powerful group or elite can be defined as a group of people that control some fixed factors. These groups are not identified by the names of people who comprise it, but by the type of fixed factors it controls. Thus, even if a group is destroyed, its members may remain powerful as part of a new group. x Tornell stresses in his paper that even though the banks’ expropriation was really a bailout, the bankers lost the “right” to operate the banks and thus lost access to future bailouts, as well as the right to obtain other types of fiscal transfers. xi See Tornell and Esquivel, pg. 18, for a complete explanation of why, from an economic standpoint, it is more advantageous to liberalize the agricultural and services sector. xii Reformers depended in 1988 and 1994 heavily on the rural vote as a result of the damaging urban votes lost with the reforms in the manufacturing sector.

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Acknowledgements I would like to thank Professor Phil Brock, my faculty mentor from the University of Washington’s Economics Department for his advice, patience, interest, support, guidance and for sharing his knowledge and experience with me. Also, I want to thank the Economics Department for awarding me Honorable Mention for this paper in “The Undergraduate Paper Competition”. I extend my gratitude to the McNair Program for the financial support and for printing this paper in the McNair Journal, and most importantly the staff, especially Vega Subramaniam, Carlos Tovares, and Gabriel Gallardo for their continuous support, patience and guidance through this long journey to graduate school and for encouraging me to get involve in research. Also, I want to thank Gerardo Luna in Mexico for his helpful comments and resources and Bob Bernreuter from the UW Instructional Center for editing this paper. Finally, I am grateful to Maryah for her patience, perseverance and for encouraging me not to give up on this research.

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